PCTEL, Inc.
Q4 2015 Earnings Call Transcript

Published: 10 Mar 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the PCTEL fourth quarter 2015 conference call. At this time, all participants are in a listen-only mode. Later, we will open up the call for 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 Carolyn Dolezal, Chief Marketing and Information Officer.

[Carolyn Dolezal:]

Thank you for joining us today for the PCTEL financial results conference call for the fourth quarter 2015. On today's call will be Marty Singer, Chairman and CEO and John Schoen, Chief Financial Officer. I am Carolyn Dolezal, Chief Marketing and Information Officer. Our remarks contain certain 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 will turn the call over to Marty. Marty?

[Marty Singer:]

Thank you, Carolyn and good evening to all of you. For those of you who have not have had the opportunity to review our press release, let me recap some of the non-GAAP highlights from the quarter. We achieved revenue of $26.1 million. Gross profit margin was 37%. Operating margin was 3%. Net income was $611,000 or $0.04 per diluted share. Cash and investments were $31.8 million, a decrease of $2.5 million from the last quarter. However, we repurchased 449,000 common shares during the quarter for $2.4 million. We paid $881,000 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 spend some time discussing our new products, markets and the strategic direction of our products and services. John?

[John Schoen:]

Thank you, Marty. Revenues were $26.1 million in the quarter and $106.6 million for the year. The quarterly revenue was down 11% from the same period last year and the annual revenue was down 0.5% from 2014. I will speak to the changes by reporting segment. RF Solutions revenues were $9.5 million in the quarter and $37.3 million for the year. The quarterly revenue was unchanged from the same period last year and the annual revenue grew 6%. For the quarter and the year, declines in revenue for scanners and in-building engineering services were offset by the engineering services revenue generated from the Nexgen acquisition. Engineering services revenue in this case refers to drive test and staffing related revenue. Separately, in-building engineering services experienced a downturn in U.S. carrier spending, particularly from AT&T. Scanning receivers experienced lower demand from Ascom and in the Asia-Pacific region. Connected solutions revenues were $16.7 million in the quarter and $69.6 million for the year. The quarterly revenue was down 16% from the same period last year and the annual revenue was down 4%. The changes for the quarter and the year were driven by lower kitting and mobile tower revenue partially offset by higher antenna product revenue. 2014 included a multimillion dollar kitting order for a Tier 1 U.S. cellular carrier. The company exited the mobile tower product line in 2015 due to declining demand and lower margins. That product line primarily sold into the U.S. and Canadian oil and natural gas markets which were negatively impacted by the drop in oil and natural gas prices. Antenna revenue was positively impacted by strong growth in broadband and wireless antennas. Let's turn to gross profit margin. Non GAAP gross profit margin as a percent of sales was 37% in the quarter and 36% for the year. And as a note, the difference between that and the 34% for GAAP is the amortization of our acquired technology and stock-based compensation. As a percent of revenue, the quarterly gross profit margin was down 4% of revenue from the same period last year and 2% of revenue for the year. I will speak to the changes by reporting segment. RF Solutions gross profit as a percent of revenue was 49% in the quarter and 47% for the year. As a percent of revenue, the quarterly gross profit margin was down 11% of revenue from the same period last year and 12% of revenue for the year. For the quarter and the year, the change is attributed to the decline in product revenues with its higher margin relative to services and services revenue that declines faster than we could adjust its largely fixed cost structure. Connected solutions gross profit as a percent of sales was 30% in the quarter and for the year. As a percent of revenue, the quarterly gross profit margin was down 1% from the same period last year and 2% for the year. For the quarter, the change is largely attributed to the significant revenue increase for our Wi-Fi antenna products, which a carry lower margin percent than our GNSS products. For the year, about half the change is due to the Wi-Fi product mix and about half from the fixed cost capacity variants created by the steep decline in mobile tower revenue. Now let's turn to operating expenses. Operating expenses were $8.9 million in the quarter and $36.2 million for the year. The quarter was about $600,000 dollars higher than the same period last year and the year was $2.9 million higher. All of the quarterly and 90% of the annual increase reflect the added software development and sales and marketing costs associated with the Nexgen acquisition. Non-GAAP income tax rate in the quarter and the year was 18%, unchanged from last year. Non-GAAP earnings per share were $0.04 in the quarter and $0.11 for the year, resulting in period-over-period decreases of $0.12 in the quarter and $0.37 