PCTEL, Inc.
Q3 2014 Earnings Call Transcript

Published: 1 Nov 2014

[Operator:]

Ladies and gentlemen thank you for standing by, and welcome to the PCTEL Third Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. Later, we will open up the call for your questions. (Operator instructions) I will now turn the call over to John Schoen, Chief Financial Officer to begin.

[John Schoen:]

Thank you for joining us today for the PCTEL financial results conference call for the third quarter 2014. On today's call will be Marty Singer, Chairman and CEO, and I am John Schoen, Chief Financial Officer. Before we begin, I would like to read our safe harbor statement. Today’s call will contain forward-looking statements within the meaning of the federal securities laws. Comments concerning our future financial performance, new products and features, product development, acquisition efforts, and expectations regarding the future growth of our wireless RF business, are forward-looking statements within the meaning of the safe harbor. Actual results may differ materially from those projected as a result of risks and uncertainties, including the ability to successfully grow our wireless products business, implement new technologies and obtain protection for the related IP. Additional discussion of these and other factors affecting the company’s business and prospects is contained in our periodic SEC filings. These statements are made only as of today and we disclaim any obligation to update information to reflect subsequent events. I would now like to turn the conference call over to Marty Singer.

[Martin Singer:]

Thank you, John, and good afternoon to everyone. Let me recap some of the non-GAAP highlights from the quarter in the event that you didn’t have time to review our press release. We achieved revenue of $27.9 million, a 6% increase from the preceding quarter. This was a record quarter, the highest revenue quarter since our management team took over in 2001. Gross profit margin was 41%. Operating margin from continuing operations was 12%. Net income was $2.9 million, or $0.16 per diluted share. Cash and investments were $59 million and we continue to have no debt. This is an increase of $5 million over last quarter. Now I’ll like to turn the call back over to John, who will discuss our financial performance in some detail. Later, I will comment on some of our business development, engineering, and marketing efforts over the past quarter as well as some of our current activities. John?

[John Schoen:]

