Wireless Telecom Group, Inc.
Q2 2017 Earnings Call Transcript

Published: 10 Aug 2017

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to the Wireless Telecom Group's Second Quarter 2017 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Mike Kandell, Chief Financial Officer. Sir, the floor is yours.

[Mike Kandell:]

Good morning, everyone, and thank you for joining us for our second quarter 2017 earnings call. Before we begin, I'd like to remind everyone on the call that our remarks today could include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the fact they do not relate strictly to historical or current facts. The company's forward-looking statements are based on management's current expectations and assumptions regarding the company's business and performance, the economy and other future conditions and forecast of future events, circumstances and results. Forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that could materially affect actual results. Important factors that could cause the company's actual results to differ materially from those in its forward-looking statements include those risk factors set forth in the company's annual report on Form 10-K filed with the SEC. The company does not undertake any obligation to update or revise any forward-looking information to reflect changes and assumptions, the occurrence of unanticipated events or otherwise. Also we want to point out that in addition to GAAP information, we will provide information relating to certain non-GAAP measures. We believe that presenting these non-GAAP or adjusted measures provides additional meaningful information to investors, which reflects how management views the business. Detailed reconciliations of non-GAAP measures to GAAP measures are set forth in a reconciliation table in our press release issued earlier today and furnished with the Form 8-K filed today with the SEC. I will now turn the call over to Tim Whelan, our Chief Executive Officer.

[Tim Whelan:]

