PCTEL, Inc.
Q3 2016 Earnings Call Transcript

Published: 29 Oct 2016

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the PCTEL third 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 will now turn the call over to John Schoen, Chief Financial Officer.

[John Schoen:]

Thank you for joining us today for the PCTEL financial results conference call for the third quarter 2016. On the call today are, Marty Singer, Chairman and CEO; Rishi Bharadwaj, Senior Vice President and General Manager of our Connected Solutions segment; David Neumann, Senior Vice President and General Manager of our RF Solutions segment; and I am 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 reporting results. Descriptions of these non-GAAP financial measures and reconciliations are included in today's earnings release, which is available on our Web-site. Now I'll turn the call over to Marty.

[Martin H. Singer:]

Thank you, John. I'm going to summarize the highlights of our earnings release, especially for those who haven't had an opportunity to read the press release that we just issued about a half hour ago. As we predicted at our last earnings conference call, our third quarter was about the same as our second quarter. We generated $24.7 million in revenue, about $500,000 greater than last quarter. We generated $2.5 million in free cash flow, slightly more than last quarter. We generated $2.1 million in EBITDA, about $200,000 less than last quarter. And we generated $1.1 million in non-GAAP net income, about $170,000 less than last quarter. This equates to $0.07 in non-GAAP EPS, which is $0.01 less than last quarter. The $24.7 million in revenue is a high watermark for us this year and reflects continued progress in our antenna business and our development of vertical markets. Our non-GAAP earnings over the past two quarters suggest a run-rate of approximately $0.30 on an ongoing annual basis. Higher revenue certainly helps us but we have also made substantial progress in streamlining costs. Our operating costs have settled in at about $32 million a year and we are doing a much better job of managing our inventory and reducing excess and obsolescence expenses. Last quarter we predicted that this quarter would be about the same. This quarter we are forecasting that our fourth quarter will be somewhat stronger than the third quarter, ranging between $24.5 million and $25.5 million. As John mentioned, Rishi Bharadwaj and David Neumann are on the call today. They will each separately describe the highlights and prospects for their separate business units. I want to make a few general observations on the quarter before turning the call over to them. This past quarter we saw the benefit of our focus on small cell, in-building, and distributed antenna systems or DAS. While DAS has slowed in the recent months, it is clear that operators, venue owners, and the infrastructure vendors are migrating toward small cell solutions. It is in this vertical market that PCTEL brings to bear all of its assets, antennas, test and measurement solutions, and engineering services. It is also the space that affords us the opportunity to acquire and maintain customers that generate multi-million dollar revenue opportunities. On our recent trip to China in which we visited the major operators, our strategic customers, and our own design and manufacturing facilities, we learned more about the deployment of small cells and the urgency with which operators are dealing with the data densification associated with the Internet of Things. Small cell deployment is not an option, but a necessity. This past quarter, we recorded record antenna shipments inside a $17.1 million quarter for Connected Solutions. Rishi's team delivered higher margins, reduced inventory, expanded capacity in Tianjin and renewed their focus on small cell and their large infrastructure customers. We see great potential for growing that business over the next few years and we will see another strong quarter to end the year. While RF Solutions had somewhat lower than anticipated results, it is important to note that scanning receiver sales did extremely well in China and Asia Pacific regions and that our direct sales into North American carriers were robust. Sales were temporarily impacted however by InfoVista's acquisition of Ascom's test and measurement operation. We expect the organizational dust there to settle down in the fourth quarter, allowing us to return to our historic run rate with the test and measurement business unit. The quarter was impacted as well by significant orders moving into the fourth quarter for both scanning receivers and our new Engage product. At the same time, we are pleased with the continued rebound in our in-building engineering services operation. We generated about 2x the revenue that we generated in the first quarter for total engineering services. As Rishi and David will elaborate on in their remarks, we see our growth fueled by five factors, two of which I have already mentioned. The first, small cell, in-building and DAS will leverage all of PCTEL's assets and it will run counter to the overall trend of flat to declining wireless infrastructure sales. We anticipate that growth in small cell antennas, in-building engineering services, and the utilization of our scanning receivers and analytics will drive our business going forward and that will leverage all of PCTEL's technology and capabilities. Second, we will continue to develop large, meaningful customers. We have an opportunity to develop our first $20 million revenue customer in 2017. These customers buy our antennas, our scanning receivers, and our services. The third, APAC, including China, has finally developed as both an important antenna and scanning receiver market for us. It is important for our investors to understand that in addition to driving product and vertical market growth, we have been driving regional growth with significant investments in China. We have a 200 person factory, a 15 person design center and significant sales personnel in China and APAC. This critical mass was essential to our business development efforts. We anticipate stronger results in the future. Fourth, we are now delivering solutions across both our business units. This is an evolution from our discrete product approach. We deliver sophisticated antenna configurations for a variety of markets, often associated with engineering services. We deliver a combination of tools, analytics and engineering services to the small and macro-cellular environments. This will drive greater value for our efforts. And fifth, we will mine our balance sheet for additional investment resources. We have made progress in reducing our E&O and inventory, and that capital will be put to use in growing our business. As many of you already know, this will be my last earnings conference call as Chairman and CEO. John and I did a quick count and this is the 60th earnings conference call that we will have done together and my 61st. While this will be my last earnings call, John will continue on and provide the same exceptional support to David Neumann next year. I want to thank John for all of his expert help in preparing for these calls and the guidance that he has provided to our executive team. He has been a great asset to me during my tenure as CEO and he has been essential to PCTEL's success over the past 15 years. I also want to acknowledge Jeff Miller, Biju Nair, and Jack Seller, who were all part of the initial team that transformed PCTEL from a wired analog modem company to a wireless enterprise. With that, let me turn the call over to John. After his financial review, Rishi Bharadwaj will discuss Connected Solutions and David Neumann will discuss RF Solutions and some of his plans for the future as he pivots to his CEO role in January. John, it's all yours.

