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TESSCO Technologies Incorporated (NASDAQ:TESS)

F4Q 2014 Earnings Conference Call

May 6, 2014 17:00 ET

Executives

David Calusdian - Investor Relations, Sharon Merrill

Robert Barnhill - Chairman and Chief Executive Officer

Aric Spitulnik - Chief Financial Officer

Analysts

Steve Shaw - Sidoti & Company

Anil Doradla - William Blair

Operator

Good day, ladies and gentlemen and welcome to the Q4 2014 TESSCO Technologies Incorporated Earnings Conference Call. My name is Jasmine, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. David Calusdian with Sharon Merrill. Please proceed.

David Calusdian

Good afternoon, everyone and thank you for joining TESSCO Technologies’ fourth quarter 2014 conference call. Joining me today are Robert Barnhill, TESSCO’s Chairman and Chief Executive Officer; and Aric Spitulnik, the company’s Chief Financial Officer.

Please note that management’s discussions today 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 would like to turn the call over to Bob Barnhill, TESSCO’s Chairman and CEO. Bob?

Robert Barnhill

Good afternoon. On today’s call, I’d like to comment on our business, the performances past year, and give you an update on our strategic initiatives and the outlook for the future. After I do that, Aric will follow with a review of our results and then we will open the call for any questions.

This past year was one of significant transition for TESSCO. Because of our strong operational and financial management, we successfully transitioned out of a $213 million third-party logistics relationship. We ended the year with a solid balance sheet and a strategic foundation and plan to drive sustainable profitable growth.

Let me quickly summarize the bottom line. 2014 earnings per share was $1.94 compared to last year’s $2.15, which included significant contribution from the third-party logistics relationship. We began the first half of the year with 11% growth in earnings of $1.06. However, in the second half of the year, the weather and uncertain economy affected our momentum resulting in the 4% core revenue growth for the year. I might say that we saw in March and especially in April and continuing into May a rebound in revenue growth. In light of our strong financials, we declared a $0.20 dividend for the third quarter and expanded our stock buyback program. In our fiscal year – new fiscal year, we expect to achieve solid revenue growth by investing in our strategic transformation plan. And today, we are providing guidance of $2.05 to $2.15 of earnings per share.

The convergence of wireless and the Internet is creating opportunities for new wireless applications that are revolutionizing the way we live, work and play. Our goal is to be the end-to-end solution provider helping organizations build, use and maintain the emerging voice data and video systems by delivering the knowledge and product and supply chain solutions required to make wireless work. Our opportunities are within these markets public carriers, private, industrial and enterprise system operators, government and commercial resellers, and consumer retailers. We support customers in these markets offering the solutions for deploying cellular base station infrastructure, wireless backhaul in building an outdoor Wi-Fi and cellular enhancement, remote monitoring and control, mobile device performance and critical two-way communications.

Fiscal year 2014 results were largely driven by the 34% revenue growth from our public carrier customers and a 20% revenue growth from our Ventev proprietary products division. Ventev sales also contribute to enhance margins, I might say. In the new fiscal year, our goal is to drive revenues to the growth of new customers and monthly total solution buyers. To achieve this we are focusing on providing the customer with an extraordinary experience as we help them resolve their challenges and capitalize on their opportunities in wireless.

Our initiatives to accomplish this goal are what we call high-tech and high-touch. The high-tech foundation is the data and Internet based system to provide the customer with knowledge, system design and configuration, procurement in delivery and control of their entire supply chain. This system integrates a master customer and product database tessco.com and a one-to-one system which will revive opportunity guidance for our marketing and sales units and customer personalized context or communication. This past unit – this past quarter we commissioned a new state-of-the-art SAP’s HANA database that will allow us to collect information from the web, transactions and our discovery about the customer’s needs and preferences.

TESSCO.com is being enhanced to make the customer’s management of their account timely, accurate, self-service and productive. (indiscernible) an experienced online digital marketer recently joined us to accelerate the development of what of the data and internet based system. While this high touch foundation provides a new enhanced experience for our customers, it also provides our marketing and sales teams with effectiveness and productivity. Specifically, it generates new opportunities from existing customers and identifies new customers and they provide – will provide the customer or the sales people with the knowledge necessary for configuring specific end to end solutions to meet their requirements. The high touch foundation is our people the sales, solutions, development, technical expert and productive support teams that allow us to develop these close relationships and expand on the design – expand and design the systems solutions and our product service offerings and deliver an extraordinary customer experience.

