PCTEL Inc (PCTI) 2002 Q3 法說會逐字稿

Good morning. My name is Selena and I will be your conference facilitator. At this time, I would like to welcome everyone to the PCTEL third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and the number 1 on your telephone keypad. If you would like to withdraw your question, press star then the number 2 on your telephone keypad. Thank you. Mr. Singer. You may begin your conference.

Good morning, everyone, particularly those of you out in California. I'm Marty Singer, Chairman and CEO of PCTEL. On behalf of PCTEL, let me thank you for joining us on our earnings call for the third quarter.

In this call we will address financial results for the quarter and the outlook for PCTEL in the fourth quarter. Joining me today is John Schoen, our chief operating officer and chief financial officer. John will take you through our financial performance for the third quarter and will provide limited financial guidance for the fourth quarter of 2002. I will then discuss the state of the business including significant events transpired during the third quarter. John?

Hello, everyone. Before I begin my financial review of the company, I will read the safe harbor statement.

During this call, Marty Singer and I will discuss PCTEL's business and in doing so, some of our statements might contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to some significant risks and uncertainties, in particular, the statements concerning our future financial performance, our ability to improve performance of our modem business, our ability to manage channel inventory, our ability to improve ROI on our intellectual property, our expectations regarding our 802.11 product, our ability to successfully invest in businesses that will support our wireless business, our forward-looking statements within the meaning of the safe harbor.

Actual results may differ materially from those projected as a result of risks. Some of these risks include the economic recovery and associated PC demand our ability to forecast customer demand in this environment, the cyclical nature of the semiconductor and PC industries, the ability to successfully address the cost structure of our modem products, the ability to successfully develop and sustain our wireless product business, the ability to develop and implement new technologies, and to obtain protection for the related intellectual property. Operating and financial results can also be affected by market conditions resulting in revenues deviating from projections. Increased operating expenses, additions to reserve positions, lower gross margins and higher working capital ratios. Our litigation expenses depend on a number of factors, not all of which are in the company's control. These as well as other risks and uncertainties including but not limited to those details from time to time in SEC filings can affect results. These forward-looking statements are made only as of today and we disclaim any obligations to update or revise the information contained in any forward-looking statements. This concludes the safe harbor statement and now I will continue with the financial review.

First let's talk about revenue. PCTEL's revenue is a combination of product and licensing revenue. The product revenue is related to the sale of modems. The licensing revenue is related to royalties associated with our patent portfolio and software license revenue related to the use of our modem software under license. Third quarter total revenue was $12.5 million, up 31% from the second quarter, and 165% from the third quarter of last year. Of that number, product revenue was up sequentially $2.4 million, up to $11.2 million, and licensing revenue was up $0.6 million to $1.3 million. The sequential increase in product revenue was driven by strong orders from one of our major customers, combined with the beginning of a fourth quarter seasonal increase in PC manufacturing. Increased software licensing revenue reflected our completion of our DFP modem release and royalties received from the sale of related products. The increase in revenue from the third quarter last year suggests that our traditional channels are no longer burdened with high inventory. The company continues to enjoy a broad revenue base. This quarter, our largest customer accounted for 31% of revenue. We have six customers who in aggregate accounted for approximately 82% of revenue in the quarter. This compares to last year in which a single customer accounted for 47% of the company's business on an annual basis. We continue to offer limited guidance with respect to revenue. Based on our market inputs, we are projecting the seasonal increase to continue through the fourth quarter and for revenue to be the same or slightly higher than that achieved in the third quarter. For all of 2002, we expect that PCTEL will report an increase of 10 to 15% in revenue over 2001. Now let's turn to gross margin.

Third quarter gross margin was 71% of total revenue and included a $3.8 million recovery of excess inventory reserves which were originally established in the third quarter of last year. This compares to 58% gross margin last quarter, and negative margin a year ago due to inventory reserves taken then. When stated without the inventory reserve recoveries, normalized third quarter gross margin was 40%, compared to 42% achieved in the second quarter of this year. The decreased percentage was attributable to a larger mix of lower margin products shipped to Taiwanese motherboard manufacturers during the quarter. Looking forward to the fourth quarter, we anticipate erosion in gross margin percent as our sales into this channel will remain relatively high. Gross margins should be between 35 and 39% in the fourth quarter. Operating expenses.