Thank you, Mike, and good afternoon. Thank you for joining us. Our agenda includes some prepared remarks then Mike will walk us through the financials and then we will open the line for some Q&A. As a reminder and a brief overview, Wireless Telecom Group is a business which enables the development, testing and deployment of wireless communication and RF instruments. We go to market with three segments under four brands. Our three segments includes Network Solutions, which operates under the trade name Microlab, which is involved in the design and manufacturing of radio frequency conditioning solutions. The second segment is Test and Measurement, which operates under the Boonton and Noisecom trade names and is involved in providing noise generation devices from military and communications applications as well as power meters and sensors for radar and other wireless communications. And Embedded Solutions is our third segment, formed with our acquisition of CommAgility on February 17, 2017. This segment is involved in signal processing and technology for network validation systems, supporting LTE and emerging 5G networks and providing LTE software and customization for private network applications. Collectively, these segments all serve the wireless communications in RF instrumentation industries. Our business has a deep level of expertise in RF wireless communication. We have known and well recognized brand names with long tenured history and we have a large installed base of products and customers. We are an approved and trusted vendor with carriers, the military and government agencies. Together, Wireless Telecom Group and our three segments represents an investment in the continued growth and evolution of wireless communication and company collectively centered and focused on a unified mission across three way cycle areas enabling the development, testing and deployment of wireless communication technology. We expect to take advantage of the long-term growth trends in wireless communication while at the same time we are also diversified across solution sets, diversified across the stages of the wireless technology lifecycle and diversified across the customer segment addressability. Over the last 12-months, we have made a number of important improvements and investments in our go-to market sales and product strategy, which are contributing to our improved water flow and increasing revenue. These accomplishments have included the acquisition of CommAgility in February 2017. Now as a refresh, our investment thesis for CommAgility was one of a complementary business involved in wireless communication development and testing. CommAgility is a profitable company and we did not build this investment case or the acquisition on cost synergies. Further, the purchase structure of the acquisition aligns the interest of shareholders and sellers through adjustment mechanisms in the purchase structure for various possible outcomes; three items of note to point out. First, we included almost 25% of the purchase consideration in equity, which aligns the four founders the long-term interests of our shareholders. Second, the equity includes lock up provisions and claw back provisions from minimum EBITDA performance of the business over the next two fiscal years. Third, the purchase consideration has earnout provisions to reward the principles for our improving performance, which also will aligns the cash flow funding requirements of the earnouts with the cash flow being generated by the CommAgility business. Importantly, these provisions allowed us to excite the seller management team about the future and align their risk and rewards for the value being generated by the CommAgility business and thus to our shareholders. Strategically, the CommAgility acquisition also accomplished five important strategic objectives for the consolidated Wireless Telecom Group. One, it enhances our value proposition with higher value LTE software and embedded digital signal processing hardware solutions and diversifies our solution set for the larger and longer-term trends impacting our customers. Two, it indexes us more strongly to the expected long-term expansion and growth of 5G deployment in private networks. Three, it enhances our scale and profitability and creates greater operational leverage and expansion of our addressable market. Four, it adds deep layer of expertise and approximately 40 more software and embedded hardware design engineers to our bench, which will positive impact our product roadmap over the longer-term. And last, it adds an immediate accretion to earnings with an improved margin and cash flow profile. Our integration activities continue with the Embedded Solutions team, shorter-term integration of corporate and back office functions are well underway and we are now currently focused on leveraging sales channels and technical and engineering expertise over the longer-term for product roadmap development and top-line growth opportunities. Together with the other changes improvements in the business along with the CommAgility acquisition, we are strategically positioning the company and our products solution set towards longer-term growth trends and larger market opportunities. The milestones and accomplishments we have announced underscoring this product and the market shift includes the following. We launched our Pan-European partnership with the Amplifier Research consolidate and improve our channel to market in EMEA. We launched our USB power meters to open up new addressable markets with different product sets in the middle range power meter markets. We launched our digital GPS repeater and splitters used for wireless network timing, which represents the introduction of a new active solution set and this elevates our expertise and passive RF conditioning, which our Microlab brand is well known for as a global leader. We launched our new twin diplexer for small cell architecture and other network densification projects to continue our product set alignment for the current and expected double-digit growth in small cell deployments. We announced the work with Harris providing LTE software and expertise and our work with IDY Corporation of Tokyo developing 4G and 5G small cell technology leveraging our new Embedded Solutions segment. We announced our selection for the US Bank Stadium deployment of our adjustable point of interface solution, which allows for a new type of variable desk solution at a superior cost of ownership model for our customers. And our recent award from the FAA for nearly $16 million for our flagship complex RF signal power sensing solution underscores the inherent value of our brand history and installed base. Now in the second quarter of 2017, we have continued making operational improvements and we have continued to sharpen our strategic direction. We completed an executive organizational restructuring, adding a Chief Technology Officer role, which we believe will have greater immediate impact to our product roadmaps, addressable markets and customers. We launched and implemented a refreshed lean manufacturing plan, which led us to the decision to write down the net realizable value of our inventory by $1.9 million. This inventory assessment and lean initiative included amongst other directives three important ships, which included inventory and production process streamlining and specifically minimization of inventory contained in various work cells at various stages of production, testing and assembling. It included a minimized inventory level designated for reuse, redesign or repair in a shortened timeline for disposition and it included an acceleration and shortening of the expected product lifecycle management, the amount of time we are allotting towards reengineering. On this point we are choosing to invest the time and efforts of our engineering manufacturing and operations teams differently and focus them on the current higher order flow from customers rather than spending additional time and energy on lifecycle inventory management and redesign for reuse of slower moving parts. In the second quarter, we have also refreshed our strategic plan, which calls for an acceleration of certain product roadmap initiatives and improve product management. Over the longer-term, we expect this will lead to shortened product life cycles, new product initiatives and strengthened agility and responsiveness for our customers as a strategic competitive advantage. With regard to the second quarter numbers, Mike will take you through them in more detail, but we are very pleased with the continued top-line revenue growth in the first half of this year compared to the first half of last year. On a consolidated basis, our revenue grew 54% in the first six months of the year, which includes our ownership of CommAgility for approximately 4.5 months. Just as importantly within the same period, we realized organic growth in both of our existing segments. Network Solutions revenue grew 15% in the first half while Test and Measurement grew 48% in the first half as compared to last year. In our Network Solutions segment, we are seeing that the network densification efforts and small cell deployments along with upgrades requiring multi-carriers and new spectrum are fueling demand for our combiner and hybrid RF conditioning solutions and we expect this to continue in the second half of the year. We are also seeing some increased sales order flow and our Test and Measurement segment being driven by an above average increase to larger projects and we see a continuation of the cyclical pattern of increased orders in Q2 and Q3 of our fiscal year representing the second half of the government fiscal year. Additionally, the sustained customer order flow strengthens our conviction for our direction and improves the forecast in the second half of the year. July was a very good month of customer bookings and as we mentioned in the press release includes a receipt of the FAA order of $1.6 million, which we have been working on for over a year. July's performance will help to drive solid bookings in the third quarter. And with this we expect Q3 bookings to drive continued strong financial results in the second half of the year at or slightly better than the first half. In summary, we have accomplished a number of important objectives over the last nine to twelve months and our financial results are beginning to reflect the growth in revenue and profits. We have more work to do, but we are encouraged that we are better positioned now to take advantage of continued future growth opportunity in our end markets. With that, I'm going to turn the call back over to Mike to walk us through the financials.

