TESSCO Technologies Inc (TESS) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2013 TESSCO Technologies Incorporated earnings conference call. My name is Teresa and I'll be your operator for today. At this time, all participants are in listen only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Ms. Harriet Fried of LHA. Please proceed.

Good morning, everyone, and thank you for joining TESSCO's conference call. With us today from management are Robert Barnhill, Chairman and Chief Executive Officer; and Aric Spitulnik, Vice President, Principal Accounting Officer and Controller.

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 recent 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. Please go ahead, Bob.

Thank you, Harriet, and good morning, everyone. As I'm sure you saw in yesterday's earnings release, we had a solid quarter. On a year-over-year basis, we generated 18% revenue growth in our core markets, and we also grew gross margin in those markets by 18%. And we set a quarterly record of earnings per share of $0.65.

The transition out of the high-revenue, low-margin third-party logistics business that we have discussed in the past has been continuing, although at somewhat of a slower pace than we initially anticipated, which does result in higher revenues than we expected. We still expect it to be substantially completed by the end of fiscal year 2013, which is this March. And we continue to maintain a strong relationship with this customer and its other programs, and supplying it with our own manufactured Ventev products.

As we transition, we've been shifting the considerable focus this 3PL relationship required towards our core business, and building on the many opportunities that are materializing by the convergence of wireless and Internet. The change is proceeding very smoothly. And we've been able to re-deploy key members into our core business that has helped us drive this quarter's growth, as well as other successes.

We continue to focus on the diversity of systems and customers. And it's interesting to just give you that counts, if you will. Today, we're serving over 20,000 different customers on a quarterly basis. We're supplying 51,000 products from almost 400 manufacturers. We're delivering 6000 orders per day. We have 99.9% order accuracy. And we have the 24x7x365 emergency response, so this is one of the reasons that customers do business with us.

We're also -- implemented a number of new marketing, sales, product and operational initiatives that we believe that will drive new levels of success in the fiscal year and beyond. In particular, as I want to continue to highlight the Internet database marketing system that we're developing. This system starts with presenting a welcoming, personal and definitive place to learn and procure products to build, use and maintain wireless systems.

And then, the system attracts and captures new customers and sales opportunities; and then directs one-to-one conversations with these opportunities to build the customers' needs; and build relationships, develop cross-sell, new customers, and obviously sales.

Another highlight is the -- this past month's International Consumer Electronics show, we introduced a suite of universal charges from Ventev, our brand for proprietary products, that power up mobile devices no matter what the brand or type or place. And it was interesting to see one of the PR that we were working on, one of the reporters made a comment that -- I'll read it to you, it's a quote. "Among the hundreds of companies showing car and home chargers, Ventev's wall port and dashboard models stood out for their beautiful industrial design and functionality. They can rapid charge two mobile devices, regardless of make or model; singly or at two at a time. Their eco-charger uses 100 of the standby power compared to ordinary chargers."

So, this is the kind of PR we've been getting, which is obviously driving new customers and new sales. Before I turn the call over to Aric to give you more details on our financials, I'm pleased to announce that our $0.18 per share dividend will be paid on February 13 to holders of record on January 30. And this is on top of the special cash dividend of $0.75 that we paid at the end of December, which is in addition to the $0.18 that we paid less quarter.

I would also like to update our business outlook for fiscal year 2013. We now expect the diluted earnings to be in the range of $2.05 to $2.15. We're moving up the bottom line, compared to our previous guidance of the $1.90 to $2.15. Also, as we go forward, you'll recall that our fourth quarter is a period that, for TESSCO, is affected most by seasonality. And it includes weather-related slowdowns in our Commercial segment and the post-holiday slowdowns in our Retail segment.

So, Aric, you want to take it from here?

All right. Thanks a lot, Bob. Good morning. We continue to be very pleased with the strong earnings results this year, especially in light of the ongoing transition of the 3PL business. This quarter was our second consecutive record earnings-per-share quarter, with $0.65 EPS, a 10% increase over last year's third quarter, and that's despite a 55% decline in gross profit in the Tier 1 Retail market.

Revenues for the quarter were $204 million. While, overall, that's a 10% decline, our quarter revenues -- which exclude the Tier 1 carrier customers -- were up 18%. Gross profit for these core customers was also up 18%, so we've not seen any margin erosion in the aggregate. As for the Tier 1 carrier business, revenue declined by 40% as the Tier 1 carrier partner continues to transition that 3PL business.