Now I would like to address our cost structure. Total operating expenses were $5.9 million in the third quarter. This included a $0.1 million restructuring charge related to employees displaced by the move of the company's corporate headquarters to Chicago. This is a $0.7 million decrease in operating expenses from last quarter, which included a $0.6 million restructuring charge pertaining to a forced reduction. Operating expenses without one-time charges declined $0.1 million from the second to the third quarter. Increases for the wireless operations were more than offset by the reduction in force associated with our DFP modem business. Operating expenses were down significantly, however, from the third quarter of 2001. Last year, charges reflecting goodwill impairment, restructuring and the amortization of goodwill totalled $16.9 million. Additionally, we reduced on going operating expenses from $9.1 million to $5.7 million in this period-to-period comparison. The company began shifting resources from modem products to our new 802.11 product in the second quarter. Costs directly attributable to our 802.11 product investments were $0.9 million in the second quarter. They rose to $1.4 million in the third quarter. The figures include resources obtained in our asset purchase of cyberPIXIE in the second quarter as well as those diverted from modem products. The resource shift will continue in the fourth quarter. We expect total operating expense cost to be approximately $6 million in the fourth quarter. This increase reflects, in part, costs associated with relocating certain functions to our new headquarters in Chicago. Now let's turn to other income.

Income from interest generated from investments was $0.6 million in the third quarter, compared with $1.4 million a year ago and $0.9 million in the second quarter of this year. The amount per quarter is expected to decline over time, should interest rates stay at current levels or decline further. Fourth quarter interest income is expected between $0.5 and $0.6 million. With regard to earnings, net income for the quarter was $3.2 million. This compares to a loss of $0.1 million in the second quarter this year, and a loss of $41.4 million a year ago. The rise in sequential quarter earnings reflects the increased gross margin on higher revenue, the benefit of a higher inventory reserve recovery, and the absence of restructuring charges. This rise in earnings from last year reflects increased gross margin on higher revenue, the benefit of an inventory recovery instead of a charge, the reduction in ongoing operating expenses costs and the absence of charges in amortization related to goodwill and restructuring.

With regard to our balance sheet, cash and short term investments ended the second quarter at $112.2 million, compared to $111 million last quarter, and $129.3 million a year ago. During the quarter, the company used $0.7 million of cash to repurchase shares of the company's shock pursuant to a stock buyback program announced in August. There were 125,800 shares repurchased during the quarter at an average price of $5.89 per share. The decrease from last year is primarily attributed to the $14.3 million licensing agreement paid in the first quarter of this year. The company continues to have no debt. That concludes my financial review. I would like to turn the call over to Marty for his summary comments.

Thanks, John. Before I make my formal remarks, it would be remiss of me not to recognize John's outstanding contributions over the past year. He is largely responsible for implementing organizational and financial disciplines throughout the organization, and we all appreciate his leadership in that regard.

During the third quarter, we continue to execute against our plan. We grew our HSP business, realized additional licensing and royalty revenue from licensees and partners, invested in our wireless feature, and we carefully managed our costs. We generated on an annualized basis approximately $480,000 for employees for the third quarter. This compares to approximately $140,000 per employee for the same quarter last year. Even with the allocation of over 30 people to our new wireless programs, our head count was at 104 at the end of the third quarter, down from 134 a year ago. This suggests some improvement in the efficiency of our HSP operation. In addition to the improved efficiency in our HSP business and progress on the licensing fund, we can report some modest success in launching our Wi-Fi software business.

During the third quarter, Maritime Telecommunication Networks, MTN, which is a subsidiary of American tower, successfully installed the complete PCTEL Wi-Fi system on the Norwegian Star, a vessel in the Norwegian cruise line. This system uses our Gateway, AAA Broker, and our Install Wizard and Roaming Client. Our goal is to supply these products throughout the cruise line industry. We also signed agreements with Novatel Wireless to private label our roaming client for use with their roaming products. In Japan, sourceNEX adopted our roaming client for retail distribution in that market. We advanced our wireless technology as well. Our development group applied for a patent on their technique for roaming across cellular and Wi-Fi systems. Our roaming client incorporates this technology and will enable cellular carriers to offload high bandwidth traffic, thus preserving their highly constrained SPECTRUM. We are excited about this product.

