CAMP4 Therapeutics Corporation
Q3 2019 Earnings Call Transcript

Published: 21 Dec 2018

[Operator:]

Welcome to the CalAmp Third Quarter Fiscal Year 2019 Results Conference Call. At this time all participants are in a listen-only mode. At the conclusion of the prepared remarks we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference call Nicole Noutsios Investor Relations for CalAmp. Nicole, you may begin your conference.

[Nicole Noutsios:]

Thank you, Operator. Good afternoon and welcome to CalAmp's third quarter fiscal year 2019 financial results conference call. With us today are CalAmp's President and Chief Executive Officer, Michael Burdiek and Chief Financial Officer, Kurt Binder. Before we begin, let me remind you that this call may contain forward-looking statements. While these forward-looking statements reflect CalAmp's best current judgment is subject to risks and uncertainties that could cause actual results to materially differ from those implied by these forward-looking projections. These risk factors are discussed in the periodic SEC filings and the earnings release issued today which are available on our Web site. We undertake no obligation to revise or update publicly any forward-looking statement to reflect future events or circumstances. Michael Burdiek will begin today's call with a view of the company's financial and operational highlights. Then Kurt Bender will provide additional details about the company's financial results and outlook. This will be followed by a question-and-answer session. With that, it's now my pleasure to turn the call over to CalAmp's President and CEO, Michael Burdiek.

[Michael Burdiek:]

Thank you for joining our call today. While we made progress on a number of business initiatives since our last earnings call, our third quarter financial results came in below our expectations. As we previously announced in Q3, we experienced execution issues associated with our supply chain diversification efforts that negatively affected our financial results. While we are disappointed with our overall third quarter financial performance we were pleased with the 25% year-over-year revenue growth in our software and subscription business. Just a few years ago, we had established a medium to long-term objective of $100 million of annual recurring revenue a target that is now very much in sight. We are clearly seeing the positive effects from our business model transformation efforts and we continue to be focused on various strategies to drive acceleration in recurring revenue growth. Despite our recent supply chain challenges and near-term macroeconomic concerns, we remain as confident as ever in our long-term growth opportunities especially those related to CalAmp's evolution as a SaaS solutions provider. That confidence is clearly expressed in the new $20 million stock repurchase program authorized by our Board and announced early last week. Before we discuss the specific financial results from the quarter I would like to provide some additional color around the supply chain issues that impacted us in Q3. As we discussed in our past earnings calls, early this year we commenced a supply chain diversification program to transfer the manufacturing of our products to various Tier 1 global contract manufacturers with facilities outside of China. We more recently accelerated these efforts in order to minimize the potential impact of any impending tariffs on us and our customers. We believe these diversification efforts are the best long-term strategy for our company in order for us to achieve greater flexibility and scale as well as geographic diversity. In Q3, however, we experienced various supply chain disruptions related to this transition as well as extended lead times driven by component shortages. This resulted in product supply delays that impacted our ability to meet customer demand. In order to address these issues, we have made certain organizational adjustments and instituted business process improvements. We are also slowing somewhat the pace of our supply chain transitions in order to reduce product delivery risks in our production operations. As we look to the future, we are exploring various strategic pathways to accelerate our transformation and reduce the uncertainties associated with hardware product sales and related supply chain challenges. We will share additional details as our plans unfold, but it’s our current expectation that next fiscal year a subset of our current Telematics device portfolio will be transitioned and sold only as part of a device as a service subscription. Our SaaS application service foundation and investments in scalability and micro services such as crash box, driver behavior analytics and security features put us in a prime position to make this device as a service transition and augment what is already a healthy and growing recurring revenue stream. To emphasize this point, in the latest quarter, our software and subscription service business contributed 23% of consolidated revenues up 25% year-over-year driven by freight transport subscriber additions and LoJack recurring revenue growth. We continue to leverage partnerships to expand the serviceable market for our SaaS solutions and in the quarter we announced a partnership with Overhaul Group to provide end-to-end real-time supply chain visibility for global transportation service providers and shippers. With Overhaul, our LoJack supply chain integrity derived solution provides granular visibility on in-transit goods thereby reducing risk of cargo theft and spoilage and driving operational efficiencies for global enterprise customers. We are also pleased to announce that late in the quarter, we signed a multi-year agreement with the public cloud service provider for approximately $5 million total contract value to track certain high value assets while in transit. This is the first commercial engagement with this important new logo and we are excited about the relationship and the role we could play as part of their overall asset visibility strategy. As we head into the coming year, we expect to convert additional large logos and drive recurring revenue growth from opportunities that in the past may have been hardware only in nature. Within our Telematics systems business, revenue was down 12% year-over-year largely due to the supply chain issues impacting Telematics device deliveries as mentioned earlier. We also saw an expected decline in legacy LoJack SVR product sales partially offset by growth in LoJack branded subscription revenues which are included in our software and subscription results. Revenue for network and OEM products was up 6% year-over-year with Caterpillar a bit stronger than expected and up 18% year-over-year. We also made steady progress with our other heavy equipment OEM with revenues up 19% versus the same period last year. Global expansion remains an important area of focus for the company and in the third quarter international revenues were 24% of our consolidated results. Within Europe, our wholly-owned LoJack Italian licensee reported strong financial results in the third quarter with revenue growth of 19% year-over-year. We are pleased with our progress with LoJack Italy and continue to explore opportunities to leverage the success of LoJack Italy on a more pan-European basis. While we had a challenging quarter, we made marked progress against our primary strategic objective to transfer CalAmp into a SaaS solutions provider. We will be amplifying our transformation efforts over the coming quarters and we remain committed to that long-term journey. With that, I will now turn the call over to Kurt Binder, our Chief Financial Officer for a financial overview and a closer look at our Q3 financial results and Q4 guidance.

