TESSCO Technologies Incorporated
Q3 2015 Earnings Call Transcript

Published: 16 Jan 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Third Quarter 2015 TESSCO Technologies Incorporated Earnings Conference Call. My name is Matthew and I will be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [Operator Instructions]. As a reminder this call is being recorded for replay purposes. And now I would like to turn the call over to Andrew Blazier with Sharon Merrill. Please proceed.

[Andrew A. Blazier:]

Good morning, everyone and thank you for joining TESSCO Technologies’ third 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 and 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 disclosure, 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 B. Barnhill:]

Thank you, and good morning. Thank you all for joining us today on such short notice. Our earnings release investors call is earlier than usual in order to communicate our results to you as soon as possible. I'll give you a summary and then Aric and I will give you more details. In summary, our results this quarter were disappointing. Our lower than expected third quarter earnings were largely the result of two primary factors. First, our carrier-based sales, which includes carriers, contractors, tower owners and some commercial resellers declined dramatically in the third quarter, even more than we had expected. And secondly, we experienced higher than normal freighting and excess and obsolete inventory expenses. In addition we were not able to recognize significant revenue from a particular customer order, all of which accounted for a $0.14 per share negative earnings impact. We continue to invest in our growth initiatives, while optimizing our organization and leadership and reducing our operating expenses. Our value proposition and strategies are sound and we are well positioned to capitalize from the future carrier builds and the overall opportunities by -- being created by the convergence of wireless and the Internet. Now let me explain more of what's happening and what are we doing to regain profitable growth. I will discuss three areas, the continued decline of purchases from our cellular carrier customers, the growth of our private system operator and retail customers and our strategic growth initiatives and organizational changes. Aric will then discuss the gross profit and operating margin decline, reducing fixed expenses, TESSCO's financial strengths and our outlook. The first area is critical, what is happening to our carrier organization customers. Sales to our carrier, tower owner and contractor customers experienced a 44% sequential decline this quarter and sales to our commercial reseller customers doing work for the carriers experienced a 16% sequential decline. The slowdown in carrier spending on 4G, LTE and DAS infrastructure builds was even more significant than we anticipated. We had believed that the carrier spending had come close to bottoming out after the end of our fiscal second quarter, but it did not. We believe that carriers have been prioritizing their capital budgets as they spent $45 billion for frequency in the fourth quarter FCC auctions. They will return to aggressively building new infrastructure in order to utilize and monetize their licenses, delivering coverage and bandwidth to their customers. Competitively all the carriers have a very strong incentive to accelerate their deployments. While we are not projecting any significant acceleration of our carrier sales in our fourth quarter, we do believe that their spending, specifically around upgrading cell sites will pick up as we begin our new fiscal year in April. DAS is more uncertain and we don't currently expect to see a rebound in carrier DAS spending until after mid-year. To regain our growth in the carrier space and to enhance our position to capitalize on the rebound we've augmented our leadership team added experienced business development executives and realigned the organization to build deeper relationships and more effective product and supply chain solution selling. Ted Winslow, Vice President has assumed the role of Market Director for our carrier organization unit. Ted is a Senior Sales and Business Development leader with more than two decades of experience, has a proven track record of achieving exceptional results through the development of strategic relationships with all levels of client organizations. Ted joined TESSCO in May 2014 and was previously with Cadmus Communications and Specialty Packaging Products. His accountability is to guide the sales team to better serve decision makers within the carrier organizations. Under Ted's leadership and our focus on product and supply chain solution selling we believe we are well-positioned to improve our market share and drive growth when the market re-bounds. The second topic is the private system operator and retail growth. Our major priority is to continue to investing in and pursue new opportunities in the emerging, industrial and enterprise private system operator market. We're making excellent progress. Revenues grew 22% over last year’s third