As already stated, we strengthened our modem business during the past quarter. We completed our software releases for the DSP modem business. Achieving that milestone permitted us to close a facility, while still realizing royalties from DSP modem sales. In the HSP arena, we reduced our standard drivers from 7 to 2. This in turn permitted us to reduce overall product releases and migrate development resources from analog modems to our wireless future. We continue to ship our high quality NDC in volume to the notebook market and our shipments to the Taiwan market improved. As we have stated for the past year, we believe that our intellectual property represents a valuable asset. We have done extensive work on claim charts that suggest several major competitors might be interested in taking a royalty-bearing license under our patents. We'll continue to pursue our interest in this area.

The management team continues to beat the drum with a very simple formula for our future. We will continue to force efficiencies in our modem business, realize the full commercial value of our intellectual property, aggressively develop and field software products that will enable the rapid growth and utilization of Wi-Fi networks, and explore interesting and accretive investment opportunities. It is exactly one year today since I took on the challenges confronting PCTEL. Our board, although extremely vigilant and demanding, gave me the opportunity to recruit and develop a high quality management team. While there is much more work to be done, I believe that the team has performed well. PCTEL veterans Carlson and Mark Wilson have developed revenue momentum with their sales and licensing efforts. Jeff Miller rationalized our modem development plan, clearing out unnecessary releases and imposing structure and control on the development organization. Biju Nair has led our investments in new technologies and created real excitement throughout the organization and John Schoen as already mentioned has done much of the heavy lifting throughout our aggressive restructuring.

We appreciate the patience of our valued customers, our shareholders and the entire PCTEL team during the period in which we have worked to restore our fundamentals and, at the same time, transitioned our company to a wireless future. We believe that we have made progress in establishing a new identity for PCTEL. We are a reliable resource for providing evolving access solutions. Modems are certainly one element of that identity, but our future rests with developing software utilities, planning tools and products that get you there by wireless or wire, LAN or WAN. We are excited about our opportunities in the access market and remain committed to the execution of our plan. Thank you for joining this conference call. That concludes a review of PCTEL and we are now ready to answer your questions. Thank you.

At this time, I would like to remind everyone if you would like to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q and A roster. Your first question comes from Doug Whitman of Whitman capital.

Great quarter, guys. If you could expand a little more on the wireless opportunity, Marty, in particular what the margin implication might be once you start doing revenues and what the cost was on the quarter? I know you're carrying a substantial number of employees there, and maybe John if you could comment on the receivable base seems amazingly low besides the fact that you obviously did a good job of collections. Could you talk a little about how you got them so low and what the outlook is for days looking forward?

Sure, Doug. I'm really happy that you had to wake up so early this morning.

So am I.

John will first comment on the accounts receivable and the cost on the wireless, then I'll talk a little bit about the prospects in the wireless business. Go ahead, John.

Yeah. Well, first of all let's talk about our model in modem business. When we started a year ago, we were faced with a high inventory level in our channel, and so what we did was we completely re-engineered how we deliver orders. What we've done is we've gotten to the point now where we will only accept an order and deliver it when our customer actually needs the inventory for his manufacturing, so there's no pushing into inventory, and so I literally will sit here and have customers calling and say to me my line is going to shut down if you don't ship to me. So what I do is not even keep them on an even cash flow, but when I do that, the benefits flow down to me. Our actual days still outstanding was 30 days in Q3 and surprisingly that's actually up five days from Q2 and the reason was the timing on a very large order to ECS but from a perspective of keeping it low, this is a sustainable model for us.

Do you want to comment on the costs in the wireless?

Yes. The way our wireless model is being put together is we account for all the costs of our software business and operating expenses, and so when the software begins to ship, it would be recognized with nearly 100% gross margin. When we ship infrastructure, though, where it was passing through, it would flow through obviously as a mix of hardware and software. But we're predominantly a software model.