Thank you, Marty. Our investors will note that the company presents non-GAAP financial information in its earnings releases. The company believes that presentation of gross profit, operating profit, and net income excluding expenses for restructuring, gain or loss on sale of assets or legal settlements, stock-based compensation, amortization and impairment of intangible assets and goodwill, and non-cash related income tax expense provide meaningful supplemental information to both management and investors. The non-GAAP financial analysis reflects the company’s core results and facilitates comparisons across reporting periods. For more information on our non-GAAP financial results and a reconciliation to GAAP measures, please refer to our earnings release that has been filed under Form 8-K with the SEC. The release can also be found on our website at www.pctel.com under Investor Relations. My discussion of results will be based on our non-GAAP financial results. So let us turn to revenue. Revenue was $27.9 million, up 6% from $26.4 million in the same quarter last year. I will speak to the changes by reporting segment. RF Solutions revenue was $9.3 million, an increase of 13% from the $8.2 million in the same quarter last year. The growth was attributed to engineering services revenue from the continued rapid growth of in-building wireless network expansion. Scanning receiver revenue was approximately the same. Connected Solutions revenues were $18.7 million in the quarter, an increase of 2% from $18.3 million in the same period last year. Site Solutions products were significantly higher while antenna products revenue continued to be lower as seen in the first half of the year. Now let us turn to gross profit. Gross profit margin as a percent of sales was 41% in the quarter, unchanged from the same period last year. RF Solutions gross profit as a percent of sales was 61% in the quarter, representing a period over period decline of 2% of sales. The decline is attributed to the increased contribution of our network engineering service revenue with its lower gross profit margin relative to scanners. Connected Solutions gross profit as percent of sales was 31% in the quarter, unchanged from the same period last year. We maintained our gross margin levels despite strong increases in our lower margin site solutions products. Now let’s turn to non-GAAP operating expenses. Operating expenses were $8 million in the quarter, unchanged from the same period last year. Within that, R&D and SG&A were also approximately the same as last year. Non-GAAP other income was $19,000 in the current quarter. As the amount represents interest on our investments netted with other miscellaneous expenses, the number will continue to be small in the current interest rate environment. You may have noticed that the company announced that we settled a law suit in October with the independent accounting firm that audited the pre-acquisition financial statements for the TelWorx assets purchased in 2012. Those statements contained material errors. For non-GAAP purposes we expense the legal fees as incurred in G&A cost and only recognize settlement income to the extent it recovers legal fees spent to date. So in the fourth quarter we will be reversing approximately $400,000 of G&A expense for the recovered legal fees spent in 2014. This will be reflected in our fourth quarter operating cost guidance that I will speak to in a minute. Non-GAAP operating margin improved to 12% of revenue from 11% in the same period last year from higher revenues on stable margins leveraged over unchanged operating costs. The non-GAAP income tax rate in the quarter and the year was 18%, unchanged from last year. Non-GAAP earnings per share from continuing operations were $0.16, an increase of $0.03 from the same period last year. Now let us turn to the balance sheet. Cash and investments ended the third quarter at approximately $59 million, or $5 million greater than the previous quarter. During the quarter the company generated free cash flow of $5.4 million, consisting of operating cash flow of $6.1 million net of capital spending of $654,000. Depreciation in the quarter was $722,000. Our free cash flow profile for the full year 2014 is shaping up to be consistent with 2013, at around 8% of revenue. September year-to-date free cash flow is $4 million. We expect fourth quarter free cash flow to be in a range of $4 million to $5 million bringing the full year in a range of $8 million to $9 million. Now I would like to discuss guidance for the fourth quarter 2014. We are guiding to a revenue range of $28.7 million to 29.3 million. Gross profit margin is expected to be approximately 42% as the fourth quarter has historically been the strongest quarter for scanning receiver revenue. Operating costs are expected to be about $8.3 million, and that is net of the $400,000 legal expense recovery I described earlier. As a reminder, our operating costs are at their highest in the fourth quarter of each year due to the seasonality of our expenses. The non-GAAP effective income tax rate is expected to remain unchanged going forward at 18%. The fully diluted share count in the fourth quarter is expected to be about 18.3 million shares. That concludes the financial review. I would like to turn the call over to Marty for his summary comments.

[Martin Singer:]