This year we are introducing a new customer generation incentive and reward program that is focused on the customer experience and relationship and the growth of the end-to-end solution purchases and total revenues. It’s also important to highlight our Ventev innovations division that achieved 20% growth this past year. Ventev develops and directs the manufacturing of products that fill an unmet need for wireless infrastructure and mobile devices accessories. Ventev’s infrastructure grew 30% in the first half of the year, but declined 7% in the second delivering 10% growth for this entire fiscal year. The decline in the second half was due to outdoor Wi-Fi and wireless products with the private system operators slowing. Again, we are seeing – we are now seeing improvement in the overall growth.

Ventev Infrastructure introduced several new outdoor Wi-Fi applications this quarter, which are being deployed with oil and gas companies, baseball stadiums, theme parks, cruise ships and we are also finding success in education outfitting college campuses with High-Density Antennas to improve wireless capacity and coverage. During the quarter Ventev partnered with General Electric to develop an integrated outdoor deployment enclosure kit for their microwave data what they call Orbit radio. This innovative GE radio integrates a range of technologies from cellular to private and license to unlicensed to support customer’s needs for secured private public and hybrid communication networks. The Ventev enclosure kit will significantly improve the quality and the production of radio deployments in the field. GE will promote the Ventev deployment enclosure kit and TESSCO will also offer the GE radio as a component to our kit. It’s a very exciting opportunity.

Ventev mobile accessories grew 25% in the first half of the year and 52% in the second half thus delivering 44% growth for the year. We continue to find success in penetrating new customer segments with our accessories and we continue develop new products. This past quarter, we had introduced a line of cases to coincide with the launch of the Samsung Galaxy S5 mobile phone. This line presents and represents a new design direction to enhance the user experience. We also developed new combination wall chargers and vehicle backup battery and charger combinations.

In summary, for the New Year, we will accelerate revenue growth by executing our primary initiatives, which are digital and online marketing, team-based selling, expanded product solutions offers, excellent customer experience, and aggressive marketing campaigns. It will be a very exciting and productive year.

So, with that, let me turn it over to Aric who will give you the details of the – the financial details of the quarter and year. Aric?

Aric Spitulnik

Thanks Bob. Before we get into the numbers, I am pleased to report that this will be the last quarter. We need to look at core revenues apart from overall revenues. Fiscal 2015 will be an apples-to-apples comparison with 2014, which will help us tell the TESSCO story in a more sustained and compelling manner.

So, now, let’s get – look at the fourth quarter results. Revenues were $124.5 million compared to $158.4 million a year ago. Core revenues, which exclude the transition from the 3PL relationship, were down 5% from the year ago quarter as the unusually severe winter weather across the country during January and February negatively impacted our performance. As Bob mentioned, we began to see improvement across the company in March and we continue to see that improvement throughout April. Core gross profit was down about 7% in Q4 and core gross margin decreased 30 basis points. Overall, gross margins were 24.2% compared to 21.4% a year ago as a result of the transition out of the low margin 3PL relationship.

SG&A was down about $3.8 million or 13% from the fourth quarter of last year as a result of the 3PL business and some of the marketing expenses that were associated with that business, as well as lower bonus accruals, which were all performance based. The decrease in sales also had a positive impact on variable expenses, such as operating labor and freight. In total, operating margins improved to 3.8% from 3% a year ago. Net income as a percentage of revenue grew to 2.4% from 1.8% in the same quarter a year ago. EPS totaled $0.35 this quarter, which was flat with last year’s fourth quarter.

Turning now to the markets, the public carrier space continued to lead the way. Revenues were up 2% year-over-year. However, gross profit was down 14% primarily due to product mix. For the year, public carrier revenue and gross profit growth were 34% and 28% respectively. While Q4 sales slowed considerably from earlier in the year, we have seen the carriers ramp up their builds recently and expect this will continue for at least the next few quarters.

