PCTEL Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.31.13 | About: PCTEL, Inc. (PCTI)

PCTEL (NASDAQ:PCTI)

Q2 2013 Earnings Call

July 31, 2013 5:15 pm ET

Executives

John W. Schoen - Chief Financial Officer, Principal Accounting Officer, Vice President and Secretary

Martin H. Singer - Chairman and Chief Executive Officer

Rishi Bharadwaj

Analysts

Matthew S. Robison - Wunderlich Securities Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the PCTEL Second Quarter 2013 Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes.

I'll now turn the call over to John Schoen, Chief Financial Officer.

John W. Schoen

Thank you, all, for joining us today, July 31, 2013, for the PCTEL financial results conference call for the second quarter 2013. On today's call will be Marty Singer, Chairman and CEO; and I'm John Schoen, Chief Financial Officer.

Before we begin, I would like to read our Safe Harbor Statement. Today's call will contain forward-looking statements within the meaning of the Federal Securities Laws. Comments concerning our future financial performance, new products and features, product development, acquisition efforts and expectations regarding the future growth of our wireless RF business, are forward-looking statements within the meaning of the Safe Harbor. Actual results may differ materially from those projected as a result of risks and uncertainties, including the ability to successfully grow our wireless products business, implement technologies and obtain protection for the related IP. Additional discussion of these and other factors affecting the company's business and prospects is contained in our periodic SEC filings. These statements are made only as of today, and we disclaim any obligation to update information to reflect subsequent events.

I would now like to turn the conference call over to Marty Singer.

Martin H. Singer

Thank you, John, and good afternoon to all of you. Let me recap some of the non-GAAP highlights from the quarter. We achieved revenue of $26.7 million, an increase of 34% over the second quarter of 2012. This is our fourth consecutive quarter in which we generated over $25 million in revenue.

Gross profit margin was 41%. Operating margin from continuing operations was 9%. Net income was $2 million or $0.11 per diluted share. And cash and investments were $51.5 million.

Now I'm going to turn the call back over to John, who will discuss our financial performance in some detail. Later, I will comment on some of our business development, engineering and marketing efforts over the past quarter, as well as some of our current activities.

John W. Schoen

Great. Thank you, Marty. Our investors will note that the company presents non-GAAP financial information in its earnings releases. The company believes that presentation of gross profit, operating profit, and net income, excluding expenses for restructuring, gain or loss on sale of assets or legal settlements, stock-based compensation, amortization and impairment of intangible assets and goodwill and noncash-related income tax 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 of 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, pctel.com, under Investor Relations. My discussion of the results will be based on our non-GAAP financial results.

Let's turn to revenue. Second quarter 2013 revenue was $26.7 million, an increase of 34% over the same period last year. The asset acquisition included in our Connected Solutions segment accounted for 22% growth, with the remaining 12% contributed by our existing pre-acquisition products and services.

As a reminder, the company began operating in 2 reporting segments starting January 1, 2013. Our Connected Solutions segment is comprised of our antennae and site solutions products, and our RF Solutions segment is comprised of our scanners and related Network Engineering Services.

From a reporting segment perspective, Connected Solutions revenue was $19.2 million, up 30% from the same period last year, reflecting the acquisition in July of last year.

Our RF Solutions segment revenue was $7.6 million, up 46% from the same period last year. All growth was organic, and reflects established product lines and services in the RF Solutions segment.

Revenue was up significantly in both scanning products and Network Engineering Services. The increase in scanner revenue is attributed to carrier spending increasing from a low point in 2012.

The Network Engineering Services revenue growth is attributed to the rapid growth of the in-building wireless network expansion.

Now let's turn to gross profit margin. Non-GAAP gross profit margin for the second quarter was 41% as compared to 44% in the same period in 2012. As expected, with the acquisition of Network Engineering Services in 2011, and the site solution assets in July 2012, the company's gross margin profile is now in the range of 38% to 41%. Stated differently, the gross margin decline from previous years reflect scanning receiver sales comprising a smaller portion of total revenue.

From a segment point of view, Connected Solutions gross profit margin was 31% compared to 35% in the same period last year. The change is attributed to the acquisition of site solutions products, which carried lower margins than our antenna products.

On a pro-forma basis though, as if the site solutions acquisition had taken place on January 1, 2012, the gross profit was up 2% from 29%.

RF Solutions gross profit margin was 65% in the quarter compared to 69% in the same period last year. The gross margin change reflects the increasing contribution of Network Engineering Services revenue to this segment.

Now let's turn to non-GAAP operating expenses, which were $8.5 million in the quarter, an increase of approximately $1.8 million or 28% from the same period last year. There are 4 areas contributing approximately $1.5 million of the increase. $550,000 for the site solutions operations, which we acquired in July of last year; $500,000 for variable compensation under the company's annual incentive plan, which paid out 0 last year; $250,000 of legal fees related to the TelWorx matter; and $200,000 in additional scanning, research and development.

