TESSCO Technologies Incorporated
Q2 2015 Earnings Call Transcript

Published: 24 Oct 2014

[Operator:]

Good day, ladies and gentlemen and welcome to the Q2 2015 TESSCO Technologies Incorporated Earnings Conference Call. My name is Whitley and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) I would now like to turn the call over to your host for today, Mr. David Calusdian with Sharon Merrill. Please proceed.

[David Calusdian:]

Good afternoon, everyone and thank you for joining TESSCO Technologies’ second quarter 2015 conference call. Joining me today are Robert Barnhill, TESSCO’s Chairman and Chief Executive Officer; and Aric Spitulnik, the Company’s Chief Financial Officer. Please note that management’s discussions today will contain forward-looking statements about anticipated results or future prospects. Forward-looking statements involve a number of risks and uncertainties and TESSCO’s results may differ materially from those discussed today. Information concerning factors that may cause such a difference can be found in TESSCO’s public disclosures, including the company’s most recent Form 10-K and other periodic reports filed with the Securities and Exchange Commission. With that introduction, I would like to turn the call over to Bob Barnhill, TESSCO’s Chairman and CEO. Bob?

[Robert Barnhill:]

Yes, thank you, good afternoon. Thank you all for joining us today. We want to review a few what is happening, why it’s happening, and what are we going to do about it. Bottom line we are disappointed with our second quarter and our year-to-date revenue and earnings results. Revenues for the quarter were up slightly compared with the year ago but well below our expectation, due to the pull back in 4G infrastructure builds by solar carriers as well as reduced government purchases. Gross margins also were lower than [indiscernible] contract sale with particularly low margins that were not offset by higher 4G infrastructure sales. This backdrop has been aggressively focused on replacing the [huge] carrier and government spend increased private system and commercial reseller sales, value engineering our business, accelerating the execution of our growth initiatives and improving profitability. We remain very committed to our strategic investment in the crucial talent and technology necessary to capitalize on the immense opportunities created by the convergence of wireless and the internet and meeting the challenges and opportunities created by the evolving needs and expectation of customers. We are making significant progress in five key transformational growth initiatives. All five of the initiatives integrate and create what we are calling the scientific marketing sales and sales system. The goal of this hi-tech, hi-touch system is to drive innovation, speed and productivity. Create an extraordinary customer experience and deeper customer relationships, leverage our strong brand and reputation and create new opportunities, sales and profits. This system build is well underway, but is not fully completed as we continue to identify the components of this system we must change architect and build. We expect all the components to be fully executed by the end of this fiscal year driving for improved performance and accelerated growth. The first initiative is to transform from a company selling product into one that architects and sells complete solutions. We’ve been focused on this for some time with a continual change in improvement, but the next but these four initiatives will accelerate the major corporate transformation. The second initiatives is to expand our offering to provide end to end solutions for the building, using and maintaining voice, data and video wireless systems. Some examples of the system we support are cellular networks, [2A] and critical communications, mobile device performance, Wi-Fi networks, wireless point to point broadband data and the internet communications. An example of this is lease line replacement in campus data coverage are perfect examples. Our enhanced cellular coverage and capacity, this is a major opportunity for us not only for carrier customers but for our industrial and enterprise customers as well. Here we provide a complete solution for both indoor and outdoor venues. Remote monitoring and control is a big category which refers to any system that allows monitoring and the control of remote assets. Examples are positive trend control, SCADA which is supervisory control and data acquisition in oil fields primarily, video surveillance and security, [end to end] and the internet of things which we’ve all been hearing a lot about and we are focusing on the smart home building automation, oil field and tank monitoring, asset tracking and (inaudible). In event of our proprietary product unit develops a product components required for Wi-Fi, play station infrastructure, mobile device performance and remote monitoring control, system design. Now [Mark] mentioned that Ventev had a very successful launch of the iPhone 6 cases, screen protectors and tower products. We also had a new stadium Wi-Fi enclosure introductions this past quarter. The third initiative is to enhance our product availability and the delivery of kidded solutions where and when required. TESSCO’S key value proposition is to provide everything to build, maintain or use wireless and deliver the requirements completely kidded ready for use when and where required at the lowest total cost. We do this well today but we have to continue to enhance our capability to remain a superior supply chain performer in the industry. The fourth initiative is to reorganize our business generation structure to better serve the customer and gain productivity for us. We are making excellent progress in creating a team of chains that is integrated and synchronized to drive results. The organization has been rebuilt consisting of three primary