[John Schoen:]

Thank you, Marty. Let's start with revenue. Revenue was $24.7 million in the quarter, down 7% from the same period last year. I will speak to the changes by reporting segment. Connected Solutions revenue was $17.1 million in the quarter, down $300,000 or 2% from the same period last year. The third quarter last year included $700,000 of mobile tower revenue, a product line we discontinued at the end of 2015. RF Solutions revenue was $7.6 million in the quarter, down $1.5 million or 17% from the same period last year. Both scanner and services revenue were down. Marty addressed the InfoVista impact to scanner revenue earlier. Within services, our in-building services grew significantly while our relatively lower margin Subject Matter Expert services declined significantly. Now let's turn to gross profit margin. Non-GAAP gross profit margin as a percent of sales was 37% in the quarter, compared to 33% in the same period last year. I will speak to the changes by segment. Connected Solutions gross profit margin as a percent of sales was 34% in the quarter, up 7% of revenue from the same period last year. The change is attributed to manufacturing cost reductions implemented in the fourth quarter last year and the exit from the lower margin mobile tower business. RF Solutions gross profit margin as a percent of sales was 44% in the quarter compared to 43% in the same period last year. The impact of lower scanner sales was offset by the decline in relatively lower margin Subject Matter Expert revenue, leaving total margin percent for this segment slightly improved. Now let's turn to non-GAAP operating expenses. Operating expenses were $7.9 million in the quarter. This is a $900,000 decrease from the same period last year. The decline is attributed to the restructuring cost reductions implemented in the second half of 2015. Non-GAAP income tax remains at 18%. Non-GAAP net income per share was $0.07 compared to non-GAAP net income of $0.01 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 let's turn to the balance sheet. Cash and investments ended the quarter at approximately $31.2 million, about $1.9 million higher than the previous quarter. In the quarter, the Company generated free cash flow of approximately $2.5 million, comprised of cash flow from operations of $2.8 million and capital spending of $300,000. The Company was able to reduce non cash and investment working capital approximately $1 million in the quarter on higher sequential revenue, primarily as the result of ongoing inventory reduction program and improvement in accounts receivable days outstanding. Depreciation in the quarter was $814,000. During the quarter, the Company paid a cash dividend of $866,000. Now, I would like to discuss guidance for the fourth quarter 2016. We anticipate fourth quarter revenue to be in a range of $24.5 million to $25.5 million and gross margin in a range of 37% to 39% of revenue. Operating costs are expected to be about $8.2 million. And as a reminder, operating costs are seasonally at their highest for the Company in the fourth quarter. 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 16.3 million shares. That concludes the financial review. I would like to turn the call over to Rishi.