In the commercial dealer and reseller market, the winter weather delayed projects result in a 9% decline in revenues and an 8% decline in gross profit for Q4 from a year ago. New technologies and regulations continue to create new opportunities for our value-add reseller market and we anticipate future growth in the sale of products through our networking VARs. For the year, revenues grew 1%, gross profit grew 3% in this market.

In the private and government systems operators market, revenue declined 3%, while gross profit declined 6%. Although many federal government agencies now have approved budgets, little funds have been released under them to-date. However, we expect several of our customers to receive aggressive funding in fiscal 2015 and will continue to improve our partnerships with government VARs to further penetrate this market and gain share. For the year, revenues and gross profits were down 5% and 6% respectively.

In the retail market, revenues declined 9.5%, while gross profit increased 1%. We saw increased business with indirect dealers with one of our Tier 1 carriers, our regional carriers, and our mass consumer electronics channels. Our Ventev brand, particularly our power products, is selling very well into both our dealer customers and our consumer electronics retailers. And we would expect it to be a strong driver for retail sales next year. We are working on opportunities in channels we have not yet penetrated such as college bookstores and cell phone repair businesses. For the year revenues in the retail market were down 8%, but due to changes in customer mix, gross profit increased by 1%.

Our balance sheet remains strong. Compared with the third quarter inventory declined nearly $1 million, cash collections remained strong during the quarter and our cash increased $3 million sequentially and $7 million year-over-year and now stands at just over $11 million. Overall, we generated $7 million of cash from operations during the quarter and $19 million for the year. We set our dividend of $0.20 per share with a record date of May 22 and a payment date of June 4. Our Board is also expanding our share repurchase program and has approved for up to $10 million of buyback in a non-accelerated manner over the next two years.

As Bob mentioned at the outset of the call, we are providing EPS guidance for fiscal year 2015 in the range of $2.05 to $2.15. This guidance takes into account the investments we are making in the new business generation, organizational talent, digital and online marketing and our enterprise technology foundation and takes into consideration the continued concerns about the state of the economy.

In closing, we made very good progress in our transition away from the 3PL relationship. We believe we are a stronger healthier company with a much more diverse customer base and we are well-positioned for accelerated growth in fiscal 2015 and beyond.

Thank you for your support of TESSCO. Operator, we will now open the call for some questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And your first question comes from the line of Steve Shaw with Sidoti & Company. Please proceed.

Steve Shaw - Sidoti & Company

Hi, guys. How are you doing?

Robert Barnhill

Hi, Steve, good.

Steve Shaw - Sidoti & Company

I was just wondering do you guys have a specific sales number attributed to the weather decline, I mean the inclement weather?

Robert Barnhill

Not an exact number, it’s hard to pinpoint exactly, but certainly January and February were clearly very down months for us and as we mentioned March really started to pick up and April really has turned around back to where we were earlier in the year. So it’s hard to say exactly, but I think if we were – if we didn’t have the weather issues, we certainly would have been in a much a better position in the fourth quarter than where we ended up as – from a revenue perspective.

Aric Spitulnik

It’s also important to recognize that we work at $1.06 at the half and that was when we increased our guidance with the vision that we add and then seemed like the between the weather and just the uncertainty in the economy, it’s just the breaks went on.

Steve Shaw - Sidoti & Company

Got it. And then along the same lines I guess in terms of gross margin if it wasn’t for the weather, would the mix that would have been that much more favorable where we would have seen a significant improvement in the gross margin than we already have with the bad weather or would have been in the same ballpark?

Robert Barnhill

I think first of all you look at the markets that were really affected were the retail market and then the private side of the business and both of those enjoyed I think the margin, the mix I mean the carrier margin is – that’s where the growth continued, it slowed down a little bit, but it was still showing growth. And that would definitely that mix would affect the mix and therefore the gross profit.

Aric Spitulnik

The private system is the highest margin and that was one of the markets that was impacted quite a bit.

Steve Shaw - Sidoti & Company

Right, okay. And then lastly, I don’t know if you guys mentioned this, especially when you are going through segments, Aric, what was the percent of revenue that the Ventev brand made up?

Aric Spitulnik

13%.

Steve Shaw - Sidoti & Company

Okay. Alright, thanks a lot guys.