While operating cost increased in total dollars as a percent of revenue, operating costs declined 1% from the same period last year.

Non-GAAP operating margin from continuing operations in the second quarter was 9% as compared to 11% in the same period last year. The change reflects a 3% decline in gross profit percent, partially offset by a 1% improvement in operating costs.

As previously discussed, the company's site solutions acquisition in July 2012 has lower gross profit and lower operating costs profile than the existing businesses.

Non-GAAP other income was $8,000 in the quarter. If the amounts are largely interest on our investments, the number will continue to be small in the current interest rate environment. The non-GAAP income tax rate in the quarter and the year was 18%, unchanged from 2012.

Non-GAAP net income from continuing operations for the second quarter was $0.11 per share compared to $0.10 per share in the same period last year. The increase is attributed to higher operating profit.

Now let us turn to the balance sheet. Cash and investments ended the second quarter at approximately $51.5 million, about $500,000 lower than the previous quarter. In the quarter, the company generated approximately $1.2 million of cash flow from operations and spent $0.7 million in capital expenditures and $1 million for both stock buyback and the regular quarterly dividend. This resulted in a $0.5 million sequential quarterly decline in cash and investments.

Depreciation for the quarter was $667,000. The company's use of cash for dividends and stock repurchases, where it makes sense, represent an important part of our shareholder value proposition. Over the last 11 years, the company has paid out over $14 million in dividends and invested over $68 million to acquire 8.7 million shares at an average price of $7.90.

Now I would like to discuss guidance for the third quarter 2013. We anticipate third quarter revenue to be in a range of $26.5 million to $27 million. We anticipate gross margin of 41%, and operating cost similar to or slightly lower than the second quarter. Our OpEx continues to be negatively impacted by continuing ERP costs, legal expenses and potential bonus accruals. This favorably impacted by restructuring of the North Carolina operations. We will realize the full benefit of the restructuring in the fourth quarter. Other income is expected to remain constant in the third quarter. The non-GAAP effective income tax rate is expected to remain unchanged going forward at 18%, the fully diluted share count in the second -- in the third quarter is expected to be about the same as it was in the second quarter of 18.1 million shares. That concludes the financial review. I would like to turn the call over to Marty for his summary comments.

Martin H. Singer

Thanks, John. My comments this afternoon will be extremely brief. I want to address certain operational changes that have had positive implications for PCTEL's profitability going forward. I'll discuss a few highlights in our 2 segments and describe what we see for the rest of the year.

Not too long ago, we were together discussing the issues related with our acquisition in North Carolina. Site solutions revenue per quarter is consistently above $4 million. We recovered damages last quarter and committed that we will move quickly to drive synergies, utilizing our facility and resources in Bloomingdale. I am pleased to report to our shareholders that this transition is close to completion. There is no manufacturing or distribution left in North Carolina, and by September, we will have reduced the headcount from 49 to 23, with approximately 15 people located in the Winston-Salem region. We have leased a new office that will cost us about 25% of what we were paying for the existing plant. More importantly, we are driving higher gross margins by focusing on larger and more profitable opportunities that are closely related to our core antenna product line. By year end, we will have increased gross margin by at least 5% for the product lines acquired last year.

We have been very pleased with the positive response to our EXflex scanning receiver. The ability for customers to select, as needed, product capabilities, spectrum compatibility and cellular technology is a game changer. The product eliminates the risk of obsolescence and appeals to a new market. Engineering service companies who prefer OpEx to CapEx investments. Our focus on in-building within RFS and Connected Solutions continues to drive new business. Revenues have quadrupled since their first quarter with us. Their work has led to additional antenna and scanning receiver opportunities. And on a recent trip down to our engineering services headquarters in Melbourne, Florida, I approved an expansion of our office space. This is a growing business.

Our SeeHawk IBTS announcement expands upon our in-building tractions. We have a great visualization tool that helps engineers and facility owners or neutral host providers to understand their RF environment. We anticipate stronger scanning receiver sales related to our in-building activities.

All of this is with a backdrop of expanding our opportunities for LTE and TD-LTE test and measurement equipment. I will be visiting China later this year and the General Manager for RFS, David Neumann, is actively involved in promoting our scanning receivers solutions in China, which hosts the largest cellular networks in the world. You can learn about the unique LTE characteristics of our scanning receiver solutions by replaying the very well-attended webinar on maximizing the value of LTE drive testing that we hosted on July 9.

Connected Solutions continues to build its business by sharpened and consistent focus on vertical markets. We began delivery of an upgraded solution into Kaiser's mobile pharmacy cart application and expanded our work on the New York City subway network, which we highlighted during our last earnings call. Our multiband timing antenna covering GPS and Russian navigation satellite standards is now being sold into Russia for LTE timing applications and we have a highly-specialized GPS antenna being sold into Raytheon.

