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PCTEL, Inc. (NASDAQ:PCTI)

Q4 2013 Earnings Conference Call

March 4, 2014 08:30 am ET

Executives

Marty Singer – Chief Executive Officer

John Schoen – Chief Financial Officer

Analysts

Matt Robison – Wunderlich Securities

Mike Crawford – B. Riley & Company

Operator

Ladies and gentlemen, thank you for standing by and welcome to the PCTEL Q4 2013 Conference Call. (Operator instructions.) As a reminder, this conference call is being recorded for replay purposes. I will now turn the call over to John Schoen, Chief Financial Officer.

John Schoen

Thank you for joining us today for the PCTEL Financial Results Conference Call for Q4 2013. On today’s call will be Marty Singer, Chairman and CEO; and I am John Schoen, the Chief Financial Officer.

First let me read the safe harbor statement before we begin. 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 new technologies and obtain protection for the related intellectual property. An 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.

Marty Singer

Thanks, John, and good morning to all of you. Let me recap some of the non-GAAP highlights from the quarter. We achieved revenue of $26 million, unchanged from Q4 2012. Gross profit margin was 42%. Operating margin from continuing operations was 10%. Net income was $2.1 million or $0.12 per diluted share. Cash and investments were $57.9 million, an increase of $3.0 million from the previous quarter.

Now I’d like to turn the call back over to John Schoen who will discuss our financial performance in some detail. Later I will comment on some of our business development, (inaudible) and marketing efforts over the past quarter as well as some of our current activities. John?

John Schoen

Thank you, Marty. Now 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 for both management and investors.

The non-GAAP financial analysis reflects the company’s core results and facilitates comparisons for cross-reporting periods. For more information on our non-GAAP financial results and a 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 at www.PCTEL.com under “Investor Relations.” My discussion of results will be based on our non-GAAP financial results.

So let’s turn to revenue. Revenues were $26.0 million in the quarter and $104.3 million for the year. The quarterly revenue is unchanged from the same period last year and the annual revenue grew 17%. Approximately 7% of the annual growth was contributed from the acquisition of Site Solutions Products in July, 2012, with the remaining 10% contributed by products and services we had for a full year in 2012. I will speak to the changes by reporting segment.

RF Solutions revenues were $8.7 million in the quarter and $30.3 million for the year, representing period-over-period growth of 44% for the quarter and 41% for the year. Revenue was up significantly in both scanning receiver products and network engineering services, with the engineering services revenue more than double in the quarter and year compared to 2012. The increase in scanning 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 in-building wireless network expansion.

Connected Solutions revenue was $17.3 million in the quarter and $74.2 million for the year, representing period-over-period comparisons of a 13% decline in the quarter and 10% growth for the year. A focused effort to eliminate both the unprofitable drop-ship business acquired in 2012 and low margin customers combined with delays in positive [train control] deployments for transit customers explains all of the Q4 decline. The Connected Solutions annual increase of 10% over 2012 is a result of the acquisition of Site Solution Products in July, 2012.

Now let’s turn to gross profit. Gross profit margin as a percent of sales was 42% in the quarter and 41% for the year, representing a 3% improvement in the quarter and remained unchanged for the year. The increase for the quarter is attributed to the increased contribution of our relatively higher-margin RF Solutions segment revenue as a percent of total revenue, and gross margin improvement in our acquired Site Solutions business.

RF Solutions gross profit as a percent of sales was 64% in the quarter and for the year, representing a period-over-period decline of 5% of sales in the quarter and 6% for the year. The decrease for the quarter and the year are attributed to the increased contribution of our network engineering services revenue with its lower gross profit margin relative to scanners. As previously discussed, revenue in scanners and network engineering services were both up from last year, but engineering services revenue was more than double 2012 levels in the quarter and the year.

Connected Solutions gross profit as a percent of sales was 31% in the quarter and for the year, representing a period-over-period improvement of 1% of sales in the quarter and was unchanged for the year. The effect of having a full year of acquired Site Solutions revenue with its lower margins relative to antennas was offset by eliminating unprofitable Site Solutions business and customers, consolidating the Site Solutions factory into our Bloomingdale facility and supply chain improvements.