Robert Barnhill

Thank you.

Operator

And your next question comes from the line of Anil Doradla with William Blair. Please proceed.

Anil Doradla - William Blair

Hey, guys. Building up on the Ventev question you talked about it grew 20%, as you look into 2015, can you give us some idea as to how we should be looking at that segment?

Robert Barnhill

I think the segment is with the – on the infrastructure side as the private systems that’s where most of our enterprise, most of the growth is coming from. We are really aggressively going after that. In fact, as we added a very experienced individual to really head up that whole enterprise platform this quarter. So, we look forward to the infrastructure side with the new products that are being developed as well as the marketing to be strong. And then the accessories side with the growth that we are seeing there, I think it won’t be as robust it has been, but it’s still going to be very strong as we move into this New Year.

Anil Doradla - William Blair

So, I mean could you maintain high-teens year-over-year growth for all of 2015 for Ventev, is that…

Robert Barnhill

I think that’s definitely is our expectation and where we are situated today on both sides of the business. Again, it’s important to – it is excellent contributor to gross margin as well.

Anil Doradla - William Blair

Right. Now, when I look at the guidance of $2.05 to $2.15, what does that guidance assume – I mean, obviously you have seen some turnaround in the demand and environment weather-related, does that assume a certain momentum that was built in April kind of sustaining or I mean, can you walk us through how you came up with the $2.05 to $2.15, what did you assume on the macro?

Aric Spitulnik

Yes. We assume that things will get a little bit better, but not substantially better. We don’t expect a significant downturn like we saw here in the last couple of months to happen again, but we also don’t expect that everything is going to be really great for the next year. So, we do expect some small improvement, but we did not forecast a complete turnaround in the economy as a whole.

Anil Doradla - William Blair

Great.

Robert Barnhill

And at the same time though we are making significant investments in this business generation system that I have been referring to and making sure that we are out and aggressively going after the business that is there and to gain bigger market share in all these markets. Also as we look at the private systems and in particular the enterprise, we still are aggressively going after new customer development and that’s why we have created this new customer development unit to bring in these new customers that we can serve and start to generate new business from them.

Anil Doradla - William Blair

Great. And Bob, one longer term strategic question, you got many pieces right from the infrastructure to the handset and accessories, you have got this whole internet of things, machine-to-machine things kicking off, can you walk us through big picture how you are looking at that space and what are the maybe key strategic areas you would like to focus on say in 2015 or 2016?

Robert Barnhill

Yes, I think that’s a great question is it we see that the two big continued growth areas are the signal enhancement, the in-building enhancement, whether be it the carrier or the private side, we are looking at new building construction, hotels, venues in terms of enhancing that cellular signal as well as the Wi-Fi signal. And then your internet of things is it where we call it the remote monitoring control, which can be from an oil and gas line to a railroad, to a person’s home. And one of the areas we are looking at is it how do we get more into the Edge device. Today, we are on the backhaul, the wireless infrastructure side, but how do we go forward and get into the sensors, the control units, and they were looking at developing, but also possible acquisition to get into that – those new areas, because the internet of things is going to be a major area. And as we say, the industrial is where we are, but where we want to continue to expand, but it’s going to be a very, very exciting and very lucrative area.

Anil Doradla - William Blair

Very good. Thanks a lot guys

Operator

(Operator Instructions) There are no remaining questions in queue at this time. I would like to turn the call back over to Mr. Bob Barnhill. Please proceed.

Robert Barnhill

Good. Thank you very much. Appreciate the questions, appreciate the opportunity to address your questions and your concerns, and as I will say it again is that as we look at this New Year is the convergence of this wireless and the internet continues to drive the expansion of the new voice, data and video systems, where we are uniquely positioned to be the source of that knowledge and the product solutions for the organizations that build, use, maintain or resell wireless. It’s an exciting space. We are going through nor we went through a period of slowdown, but it definitely is going to rebound.

In closing, I would like to thank our customers, our manufacturers, our team members, our shareowners, and you for the continued support. We look to accelerating our core growth in fiscal year 2015 and beyond. So, thank you and look forward to talking to you in three moths, if not before. Thank you very much.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect and you all have a great day.

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