units, first unified sales team reach customers consisting of the development executive and account specialist also – on specific customer segments. Second, solutions development product management teams does research and developed new systems to support and provide the right offering and solution. And then we have the solutions architects and technical experts to be a part of the sales process. In the third unit, marketing teams to create strategy, design, go-to-markets campaigns and build to manage the digital platform. While we’ve been reorganizing we are aggressively training and recruiting to ensure that we have the right capability commitment, passion, experience and the energy required in each team. Just as an example last week we finalized an intense, strategic solution based selling training with all people, all of our sales people and solution architect team members. This program includes continual on-going individual proceed. New industry experienced executives and – are joining us in every unit. And the last initiative is to finalize the build of our digital technology platform. This hi-tech platform integrates and directs the hi-touch component to deliver to the customer an extraordinary experience. At TESSCO the [indiscernible] performed provides new opportunities with existing new customers, the insight to develop customer sales strategies to provide relevant communications in [indiscernible] and the ability to create a more efficient and productive sales process and end to end solution sale. The TESSCO digital platform consists of four integrated technology components. The first is the foundational predictive analytic big database. I reviewed this with you last quarter. This component continues to deliver more and more value to the system. This incredible database brings together sales transaction, customer product, web, marketing and industry data into a single knowledge center creating the analytics to better understand the results, trends and customer behavior and requirements. Already we’ve utilized this toot to design and measure new performance metrics that are critical to our growth and provide metrics and analytical tool to the team members. Sales and marketing we see and TESCO.com presents product recommendations and alternative sources for specific customers prior at or after the point of sale. Today we are receiving predictive analytic capabilities to anticipate opportunities develop deeper behavioral segmentation and provide proactive and action built guidance to our business generation teams. The second component is the primary phase to the customer TESCO.com. TESCO.com is positioned as the definitive source for delivering personalized content for each customer to gain knowledge for building, using and maintaining the wireless system designing and configurate solutions, managing the purchase and direct delivery of their product and solutions requirement and the complete control of the entire procurement supply chain. The third component is one to one customer contextual communication. This component develops and builds customer growth specific digital and personal communication to develop new opportunities, support the sales process and respond to transactional events. Our customer communication interchange is to treat every customer as their only customer, delivering only the information and knowledge that is relevant to them. Big Data, TESSCO.com and our sales talent continue to define that the individuals profile and preferences for better and better one to one communication and interchange. In the fourth as the opportunity capture, pursue guidance and result tracking component, opportunities with new or existing customers are generated from the multiple sources of one to one communication TESSCO.com, digital campaigns, events, the internet, big data predictive analytics and so on. These opportunities are fed into our rebuild optimize CRM system for assignment, strategic planning, opportunity pursuit, sales process and tracking. This new system is very exciting and provides us a systemic productive, to profit from a vast number of opportunities. Each technology element is currently been developed and executed. The most visible element of our progress will be a new TESSCO.com which we expect to launch near the beginning of the calendar year. This state of the art website will be well ahead of our current digital presence supporting both customer’s needs and TESSCO business developments and productivity objectives. Our scientific market and sales high tech, high touch system will drive the customer experience and profitable growth for new customer’s end to end solution sales and productivity, the results from this system are developing and we expect to accelerate in the New Year. Now I’d like to give you a look into remainder of the year. Considering the current challenging business environment, our six months results, the expectation that the carrier will not renew their spending until after New Year and a quarterly impact of about $0.10 per share for more talent and technology investment. We’re lowering our EPS guidance for fiscal year of 2015 to be in the range of $1.40 to $1.55. In summary, even as we work through our difficult business environment in our less than expected results, we are excited about our progress on our initiative – strategic initiatives. Our investment and people in technology will enable TESSCO to capture more of the opportunities being created by the convergence of wireless and internet. We're positioning TESSCO to meet challenges created by a fast evolving market, and we're using innovation, creativity and scientific thinking to dramatically change how we do business. We remain intensely focused on shareholder value and continuing return capital through dividends and share repurchases. So Aric, with that would you please give us the details of the second quarter performance.