Now let’s turn to operating expenses. Operating expenses were $8.4 million in the quarter and $33.1 million for the year, representing period-over-period comparisons of a $100,000 increase in the quarter and a $4.1 million increase for the year. The largest components for the annual operating increase were $2.0 million for the company’s accrual of its annual short-term incentive plan that paid out zero in 2012; $1.2 million invested in scanning receiver R&D; and $400,000 related to the Site Solution acquisition being included in the company’s results for a full year in 2013.

Non-GAAP operating margin as a percent of sales were 10% in the quarter and 9% for the year, an improvement as a percent of sales of 3% in the quarter and 1% for the year. The increased revenue and resulting higher gross profit in both the quarter and the year more than offset any changes in operating costs. Non-GAAP other income was $14,000 in the current quarter. As 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 earnings per share from continuing operations were $0.12 in the quarter and $0.42 for the year, resulting in period-over-period increases of $0.04 in the quarter and $0.08 for the year.

Now let us turn to the balance sheet. Cash and investments ended Q4 at approximately $57.9 million, about $3.0 million higher than the previous quarter. In the quarter the company generated approximately $4.2 million of cash flow from operations, spent $1.0 million in capital expenditures yielding free cash flow – that is cash flow from operations less capital spending – as a percent of revenue of 12.3% in the quarter. Depreciation in the quarter was $665,000.

For the year, the company generated free cash flow of approximately $8.4 million or 8.1% of revenue. Of that free cash flow the company returned $2.6 million to shareholders in the form of regular dividends and $400,000 in the form of stock buybacks – or in aggregate about 35% of the free cash flow generated.

Now I’d like to discuss guidance for Q1 2014. We anticipate Q1 revenue to be in a range of $24.5 million to $25.0 million, which is slightly lower than the same period last year. Within the total revenue comparison we expect about a 30% increase in RF Solutions revenue and a 10% decline in Connected Solutions segment revenue. We believe the Connected Solutions decline is cyclical and we do reaffirm total company revenue guidance for the year.

Gross profit margin for the quarter is expected to be about 40% and operating costs are expected to be approximately $8.4 million. The non-GAAP effective income tax rate is expected to remain unchanged going forward at 18%. The fully diluted share count in Q1 is expected to be about 18.7 million shares.

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

Marty Singer

Thanks, John, and after our comments we’ll be happy to answer any questions about the changes in revenue forecast for Connected Solutions and give you a little bit more color on that – particularly how we are reengineering the Site Solutions business that we acquired a year and a half ago.

Perhaps the best way to update our shareholders is to review our activities at three recent industry events, the Mobile World Congress and HIMSS, the Healthcare Information and Management System Society Conference, and the In-Building Wireless Summit sponsored by PCTEL. Let me begin with a brief report on my recent trip to Barcelona for the Mobile World Congress.

As most of you know, the Mobile World Congress has become the most important annual cellular infrastructure event. While non-crucial for our Connected Solutions business it is an important event for the exposure of our RF Solutions products and engineering services.

At the MWC we unveiled two new and breakthrough products. We displayed our new in-building scanning receiver tool, the IBflex, that features compatibility with tablet user interfaces, has hot-swappable batteries and modular feature sets. The product supports all global cellular standards, wireless frequencies, and MIMO. Additionally it enables the testing of WiFi networks that are often used in conjunction with licensed frequency.

The IBflex can be updated remotely via an internet connection, has significant onboard storage, Bluetooth connectivity and an outdoor mode enhanced processing power and speed for outdoor data collection.

We displayed the Flex at the ASCOM booth and conducted live tests in the MWC Convention Center, and demonstrated its flexibility and user-friendly interface. The product was a huge hit. We expect that the IBflex will complement our strong efforts in developing our in-building product and engineering services business. We also note that this product accounted for the increase in 2013 RF Solutions development spending over 2012 as well as the sequential increase in development spending from Q3 to Q4 of 2013.

