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TESSCO Technologies (NASDAQ:TESS)

Q2 2014 Earnings Call

October 24, 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 - Chief Financial Officer, Principal Accounting Officer, Vice President and Corporate Secretary

Analysts

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Fiscal 2014 TESSCO Technologies Inc. Earnings Conference Call. My name is Ashley, and I will be your coordinator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Ms. Harriet Fried with LHA. Please proceed.

Harriet C. Fried

Good morning, everyone, and thank you for joining TESSCO's conference call. With us today from management are Robert Barnhill, Chairman and Chief Executive Officer; and Aric Spitulnik, Chief Financial Officer. 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. With that introduction, I'd like to turn the call over to Mr. Barnhill. Please go ahead, Bob.

Robert B. Barnhill

Thank you, Harriet, and thank you, all, for joining us today. First, I'd like to announce Aric Spitulnik, that I'm sure you've all heard from over the past several quarters, that he was elected to the position of Chief Financial Officer. Aric joined TESSCO in 2000, and he served as the company's Controller since 2005. Over the past year, he had an expanded role in all financial and strategic areas of our business. So I'm very delighted to recognize his contribution and talent with this appointment, and I'm confident that his in-depth knowledge and experience will contribute to our ongoing success. So congratulations, Aric.

Aric M. Spitulnik

Thanks, Bob.

Robert B. Barnhill

As you know, TESSCO started a new chapter at the beginning of this fiscal year. And during this, our second quarter, we made great progress transitioning our business to single focus on being a total solutions provider, and replacing the profit contribution from the $213 million in annual revenues we generated from a third-party logistics relationship, that we all know ended in fiscal year of '13.

As you look at our results, the 59% growth in purchases from our public network operator customers and the 22% growth in the sales of our Ventev proprietary products, really demonstrate that our customers recognize the benefit of a partner that can bring the right products and solutions together to deliver everything that is required to build, use and maintain wireless systems when and where they need it at the lowest total cost. The strong 59% growth from our carrier and tower owner customers is a result of the aggressive spends that they're making to enhance their systems and meet the surging demand for wireless broadband coverage and capacity. The market is very strong right now, but we also believe that we're being successful in expanding our market share through deliberate focus on selling full solutions and our outstanding offering and execution.

The 22% growth in the sale of our Ventev proprietary products came from both the infrastructure and the mobile accessory side of this division. This division is where we design and manufacture products that fit unmet market needs. Ventev infrastructure introduced several new products, outdoor WiFi antennas that support the major radio manufacturers access points in very challenging environments. We also introduced compatible antennas in support of the new 802.11 AC radio technologies. And we're having great success in education, health care, enterprise markets, oil and gas and utility, in addition to our carrier and VAR markets. On the Ventev mobile accessory side, we continue to expand our business with the introduction of several new mobile device accessories, primarily cases and power, and we made continued penetration into current accounts and we developed our new markets and new customers. Our product -- power product such as wall chargers and car chargers, backup battery cases drove much of the growth. Probably, if we maintain strong carrier customer and Ventev results, our goal is to expand this level of success into our other customer markets, namely the industrial and enterprise system operators, government and resellers. Our confidence in achieving this goal is high because of the strength of our value proposition, product offering, marketing, sales and delivery strategies, and the new opportunities that we're seeing in the expanding world of voice data, video and wireless connectivity.

Let me just take a minute and review some of the additional highlights of the quarter. We put on our offering -- we put all our offering, then value on full display earlier this month when we hosted a national Innovation Showcase at the Ravens Stadium in Baltimore. This event is really the Mecca of what's happening in wireless, which showcased all the products and systems to make wireless work in one single location in 2 days. In addition to displaying the innovative products, we held workshops on the future of DAS, Distributed Antenna Systems, that are used for signal coverage and capacity enhancement, which by the way is the Ravens Stadium was showcasing our supply of all of these 2,000-some antennas that provide us -- that enhance coverage at Ravens Stadium. We also had seminars in the emergence of the small cell systems and field testing, RF, fiber and then issues in public safety and then the mobile workplace.

