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PCTEL, Inc. (NASDAQ:PCTI)

Q3 2008 Earnings Call

October 27, 2008 5:15 pm ET

Executives

Marty Singer - Chairman and CEO

Jack Seller - Director of Marketing

John Schoen - CFO

Analysts

Michael Coady - B. Riley & Company, Inc.

Ken Muth - Robert W. Baird

Eric Kainer - ThinkEquity

Brian Horey - Aurelian Management

Shou Wang - Lotus

Operator

Good day, everyone, and welcome to today's PCTEL Incorporated third quarter 2008 earnings conference call. Today's call is being recorded.

At this time, I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Marty Singer. Please go ahead, sir.

Marty Singer

Thank you, Jennifer. Good afternoon, and thank you for joining us for our third quarter earnings conference call. With me today are Jack Seller, our Director of Marketing, and John Schoen, PCTEL's CFO. Jack will review the Safe Harbor statement, John will discuss our results and our financial performance in some detail, and I will comment on our progress over the past quarter and what we see in the future.

With that as introduction, I will turn the call over to Jack Seller, who will read our Safe Harbor statement.

Jack Seller

Today's call will contain forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. Specifically the statements regarding PCTEL's future financial performance and our expectations, opportunities and risks regarding growth in 2009 are forward-looking statements within the meaning of the Safe Harbor.

These statements are based on management's current expectations, and actual results may differ materially from those projected as a result of certain risks and uncertainties, including the ability to successfully grow the wireless product business and the ability to implement new technologies and obtain protection for the related intellectual property.

These and other risks and uncertainties are detailed in PCTEL's Securities and Exchange Commission filings. These forward-looking statements are made only as of the date hereof, and PCTEL disclaims any obligation to update or revise the information contained in any forward-looking statement whether as a result of new information, future events, or otherwise.

I would now like to turn the conference call over to John Schoen, who will provide you with the financial details of the quarter.

John Schoen

Thank you, Jack, and good afternoon or evening to everyone. Our investors will note that the company presents non-GAAP financial information in its earnings releases. The company believes that presentation of operating profit excluding restructuring charges, gain or loss on sale or impairment of assets, non-cash based expense, including stock and stock option based compensation, amortization and impairment of intangible assets and goodwill related to the company's acquisitions, and presentation of net income, excluding these charges as well as non-cash-based income expense, provide meaningful supplemental information to both management and investors.

The non-GAAP financial analysis reflects the company's core results and facilitates comparisons across reporting periods. For more information on our non-GAAP financial results and reconciliation to GAAP measures, please refer to our earnings release that has been filed under Form 8-K with the SEC. The release can also be found on our website under Investor Relations. My discussion of results will be based on our non-GAAP financial results.

As a reminder, the company closed the sale of its Mobility Solutions Software Group, or MSG, to Smith Micro in January of this year. The company's financial statements have been revised to reflect MSG as a discontinued operation. My discussion of the financial results will address continuing operations.

Let's start with revenue. Third quarter 2008 revenue from continuing ops was $20.1 million, compared to $17.6 million in the third quarter of 2007, an increase of 14%. Revenue for both scanning receivers and antenna products grew at approximately the same rate versus the third quarter last year.

Scanning receiver revenue was up on the strength of UMTS deployments. Antenna revenue growth from the same period last year was split about half from the acquisition of Bluewave earlier this year and half from organic growth.

Non-GAAP gross profit margin from continuing operations for the third quarter was 48%, versus 45% in the same period last year. Both scanning receiver products and antenna products experienced improved margins as a result of favorable product mix and leveraging fixed costs over higher volume.

Third quarter non-GAAP R&D and SG&A from continuing operations were $6.9 million, down $300,000 from the same quarter last year. R&D expense was higher by $400,000 on engineering investments, at both scanning receivers and antennas. For example, this is the first full quarter of expenses related to our new antenna design team in China.

SG&A is $700,000 lower through efficiencies resulting from our decision to divest our software business, and better control of our sales and marketing expenses. The connection royalty was lower than last year by $50,000, as the contractual quarterly cap is lower in 2008.

Non-GAAP operating income from continuing operations in the third quarter was $2.9 million, or 15% of revenue, compared to $1 million, or 6% of revenue, in the same period last year. The results reflect improved gross profit on higher revenue and lower operating expenses. In two of the last four quarters, we have achieved our long-term goal of sustaining a 15% operating profit.

