TESSCO Technologies, Inc. (NASDAQ:TESS) Q4 2019 Results Conference Call May 7, 2019 8:30 AM ET
Jamie Bernard - IR
Murray Wright - President and CEO
Aric Spitulnik - CFO
Conference Call Participants
Bill Dezellem - Tieton Capital
Tim Paul - Capital Management
Good morning, my name is Lisa, and I'll be your conference operator today.
At this time, I would like to welcome everyone to the TESSCO Technologies Inc. Q4 2019 Earnings Conference Call. [Operator Instructions] Thank you. Jamie Bernard, you may begin your conference.
Good morning, everyone, and thank you for joining TESSCO's Q4 2019 conference call.
Joining me today are Murray Wright, TESSCO's President and Chief Executive Officer; and Aric Spitulnik, the company's CFO.
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 disclosures, 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 Murray Wright, TESSCO's President and CEO. Murray?
Thank you, Jamie, and good morning, everyone. Thanks for joining us on the call today. We ended our fiscal year with results in line with the targets we outlined on our third quarter call.
We achieved full year revenue and earnings growth as well as positive earnings in the fourth quarter, our seasonally most challenging quarter. This marks the second consecutive year we delivered fourth quarter profitability after 3 years of fourth quarter losses.
Our results demonstrate that our strategy, execution and strong customer focus are setting us up for long-term success and continued growth.
Before reviewing our fourth quarter performance by segment, I would like to briefly highlight a few of our achievements during the past year.
First, on a financial perspective, we achieved annual revenue growth of 5%, primarily fueled by growth of 36% in the Public Carrier ecosystem.
Our cost management initiatives have been effective, reducing SG&A expense as a percentage of sales by nearly 1%. And as the year progressed, we improved our balance sheet through deliberate measures to reduce DSO in inventory. And consequently, we delivered cash from operations of $5 million in the fourth quarter up from a negative $1.9 million last year.
We are confident in our ability to grow the business, both in revenues and in profitability over the long term. Due to the nature of our project-based business, our results are likely to continue to be subject to quarter-to-quarter fluctuations.
Here are few additional highlights for the year. First, we completed the implementation of our revised go-to-market strategy in our commercial business. This began with the regionalization of our sales force, which enabled us to consolidate our private system operator and government channels with our VAR and Integrator customers. This is crucial to providing stronger engagement with our customers, better alignment with our supplier partners and greater efficiency and scalability for our sales teams.
Secondly, we've recently created a team of new business development professionals, supporting both the Commercial and Retail businesses.
As a result of these investments, we are expecting new customer wins and growth in channels and markets, where we have not had a significant market share in the past. Third, we completed several technology enhancements and initiated several others that are starting to or expected to have a positive effect on the business. These cover a wide range of areas, including our network infrastructure; tessco.com; OASIS, our proprietary customer project management tool, a new data-driven pricing tool and enhancements to our salesforce.com platform. And finally, we've conducted a thorough supplier rationalization initiative, with the purpose of gaining deeper relationships with our most-valued suppliers. This has enabled us to focus on fewer suppliers and SKUs while simultaneously improving our purchasing power, increasing returns and reducing excess inventory. These accomplishments set us up well to capitalize on exciting near and long-term growth opportunities.
Now let's review the details of our market results, starting with our Public Carrier ecosystem. Within our Commercial segment, our Public Carrier business continues to lead the way with Q4 revenues up 13% and up 36% for the full year. What's exciting to us is that our 36% increase compares to a recently estimated telecom market CapEx spend of only 1.5%. This reinforces our previous statements that we are growing our market share, and it is directly attributable to TESSCO's value proposition.
We've expanded our relationships with our largest customers, including programs with Verizon and MasTec. And we've been winning new business with large turf and other general contractors. FirstNet, the nationwide wireless broadband public safety network was a key driver in Public Carrier growth in fiscal 2019. We expect to see steady FirstNet demand in our Carrier and VAR and Integrator channel throughout fiscal 2020.
Moving on to the VAR and Integrator market. Revenues were down 7% in the fourth quarter and 3% on a full year basis. As we previously mentioned, during the year, we completed the restructuring of our VAR and Integrator business to a regional sales model. This was a disruptive process, but one that positions this business for solid growth in the future. We're beginning to leverage this new model to capitalize on exciting growth opportunities. In addition to further support our efforts with these customers, we're investing in more sales coverage.
Our fourth quarter results were impacted by the government shutdown, which not only led to softer sales to government customers but also delayed any projects that required FCC approval. While difficult to measure the precise impact, the shutdown resulted in lost sales of at least $2 million.
