TESSCO Technologies Inc (TESS) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2012 TESSCO Technologies earnings conference call. My name is Jeremy and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

At this time I would now like to turn the presentation over to your host for today's call, Ms. Harriet Fried of LHA. Ma'am?

Thank you, operator. Good morning, everyone, and thank you for joining TESSCO's conference call. With us today from management are Robert Barnhill, Chairman, President, and Chief Executive Officer, and David Young, Senior Vice President and Chief Financial Officer.

Management's discussions this morning will contain forward-looking statements about anticipated results and future prospects. Forward-looking statements involve a number of risks and uncertainties, and TESSCO's results may differ materially from those discussed today. Information concerning factors that may cause such a difference can be found in TESSCO's public disclosure, including the Company's most recent Form 10-K and other periodic reports filed with the Securities and Exchange Commission.

With that introduction, I would like to turn the call over to Mr. Barnhill. Go ahead please, Bob.

Thank you, Harriet, and good morning. We were delighted to announce our final third-quarter results yesterday evening. The results represent new quarterly records for both revenues and earnings.

The revenues hit $226 million. Earnings per share were $0.59, and we are going to continue our $0.15 per-share quarterly dividend. And I think most of you saw that we tightened our range for this fiscal year, which ends in March, to $1.90 to $2.10.

These records reflect our success in leveraging the extraordinary breadth and depth of opportunities that are being created by the convergence of wireless and the Internet. They also reflect the success of our efforts to expand into new segments and develop new solutions for the systems that we support, and our ongoing initiatives to enhance our profitability and productivity.

I think as you will recall, last quarter we introduced a new segment reporting structure that breaks out our commercial and retail customer segments, to give you a better view of where our business is coming from and how it is driving our bottom-line results and how we manage the business. In the third quarter, we saw sales in our retail segment really surge as our customers, including the Tier 1 carrier customers that we serve, as these customers respond to the consumers' quest to equip their smartphones with new cases, chargers, and headsets. Also, our commercial segment contributed strongly to the results as we supported the construction and maintenance of their wireless systems.

As we delivered the exceptional value to our customers, we grew profitability. For the quarter, our operating profit margin was 3.5%, a 35% increase over last year's third quarter.

The fiscal year 2012 is indeed proving to be a remarkable year for TESSCO as we successfully leverage our many opportunities and broaden the addressable market, all with new levels of profitability. Going forward, we expect the continued explosion of smartphone devices and the required support accessories. We see the accelerated expansion of the carrier networks to support the devices' insatiable demand for bandwidth, and we see the creation of new private systems that really transform the way we live, work, and play.

And we are there. We are right in this convergence. We are leveraging these trends and delivering the immediate, reliable availability of the product plus the supply chain solutions at the lowest total cost to our suppliers.

Be assured we will continue our goal of driving shareowner value with intense focus on the success of our customers, manufacturers, and team members. So with that preamble I would like to turn it over to Dave Young, who will give you really more of the details of our third quarter. Dave?

Great. Thanks, Bob. Good morning. We continue, as Bob said, to be very excited about these record results so far this fiscal year. During the quarter, our retail segment really had outstanding performance; and the commercial segment showed solid growth and strong profitability.

The financial statements looked little different this quarter, mostly related to the expansion of our relationship with our largest customer. The strong top line, coupled with the lower gross margins that we have been expecting, definitely occurred this past quarter.

The growth in this relationship also affected the balance sheet as it drove significant growth in inventory, receivables, and payables. We think our new segment reporting helps to show pretty clearly the effects of this expansion, and we will get into those details in a few minutes.

But first I will give some highlights of the consolidated performance. And all quarterly comparisons here are to last year's third quarter.

Revenues, as Bob said, totaled $226 million. That is a 35% increase from last year. Not including the Tier 1 customers, our revenue grew by 6%.

Gross profit reached $40 million, which is a 17% increase. Not including the Tier 1 customers, gross profit increased by 9%. So again not including the Tier 1 customer, our gross margin was up by about 80 basis points to 24.5% for the quarter. After accounting for the increased lower margin business from the Tier 1 carrier customer, our consolidated gross margins declined from 20.1% to 17.4%.

Our SG&A expense increased by $2 million or 7% for the quarter, totaling about $32 million, a result of the higher pay-for-performance bonus accruals this quarter. Excluding that increase, we saw strong productivity gains, mostly in compensation and in our freight expense.