[Kurt Binder:]

Thank you, Michael. It is a pleasure to be here today. My commentary will include references to the non-GAAP financial measures of adjusted basis net income, adjusted EBITDA and adjusted EBITDA margin. A full reconciliation of these non-GAAP measures and the closest corresponding GAAP basis measures is included in the press release announcing our third quarter earnings that was issued earlier today. Our consolidated revenue for the third quarter of fiscal 2019 was $88.5 million a decrease of 6% year-over-year. Our operating cash flow and profitability were solid in the third quarter as we generated $11.3 million of operating cash flow coupled with adjusted EBITDA of $11.4 million or an adjusted EBITDA margin of 13%. Within our Telematics Systems business revenue for the third quarter was $68.6 million or a decrease of 12% year-over-year. MRM Telematics sales decreased $2.7 million or 7% year-over-year and more negatively impacted by the supply chain issues mentioned earlier as well as somewhat lower demand in Europe and Latin America. Legacy LoJack SVR product sales declined by $7.8 million or 39% year-over-year with regional macroeconomic factors impacting the order flow from some of the larger international licensees. Network and OEM products revenue was $19.7 million for the third quarter of fiscal 2019 or a 6% increase over the same prior year period. The year-over-year increase in revenue is due to solid product demand from Caterpillar as well as another OEM customer. The software and subscription services business was up 25% year-over-year to $19.9 million in the third quarter. Revenue growth was driven by freight transport subscriber additions and LoJack's subscription services. Across all of our SaaS and recurring service platforms, we now have 862,000 unique subscribers compared to approximately 821,000 in the prior quarter. LoJack Italy once again produced strong results delivering $5 million in revenue up 19% year-over-year. LoJack Italy is a key pillar of our international growth strategy and we look to emulate the success of LoJack Italy in other regions around the world. Consolidated gross margin was 41.1% up from 40.8% in the same period last year. Gross margin was up over the prior year principally due to a higher portion of our consolidated revenues being generated from our software and subscription services business. Over the long-term as we transition our business model to a higher percentage of software and subscription service revenue, we expect our gross margins to improve. In OpEx, our GAAP basis R&D, sales and marketing and G&A expenses in the third quarter as percentages of revenue were 8%, 14% and 13% respectively. Our R&D expenses increased year-over-year due to increased engineering headcount to support strategic customer engagements and our Telematics technology roadmap. For fiscal 2019 as a whole, GAAP basis R&D, sales and marketing and G&A expenses as percentages of revenue are expected to be approximately 8%, 13% and 13% respectively. Turning to our non-GAAP basis OpEx for the full year, R&D, sales and marketing and G&A expense as percentages of revenue are expected to be 7%, 13% and 10% respectively. The GAAP basis net loss in the third quarter was $522,000 or a loss of $0.02 per share compared to net income of $11.8 million or $0.33 per diluted share in the same prior year period. The GAAP basis net loss is due to a $1.2 million restructuring charge for vacant offices, severance and employee related costs. The GAAP basis net income change year-over-year is due to the gain on legal settlement with a former LoJack battery supplier of which we recognized $2.5 million in the fiscal year 2019 third quarter versus $13.3 million in the same prior year period. Non-GAAP net income for the third quarter was $8.9 million or $0.25 per diluted share compared to $11.2 million or $0.31 per diluted share in the same prior year period. The decrease in non-GAAP net income is due to the decrease in revenue as previously discussed. I will now provide some additional details on our balance sheet. We are in a strong liquidity position and at the end of the third quarter; we had total cash and marketable securities of $301.8 million and total outstanding debt of $272.4 million which represents the aggregate carrying value of our convertible unsecured notes due in May 2020 and August 2025. I also want to give an update on our share repurchase program. We have exhausted our previously authorized share repurchase program with $39 million of repurchases since May of this year including approximately $10 million of repurchases in the third quarter. In December, our Board of Directors authorized another one year share repurchase program and the company can now repurchase up to an additional $20 million of our outstanding common stock. Our consolidated net accounts receivable balance was $72.4 million at the end of the third quarter representing an average collection period of 64 days. While total inventory at the end of the quarter was $31.5 million representing an annual inventory turns of approximately 6.5x. Our cash conversion cycle time was 60 days at the end of the latest quarter compared to 32 days in the prior quarter. The cash conversion cycle time in the prior quarter was impacted by a service provider payment matter which was resolved in the current quarter. Additionally our deferred revenue balance was $46.6 million which is attributable to continued growth in our contract backlog as well as the adoption of the new revenue recognition standard commonly referred to as ASC 606. In Q3, we recorded an income tax benefit of $778,000 on a net pre-tax loss of $855,000. For the nine months ended November 30, 2018, our GAAP basis effective tax rate was approximately 5% which is lower than the statutory U.S. federal income tax rate due principally to a portion of our taxable income being earned in jurisdictions subject to lower tax rates coupled with R&D tax credits and other benefits. For fiscal 2019, we expect on a GAAP basis effective tax rate to be approximately 7% and our non-GAAP cash basis tax rate to be around 2%. Now turning to our Q4 outlook. We are incorporating factors into our guidance including ongoing supply chain challenges, risks associated with the timing of Chinese New Year as well as a cautious macroeconomic outlook particularly in our international markets where we have seen some recent weakness. We expect fourth quarter consolidated revenue in the range of $86 million to $92 million. At the bottom line, we expect fourth quarter GAAP basis net income to be in the range of a net loss of $0.02 per share to a net income of $0.04 per diluted share which includes the expected contribution of approximately $2.5 million from the remaining installment of the legal settlement with LoJack's former supplier. We also expect fourth quarter non-GAAP net income in the range of $0.23 to $0.29 per diluted share and adjusted EBITDA in the range of $10 million to $14 million. With that, I'll turn the call back over to Michael to provide some final comments before we open the call up for questions.