We remain bullish about this market and are seeing positive trends for FY '20. For example, we expect to see growth in IoT spending this year and accordingly, are adding more IoT vendors to our line card. We recently added Digi International, a top-tier IoT manufacturer and renowned force in the IoT market. This further complements our already-strong IoT offering, featuring many industry leaders, including Sierra Wireless, Samsung, Laird and Monnit among others.
We also secured a significant IoT distribution agreement from multibillion dollar national service provider. And finally, DAS spends remain strong, and we expect that should continue throughout the new fiscal year. Our Ventev Infrastructure products have continued to perform well in the second half of the fiscal year. Ventev infra products support most major WiFi access points and LTE modems.
During the fourth quarter, Ventev infra solutions were used in the world's largest entertainment complexes in California, Florida and Japan as well as a large outdoor football stadium and in 2 large automobile manufacturing plants.
Our customers are choosing Ventev solutions because our innovative products deliver high-quality performance and have differentiated features not readily available in the marketplace.
Turning to our Retail segment. As you are all aware the dynamics of Retail are continuously evolving and we're seeing significant consolidation at multiple levels throughout the supply chain. Unfortunately, in Q4, this impacted TESSCO. One of our largest customers was acquired and the surviving entity has selected a different business model in which TESSCO will no longer be their primary distribution source.
We have a strong relationship with the new entity and are continuing to sell products to them but at a much lower run rate. Additionally, the most recent iPhone launch in September was significantly weaker than recent launches.
During the 2018 holiday period, iPhone sales suffered the worst quarterly decline in 3 years. And Apple recently published that its Q1 2019 iPhone sales were down 15%. While the launch had a minimally incremental impact on our fiscal third quarter sales, the level of replenishment orders, we typically see during our fourth quarter, didn't materialize, resulting in lower accessory sales in the quarter. As a result of these factors, Retail revenues were down 11% for the fourth quarter and 4% for the full year.
Despite the volatility in the retail market, we continue to win opportunities, including product placement in a number of high-end retail store chains and some mass CE stores.
We are also focused on taking a greater share of the $9 billion North American accessory market in 3 ways: first, we're aggressively pursuing new channels, including high-end retail stores, prepaid, insurance, nonconsumer and wholesale and cable stores; second, we're focused on gaining greater market share with our existing retail customers by introducing new services and technology; and finally, we are targeting emerging and top brands in our existing product categories.
During the quarter, our Ventev Mobile device accessories unit launched new products that highlight our efforts to drive growth with innovative offerings. For example, Ventev beat the competition to market with chargers that have quick charge and wireless capabilities.
We're also excited that our Ventev mobility solutions are now offered in a Home Depot trial in 21 stores on the West Coast, and that trial is going well.
I'll now turn the call over to Aric for a discussion of the financial results, and I'll be back to provide some final thoughts on our outlook for fiscal 2020.
Aric, over to you.
Thank you, Murray. Good morning, everyone. Overall, we did what we said we would do in Q4, we grew revenue and profitability for the year and delivered a profitable fourth quarter.
The Commercial business continues to grow and is well positioned to take advantage of the technology advancements coming in the years ahead.
Despite the recent challenges in Retail, we believe that Retail can be a profitable and growing business for us.
Let me give you an overview of the fourth quarter. Revenues totaled at $145 million, down 3% from the prior year. Note that last year's fourth quarter included an extra week. So on a per-day basis, revenues actually were up 5%.
Gross profit for the quarter was $28.3 million, down 10% from the prior year quarter. Sales to our lower-margin Public Carrier market constituted a larger percentage of overall revenue and higher tariffs increased our freighting costs. As a result, gross margins for the quarter declined to 19.5% from 21.2% in the fourth quarter of fiscal 2018. As a result of our cost management initiatives and with one last week in the quarter, SG&A expenses were down 10% from the prior year.
As a percentage of revenue, SG&A expenses decreased 170 basis points to 18.8%. Our operating income was $1 million for the quarter compared with $1.2 million last year, and margins were essentially flat. Full year operating profit was $8.2 million up from $7.9 million last year, and that -- and the margin was 1.3%, also essentially flat. Net income for the fourth quarter was $0.5 million or 0.3% of revenue, compared with $1.2 million or 0.8% of revenue a year ago.
Full year net income was $5.6 million compared with $5.2 million for fiscal 2018, or 0.9% of revenue in both years. Fourth quarter diluted earnings per share were $0.06 compared with $0.14 a year ago. As operating income was only down slightly, this larger decrease in earnings was primarily caused by onetime $0.06 tax benefit in last year's fourth quarter. For the full year, earnings per share were $0.65, up 7% as a result of higher revenues, our focus on profit improvement and a lower tax rate due to the new tax laws.