quarter. However there has been some gross margin compression which Aric will address shortly but we are pleased with the growth and the opportunities we're seeing and the expected continued growth. Retail has also performed well this year, growing 19% over last year’s third quarter. New products and the iPhone 6 and other smartphone launches and our training and procurement assistance offerings has generated new customers and sales. While these two markets are growing their contribution was not significant enough to offset the weakness in the carrier commercial reseller and government markets. The third key area that I want to review with you is our strategic growth initiatives and organizational changes. We continue to invest in talent and technology, while improving efficiency, reducing expenses and optimizing our organization and leadership. As we have discussed we've several important strategic growth initiatives underway. We've made considerable progress but it is taking more time than expected for these initiatives to generate the full benefits we expect. We are now prioritizing three key initiatives to speed execution and reduce cost. The first is transitioning from reactive selling to proactive and then solution selling. We believe this model will improve the customer experience while growing customer relationships, cross sell and overall sales. To accelerate the transition and better capitalize our market opportunities we've appointed Mark Wymer, Vice President to be Head of the entire market development and sales group and to be a member of our senior leadership executive team reporting directly to me. Mark is tasked with developing marketing strategy and leading the sales organization to meet the corporate growth targets. Mark joined in May 2014 and was previously with AOL and Hughes Network Systems. Mark has extensive background in business development and marketing operations with a proven track record of business growth. The second key initiative is to expand our offering to architect and deliver the knowledge and end-to-end product and supply chain solutions that enable our customers to build, use and maintain voice, data and video systems. Today we support the major cellular Wi-Fi broadband connectivity two-way systems. And today we are also exploring new systems to support within our remote monitoring control area, tank and fleet monitoring, asset tracking -- and asset tracking. Within our mobile device performance area we're expanding into the home automation and mobile device privacy through then present [ph]. Our objective is to ensure that we have the right products from the leading manufacturers to build the end-to-end solution for these systems. As we seek new manufacturing partners they could also be complementary acquisitions and/or organic growth opportunities for Ventev, our proprietary products unit which designs and manufactures the unmet needs. In addition to expanding the systems we support and products we offer we focus on deepening and broadening our relationships with our manufacturing partners. During the last few months new opportunities with two important partners have emerged. Our largest vendor Commscope has reduced its wireless distribution base, naming TESSCO as one of its core preferred U.S. wireless distributing partners. We expect this to present us with the opportunity to gain share from those distributors who no longer offer Commscope products. In addition, Samsung selected TESSCO as its primary partner to market and offer their mobile device accessories to our enterprise customers. These growing relationships demonstrate the value we provide to both our customers and our manufacturing partners and are expect -- and we expect them to yield long-term benefits. The last initiative I want to review is the expansion and enhancement of our digital marketing system, which includes TESSCO and Ventev.com and the one-to-one communications and opportunity creation and the sales guidance system. This entire system is improving the customer experience and providing TESSCO with new opportunities and enhanced productivity. Results from the system are emerging and we expect to see increasing benefits from this initiative on a daily basis. To better execute our digital and online efforts as well as traditional marketing we have reorganized this marketing group and appointed Craig Oldham, Vice President as the Group's head and as a member of our senior leadership executive team reporting directly to me. Craig has brought leadership to the marketing organization and gained momentum in transforming our digital experiences and capabilities. He has a proven track record developing e-commerce platforms within integrated marketing and advertising programs built on customer insights and competitive differentiators. Craig joined TESSCO in March 2014 and has extensive experience across the telecommunications, insurance and financial services industry, having served -- previously been at SprintPCS, Ameritech, now AT&T, Allstate, Zurich Financial Services and the American Red Cross. So I will now turn it over to Aric to continue the discussions, Aric?