[Aric Spitulnik:]

Thanks, Bob. Let's look at the second quarter results. Revenues were $149 million compared with $147 million a year ago. Revenue growth was mixed among our markets with the retail market showing the most strength on a year-over-year basis. Gross profit was $35.4 million in Q2 compared to $36.5 million [inaudible]. Gross margin was 23.9% compared to 24.9% a year ago. The decline in gross margin was primarily the result of a change in product mix, as we experienced increased sales of lower margin distributed antenna systems or DAS equipment. As we continue to be successful with DAS, we are trying to offset the lower margins by working on a greater penetration on this market with our higher margins infrastructure and installation test to maintenance products. Outside of the public network market revenues and gross profits were both up by about 2% with stable gross margins. SG&A was $30 million up about 2% from the second quarter of 2014, primarily due to increased expenses associated with our investments and talent and technology. As a result operating margins was 3.9% versus 5.2% in prior year quarter. While we continue to make these critical investments to drive future growth, we expect improving operating margins as the revenue we expect to see from these investments begins to be realized. We estimate we'll spend a total of about $1.5 million on third party expenses relate into these investments during our current fiscal year that will be charged SG&A and almost $2 million in new business generation talent, specifically tied to the initiatives. Most of the third party expenses will not reoccur in fiscal year 2015, but it will be partially offset by higher depreciation expense. Net income for the quarter was $3.5 million down from $4.6 million in the second quarter a year ago. EPS totaled $0.42 this quarter compared to $0.55 in the second quarter of 2014. Now turning to the markets, in the public carrier market, revenues were essentially flat year-over-year. However gross profit was down 19%. We expected some slower spending this year from the tier 1 carriers compared with last year. However the slowdown is been dramatic and we expect it to continue at least to the end of the calendar year. DAS demand remained strong. However, it was not enough to offset the decline in the rest of the market. Small cell continues to be an emerging story, but likely not a significant contributor revenue unto at least 2016. In the commercial dealer and reseller market, revenue increased 1% and gross profit rose 2% from a year ago. We have seen demand for increased indoor cellular and data coverage which should indicate eventual demand for small cell systems once then market develops more fully. In the private and government systems operator market, revenues declined 5% while gross profit declined 4% year-over-year. On the private system front, we continue to make investments in talent and have several potential significant projects in the works. Some of these projects will also have a longer cell cycle than some of our traditional customer projects. On the government side, we are beginning to see an up-tick in federal activities in several projects we developed last year are now receiving initial funding. At the state local level we saw slightly sluggish demand as new budget approvals were delayed. Government sales make up about 30% of this market and were a major drag on it this quarter. Excluding the government sales, revenues from the private system operators grew 2% from last year. Turning to the retail market, the launches of various new Samsung products and Apple's iPhone 6 products have been quite positive for TESSCO. These products are driving strong consumer interest in store and online traffic for our customers. Tight competition among the carriers has also benefited TESSCO, as pricing wars have encouraged consumers to replace their handsets, leading to the purchase of new accessories. We expect that trend to continue. Revenue and gross profit increased 9% and 8% respectively from last year’s Q2. Turning to the balance sheet. Inventory did increase from Q1 as we saw a ramp up in orders from one of our customers and as we built inventory for the retail holiday season. That inventory was about $9 million related to this large customer which is binding, so there is no obsolescence risk for TESSCO. We expect to monetize this inventory possibly by the end of the third quarter and almost certainly by the end of the fiscal year. Our cash balance was $2.7 million. We continue to have a very strong balance sheet with no operational debt, which is allowing us to continue to make a long-term investments necessary to build the foundation for future growth. We set our dividend at $0.20 per share with a record date of November 5 and the payment date of November 19. During the quarter and our recently expanded repurchase program, we bought back about 8000 shares and we continue to evaluate opportunities to continue. The remaining outstanding up to $9.8 million under our buyback program carried for 2016. Thank you for your support at TESSCO. Operator, we'll now open the call for questions.