Now turning to the balance sheet. As we've stated before, growth in the Public Carrier ecosystem inherently puts pressure on inventory and receivables. We have focused on improving these metrics this past year and we continue to make progress in the fourth quarter as inventory declined significantly. This contributed to our ability to generate $5 million of cash from operations, and we reduced the balance on our line of credit by $3 million again this quarter.
While we continue to focus on tight inventory management in the first quarter of FY '20, we're making some strategic inventory investments to support the Public Carrier business and expect inventory to be up at the end of the quarter. Finally, we've set our dividend of $0.20 per share with a record date of May 22 and the payment date of June 5. Before turning the call back to Murray, I wanted to briefly touch on tariffs. As a reminder, our Ventev mobility products or the TESSCO products most impacted by tariffs and are currently subjected to a 10% tariff.
Based on the President's announcement over the weekend, this is expected to increase to 25% at the end of the week. Our product sourcing team has been aggressively renegotiating contracts in China and signing new suppliers in other countries without tariff issues. While we also -- while we don't expect these efforts to meaningful benefit our business until mid till Q2, we do have tariff mitigation initiatives in place, and are confident that tariffs will not materially affect our business in the second half of the year. As you can see, we hit some market-driven challenges this quarter with the Retail business and tariffs.
As Murray will cover momentarily, we expect to see a one quarter interruption in our earnings growth trajectory. However, we are confident that the initiatives we have in place in our Retail and Commercial businesses will enable us to deliver overall revenue and earnings growth in fiscal 2020.
With that, let me turn it back to Murray.
Thank you, Aric. We believe our strategic efforts this past year will lead to top line growth and increased profitability in the coming year. Due in part to the Retail customer transition, we expect overall revenue and earnings to start slowly and build momentum as we move through fiscal 2020.
In our Retail segment, we are forecasting a modest decline for FY '20 due to the factors I discussed earlier. While we are confident in our ability to execute on the new business initiatives we are pursuing, we do not expect to be fully able to offset Retail challenges in this fiscal year.
Turning to our Commercial segment. We project high single-digit growth for fiscal 2020, which includes both the Carrier and VAR and Integrator markets.
In our Carrier business, we anticipate growth in FY '20 to be driven by our focus on new business development as well as new wireless industry technologies, these include CBRS as well as the build-out of 5G, which we expect will begin to affect our results late this fiscal year or early FY '21 and for several years to come.
In our VAR and Integrator market, we expect to drive top line revenue and market share growth, as a result of the full year effect of our enhanced go-to-market strategy.
To capitalize on the exciting trends in the Carrier and VAR and Integrator markets, we'll continue to make significant and important investments in technology. The Commercial business will remain robust as 5G proliferates in the marketplace. We believe that having the right tightly integrated technology will help us capitalize on those opportunities.
You've heard me speak in the past about the need for every company today to be a technology company. But being a technology company is not enough. We'll be a technology company with a purpose, and this means we will make investments in technology but only after rigorous examination of tools that will tangibly contribute to top line growth, efficiency improvements and incremental long-term profitability to ensure a sustainable and vibrant future.
We are continuing our digital transformation to improve the customer experience, enhance productivity and gain competitive advantage through innovative cloud-based technology. This will evolve in, this will involve investments in key areas such as core technology, e-commerce, customer and supplier integration and market data analytics for both TESSCO and our customers.
Now let me summarize the business outlook.
Due to the Retail customer transition and 2 additional expenses in the first quarter, including onetime charge related to resource reductions completed in the quarter, we anticipate the first quarter earnings to be negative. We do, however, expect annual revenue growth and increased profitability in FY 2020.
More importantly, many market forecasts and our own research indicate we are on the cusp of several years of double-digit wireless ecosystem growth. Accordingly, we are focused not only on participating in this market momentum, but also to continue to gain market share.
We expect our initiatives and the investments we are making to position us for above market top line growth and provide efficiencies to grow profits even faster.
Our team is energized, and we are confident in our plans to capitalize on opportunities in FY '20 and beyond. We believe our value proposition, engagement with customers, new business initiatives and continued enhancements in our technology will drive increased long-term sales, productivity and profitability.
And with that, operator, we'll be open for questions.
[Operator Instructions] And our first question comes from the line of Maggie Nolan from William Blair.