[Michael Burdiek:]

Thank you, Kurt. While we are disappointed with this quarter's results, we are taking actions to address our short-term challenges and better position the company for long-term growth and profitability. As we head into the new year, we will continue to focus intensely on accelerating CalAmp's transformation and creating value through growth and higher margin innovative Telematics subscription services. With that, I would like to wish you all a very happy and healthy holiday season and we will now open up the call to questions. Operator?

[Operator:]

Thank you, Michael. [Operator Instructions] Your first question comes from the line of Mike Walkley with Canaccord Genuity. Your line is open.

[Mike Walkley:]

Great. Thanks and happy holidays to everybody on the call. Michael, if you could just help us kind of walk through the impact to the quarter from both supply demand. Can you help us think about what impact could be on the supply side for the revenue shortfall? Any chance you can kind of get an idea of what's off so maybe demand related given some of the macro issues you highlighted?

[Michael Burdiek:]

Yes. Well, thanks Mike. Happy holidays to you as well. I would say you sort of split it in two, I think at least half of the issues that we had relative to our original guidance were supply chain related I would say maybe up to half are somewhat international macroeconomic demand-related. We had more past due backlog scheduled against customer orders at the end of Q3 than we've ever had in my recollection in the history of the company. So clearly we had some execution issues on the supply side. And then, internationally, we saw a little bit weaker demand in Europe and certainly weaker demand from two of our larger international licensees, one in South America and another in South Africa that we would probably characterize as somewhat macroeconomic related although the African situation is slightly different. And obviously, we're taking steps as we said in the prepared remarks to try to address the supply chain issues and challenges. We remained a little bit cautious as it relates to the macroeconomic environment globally and especially in some regional areas around the world.

[Mike Walkley:]

Thanks. Just to follow up on that, what are the areas you're seeing supply shortage, any certain types of components and are they easing at all given some of the overall tech macro weakness particularly in the smartphone market et cetera?

[Michael Burdiek:]

Yes. That's a great question. It's not necessarily the ones you would assume. In terms of key components, we usually have direct relationships with the suppliers and are usually in a good position to understand exactly what the supply availability is given our demand. It tended to be more along the discrete component lines. And I think one thing that's happened is that many of the distribution channels that have been established and optimized to support contract manufacturing activities specifically in China have been completely disrupted. As you've seen a rush of companies moving production operations out of China and the new supply channels have not necessarily been reestablished or optimized. I think that the supply chain issues and the movement of manufacturing from China to other regions around the world partly explains why we've had some issues around component supply. And as it relates to sort of weather that's been improving or not, can't really say we're still in the midst of re-evaluating everything and trying to understand exactly what went wrong in Q3 and what we can do to make sure that it doesn't happen again.