Accordingly, our operating income in Q3 was $8 million; that is up 82%. Our operating margin, as Bob said again, was 3.5% compared to last year's 2.6%. So despite the significant increase in low gross margin sales this quarter, we were able to again show nice growth in our operating margin compared to last year's quarter.

Net income was $4.8 million, $0.59 a share, and both of those are records. EBITDA reached $9 million, $1.12 per share; again records there.

And for the nine months, revenues totaled $539 million. Our operating margin was 3.9%. Net income was $13 million or $1.60 a share. And EBITDA reached $25 million, $3.08 per share.

Now a little more detail on the segments. As you may recall from last quarter and Bob already mentioned, we are now reporting a financial performance down to the net profit contribution level based on the two segments.

So we will start with the commercial segment. Revenues totaled $85 million. That is up 2% compared to last year. Our gross profit in this segment totaled $22 million; that is up 3%.

Revenues in the private system operator and government market were up 9% year-over-year. As we've said in past quarters, this is a very exciting area for us. There are a lot of vertical markets that we can sell to here -- enterprises, utilities, governments, transportation, education, healthcare, energy. And these entities are really increasing their use of wireless networks in their business.

We think there is a lot of opportunity here to provide our customers with customized solutions that will include our infrastructure proprietary products. Our gross profits in this market are up 11%, so revenue growth of 9%, gross profit growth of 11%. So these customized solutions and proprietary products are driving improved margins.

Revenues in our commercial dealer and reseller market increased 15% and gross profit was up 11%. These commercial resellers are working on many of the same types of products that I just mentioned, so we are very enthusiastic about this market too.

Then, revenues and gross profit in our public carrier contractor and program manager market both declined by 21% year-over-year. We continue to see the carriers delay their build plans, but we think there is a chance to see some turnaround in this market next year as the carriers are starting to think about more aggressive build plans and other initiatives like IDANs, indoor distributed antenna systems, start to take hold.

Our commercial segment expenses for the third quarter were approximately $10 million. That is down about 13% compared to last year's quarter, mostly related to lower marketing and people costs.

We have really gained some productivity in our business generation teams with improved systems and a much stronger focus on electronic market. Consequently, our profit contribution in this segment totaled nearly $11 million; that is up 24%. This segment really has been producing very nice results, and we are proud of the growing margins and profitability here.

Now to the retail segment. Revenues were $141 million. That is up 67% from the prior year. Gross profit totaled $18 million, an increase of 41%.

In our non-Tier 1 market, the retail dealer and Tier 2-Tier 3 carrier market, revenues grew by 15% as we continue to penetrate and add accounts in this market. Our gross profit increased by 36%. So 15% revenue growth, 36% gross profit growth; really nice margin pickup here.

Our revenue growth in the Tier 1 carrier market was 93%. But with the lower margins, gross profits grew by 44%. Both of these primarily a result of the expanded business relationship with our largest customer. For the quarter, revenues from our largest customer accounted for 45% of our total sales compared to 30% in last year's third quarter.

Direct expenses in this segment were up 7%, a result of higher market development funds paid to our largest customer. Those are completely variable to revenue. They have been around since the beginning of our relationship there. But with the big increase in revenue, that obviously is up.

That increase was mostly offset by lower marketing compensation and freight expense in the non-Tier 1 business; similar productivity improvements to the commercial side. The retail segment net profit totaled $9 million; that is a 100% increase.

Then below the segment profit contribution lines, our corporate support expense grew by about 33%. That is primarily due to higher bonus accruals that I discussed earlier, partially offset by lower people costs and reductions in other overhead-type expenses.

Now to the balance sheet. Our inventory increased by about $12 million this quarter. This increase is almost exclusively related to the expansion of this relationship with our large customer.

Despite that growth, inventory turns were 12 times, up from about 8.5 times last quarter, so a good result. That inventory with the large customer turns pretty quickly.

We had strong cash collections quarter, but due to the strong sales our AR increased by about $52 million. Our days sales outstanding were 39 for the quarter.

Since the increase in inventory and receivables was more than offset by the increase in payables plus net income, we generated about $5 million in cash from operations for the quarter. We ended the quarter with $14.5 million in cash on the balance sheet; no outstanding balance on our credit facility.

Our Board set the date for the next quarterly dividend payment. It's a $0.15 per share dividend to be paid on February 15 to shareholders of record on February 1.

