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TESSCO Technologies Inc. (NASDAQ:TESS)

F2Q08 (Qtr End 09/28/08) Earnings Call Transcript

October 22, 2008, 10:00 pm ET

Executives

Robert Barnhill - Chairman, President and CEO

David Young - SVP, CFO and Corporate Secretary

Analysts

Ted Moreau - The Cardinal Group

Brian

Operator

Good morning, and welcome to TESSCO Technologies Second Quarter Conference Call. Today's call is being recorded and will be available for audio replay today at 12:00 P.M. Eastern Standard time. You can access the replay by calling 888-286-8010 and entering the confirmation number 72706588. Today's call is also available via webcast at www.tessco.com/go/pressroom.

As in most presentations the following discussion contains forward-looking statements and TESSCO's results may differ materially from those discussed here. Additional information concerning factors that may cause such a difference can be found in TESSCO's public disclosure, including TESSCO's most recent report on Form 10-K as well as prior and subsequently filed reports.

I am pleased to introduce Robert Barnhill, Chairman, President, and Chief Executive Officer and David Young, Senior Vice President and Chief Financial Officer of TESSCO. Also, in order to facilitate dialog, Ted Moreau of the Cardinal Group, TESSCO's retained Investor Relations consultant will also join the call during the question-and-answer period.

I will now turn the conference over to Robert Barnhill. Please proceed, sir.

Robert Barnhill

Good morning. I am very excited to review with you this morning our third consecutive quarter of record results. Our performance was excellent in what we all know is a very difficult economic environment.

Let me just quickly review the highlights. The earnings per share grew 246% reaching $0.45 for the quarter and it drove trailing earnings per share to a $1.44. If you look at yesterday’s closing price of $11.94, we are selling at just at -- little over eight times multiple. EBITDA reached a $1.00 and trailing EBITDA came in at $3.20 putting our multiple at $3.7. So there is a lot of opportunity there in terms of being undervalued. Our operating margins more than doubled reaching 2.7%. We believe our success is a function of our industry, the value proposition strategy and our execution. Let me just highlight each of the elements of our success and future opportunity.

First, we are leaders in the expanding and conversion world of mobile, fix and enabling wireless broadband systems. Well beyond where we started in two-way radio and then cellular. Our value proposition of being your total source, delivering everything where and when required is resonating with our customers that build, operate and use these systems. By assuring guaranteed availability and delivery, we continue to expand our customer base and the products they purchase from us.

And then our focus on pricing strategy, procurement cost in our proprietary products has grown gross margins, and this growth combined with our operational productivity has dramatically improved our bottom-line margins. Dave Young will now give us a little deeper insight into our results. David?

David Young

Thanks, Bob and good morning. As Bob said, it was a very strong quarter for us and we are pleased to report these results. In all comparisons that I talk about will be against last year’s second quarter, unless I say otherwise.

Our revenues grew by 8%, reached a $144 million, while gross profit grew by 19% and totaled $34 million. Gross margin was up and it totaled 23.8% compared to 21.6%. That’s largely a result of the change in product mix related to sales of accessory products to our retail tier 1 carrier, as well as, continued improved margins in our core non-concentrated business. We are very pleased with this margin growth and it really is a result of delivering value inclusion to the market.

Our operating expenses totaled $30 million, and showed a 11% increase, resulting from increased business generation comp expenses as we continue to focus on increasing our sales organization, plus an increased bonus accrual this quarter. Increasing the capability of our sales team is the focus for us over the last twelve months as we look forward -- as we look to further penetrate our existing customers, as well as, significantly increase the number of customers with whom we do business. We believe that we have managed other operating expenses very well as this 11% SG&A growth was on a 19% gross profit increase.

EBITDA doubled this quarter, totaling $5 million, or as Bob said, an even $1.00 per share. That compares to $2.5 million or $0.46 per diluted share in the last second quarter. Net income more than tripled totaling $2.2 million, $0.45 a share compared to $700,000 or $0.13 a share last year. Inventory turns declined a little bit from 8.8 to 8.4 driven by an increase in inventory. When we look at the inventory balance compared to the beginning of the year we have grown about $5 million. That’s largely a result of growth and accessories related to the upcoming holiday season but we are still managing through our availability initiative and it gets as we get through that process you may see inventory continue to be up especially in this economy as we are taking on more inventories to meet the needs -- the immediate availability and needs of our customers.