[Rishi Bharadwaj:]

Thank you, John. As Marty and John mentioned earlier, we had a very good quarter in Connected Solutions. We have developed momentum in small cells with our key OEM customers. We had good order inflow in third quarter with shipments in China being particularly strong. Aside from current product shipments, we have a healthy pipeline of new projects for PIM rated antennas with global LTE frequency coverage, multiband antennas with Wi-Fi and specialized GNSS antennas for network timing. We have made additional investments in R&D and operations in China to support the opportunities in this area. In the past, we have mentioned our design wins with two major North American utilities for Smart Grid. We had strong shipments of our specialized antennas for network infrastructure deployment in this area. In addition, we also assisted a new OEM customer complete their carrier certification for wireless power line sensor using our new customized integrated antennas. Utilities in North America continue to spend on upgrading their Smart Grid infrastructure. We expect this to be a multi-year opportunity for PCTEL. Outside of North America, we have some of the largest utilities in Europe who have started testing our antennas for fault detection and process automation. In agriculture, we completed final production qualification and initiated production of our new multiband antenna platform with GNSS, Wi-Fi and LTE capabilities for a major agriculture equipment manufacturer. We are working with multiple agriculture OEMs to provide specialized antenna systems that enable machine control, semi-autonomous driving, in-cab entertainment and sensor communications. Besides applicability in agriculture, our new antenna platforms are also ideal for IoT, rail, commercial fleet and other heavy equipment automation applications. In the third quarter, we expanded our VenU product line for high density applications with the release of additional configurations of 802.11ac MIMO directional panel antennas at Cisco Live. Our recently released multiband Trooper antenna platform was also selected by a major public safety OEM and by a fleet OEM for launch with its cellular router platforms. We'll be displaying our industrial wireless antenna products and design services at SPS IPC Drives process automation tradeshow in Nuremberg, Germany in November. Now, I would like to turn the call over to David.

[David Neumann:]

Thank you, Rishi. As Marty mentioned, we were pleased with the development of our RF Solutions business in China, Japan, and the other regions within APAC this quarter. We continued to make progress with Verizon and AT&T in the U.S. and we launched several products that leverage our strong IBflex base. We also saw a significant rebound in our engineering services business. Let me expand upon these themes. Third quarter is typically our weakest quarter for scanning receivers, but in both China and Japan we experienced significant sales, and we are forecasting a similar fourth quarter. We are making progress with our Engage product and anticipate strong sales as we build upon momentum from the third quarter. Our focus this quarter, with respect to Engage, is further integration into our engineering services group to simplify data collection and report generation. We announced the release of our latest SeeHawk Touch application about two weeks ago, which addresses a pressing customer need to simplify and reduce the cost of commissioning small cell and DAS networks. SeeHawk Touch collects RF data from our IBflex scanning receiver and then compares that data against the network design provided by iBwave Mobile Planner. This automated approach reduces the cost to commission an in-building network significantly. The integration of Engage, which captures user experience, is central to our overall engineering services strategy. We are integrating the Engage-generated data with our IBflex and Touch to support our small cell verification tools. This new configuration, where the IBflex captures network information, Engage captures user experience information, and Touch which aggregates the user network information from both devices, this permits us to deliver a complete network profile for in-building networks. In upcoming months, we will build upon this capability and automatically store these profiles in the cloud and deliver dashboard reports to our customers. All of these reports will be automatically generated and delivered to our customers within minutes. This is an important element of our continued investment in SeeHawk Analytics. As we move forward in RF Solutions, we will continue to leverage our two greatest assets, our large installed base and our technological leadership. We are far along in our preparation for 5G, the enhancement of our Wi-Fi capabilities, and perhaps most importantly, the application of the IBflex to utilities, rail and public safety. We were encouraged by our Connected Solutions segment's recent antenna sales into LA-RICS and we anticipate a strong demand for test and measurement tools as public safety shifts to LTE and other carrier-based protocols. I mentioned the recovery in engineering services. To give you a general idea of our activity, we provided engineering services to 150 venues in the third quarter. We anticipate that our core in-building engineering services will remain at current levels while our lower-margin drive testing services may experience a decline. Increasingly, we see an opportunity to collect, analyze and immediately display cloud-based data to our customers. Within that context, the real-time dashboard and reporting through our SeeHawk Analytics platform that I just mentioned will be important to the growth and profitability of our services operation. Automated analysis will decrease the time it takes to provide results to our engineering services customers, allowing them to make decisions more quickly. We will be presenting these solutions and our products, including our in-building antennas, at the European DAS and Small Cell Congress in Munich at the end of November. Finally, I wanted to comment briefly on the upcoming succession in January. As you know, Marty announced he is retiring during 2017 and stepping down from the Chairman and CEO role in January. I am honored that the Board and Marty have demonstrated confidence in me to lead PCTEL. I'm looking forward to the challenge and I have great confidence in the future success of PCTEL, largely because of the strength of the management team that will be supporting me. Rishi, who has done an outstanding job leading Connected Solutions, will continue to lead that business and Jeff Miller will take over the leadership of RF Solutions. Their experience and leadership coupled with the unbelievable support from the executive team, specifically John Schoen, Shelley Bacastow and Les Sgnilek, bodes well for our future. Marty?