Our vertical marketing and in particular, our in-building focus aligns PCTEL with large OEMs who provide industrial-strength, WiFi base stations. We are now an active participant in the Cisco Live exhibition and our sales to Cisco and other OEMs continues to grow.

On the utility and Smart Grid side of the business, we also attended the UTC Telecom show, and we are now working on a new funnel of $10 million to $15 million in vertical market opportunities. These opportunities include site solutions that we provide to turnkey resellers to the carriers.

Our efforts to expand our Connected Solutions market include regional expansion. Daniel Laredo, who heads up our EMEA offices out of Israel, recently added an experienced sales professional to promote our sales in Europe. This will be our first antenna-focused sales presence in Europe in quite some time. We believe that there are significant opportunities in Germany, Northern Europe, Russia and Eastern Europe.

As John indicated, we are on pace to achieve $105 million to $107 million in 2013 if we continue to generate between $26 million and $27 million in revenue per quarter.

Our second half is typically stronger than our first half, and we've achieved $51.8 million in the first half of 2013. We anticipate small incremental improvements in gross margin for the remainder of the year, and anticipate that the third quarter will be similar in revenue and gross margin to the second quarter. This will be the fifth consecutive quarter in which we exceeded $25 million.

Indeed, it now appears that we have 2 segments. Connected Solutions and RF Solutions, both with more predictable performance ranges. We see Connected Solutions generating $19 million to $19.5 million a quarter, and RF Solutions generating $7 million to $8 million a quarter. Our focus is to develop new business that moves us to a higher quarterly revenue benchmark for 2014. We look forward to meeting with many of our investors during August. B. Riley is actively putting together a nondeal roadshow to reacquaint their clients with PCTEL and we encourage investors to participate, since we are not scheduled to participate in any of the September investment conferences.

Our first regional focus will be in Dallas. We'll be showcasing our products, however, at ION GNSS, which is a GPS technology show in Nashville, and LTE Asia in Singapore.

With that, we've concluded our prepared remarks and have set aside 30 minutes for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Matt Robison from Wunderlich.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

First, Marty, pretty stunning performance from RF Solutions. How do you -- how should we look at the mix in the next couple of quarters? Is it pretty much the same as the second quarter?

Martin H. Singer

I would say roughly 4:1, maybe slightly less if the indoor engineering business continues to grow. We did have a record bookings and billing month in July for that business. So they're off to a good start. Still, I think somewhere between 3.5 and 4:1 is the proper ratio. It's highly dependent on the speed with which the TD-LTE business materializes in China. Right now, we are shipping product for early test and deployment, but we are not yet near the point where we really see the potential for a flood of new orders.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

So 3.5:1, the 4:1 implies kind of a return back to something more like the first quarter in terms of mix?

Martin H. Singer

No, really, like the second quarter.

John W. Schoen

Like the second quarter.

Martin H. Singer

Second quarter was 4:1.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

I'm looking at a chart that says something a little bit different than that with 19.2 for connected and 7.6 for...

Martin H. Singer

You asked me the ratio of scanning receivers to engineering services. You're now asking me about Connected Solutions.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

I didn't know. I must have misspoke.

Martin H. Singer

Okay, so here's what it is. It's roughly 4:1 within RFS, scanning receivers to services. It is roughly 2.5, maybe 2.6:1 Connected Solutions to RFS. And that could decline. We see some opportunity as we said for growth in both the scanning receivers and the engineering services.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

Okay. So we should also, I guess, expect maybe something like double the -- more than double the operating contribution from RFS versus Connected?

John W. Schoen

Yes. As you look in the segment information we provided, you've got one segment at roughly 35 or 31 points of margin and the other one at 65 points.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

Yes, right. So basically do you anticipate at least, in the back half to kind of have a replay of the mix between the 2 major divisions that you saw on the second quarter, it sounds like?

John W. Schoen

Well, I would expect the ratio to be -- to repeat itself in the third quarter that you saw in the second quarter, Connected Solutions to RFS. And with -- usually, the fourth quarter is the strongest quarter for RFS.

Martin H. Singer

And so, we'd see a decline then in the ratio of CS to RFS.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

Even more pronounced than, okay.

Martin H. Singer

Correct.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

John, your accounts payable days was the lowest since 2010, and it looked like that was maybe the principal reason why the operating cash flow was not as strong as adjusted income?

John W. Schoen

Yes, yes. At the end of the day, what we're -- what we have is we're making great inroads at filling big OEMs like Cisco. And I've got a mismatch between what their contractual terms are and what mine are. And the vendors that we use for them, basically Cisco paid 90 and I get 60 on that. Then as we -- more and more of our COGS are related to that mismatch, my payable days are getting out of whack compared to receivables. First of history.

