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TESSCO Technologies, Inc. (NASDAQ:TESS)

Q1 2014 Earnings Call

July 25, 2013 10:00 am ET

Executives

Harriet C. Fried - Senior Vice President - New York Office

Robert B. Barnhill - Founder, Chairman, Chief Executive Officer, President and Member of Risk & Strategy Committee

Aric M. Spitulnik - Principal Accounting Officer, Vice President, Corporate Secretary and Controller

Analysts

Steve Shaw - Sidoti & Company, LLC

Thomas Kerr - Singular Research

Operator

Good day, ladies and gentlemen, and welcome to Q1 2014 TESSCO Technologies Earnings Conference Call. My name is Delou, and I will be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Ms. Harriet Fried of LHA. Please proceed, ma'am.

Harriet C. Fried

Good morning, everyone, and thank you for joining TESSCO's First Quarter Fiscal 2014 Conference Call. With us today from management are Robert Barnhill, Chairman and Chief Executive Officer; and Aric Spitulnik, Vice President, Principal Accounting Officer and Controller.

Management's discussions this morning will contain forward-looking statements about anticipated results and future prospects. Forward-looking statements involve a number of risks and uncertainties, and TESSCO's results may differ materially from those discussed today. Information concerning factors that may cause such a difference can be found in TESSCO's public disclosure, including the company's most recent Form 10-K and other periodic reports filed with the Securities and Exchange Commission.

To supplement the company's consolidated financial statements, the company is using certain non-GAAP financial measures in today's conference call. A reconciliation of these financial measures to GAAP is provided in the company's press release.

With that introduction, I would like to turn the call over to Mr. Barnhill. Please go ahead, Bob.

Robert B. Barnhill

Thank you, Harriet, and good morning to everyone. So this first quarter and fiscal year 2014 was the start of a new chapter for TESSCO. First, I'm very pleased with our numbers, especially our 18% core revenue growth and the $0.51 in earnings per share. I believe, as you know, during the fourth quarter of fiscal year '13, we successfully completed our transition out of the high-revenue but low-margin 3PL business with the Tier 1 carrier. So this quarter, we were essentially cold turkey. It was our first quarter where we can focus exclusively on being the total source of the product solutions to build, use and maintain wireless systems.

So our results for the quarter showed a promise of the intensified focus. Earnings matched last year's first quarter, and this was without the benefit of the former 3PL third-party logistics relationship, which contributed $70 million in revenues and $5.4 million in gross profit contribution for the first quarter of last year. So a tremendous achievement that we made.

So these results really underscore what I said in last earnings call, and want to emphasize again, that our business is now strategically stronger, with higher margins and low customer concentration. In fact, in the first -- in this first quarter, no single customer contributed more than 6% of our revenues and our margin showed the strength of our value proposition.

So during the quarter, we were particularly effective in achieving an amazing 87% revenue increase in our public network operator customers. And again, I want to -- it was 87% over last first year (sic) [quarter]. So the strong growth was a result of the carrier's aggressive spend to enhance their systems to meet the insatiable demand for wireless broadband coverage and capacity.

So while this market is robust right now, we believe that we've also been very successful in expanding our market share. We had especially good success with the fiber-to-the-tower solution with a good mix of carriers, and this solution involved putting the radio head on the top of the tower rather than at the bottom of the tower in a shed, and running fiber cable from the -- up to the radio heads. And what this does is it reduces the weight load from using heavy coax cable and also increases the signal strength efficiency of the radios themselves. Also we're delivering directly to the job site our value proposition of all the products required, everything kitted and ready for immediate use.

So this is the fourth straight quarter of significant year-over-year growth in the public carrier market. We don't expect to see these types of growth percentages, but we do expect continued strong performance in this market at least through the remainder of this calendar year.

Another highlight of the quarter was a 37% growth in the sales of our Ventev products, which are -- these are the products that we design and manufacture to fulfill what we find as the unmet market needs. There's 2 pieces of Ventev. One is the infrastructure side, and then the mobile accessory side. On the wireless infrastructure side, we offer Wi-Fi infrastructure, which is cable, the enclosures, antennas. And then on the base station infrastructure side, cables, power and integrated systems. Here, our growth was driven by achieving larger purchases of some of the big -- bigger site build outs in the public carrier market and also gains we made in education and hospitality industries, and then finally, introducing a new line of outdoor access points.