[Martin H. Singer:]

Thanks, David, and good luck. That concludes our formal comments on the quarter and what we look forward to over the next several months. We typically set aside about 30 minutes for your questions and we're ready to take those questions now. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Matt Robison from Wunderlich. Your line is open.

[Matthew Robison:]

Thank you and congratulations on the transition everyone. So, what are we doing to – it looks like the RFS activity is waning a bit and you've got some nice activity on the antenna side. What's the path to $100 million next year or is there one, and with this gross margin a little bit lower than what we were looking for, how do we improve on that if the scanning receiver business is going to be volatile?

[Martin H. Singer:]

We weren't prepared to give guidance on 2017 at this call, but I will tell you that we think that we will do in excess of $100 million next year. We see antennas growing from where it will end up this year and we think that RFS could be about the same, and if those things occur, we will be over $100 million. When you say 'waning', I would say this. There is no question that we had a huge disruption in the third quarter related to InfoVista's acquisition of the test and measurement business from Ascom. We talked to many of their salespeople who were at several organizational meetings, taking them out of the marketplace. We believe that scanning receivers will return to reasonable historic levels with those OEMs, and at the same time we think that our business in China and APAC and in the private wireless network arena will grow. We do think Matt that the SME, the Subject Matter Expert engineering services within RFS will decline. It's a low margin business. We use it to do things like drive test. It's not really the niche that we've tried to cultivate in in-building services. We think that in-building services however will improve. And back to Connected Solutions, you know that we suffered a decline because we took out businesses that we no longer felt were core, such as mobile tower and some of the very inexpensive chips that we were doing. Now what Rishi is doing is he's putting chips together for let's say the rail industry where a lot of the content comes from us, 28 to 40 antennas in a well-designed kit that goes on top of a locomotive. That's the type of kit that we want to be promoting in 2017, and taking those businesses and setting them aside as additional products and configurations to our core antenna business, the antenna business is really going to grow because of the small cell and in-building momentum. And we've got something going here with the major OEMs in that space.

[Matthew Robison:]

How should we be thinking about margins?

[Martin H. Singer:]

I think that what you do see in the segment reporting, I'll let John comment on this, we're seeing an improvement of the margins in our antenna business. I think the antenna business will grow more rapidly than RF Solutions, and therefore, the mix may not be as favorable but it should still improve. Why don't you comment, John, on the margins?

[John Schoen:]

I think that the pointed answer is, in order to get to the 39 points we did in Q2, scanner revenue has to return to Q2's revenue levels. There is no doubt about it, because inside the pieces, the margins on every product line are either stable or improving, but without scanners making up that same portion they did in Q2, that's how you get to 39 points that's been modelled.