for the year. Now let us turn to the balance sheet. Cash and investments ended the fourth quarter at approximately $31.8 million, about $2.5 million than the previous quarter. In the quarter, the company generated free cash flow of approximately $900,000 comprised of cash flow from operations $1.4 million and capital spending of $500,000. For the year, free cash flow was $7.1 million, comprised of cash flow from operations of $9.2 million and capital spending of $2.1 million. This represents a $1.7 million increase or 33% from 2014. Depreciation in the quarter was $788,000 and $3.1 million for the year. During the year, the company repurchased 1.94 million shares for $12.1 million and paid cash dividends of approximately $3.7 million. Now I would like to discuss the guidance for the first quarter of 2015. We anticipate first quarter revenue to be between $22 million to $24 million. While the first quarter of each year is typically the lowest for PCTEL, we are seeing continued revenue pressure beyond that for in-building engineering services. We expect that revenue will recover to $25 million to $26 million the second quarter and that we will generate $56 million to $58 million in the second half. During the first quarter, we anticipate gross profit margin in a range of 35% to 35.5% and operating costs of approximately $8.1 million. With restructuring actions taken in the fourth quarter 2015 and the first quarter and 2016, we anticipate 2016 operating costs to now be in a range of $325 million to $33.3 million. Our goal, with the inclusion of all new software development and sales expenses associated with the Nexgen acquisition, is to match 2014 expense levels, which were $33.3 million in 2014 and $36.2 million in 2015. The non-GAAP effective income tax rate is expected to remain unchanged going forward at 18%. The fully diluted share count in the first quarter is expected to be about 16.7 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. As John already summarized, 2015 challenged PCTEL across the board and of those challenges continue. Last year, we got off to an unusually poor start with network engineering services, NES, after that group that grown by over seven times since 2011. That group continues to struggle. Just as a benchmark, one of the neutral host tower companies did 300 projects with us in 2014 but declined to 80 projects in 2015 with the erosion of carrier capital spending in the U.S. We believe that some of that spending will recall in the second half of the year. As you also know, we acquired Nexgen, only to abruptly lose its major customers and revenue source and sharp drops in carrier spending impacted scanning receiver sales in small cell deployment. This was reflected in a sharp decline in orders from one of our major test and measurement OEMs. Later in the year, ripples from the collapse in oil prices diminished the need for telemetry in large oilfields and the specialized antennas serve that market. It has been a tough environment. We have been working hard to deal with this environment. Our actions, as John discussed, include significant reductions in our costs. Indeed, we are now at 2014 spending levels, about 48 million a quarter and that includes all new engineering development and marketing costs for our data analytics products. At this point, however, we must restore revenue growth. PCTEL management is impatient with the revenue stagnation and we have an active program to regain revenue momentum. I want to use our time today to review our top five actions to accelerate revenue growth and to double EBITDA top over 2015. First, we need to restore network engineering services revenue to the record level achieved in 2014. We will be establishing greater expertise in Wi-Fi and DAS planning and introducing new services that are more relevant to today's in-building environments. These include PIM testing and interference management. We anticipate building upon our success with a major airline where we tested, monitored and commission the cellular network the back calls RFID information for baggage handling. The ability of our engineering group to work across different wireless protocols will become increasingly important as hybrid solutions dominate in-building networks. We also see a stronger future in vertical specialized market such as transportation, hospitality and entertainment. Second, we will deliver on our commitment to deliver a system solution in network test and measurement. As you recall, we acquired Nexgen because we anticipated that our scanning receiver business would be under pressure. We have believed for some time the test and measurement solutions of the future would demand lower cost data acquisition tools coupled with cloud-based analytics. It is vital to our future that we execute this strategy. In the second quarter, we will be releasing two products that will transform the RF Solutions business. One product will give us a UE, a user element, or handset-based collection tool that can be deployed independently or coupled with our scanning receiver. Our solution will allow any customer to download software onto an Android subscriber unit with a QUALCOMM chipset. As we have been presenting to our investors, this new product will permit PCTEL to deliver a test and measurement configuration at a disruptive price. This will reduce our