PCTEL, Inc.
Q2 2016 Earnings Call Transcript

Published: 3 Aug 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the PCTEL Second Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. Later, we will open up the call for your questions. Instructions for queuing up will be provided at that time. As a reminder, this conference call is being recorded for replay purposes. I’ll now turn the call over to John Schoen, Chief Financial Officer. Please go ahead.

[John Schoen:]

Thank you for joining us today for the PCTEL financial results conference call for the second quarter 2016. On today’s call will be Marty Singer, Chairman and CEO; and I am John Schoen, the Chief Financial Officer. Our remarks contain forward-looking statements and projections of future results. Please review the forward-looking statement section at the end of today’s earnings release for various factors that could cause actual results to differ materially from projections. PCTEL reports its financial results in accordance with U.S. Generally Accepted Accounting Principles. Today’s call will contain various operating results on an adjusted non-GAAP basis, which excludes items that affect the comparability of reported results. Descriptions of these non-GAAP financial measures and reconciliations are included in today’s earnings release, which is available on our website. Now, I’ll turn the call over to Marty.

[Marty Singer:]

Thanks, John, and good evening or good afternoon to all of you. For those of you, who have not had the opportunity to review our press release, let me recap some of the non-GAAP highlights from the quarter. We achieved revenue of $24.2 million, an increase of approximately $3.2 million over the first quarter. Gross profit margin was 39%. Operating margin was 6%. Net income was $1.3 million, or $0.08 per diluted share. Cash and investments were $29.3 million, an increase of $1.4 million from last quarter. We generated approximately $2.4 million of free cash flow and we paid $853,000 in dividends. At this point, I will turn the call over to John Schoen, who will discuss our financial performance in some detail. After John completes his remarks, I will discuss our new products, markets and strategic direction. John?

[John Schoen:]

Let’s start with revenue. Revenues were $24.2 million in the quarter, down 12% from the same period last year. I will speak to the changes by reporting segment. RF Solutions revenue was $8.5 million in the quarter, down $1.1 million, or 11%, from the same period last year. Services revenue declined largely associated with Samsung, which was partially offset by growth in product revenue. The Samsung contract ended after the second quarter last year. Connected solutions revenue was $15.8 million in the quarter, down $2.3 million, or 13%, from the same period last year. The second quarter last year included a $3 million discrete project for Cisco and $350,000 in mobile tower revenue. Now let’s turn to gross profit margin. Non-GAAP gross profit margin as a percent of sales was 39% in the quarter, compared to 35% in the same period last year. I will speak to the changes by segment. RF Solutions gross profit margin as a percent of sales 53% in the quarter compared to the 44% in the same period last year. The major contributor to the improvement was the increased mix of product revenue with its higher margins compared to services. Connected solutions gross profit margin as a percent of sales was 31% in the quarter, up 3% of revenue from the same period last year. The changes attributed to manufacturing cost reductions implemented in the fourth quarter last year. Now let’s turn to non-GAAP operating expenses. Operating expenses were $8 million in the quarter. This is a $1.4 million decrease from the same period last year. The decline is attributed to the restructuring cost reductions implemented in the second half of 2015. The non-GAAP income tax rate in the quarter and the year was 18% unchanged from the prior year. Non-GAAP net income per share was $0.08 compared to non-GAAP net income of $0.02 in the same period last year. The increase was driven by cost reductions implemented in both manufacturing and operations during the second half of 2015. Now as a departure, we did have two large GAAP volumes charges happened in the quarter and so I will speak to them now. Our GAAP earnings in the quarter were a loss of $11.1 million, or $0.69 per share. There were two non-cash charges that aggregated to $12.4 million pre-tax, or $0.66, of the loss net of tax. The first was $4.7 million non-cash impairment of acquired intangible assets related to engineering services. The company experienced a decline in services revenue, primarily related to the ending of the Samsung contract after the second quarter of 2015 and a slowdown in DAS spending by the carriers. The company is replacing net revenue with other types of work, but it is not experiencing the same margins it had when the assets were originally capitalized. The result is an impairment of intangible assets by $4.7 million. The second item is a $7.6 million charge for the establishment of evaluation reserve on the deferred tax assets in the U.S. tax jurisdiction. For U.S. tax purposes, the company deducts the intangible assets and goodwill from its acquisitions over a 15 year period, but they are amortized over a much shorter period for book, creating a deferred tax asset. The company’s growing success in small cell sales to large wireless infrastructure OEMs has cost more of the company’s anticipated future worldwide taxable income to the outside of the United States than previously forecasted. Result is the company believes some of its future U.S. tax benefits will not be realized as they will not be recoverable within the maximum carry forward period. Now let’s turn to the balance sheet. Cash and investments ended the quarter at $29.3 million, about $1.4 million higher than the pervious quarter. In the quarter, the company generated free cash flow of approximately $2.4 million comprised of cash flow from operations of $3.1 million and capital spending of $700,000. The company was able to reduce working capital approximately $1 million in the quarter on higher sequential revenue as a result of its ongoing inventory reduction program. Depreciation in the quarter was $799,000 and during the quarter the company paid a cash dividend of $853,000. Now, I would like to discuss guidance for the third quarter. We anticipate third quarter revenue gross margin and operating costs to be in line with the quarter just ended. The non-GAAP effective income tax rate is expected to remain unchanged going forward at 18%. The fully diluted share count in the quarter is expected to be about 16 million shares. That concludes the financial review. I would like to turn the call over to Marty for his summary comments.