[Operator:]

(Operator Instructions) Our first question comes from the line of Nil Doradla with William Blair. Please proceed.

[Nil Doradla:]

Thanks, for letting me ask the question. Bob, I have a couple of questions here. The issue that you talked around 4G was that limited to a single carrier or was that widespread across multiple carriers?

[Aric Spitulnik:]

Hi, Nil. It’s Aric. It was primarily with one – one we’ve had relationship with in the past, but there is others that had some impact as well. But it was primarily with one.

[Nil Doradla:]

On that carrier what are the areas of spending weakness, I mean, what parts of the infrastructure are witnessed there?

[Aric Spitulnik:]

We've seen [inaudible]

[Robert Barnhill:]

Yes, lot of that was dealing with (inaudible) acquisition, but it’s pretty much – and they even slowdown on some of the DAS builds that they were doing with the contractors. So as…

[Nil Doradla:]

You've talked – sorry go ahead.

[Robert Barnhill:]

This says lot more than we expected that’s for sure.

[Nil Doradla:]

You talked about, I think one or two quarter hiccup, what makes you say that as we get into the next year after a quarter or two it’s going to come back?

[Robert Barnhill:]

What makes us think it will come back?

[Nil Doradla:]

Yes.

[Robert Barnhill:]

So, basically I mean, there is a huge consumption of broadband that they got to continue to build up, also that they have major interest in putting in these DAS systems into various venues. So we think that it could pass the first year, if we're going to see an accelerated spend. And then also that we're getting – we're doing work with other carriers as well and we're expanding that.

[Nil Doradla:]

And finally, I mean, you talked about the Ventev doing well, especially on the iPhone 6. Can you give us a little bit more color around the launch of this product and when you compare with your previous versions of the iPhone by what magnitude or what is the – any qualitative color?

[Robert Barnhill:]

Yes, it was a pretty exciting with cases, you never quite know whether you have the right dimensions and the right product. And we had inventory and we nailed it in terms of the product design and so we were really one of the first to market. So that was very exciting, both for the case as well as for the screen protector and we've got a very innovative screen protector that’s glass and if you drop the phone the glass cover shadows observing all the impact way from the phone itself. And then our Ventev power continues to do very well and I think Aric mentioned that we've got this Samsung fast charger which – that is – has a Qualcomm shipped in it that goes with the Samsung phone. So it’s a rapid charge. So that’s been very exciting. So that side is being doing well and then the – as I mentioned the infrastructure we've got some very innovative product for the stadiums. This is an enclosure for an access point that can go on to the railing or even better – it goes on to the bottom of seats, so that you can get Wi-Fi coverage throughout the entire stadium. And it’s another example of Ventev's discovering the unmet needs and either on the commercial side or on the accessory side.

[Nil Doradla:]

So, Bob coming back to the infrastructure, it was M&A driven parts in the spending, right, is that a fair way to characterize it?

[Robert Barnhill:]

Yes. I mean, spending rate of the carries? Yes. And then also that we're seeing the overall softness in the private system operators, as well and that carries over to the bars. There is a great hesitancy in the marketplace for people to commit and build new systems.

[Nil Doradla:]

And finally this is North America centric obviously because you are exposures there, and that you'd not be on that, right?

[Robert Barnhill:]

Yes, it’s North American centric, yes.

[Nil Doradla:]

Thanks a lot guys.

[Robert Barnhill:]

Okay. Thank you. Good to talk to you.

[Operator:]

(Operator Instructions) There are no further questions in the queue. I will now turn the call back over to Mr. Barnhill.

[Robert Barnhill:]

Okay, thank you. And Nil I appreciate your questions. I just want to close with reminding us all that we remained focused on sharing our value creation and continuing to return capital through investments and share repurchases. We're working hard and we're working smart to value engineer our business, improve profitability and execute on our growth initiatives. I thank you for your support and look forward to talking to you next quarter.

[Operator:]

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.