Thanks, John. I want to briefly discuss advances in our RF Solutions product line, our strengthening position in wireless broadband antenna technology, progress in delivering site solutions to carriers and oil and gas markets, and our in-building initiatives. As we announced at this year’s Mobile World Congress, we launched three new products earlier this year; our new IBflex, our SeeWave Interference Detection System, and our SeeGull CW Transmitter. We have realized encouraging sales levels in all three areas. The IBflex is now our leading scanning receiver. It has unique in-building benchmarking and optimization characteristics, and has contributed to the growth of our in-building network engineering operation. Similarly, our new SeeGull CW transmitter accelerates the acquisition of in-building coverage data and our SeeWave system allows any existing PCTEL Scanning Receiver to transform into a precision tool for isolating interference sources. Just to be clear, this means our installed base of scanning receivers, one of our greatest assets is completely available for additional revenue recognition if our customers move to implement our SeeWave Interference Detection System. These products also position PCTEL to play an important role in addressing issues related to spectrum sharing and spectrum redeployment as the government relaxes regulations on the utilization of restricted spectrum. Broadband wireless technology along with our GNSS product line represents a cornerstone of our performance critical antenna product line. During this year, we added both Aruba and Extreme as important OEM infrastructure suppliers who incorporate our wireless broadband antennas into their Wi-Fi base stations. We are also a preferred supplier of wireless broadband antennas to Cisco, along with several other OEM suppliers. We have also been successful in incorporating LTE into complex, combinatorial antennas that include GNSS and other technologies. We have successfully penetrated fleet, transit and rail with these performance critical antennas. Although the deployment of small cells has not been as rapid as we anticipated, we had our strongest quarter in shipping small cell site solution kits into the growing US market. We anticipate a 50% sequential increase in fourth quarter shipments of cell site kits. Similarly, we had our strongest quarter in shipping mobile towers. These included highly accessorized towers for emergency management applications and others that were crucial in SCADA applications for oil and gas, particularly in North-west Canada. We anticipate a run rate business of about $1 million a quarter in mobile towers and hope to expand that in 2015. Over the past two years, we have discussed our commitment to in-building wireless networks. This past January we held an in-building wireless forum and invited industry leaders to discuss trends and requirements for this high growth market. Our focus has been well-founded. In addition to our investment in relevant test and measurement tools and our benchmarking and commissioning services, we launched our first PIM-tested antennas. By the first quarter 2015, we will have a complete product line including splitters, combiners, load terminations, and a portfolio of ceiling mount and other antennas. These antennas will expand upon our success with the New York City’s Subway project as we address opportunities throughout the in-building market. As has been the case throughout the past year and, indeed, in 2013 our Network Engineering Services continues to expand as we benchmark and commission in-building network designs. Facilitated by the availability of our leading scanning receiver and visualization tools, we have increased our quarterly revenue by eight times since acquiring Envision Wireless approximately three years ago. We continue to explore several acquisition opportunities. Our focus is on products that are consistent with our existing distribution and engineering strengths, software tools that enhance our in-building and wireless design efforts, and assets that will extend our regional reach. We will update our shareholders when we have something to report. As previously announced, we settled our lawsuits with the investment banker and accountants that advised or provided services related to the acquisition of the Telworx assets. As shareholders might recall and as reported in our March 2013 filings, the company discovered accounting irregularities that occurred prior to the acquisition of those assets. At that time, the company communicated to its shareholders that it would seek restitution from responsible parties. This included Tim Scronce, management of the TelWorx Entities, the accounting firm that produced the audited financials and the investment banker who represented Tim Scronce. Over the past 18 months, we pursued both professional groups and we were pleased to settle these matters. As John explained, other income increased as a result of this settlement and we were able to absorb the legal costs without impairing our non-GAAP earnings per share. It is now time to move on and accelerate the growth of the assets that we acquired over two years ago. With respect to 2014 and 2015 guidance, we have a clearer view on how we will finish the current year and our potential growth in 2015. We anticipate another record quarter possibly over $29 million in the fourth quarter. Our 2014 revenue will be around $107 million. In 2015, we anticipate revenue growth in a range of 15% to 20% for our RF Solutions operation and 10% to 15% for Connected Solutions. This should result in 2015 revenues between $120 million and $123 million. With that I concluded I prepared remarks, and we have set aside 30 minutes for your questions. Operator?

[Operator:]

(Operator instructions)

[Martin Singer:]

We are ready.

[Operator:]

Your first question comes from the line of Matt Robinson.

[Matthew S. Robison:]

Hi, thanks and nice job working through the environment out there with service providers and OEMs, can you give us a little flavor as to where you think you are going to see the strength versus weaknesses in the fourth quarter both for Connected and RF?

[Martin Singer:]