Every year, this showcase grows. And this year, we had representatives from more than 100 of the leading manufacturers in the industry, 500 key customers. And in total, we had 1,300 professionals that experienced how TESSCO makes wireless work for them. Our manufacturing partners thought it was the best forum in the industry. For next year, we want to add an Investor Day to give you and the other analysts and share owners, an opportunity to meet our talented team, as well as hear from our manufacturers and customers.

Also looking at the highlights during this quarter, we created a new marketing customer acquisition and development unit that is entirely focused on finding an on-boarding new customers and new segments. We're also creating a new team focused solely on the enterprise private system market exclusively. Historically, we've been primarily focused on the industrial private system markets, oil, gas, transportation, utilities, mining, manufacturers and service centers, and we're going to keep this focus but then add this new enterprise unit that will focus on the health care, hospitality, education, retail, data centers and other enterprises. While we know that this segment has vast needs for our products and solutions that TESSCO delivers, we're also creating a solutions development team. This team will accelerate the assurance that we can offer the customer an end-to-end solution for the build, use and maintenance of the emergent system. We're constantly expanding our proactive solution sales engineering team that works closely with our sales executives to assure that we build the right and total solution for the customer.

As we've talked in the past, we're continuing to expand our iMarketing system, our Internet database marketing system, which is the combination of TESSCO and Ventev websites, and what we call our one-to-one communications and sales activity guidance system. This system integrates all of our go-to-market campaigns, our customer interchange conversation guidance, opportunity development. It is the customer delivery profile preference privilege and results data center. It drives new customer acquisition, attraction, acquisition and development, and it is the customer's primary source of knowledge and the ability to design and configure solution, purchase and direct delivery and control their supply chain. It also offers substitutes, alternatives and companion items when a customer is shopping, and then it guides -- it gives the business generation team that guides them with them with their -- for their activity, opportunity pursuit and tests. Bottom line, this system will greatly improve our customer service, cross-sell, new customer development and our marketing and sales productivity. So there's a lot happening in TESSCO. All to better serve our customers' challenges and requirements and provide extraordinary service and then drive, obviously, sales and profits.

So with that, I'll turn it over to Aric, our new CFO, to give you the details of the financials. Aric?

Aric M. Spitulnik

Thanks, Bob, good morning. Before I get started, I just want to take the opportunity to thank Bob and the Board for this great opportunity. I'm very excited to continue to work on putting TESSCO in the very best position to grow in a profitable manner. So I'll get into the quarter's results.

As Bob said, we're very encouraged by the strong first half of this fiscal year. Revenues for the quarter were $147 million. The core revenues, which exclude the transition 3PL relationship, were up 5%. Overall, revenues declined 26%, but that's entirely due to the transitions through 3PL business.

Gross profit for the core customers was up 7%, so gross margins did tick up slightly in the ongoing business. The growth of the Ventev business that Bob discussed has certainly helped us keep those margins stable. That's tough to offset certain -- growth in the public carrier space, which is great. That market though, generally, carries a slightly lower gross margin than the other markets. So the Ventev is helping to offset that. At the same time, this transition out of this 3PL business drove an increase in overall gross margins from 19.6% to 24.9%. SG&A was down about $1 million or 3% this quarter. That was primarily, again, a result of the 3PL business and some of the marketing expenses that are no longer associated with that business. So overall, the loss of about $58 million in the transition 3PL revenues resulted in operating income down about $1 million. On a percentage basis, operating margins rose from 4.4% to 5.2%.

Net income as a percent of revenue grew from 2.7% to 3.1%. While the comparison to last year's second quarter was certainly skewed by the 3PL business, we did see sequential growth in revenues, gross profit, net income and earnings per share. And we see that as a validation that our strategies and executions are working to continue to build a healthy, well-positioned business.