Day sales outstanding decreased slightly from 38 to 33 as partly due to the timings of sales and collections during the various quarters, given that’s current economic and credit situation we’re even more focused on these balance sheet items and so far we haven’t seen any material changes in our write-offs.

During the quarter we generated about $2.6 million of cash flow from operations. And to get through a little more detail on the line of businesses, network infrastructure our revenues totaled $48 million that’s a 13% increase as a result high sales of our propagation and site support products that’s partially offset by slightly lower sales of broadband products and those broadband products typically carry lower gross margins in the higher propagation and site support products.

The broadband sales did come back sequentially so we’re pleased with that and really this entire line of business has had a great start to the year. Gross margin in this line of business increased from just under 25% to just over 27% that’s due to the mix change I just described as well as the strong performance from our proprietary products in this line.

Buyers in this line of business increased 6% and purchases per buyer increased 7%, so really nice network infrastructure results. It’s another strong quarter for multi devices and accessories. Revenues totaled $73 million that’s an 8% increase primarily as a result of increased sales of cellular accessories to resellers and users.

Gross profit in this line of business increased 23% primarily as a result of changes in the product mix to the tier 1 carrier as well as significantly improved margins to our other retail customers and a lot of this again was driven by expenses of our sales and proprietary profits.

Our buyers and their monthly purchases excluding the tier 1 carrier remain flat. For the test and maintenance our revenues were $23 million that’s a 3% increase. Gross profit remains flat and buyers in this line just slightly declined but their purchases increased by about 6%.

On to the stock buyback program during the second quarter we repurchased 539,000 shares of these numbers of shares 69,000 were in the near daily systematic purchases under our stock buyback program. The average price for these purchases was $14.74. Also recall that early in the quarter we bought 470,000 shares in a privately negotiated transaction for $13.64 a share.

Under the current buyback authorization we’ve got 185,000 shares that remain available for repurchase from time to time in the open market or by block purchase or through negotiated transactions. Purchases are funded by working capital in our revolving line of credit and no timetable has been set for the completion of this program.

So in summary, we are really pleased, we feel that the strong results were basically across the board and especially given the economic environment where we’ve been operating in. We do as Bob said expected to remain tough but we believe we’ve got a great team of people and that we’re very well positioned to continue our success.

I’ll now turn it back to Bob to talk about the business outlook.

Robert Barnhill

Thanks Dave. Let me just summarize where we are. We ended the quarter with outstanding growth of profits, excellent momentum in all areas minimal debt and significant credit availability and the preparedness for what we know will be a continued difficult marketplace, so in light of all this we’re reaffirming the fiscal year guidance that we gave of the $1.35 to $1.50 per share.

So, this one I’d just like to open it up for any questions and we will see whether we can give you the answers you are looking for.

David Young

Operator we’re ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And your first question comes from the line of Ted Moreau. Please proceed.

Ted Moreau - The Cardinal Group

Good morning, great quarter, great results and it’s good to see the stock responding. A couple of things first and then I’ll turn it back to the audience, but Bob and Dave if you can talk a little bit about the operating margin levels where you are, what’s going to drive the operating margins going ahead and including the proprietary product initiatives that you have in place and the impact that might have?

Robert Barnhill

Well let’s separate it in two pieces one the gross margin and that our operating productivity. The gross margins are it's historically they all depend upon a mix of product but we are being very systematic in terms of making sure that we’re rewarded by our customers for the value that we deliver constantly looking at pricing in all areas pricing is held if not improved and this is unique as we look at a lot of our competitors are using pricing as a strategy to try to build business in these times but we’re using our value and as David mentioned our ability we’ve been able to deliver what our customers need when they need it. So we’re helping them reduce their inventories, reduce their total cost and we’re providing them that quick response.

Proprietary products, we’re developing in all areas not just accessories. We’re looking at the network infrastructure product, installation test and maintenance product and we have some very exciting programs there that give the customers enhanced value, increased innovation in certain product areas as well as obviously giving us a better margin.