[Marty Singer:]

Thank you, John. And thank you again for participating in the call. Let me just mention that in Bloomingdale I have with me a good representation of our Executive Team. I have Rishi Bharadwaj, who heads our Connected Solutions group. I have Shelley Bacastow who is our Vice President and General Counsel, John of course you heard from and Les Sgnilek who heads up our Corporate Resources. And then also on the line is David Neumann who is the Senior Vice President of our RF Solutions Group. When I am done with my remarks here and you have questions, I want you to feel free to direct those questions to the members of the Executive Team. Anyways we were pleased with the sequential quarterly rebound in all of our core business activities. As we suggested in our last earnings call we anticipated that our business development activities with major OEMs such as Huawei would result in stronger antenna revenues for the second quarter and for the second half of the year. We also thought that our in-building and engineering services and our staffing business which showed renewed growth. We now expect that by the end of the year the run-rate for our services operation will be nearly double what it was in the first quarter. Finally we thought that carrier spending in the US and in China would strengthen and that would favorably impact our Scanning Receiver sales that happens as well. As you may recall we are also committed to reducing our operating expenses to 2014 levels. We exceeded that goal and are currently running at an annual operating expense level of $32 million, $1 million below 2014 OpEx run rates. We also did a much better job of controlling inventory and other COGS related expenses. John already reviewed the impact of these efforts on earnings and free cash flow. By the end of the year we will have eliminated over $4 million in inventory and greatly reduced our third party storage costs. We do anticipate some cost increases primarily in sales, business development and some expenses associated with the introduction of new products. As we have previously announced we have launched Engage our subscriber based test and measurement tool a variety of cloud based SeeHawk Analytic capabilities, new engineering services and vastly expanded in building and Mobile Antennas product line. We expect OpEx to increase modestly in the fourth quarter as we focus on the execution of our product development road map, expansion of our engineering services business and sales growth. Let me now turn to specific events in our connected solutions and RF solutions segments. Connected Solutions had a very strong quarter with respect to major customer developments. In addition to Huawei we had our first significant sale in to an LTE based public safety agency. We shipped over 3000 antennas for a coach voice communication systems used in professional football and very strong GNSS sales into the aviation market. Small Cells continue to emerge as an important multi-year opportunity for PCTEL. By the end of the year we anticipate GNSS LTE and Wi-Fi sales into the three largest cellular infrastructure vendors. In-building opportunities are now served by our VenU Sector Antennas by major North American radio manufactures and we have also applied our VenU PIM160 products to Outdoor DAS applications. RF Solutions experienced sequential quarter revenue growth across the board, some of it directly related to in-building. Engineering services nearly doubled and overall services increased approximately 60%. In addition to a 100,000 mile drive test project we secured preparatory Engineering Services from a