[Mike Kandell:]

Thank, Tim. Good afternoon again everyone. Our second quarter 2017 results include three months of CommAgility, which will affect all of the quarter-to-quarter comparisons. In our press release and in our 10-Q, we have broken out this impact and I will highlight some of that here as well. We are very pleased with the results of Q2, which reflects higher revenues across all of our segments. Our net loss of approximately $1.4 million includes non-cash inventory impairment charge of $1.9 million along with $470,000 of restructuring charges primarily related to the departure of our Chief Operating Officer. These results were consistent with our expectations and guidance in our first quarter earnings call. We were slightly higher on revenues; slightly below on gross profit if you exclude the non-cash impairment charge and slightly below non-GAAP operating expenses. Collectively, this resulted in non-GAAP adjusted EBITDA of over $900,000. Our revenues in Q2 increased by $4.3 million to $11.9 million representing a 57% increase from Q2 2016. This increase includes $3 million of revenue in our Embedded Solutions segment which represents our CommAgility acquisition. This increase also reflects organic growth in both our Network Solutions and our Test and Measurement segments. Networks solutions revenue increased 141,000 or just about three percent from the prior year and the $5.6 million of revenues reflects the best quarter of revenue for Network Solutions since Q1 2015. Test and Measurement revenue increased $1.2 million, or 55% from the prior year period and is the second best quarter of revenue for that segment since 2015. The revenue increases were due to improved spending by our wireless carrier, government and military end markets increase project wins, the launch of our customer portal and other product and customer facing improvements. On a regional basis, the Americas which we defined as Canada, North America and South America account for the majority of our revenue. For the first six months of 2017, Americas’ revenue represented 71% of our revenue, or $15.3 million, which compares to 78% in the same period in 2016. The change from the prior year is due to the inclusion of our new segment, Embedded Solutions, which includes the CommAgility acquisition for which nearly 60% of that segment revenue is from EMEA and the remainder is from the Americas. On a regional basis we were pleased net revenues increased across all regions both organically and with the inclusion of Embedded Solutions. We see our businesses and channels performing well in every region, but we were expecting slightly higher revenue from EMEA in the first half, which was largely offset by higher Americas revenue. Our book to bill ratio in Q2 was 1.02 and as Tim mentioned we are seeing continued strong bookings in July highlighted by the receipt of the $1.6 million FAA order. Overall, we are encouraged by our bookings trajectory and expect a strong second half of the year. Our gross profit in Q2 of $3.3 million, or 28% of revenue decreased from last year's Q2 gross profit of 44% primarily related to the $1.9 million inventory impairment charge, which Tim spoke about. The inventory impairment charge was triggered by two key events in the second quarter

[Tim Whelan:]

Thank you, Mike. So, overall, we are very pleased with our Q2 and our first half accomplishments. Looking into the second half of the year at this time, we expect our Q3 revenues in the $11.5 million to $12 million range. We expect gross margins in Q3 between 45% and 47% and we expect non-GAAP operating expenses to be between $4.5 million and $4.7 million. Other themes of expectations for the second half of the year, we expect continued strong order flow in all of our segments in Q3 though we expect customer activity in order flow in Q4 to slow somewhat, which has been a historical seasonal pattern for the business. We intend to carefully manage our cash flow for positive cash from operations and profitable revenue growth. And we expect to continue to invest in our R&D, our product roadmaps and our IT infrastructure to position the company for current and future trends of growth for each segment and for each region. Thank you and operator, if you could please open the lines for questions.