And also in the gross margins just how we’re managing our delivery cost is again helping us maintain and improve those gross margins. On the operating side the productivity that we’re driving as far as the productivity of the configuration, fulfillment and delivery continues to grow we have our facilities in place that have considerable amount of headroom in terms of capacity. So we don’t see the necessity to be adding infrastructure as we continue to grow the top-line and grow our overall level of sales. So we see and we’re obviously staying very lean continue to stay lean, which we have over this past year to improve that level of operating margins. As I mentioned we do have a great plan as we go forward to make sure that we can handle anything that this economy and marketplace throws at us. So, we feel very good about as we go forward maintaining the gross margins, enhancing the gross margins and enhancing that operating productivity.

Ted Moreau - The Cardinal Group

Great, and Bob can you just spend a moment on the proprietary products what percent of sales are they and how do those margins compare to the traditional business?

Robert Barnhill

We’re looking at the overall sales around 10% of revenues growing and margins all end when you look at the supply chain cost, the manufacturing cost is considerably better than our corporate average of gross margin. So it’s exciting and as I mentioned it is exciting from the customers perspective as well as our perspective is that we are giving the customer enhanced value as it relates to product innovation as well as list pricing as well as margins to them.

Ted Moreau - The Cardinal Group

And where do think proprietary products can ultimately develop in terms of presenting your business?

Robert Barnhill

Well our strategy again is to make sure that we offer our customers a choice, so we will continue to enhance our branded product sales but we definitely want to grow proprietary products much greater than 10%. But it’s a balance, I mean what we have today here at Baltimore 110 manufacturers are presenting their products to our entire sales force so we have very close relationships with all of our various brands and manufacturers so it's a balance of where our proprietary products will fill the voids as well as leverage the opportunities we have.

Ted Moreau - The Cardinal Group

Alright. And maybe one other question on profitability and then I’ll turn it back and then I’ll get some other market questions, but the 2.7% operating margin how does that compare to kind of the high-end and the low-ends over the last let’s say several years?

David Young

Yeah we’re certainly at the high-end of where we’ve been recently but as Bob said we believe that we’ve got a lot of operating leveraging and our internal targets are to significantly improve that someway.

Ted Moreau - The Cardinal Group

Okay

David Young

And as we drive those throughput profits the gross profit and less all the variable expenses we see our fixed expenses not increasing, the only real fixed expense that we’ve been growing is our sales team and in this marketplace we’re starting to temper that growth as we move forward and make sure that we get the new people that we’ve added really grounded and productive before we expand that. So as we can grow those gross profits it pretty much brings through to the bottom line the operating leverage really kicks in.

Ted Moreau - The Cardinal Group

Great. I’ve got some other questions but I think I will turn it over to the floor to see if there is other.

Robert Barnhill

Okay. Thanks Ted.

Operator

And your next question comes from the line of Anil Doradla. Please proceed.

Brian

Good morning

Robert Barnhill

Good morning

Brian

It’s actually Brian for Anil.

Robert Barnhill

Hi Brian.

Brian

Just wanted to drill down a little bit more maybe if we can on the operating margins and you talked about pricing strategies, procurement costs, proprietary products etcetera, and I realize that it might be difficult but can you -- are you able to clarify how much of those factors drove the improvement year-over-year when we look at a 170 basis points or maybe at least qualitatively which ones are the most important as we look at the outlook?

David Young

Yeah I think that -- I would say that mix probably is the biggest piece of growth, and so some of the successes we have had in network infrastructure, we are selling a lot of cable and a lot of RF propagation that -- that certainly drives those margins up. Our proprietary line in the network infrastructure, the TerraWave product that we acquired a few years ago that is been having a lot of success result. So those drive margins as well.

I think that what we have been able to do in the major tier 1 customer, you can see that we have been able to significantly grow those margins through getting more of the proprietary after-market products in there as opposed to the more of the OEM Bluetooth product. So, it is kind of, I think it is mix, but a lot of is driven by the proprietary line as well as the sort of the better pricing strategies that we have put in place just across the board.