[Mike Walkley:]

Okay. Thank you. And then a follow up from me on that. How do you see the kind of the supply issues and the movement of supply chain impacting the next quarter guidance? Is that still an overhang into the guidance, or do you see that kind of clearing as the quarter works through?

[Kurt Binder:]

Yes, Mike. This is Kurt. I think to answer your question, we do see some continued impact of the supply chain and we've incorporated that into our guidance. We made some notes in our earnings announcement that we factored in the supply chain challenges coupled with the timing of Chinese New Year because as you probably know our fiscal year being February 28 and Chinese New Year basically running the first two weeks of February creates an ordinary situation that we have to deal with. So our approach for this quarter has really been to lean in a bit more on inventory especially sort of our high volume generic type products, get a little bit closer to our partners and suppliers to make sure we have our finger on the pulse as to what they're building and make sure that we can bring the product to our customers as the demand require. So we have made some changes there and we've incorporated some of the concerns around the supply chain into our guidance.

[Mike Walkley:]

Great. Thanks. Last question for me and I will pass it on. Michael you talked about selling certain hardware products only if they have a recurring revenue I guess software subscription attached to that. Can you kind of walk us through maybe how that feedback is from customers or is it just too early in that process. And then, also just I miss the software subscription sub numbers, if you guys could give me that again. That would be helpful. Thanks.

[Michael Burdiek:]

Yes. I'll take the first part of that question and Kurt can give you the software sub number. We wouldn't have talked about that transition on the call had we not had some confidence that there are certain key customers in particular who are not only willing, but anxious and interested in adopting the device as a service model. And those customers tend to be ones that were already contemplating moving over to our software platform in order to get access to those various micro services including crash box and security features and in some cases driver behavior analytics. And so as we canvassed our customer base more broadly, we identified a couple of products that are naturals for this transition and early next fiscal year we will be launching the first product as part of that program. And then, probably following up through the year with additional products that we would bundle as part of the subscription service.

[Kurt Binder:]

And Mike to answer your question about the subscribers we had 862,000 subscribers at the end of this quarter that was up from about 821,000 last quarter driven principally from our fleet management services and continued progress on LoJack Italia.

[Mike Walkley:]

Great. Thank you very much.

[Michael Burdiek:]

Thank you.

[Operator:]

Your next question comes from the line of Scott Searle with ROTH Capital. Your line is open.

[Scott Searle:]

Hey, good afternoon. Happy Holidays. Hey guys just to quickly follow up on Mike's question. From a supply chain standpoint, it sounds like then it was somewhere in the ballpark of $4 million or so impact to the top-line. It sounds like that continues into the February quarter. What's your comfort level looking beyond February at the current time, or do you expect it to be alleviated at that point in time? And are those sales going away or they lost sales or do you expect them to come back at some point?

[Michael Burdiek:]

Well, yes, we do believe that there will be some carryover impact in terms of our ability to fulfill demand in Q4. But I would say we do expect to catch up a little bit and kind of clear some of that path to backlog as it relates to how long we think that the situation could persist. I think until our supply chain transitions are complete and settled, I think we will continue to face a little bit of a headwind and some uncertainty, but we believe that as each day and each week passes that we'll be making improvements from a process standpoint so that we'll be much more effective and perhaps when we're through all of this be more effective than ever in terms of our ability to fulfill against demand. We don't really believe that we've lost any business because of this although, obviously, it stresses customer relationships when you're not able to fulfill demand against promised dates. And so I think, overall, I think we're optimistic that we'll get through this. It's unfortunate that impacted us in Q3 and there would be a little bit of a carryover into Q4. But I would like to point out as we clear some of that past due backlog, we do expect that on the network and OEM product side, we will actually see a little bit of shift downward in demand from Caterpillar, it's a bit seasonal as it was last year. And so the improvement on the MRM Telematics device front is somewhat masked off by an expected decline sequentially in the Caterpillar business.

[Scott Searle:]

And Mike maybe just a follow up on Caterpillar since you hit it there. What sort of visibility are you getting to new design wins within Caterpillar, I think you were -- you had decent penetration, but still a ways to go. Are you expecting that to be a growth opportunity for you in the next fiscal year?

[Michael Burdiek:]

Certainly as I just mentioned not a growth opportunity in Q4 because of the seasonal aspects of that business. But as it relates to visibility into Caterpillar demand, I would say it's very good perhaps as good as any of our customers. And we continue to make progress on new designs and we think that once we have a broader footprint as it relates to the serviceable market of machines they build. I think it will represent an incremental growth opportunity. But I wouldn't say we should set any expectations for that to happen this quarter or maybe even the first quarter of next year.