[Operator:]

[Operator Instructions] Your first question is coming from David Achey. Please announce your affiliation and pose your question. Your line is live.

[David Achey:]

Hey, Tim and Mike. It’s Dave Achey from The Horton Fund. Nice quarter.

[Tim Whelan:]

Hi, Dave, thank you. Thanks for joining us.

[David Achey:]

Of course, so just wondering about the acquisition if you could maybe elaborate on how CommAgility is performing relative to your expectations in fact when you the decision to acquire the business?

[Tim Whelan:]

Well, I would point you to the revenues in the segment footnote. You will see there is $4 million of revenue in 4.5 months. You'll see this is cracking closely to the 8-K/A we filed on the pro forma financials, which disclosed our business that was doing just under $11 million, producing gross margins of 60% for the fiscal period 2016 on a pro forma basis and income before taxes was just under $1 million, which included $1.7 million of intangible. So if you look at the 8-K/A as a profile of the business, you'll see that the revenue production in the first 4.5 ownership is tracking closely to where they are at. We're still quite pleased with that acquisition. They’re performing as expected. The integration is going well and we've got high hopes on both the funnel to backlog and opportunity at hand.

[David Achey:]

Great, that’s helpful. And in terms of the gross margin for CommAgility, I understand that from prior conversation with you, I shouldn’t really look at it on quarter-to-quarter basis. So this is just the pendulum swing one way versus the other and we still look at the initial presentation for what kind of the go forward run rate of the gross margin for that business would be?

[Tim Whelan:]

Yeah, I think this year there will be a higher concentration of hardware, which will have a lower overall gross margin profile than in the software. We're carefully tracking the – they record under UK GAAP when we translate that back to U.S. GAAP, which is what you're seeing. And certainly, the change in margin from the historical periods and the current period is part of that revenue mix. We are not observing any price erosion or margin deterioration.

[David Achey:]

Okay, great. Then on the lean initiatives, obviously, I'm sure it was a tough decision to take the write down, but always happy to see that we're looking for ways to improve efficiency and margins. Would you anticipate to see an improvement in gross profit margins over time from these initiatives?

[Mike Kandell:]

Dave, this is Mike. I mean I think I don't necessarily think we're seeing an improvement right away. I think this is a long-term initiative decision to take the write down. We assess. We do a bottoms up review of inventory annually. We accelerated that process because of these two triggering events this quarter. And you know given the lean initiative and the realignment of the strategic plan, it resulted in a pretty significant charge.

[David Achey:]

Okay. One last one and I will get back in the queue. From a seasonality standpoint, last year Q4 was close to 30% of the company's overall revenue for the year. Is the business seasonal? Should we think about it that way? Or was that kind of an anomaly?

[Mike Kandell:]

My comments during our prepared remarks Dave was that we do see the customer order flow trail down in Q4, calendar Q4. Calendar Q4 is the first quarter of the government fiscal period and they're just quieter. And as the fourth quarter within our enterprise and carrier space, they go more into the planning mode. So I would mimic comments that Q2 and Q3 are building seasons, where we have the highest level of order flow. That will not always translate to revenue. As we mentioned the FAA order that will be delivered over three to five months. So you will have a little bit of a difference between order flow and revenue. So the historical patterns, I think, are a good way to look to the future, but right now I can't necessarily give you a Q4 projection. There's too many moving pieces right now.

[David Achey:]

Fair enough. Thanks for answering the questions.

[Tim Whelan:]

Sure, thanks Dave.