And the pricing strategies are, we are obviously remaining our competitiveness in the market place and beginning to give our customers value, but when you look at the pricing, when you look at the 32,000 products with varying velocities, the fast velocity, the slow velocity, the companion products, we continue to get more and more sophisticated as it relates to those pricing strategies, assuring that we are competitive but at the same time, being faced with the value that we deliver.

So that’s -- it’s also -- it is helping us the pricing strategies in this particular marketplace where it is so easy to start to use price as a tool. We have had just very strong discipline to make sure that we were -- we don’t go there, but also assuring that we can deliver to the customer what they need when they need it.

Brian

Great. Thanks. And then our gross margin, being down quarter-over-quarter, we would assume that that’s sort of a Bluetooth rebound there that was a little bit lower margin, but obviously still positive for the gross profit dollars?

David Young

Yes, that’s right. I mean, you can see the large growth in revenues and mobile devices and accessories, and a large chunk of that was related to the some Bluetooth initiatives that we did with a major carrier early in the quarter.

Brian

And so if you look out a little next couple of quarters, do you feel like there is a lot of pent-up demand, I know you talked about some legislation in California and etc.?

David Young

Yes.

Brian

And so, should we be expecting Bluetooth to continue kind of building on this momentum from the current quarter?

David Young

Our projections show that that demand from that major carrier is going to soften some throughout the second half of the year. So I don’t think I would expect that sort of level of Bluetooth. You know, it is also interesting adjusting aside, this hand free is obviously becoming a very big initiative for States, but hands free or corded kits as well as Bluetooth, and as well as car kits, and so we have really expanded our line in corded headsets. It offers the customer much lower pricing, but then that’s where our proprietary products kick in on those corded headsets whereas our branded Bluetooth product carries a very low margin.

So we are working with those kinds of strategies as well as serving the market where we are offering alternative products that give the customer better value, but also give us better margins.

Brian

Thanks. And then in terms of the tier 1 customer, can you just give from a higher level what kind of tax rate are you seeing in the iPhone relative to a lower end phone and then, sort of, how you figure into those attach rates in terms of, are you just benefiting from a generally higher attach rates or sheer volumes of the iPhone or do you think you are gaining share in the accessory world at AT&T?

David Young

We are probably growing share. We started with a pretty low share of the iPhone accessories as they brought in -- as Apple brought in their incumbents, if you will. And so, we didn’t enjoy a whole lot of that business, but we -- as a carrier. But from the independent channel, that business is growing very, very handsomely as we are looking at the overall iPhone product. It is very exciting and whether it be cases or headsets or whatever, the user of that phone wants to protect the phone, and as we see more and more of these high-end phones come out we are very excited about the attach rate for accessories through the independent channel as well as with the carrier.

Robert Barnhill

Yes, I think we are seeing most – what’s benefiting us, I think the most, we have benefited from all those attach rates, but the case attach rate has been really pretty beneficial to us. We have got a very neat line of cases that we have been selling. And there is lot of -- there is pretty high tax rate. When you spend that much money on a phone you want to protect it. So we are seeing attach rates on the cases to be pretty high.

It is also an interesting as a lot of the new iPhone, the 3G Phone were sold to people that had the original phone, and it was great that the form factor was changed. So the old case didn’t work with the new phone. So, you know, and I think that’s what we are going to see going forward with all these new phones coming out. Once you get a new phone, you need a whole new line up of accessories.

Brian

Yeah that’s interesting, that’s actually I was going to ask you I mean when you look at the product roadmap you see this sort of being sustainable when you look at some of the iPhone competitors if you will similarly high attached rates and then your share continuing to sort of either maintain or grow in the next product refreshes.

David Young

Yeah I think that our share is most of our competitors are really smaller, much smaller independent companies. And the facts that we have the total source and we have the breadth and choice of product it’s really becoming much more important as we move in to the market and with the diversity of customers that we are selling. So it’s -- accessories are going to be continue to be very strong but not to overshadow the other sides of our business in terms of network infrastructure, fixed broadband, installation tests, training that’s one of the things that’s really helping us today and it will continue to fuel our growth is the diversity of customers and the diversity of products.

Brian

And so when you look at cross-selling opportunities our initiatives is there a way that you can quantify the amount of you’re booked that existing customers are purchasing today? I mean is there a metric that you’re tracking and then and whatever it is where do you think it is today relative to where it could be over the next two or five years?