[Scott Searle:]

Yes. Mike maybe to follow up as well on some of the macro softness comments. It sounds like Europe is certainly an area of concern? Is there any more granularity, is it specific to a couple of markets that you're seeing within Europe or is it pan-European base? And also from an end market standpoint, any color or granularity you could provide there would be helpful. And lastly, you mentioned $5 million win on the services side, wondering what the pipeline of opportunity and size of deals is looking like as you look out into the current quarter and the next fiscal year? Thanks.

[Michael Burdiek:]

Sure. I like how you ask the questions in 3s. The European weakness, I would say is somewhat concentrated in U.K. The U.K. is our biggest European market. We have a lot of business there both in fleet as well as on some consumer applications. So the U.K. was definitely off. Obviously, we've got the Brexit effect that I think is somewhat impacting the market there. But I wouldn't say it's fallen off precipitously and given that the U.K. represents our largest individual market in Europe obviously that has a big influence and impact on overall demand. As it relates to software and subscription service revenue and pipeline; the pipeline is outstanding. I'll underscore that word outstanding. I think we've seen the overall size of the pipeline nearly double over the course of the last two quarters and a substantial percentage of that pipeline and those opportunities are related to these asset visibility solutions, which were somewhat articulated and described as it relates to that new customer engagement. And we see asset visibility and supply chain integrity applications absolutely being substantial portion perhaps as much as half of our existing pipeline of opportunities. In the customer engagements there are -- generally involved very, very large well recognized global logos. And so we're really, really excited about that.

[Scott Searle:]

Just a follow-up like…

[Operator:]

Your next question comes from the line of Jonathan Ho with William Blair. Your line is open.

[Jonathan Ho:]

Hi, there. Good afternoon. I just wanted to follow up and dig a little bit deeper into the supply chain issues. Can you maybe give us a sense of whether there was a single outsource partner that was involved or were there multiple sort of partners that were impacted?

[Michael Burdiek:]

I would say it was probably multiple because we had challenges with some of our legacy contract manufacturing partners. And of course, we've had some challenges and issues in the transition and ramping our production with some of the newer partners. So the whole thing -- it's very much intertwined. I mean one sort of creates an effect on the other. And, obviously, we've got a lot of work to do there in order to make sure that we make improvements in this quarter and subsequent quarters.

[Jonathan Ho:]

Got it. And then in terms of the impact from the tariffs for products that remain manufactured in China. Are you guys factoring anything or how should we be thinking about that as we think about the tariffs actually kicking in, in the early part of calendar '19.

[Michael Burdiek:]

That's a good question. As we stated in the prepared remarks, we've decided that we're going to slow the transition somewhat. We think that the 90-day moratorium on tariff escalation, I think works in our favor in that regard. Also I think we've taken a view or we're starting to adopt the view that ultimately that's not a long-term situation. And so, we have good suppliers who provide good value and can provide our products at an attractive cost relative to other alternatives. Then we've decided that there's no reason not to maintain a certain degree of manufacturing capacity in China especially with those who have been the most reliable partners and suppliers for us in the past. And so in order to de-risk future product deliveries especially in this quarter and in next quarter, we're trying to sort of fortify those relationships and give some surety that that some of our partners this one in particular in China are probably going to be long-term manufacturing partners for us.

[Jonathan Ho:]

Thank you.

[Michael Burdiek:]

You're welcome.

[Operator:]

Your next question comes from the line of Jerry Revich with Goldman Sachs. Your line is open.

[Unidentified Analyst:]

Hi, everyone. This is [indiscernible] on for Jerry.

[Michael Burdiek:]

Hello.

[Unidentified Analyst:]

I was just hoping or wondering if you could help us quantify the impact of this supply chain diversification program. Unless I missed any additional detail, it's a little bit tough to pull back the supposed onetime headwind and try and get a good feel for underlying demand in the quarter. If I look at MRM, so you said that business was down 7% year-over-year, but how does that stack up to the end market, which is growing very strongly at the moment. Just wanted to get a better feel for how the underlying business is trending both now and in your next quarter guidance?

[Michael Burdiek:]

Yes. Well, as it relates to the MRM business bookings activity actually was consistent with what we saw in the prior quarter. But the U.S. was probably a lot more stable or as strong as expected whereas other of the international markets and we spoke about Europe in some detail earlier, we're probably a little bit weaker than expected. And then, of course, compounding that was the supply chain challenges that we had that that really kind of constrained us as it relates to fulfilling customer demand at the end of the quarter. So hopefully that helps you a little bit. We think that the core MRM product demand is more or less solid. And we do see and again we're a little bit gun shy. We do see the potential for some macro risks and as we experienced a couple of years ago when business investment slowed, we saw an impact on our MRM Telematics business as companies throttled back their investments, their capital expenditures and investments in infrastructure and other and other goods. And so because of that experience, which is not that far in the past, we're very cautious and they see a lot of indicators that the U.S. economy could slow. And so we want to provide cautious outlook as opposed to being overly bullish on our core business although we think fundamentally it remains pretty healthy.