[Operator:]

Your next question is coming from Ralf Muller. Sir, your line is live.

[Ralf Muller:]

Hi, Mike and Tim. The impairment charge, would you look for more going forward? Or do you think that’s behind this now?

[Tim Whelan:]

I think it’s behind this now, Ralf. Again, these are two pretty significant events that happened in Q2. The realignment of our strategy, the decision to move engineers away from trying to redesign, slow moving passive components and into our new small cell – small cell product line as well as just handling the high volume of new orders that are coming in. And again, this impairment was the result of a bottoms up review of every line item in an inventory. It's something that the company does every year. Typically at the end of the year, we accelerated it to Q2 because of the adoption of lean manufacturing principles and the realignment of our strategy.

[Ralf Muller:]

Right. Well in simple terms the loss was about the same as the impairment charge. Could you say that if you didn’t have that that you could be pretty much on a breakeven basis EBITDA loss?

[Mike Kandell:]

I think if you were to look at – and I would be careful to look at the pre-tax loss of approximately $4 million, $4.1 million for the six months and if you were to consider those things such as M&A charges of 1.3, inventory charge of 1.9 and 470,000 attributable to a restructuring of COO, I think those – that’s a fair way to look at that as more of breakeven in the first six months.

[Ralf Muller:]

Okay, you’re not able to say now and you might project on a break even basis. So, is that correct?

[Mike Kandell:]

On a GAAP level, I think that’s a little bit more difficult. We’re very pleased that we generated positive cash flow from operations and positive EBITDA measurement and my comment very indicated that we do expect that in the second half of the year as well.

[Ralf Muller:]

Okay, very good. Congratulations. Good quarter. Thank you.

[Mike Kandell:]

Thank you.

[Tim Whelan:]

Thanks, Ralf.

[Operator:]

Your next question is coming from [indiscernible]. Your line is live.

[Unidentified Analyst:]

Good afternoon. I have a question for Mike and Tim looking longer-term. There’s obviously some radical changes in the company with the CommAgility acquisition. You’ve taken the bulls by the horn and have adopted this lean initiative and written-off inventories. What are reasonable financial metrics for Wireless Telecom Group that we should expect as investors in the company looking out two, three, four or five years? What's the stretch goals that management aspires to determine post this acquisition and restructuring? What are reasonable return on assets, return on sales, sales growth to try to determine how much earnings and cash flow you can generate as we look out a few years from now?

[Tim Whelan:]

Sure. So I point to an investor deck that we've published this time of the CommAgility acquisition and within that deck, we have cited a vision to get a little over $100 million of revenue in a three year or four year period, so that that's one metric. That also articulated a drive to get our EBITDA as a percent of revenue over the 10% mark and close to 15% mark. So I'd use that as one frame of reference. From a longer term perspective, I don't have all your answers on return on assets from return on equity, although we are very carefully developing our own measurements in KPI’s internally and sure we're improving on those metrics. What I would tell you are a couple of themes that we continue to repeat that we believe that the growth of private LTE networks is going to be a long-term growth trend that I'd point you to a case study by ABI research, which was performed on Ocado UK retailer, which deployed a private LTE network to manage robotic order fulfillment operations. Those kinds of case studies will drive the Embedded Solutions business. And they're quite successful now in winning contracts at fairly sizable names. A second orientation is how we are aligning the business to be not just a niche player within Test and Measurement, but to leverage our brand and to have different functionality and attack larger markets. And I think that will create some growth opportunity for us. And the third thing in terms of the Network Solutions, the orientation to the solution sets and to small cell architecture aligns us to a growth trend that you can see a lot of third-party documentation on the growth expectations for small cell architecture, which follows the densification initiatives by the carriers as they move to 5G, which is another long-term trend. So while I'm not going to call out and I'm not prepared to talk about our CAGR at our revenue or profitability line and I hope to be prepared at some point to do that. We're just not doing it right now. I do believe we're aligning ourselves to the right kind of market trends that will drive continued growth and profitability.