I would expect it to remain stable now to where you saw Q2.

Matthew S. Robison - Wunderlich Securities Inc., Research Division

So we should have a little bit of a bounce back in operating cash flow?

John W. Schoen

Yes, yes.

Operator

[Operator Instructions] Your next question comes from the line of [indiscernible] from B. Riley & Co.

Unknown Analyst

My first question is how do you see the growth of in-building in DAS impacting your service and product portfolio?

Martin H. Singer

That's a great question. As you know, [indiscernible], we have been really focused on our in-building thesis. It possibly impacts all 3 of our concentrated business activities. Antennas, such as the antennas that we put into the New York subway. Engineering services, where we provide design, benchmarking and in some cases, commissioning of installations, looking at the impact of those design changes. And quite frankly, the use of our scanning receivers in in-building applications. So we believe that the growth of in-building will lead to greater DAS deployments, which will allow us to sell cables, connectors, amplifiers, enclosures and antennas and provide educational services and test equipment. I actually have Rishi Bharadwaj here, who's the Vice President of our Business Development and Marketing, do you have anything to add to that, Rishi?

Rishi Bharadwaj

Well, you're seeing a pretty strong uptake in our in-building deployment. And you have seen with us going through Cisco and several other OEMs as well. And that's quite consistent with our interaction with direct users.

Martin H. Singer

Yes. One really good measure of this, [indiscernible], is that if you look at what Ericsson paid for BelAir, they paid 6x BelAir's revenue. Not 6x EBITDA, but 6x their revenue. And the reason Ericsson did that is they were looking at what they had in their in-building portfolio to meet the -- just skyrocketing opportunity for in-building so they could compete with Cisco, so they compete with other infrastructure providers. And I think that's a measure of the excitement about the growth in this area.

Unknown Analyst

All right. All right, my second question is what's the update on EXflex, since you have introduced the scanning receiver to the market?

Martin H. Singer

That EXflex is based on our scanning receiver model EX -- SeeGull EX and the flex and the uptake has been very strong. We sold in the neighborhood of 50 of them soon after we announced this. We believe that the EXflex could become our flagship product, as we not only sell into our traditional markets in particular Ascom, who has long requested a scanning receiver that was less vulnerable to obsolescence. But in addition to that, we believe that now, we are going to expand on our small sales historically, into service engineering groups. So when you think about people like Crown Castle, American Tower, LCC, Sellplan, Rama [ph] and then construction-type companies who have gone into this area like Multiband, Goodman, Connectivity Solutions, all of those types of organizations would prefer not to make capital expenditures. They would prefer to make OpEx expenditures in real-time that they could pass on to their customers. By having the EXflex, where you can rent the technology or the spectrum or the particular set of capabilities that you need, it allows them to match those changing monthly expenses to their changing revenue profile, and that's where we think it's going to really be an important product line for us.

Unknown Analyst

Perfect. And my last question is, also it looks like TD-LTE time has finally come in China. So what's the expected impact of TD-LTE to PCTEL?

Martin H. Singer

Well, just look at the number of subscribers for, let's say, Verizon. If Verizon had every single person in the United States, it would have roughly 280 million subscribers, well, it's less than that. China Mobile reports over 600 million subscribers and some people believe that's rapidly going to 1 billion. It dwarfs any other operator on the planet. So if we take what our typical sales could be to Verizon in a year, our sales to China Mobile could be 4 to 5x greater than that for our scanning receiver product line. Now clearly, we have barriers there. There are local Chinese suppliers, the scanning receivers. There are local Chinese engineering groups that will have a bias towards some of the local providers but still, we believe that we are in the shortlist at every national and regional competition for our scanning receivers and these scanning receivers are going to cost some place between $15,000 and $30,000 a piece, and we'll be working closely with our strategic OEMs, such as Ascom and -- who is our primary outlet at this point and a very, very important partner as we move into these new markets, but also we do sell directly to Huawei and to other entities in China.

Unknown Analyst

So as of now, do you have any final agreement in place or contracts in place with the other providers?

Martin H. Singer

This is not like our antenna business where you have longer-term contracts with the distributor or within OEM. Historically, if you follow our business, there is a very short-term backlog for scanning receivers and these are done on a PO-by-PO basis, in large part.

Martin H. Singer

Thank you very much, and we look forward to working with you in the future as you help out Mike in this area. Okay, operator, I don't believe that there any other questions, is that right?

Operator

There are no further questions at this time.

Martin H. Singer

Well, I want to thank all of you for participating in this call, and we look forward to meeting you in August on our nondeal roadshow, and at industry conferences and exhibitions, and we'll update you at our next earnings release conference call. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect.

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