[Unidentified Analyst:]

So again, down 7 year-over-year and so if we strip out that the supply chain impact, are we looking at flat year-over-year, are we looking at upper single digits. Just trying to get a feel for how you guys are performing against your end markets, your peers and how we're sort of thing about this business going forward just because the supply chains kind of thrown over a wrench in and at least the near-term?

[Michael Burdiek:]

I would say it's probably more or less flat to last year if you factor in supply chain issues which would imply that that Europe was a little bit weaker and the U.S. was a little bit stronger than a year ago.

[Unidentified Analyst:]

Got it. Understood. Thank you very much.

[Michael Burdiek:]

You're welcome.

[Operator:]

Your next question comes from the line of David Gearhart with First Analysis. Your line is open.

[David Gearhart:]

Hi. Good afternoon. Thank you for taking my questions. First question, I wanted to ask about an update on the two large MRM customers that you had that took a large inventory in fiscal Q1 and pulled back on ordering in fiscal Q2. I think you had said that you expected them to come back more meaningfully in the second half. Just wondering what where they were in terms of order patterns in the quarter. And if so, was that a contributor to the MRM for the quarter or was it a continued headwind?

[Michael Burdiek:]

Well, good question, David. So we talked about I think it was $6 million of orders that we had in Q1 or didn't repeat in Q2 from those two large MRM customers. One of them was back ordering at higher levels than they did in Q2 although not to the level they did in Q1. And the other one actually was quite dormant again in Q3. So definitely not to back to the level of positive impact that we saw -- what late last fiscal year and into first quarter of this fiscal year. Now I would say of our top five, most -- at least four or five addressed large enterprise fleet applications. They've been relatively quiet. I would say certainly below historic norms in terms of their order flow Q2 into Q3. What we've seen though, however, is the breadth of the market in the U.S. especially it's actually been pretty good. So some of the smaller or medium size fleet management service providers who've been historic customers of ours have remained pretty steady. And in fact some are actually emerging I would say into more prominent roles in our top 10 customer list.

[David Gearhart:]

Got it. And then, two more for me, I just wondered if you'd give us an update on LotSmart and SureDrive. I think you are foreseeing $1 million per quarter run rate exiting the year. Just wanted an update there as well as an update on your transition on the [indiscernible] telematics cloud to a third-party data center and LTE cost optimization efforts for your newer hardware?

[Michael Burdiek:]

So LotSmart and SureDrive, some growth is actually, excuse me, pretty good in Q2 and I'm sorry Q3 and in revenue growth was up almost 50% obviously from a very, very low base. And I believe the LotSmart subs were about 20%, SureDrive subs were up about 30% in Q3, so tracking well. I think those sub additions could have been greater had we had available and certified our latest generation consumer LTE-based telematics device. So we've sort of been throttling subscriber additions while we've got the newer next generation essentially future proof LTE products ready for market to bundle with LotSmart and SureDrive. We've gotten through that gate and so we would expect the sub numbers to start increasing again here right after the first of the year. So we'll probably be a little bit below that maybe million dollar quarterly recurring revenue run rate for LotSmart and SureDrive in combination as we exit the year. But we're on a very good track and we're very pleased with how those applications are being received in the dealer channel here in the United States. As it relates to the transition of CTC to our public cloud service provider we made excellent progress. I would say transitioning a number of our different applications to the public cloud. And I would say very much on track there. And unfortunately, it hasn't probably had quite the negative effect on software and subscription margins as we may have thought partly because we're starting to realize some of the economies associated with moving more applications to that one particular public cloud service provider partner.

[David Gearhart:]

And then, the last question was the LTE cost optimization program on the hardware that was released. I know previously it said that it's -- it has not gone to those programs is because we need to expedite it. But just wondering, if you've had a chance to work through component cost or reductions on those products.

[Michael Burdiek:]

Yes. Well, overall in Q3, we saw a little bit of margin expansion within our MRM device product portfolio and implied and that is really that we've been able to make progress in terms of cost optimizing the entire portfolio especially the LTE products. So I think we're making good progress there.

[David Gearhart:]

Okay. Thanks for the color.

[Michael Burdiek:]

You're welcome.

[Operator:]

Your next question comes from the line of George Notter from Jefferies. Your line is open.

[George Notter:]

Hi, there. Thanks very much. I guess I wanted to learn a little bit more about your plans in the device as a subscription area. I think from prior question you mentioned that there were certain customers who are interested in moving on to a subscription model. And I guess, I'm confused because I think that's always been an initiative within the company as to kind of have success on the subscription side and transition folks over. But from the monologue it sounded like you were going to do something a little bit more aggressive with customers and not sell devices on a standalone basis readily. Could you just clarify that on what you're exactly planning to do there? Thanks a lot.