On the mobile accessory side, we offer cases and protection, chargeable cases, portable power chargers, power hubs, cables and headsets. And here, our growth was reflective of the success of our Ventev power line of products we debuted in the second half of the year. These products received excellent reviews from our retail store customers, consumers, the press. And now we've started to see the conversion of these great reviews into store placement and to sales.

The private system and government market still is not showing -- is still showing a decline year-over-year, but we did see some minor sequential growth. Much of our purchases that are coming from these customers are flowing through our resellers and integrators. And going forward, we'll be developing a reporting system that will reflect the end market and end customers, so we can see the efforts of -- see the results of our efforts and see the actual sales that are coming from this marketplace, which we still believe is going to be a major growth driver for us.

Overall, we are confident in our ability to remain -- to generate strong results. We're reaffirming our guidance that we provided for fiscal year '14 and that being an earnings per share of $1.75 to $2.05. And again remember that this is without the benefit of any lift that we had last year, which was $213 million of the 3PL revenues and $15 million of gross profit contribution, all of which is again transitioned out.

Also, as we announced yesterday, we set the pay date for the $0.18 quarterly dividend. It will be paid on August 21 to shareowners on record of August 7. So with that, I'll turn it over to Aric to give you some details on the financials. Aric?

Aric M. Spitulnik

All right. Thanks, Bob. Good morning. We're extremely pleased by our strong start to this fiscal year. Being able to make up the profit contribution of $70 million dollars of 3PL revenues from last year, this is a significant accomplishment. Before I discuss the quarter, I wanted to let you know that we have changed our segment reporting. At the beginning of this fiscal year, we reorganized internally, and therefore, we no longer break out our teams into Commercial and Retail segments. So starting this quarter, we will only have 1 reporting segment. We're continuing to show revenue and gross profit results by each of the markets and products, so nothing has changed there.

Also, I wanted to point out and echo about the fiscal year being a difficult comparison on the basis of revenues alone. The transitioned 3PL business generated over $200 million in revenues last year. While this quarter demonstrates our ability to largely make up the gross profit and earnings from that lost revenue, we will show overall revenue declines for the next several quarters. As Bob said though, our business is strategically stronger, with higher margins and very low customer concentration.

So let's go over the first quarter in more detail. Revenues were $144 million. The core revenues, which exclude the 3PL relationship, were up 18%, while the overall revenues had declined 25%. Gross profit for those core customers was also up 18%, so our gross margin remains steady.

At the same time, the transition of the low-margin 3PL business is driving increase in overall gross margins from 18.4% to 24.6%. Gross profit dollars were essentially flat, so we made up last year's $5.5 million 3PL contribution with core gross profit in this quarter.

SG&A was also essentially flat, primarily a result of lower marketing expenses associated with the 3PL business, offset by some higher new business generation costs, including compensation. Accordingly, our Q1 operating income, net income and earnings per share were all steady from last year. Operating income was $7 million, net income was $4.3 million or $0.51 per share, and EBITDA was $8.2 million or $0.98 per share. However, on a percentage basis, operating margins rose from 3.6% to 4.8%, net income margin rose from 2.2% to 3.0%.

So a little more detail on the market results. As Bob said, we're very proud of the results we drove in the public carrier market, as we continue to execute our strategy of increasing our involvement in system builds. While we do not -- while we continue to see increased activity in the market, we are also winning a higher market share. Revenues grew by 87% and gross margins by 77%. We continue to see solid growth in the commercial dealers and resellers market with 14% revenue growth and 16% gross profit growth.

The private system and government system operators market posted a 6% decline and a 4% gross profit decline. However, as we said, we did see some small revenue growth sequentially in that market. We still see major opportunities here, and as Bob said, we're seeing some of the sales in this market going over to the commercial retailers, as they're using integrators more and more.

In our retail market, revenues and gross profit increased by 4% and 9%, respectively. Sequential revenues grew 16% over Q4. So we continue to be very strong serving those independent carrier agents and other retailers, with exceptional customer service and high value add.