While this dampened earnings, and I realize that some of the headlines are that we missed our non-GAAP EPS by a penny, dampening earnings in Q4 – we consider this a great investment that will benefit shareholders as PCTEL moves forward with its in-building initiatives. This will be a great investment over the long term.

We also introduced SeeWave. SeeWave is an interference detection and locating system. As many of you know, interference – particularly in LTE networks – impairs data capacity and throughput. SeeWave features a custom antenna from our Connected Solutions group, which by the way was one of the first real synergistic development activities between our two divisions. It also features a sophisticated algorithmic software tool and an intuitive tablet-based user interface.

SeeWave will allow customers, particularly cellular carrier engineers and engineering firms, to quickly and accurately detect and locate interference sources without suspending service, deploying engineers to multiple sites, or conducting repetitive drive tests. Whenever we demonstrated SeeWave at MWC we drew a big crowd. It’s a product where you point an interesting-looing antenna – it has a trigger that can take instantaneous measurements, store them on a scanning receiver, and then display them on a tablet.

SeeWave will work with the installed base of SeaGull scanning receivers and SeaHawk visualization tools and it will work with any customer that is looking for the potential of displacing a capital investment in this equipment within one month of ownership.

At HIMSS our Connected Solutions segment introduced both portable LTE antennas and a low-profile WiFi antenna for in-building applications. As we continue to stress at investment conferences and in our marketing communications, PCTEL remains focused on the in-building wireless explosion. These two new products, SeaWave and IBflex, contributed to a higher-than-anticipated development engineering expense but they’re worthwhile investments in our future as we’ve stated previously.

PCTEL sponsored an industry event of its own with contributions from both RFS and Tesco with whom we enjoy a strong relationship. The event, the In-Building Wireless Summit brought together carriers, tolerant site management companies, venue owners, real estate management companies, property managers and engineering procurement and contract management companies – or the so-called EPCMs.

The Summit focused on the economics and dynamics of owning the problem of in-building wireless coverage, the competing solutions, and the drivers for change and improvements. The Summit was well attended and the panel discussion was moderated by industry experts Matt Robinson and Roger Crockett, formerly of BusinessWeek. The pressure to improve wireless coverage and capacity using cellular, WiFi and engineering services became even clearer and confirmed our investment in our rapidly growing engineering services in-building tools and in-building antenna solutions and kits.

Let me turn now to significant successes in our markets. Our Connected Solutions group saw strong Q4 orders for our new multi-band GNSS antenna from applications in Russia. Our GNSS product was approved for general release in Q4 and shipments have just begun.

After a year of business development activities we also began shipments for a custom WiFi antenna to upgrade all access points in a major urban public school system. This commenced a five-year project that will serve as a reference for similar opportunities throughout the US.

We began shipments of a high-power ruggedized antenna for an outdoor WiFi access point to one of the top wireless infrastructure providers in the US, and we received an order from a major defense systems integrator for one of our mobile tower product lines. The towers will be delivered during Q1 and Q2 and will be deployed as part of FEMA’s emergency response protocol.

Over the past six months we have established a second OEM mobile tower provider. The qualification process involved a customer tour on which the manufacturer received feedback on quality and performance issues. This new line, the PCTEL mobile tower product line, complements our existing MAG mobile tower line. We expect strong sales from the new product line in 2014. Initial orders for products have been received and deliveries started in December. We will continue to offer the existing MAG product line and it will continue to be an important product for many of our customers.

Our kitting business which was the primary asset that we acquired in July, 2012, has expanded. Although sales were not strong in 2013 and especially in Q4, we developed business opportunities with a major cellular carrier related to LTE site deployments and site expansion for AWS spectrum. There’s a potential opportunity in small cell expansion, and more broadly as tier one players rush to deploy 4G technology on a number of platforms to provide capacity to address the growth of data-consumptive devices.

The opportunities go beyond cellular and the carriers. On the rail side we have qualifying antenna and cabling systems for new locomotives being built to be compatible with the mandated Positive Train Control standards. This is in addition to the existing wayside deployments that we continue to support.