Yes. RF Solutions is pretty straightforward. We expect that China will be strong for us. We really started to see a nice up tick in our sales. We are providing our scanning receiver particularly the IBflex into all of the major carriers at this time. Although there is a general slowdown across the entire country in China it is still a relative Greenfield situation and so we will continue to see growth there. We are also seeing some strong growth in selected carrier markets notably Sprint and T-Mobile as they move forward with some of their plans. And we are starting to see some interest in our SeeWave Detection System, and also the CW Transmitter, which is now going to be distributed by one of the larger distributors in the country in addition to our direct sales opportunity. So all of those should be reasonable. On the antenna side, or the Connected Solutions side I’m really pleased to report that we are starting to see an up tick in our antenna sales. We dropped down in the $12 million to $13 million range in the first quarter, which was 100% of the reason for our shortfall in the first quarter and that has plagued us the entire year. But second and third quarter showed a nice rebounce. We are seeing some of our legacy customers come back and when you add into that our success with, we are merging OEM radio providers or base station providers such as Extreme and Aruba we certainly have the table set to do well in our broadband wireless area. Our GNSS product line when you think about our industrial wireless antennas we are really strong in two areas, broadband wireless which includes Wi-Fi and LTE and combinations of those in flat panel ceiling mounts on these and so on. And then we are very strong in GNSS, and in GNSS we started an initiative about a year and a half ago to really penetrate fleet and other areas in transit, and so we expect strength there. I don’t think towers will be particularly strong. As I said we’re hoping to get to a run rate of about a million a quarter there, but site solutions because of a backlog we have, we have really strong visibility on the [Pos] should be about 50% higher than it was in the third quarter. As you probably know though from all the reports [Verizon ATF] slowed some of their LTE small cell deployment and indeed some of the groups that actually do the physical work of deployment are a little backed up. Even with that though we will show pretty strong growth in the fourth quarter and that should continue into next year, and finally of course our engineering services should be reasonable.

[Matthew S. Robison:]

So you think you will have a positive comparison then for the Connected Solutions in the fourth quarter?

[Martin Singer:]

Yes, yes. Yes, I think if you just look at small cell deployment alone that aspect of our site solution business should be up about 50%. Offsetting that a little bit will be a little bit of a decline in the AWS kits that we provide.

[Matthew S. Robison:]

Thank you.

[Martin Singer:]

Thank you.

[Operator:]

Your next question comes from the line of Mike Crawford.

[Martin Singer:]

Hi, Mike. How are you today?

[Michael Crawford:]

Fine, good. Marty what it will take to turnaround or at least do you see a light at the end of the tunnel or further weakness in some of the antenna products?

[Martin Singer:]

Well, like I say, that weakness was largely in three areas in the first quarter. We have been running at about 14.5 just in straight up antennas a quarter and we dipped down to the 12 million to 13 million range, but now we are – we are back into that run rate and we are hoping to top over a 15 million run rate as we head into 2015. So our weakness was in three areas, one, we had an incredibly strong run with Jackhammer, the Cisco Wi-Fi base station project and that more or less came to an end. We had a surge over the last two years in our timing antennas, and then Motorola had some weakness for our traditional public safety. Now what is happening in public safety part of that weakness has been historically because of the revenue prices for the government, both Federal and local, but another part that has not been well covered at all is the fact that there is a transition going on. People are moving from LMR to LTE and so we have refreshed our product. We are now able to deliver LTE capability in the LMR traditional bands and we expect to see some growth now in public safety. So companies like Motorola, our defense systems integrators that are in that area even some dispatch in other private networks are making that move and I think that will grow. The second thing is that as we mentioned the Jackhammer product just came to a natural end, but Cisco was refreshing that and some of the other OEM players in that space such as Aruba and Extreme have really come onboard very quickly and now we are seeing reasonable business from all three companies in that space. And then, with respect to our GNSS product line that suffered as I said from – well, not suffered, but we just had tremendous surge in GPS timing antennas and as those are built out that came down a little bit, but what we have done now is we have all four navigation or satellite technologies incorporated in our GNSS products, Galileo, GLONASS, BeiDou, and GPS, and that timing business is going to be worldwide and so we are moving to provide that product in those markets, particularly in small cell and then also in navigation. And then I will mention one other broad area of strength, and that is the combination of small cell and in-building. As capacity and coverage is distributed by small cells or DAS or oDAS systems, they will need products like ours. So a typical small cell now requires five antennas, a timing antenna, and four other antennas for backhaul and communication. And we have antennas that are designed to meet that need and then in addition we launched our first PIM-rated antenna. We got tremendous amount of experience with this in the New York City subway project. We now are combining both products that we design, develop and manufacture here as well as those that we spec and outsource, and we expect to have a complete PIM-rated product line for in-building applications during 2015. We will see some strength there.