This is Ted on for Maggie. So I wanted to dig in a little bit about the Retail customer. I know you mentioned, it was, kind of, acquired during this quarter and changed their business model. How much revenue did they contribute since fiscal 2019? And then secondly, how much dilution could we possibly expect from them on the lower volumes this year?
So a customer is less than $5 million -- or 5% of our overall revenues, but close to the $5 million so -- or 5%, so there are significant customers. I would expect the vast majority of that to go towards this new model that they have in place, but at the same time, it's relatively new. This is not information that we've had for very long, and we're still working through exactly what we're going to be selling to them and in what quantity. So it's not something we're going to -- we can definitively say exactly how much of that would go down this year.
Understood. So then transitioning, so I believe last quarter you guys mentioned that you completed the sales realignment to the regional model. We wanted to ask about the planned resource changes that you had mentioned on the call and in the press release? How much of a headwind do you anticipate from this resource reduction in the first quarter and for the full year?
So from a dollar perspective, it's about roughly $0.5 million type charge that we're looking for -- or we're looking at in Q1. Does that answer your question? I'm not sure if I understood exactly what you're asking for.
Yes. And then for the full year, is that 500, then could plan to play out then on a quarterly -- is that a quarterly run rate for you guys?
I'm sorry. So you're asking what's the cost benefit of the reduction? So the cost benefit is about $2 million for the year. So it's roughly $0.5 million benefit in every quarter. But in Q1, we'll have charge of $0.5 million or so as a result of some severance and other costs.
Got it. Got it. And then 1 last question for me. What was the diluted EPS share count for the fourth quarter?
Let me grab that here for you, 8.587 million shares.
Our next question comes from the line of Bill Dezellem from Tieton Capital.
I have a group of questions here. First of all, would you please discuss the Home Depot trial? And what is it that you're doing with them? And I think you mentioned that, that was going well. So yes, if it continues favorable, what could that ultimately mean?
So Bill -- hi, it's Murray, thanks for that question. Yes, it works good about being able to open the door at Home Depot. As I indicated on my previous remarks, we have 21 stores. It's a trial right now. So it's a very new relationship, and we've done some replenishment orders there, which is a good sign. But honestly, it's just too early in the relationship to determine what the potential of it is. And I think you can probably guess as well as I can how many Home Depot stores there are nationally. So I'd say that's the total potential that's potentially available. It's just -- it takes -- it's a process. So I think we're working our way through this. And I would just add, Bill, that it's not the only store that we have trials in today that are new to our Retail team, that are names that you would recognize. Home Depot is just one of those accounts that we can name them at this point, but there are others that are in, kind of, similar pipeline, sales pipeline development mode right now.
And just to make sure that I'm understanding this correctly, this is where you are providing cases and other cell phone accessories that they would hang on at their bank account and cash registers?
In the case, in the instance of Home Depot, it's primarily power, cables and power.
Excellent. That is very helpful.
Nevertheless, it's, yes, accessories, yes.
Right. Great. And then I'm going to shift, if I may. In your opening remark, you made reference to new resources that are essentially being put in place to help your sales teams. Would you give us some more detail in terms of what you're referring to there? And just how helpful that could ultimately be?
Are you referring to the comments around business development resources?
Yes, that's exactly right.
Yes. Okay. So one of the things that we recognize is that our value proposition is resonating with our current customers, and really what we wanted to do is focus on places where we're not. So if you pick the Commercial business, for instance, we've been discussing the national service providers, the NSPs, and we've set up a team of people. So if you think about this, Bill, as you know, we have to go higher the people, we, they have to be ingrained into the TESSCO culture and understand our value proposition. And then we have to usually find a way to get ourselves into some of these accounts with our strong value prop.
And so in both Retail team and our Commercial team, we've set up these business development teams, which, I think, for our shareholders to recognize is that this is an investment that TESSCO is making because we believe that there is, that our value proposition will resonate, and we will get a return on that investment. So that's the stage that we're at right now. We're excited about some of the early developments here, but it's a little bit too early to tell. There's some small wins that I could certainly point to and that gives us a lot of excitement around what the potential future could look like here.
So these are people that work in conjunction with or in advance of the sales team? Or, I'm sorry, I am a little bit confused. Maybe [indiscernible] take offline, okay?
Yes. It's a little bit of both frankly though. It's some additional resources from a technical perspective and then it's additional engage, selling resources that are engaged directly with the sales organization. And we have gone to the marketplace and moved, brought some people into the company that are different profiles than what we have had in the past. So it, you're on the right track. It's just a little bit of different resources, there are selling resources and there are support resources here.