RF Solutions delivered engineering services to over a dozen malls for Black Friday, six hotels for the Super Bowl, a major convention center and two prominent motor speedways all in Q4. Revenues have increased from 5x to 6x since our first quarter of operation and we anticipate a 50% increase in engineering services billings this year.

Our scanning receiver sales benefited from very strong penetration into tier one North American cellular operators in Q4, strong global support of our leading OEM reseller ASCOM and sales into several new regions within China for the initial stages of the TD-LTE deployment. Our EMEA team continues to find new opportunities in Russia including the Sochi Olympics, and PCTEL is now the dominant supplier of scanning receivers used for test and measurement of wireless networks in Russia.

In addition to all of these organic growth activities PCTEL continues to explore opportunities to acquire productive, accretive assets that are consistent with our business plan and that would represent a profitable and strategically sound use of our cash. We will update investors as events unfold.

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

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) Thank you. Your first response is from Matt Robison.

Matt Robison – Wunderlich Securities

Good morning. Congratulations on the cash flow. John, what should we expect for cash flow this quarter?

John Schoen

Well, if you go back and look at our history we typically are negative cash in Q1, breakeven in Q2 and then we really hit it solid in the back half. I would say we’ll probably come out $3 million in the quarter just because we have to pay all the annual accruals, and that’s consistent with what we did last year; and then breakeven to $0.5 million; the quarter after that up. And then we’ll generate, I would expect cash flow as a percent of revenue in the same range as we did this year.

Matt Robison – Wunderlich Securities

And your earlier comment that you’d let us know what the depreciation is for the quarter?

John Schoen

Yeah, it was $665,000.

Matt Robison – Wunderlich Securities

Okay, thanks. So the Q3 sequential decline for Connected Solutions, you explained part of that for this quarter. How many more quarters of sequential decline do you expect, Marty?

Marty Singer

Yeah, I think you’re going to see full recovery by Q3 and partial recovery by Q2. Here’s the deal: in Q4 over 200% of the shortfall was in the legacy Telworks assets. So you’ll recall that after we bought them we did have a couple of strong quarters, but it was filed with some really crappy drop-ship business and some kitting business that never materialized, and we also fired some customers as we made the transition from Lexington to Bloomingdale.

We now have established a platform. If you were to come here, Matt, you would see that we have now completely transferred everything. We have a nice kitting operation going in our Bloomingdale facility and we are building up the more profitable portion of that business. And by Q2 I expect Connected Solutions to start hitting its mark of well over $20 million a quarter.

And in addition to that there has been in Q1, I would call it not a slowdown but a little bit of a breather from three of our largest customers – one of our major distributors, two of our OEMs in WiFi and public safety business. They have complained tremendously about weather. I would not use weather as an excuse but it has certainly come back to us that there’s been a slowdown for them. And we expect that influence Q1 – that’s why we gave a somewhat less robust revenue profile. But in Q2 we think that that’s going to fully recover.

On the positive side our core products, the GPS product line, the Fleet product line, our WiFi product line, our OMNI product line are all continuing to gain traction. As I said we’re seeing strong kitting opportunities with the site preparation kits for AWS, small cell kits. We’re shipping out prototypes of those kits this quarter; that business won’t begin until mid-Q2, Q3 with big numbers. But we’re talking about enormous opportunity there that will make the Lexington acquisition look quite good.

Another side in RFS, we’re really rolling along. We’re going to get a pretty big uptick from the IBflex, from SeeWave and continued growth in the network engineering services.

Matt Robison – Wunderlich Securities

John, you mentioned keeping the full-year revenue level where you’re at before in your prior commentary but you didn’t say what that was, so maybe repeat that for the benefit of those that might not have been on the last call.

John Schoen

Yeah, we’re still in the $112 million to $114 million range.

Matt Robison – Wunderlich Securities

Okay. And Marty, when does this rail business that slipped materialize again?