dependence upon third parties to deliver our scanning receiver to the market. Third, in 2015, we began to get traction with our SeeWave interference management system. Interference management has emerged as the key network performance issue with LTE networks. Interference impairs capacity, in some cases up to 50%. Failure to deal effectively with interference results in unnecessary infrastructure investments and very unhappy customers. In 2016, we will augment SeeWave with a highly focused data analytics tool. We will be discussing that product at the DAS World Congress in May. Fourth, we will continue to rebuild our engineering staffing and consulting operation. In the wake of last year's Samsung loss, that operation no longer had scale. We have rebuilt the operation and now have traction with new customers including carriers and neutral host providers. We are in the process of completing the integration of our in-building engineering services, staffing and data analytics into one organization. Fifth, we expect to generate $70 million in connected solutions by expanding our OEM footprint, delivering new products into rail, fleet, utilities and high density in-building environments. We are particularly optimistic about our latest projects with John Deere, Huawei, Aruba, Extreme and Cisco. These revenue-generating actions coupled with a new cost structure will permit us to double EBITDA over 2015 levels. In addition to these actions, I want to point out that we continue to release new leadership products throughout the year. Our new products, most notably the MXflex with eMBMS capability and our enhanced SeeWave interference hunting platform, will serve us well as we move into the second half of 2016. The eMBMS capability permits cellular carrier and others to test their network's capability to deliver broadcast video services and as an example broadcast TV. At the Mobile World Congress, we advanced this product even further with the incorporation of 4x4 MIMO capability. If you attended the show and went to Hall 6, you would have seen our scanning receivers displayed at several vendor booths. In connected solutions, we released our ultra high gain train top antenna, our new multiband mobile antenna for precision agriculture, our VenU Stadium antennas, our new PIM antennas and two new small cell antennas. We have developed strong traction in China with a leading telecom OEM for small cells and Wi-Fi. We started production shipments of our new PIM rated small cell antenna in Q4 and expect the volumes to grow significantly in 2016, along with additional new product releases with this customer. Regarding stadium environments, we shipped over $500,000 and that was in the second half of the year of our newly released Wave 2 panel antennas for stadium deployments. Next quarter, we will launch a highly optimized antenna for under seat deployments. This will simplify Wi-Fi deployments in new open bowl stadium designs across the country. These antennas are unique, in that take into consideration the impact of densely packed human beings in an arena. In Q4, our new mobile multiband antennas were selected by a major public safety agency for a fleet-wide upgrade. Besides providing our products, we also helped the agency optimize the antenna placements on the vehicle rooftops minimizing interference. This type of real estate optimization could evolve into a service opportunity for PCTEL. We are supporting several radio vendors in these deployments and expect this to become a standard that will get utilized with other public safety agencies across the country. We have started shipments of our products this quarter. Several of our new antenna products are under trial by key electric utilities and OEMS in this space for power line monitoring and power distribution and automation networks. We expect successful completion of these trials and production shipments in Q2. Two weeks ago, the PCTEL team spent an exciting week meeting with customers and partners at the Mobile World Congress. The industry is at an interesting inflection point. For example, 5G will erase the distinction between licensed cellular airwaves and unlicensed Wi-Fi spectrum. The data-hungry applications inherent in the Internet of Things, IoT, will demand the aggregation of cellular and Wi-Fi capacity. Networks are moving into the cloud with only the antennas peeking out. Interference and how to limit it so that it doesn't impair cellular capacity challenges increasingly complex networks. In-building remains the focal point of cutting edge network design tools and private networks represent an increasing share of the wireless market. These are great opportunities for companies with expertise in antennas, design tools, analytics and engineering services. In May, as I already mentioned, we will be launching some of our new antenna and RF Solutions products at the DAS World Congress in Las Vegas from May 16 to May 18. The following week, David Neumann, our SVP and General Manager for RF Solutions and I will be meeting with institutional investors at the B. Riley Growth Conference in Los Angeles. Later that month, we will be attending CommunicAsia. We welcome meeting with you at these upcoming events. I want to thank you all for participating in our call this afternoon and we have set aside 30 minutes to respond to your questions. Operator?