And, as Bob mentioned, we amended our business outlook and our quarterly preannouncement a couple of weeks ago. We reaffirmed that in this release last night. And based on year-to-date results and our projections, we expect annual EPS to be in the range of $1.90 to $2.10.

So to close, we are very pleased with this past quarter's record results. We very productively handled the significant increase in volumes from our largest customer while we grew the top line and bottom line in the rest of our business and we maintained our strong balance sheet. So, Jeremy, we are now ready for some questions.

(Operator Instructions) Anil Doradla, William Blair.

Hi, guys. It's Brian Nugent in for Anil. Congrats on the execution with the transition there. I do have some questions on that relationship.

Just trying to get a sense -- this might be difficult -- but some kind of sense of how much of the growth was the expansion of the relationship versus we had some new smartphone releases and then we also had a seasonally strong quarter. So just wondering; can you talk about all those factors?

What kind of typical seasonal lift would you get, or a typical lift from the iPhone? And then some sense of how many more SKUs you are handling right now versus a year ago might be helpful.

I think as far as the lift, I think you'll recall from the second quarter it was slower than we expected because there was a lot of delays in the launches, which we saw pick up in the third quarter. So we definitely saw the lift, number one, of the new smartphones coming in, the new demand, and then obviously the holiday season. As I mentioned early on, it really was a surge of business.

We saw the same thing in our total retail segment, without the Tier 1 carriers in it. It was very strong. Dave, you might comment about the expansion with all the other new SKUs.

Yes, I think Brian, when we looked -- if you look at last year, the Tier 1 business, the second quarter of last year had the iPhone in it. And so we saw the impact of the iPhone launch.

And the holiday season and the December quarter were about the same revenue numbers in that Tier 1 carrier market. So I think that that tells us that an iPhone is sort of like the holiday season. So we had obviously both of them this quarter.

The expansion of the relationship has been a couple hundred SKUs probably, I think, and from maybe another 20 or 30 different manufacturers that we've brought in during the quarter.

So it expanded by a couple hundred SKUs?

Yes.

And those SKUs, those new -- a lot of it are totally new products to us, which we are taking into our independent channel as well. It is a real tribute to the TESSCO team to take on that level of expansion that quickly in virtually a flawless way.

And you can see that we did it without increasing costs, and inventories came up appropriately, but still with the high turn, as Dave mentioned. It was pretty exciting what we did.

Certainly. Then it might be hard to say at this stage, but is there any like milestone or any sense of when the large customer might be changing the model again, or the timing, or what impact it might have? Is there any sense of when that could occur? Or are you comfortable over the next couple quarters?

Yes; I mean we're working with them continually to improve the entire availability, reduce the inventory in the channel, and lower total costs. So I mean it's almost a continued evolution at this particular point as far as to continue to enhance their overall service levels at the store, the products that they present. So I think that we will see a continued shaping of that relationship as we go forward.

Fair enough. Then it sounds like, if it continues like this, you are going to get a little more seasonality in the overall business if it stays the same. Can you give a sense of how much of your OpEx is variable?

So if you saw the total shared expenses go up, is that like a flattish number, and then the segment OpEx will stay the same as a percentage of sales? Or can you just give a sense of how you are going to manage that if there is this kind of seasonal impact going up this quarter and probably down the next quarter?

There's two big components of that retail segment expense line, as we talked about. It is the more fixed component, which is our marketing costs, our sales people, all the different purchasing and all the different functions related to that business. But then you have got the purely variable with the Tier 1 revenues, that market development fund.

So we don't break those out, but we would expect as the revenues decline you will see that variable piece around seasonality -- you will see that variable piece come down significantly and the fixed obviously stay pretty much where it is. So I think it's -- there is a significant amount of that expense that is variable. Yes.

And then we have got some labor as well that is up in the margin line, though, right? That is all variable as well.

So most of the packaging labor that we are doing is up in the variable cost there, so that is up in margin. So that will move with revenue as well.

Got you. Then the non-concentrated business I think you showed a good year-over-year increase. It was down a little bit sequentially. Is that just mix? Or is there any other factors that might be causing that?

And then can you just talk about outside of the concentrated business, what kind of leverage you have for gross margin improvement in the fourth quarter and longer term?