And to your other question, Doug, we have about 33 people now working on wireless. I think the costs in the third quarter were $1.4 million?

$1.4 million, up from $0.9 in the second quarter.

Right. In terms what it looks like, we're just starting to get traction, as I said, with those orders. We expect to start seeing some revenue, more significant revenue from this area in the first quarter of next year, and as John has already commented, the margins in that area will be significantly higher than what they are in our core modem business.

And last question would be, I know connection hasn't reported yet, but what do you think your market share pick-up is like?

You know, they commented once on our market share, and, you know, I thought it was a little bit bush league. I don't want to comment on their market share. I think that we are doing well in some PC OEM accounts where, you know, certain parts of that business were closed off to us that may or may not be at the expense of one of these competitors, but I really can't comment on their specific share.

Okay. So you think you're gaining share?

I might be, although it's difficult to tell.

I don't mind waking up for this kind of quarter.

Okay. Thanks a lot for the question, Doug.

Your next question comes from Wes Cummings of B. Riley & Co.

Have to get you up early too.

That's all right. On a couple of questions here, first on the modem business, could you comment on pricing trends during the quarter for the modems?

Yeah. Overall, our ASP declined in the third quarter from the second quarter, but that really is not a result of a price decrease so much as it is a result of a different product mix. So if you look at the first and second quarter, we had the benefit and a little bit of the cost not having as much business from motherboard and channel card manufacturers in the past, and historically prices are a little bit higher with the PC OEMs. Although our PC OEM business increased in the third quarter, our business from Taiwan increased at a faster rate and so our average ASP declined. But without commenting on any specific customer, I will say that in Taiwan, we actually realized a price increase that we'll see in the fourth quarter. However, because that business will be stronger relative to the rest of our business, we still may see some overall price erosion.

Okay. And then competition in that market, just-can you comment on kind of what the competitive landscape looks like right now, you know, maybe hearing that some people are not as interested in being in this market anymore?

Well, you know, I'd be happy to report that's true, but unfortunately, I have to report that we see some substantial competitors still. We think that SmartLink is doing quite well out of Israel. We think that ConnectSON remains a very strong and tough competitor. We think Gear is strong and tough with a strong foothold in Japan and we have to work every day to get our business, and we see Broadcom as active in this market. There may be some [inaudible], and we also believe that Intel is shipping in China, and while we're unclear about what ESF is doing at this time. But in terms of our day to day work effort, Wes, there hasn't been an opportunity for us to breathe a sigh of relief and say, gee, the field is clear here, we're unchallenged.

Uh-huh.

So it's still tough out there.

Okay. And the revenue increase in the third quarter, I guess I was surprised a little bit by the strength in the modem business. Can you characterize that as, you know, the strength coming from just finally clearing the channel inventory out or, you know, maybe some potential market share gain? I mean, where are you guys seeing the strength?

I think that there are three elements to our increase in our traditional product revenues. First, John has done an exceptional job along with the sales force in fulfilling these orders in a disciplined and yet a very customer-responsive fashion. That's resulted in a drying out of the inventory, and yeah, we're just not facing our own product or other people's products in the channel. So that has helped.

I also believe that we have benefited from being in the business for over a year now with the MDC, the modem daughter card, and that's become our flagship product. It's an extremely high quality, very reliable product. We've been delighted with our support from Silicon Labs in shaking out any of the early problems that we had about a year ago. They've been a terrific partner here, and I think that as we have improved the quality of that product, that it's become more attractive for other customers to buy. The second thing is, the success of the MDC product and getting the MDC product sold in other areas.

I would also say that the third is something that is out of our control, which is that I think as John mentioned earlier, interest may have been- there may have been a seasonal increase as some of the PC manufacturers prepare for the end of the year, but that's a bit of conjecture on my part. We're certainly seeing an indication, as John mentioned that, this seasonal increase should continue through the fourth quarter. I hope that answers your question.

Yeah, that definitely does. And then a couple of questions on the wireless side. Did you say you would recognize revenue in Q1 from the wireless business?

Yes, we will.