Great. And then I'm actually going to circle back, if I could, to the Home Depot trial and your comment that you, this was not the only name brand store that you are trialing. So those are -- other trials are still ongoing? And how many are you in the middle of?
In some of the named department stores, I'd say 5-ish.
Okay. And anything else you want to add to other that are not department stores that you're in trial?
Well, I think that's the big news right now. I mean, I think, that there is still opportunity in the indirect dealer channel where we're playing today. And the circumstances that we referenced on the call, Bill, are, it's one of those scenarios where because of the dynamics in retail people are looking for opportunities and we think our -- we know our value proposition is resonating very well. But to control our own destiny here, we need to expand our footprint of customers, and that's what we're working on simultaneously.
Great. And then I would like to jump, if I may, to the -- really your VAR and Integrator growth is an area that I think is kind of where you would like to put some extra emphasis on in this coming fiscal year. So would you talk about what the most important go-forward, I guess, factor or strategy or initiatives would be to drive improved results in that VAR and Integrator market?
I think, first of all, Bill, we've commented on several of the previous quarters that the disruption factor in the VAR and Integrator market that we introduced to TESSCO last year. I mean we're out the other side of that now in Q4. And we've got our team in place, new accounts, new reps, new sellers selling into new -- their new territories. And we're very confident that the growth will start to materialize in our VAR and Integrator market this year. And that will be a direct result of the changes that we made throughout last year trying to balance and navigate our way through disruptive changes whilst still trying to deliver results.
Would you expect larger growth in the VAR and Integrator market in fiscal '20 than you will see in the Public Carrier market?
I think it's -- we're planning for it, like, it to be about the same.
And I assume you're talking in percentages, not dollars?
Right. And then do we have time for me to ask one additional question?
So one of the things that is clear when looking at your income statement is that there's a lot of leverage. So revenues were down about $7 million and earnings declined 26%. And I also do recognize that there are some margin changes that also took place. But when I look at this, it makes me think or wonder, is this indicative of the leverage that this business has also on the upside. So if you start to see some meaningful revenue growth, which would happen if your largest market, the VAR and Integrator market, would start showing the sort of growth of Public Carrier is and/or you start to have some wins in the Retail in some of these larger department stores, then you end up with some really big earnings growth very quickly on what otherwise might be considered solid but modest revenue growth.
Yes. I mean, I think, you're on a very good point. And one of the ways that I think we can look at it is $1 million for us, $1.1 million is $0.10 a share. Like almost every $100,000 is $0.01. And the scenario that we referenced with the Retail customer, it could have gone, things could have gone either way in an acquisition. And then to answer your question directly, there is tremendous amount of leverage. Usually, when you secure a large account, you fight your way through some of the learning curve that happens initially. But the upside opportunity in some of these markets that we positioned ourselves in with, if we get the growth that we're expecting, you're absolutely correct.
And our final question today comes from the line of Tim Paul from Capital Management.
I was wondering what accounts receivable growing faster than those of that due to the timing of orders and shipments? Or what would you say that is?
Yes, that's 100% correct. We had a pretty strong March. So the timing of the receivables were definitely back-loaded. Our aging is actually better than it was 90 days ago. So it's not a collection issue, it's all about the timing of the sales.
Is the timing due to seasonality? Or did the quarter just get stronger as you went through?
Yes. Our fourth quarter is always a challenging quarter from a timing perspective. January is almost always our worse month. Just from the weather outside, the post-holiday season and then people getting budgets in line. So January always starts very slow. February starts to pick up and then March kind of gets us back to where we would expect to be kind of going forward. So it's always a similar kind of run rate here for the fourth quarter.
Mentioned several proactive steps you're taking with the tariffs and how to handle that. But I would assume your competitors have the same issue. Why is it so hard to pass through those costs to the end customer?
We have done that on many of the products we don't actually manufacture. And as a manufacturer though, it's a bit particularly in the mobile device accessory side. Most of our competition is doing what we're doing, is finding ways around the tariffs, maybe some minor increases in the prices, but trying to find ways around the tariffs. I think just because it's a little bit more competitive. So we currently are doing the same thing. And as I said, I think this will be a 1 to 1.5 quarter issue for us here, but by the second, middle of the second quarter, end of the third quarter, the tariffs won't be an issue for us at all.
We have no further questions. Thank you. I'll turn the call back to the presenters for closing remarks.
Thank you, Lisa, and thanks to everyone for joining us today. We appreciate your support of TESSCO. And as always, I would like to thank our team members for their continued hard work and their dedication. Have a great day everyone.
This concludes today's conference call. You may now disconnect.