Other income was $100,000 in the third quarter, compared to $820,000 a year ago. There are two factors contributing to the decline. As I will outline in more detail in the balance sheet review, we are heavily invested in Federal Government agency paper for safety. The yields on that are very low compared to the commercial paper we were invested in a year ago before the credit market turmoil.

Secondly, the company experienced a $250,000 mark-to-market loss recorded in the quarter, from the company's remaining investment in the Columbia Strategic Asset Portfolio, an enhanced cash fund. I will discuss the Columbia fund in more detail during my review of the balance sheet and income statement guidance.

With regard to non-GAAP income taxes, the non-GAAP income tax rate is 16% and we expected to remain at that level for the full year 2008. With regards to earnings, non-GAAP net income from continuing ops for the third quarter 2008 was $2.6 million, or $0.14 per diluted share. This compares to non-GAAP net income of $1.8 million or $0.09 per diluted share in the third quarter of 2007.

To summarize the differences, net income from continuing operations was higher from increased gross profit on higher revenue and lower operating costs, which was partially offset by lower interest and a higher tax rate in 2008.

Now let's turn to the balance sheet. Cash and investments ended the quarter at $80 million, of which $67 million is classified as short-term and $13 million is classified as long-term. This is a sequential decrease of $5 million from the second quarter this year. The largest contributing factor to the change was the company's market repurchase of 503,000 shares of its common stock during the quarter for approximately $5 million.

After the third quarter ended, we completed our authorized stock buyback, with an additional 490,000 shares purchased for $4.5 million, leaving our cash and investments as of today's date at approximately $75 million. Of the roughly $80 million in cash and investments on hand at the end of the third quarter, the company had approximately $1 million in operating bank accounts, $52 million in AAA money market funds, which are in turn invested 100% in short-term US Federal Government agency securities, or bank repurchase agreements collateralized by the same, $14 million in the Columbia Strategic Cash Portfolio Fund, an enhanced cash money market fund, and $13 million in tax-exempt pre-refunded municipal notes.

Now let's turn to our income statement guidance for the fourth quarter 2008. Marty will discuss guidance as well in his prepared remarks. We anticipate revenue for the fourth quarter to be in a range of $17.5 million to $18.5 million, versus revenue of $19.1 million in the same quarter last year. The company is seeing weaker order booking rates than the fourth quarter last year and the quarter just completed.

Non-GAAP gross profit percent for the fourth quarter is expected to be in a range of 45% to 46%, down from the 48% in the third quarter. The mix of antenna product orders we are seeing so far in the fourth quarter are of lower margin than experienced in the last quarter. Additionally, at lower volumes, we will not experience the same level of fixed cost leverage.

Non-GAAP, R&D, and SG&A from continuing ops are expected to be between $6.9 million and $7.1 million for the fourth quarter, reflecting higher investment than last quarter in R&D, as well as a seasonal SG&A spending spike that we normally see in the fourth quarter. The connection royalty is expected to be 200,000, consistent with the quarter just ended.

Other income and expense is expected to be a net expense of $100,000 in the fourth quarter. The most recent round of turmoil in the credit markets is driving mark-to-market losses in the company's remaining $14 million investment in the Columbia Strategic Asset Fund that are expected to more than offset the interest earned on the rest of the company's investments during the fourth quarter.

As a reminder, the Columbia fund is in the process of liquidating. We originally started last year with just over $43 million in the fund, and our balance is just down to under $14 million. Additionally, the fund has announced another $2 million liquidation payment payable this week, which will bring the balance to $12 million.

While the fund manager will have been successful in liquidating over 70% of the original balance by October end, we are not in a position to predict the ultimate outcome of the liquidation. The non-GAAP effective income tax rate remains unchanged at 16%.

I would like to turn to the guidance for the full year 2009. Marty will comment in more detail during his prepared remarks, but we are cautious about our outlook for 2009, given the recent trends in order flow and the overall worldwide economic outlook.

We are offering the following guidance for the full year 2009. Revenue is expected to be in a range of $80 million to $84 million, which at its midpoint represents approximately 7% organic growth over 2008. We have not included the potential for acquisitions in the guidance offered.

Non-GAAP gross profit percent is expected to be in a range of 46% to 48%, which is the same range as 2008. Non-GAAP R&D and SG&A are expected to be in a range of $29 million to $30 million.

The connection royalty is expected to be $400,000 for the year, which is $200,000 per quarter through the first two quarters. There are no more payments due under their license after the second quarter.