David Young

Yes we obviously track it and our ten year customers the cross-sale is very high and so our marketing opportunities that how do we get our newer customers to accelerate that cross sale if we can take our ten year customer and get the same cross sale across the entire the upside is just gigantic and not only does it become much more strategically healthy to have a high level of cross sale because the customers looking for all the needs, but it dramatically obviously improves sales but the margin improvement -- the operating margin improvement is again a high because you’re putting more in one box and it just all prints through. So that is our major initiative as we breadth if we go in to the different markets cross-sale is everybody’s metrics it’s on their performance, value share payment, the sales team is compensated for so that is our primary initiative driver today is how do we get that cross-sale.

Brian

Great, and then you mentioned there is some positive results out of TerraWave and GigaWave I was wondering if you can little bit more color on that one of the drivers there in that business?

David Young

Yeah the TerraWave business especially GigaWave had a good quarter and as the training the whole training line did, but we are really seeing some strong results in TerraWave, that business we have been doing a good job over the last few quarters of more fully integrating spending having the positive TerraWave product people spend more time with our sales people and really strengthening that. So they had a couple of just really strong quarters in a row, and we’re looking at expanding the types of products so they’re mostly Wi-LAN accessories right now. So they are getting in to lots of different areas of all across network infrastructure. So, we really expect that business to continue that be really strong. That’s very accretive positive acquisition for us.

Brian

Great and then in terms of just overall infrastructure spending environment another somewhat of a trade off on sort of macro issues versus data consumption still arising. Just wondering if you give your outlook there as far as what you’re seeing I mean is it deteriorating or just kind of holding steady from and already cautious for you?

Robert Barnhill

I think its whole and steady I believe that this current turmoil is and probably retarded in to a little bit in terms of the public system infrastructure spend I think those of us that are heavy users really recognize the carrier has to improve the capacity their systems which will certainly drive our overall business.

The area that we’re the most excited about are the private systems, the WiMax systems, point-to-multipoint where enterprises can reduce their phone bills what they are paying the phone company for that access for the last mile. So what we have some great WiMax products, private systems in the 3.65 gigahertz area that we launched a couple of weeks ago and bookings are starting to really grow for that. So the overall what we call infrastructure includes the all of the support products power, steel, cable, and tennis but also is in to the Wi-LAN, the wide area networks as well as the local area networks.

Brian

Alright. Thanks a lot guys.

Robert Barnhill

Thank You.

David Young

Thank you.

Operator

We have no further questions -- we have another question from Ted Moreau. Please proceed.

Robert Barnhill

Ted?

Ted Moreau - The Cardinal Group

The discussion on the iPhone, but --

David Young

Ted, we missed your first part. You cut out, so if you can --

Ted Moreau - The Cardinal Group

Can you hear me now?

David Young

Yes, we’ve got you now.

Ted Moreau - The Cardinal Group

Yes, okay. I just wanted to get one final question in here on a issue that I think is really going to drag your business, and I would like to get your comments. It takes a little editorializing here, but apparently the head of AT&T who was involved with the Apple iPhone deal is talking about working on introducing wireless links and devices other cell phones, and he is going to head up an organization to promote the inclusion of cellular links in everything from computers and digital cameras to car navigation and entertainment systems. Can you still hear me?

David Young

Yes.

Ted Moreau - The Cardinal Group

Okay. There is some (inaudible) backward. So – and the idea is that Google apparently has stimulated a need to open the networks by AT&T and also Verizon, Sprint and Vodafone have all talked about having open networks. And the idea is that to drive the growth in cellular, they are talking about potentially hundreds of different types of devices, many different models, and other items beside cell phones. And it just seems to me that with the framework that you have for distribution of cellular accessories that you are well positioned to be able to distribute these other proliferation of devices that I think are going to come on the market. I’d just like your comment on that.