Brian, when you say down a little bit, yes, it should be -- it is up a little bit I think, sequentially anyhow. And you are talking about just the commercial business?

I am just talking about non-Tier 1.

Yes, okay. So non-Tier 1 was about $118 million this quarter and $109 million in the second quarter. So most of that growth was driven by the retail non-Tier 1 business. It had a really good quarter there, again buoyed by the holiday season, but significant increase compared to last year's quarter, too.

The commercial business was up a little bit on the top-line, driven -- nice growth in the VAR and SMU, the private systems side, offset by the decline in the carrier market.

So I think that seasonally this is always a pretty good quarter for the commercial business, and the March quarter is a little bit weaker. But we think there are some things that are in the pipe that may impact that trend this year and have a little bit stronger commercial quarter, the fourth quarter.

Okay. Yes I think it sounds like you're pretty bullish on the private systems.

Yes.

And government. So, is there any -- I think are you referring to some of the stuff that you have highlighted in the past, the railroad projects and the smart grids? Or is there any -- can you just give an overall picture of what kind of -- what is getting you so optimistic there?

Yes, I think first of all is we believe we are going to start seeing and we are starting to see some of the carrier builds. I think we all know that the AT&T/T-Mobile merger really put everything on quiet or on hold, if you will. But now both of them are going to have to start to supplement their systems, where they thought that the merger would help them with that bandwidth. So we are starting to work with some of the program managers now, and we are starting to get some insight into the carrier builds.

Then to your question, we are seeing new business from the railroad. It is not really the Positive Train Control that we have talked about; that continues to be delayed. But because we are in there with that, it is driving other new opportunity.

Same thing with GE. We are seeing new opportunity even inside of GE.

We did -- I think it was this quarter -- the stadium build, that we put a DAS system in, a distributed antenna system, into a stadium to help with cellular coverage when you've got a big fan base that are coming in and trying to use their phones and their cameras. So that was -- that's very, very successful. I was in the stadium this past weekend; I mean it was really handling a lot of data. That system was something that we designed and one of our good integrators totally installed the system.

So, in smart grid you mentioned we're getting some of our proprietary product, some of the Ventev mounts into the system, in addition to our other products. So the exciting thing is as we look across, we go from utilities to transportation back to the carriers, and we are seeing a lot of new opportunity come up.

Great. Then lastly, just always interested in your macro commentary. I think you just hit on the key issue is carrier spending. I was curious if you are -- it sounds like you are seeing that more as a pause in CapEx by the operators, which it seems like you have seen. But it sounds like your commentary is that there is maybe some light at the end of that tunnel.

Yes, you know, when you look at it, they're really at a tipping point. As we talked I believe the last call, I think the iPhone 5 was held back because Apple was not comfortable with the bandwidth that was out there to support that device. It's one of the limiting factors right now with continued expansion of the smartphone, is the overall capacity, the bandwidth capacity and power consumption of the device.

And we have got some really exciting things with power. We have got this Powermat project with Duracell that is very exciting as far as giving -- putting it in stores, putting it in automobiles, where you can basically just put your smartphone on this mat and it will charge it without having to carry your charger around with you.

So these are the things that we -- and what is exciting about the business is you've got these smartphone devices that are driving this bandwidth. And the bandwidth is what allows the smartphone devices, but you are right that we just haven't seen that carrier build. But they have just got to start moving out to assure that there is bandwidth to support the demand of the consumer.

Yes. In light of that, it makes for a pretty good performance in that kind of environment. So congrats and thanks for taking my questions.

Well, and you know, your last bit about -- the environment is still not -- there is not a lot of wind to your back. I mean there is -- everybody continues to be very cautious, controlling inventories, controlling spend.

I think that the main thing that we saw that was really kind of getting back to the good, strong economy was just the consumers' demand for these devices and their accessories.

Yes. All right. Thanks a lot, guys.

Steve Shaw, Sidoti & Company.

This may go hand in hand somewhat with I think it was the first question; but can you just provide some color on the relationship with ZAGG and what that either did for you guys or will do going forward?

Yes. ZAGG has some very exciting products and we are working on major launches into the independent channel. They have been very successful in other channels and really haven't penetrated the carrier independent channel. As we are very focused on the independent agents for AT&T and Sprint and Verizon and T-Mobile.

And they have got the project -- the products that they have are very exciting, very innovative. And we are building the go-to-market strategies right now that are going to really get into 6,000, 10,000 different dealers.