national sports league to support their play-off games and project with SouthernLINC, Ericsson, Mobility and Sprint. Our IB flex enjoyed strong sales in North-American Markets and we saw continued growth in APAC. We had a strong quarter with a major US carrier, our first IB flex order with Google and we secured our first orders after launching our subscriber based Engage product at the DAS and Small Cell’s World Congress. Engage is now fully integrated with our scanning receivers and analytic tools. Our cloud based SeeHawk analytics post processing tool now supports all of PCTEL’s custom measurement products and provides real-time support in reporting for our network engineering services group. The recent announcements regarding the allocation of spectrum for 5G will accelerate the development of new networks and the transformation of existing networks. This type of SeaChange in wireless technology creates new opportunities for PCTEL. The deployment of 5G and the transition of public safety networks to LTE will require test and measurement equipment engineering services, and our performance critical antennas. Moreover the aggregation of Wi-Fi in LTE requires the type of expertise that PCTEL has developed over years of RF experience. Of course the underlying impetus for 5G and more efficient use of spectrum is what drives our core business. The planets unquenchable thirst for wireless data. We are reactive in variety of industry events including the B. Riley Investment Conference and the IDEA Conference in Boston. We attended and presented at Cisco Live, NEDAS Boston, CommunicAsia, to LTE Latin America Conference, the North Eastern DAS Conference. Mobile World Congress in Shanghai and Interop Japan with our value added distributor [indiscernible], we also attended the invitation only sports, entertainment, alliance and technology conference also referred to as SEAT. We attended the RSSI the Railway Systems Supplier meeting in Grapevine Texas where we featured PCTEL’s innovative custom and telephone designs for the rail industry. We will be presenting our products at Wireless Connect at the University of Maryland on August 10 to 11. And we will presenting at the IDEAs conference in Chicago later this month on August 30. We look forward to meeting with investors, customers and others at these events. We have set aside 30 minutes for your questions and I’ll now turn the call over to the operator. Operator?

[Operator:]

[Operator Instructions] Our first question comes from Matt Robison of Wunderlich.

[Matt Robison:]

Hi congrats on the results and cash flow John why do you say you think revenue might be for the third quarter.

[John Schoen:]

About the same.

[Matt Robison:]

You guys were looking to do something like $100 million I thought this year, how you are going to get there now?

[John Schoen:]

I think it looks more like $96 million to $99 million.

[Matt Robison:]

Okay.

[John Schoen:]

We do have some upside in the third quarter finance [ph] but we are really committed to making our guidance. So the loss of kitting business that we had last year, the mobile tower business, this $3 million project that we had with Cisco for a major customer, some of that’s been difficult to replace. I think what you’ll see though is our gross margins are going to start going up and we’ll have a lot of momentum in the fourth quarter going in next year with our antenna sales into small cell and Wi-Fi vendors.

[Matt Robison:]

Are you able to get the engineering services for small cell and why maybe explain a little bit why was – why DAS worked for you may be more than small cell [indiscernible].