Other income, which is primarily interest income on our invested cash, is expected to be approximately $1 to $1.2 million next year, based on our intention to concentrate our investments in short-term duration US Federal government agency paper, as well as our expectation that our remaining investment in the Columbia Strategic Asset Fund will continue with a net yield of zero to slightly negative.

We remain exposed to mark-to-market losses with the Columbia fund until the liquidation is complete. The non-GAAP income tax rate is expected to be between 16% and 18%.

That concludes the financial review. I would like to turn the call over to Marty for summary comments.

Marty Singer

Thank you, John, and thank you, Jeff. My remarks this evening will focus on four areas: trends in our business environments which are impacting PCTEL, operational and sales progress, guidance for the fourth quarter and the 2009 year, and our M&A efforts. As we mentioned at the outset, we have set aside 30 minutes for your questions.

Let me talk about the trends first. As we have explained at various investor presentations, our antenna and scanning receiver businesses are exposed to different markets. Over 90% of our antenna business is focused on the enterprise space. Our definition of enterprise includes public safety as well as business operations. Within the enterprise space, we focus on vertical markets, such as in-building wireless, SCADA, fleet management, dispatch, military applications, and wireless LANs.

We compete in the carrier antenna space on an exception basis only. GPS timing antennas and WiMAX antennas are two product lines with exposure to the carrier antenna space.

Our scanning receiver product line focuses on the carrier market and derives limited revenue from private, in this case military, networks. Our scanning receivers are integrated into third-party test and measurement systems, and then distributed to the carriers worldwide.

Both businesses take advantage of a leveraged sales model. In our antenna business, we sell to distributors and OEM suppliers of wireless equipment. In our scanning receiver business, a significant portion of our sales are made to OEM vendors of wireless test and measurement equipment.

The differences between the two product lines expose us to different risks and opportunities. As John has already summarized, we have been able to navigate through a very challenging economic time for carriers because most of our antenna sales are to the enterprise, and demand for our scanning receivers is consistent with reduced carrier CapEx investment.

We are currently being helped by a few trends. More businesses are converting their operations from wire to wireless networks. This is helpful to our antenna business as enterprise solutions utilize VHF and UHF radio frequencies. Demand for greater bandwidth over wireless network also helps drive our business, as does the wireless growth in developing economies.

Our scanning receivers are, for example, being deployed in China and India. These positive trends explain, in part, why we have been able to continue to grow revenues despite a difficult economic environment.

There are unhelpful trends as well. WiMAX is clearly being deployed at a far less aggressive rate than initially anticipated. Most deployments are dominantly last mile fixed wireless offerings.

Mobile WiMAX is still limited to trial status. More importantly, the general business environment characterized by a lack of liquidity is likely to impact negatively our Land Mobile Radio and our in-building growth opportunities among others.

With these potential risks, we believe our attention to our cost structure has already enabled us to do more with less. As John's financial review indicates, we have made progress in leveraging our underlying cost structure. Efficiencies in SG&A have more than offset our increased investment in R&D.

We must continue to develop our highly leveraged sales model, OEM and distributor channels. We believe that over time we will achieve a financial model with OpEx at 30% of revenue. It is our long-term goal to achieve a sustainable operating profit of 15%. We have been successful in achieving this model in two of the past four quarters, we are committed to this goal and we'll take appropriate action to manage our OpEx in response to slower growth.

On the sales front, we released four new antenna products and two new scanning receiver products during the third quarter. In addition to enhancing performance of our SeeGull EX platform, we released a new EX WiMAX scanning receiver that operates at the 3.5 gigahertz frequency band. This will enhance our ability to market our products in Europe and elsewhere.

With respect to our antenna product line, we continue to roll out our new Multi-band GPS Antenna that is compatible with the three major satellite services GPS, Galileo, and Glonass. We also released an integrated GPS timing antenna and receiver that substantially reduces costs for our customers. We continue to build upon our in-building presence with the introduction of a new 700-megahertz antenna for public safety applications.

Finally, we have made some promising inroads into defense applications, specifically ICOM in Iraq, with new wideband UHF mobile antennas. We have been very pleased with several developments in marketing and sales. Although as I will discuss later there is softness in the fully mobile WiMAX market, we're beginning to see reasonable results in the point-to-point and multi endpoint to multi-point WiMAX market.

We shipped 2500 WiMAX sector panels to a major OEM vendor during the quarter, and we are now sole source for several SKUs with another OEM vendor. During the quarter, we also received certification in Russia for our WiMAX antenna product line. We have also witnessed continued growth in Canopy antenna sales into Motorola, which is a proprietary precursor to WiMAX that has benefited from the slower WiMAX deployment.