[Michael Burdiek:]

Sure. Thanks George. First of all, we haven't shifted strategically in any meaningful way. I mean we continue to try to build our subscription revenues through bundled end-to-end applications those being asset outlook of outlook LotSmart, SureDrive. We also continue to pursue onboarding of customers onto the CalAmp telematics cloud. So we would become the platform service provider for those who would decide to develop their own applications. And I would say what's always been on the strategic roadmap, but now seems to be more realizable given customer orientation and demand and interest is the opportunity to bundle a number of different micro services as part of a subscription for a device which really in and of itself back somewhat as a platform. So it allows customers who are currently device customers to economically adopt a number of micro services on a sensible subscription basis as opposed to sort of buying them on a al a carte basis, which was what we had with a number of different customers who ultimately concluded that it makes a lot more sense to buy them as a bundle as opposed to an al a carte method. So it's really just a different go-to-market methodology and certainly makes it a lot easier for us in terms of provisioning and distribution to have them as part of a service bundle as opposed to trying to sell the device and in a separate and distinct transaction to try to sell the individual micro services. And it certainly makes it easier from a configuration and integration standpoint to bundle them that way. So it's a much more efficient process both for us as a supplier and for our customers as consumers.

[George Notter:]

Got it. Okay. So in other words customers are still going to drive their -- the economic model that they buy telematics under whether it's devices or subscription or al a carte or otherwise?

[Michael Burdiek:]

Correct. And it also facilitates by the way the adoption or the transition to our telematics cloud platform given it's the service delivery mechanism for the micro services. And so it sort of facilitates a two step process to becoming part of our platform service ecosystem.

[George Notter:]

Got it. Okay. And then, last one I was curious about lead times, product lead times in responding to customer orders on the telematics device side. What would those be now just given the supply chain issues you've had.

[Michael Burdiek:]

Well, in Q3, certainly longer than they had been historically and we're anticipating they'll be a little bit elongated while we work through some of these short-term execution issues that we described earlier. But again, we were looking at this as a lesson learned exercise and we want to come out of this being better than ever as it relates to being responsive to customer demand.

[George Notter:]

Got it. Thank you.

[Michael Burdiek:]

You're welcome.

[Operator:]

Your next question comes from the line of Josh Nichols with B. Riley FBR. Your line is open.

[Josh Nichols:]

Yes. Thanks for taking the question. I was looking and wanted to ask -- focus a little bit more on the SaaS. You've had a nice revenue acceleration on that piece of the business over the last couple quarters with the growth rate increasing. Do you think that given your commentary about the pipeline, do you think that you could see further acceleration of the growth rate of the SaaS and what type of runway do you have with your current unnamed global parcel delivery customer.

[Michael Burdiek:]

Really good question. So as it relates to the onboarding of that customer that freight transport customer. We've almost gotten to the end of the initial program, but there is a pipeline of follow-on opportunities there which we're excited about. So I'd say the next quarter or two there will be a little bit of pause as relates to software and subscription revenue growth, but we expect again onboard new programs with the global freight transport customer, we expect to see continued progress and recurring revenues derived from the LoJack dealer channel here in the States. We expect to see ongoing progress and growth of recurring revenues in LoJack Italy and as we get into the middle of next fiscal year we would expect to see a nice recurring revenue contribution from the devices as a service offering that we plan to roll out really in first quarter of next year.

[Josh Nichols:]

Great. And then, I did want to ask just regarding the backlog. The past two backlogs that we talked about on the call already, was that largely impacting like one or two of the company's larger customers or spread-off a number of customers or impacting the region just trying to get a little bit better feel?

[Michael Burdiek:]

It was indiscriminate unfortunately. It affected virtually everybody.

[Josh Nichols:]

And then, just since you mentioned it before, but some improving cost structure with some of the newer LTE products. Like what percentage of hardware sales are LTE or [indiscernible] at this point.

[Michael Burdiek:]

Good question. In the latest quarter, it was actually down as a percentage of unit volume and down as a percentage of revenue because some of our larger customers, some of which we talked about earlier on this call are the larger consumers of LTE products. But I think it was around 20%, roughly 20% in unit volume. I'm sorry 20% of revenue and probably somewhat lower as a percentage of unit volume in Q3.

[Josh Nichols:]

Thanks Michael.

[Michael Burdiek:]

You're welcome.

[Operator:]

Your next question comes from the line of Mike Latimore with Northland Capital Markets. Your line is open.

[Mike Latimore:]

Thank you. I just wanted to follow-up on the comment that you just made there. Mike you said over the next quarter or two, you thought the SaaS business would -- you said pause believing that the growth rate would stay somewhat similar or can you just help clarify a little bit?