Marty Singer

I mean right now we’re at the precipice of whether or not it’s going to hit in Q1 or Q2. We’ve got one major order that is a timing issue right now, but at the very latest you’re going to see the rail business materialize in Q2.

Matt Robison – Wunderlich Securities

Is your guidance expecting it in Q1?

Marty Singer

No, the guidance that John gave assumes that we will not get it and we will not get small cell kits in Q1. So the guidance assumes that those have all moved into Q2.

Matt Robison – Wunderlich Securities

Okay. Thanks a lot.

Marty Singer

Thank you.

Operator

Thank you. Your next response is from Mike Crawford. Please go ahead.

Mike Crawford – B. Riley & Company

Thank you. On the network engineering services revenues that more than doubled year-over-year about approximately what level of revenue are you generating from that business today?

Marty Singer

Well we hate to get down to those microscopic levels but let’s say for argument’s sake that you can expect $2.0 million to $2.5 million a quarter.

Mike Crawford – B. Riley & Company

Okay, thanks Marty. And then you said you were excited about the investment in IBflex, so what is the approximate level of that investment and what are your aspirations for that product?

John Schoen

Just the increment alone going from Q3 to Q4 was $350,000; there’s probably $0.5 million a quarter tied up in it for this quarter and Q1, and it will ratchet down a little bit in Q2 and then a little bit more in Q3. $0.5 million a quarter.

Mike Crawford – B. Riley & Company

So altogether you’re investing, I’m not sure what the answer is – a couple million dollars to develop this product?

Marty Singer

I would say the program cost us about $2 million which is about half of what the MX cost us. But the big breakthrough in IBflex was combining the flexibility that we got when we did the EXflex. In other words, the ability to support all spectrums on a dial-in basis – you know, you just dial in what spectrum you’re testing; to support all of the technologies on a temporary or permanent basis. But whatever the case is you can download the technology you want over the internet.

And the third thing that the Flex did was it gave us a pay-per-use capability. Somebody can rent a feature set like MIMO for a period of time. What the in-building did was it took a form factor and it cut it basically in half, and so now… And also it allowed for variable processing time. So you know, when you are drive testing you need to sample continually because you are driving – you’re going at a fast pace. Battery life isn’t an issue there because you have it plugged in.

When you’re walking you don’t have to sample quite as fast so you can save the battery, and in addition we invented a hot-swappable battery. So somebody can test buildings all day without taking their equipment down. Just as importantly, it has a Bluetooth interface so now anybody who puts our visualization tools, let’s say on an Android tablet can have a Bluetooth connection to their mobile device; see and store the results. And then finally with a simple dongle attachment this simultaneously tests WiFi which has become a requirement in any in-building network design.

So it’s interesting to me that not only did ASCOM display our product at their booth, but when we went over to another vendor who I won’t mention who was acquired by a competitor, they also had our product in their booth. And I believe it’s going to help us sign up additional OEMs who are in the test and measurement business, and I think it’ll be very attractive to people in the network engineering business.

Mike Crawford – B. Riley & Company

Okay, thanks Marty. And then last question: on Positive Train Control we’ve seen MetroLink go by ahead of mandate in Southern California, but other railway operators are continuing to drag their feet and are trying to get this thing pushed out even further. So I understand it sounds like you have some specific order to ship likely in Q2, but other than that are you seeing continued delays in PTC in general? What are your thoughts there?

Marty Singer

I don’t think we’re seeing really delays – it’s a matter of people lining up their capital budgets. But I definitely see this as a 2014 event and it’s a 2014 event that I believe is going to kick off a five-year period of growth.

Mike Crawford – B. Riley & Company

Okay great, thank you very much.

Marty Singer

Thank you.

Operator

Thank you. (Operator instructions.) There are no responses in the queue at this time.

John Schoen

Okay, well thank you very much for joining us so early in the morning and we will update you at our next earnings conference call. I plan on presenting at the B. Riley Investment Conference in May and hope to see you there and I hope also to be on non-deal roadshows with the two companies that follow us. Thank you again.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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