We had four strong sales events in China. We received our first GPS timing antenna order from a major OEM for an application in China and our first significant CDMA scanning receiver order for deployment in China's CDMA networks. We also secured two new CLARIFY contracts in that country, directly from large carriers, and we sold our GPS antenna for a military application as well.

We continue to grow our presence in Latin America. During the third quarter, we secured our first CLARIFY contract in Chile, and our first scanning receiver order from Nextel International in Brazil. The latter reflects our decision to enter into a licensing agreement with Motorola a few years ago, and to meet the long-term international market requirement to support item-based networks with solid test and measurement tools.

John has already talked about guidance, but I just wanted to add a few comments. While we were pleased that we were able to grow revenue and gross profit margin for the third quarter, it has become clear that the market has softened for at least some of the reasons just discussed. Before I discuss the revenue guidance in more detail, let me briefly summarize these factors.

As we have already mentioned, we expect the business environment will be challenging. Indeed, in the WiMAX space, network operators who intended to offer data-only services have revised their business plans. It is clear that they need to offer a double play of voice and data to realize a reasonable return on their investment. We anticipated $2 million in the WiMAX antenna sales in the fourth quarter that will not materialize this year because of these delays.

We had also anticipated a small bump for our new WiMAX scanning receivers. These orders first moved out of the second quarter, then out of the third quarter, and we now no longer anticipate but now receiving them in 2008. We do, however, believe that we will capture this revenue in 2009. We also reported earlier that we have sold off the remaining antenna products from our Irish operation. While the revenue was small and of relatively low margin, we had some in the forecast for the second half of the year that we will not be able to replace in 2008.

These factors, along with a generally deteriorating economic environment, will result in lower fourth quarter revenue than we originally anticipated. As John indicated, we believe we'll generate between $17.5 million and $18.5 million in revenue in the fourth quarter. As a result, we anticipate revenues of $76 million to $77 million for the year.

We believe that we can achieve the 2009 revenue guidance that John discussed based on new technology deployments that will require our scanning receivers and the pressure on network engineers to squeeze more capacity out of the same infrastructure. We expect our scanning receiver business to grow no less than 10% on a year-over-year basis.

While we expect LMR and public safety business will be flat year-over-year in 2009, we expect 10% to 20% growth in our GPS product line and significant growth in our WiMAX sales, despite the slow rollout of the mobile application for WiMAX, I've already discussed.

Regionally, we still expect strong growth in China and South America. In total, we are forecasting a 3% to 5% growth in antenna revenue.

One area that you all have expressed interest in is our M&A activities. Perhaps some of you saw Jack Welch on CNBC's Morning Call program a few weeks ago. He pointed out that in times such as these you attempt to bury or buy your competitors.

Looking back we are pleased about several decisions that we have made that put us in a reasonably strong position to not only weather but to perhaps thrive in these challenging times.

You will recall that we divested our software group for approximately $64 million, a $62 million gain on our initial investment. You may also recall that we divested the remaining Sigma assets and realized an additional $9 million tax benefit that helped us protect this gain.

While we returned much of this money to the shareholders in the form of a 4 million share buyback for $34.2 million that was completed in October, and a $10.5 million special dividend, we have held on to that asset anticipating that we would soon be in a buyers market.

As of today, we have $75 million in cash and investments, $13 million of which is considered long-term and that John has already reviewed, and we believe that this asset will be extremely valuable to us in this recessionary market as the price of various assets in the industry continues to decline.

We believe that there are many strong candidates for acquisition, and that those targets have limited alternatives in the current environment. We are currently evaluating several of these target companies. Again we plan on making only neutral to accretive acquisitions, and we will focus on relatively small companies, $2 million to 15 million in revenue.

Based on our experience, we are best at integrating operations with those size characteristics. We believe that we have extremely good opportunities to invest a portion of the remaining $75 million.

Despite the current economic challenges, we met or exceeded our objectives for the third quarter. We are extremely pleased to report on our progress and delivering new products, penetrating new markets, and controlling our costs.

We continue to be shareholder focused. This past year, we declared a special dividend, maintained our gross margins during a period of significant cost increases, and continued to support our stock through stock buybacks. We believe that all of these actions have and will continue to lead to increase shareholder value.

While we need to acknowledge the severity of the current economic outlook and its potential impact on our business, we need to remind investors of the positive trends that we are seeing that will contribute to our growth longer-term.