[Operator:]

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

[Marty Singer:]

Hi Matt.

[Matt Robison:]

Hi Marty, John. Can you give us a little bit of regional perspective on the scanner business these days, Marty?

[Marty Singer:]

The Americans were reasonably strong throughout the year, but there is a bit of saturation occurring in the Americas. And the other aspect of the demand is that as you should know and as has been well documented, China is just in a much slower growth mode than it was over the last couple of years. We think that that's actually going to change. We were active in several bids and we also believe that this new configuration that we are offering with the unique scanning receiver device, it's going to be helpful in cost sensitive regions. We will tell you that the IBflex is doing remarkably well. It's the fastest take-up we have ever had of a new product and we expect to get some significant test business for the larger MXflex with the eMBMS capability in the 4x4. But I would say that the three things pushing against us were slowdown in China, which we discussed throughout the year. We probably did about $1 million to $2 million less than we anticipated there. And then one of our key OEMs did about $3 million less than they did the previous year and we believe that that was led by some saturation in the U.S. The third, of course, is that this is a market where you are going continue to see some price pressure. And that's why, by the way, we felt it was so important last year to move to a more crowd-based, cloud-based test and measurement solution for the industry.

[Matt Robison:]

So it sounds like you think the connected solutions and antennas in particular, they are going to have some growth this year. What's your feeling for scanners?

[Marty Singer:]

I think scanners will do about the same and a little bit stronger than last year. I think that we could and we will know a little bit more after the second quarter, we could see some significant revenue upside from this new product that we will be releasing later in the second quarter, the user element device. And we will have to see what the rate of growth is there before we can tell you more about the second half in scanning receivers. We also believe that we are going to see some scanning receiver uptake with one of the key applications of SeeHawk analytics. We are working very hard in the area interference mitigation and interference management. We want to talk more about that after the DAS World Congress when we do the full launch of that product.

[Matt Robison:]

Okay. And so is there a regional component that you think will drive the growth other than just easy comparison in China?

[Marty Singer:]

Yes. I think China will be up 20% to 25% over last year. Let's say APAC will be up 205 to 25% over last year.

[Matt Robison:]

Okay. John, so I know it's year-end and presumably there is some degree of bonus activity, but does that explain this big uptick in sales and marketing expenses in the fourth quarter?

[John Schoen:]

Particularly in fourth quarter?

[Matt Robison:]

Yes.

[John Schoen:]

Well, our sales force is on a quota squared system where commissions rise sequentially quarter-by-quarter because they earn more of it the closer they get to the end.

[Marty Singer:]

So for example, Matt, the way our quota system works is, it's commission equals quota squared and we don't payout quarterly. We payout as they achieve that percentage. And so near to the end of the year is when you are going to have bigger payouts to the sales organization.

[John Schoen:]

And the other thing we did was we did do a reorganization where one of our Senior VPs moved from G&A into sales and marketing during the quarter.

[Marty Singer:]

Yes. Jeff Miller moved from corporate into sales and marketing for RF Solutions.

[Matt Robison:]

Okay. Thanks.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Mike Crawford from B. Riley. Your line is open.

[Mike Crawford:]

Thank you. Marty, you said you saw some strength in the broadband wireless antennas, but Wi-Fi antennas lower than segment margin. How would you characterize that business on a commodity versus a value-added scale?