We are developing a training program now. A lot of their products take some -- their screen protector, the shield takes some finesse if you will in terms of installing it. We are putting some training programs together to help launch those products. So it is going to -- it is a great new relationship for us.

Then, while on the topic of consumer side of things, would you guys need events like a new iPhone, the iPhone 5 or 6 or other phones that come out, to keep that growing? Or is that where the ZAGG relationship comes in, and other things similar to that?

Yes, I think first of all that the new phones drive a lot of delta business, okay? Because usually there is a new form factor, so it is another device, it is another SKU. So that is something we watch very carefully, and we have got a complete roadmap where we know what we have to be developing and what we have to get in.

But then having (technical difficulty), there is still -- we are sitting here today in the conference room and we are trying to scrounge up a charger, if you can believe that. I mean it's because one was misplaced.

So you've got this insatiable demand for new chargers. One for your car, one for your house, one for your office. So, you've got -- and today it is becoming much more -- you can't live without it.

And then we see with cases people are constantly -- they want to get better protection, they want to get better style. So you've got that embedded market that is feeding the existing phones out there in addition to just taking care of the new phones when they come out.

Okay. Then, Dave, you mentioned some of the drastic changes on the balance sheet due to the Tier 1 growth. Any color on what that is going to look like for the remainder of the year, some of those items?

Yes, I think -- I mean the inventory is going to move pretty much in step with sales. So I think as the seasonality of the post-holiday, post-iPhone launch, we would expect some decline in the Tier 1 sales.

That will be mirrored by a decline in inventory, and payables for that matter, and receivables I think. So everything should really pretty much track with what we are seeing in terms of sales.

Like I said during the script, there is really not -- we didn't grow much at all our inventory in our core business; so we continued to do a really good job there rationalizing inventory, reducing lead times, managing to lower our working capital there. So it should track pretty closely going forward with sales.

Okay, thank you.

Eric Martin.

Good morning, guys. Great quarter. Just wanted to get some color, if you can provide it, on the gross margins in the retail segment, particularly with the Tier 1. How should we model out -- how should we look at that segment as we roll forward?

You have commented that the Tier 1 segment obviously is looking for better pricing. But I just wonder; is there an ability to set aside their demand on pricing, but also at least stabilize the gross margin percentage in that segment as we roll forward? Or are we going to continue to see some compression there?

I think that in the near term, we are probably going to see a margin similar to where we are right now. I think that we -- this entire quarter had the new arrangement in it. So there will be some movement in terms of mix with Bluetooth versus cases versus screen protection versus memory, whatever.

But I would expect the margin to be pretty similar in the near term. Looking out past that is kind of hard for us to do.

Got you. Is there anything in the supply chain that you see today, other than how you negotiate pricing with your customers, that are puts and takes as we roll forward over the next few quarters?

Well, I think that we have done a pretty nice job in year-over-year growing the margins everywhere other than in that Tier 1 business, and we expect that to continue. I think that big emphasis on proprietary products, both on the commercial side and on the retail side, that should -- as we get more share of that market, that should at the very least buoy any other pricing pressures or whatever. So our goal is to continue to increase those margins some; but I think we expect them to be pretty flat.

Great. Look, guys, all my other questions were answered before. So again congratulations and good luck.

(Operator Instructions) Okay, it seems there are no further questions at this time. I would like to turn the call back to Mr. Barnhill for any closing remarks.

Good. Thank you. Well, thank you for joining us. Thanks for the questions. I think we hopefully gave you some more insight in terms of what our business is doing and clearly that this fiscal year is shaping up to be the remarkable year that we expected. We are just doing a lot of things in a lot of areas that are all adding to the bottom line.

Then most importantly, the product and the supply chain solutions we offer, combined with our outstanding execution, really assure our customers that they are going to have what they need when and where they need it, but at the same time lowering their inventories and their cost of ownership. As we have mentioned, in this economy our business model is playing to even more, that when customers are very lean on their inventories they depend upon us to making sure that we can deliver what they need to take care of their customers.

And as we talked earlier, we are very excited about the possibilities for the future and look forward to talking with you again when we were report our fourth quarter and obviously our fiscal year results. So, with that, thank you very much and have a great day.

Thank you for your participation in today's conference, ladies and gentlemen. This does conclude the presentation and you may now disconnect. Have yourselves a wonderful day.