These factors are, more businesses are converting their operations from wire to wireless networks. This is helpful to our antenna business, as enterprise solutions utilize VHF and UHF radio frequencies.

Again, demand for greater bandwidth over wireless networks also helps drive our business as does the wireless growth in developing economies. Our scanning receivers are being deployed in China and India.

Finally, we have a solid balance sheet with sufficient cash to fund working capital, take advantage of acquisition opportunities, and return value to shareholders where we feel it is appropriate.

That concludes my prepared comments and we'll now open the call to take your questions. We have set aside 30 minutes for this portion of the conference call. Jennifer?

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Michael Coady with B. Riley.

Michael Coady - B. Riley & Company, Inc.

Thanks. Good afternoon, Marty and John.

Marty Singer

Hi, Michael.

Michael Coady - B. Riley & Company, Inc.

Marty, could you describe the trend of order bookings in September and then through October? It seems as though we've heard pretty consistently that it was in the last two weeks of September that things fell off. However, different companies, different managements are saying that things actually stabilized after that, although the environment is still uncertain. How would you classify it just in general over the last couple of months?

Marty Singer

You're asking that question for both businesses; the antenna business or the scanning receiver business?

Michael Coady - B. Riley & Company, Inc.

I'll take all detail that you'll provide.

Marty Singer

Well, just by its nature, our scanning receiver business is very, very lumpy. We tend to get large orders from the OEMs, and the timing is never really the kind of timing that allows you get a lot of visibility or to give a clear view on backlog. And our third quarter in scanning receivers actually did not really slow down. It was at a more normal run rate.

You may recall in the last quarter we warned everybody that we had an unusually strong quarter for scanning receivers and there was a particular customer who wanted shipments in the second quarter that normally would have been in the third and even in the fourth quarter. So in terms of the scanners, we're running at about our normal run rate.

In the antenna business, I would say that what we've seen is some softness and what we traditionally refer to as our project business. We have large OEMs that have, let's say, a GPS project for fleet management or so on, and it's been difficult. Here's how we would describe the difficulty. The difficulty is in actively replacing new projects for some of the projects that are turning down. We are replacing them but at a slower rate than we have replaced them in the past.

I wouldn't describe it as a dramatic fall-off in the visibility of our orders but rather the speed with which we can replace the project business. The other answer I would give to you is that a couple of our distributors showed very strong order placement in the third quarter, but we've seen a couple distributors that seem to have a more general problem. I think there's consolidation going on there, and so we've seen a shifting around and a decrease in the volume of business coming from some of our traditional distributors.

I think also that the spike in costs that everybody experienced in the second and third quarter with transportation slowed down business. Independent of anything else you heard about business, liquidity factors and so on, people were placing premiums for freight and transportation. And I think that that people have so much to spend, and if they have to spend it on transportation, the number of units they order goes down. So those were the type of trends we saw, Michael.

Michael Coady - B. Riley & Company, Inc.

Okay. Thanks. I appreciate that level of detail. In terms of the M&A pipeline, you mentioned that you've been active there. Would you characterize anything, I obviously can't say too much, but some near-term opportunities? Are you waiting for price to reach a certain point?

Marty Singer

I don't think we're waiting for the price to reach at certain point. I think, in all these cases, we have pretty frank discussions. I think it's a matter of completing the due diligence.

Michael Coady - B. Riley & Company, Inc.

Okay. John, what do you expect share count to be in Q4?

John Schoen

Expect it to be about 18.5 million.

Michael Coady - B. Riley & Company, Inc.

Okay. Do you have a geographic breakdown of revenues in the third quarter?

John Shane

Typically that's something we do for the Q.

Michael Coady - B. Riley & Company, Inc.

Okay. Thanks for answering my questions. Good luck in the fourth quarter, and good job handling the economic environment.

John Shane

Thanks.

Operator

We will take our next question from Ken Muth with Robert Baird.

Marty Singer

Hi, Ken.

Ken Muth - Robert W. Baird

Hi. On guidance you seem to be talking about a low end of $80 million to $82 million, how confident are you? I know we don't have a ton of visibility, but do you feel that that's your low end, or is that still somewhat of an aggressive guidance?

John Schoen

The range contemplates that we see a first half slightly higher than the guidance that we gave for the fourth quarter. We gave a guidance of 17.5 to 18.5. We see the trend, at least in the first half, as the economy goes through its recessionary throws, to be in the $18 million to $19 million a quarter, which is slightly above where we're at today. These numbers contemplate that there are going to be some things that we see happening in the second half of next year. So I think we're pretty confident that $80 million is a low number.