[Michael Crawford:]

Okay, thank you Martin, just to follow up on the public safety aspect, it seems like FirstNet there is finally going to be some dollars trickling in in the coming 12 months, is that tied to your –

[Martin Singer:]

Yes.

[Michael Crawford:]

Expectation here?

[Martin Singer:]

That isn’t tied to our expectation and there is really a broad trend that I think is probably underappreciated in the industry and what it means for antennas, engineering services and scanning receivers, and that is this major national issue of spectrum redeployment. So I know with your question that you are fully aware of the coastal spectrum that has been relegated to government and defense use, but of course it is totally unused in the centre of the country and even along those coastal areas, it is really only used in pockets around Naval ports or coastguard locations and so on. There is going to be an explosion of use of that spectrum for small cell and there is going to be a tremendous amount of design work, antenna opportunity and scanning receiver opportunity that we think will make the US a more interesting growth prospect for companies like ours over the next three or four years.

[Michael Crawford:]

Okay. Thank you and then regarding your director who stepped off the board to help lead up to your strategic alternative process, can you just talk about what it is you are looking for in M&A, does it need to be accretive out of the gate or how are you thinking about this?

[Martin Singer:]

Well, there is – let me just back up and describe Carolyn Dolezal’s role. Carolyn, as you may or may not know, worked at SmithBucklin, and also at Motorola and ran some businesses that were independent of both of those in the communication area, and she has a broad skill set that could apply to a lot of things that we do operationally as well as strategically or M&A. But the moved here into the role to fill two immediate needs. One, we have had a very diffused approach to branding and marketing, and we have rolled out the performance critical telecom brand. We want to imprint that with many of the things we do, have people understand what is unique about our industrial Wireless antennas, our engineering services and our scanning receivers. And Carolyn is tasked with bringing together all of our marketing efforts. We have never had a Vice President of Marketing. We have sort of handled that out of our collective back pockets. The second thing is that I personally look at I would say 25 to 30 companies a year in some detail, and I have some time constraints in that I am really trying to work on the growth of our businesses themselves, and I needed some help in processing the candidates for acquisition that we are looking at. And so Carolyn is filling that role. In terms of what we are looking at it is as I said in the prepared remarks, we are trying to expand what we do in RFS and to look at companies that provide analytic tools, particularly that might get us into big data. We have all this data that we can acquire with our various devices and that we collect for engineering services. We are looking for regional expansion. We are weak with our antennas in Europe and CALA. We would like to change that. And the third thing is that we think we can expand our product line in the antenna space as long as it is compatible with distribution. We are in fact looking for things that are immediately accretive and at or below, maybe slightly above the EBITDA multiple, where we trade, and so shareholders should be comfortable that we are not going to pay an extraordinary multiple for anything. We are just not going to take that kind of risk with our cash.

[Michael Crawford:]

Okay, thank you.

[Martin Singer:]

Okay. Thank you. Oh, Mike?

[Michael Crawford:]

Yes.

[Martin Singer:]

I wanted to thank you for sending the Bulls Pau Gasol. I really appreciated how we played against the Knicks yesterday.

[Operator:]

(Operator instructions) Your next question comes from the line of [Indiscernible].

[Unidentified Analyst:]

Hi Marty, I appreciate your taking my questions.

[Martin Singer:]

Sure.

[Unidentified Analyst:]

First of all, can you talk about the guidance you outlined for 2015 in reference to the financial goals that you laid out a few months ago because I’m not sure that I misheard but it seems like there is the substantial difference in I guess –

[Martin Singer:]

A little bit lower, we thought that we would be closer to something like 127 or 128, I think is what we set out in that earlier investment. We are talking now about 121 to 123 or 120 to 123. And the main reason for that is uncertainty about the deployment of the small cells. We had anticipated based on the POs that we are receiving that this was going to be deployed pretty rapidly and probably as you have seen in the press and that was mentioned by Matt Robison earlier, there has been pretty pronounced slowdown in the deployment of small cells, and so almost all of that difference is related to that.