[John Schoen:]

I think that small cell will work quite well. I think the magic of DAS was that at one point in time the carriers made a strong financial commitment to deploying DAS in very large buildings. And as they’ve struggled to get a return on that investment, they backed off on that investment and turned it over to venue owners or to systems integrators. And what that has done to everybody in DAS is it has slowed DAS deployment down, because imagine as the systems integrator goes into let’s say a large hospital and it’s got to tap into the signal let’s say of four carriers and it has to negotiate all of those permissions. So that becomes difficult when one operator is not willing to go in, make the investment and then essentially lease that network as more or less a neutral host to the other carriers. Having said that, DAS particularly pass of DAS was running into some issues. It solved coverage, but it didn’t necessarily solve capacity. And so now you see a trend towards the deployment of C-RAN, Centralized Radio Access Networks and the remoting of Small Cells into large venues. There will be some significant engineering services business there, there will certainly be a lot of antenna business there and there will also be a lot of business for IBflex as these get deployed. There is a question about the reality of SON or self-optimizing networks and if these Small Cells can be deployed without a lot of engineering let’s say around problem such as neighbor list optimization. But we do believe that there will continue to be DAS, it will go more slowly because of the shift and responsibilities for its deployment and planing, but we also feel that there is going to be significant opportunities with small cell.

[Matt Robison:]

It sounds like if you’re going to do in $96 million to $99 million, then you’re thinking that you might see some sequential growth in the fourth quarter.

[John Schoen:]

Yes.

[Matt Robison:]

How do you see the relative strengths of your product lines between third and fourth quarter?

[John Schoen:]

We think that antennas will see a nice up swing in the fourth quarter because a couple of our OEM contracts on Small Cells are really hitting their stride. We think that this discrete project that we had will have some rebirth. We also think that we’re going to see some strong GNS sales, not just to aviation as reported, but also timing. And then finally, probably one of our most promising verticals for growth is rail and more broadly fleet. And those verticals are moving along quite nicely. We also think there’s going to be some opportunity to move our engineering services out of what has been exclusively carrier and in building into SCADA. We’re getting some experience with utilities and oil and gas, where they need some systems engineering related to their network and we think that that is a promising area. With respect to RF solutions, we think we’re going to have sequential growth in our staffing business, maybe to the tune of $100,000 a month improvement, every month as we scale that business. We talked about his national drive test campaign we have for our major carrier, we think we’ll see a nice bump in the third quarter and a stronger bump in the fourth quarter. And then we think that scanning receivers is back to reasonable historic levels. So we think we’ll see a growth across the Board and that’s how we get to the $96 million to $99 million.

[Matt Robison:]

Thank you very much.

[John Schoen:]

Sure.

[Operator:]

[Operator Instructions] Our next question is from Michael Crawford of B. Riley & Company.

[Michael Crawford:]

Thank you. You talked about getting and the Small Cells by the end of the year selling to all three major vendors which I take that to be Huawei which we know you are strong with, but also Nokia which bought Alcatel-Lucent and I suppose Ericsson is that what you are getting at?

[Marty Singer:]

That would be reasonably accurate.

[Michael Crawford:]

And so what historically have you done with Nokia and then Alcatel-Lucent before…

[Marty Singer:]

Rishi do you want to comment on our historical business with those two infrastructure vendors?

[Rishi Bharadwaj:]

Sure, we have been supplying them custom antennas that integrate inside their OEM and inside their radio or small cell radios for Nokia. And we’ve also working with them on the next-generation platform which they are planning to use for not just cellular LTE coverage, but also expanding into Wi-Fi offloading, as well. Huawei we have been certainly very strong in terms of our design wins and we’ve been shifting antennas for TDD small cell applications. And then we plant to start shipping them our GPS timing antennas for network timing as well.

[Michael Crawford:]

Okay. Thank you. And then when you talked Marty about scanning receivers returning to reasonable historic levels, do I take that to mean over $5 million of revenue per quarter?

[Marty Singer:]

Yes.

[Michael Crawford:]

Versus where it has been running more…

[Marty Singer:]

Well, we’ve had a couple of quarters where it was down to $4 million to $4.5 million which are miserable quarters for us. But we’re seeing some strength, I will tell you that although sometimes Ascom, you will announcements that they are focused on their hospital business, hospital communication business. We’ve actually seeing some strong business from Ascom, some good progress in different areas. And we have sold to other OEMs but I will tell you the other thing that’s happened is that David Neumann is on the line has done a great job of building some stronger direct sales. David, do you want to comment at all on that?