Ken Muth - Robert W. Baird

Okay.

Marty Singer

And the range, I think, was $80 million to $84 million.

Ken Muth - Robert W. Baird

He is quoting midpoint.

Marty Singer

Yes, midpoint, right.

Ken Muth - Robert W. Baird

And then it seems actually you've done a nice job, even at that lower number your gross margin guidance was 46 to 48. That still seems sufficiently high actually given that the revenues are a little bit lower. Are you doing anything there on additional cost savings, or how are you able to keep the margins at that level?

Marty Singer

One of the comments I made in my remarks, Ken, was that we are really pushing the leverage sales model. I think today we stand at 20 people in the field, and that includes everybody. Not too long ago, it was 25 and we had a whole group of manufacturers reps. Now that we brought Bob Suastegui in about a year and a half ago, and since that time, we've actually strengthened our sales and our sales expense has gone down, and you are going to see some positive results of that in the fourth quarter, full benefit of some of the actions we took in the third quarter.

Those will be rolled forward into next year. We are also going to be making some decisions, Ken, about the allocation of our sales dollars to different regions in the world, perhaps cutting back on some of the more expensive areas and reallocating a portion of those expenses to regions where we feel we can get a better return.

G&A continues to decline. John has done an outstanding job in reducing expenses in IT, in human resources, in treasury, in corporate governance and so on. I will mention that, as you know, I think this past year my salary was frozen. And as we evaluate what our expense structure is for 2009, I think it's quite likely that you will see salary reductions or salary freezes across the entire executive team, reaching down maybe to the top 20 people, so that we can avoid taking some harder losses within, let's say, the factory and we can hit our OpEx target.

I think as we've mentioned now at the last few conferences, and if you go on to our website, our longer-term goal was to get this consistent 45% to 48% gross margin, to get down to 30% operating expenses by 2011 and to become a consistent 15% to 16% operating profit company.

I think we're actually ahead of our schedule. In two out of the last four quarters we've been a 15% operating company. We've been able to keep our margins up above 45%, 46%, and I think by the beginning of 2010 you are going to start to see us at a 30% operating expense company. And that's our goal. Go ahead, John.

John Schoen

Specifically to your question on gross margin, yes, your math would be correct. The closer you get to the low end of the range, the lower you'd also be in the range of the gross margin percent.

Marty Singer

Right.

John Schoen

With respect to leveraging, 46% goes with 80, and 48% goes with 84.

Ken Muth - Robert W. Baird

Okay. And what about the tax rate quickly, John, for '09?

Marty Singer

16% to 18%.

John Schoen

Yes, 16% to 18%. We are going see a slight bump in that tax rate, and the reason is because I was able to, with the disposition of the remaining Sigma product lines, I have less goodwill tax deduction going forward, which I should get on my tax return. So, it’s supposed to 16 point but I would model somewhere closer to 17, maybe 17.5, in that range is most likely.

Ken Muth - Robert W. Baird

Great, thank you.

John Schoen

Okay.

Operator

(Operator Instructions). We will take our next question from Eric Kainer with ThinkEquity.

Eric Kainer - ThinkEquity

Thank you very much for taking may call, and congratulations on a very fine quarter.

Marty Singer

Thanks, Eric.

Eric Kainer - ThinkEquity

We all wish that we had a better environment as we were moving forward, but that's just not the reality of the situation. I wonder if you can talk more specifically, especially to the public sector spending, where you're selling a lot of your antennas. Both domestically and to the extent that you have overseas sales there, what might you be expecting or what might be implicit in your thinking as we roll that forward into 2009?

Marty Singer

Yes. I've been thinking quite a bit about this and trying to align our forecast with reality here, and on the downside, as you know, tax receipts are down, and tax receipts are used for building out public networks. On the other hand, there are not a lot of governors or mayors or other public officials when you look at the TSA or any other part of the Federal Government that has networks that are anxious to be in a position of not replacing antennas when they bend in the wind or not building out those networks that are central to public safety.

So I do anticipate, that the lack of tax receipts are going to mean fewer police cars that are deployed, fewer new fire engines, maybe a slower rate of growth, but that's sort of the blessing and the curse of Land Mobile Radio.