[Matthew Robison:]

Do you get any incremental operating leverage from the antennas for these OEMs and such?

[John Schoen:]

Yes. I mean, we're in the mid-30s now in margin. I mean, the antenna margin was up 7 points year-over-year from all this reduction that we've been doing. So, the more he grows, the more leverage we get.

[Martin H. Singer:]

One of the advantage of some of these large OEMs in the small cell space is we're getting a little better visibility. We essentially had close to zero overtime and expedite costs in the third quarter. We were able to plan much more effectively, and that's a nice contribution to gross margin in Connected Solutions.

[Matthew Robison:]

Okay, thanks.

[Operator:]

Your next question comes from the line of Mike Crawford at B. Riley. Your line is open.

[Michael Crawford:]

Do you think some of the decline in the RFS business is related to advances in personal computing power where basically in a phone you can through an app people can get much of the data that used to cost many thousands to provide?

[David Neumann:]

I don't think so, Mike, because phone or UE testing via phone has been around for a long time, and typically the operators use the UE testing, no matter what processing power it has, to evaluate what a customer experiences in the market. The scanning receivers is a really different type of tool and that goes much deeper in the RF to look at the signal levels, on coverage, interference. So, I think the two types of testing will run side-by-side for some time.

[Michael Crawford:]

There's been so much consolidation in that space. Why wouldn't you look to sell that aspect of your business to lower cost right now? For such a small company, there is this large amount of corporate overhead.

[Martin H. Singer:]

Only comment on that, I don't think that we would take our earnings release conference call to discuss our M&A plans. However, the Company is always interested in achieving greater focus, and if opportunities come about that permit us to do that, the Board has always been open to that type of activity. Right now though, I would point out that the consolidation in the test and measurement space in many ways is helpful to us. So, for example, if you were to go to some of the major OEMs and ask them, who remains neutral as a supplier of scanning receivers, PCTEL is really the company that has complete neutrality. Rohde & Schwarz acquired SwissQual. So they are tightly coupled with a test and measurement configuration. Anite has a small product line in this area, but they still use our product. And so, we think that our position of being neutral and being the PCTEL inside the major OEM test and measurement configurations are out there is still quite helpful.

[Michael Crawford:]

Okay. And then you talked about the potential $20 million revenue customer next year I believe related to small cell deployment. What's the revenue of that customer this year expected to be?

[Martin H. Singer:]

That particular customer, if you were to combine antennas, scanning receivers and services, it would be in the $11 million or $12 million range, and we have other customers that are approaching that, and we believe that over the next five years we should be able to put together three customers of that size. And again, when you say related to small cell, people gravitate to on image of a literal small cell, and that is appropriate when you think about antennas. But then you have deployment and you need scanning receivers and you need engineering services for the commissioning and the optimization and benchmarking of those systems. So, it really does leverage all of the assets and we'll see revenue from all three of those areas.

[Michael Crawford:]

All right, thanks. And then final question is, what is it that Airgain is doing that's enabling them to grow while you've been shrinking or at best flattish?

[Martin H. Singer:]

Our antenna in itself is growing, and so you'd have to compare that apples-to-apples, but what I believe Airgain's model is, is to focus on consumer devices, particularly home consumer devices, TV, audio, home entertainment, and I don't want to comment on their business model except to say, we were once in the modem business and that type of business can become rapidly commoditized. I'll remind you, Mike, that when PCTEL put forth its first soft or HST modem, it was at 56 kilobits but could fit comfortably within a PC or a laptop. I think its price was $27. By 2003, the price of that modem was $2.35 to Dell and $1.85 to the Taiwanese motherboard manufacturers. So, consumer electronics is one place to go. We think that the vertical markets that we're associated with, fleet, rail, education, utilities, and so on, are going to be great places to be in the future.

[Michael Crawford:]

Okay. Thank you.

[Operator:]

[Operator Instructions] There are no further questions at this time. I will turn the call back over to the presenters.

[Martin H. Singer:]

Thank you for participating in our third quarter earnings release conference call. All of us look forward to seeing you at various industry events and David looks forward to sharing the next call probably in late February or early March. Thank you and goodbye.

[Operator:]

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