[David Neumann:]

Just one point on Small Cells we talk Small Cells driving engineering growth. But it also drives the product sales in IBflex, a small cell might be $15,000, $20,000 to install. So it’s difficult for the carriers to justify large expense to test those networks. Given the IBflex penetration, the market in all the carriers, we’ve developed some software applications that run on Android that allow the operators to test their small cell deployments using the installed base of IBflex that they already own. So as Marty said Q4 should be pretty good and typically it’s a stronger quarter for scanning receivers. But it’s also important to note that we are starting to add that applications that leverage the power of the scanning receivers.

[Marty Singer:]

Mike did you get your question answered there.

[Michael Crawford:]

Sure, thank you. I mean it seems, well, you introduced these nice cloud-based, cloud source products but on the other hand, the lower priced products right. So, it’s not hard to see why sales of scanning receiver type products would get down below $20 million a year, right with lower-priced solutions?

[David Neumann:]

Well, I think that’s…

[Marty Singer:]

David, hold on for a second. I think one of the points that we made at the last conference call and I think I made when I was out at your conference Mike, is that while it is true that Engage is a lower priced product remember that what you get is a much higher attach rate. So right now if you were to look at drive test or walk test systems. There is a pretty low attached rate of sophisticated scanning receivers with those overall systems. With Engage we are looking to increase that attach rate not necessarily in a way that displaces IBflex but augments IBflex. So what David was alluding to is on the case of a small cell that only cost $15,000 to $20,000. You have to look for devices that many, many technicians can have that aren’t going to cost us much as a traditional drive test system that you are using to benchmark or optimize macro cellular towers across $500,000 to 1 $million. So I think what you’re going to see is with one type of product Engage you put it in everybody’s hand. Okay, also if you’re going and building what Engage gives you when coupled with IBflex is user experience and immediate reporting. So the IBflex pulls out all the network parameters but then with Engage you actually start to look at what’s the users’ experience when accessing an FTP site. What’s the users’ experience when downloading a YouTube video, what’s the users’ experience when making a voice call and you couple that with a network parameters you move that into the cloud and then you can do post processing on that in an immediate way. Suddenly it certainly leads to an erosion of price points. I think it leads to different configurations.

[Michael Crawford:]

Okay, thanks, Marty. And then last question just regarding 5G so what these microwave band spectrum. I guess the good news for you is that the Small Cells themselves are really small they don’t propagate that far, to that you probably need a ton of them compared to what you see out now but on the flip side these things aren’t really expected to be deployed nearly large amount for four or five years, isn’t that true?

[Marty Singer:]

David, do you want to comment on that?

[David Neumann:]

Yes, I think that one spectrum swap that you’re talking about Mike but 5G is really a path and 3GPP have a number of iterations of specs that we’ll go through before we eventually get the 5G. And there is other spectrum on the lower end spectrum which plays a very well for PCTEL and that means the operators and users will start using for example unlicensed spectrum for LTE or versions of LTE that we’ll work with Wi-Fi. So there are state of that were pretty strong in today but we will need to tweak and adjust the tools to satisfy meet the requirements of these new different 3GPP specs. So yes, long-term 5G is years away, but it’s a process and we are in a pretty strong position throughout that process.

[Michael Crawford:]

Okay, thank you.

[Marty Singer:]

Operator, are there any other questions?

[Operator:]

There are no further questions at this time. I’ll now turn the call back to Marty Singer for final remarks.

[Marty Singer:]

Once again I want to thank all of you for participating in our earnings conference call. We look forward to updating you at our next call and hope to see you at various industry events over the next quarter. Thank you and good bye.

[Operator:]

Thank you. This does conclude today’s conference call. You may now disconnect.