Okay. And can you just comment on in Wi-Fi, on the hardware side, I mean, it is an extremely competitive market, what you kind of see as far as first the state of the market as far as its readiness for your types of products, and then secondly, the competition in the market for the software that you're offering.

Yeah. Well, there's really two separate questions there. The hardware and the software. Both markets are competitive, but I believe that the market is absolutely ready for the software that we have to offer. And just let me comment on that. I've turned into a wireless LAN heavy user, and, you know, I use our products, so for example, the Roaming Client, I had that installed on my PC and we've demonstrated this to several customers to very, very favorable reviews, and what it permits you to do is the following. You install this, you use whatever 802.11 card you happen to have. It does not have to be a PCTEL card. It can be any of the major volume cards. And you go from one environment to the other, and the roaming client automatically sets your proxy settings, goes out an gets an IP address, log-in credentials and so on, as opposed to having to go into your computer and modify these things manually, you know, particularly for someone who's not comfortable doing those operations, this is a great benefit.

But in addition to that, the Roaming Client is something that we can customize for any customer, give them their identity, their logo, so when we sell it to Novatel Wireless it will have a Novatel Wireless look and feel. But one of the real benefits to this is that, you know, the cellular carriers really want to get into wireless data in a big way. 3G does not look like it's happening anytime soon. They want to get the most out of 2.5G, but those networks are highly constrained in terms of spectrum. If they put a lot of data on them, it's going to create problems. So what the Roaming Client is if an 802.11 network is available, it puts you on that network. If it's not, it finds the cellular network. And if you're on a cellular network and you have an opportunity to go to the higher bandwidth unconstrained 802.11, it has a bias for putting you on to that network. So we have very high expectations for this product. We're in a lot of trials with various carriers, both in the United States and Europe, and we think the market is ready for this product, and we think, you know, that there's a good opportunity.

As we mentioned, Sourcenext, which is a large distributor of software products, has put the Roaming Client into retail environments as well. With respect to our hardware efforts, you are correct in pointing out that this is a very competitive market. I would point out, though, that even in this hardware area, should that be difficult for us, we have developed several software utilities associated with 802.11 such as diagnostic and test that we will be able to make-we will be able to make available to any 802.11 hardware manufacturer, so we think we're flexible in how we've approach this business and will get value out of that one way or another.

Okay. Thanks.

Okay?

That's all I've got. Thanks, guys.

Thanks a lot, Wes.

Your next question comes from Peter Black of Winfield Capital.

Good morning. Can you just talk about sales in the notebook PC market, how important that is to your overall revenue base and what-kind of generally what the order trends look like? It just occurred to me, I was on a conference call last week for a company called CDW computer centers which distributes PCs, notebooks, servers, all that stuff, and one of their biggest areas of disappointment was in sales of notebook PCs.

Well, that's interesting. I mean, all the data we see is that within PCs overall, notebooks are an ever-increasing percentage of PC sales, so they may be disappointed, but there's no question that notebooks as a percentage of overall PC sales are increasing and adding a product that's well suited for notebooks as opposed to desktops is I think where you want to be in this marketplace. And having said that, our data would suggest otherwise, you know, from-I guess from the comments that you have made, our MDC sales are increasing, they are an increasing percentage of our overall modem revenue. I think our sales for the PC OEM accepting NDCs are over 30%.

Thanks a lot. One other question. Can you explain in plain English how the Wi-Fi works in that sale to the Norwegian cruise market?

What we sold them was a complete system, so NTN has a satellite connection to these cruise ships, and they sort of own the various communication and data services that go there. What we provide to them is a building system, a gateway that aggregates all of the wireless traffic on the boat, and then we provide them with two software packages, an Install Wizard that makes it very easy for Guests on the boat to install an 802.11 PCMCI card, and a Roaming Client that allows them to roam on to the various 802.11 environments so that they don't have to do-essentially they don't have to do anything. They put in their card and they're ready to go. So in the case of NTN, we made a complete system sale. We believe that we will have five to six shifts outfitted by first quarter of next year, and as I said, our goal is to go after all of them with NTN as the systems integrator.

Okay. Thanks a lot. Appreciate it.

Thanks, Peter.