Robert Barnhill

I think, Ted, you have really given a great example of this expansion and conversions that we’re seeing in the world of wireless. And what AT&T was talking about in their press releases is exactly where the industry is going is that how do you use wireless as the primary access to every possible consumer appliance that’s out there, whether it be a computer, whether it be a cell phone, as you mentioned, the camera, car navigation, video surveillance, which is a big area that we’re expanding into. And it’s what AT&T is talking about is how do they get these products riding on their network. And then also what we’re seeing is that how do you get these devices riding on the private networks as well. And just as you’ve seen with the iPhone you can ride on AT&T’s network or you can go into a Wi-Fi, where you’re riding on your private network.

So, there is again two pieces to answer your question is, we’re going to be there and we’re there as far as the accessories for these devices, whether it be the Google device or the new Motorola Android that they just announced or these. So, we’re looking at the device accessory, but we’re also looking at the device as we get into some others other than the phones, whether it be computer chips or we’re selling tons of memory now that is going into these systems. So -- and then the other piece once you get beyond the device and the device accessory, it’s just the infrastructure that is going to drive these things.

So, it’s very exciting. I mean that’s when I opened today is in terms of we’re well beyond where we started in two-way radio and I think it’s important that we all acknowledge that last week was the 25th anniversary of cellular. 25 years ago they turned on the system in Chicago. Within six weeks later they turned the system on in Baltimore. So, where 25 years later we’re looking at this exciting conversions is just linked with opportunity for us.

Ted Moreau - The Cardinal Group

Well, I really find this an interesting development, and if I – I mean I think this is sooner rather than later, and looks like now that they are setting up a division and I think they are going to start to begin next year to start to drive some of these devices over the network. So you think you’ll be involved with not only the accessory and support and infrastructure, but it may well be the devices themselves?

Robert Barnhill

Yes, we’re obviously looking at the device. I mean the biggest problem, the reason we have never been in the phone business is just the margin structure with the subsidies with the phones; it just is not a profitable business, but if we look -- I mean we’re selling today GPS. We’re selling the -- we’re not in the cameras yet, but certainly from an entertainment system point of view, I mean there are still the speaker systems rather than the device itself. But we continue to look at those opportunities.

Ted Moreau - The Cardinal Group

Right. And so won’t it be the consumer electronic show, or we should be looking for a lot of introduction of lot of these new initiatives?

Robert Barnhill

Well, you’re going to see with our inventive product line you’re going to see some of these new products here in the next several weeks that we’re going to be introducing that are certainly -- they attached to the iPhone and the other products that are out there.

Ted Moreau - The Cardinal Group

Yes, great. Great. Well, it will be very interesting to see how this plays out because I find this, not just a talk, but when you are setting up a division and the head guy that’s driven the iPhone positioning with AT&T is going to be driving these other devices into the open networks could be very interesting.

Robert Barnhill

And also just one last thought on these new devices is that it’s going to help drive the fundamental access with phone access. So, if I am looking at that kind of a landline at home, and then I’ve got this opportunity that where I can converge all my computers and digital cameras over to the network, I just might terminate my landline at home and then just think what that’s going to do to the overall expansion of cellular. And we have already seen with younger people today, they don’t have a landline. They are using their cell phone as a primary line, and I think in today’s economies it’s going to be driven in that direction as well, which is again going to drive accessories, it’s going to drive phones and it’s going to drive infrastructure spend.

Ted Moreau - The Cardinal Group

And it’s sort of self-fulfilling prophecy, because it will drive traffic and that will have all kinds of ancillary benefits?

Robert Barnhill

Absolutely, and we are at good place.

Ted Moreau - The Cardinal Group

Great. Thanks Bob.

Robert Barnhil

Thanks Ted.

Operator

You have no further questions at this time.

Robert Barnhill

Well, great. It’s good -- great questions. We’ve certainly appreciated at the opportunity. And I just wanted to again reiterate that as we look forward, we believe we are in a very strong position to prevail in a weak market, and obviously, capitalize when the market strengthens, and when these new opportunities emerge that we have been talking about. And we are going to continue to aggressively expand our industry leadership in delivering this total source offering when and where our customers need it. And our fundamental goal remains to create enduring superior value for our customers, our manufacturers, our team members, and our shareowners.

So, look forward to talking to you and in 90 days, and it’s going to be an interesting time for all of us. But, we feel very, very positive about where we are. So, thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This now concludes your call. You may now disconnect. Good day.

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