So a little bit more on the markets. The public carrier space, as Bob said, continues to produce tremendous results. We do see increased activity and we're also believe we are winning higher market share. Revenues and gross profits in that market both grew by about 60%. We continue to see growth in the commercial dealers and reseller market as well, with 2% revenue growth and 3% gross profit growth. The private government system operators market posted a 9% revenue and gross profit decline. However, for the second straight quarter, we did see sequential revenue growth in that market, so things are not where they need to be yet, we are building some strong momentum. In the retail market, revenues and gross profit decreased by 13% and 4%, respectively. We have seen -- we've been seeing some changes in the business models with the carriers themselves that have impacted the indirect sales, and that the direct sales to the carrier and also to the independent agents. However, our value proposition continues to play well, and we are taking steps to get more connected to these customers, including more sales training, improve supply chain solutions and merchandising and product support.

Also, we're beginning to speak much more aggressive in attacking the retail market outside of those carriers. We've seen some small wins already in that space, and we are working on several more opportunities as we speak. And of course, as Bob mentioned, our new customer acquisition team will also help support that effort. So for the balance sheet, inventory was essentially flat this quarter. However, it does remain a little bit higher than our historical levels, mostly to support the sales in the public carrier market. This is high-dollar inventory, we're holding a little longer than we normally do. But we do still believe it's essential to our strategy of growing market share in that space. However, due to the strong cash collections we saw this quarter, we're able to pay off the balance on the line of credit we had last quarter and ended with about $3 million of cash on the balance sheet.

Overall, we generated just under $15 million of cash from operations during the quarter. We also set our dividend of $0.18, the record date is November 6, the payment date is November 20. And we did raise our guidance from $1.75 to $2.05, up to $1.90 to $2.10. So in closing, we're very proud of the quarter. We made great progress in the core business, and we have many growth opportunities in front of us for the rest of this year and beyond.

Thank you. And operator, we'll now open the line for some questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Anil Doradla with William Blair.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

So when I look at the Ventev products, I think it was up 17% this quarter, 37% last quarter. What's driving this? I mean, is this just a newer procurements or the way you market the products, and above you're talking about some iMarketing and some of those efforts, but can you help us understand this?

Robert B. Barnhill

Sure. I think that first on the accessory side, we have a very innovative power offer, which all the way from the product itself, to the cabling, to the packaging, which is gaining great success. We just had a major big box -- company take on the product, the dealer channel has been very good for us, so that's driving significant increases. And then on the infrastructure side, these new technologies, as I mentioned, the new -- where we're introducing the new antennas for this new technology, and then this -- what I was saying that the hospital environment -- is it -- how do you take wireless outside and how do you have enclosure that's going to protect the access point. And then also the power systems that we’re coming up with, that are primarily a derivative of what we develop for Positive Train Control, but it's not yet. We're still seeing some of that business, some of the trial systems, that's still hasn't materialized, but we've leveraged what we developed into the other markets: Security or oil and gas, pipelines. Also to answer your question, we have each unit, accessories, as well as the infrastructure has their own sales management team that work directly with the TESSCO account managers, as well as develop business on their own when they're out in the field.

Aric M. Spitulnik

Yes. I think that's -- just to add to that a little bit. Yes, over the last couple of years, we've done a lot of investments in the people -- in Ventev, both on the sales and on the products side and that's really starting to pay off and we really are doing a lot more innovation now than we ever had in the past and the market is definitely responded very well to some of these new products but they're not seeing from other manufacturers...

Robert B. Barnhill

Now, we've got a very aggressive product roadmap on both sides and we're getting acceleration and developments in execution of those products.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Now, when I look at your Ventev products, I mean, do you participate in the manufacturing of some of these products? And, I mean, where I'm going with this question is, given the rising cost of labor in emerging countries, in China, mostly, does that have any margin impact on Ventev products going forward?