So onto the balance sheet. We did have some significant investments in inventory this quarter. Inventory grew about $6 million, mostly to support these builds that are going on in the public carrier market. So we feel like we need to have the inventory on hand in order to sell it, given that the carriers aren't holding any of that inventory themselves. So this is high-dollar inventory that we're holding a little longer than we normally do. But again, we believe it's essential to the strategy of growing the market share in that space.

Because of the increased dollars and slow return in inventory, we had a balance of about $9 million under our $35 million revolving line of credit. Overall, we used just over $10 million of cash from operations during the quarter, caused in part mostly by inventories, while AC has also come down some. We also paid our bonuses from last year during this quarter and that was about $7 million. We believe our cash position will improve significantly as the year progresses.

As Bob mentioned, we reaffirmed our guidance for 2014 in the range of $1.75 to $2.05. So $0.51 first quarter was a very nice start to achieving that range. We are very proud of this quarter and we've made great progress in our core business and there are many growth opportunities in front of us this year. Thank you. And operator, we'll now open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Steve Shaw of Sidoti & Company.

Steve Shaw - Sidoti & Company, LLC

Bob, can you talk about -- a little about the progress in the hospitality business that you mentioned?

Robert B. Barnhill

When we call hospitality, we're looking at cruise ships, looking at theme parks, and we continue to see some very exciting things that are happening in this market, where they're building the Wi-Fi systems out to serve their customers, as well as take care of their own internal business. Aric, do you got any -- I mean, it's an exciting market for us. In fact, we're rebuilding and reinforcing our sales teams to focus exclusively on that channel.

Steve Shaw - Sidoti & Company, LLC

Okay. And then, last we spoke, I think the new line of chargers were in trial sales. Are we beyond that yet?

Robert B. Barnhill

Yes, we're beyond that. We've got new products coming behind it. It's being very well received by the trade, want the product, the product performance, the appearance and the packaging is very appealing to the retail stores. So we've got a whole roadmap of new products that are coming behind it. We just launched the charging case, which is again, being met with great, great success. So that's part of that growth that we saw year-over-year in Ventev, totally.

Operator

The next question is from the line of Tom Kerr of Singular Research.

Thomas Kerr - Singular Research

Just on the increase in inventory in the lines of credit, what's the timing that gets reversed? Is it a next quarter deal or does it play out over the fiscal year in terms of seeing it down and as you normalize?

Robert B. Barnhill

A lot of it, again, is reflective of our anticipation of the sales that are coming. So we'll be continuing to invest in the inventory for future sales, so...

Aric M. Spitulnik

Yes, I think a lot of it will come down in Q2. It may not reverse all the way to positive, but I think we will see some kind of significant reduction in the line of credit this quarter.

Thomas Kerr - Singular Research

Still sort of the policy to be -- have low levels of debt and not maintain $10 million to $15 million of debt?

Aric M. Spitulnik

Right. That's where we intend to be, and we think we will be there if not by the end of next quarter, most likely in the following quarter.

Thomas Kerr - Singular Research

And was there any other working capital items that affected the cash decrease or line of credit increase besides the inventories?

Aric M. Spitulnik

There is the inventory and the payment of last year's bonuses. So when we pay annual bonuses, they all get paid in the first quarter. There's a lot of taxes and things associated with that as well. So that all comes out in the first quarter.

Operator

[Operator Instructions] Sir, we have no further question in the queue. I would now like to turn the call over to Mr. Robert Barnhill for any closing remarks.

Robert B. Barnhill

All right, thank you. Thank you for joining us today. We're obviously in a very exciting marketplace, as I've said before, in my years, it's probably the most exciting, exciting time that I've ever seen with all these new opportunities being created. I know that our Q1 results also show the real promise of us continuing to execute on our value proposition. So as we -- just to reiterate, our goal is to accelerate this year the expansion of our customer base and the relationships, to introduce new products and new product solutions and continue the enhancement of the margins and returns. And so we're very energized by our results and the opportunities we see, and look forward to giving you an update in the fall. So thank you again for your support and thanks for being on the call. Have a great day.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference call. You may now disconnect. Enjoy your day. Thank you.

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