In a great year, it grows 8%, in a bad year it grows 3%. And so maybe a really bad year, it's flat. So I think if you look at half of our antenna business, it's 0 to 3% growth. And that's how we're viewing it. Now, the more promising aspect of that is that the same type of antenna is used for public safety are used in Land Mobile Radio networks, applied to enterprise, for example, SCADA, supervisory control and data acquisition and there is manufacturing operations.

Well, all of those networks are moving from wired to wireless and we'll see a benefit from that. Now, it could be the case that we are going to see some retrenching of spending plans. On the other hand, all of that spending is going to be on wireless and not on the wire. So if you're looking for a part of the market that might not be impacted quite as negatively as all this telecom, I would maintain that we would be in that part of the market that we're likely to see less of a dramatic downturn than other areas.

We're really exploring some interesting opportunities outside the US, in, military networks or the military entities of other countries. And I think that we have some good opportunities there that will be entirely new. So on the downside, Eric, you have tax receipts that are down, leading to less spending. We're not going to be immune to that.

On the enterprise side, for the LMR public safety type of antennas, you have difficulty in getting credit, people spending less, but on the positive side, these are the type of networks that still have go up, still have to be maintained, still have to be refreshed, and again, I don't know a lot of mayors and governors and other government officials that want to see the public safety network degrade.

I'll mention one other element here. I was just in Israel and I won't tell which you company, but there's a company already building base stations for the TV white spaces. As you know, the FCC has taken a pretty aggressive posture here and said all those white spaces at 700 meg can be used for a national public safety network.

And all the people who were complaining that we're in the microphone business or the speaker business, broadcasting within theaters for example, and they've said, it's a bad complaint that it might interfere with your microphones. But we still would like to see these networks used for public safety. Well, that's an entirely new network and I believe that those networks are going to be deployed and that would be very positive for our products.

Eric Kainer - ThinkEquity

You mentioned in your answer there SCADA which is always intriguing to me. How exposed are you to the oil and gas industry and might that provide potentially a little bit of surprise on the upside as we look into 2009?

Marty Singer

Well, that's a pretty good observation, and your question makes me think that I should have mentioned that in our prepared comments. As you know, we made the acquisition of the Bluewave product line back in April. And we're anticipating doing a little less than a million dollars a quarter, and we're actually doing a little better than that. And those are ruggedized jogging antennas that can be used for any number of purposes, but specifically are used quite widely in oil and gas industry.

And for the first time, PCTEL is now attending conferences and exhibitions in that space. And our product, the Bluewave product line has great brand recognition and now with the financial strength that we have, we see a lot more confidence in those buying these products. And I think we could see an upside in that area next year.

Eric Kainer - ThinkEquity

Okay. Thank you very much and good luck as we go forward.

Marty Singer

Thanks a lot, Eric.

Operator

We will go next to Brian Horey with Aurelian Management.

Brian Horey - Aurelian Management

Thanks for taking my question.

Marty Singer

Sure.

Brian Horey - Aurelian Management

I wondered, if you could estimate for us what share of the growth for this upcoming year will come out of emerging markets?

Marty Singer

That's hard to say. The way I look at it is that, right now on the scanning receiver market, about 60% of our business, as best we can tell, is coming from outside the United States. But we have to rely on our OEMs to give us essentially point of sale information, which is something we only get update every six months or so. Of that, 60%, I would say about a third is coming from emerging markets, China, India, Eastern Europe, Russia, other parts of Asia.

Concerning antennas, I think it's safe to say that almost none of our sales comes from emerging markets. The bulk of our antenna sales, over 80%, are in the US and in South America. We have some antenna sales that are made outside of the United States, the other 20%. But once again it's difficult to tell you where those products end up. I'll give you an example. Right now, we're designing an embedded antenna for an OEM base station provider for the WiMAX technology in Israel.

That antenna is embedded and is shipped to some placed around the world. Now, some of those are likely to go to emerging economies, but we can't tell you exactly how many of those are being shipped there, but some are. But in terms of direct sales, the answer would be zero. And then there would be a percentage of our sales in WiMAX, where we're embedding our antennas that we're essentially leveraging an OEM to ship to other places.

Brian Horey - Aurelian Management

Okay. On the list of your worries for next year, there are a lot of different scenarios out there now for what might happen to the emerging markets; they're lagging us in terms of the downturn of the cycle, and things have gotten, depending on the market you're looking at, a lot more dislocated in the last few weeks. On that list of worries, where does a more pronounced downturn in growth in places like China and Russia and India; where does that rank on the list of things that keep you guys up at night?