[Aric Spitulnik:]

Thanks Bob. As Bob mentioned, the public carrier revenues were way down this quarter. However, excluding that market overall revenues did increase 5%. Although along with the softness in the carrier space we saw declines in gross profit and operating margins. Gross profit margin was down compared to last year's third quarter, declining from 24.9% to 24.1%. We experienced higher freighting cost this quarter, primarily associated with our Ventev products. These costs resulted from labor and capacity issues with the West Coast Ports as well as the constrained supply of iPhone connectors that are used in our chargers. The increase in inventory write-offs and reserves is due in part to some aging inventory relating to the carrier slowdown and cellphone cases associated with older phone models. While both of these inventory categories are excess we believe we will sell through the vast majority of it but possibly at reduced sell prices. Outside of these two issues our gross margin was essentially flat. However we did see some variations within each individual market caused by product mix. Going forward our focus is squarely on selling complete solutions so that lower margin products like DAS and test equipment are offset by sales of higher margin products that we expect to accompany them. We are also intensely focused on ensuring that we are compensated for the complete value that we deliver. Operating margins also were lower than historical levels. The lower gross profit and gross margin combined with the higher talent and technology investments we have been making reduced this quarter's operating margin to 2% compared with 4.9% in last year's third quarter. In order to combat the higher expenses and lower margins we have undertaken efficiency and cost reduction efforts. We are aggressively evaluating our business to identify unproductive or unnecessary activities and resources. We have been taking and continue to take steps to address these areas, including cost cutting, process improvements and exiting unprofitable initiatives. At the same time we are ensuring that we have the right mix of talent and experience in our sales and marketing and fulfillment engine to drive long term profitable growth. As a result of these efforts we expect to see net future cost savings of 3% to 5% for our current fixed expense levels beginning in fiscal 2016. This would equate to approximately 20% to 30% of annual earnings per share. Despite the soft market our financial position is very strong. Last quarter we discussed a large inventory balance related to one tower owner customer. We are hoping to monetize that inventory this quarter and possibly recognize the revenue related to the sale. We did in fact receive payment for the inventory. However the customer’s requested that the inventory remain in our facility until they are ready to deploy it. Due to the accounting rules in this area we are unable to recognize revenue on this transaction until the inventory is shipped. We now expect that to occur sometime after the beginning of fiscal of 2016. Due in part to the cash received from that transaction we generated $13.6 million in cash from operations during the quarter. We also reduced both inventory and receivables by approximately $17 [ph] million. Cash on hand was $9.5 million with no operational debt. We did buyback approximately 150,000 shares of stock for about $4.3 million during the quarter. We remain committed to returning value to our shareholders through our dividend and accordingly the dividend will continue at $0.20 per share with a record date of February 4th and a payment date of February 18th. Turning to our outlook and guidance for the remainder of the fiscal year, due to the continued softness in the carrier space we do not expect the carriers to renew spending until early in our 2016 fiscal year. Accordingly we expect to see a decline in overall fourth quarter revenues year-over-year. As a result of the challenging business environment and the short-term costs associated with some of the expense reduction numbers that are underway we are not providing specific earnings guidance for the fiscal fourth quarter, and we are withdrawing our fiscal 2015 guidance. We would also note that our fourth quarter is traditionally our seasonally weakest for the year. So we are expecting an earnings decline from the third quarter. We fully expect to issue earnings guidance for fiscal year 2016 when we reach our full year fiscal 2015 results. While the carrier slowdown has had a significant impact on our results this year we are taking the right action and we are executing the right strategies to build long-term profitable growth. Thank you for your continued support of TESSCO. Operator, we will now open the call for some questions.

[Operator:]

Thank you. [Operator Instructions]. And your first question comes from the line of Anil Doradla of William Blair. Please proceed.

[Unidentified Analyst:]

Hey guys, it’s Matt Scherer [ph] on for Anil. My first question kind of could you do provide a little bit more color on the slower spending by the carriers and is it still the same particular customer that you guys had discussed in the last earnings call?

[Robert B. Barnhill:]

The primary, the customers I mean, we are focused on that one supplier that -- or one customer with the DAS product as well as [indiscernible]. And if you look at the overall pullback it’s basically AT&T stopped its spending mid-year; Sprint did the same, whereas Verizon and T-Mobile continued. We have a good presence with both. We're also part of this reorganization. We built a totally dedicated team for Verizon and we have a great sales leader that is from Verizon, that is driving the Verizon customer segment. So it's a -- we've had -- we have business from all of the carriers and remember it is a huge ecosystem that you've got, the contractors as well as the tower owners as well as the carriers on a direct basis. And we know we're going to do some great things with all of these companies when they really start to spend. But it is -- one of the executives told me that they were “keeping their powder dry as they continued to go into the auctions for the spectrum.” So everybody was very tentative in terms of how they allocated their CapEx expenses.

[Unidentified Analyst:]

Okay, and then kind of a follow up to that is as we move into fiscal '16 and you see the spending start to pick-up at the carriers, how do you -- at like what rate would you expect the spending to return kind of going back to historical rates or a more accelerated rate, since they haven't been spending recently?

[Robert B. Barnhill:]

That's a real challenge. I mean they're already starting to release contracts with some of the contractors to do the work. But as they tell us they're still in the dark in terms of when the builds are going to begin. So it's a -- I mean they have to deploy the spectrum. I mean they didn't buy all the spectrum with the view of just sitting on it. And as I mentioned in the call is that it's -- that competitively they have to start to move out. What we've -- we’ve never seen, we seen cyclicality with the carriers over the years that we've been doing business with them but never as dramatic as this has been. And I believe that they are going -- excuse me I'm coming off the flu, but it's -- I think we'll see they're getting their plans together, but as we mentioned I don't think we're going to see a whole lot of growth in this fourth quarter.

[Unidentified Analyst:]

Okay, and then kind of moving over into the retail segment, the partnership with Samsung, how do you see that playing out in fiscal '16, is that like a market -- is that like a revenue opportunity similar that you see with the iPhone and Apple products or is that a much larger opportunity as you start to move through the process of the partnership?