[Unidentified Analyst:]

So, timing only, and it doesn’t affect 2016 or the goals?

[Martin Singer:]

I believe that 2016 is going to be a strong year because we are going to see not just the small cell deployment, but you will see the takeoff of our PIM-rated antennas in that environment and other antennas that we have that will take advantage of what the operators say are about 40,000 small cells a year. And that is not in total. That is for each of the major carriers and then of course that is going to also impact the capital deployment plans of other carriers.

[Unidentified Analyst:]

I appreciate that and then the other question just has to do with capital allocation and I know you brought up earlier about the acquisition criteria, what are the thoughts around returning cash to shareholders. It seems like that would be in the best interests of shareholders and the company is trading at a valuation that it seems like that could be a reasonable use of cash relative to the cash that we have on the balance sheet, and also relative to other acquisition alternatives.

[Martin Singer:]

Well, we of course appreciate that input from you. But we look at it in this way and our board has always been committed to returning value to the shareholders. First, the company has an extraordinary history of doing exactly as you just suggested. We spent approximately $80 million on stock buyback during my tenure. And on an annual basis, we always authorize some amount of stock buyback. Our philosophy though is that we have cash and we should deploy it in three different areas all in moderation. We don’t do all stock buyback, we don’t do all dividends and we don’t do all acquisitions. We believe that shareholders benefit from us deploying cash in a way that helps us accelerate revenue growth, particularly if it is consistent with our strengths, our distribution channels, our technology, areas of competence and so on. So I think cash should be deployed in that area. We deploy cash to buy back stock and we return a consistent quarterly dividend to shareholders. So, I don’t think that you would get any [core] from us about the importance of returning value to shareholders. We just have a philosophy of exercising all three levers and not just one.

[Unidentified Analyst:]

Well, all I would say is that assuming we hit the goals that we are talking about financially it seems like we are good value relative to other alternatives. So, I wish well –

[Martin Singer:]

So I would encourage you to buy – I think you are right. I would encourage you to buy more stock.

[Unidentified Analyst:]

And I wish us well on achieving the targets. Thank you for taking my questions.

[Martin Singer:]

Sure. Thank you. Are there any other questions?

[Operator:]

I have a question. [Indiscernible]

[Martin Singer:]

Hello. It seems like there is one more question from [Indiscernible].

[Operator:]

There is a question from the line of [Indiscernible].

[Unidentified Analyst:]

Yes, just, I guess following up on that last question with the stock being so cheap and so much cash on the balance sheet, it just seems that the policy of doing a little bit of acquisition or little bit of dividend that has really gotten shareholders nowhere over the last 10 years, so I’m just curious why the board wouldn’t consider doing something a little bit more aggressive with the cash vis-à-vis a large special dividend, a large share repurchase and why those aren’t better alternatives then the status quo?

[Martin Singer:]

Well, we think we have accomplished something of value for the shareholders. When we took over the company it was basically bankrupt. And now we have three platforms that have taken us awhile to construct that are performing well, and we think we have great opportunities to enhance those platforms with well focused acquisitions and at the same time and on a disciplined basis returning value to the shareholders in the form of dividends and buyback and in terms of aggressive actions we have at times taken actions giving us special one-time $10 million dividend and also as I say spending approximately $80 million on stock buyback over the last decade.

[Unidentified Analyst:]

Do you think the shareholders would be better off if the company was put up for sale?

[Martin Singer:]

I haven’t thought about that. Right now we are focused on building the company.

[Unidentified Analyst:]

I would hope that the board considers all alternatives at all times.

[Martin Singer:]

Is that a question?

[Unidentified Analyst:]

No. That is my comment.

[Martin Singer:]

Okay. Thank you. Are there any other questions?

[Operator:]

There are no further questions.