[Marty Singer:]

Its' clearly the value-added. What puts pressure on you is your dealing with OEM vendors that are just massive in size and it can be a competitive situation. But the margins are decent there. The other issue, of course, is that when we start with a new OEM and we have a new win, there are some growing pains early on. One of these OEMs in particular is new for us. I am not going to mention OEM but I will tell you that we did less than $200,000 in 2014, $1.7 million in 2015 and we are going to be between $4 million and $6 million with that OEM in 2016. And so 2015 as we grew that business and got a bigger share, there was some pressure on our margins. There is details that you fool round with like paint finish and ceiling and that causes a temporary disruption in cost of goods sold, but we are getting to a steadier state with some of these products now and we should see some stabilization of the gross margins in that Wi-Fi arena.

[Mike Crawford:]

Okay. Thank you. And then on Nexgen, which no longer scales, can you just and also there was another $500,000 adjustment in the current quarter to pro forma EPS related to Nexgen, can you just recap exactly where we are with Nexgen, now that Samsung is no longer using that technology to help Sprint?

[Marty Singer:]

Yes. Well, first Samsung was primarily a customer for services where the data analytics was a tool that they used. But most of those contracts were of a statement of work nature with a monthly recurring feature. So that business is now a small component of software, an overwhelming proportion of engineering services, both macro engineering so that complements our in-building engineering services and what we call subject matter experts. So the bulk of that business is macro engineering subject matter experts and we are now placing our engineers in doing projects for neutral host providers, some other carriers and some other third party vendors and that business us stabilizing and growing. We expect that to nearly double from first quarter to fourth quarter. In the case of our data analytics, the SeeHawk analytics, what we are promoting now are specific applications such as a postprocessing of drive test data to get at interference mitigation and interference management and that again will be coupled with new engineering services. If I look at our in-building engineering services, Mike, I can't get down to the revenue number there because of it would be going below our segment reporting. But let me say this. We pay about 5% of our total revenue in software fees. So the same model is going to hold for interference management where the smaller component is associated with software licensing and sales and the larger component are value-added services for which we get pretty decent margin.

[Mike Crawford:]

Okay. You mentioned that Jeff is now charged with sales and marketing at the RF Solutions group now. Now that group had 21% segment EBIT margin two years ago. It's down to essentially zero in 2015. So historically, it's been quite a profitable segment. So how do you get RF Solutions margins back up to the teens or even the 20% range from where they are now?

[Marty Singer:]

Yes. Well, recognize that the reason that you are down to breakeven is because it now includes the Nexgen operation, all of the sales, marketing and development and engineering costs associated with the design of a new tool. The core business, the in-building engineering service and the scanning receivers, are still quite profitable. So the first answer to your question is that we need scale associated with the engineering services that were associated with Nexgen and we need to successfully market the data analytics and you will see in the first and second quarter of this year we have driven down the cost associated with Nexgen development and marketing and we will start to see an earnings benefit for that in that segment. The second answer, of course, is this scale in our in-building engineering services. That business declined by about 10% year-over-year. And in engineering services business, if you go from 100% utilization of your engineering team to 90%, you lose a lot of the profit. And so this year, we have cut back on the size of that engineering team and we expect to get to a much higher utilization rate throughout the year and we have also gone back to our historic mix of full-time employees and temporary employees.

[Mike Crawford:]

Okay. Well, thank you very much.

[Marty Singer:]

Sure. Are there any other questions? It looks like Matt has another question?

[Operator:]

Yes. Your next question comes from the line of Matt Robinson from Wunderlich. Your line is open.

[Matt Robison:]

Yes. Thanks. I wanted to dive a little deeper into the components of the sequentially increase you anticipate for the second half. It looks like you are thinking second revenue would be 17.5% above first half revenue. So maybe you can just review what the components of that improvement are?

[Marty Singer:]

Yes. Dealing with the top level, I think we will move from the 16% to 17% to the 17% to 19% in connected solution. That's one component of the growth. We think that scanning receivers will increase for a variety of reasons. You mentioned one before and that's a growth in APAC, but also in-building, use of IBflex with our interference management tool and we also anticipate a scaling of our engineering services. So those are the three primary components.