[Robert B. Barnhill:]

I think it's going to be a part of the whole also. The thing that we're excited about is that they're focused on the enterprise in addition to retail. And so that's -- and what we're trying to do is get -- take our accessories into the enterprise market as well as into the retail market and with the focus of Samsung, their marketing, their efforts, it’s really going to a aid us in going into that market space.

[Aric Spitulnik:]

Yeah, and this particular transaction will show up in our private systems operators' market. It's not a retail play because it's going after the end-users and not through a retailer.

[Unidentified Analyst:]

Okay, and then, in regards to the reduction in the fixed expense levels in 2016. Just to clarify, is that 3% to 5% reduction in like total expenses or is that like a percentage of revenue or how should we kind of look at that as we move forward?

[Aric Spitulnik:]

Yeah, one clarification. I think I misspoke and said 20% to 30%, it's 3% to 5% we’d have a company [inaudible]. I think to answer your question, the 3% to 5% is on fixed expenses which is not all of our expenses in regard to certain variable expenses around compensation and some other things. So it's around a $90 million give or take base that we're looking at for this year of fixed expenses if you pull those out.

[Unidentified Analyst:]

If you pull -- after you pull that 3% to 5% out or before you pull the 3% to 5% out?

[Aric Spitulnik:]

The base of fixed expenses is about $90 million. So if you take 3% to 5%...

[Unidentified Analyst:]

Okay, all right, that makes sense. And then touching on the margins, kind of as you see the carrier spending return in 2016 how should we look at gross margins moving throughout the fiscal year?

[Aric Spitulnik:]

Yeah, so as the carriers begin to pick up, which I think we will probably see a ramp but not a huge ramp, it’s probably kind of [indiscernible]. The carriers are definitely a lower margin business for us. At the same time the private systems which is really where we are attacking even harder that's a higher margin business for us. So we conceive that two of those offset and it usually does with us, it comes down to the product mix. Private systems seems a little bit lower than it has been because they were buying all the test equipment. Just happened to be where some of the bigger deals were this quarter and that can change from quarter-to-quarter. So we always see some significant fluctuations just based on product mix. But in general I think that what we are looking at is private systems increasing will offset the decline in the margin if the carriers increase.

[Robert B. Barnhill:]

It's also important that this year a lot of our sales have been DAS oriented, DAS is a lower margin and the LTE builds had slowed and then really pulled back. So as the LTE comes in first as the margin is higher for the LTE builds than it is for DAS. So it's a -- but at the same time the DAS business is still very good.

[Aric Spitulnik:]

Yeah, it’s high dollar.

[Robert B. Barnhill:]

High dollars, but the margins are lower.

[Aric Spitulnik:]

Right.

[Unidentified Analyst:]

All right. Well that's all the questions I have. Thanks for answering them.

[Robert B. Barnhill:]

Thanks, Matt.

[Aric Spitulnik:]

All right, thanks.

[Operator:]

[Operator Instructions]. Question now from David [indiscernible]. Please go ahead.

[Unidentified Analyst:]

When did you become Commscope preferred supplier and when did that begin to take effect for you guys? And can you talk about the criteria used to select the preferred supplier list?

[Robert B. Barnhill:]

Yeah, we've been a Commscope partner for some time. This reduction of the distributor base was announced a couple of months ago but been effective what, January 1.

[Aric Spitulnik:]

Yeah, around the start of the year.

[Robert B. Barnhill:]

So we are just now -- as we said, we have the opportunity that, that business that was going through -- the no longer distributors is sizable and obviously it's going to be shared with the remaining four distributors but hopefully we'll get a bigger share.

[Unidentified Analyst:]

Got you. Thank you.

[Operator:]

Thank you for your questions. I would now like to turn the call over to Bob Barnhill for closing remarks.

[Robert B. Barnhill:]

Good, thank you. While disappointed with our third quarter results, our value proposition and our strategies are sound and our foundation capabilities and capacity is strong. We are well positioned to capitalize in a rebounding carrier market and the overall opportunities being created by this convergence of wireless and the internet. We look forward to executing on our initiative and completing the changes in this fourth quarter and entering the new fiscal year with the expectation of growth. I really thank you for being on the call today and thank you for your continued support and we look forward to sharing great news in a couple months. Thank you.

[Operator:]

Thank you for joining today's conference. Ladies and gentlemen, this concludes the presentation. You may now disconnect. Good day.