Marty Singer

I would say, interestingly enough, that is maybe number 10 on my list of things to worry about. And I'll tell you why. If I look at the numbers that John has given you, I break my business almost mentally into a third, a third, and a third. A third for Land Mobile Radio antennas, a third for all other antennas, and a third for scanning receivers.

And if I look at Land Mobile Radio antennas, most of that business is right here in the US, some of it is elsewhere, but a very small amount. If I look at all my other third, WiMAX, WiFi, GPS, the type of business I have there were not terribly exposed to deployment.

We are in WiMAX, but if you look at the whole constellation of our sales, it's still a relatively small percentage. The type of antenna that we have that we'll get great margin for, like a GPS antenna, is used in timing applications or other cellular networks, usually not in emerging countries.

So the first third; LMR, not at all. For the second third; all the other antennas, not at all. Now if I go to scanning receivers, I would say I worry a little there, because some of the scanning receivers are finding their way into China and India, a little bit into Russia, but out of that amount, that $27 million, a third, just broad strokes, not a huge exposure. It's really an upside. Does that help you?

Brian Horey - Aurelian Management

Yeah. That's very helpful color. Thank you.

Marty Singer

Thanks.

Operator

We will take our final question from [Shou Wang with Lotus].

Marty Singer

Hi, Shou. It's been a while.

Shou Wang - Lotus

Hi, good afternoon. Thanks for taking my call.

Marty Singer

Sure.

Shou Wang - Lotus

Do you have a head count number at the end of the September quarter?

Marty Singer

330 with contractors.

Shou Wang - Lotus

With contractors?

Marty Singer

By the way, the fastest growing area of headcount for us has been in Tianjin where we've picked up some of our own antenna projection. Now it's about 40 to 45 people, but 330, 335 with contractors, and our headcount is actually down slightly second quarter to third quarter.

Shou Wang - Lotus

It may be a little bit early. As you are going through the budgeting process, do you have a sense as to what that might be, say at the end of 2009?

Marty Singer

What I said is, I'm not anticipating right now layoffs, or reduction in staff. I think that we're going to be able to deliver what we need to deliver in terms of earnings and profit. Taking the actions that I discussed in my earlier comments, we continue to work on delivering a more highly leveraged sales model, better gross margin performance, and we plan to first tax those who can afford the tax in our company. John, I , and other executives, are looking at either a freeze or salary reduction, and then a broader freeze in some areas of our business.

And then as I said, continued focus on G&A expenses, continued focus on sales. So right now we're not anticipating dramatic actions there. We're certainly looking at it carefully, but we think we can achieve our model with the current budget that we're laying out.

Shou Wang - Lotus

On the interference detection patent issue, could you provide a little color on what you think the legal expenses associated with that, or is it not that large?

Marty Singer

Right now they are immaterial. And the first thing we're trying to do is to make sure that we're dealing with others who have legitimate patents. And we believe that in this particular case, the intellectual property that has been proposed is legitimate. We've been proven right the first time. All 13 claims were eliminated and we are very confident of our current appeal on a second patent. And after we have a correct understanding of the intellectual property strength of these industry participants, then we'll assess where we want to go with that.

But right now, asking for reexamination in front of the USPTO, is perhaps one of the most cost-effective things we can do in the IP world. It's not litigation, it's an administrative procedure.

John Schoen

And just to be clear, these are people that are using our intellectual property, not the other way around.

Shou Wang - Lotus

I understood.

Marty Singer

Yes. I think he knows what is in the press releases.

Shou Wang - Lotus

If I think about, if this goes the way you think it would go, could we see an increase on the G&A line for litigation expense around three or four quarters out?

Marty Singer

I wouldn't comment on that because, for two reasons. Let me just say I don't know, and the third, anything I would say in the conference call like this is going to be reviewed by parties on the other side, and I don't want to discuss what my actions are going to be at this time.

Shou Wang - Lotus

Thank you.

Marty Singer

Okay. Jennifer, are there any other questions in queue?

Operator

That was the final question.

Marty Singer

Okay. Well, I thank all of you for your participation in our call, and we look forward to discussing our results at our next earnings release call. Thank you.

Operator

Ladies and gentlemen, a replay of today's conference will be made available beginning at 8:15 PM Central Standard Time running through October 31, 2008, at 8:15 PM Central Standard Time. You may access the replay by dialing 719-457-0820, or toll-free 888-203-1112, and entering passcode 7490917.

This does conclude today's conference. We thank you for your participation. You may now disconnect.

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