[Matt Robison:]

Okay. And that's, then the scaling of the engineering services, has to do with the new capabilities you are bringing on?

[Marty Singer:]

Yes. There will be two things that we are doing that we think are going to be impactful for revenue in RF Solutions. The first is, I mentioned, we are adding a user element or a subscriber base test and measurement collection tool to our portfolio. That's going to do a few things. One and in fact this has been in our investor package since October where we show the combination of the scanning receiver and UE device where the information immediately goes into the cloud and that replaces a configuration where you have one of these massive systems with an integrated scanning receiver, local storage and then later reporting to postprocessing. The difference could be, for example a combined price of $20,000, to $25,000 to $30,000 versus $80,000 to $90,000 for a retail test and measurement system. The second thing is, it's going to give us direct access to some of these customers. The third, it's going to be very consistent with our emphasis on interference management. The combination of the scanning receiver, a low-cost tool doing multiple tests, multiple data collection, putting these into the cloud and applying new algorithms that we have developed for interference management will be pretty powerful.

[Matt Robison:]

Subscriber based approach, it sounds like it's a little bit contrary to what we have heard from you over the first years where you have got a scanning receiver that has a lot of spectrum capabilities to [indiscernible]?

[Marty Singer:]

Still does. But now, it's coupled with the user element device rather than a really massive system. And you still get all the capabilities on the scanning receiver, but now you have the user experience associated with that without having to have a pretty expensive system.

[Matt Robison:]

So it's basically the biggest advance that you are moving up the endpoint devices as the storage that you can put in the cloud?

[Marty Singer:]

Well, storage and the size of those legacy custom measurement systems. I think a lot of the legacy systems are struggling. And the scanning receiver is the heart and soul of those systems and when coupled with user element, it's going to be a pretty powerful alternative.

[Matt Robison:]

And the increase in connected solutions, is that going to be driven by antenna business, you anticipate?

[Marty Singer:]

Yes. We do have some interesting kitting business there. We are starting to do a little bit more kitting with radios as opposed to, let's say, enclosures and connectors and so on. So it's a higher level of kitting. But really what happens, if you look at the antenna business, the antenna business within connected solutions has consistently grown over the last three years and it's looking pretty good. And if you look at it, what's driving the growth is our traction with global accounts like Motorola, Cisco, Aruba, Extreme, Huawei, Motorola. When we took over this business Matt, 70% of our business, maybe as much as 73% of our business was with the large RF distributors. Only 27% to 30% was with the OEMs. That's completely flipped. It's about 80% with OEMs and 20% with distributors and we are growing our business through those OEMs. And those OEMs are not just the radio manufacturers, but people like John Deere and precision agriculture. So that's a big part of the growth.

[Matt Robison:]

So can you talk about back when it was 73% distribution, was that back in Maxrad days and pre-Maxrad?

[Marty Singer:]

Well and for the first three years that we had the antenna business and overtime we really transformed that business to be much more of the direct OEM business and we have established a global accounts team and we have much better access to the customers and global access. The other element is that for the first time, we have a meaningful in-building antenna portfolio with our PIM rated antennas and these specially designed custom-designed stadium antennas. And we think that will be a pretty good growth source and we continue to sell into small cell and small cell still represents five antennas per small cell, two LTE, two Wi-Fi and one GPS. The other segment that's doing well for us is fleet and within fleet, in particular, rail. So we are expecting a traction in all of those areas.

[Matt Robison:]

Thank you.

[Marty Singer:]

You are welcome.

[Operator:]

There are no further questions at this time. I will now turn the call back over to Marty Singer for closing comments.

[Marty Singer:]

I want to thank all of you again for participating in the earnings call. We look forward to updating you at our next earnings call and we look forward to meeting you at various the industry events and investor conference that B. Riley is hosting. Thank you and good night.

[Operator:]

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