I would like to give everyone an additional minute to ask a question. Again, if you would like to ask a question, simply press star then the number 1 on your telephone keypad at this time.

If anybody is having difficulty getting in, please call (847)951-8361, and let us know.

Your next question comes from Stan Trilling of UBS.

Good morning, gentlemen. Great quarter.

Thanks, Stan.

You had mentioned in the release about the- that you have costs under control. What type of cost containment benefits are we yet to see?

Well, you're right, we did express some belief that we've made progress on cost control, and we think we have. I think John reported that we were over 9 million in operating expenses third quarter of last year and we're 5.9, I think including a restructuring charge, this quarter, so I think it is fair to say that we've made some progress.

In terms of additional cost control, there's a few things. One, our lease is up in Milipitas. That was a gigantic facility. I think our total rent and cost there were $1.7 million dollars. We've moved in this Chicago office and we're relocating to a smaller facility in Milipitas. I believe our total cost will be between 7 and $800,000 dollars for the two facilities, so next year we're looking at a reduction of a million dollars. We are consolidating two Taiwan offices. We'll be saving some amount there. There's some other consolidation actions that we're taking with respect to development efforts that will allow us to realize some additional cost reductions, and in general, we're just being extremely careful. But I think that you'll see-I think you'll see some progress in the fourth quarter and first quarter of next year.

You guys have been great shepherds of the cash. How are you marketing the Wi-Fi products, and who would be your top three prospects?

Well, I won't tell you by customer name. But I will tell you by area who we're looking at. We're looking at actively marketing the product into the wireless carriers, the cellular carriers. We're looking very hard at the WISPs, the wireless ISPs, and then we're looking at various type of hardware manufacturers. For example, those people who sell access cards and need software utilities to facilitate the use of their product. Does that answer your question?

Yes, it does. Any priority of the three types?

Oh, we'd love to have a big hit with the wireless carriers, and we're putting a major push on there and we have our product in several evaluations. You know, I think the wireless carriers and even some of the wire line carriers who want to get into offering wireless data use as part of a package are great targets for this product.

Okay. What do you perceive as a reasonable percentage of your revenue coming from Wi-Fi next year?

Well, we're not offering guidance on 2003 in this call. We have a board meeting coming up next week where we'll have our 2003 plan approved, and we'll be ready to discuss that in some form that all of you will have access to at some point after the board meeting.

Thank you very much.

Thanks, Stan.

At this time, there are no further questions.

Okay. Would you give people one more minute?

Yes, I sure will. Again, if you would like to ask a question, simply press star, then the number 1 on your telephone keypad now, please. There are still no questions, sir.

Okay. One more comment. I just want to remind everyone that for this week at least, we're in our Chicago headquarters. My number is (773)243-3001. John's number is (773)243-3002.

Mr. Singer, you have a follow-up question from Stan Trilling of UBS.

Hi, Stan.

Yes. In your-you also talked and in your presentation talking about possible acquisitions. Could you give us a picture of what type of acquisition, size, where it fits, that you would be looking at?

We're looking at acquisitions that would strengthen one of our core initiatives. I think that we have two core initiatives. Obviously the wireless area in transitioning our company so that wireless represents a greater percentage of our revenue. The other area, of course, is software utilities. You know, at the end of the day, HSP modems are a software utility, a communication software utility. Our Wi-Fi products are software utilities. There are other opportunities in that area. We're also interested in perhaps products that help optimize the performance of wireless networks, either 802.11 or cellular, because we think that, you know, the success of wireless data is going to depend somewhat on the ability to effectively use the spectrum to avoid interference and so on. That's a type of area that this particular management team is extremely-you know, has a lot of comfort with because of our background at Safeco and we really think we can do something with it, so those are the broad areas. I think in general, our acquisitions will be smaller but accretive. We're very mindful of the fact that, you know, we have to be careful about management bandwidth and we have to be able to take in companies that we can integrate into PCTEL. So we are working hard in this area right now. We're not looking to deplete all of our cash in doing this, and, you know, you can be assured that it will be done conservatively.

Thank you.

There are still no other questions, sir.

Okay. With that, I'd like to thank everybody for participating, and look forward to talking with you next quarter.

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