[Michael Burdiek:]

We would expect to see the growth rate to slow. And when I say pause, I was referring to the specific global freight transport customer and they are talking about the business as a whole. I would like to point out that in Q3, we did have some professional services things for our training and customer onboarding activities that help reduce the number a little bit in Q3. Once you've deployed a system with the customer those service revenues tend to decline. So that will be a little bit of a headwind going into Q4. But overall, we think that the customer relationships and the overall market backdrop for our SaaS solutions is very favorable.

[Mike Latimore:]

And the SaaS business is it, effective EBITDA margin on that business, is it above or below corporate average?

[Michael Burdiek:]

It's a really good question. It's above. It's above corporate average. And I'll take this opportunity to point out that if you are going to look at the growth rate in our software subscription business and add to it our EBITDA margin we're certainly over the rule of 40. In the software and subscription world in the SaaS world that generally garners pretty good multiples, which suggests that your current market valuation is roughly reflected in our software and subscription revenue business, which discounts completely which we think is ridiculous, our hardware business which is very profitable and obviously pass cash flow generative.

[Mike Latimore:]

Yes. And then on -- you mentioned on the LoJack SVR, I guess hardware business, where did that come in relative to your expectations. And what's the sort of prognosis there for some improvement let's say.

[Michael Burdiek:]

I'm sorry could you repeat the question Mike.

[Mike Latimore:]

Sure. I think you said on the LoJack SVR, I think hardware business, I think you said it was down 39%. And where was that relative to maybe your expectations and how do you think about that business going forward.

[Michael Burdiek:]

That was the legacy SVR product revenues. So more than half of that was accounted for by two of the international licensees. So we're part of that broader international macroeconomic issue that we described earlier. We would expect that actually despite the macroeconomic challenges especially in Argentina and some of the issues and challenges we faced in South Africa, we would expect some rebound in that business going forward. And as it relates to the U.S. business more or less in line with expectations, which was a modest decline sequentially.

[Mike Latimore:]

Okay. Thank you.

[Michael Burdiek:]

You're welcome.

[Operator:]

And your next question comes from the line of Anthony Stoss with Craig-Hallum. Your line is open.

[Anthony Stoss:]

Hey, Michael, I'm curious if you can share with us what percentage of your hardware is currently being manufactured in China now and where do you see that going or do you optimally want to be made a year from now? And then a question for Kurt. Do you expect to take any charges -- hardware equipment charges going forward and/or any impact to gross margins over the next couple of quarters related to charges on this transition?

[Michael Burdiek:]

Tony I'll take the first part of the question. So in Q3, I would say easily 60% of our product shipments were still delivered out of China. Our target was to try to get that to 40% by the end of the fiscal year. I think we're going to probably not do that for the reasons we talked about earlier just to create some stability and make sure we get all of our business process issues resolved. There are a few customer -- relative customs product customer opportunities which we will transition completely out of China. And as mentioned earlier, we'll probably preserve some level of manufacturing activity in China medium to longer term. But I would expect that that would be less than 50% of our overall hardware deliveries and manufacturing capacity. We're not going to get there as fast as we originally thought we would get there and we're going to intentionally slow that transition process.

[Kurt Binder:]

And in reference to your question regarding inventorying and charges, we have been looking at our inventory balances and composition very closely over the last several quarters. We've been working to either sell the inventory that is aging or transitioning between suppliers into the market to minimize our I need to record any charges. So we're going to have -- as this transition occurs certainly you have some challenges to deal with on the inventory front. But I don't think it will result in any major or excess and obsolete inventory reserve hits. I do think that though as we deal with the continued shut down of our internal manufacturing facility there could be some added charges that we've -- somewhat of what we've recorded in the last nine months for vacant facilities. That is a possibility there.

[Anthony Stoss:]

Then Michael as a follow up, is there any risk as you're transitioning to these new contract manufacturers or partners on quality or defects, have you seen anything that's out of the ordinary and that's something to -- that you're worried about.

[Michael Burdiek:]

Well, certainly a concern. It's always a concern. And in many ways when we transition a product from one contract manufacturer to another, it's essentially an entire new product introduction process including all of the various production verification builds and all of the rest. And so we're pretty methodical about that. And certainly, the Tier 1 contract manufacturing partners that we're transitioning a fair amount of this business are pre-sophisticated as it relates to those production verification processes. And so I would say there's no more risk around quality issues or defects in the transition than there would be in any major new product development release. And so far I would say, we haven't really experienced any escalation in terms of defect rates as relates to products that have been transitioned to these newer partners.

[Anthony Stoss:]

Got it. Thank you.

[Michael Burdiek:]

You're welcome.

[Operator:]

At this time, there are no further questions. This concludes the question-and-answer session.

[Michael Burdiek:]

Well, thank you for joining our call today. Happy holidays and we'll look forward to speaking to everyone at the end of our fiscal year.

[Operator:]

This concludes today's conference call. You may now disconnect.