[Unidentified Analyst:]

Okay. I agree with you about the small cell build out because I was speaking with someone, who indicated they were with an engineering group that indicated that the – as they rollout autonomous driving and 5G. We’re going to have to increase the data network by factors of three, five, ten times over the next five to seven years. So you're in the front of a very large wave that you could benefit from. So back to my original question, what do you think you need in terms of R&D sales and marketing in G&A to support $100 million revenue company? How do you model that? Is it a percent of sales, is it an absolute dollar level that you need to accomplish that?

[Tim Whelan:]

No, we – again, Nicholas, so I'm not prepared to call that numbers. What I do believe that the R&D initiative should continue to be somewhere in the 10 to 12 perhaps even 10 to 15 points of revenue, not that that's how we're planning or projecting. But I believe strongly in a continued investment within R&D to drive both near-term and longer-term initiatives for top-line growth, number one. And number two, the company's brand, their culture here and D&A is one of engineering, its engineers throughout the company. And I'm trying to reenergize that and ensure that that remains part of our D&A. And that we're seeing strategically agile against those competitors we go head-to-head within the market, which are far, far bigger than us. And one way to compete in a market with a far bigger competitor is to be more nimble in decision making and quicker to address those opportunities, which may be seen by competitors as too small, while those will contribute significant growth to us. So that’s a couple points on it though it’s not specific in terms of numbers. In terms of operating leverage, I think that’s the creation and that's the indication of – I’ll give you some examples. We invested in our iControl portal. The iControl portal had taken orders from customers over the holidays and over weekends. That's the creation of operational leverage. So, I believe thematically that the investment in IT, investment in automation and invest in continue operational efficiency is what will drive our operational leverage going forward.

[Unidentified Analyst:]

Okay. One last question, for 2017 and 2018, what do you expect depreciation and amortization to be for the company?

[Mike Kandell:]

I would call out, as this similar to run rate that what you're seeing from the first half of the year. I don't expect any major increase.

[Unidentified Analyst:]

Okay. So, a little over 2.1 – something like $2.1 million?

[Mike Kandell:]

Yes. The one thing I'll point out Nick to is that our purchase price allocation for CommAgility, as I noted, the 10-Q is still preliminary. So we could have some movement on amortization as we finalize that – finalize the intangibles.

[Unidentified Analyst:]

Okay. And what about capital spending for 2017 and 2018?

[Mike Kandell:]

We haven't broadcast any numbers. Last year's number I think is probably a good proxy and how we think about CapEx that includes both maintenance and investment CapEx, because the comments I made about the belief and investment I can’t expect that will go down. The CapEx needs of our new Embedded Solutions segment are not significant. So I think as you evaluate the 2016 period for CapEx that’s a good proxy going forward.

[Unidentified Analyst:]

Okay, thank you very much. Nice quarter and good luck. Thank you.

[Mike Kandell:]

Thank you.

[Tim Whelan:]

Thank you.

[Operator:]

Your next question is coming from Fernando Canto. Sir, your line is live.

[Fernando Canto:]

Congratulation, Tim and Mike on a very good quarter. Could you put some colors on that U.S. Bank Stadium order as to how big is it and we can expect some other stadium to go along with that?

[Tim Whelan:]

We do number of stadiums. And so in terms of our Network Solutions order flow, we see approximately 20% of all order flow or what we define as large projects, over 1,000 in size. The largest of those are the ones that we would contemplate announcing to the market although we have not done that in the past and I'm not prepared to announce the exact number right now, but at least that gives you some sizing. We have done a number of stadiums both large and small, and that's a part of our business, that we're improving or tracking and proving our funnel and metrics within the sales team and part of what we're developing in terms of strategic sales targeting.

[Fernando Canto:]

All right, okay. Thank you very much and congratulation again on a very good quarter.

[Mike Kandell:]

Thank you.

[Tim Whelan:]

Thank you.

[Operator:]

There are no further questions in queue.

[Tim Whelan:]

Great. Well, again thank you everyone for joining us tonight. We're looking forward to speaking to you again after Q3.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.