Robert B. Barnhill

Everything is contract manufactured, however, we do a lot of the assembly, the final assembly, especially in the Ventev infrastructure power products. We're always scanning where is the best place to have these products manufactured. Still, most of the products are coming from China, and we've been able to hold cost pretty well. It's a function of the total landed cost and material cost, the labor, but then also the freight to get the product in. But so far, everything is good. But we continue to scan the rest of the world in terms of where we can go. Fortunately or unfortunately, is that the China still continues to have the manufacturing expertise to manufacture the products that we're developing.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

So when you look at next 12 to 24 months, are you confident in maintaining your margin profile on Ventev?

Robert B. Barnhill

Right, I believe so. Yes, I think it's going to -- the infrastructure products, definitely, as we get into some of these big bucks retailers, that margin might be squeezed a little bit. But I think, overall, based upon our procurement, as well as our design, we'll be able to maintain those margins.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

So when I look at the long-term growth on your proprietary products, do you think you can sustain 20% growth or do you think that's going to moderate over time?

Robert B. Barnhill

No. I think that's certainly our goal in excess of 20% -- I mean, it's still a small number, I mean we're what 13%, Aric?

Aric M. Spitulnik

Yes, 13% of the total.

Robert B. Barnhill

13% of the total volume, but our goal is to get to 30% very quickly, and so with the new products, the new markets, we expect a robust growth.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Now switching to the public carrier market, 59% growth, that's pretty strong. Obviously, we've had these issues around fiscal cliff and all those macro-related issues. So how do you look at that space and over the next quarter or 2?

Robert B. Barnhill

We believe that the -- it's definitely going to modulate a little bit. I think we're -- we've seen a real boom. One of the strong areas has been the DAS system, the signal enhancement, especially with the tower owners that are putting together these DAS systems for the carriers, but also LTE has been driving. We take great success in terms of working with, we call the entire ecosystem, whether it be the carrier direct or with the contractors, program managers, or the tower owners. But we're not projecting that exaggerated growth that we've seen over the last 2 quarters.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

And coming back to the gross margin, with 3PL relationship coming out of the mix, and obviously, the proprietary products are growing, you got the Ventev stuff coming in. When I look at the core business, gross margins appear flat. I'm just trying to understand, what is going to limit the gross margin expansion? Or is that something we can expect going forward?

Robert B. Barnhill

Well, I think it's a -- one, it's a combination of the mix with proprietary products, and we've got a very sophisticated and continue to advance pricing system that we're looking at market-based pricing, we expect that we can pick up a couple of basis points as we really get dial-in each market, so price sensitivity. And as Aric said that the margin of the carrier space is definitely lower than our other channels, so it also depends upon the mix of the customer base that we're selling to.

Aric M. Spitulnik

Yes. I think outside of that public carrier space, I think we've done a real good job of maintaining the margins across all the product line. It's really just in the carrier space, it's a combination of their product mix including the DAS, which is a little bit lower margins for us and the carriers themselves, the bigger customers that we're selling to. But outside of those -- that pocket, generally, we've been able to maintain or even grow most of our product margins.

Robert B. Barnhill

When we say that we're -- want to be intensely solution-focused, that's another way to drive cross-sell. And part of that the more we can cross-sell, the other areas, tools and shop supplies and training, that's going to definitely drive margin. I mean, obviously, as we're getting the business from the high-volume items, which are price-sensitive, but these other areas that we can cross-sell into, to build that total solution out are much higher margin products.

Operator

[Operator Instructions] I will now like to turn the conference back over to Bob Barnhill for closing remarks.

Robert B. Barnhill

Great. Well, thank you. And thank you, all, for being with us today. I think it's obvious that we're in a very exciting and dynamic marketplace. It's -- there's just a tremendous amount of new opportunities being presented to us. I mean, we're -- you going to be hearing us as we go forward machine-to-machine and advance Remote Monitoring & Control systems and machine-building systems. And as we discussed, we really believe that the second quarter results and the results from the first quarter are really demonstrating the strength of our value proposition, our product offering, our marketing sales and delivery strategy and our execution, as I mentioned before. This is the foundation for our continued growth. So I thank you, again, for your support and being on the call, and have a great day. And I look forward to talking to you in another couple of months.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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