Also, last year's third quarter was by far the largest revenue quarter we've had in the Tier 1 business. And as I mentioned, we saw the continued reduction in margin from that Tier 1 customer; all of that attributable to the transitioning 3PL business.

Sequentially, revenues in the Tier 1 business were essentially flat. We had been expecting a faster decline with the transition of the Tier 1 partner, but that has been slower than we expected. However, we're still on track for that business to be transitioned by the end of the year. And, accordingly, we do expect a significant drop in revenues from that business in the fourth quarter.

The combination of the strong quarter gross profit growth and the large decline in the Tier 1 carriers resulted in an overall gross profit decline of about 1%.

SG&A was down 4% for the quarter, primarily a result of lower marketing expenses associated with the Tier 1 business, and some lower performance bonus accruals.

Accordingly, our Q3 operating income was up nearly $1 million compared to last year's third quarter. And our operating margins continued to improve over last year, reaching 4.3%. EPS was $0.65, as I mentioned earlier, a second consecutive record quarter. EBITDA reached $10 million this quarter, or $1.20 per share.

Now I'll give you a little bit more detail on the segments, and I'll start with Commercial. Commercial revenues and gross profits were up 17% over last year's third quarter. We are particularly encouraged by the results we drove in the public carrier, contractor, and program manager market, as we continue to execute on our strategy of increasing our involvement in the system build-outs that are going on right now.

Revenues in this market grew by 75%, and gross profit grew by 58%. We also posted double-digit gross profit growth in the commercial dealer and reseller market; while the private and government system operator market posted a small decline. So, for the Commercial business as a whole, a 17% gross profit growth combined with the 10% expense growth resulted in a segment gross profit of $14 million, up about 24%.

Now for the Retail market -- to properly assess the Retail market, we need to look at that segment in two pieces; the core business and the Tier 1 business. In the core Retail market, revenues and gross profit increased by 20%. So we continue to be very strong serving the independent carrier agent and other retailers, with exceptional customer service and high value-add.

In our Tier 1 carrier market, where we are transitioning out of the low-margin 3PL relationship, revenue declined by 40%, and gross profit was down 55%. And as I said, we'll be out of that business by the end of the year. Direct expenses in that segment were down 15%, and that's primarily due to the variable expenses associated with that 3PL business.

Overall, the Retail segment net profit contribution totaled almost $6 million, which was a 34% decline. We used a little over $5 million of cash in operations during the quarter, and ended the quarter with $2.5 million in cash, with no outstanding balance on our revolving credit facility. Remember that we paid out the $0.75 special dividend in December, on top of the quarterly $0.18 dividend.

Also, our inventory levels came down quite a bit this quarter; but inventory is still a little higher than it has historically been. However, our turns are still 9 times this quarter. And as Bob mentioned, we announced the dividend of $0.18 that will be paid on February 13 to shareholders of record on January 30.

Bob also mentioned the yearly earnings guidance that we increased to $2.05 to $2.15. That would put us on track to achieve a fifth consecutive record earning year, despite what will be a significant reduction in Tier 1 gross profit. And to give you just a little more color on the impact of that Tier 1 business, the revenues from that business so far this year have been about $186 million. Gross margin on that business is about 10%. And the expenses that will transition are mostly variable, typically about 2% of revenues.

We think this was an excellent third quarter; a very strong follow-up to what was a great second quarter. We continue to achieve strong growth in the core business. Given our momentum in the core business and our strong balance sheet, we believe we are well-positioned as we finish out the fiscal year.

Thank you. And, Operator, we'll now open the line for questions.

(Operator Instructions). Anil Doradla, William Blair.

Hi, guys. Good morning. It's Brian Nugent for Anil. Thanks for taking the question. I wanted to focus mainly on two segments -- first, the public carrier market; some really good growth there. I just wanted to ask about, basically, the key drivers. Are there a lot of large projects that you expect to normalize over the next couple of quarters?

The North American carriers are really starting to get behind the 4G networks. And we're seeing a lot of AT&T, Verizon, Sprint, who are actively deploying their networks. And we haven't seen any real -- anything from T-Mobile yet. So the Tier 2s, if you will, will follow behind the Tier 1s. And we've really structured our sales team around the whole -- what we call the ecosystem of the public networks, where not only do you have the carriers and you've got the OEMs, but the program managers in our traditional strength with the general contractors.

So, it's a combination of the increased spend, but also a result of our intense focus and reorganizing the sales teams to really be focused on harvesting the opportunities in this segment.

So, are there significant large projects that are ramping right now?

Yes, it's -- now they are aggressively building. It's still -- it's strong, but it's all the 4G systems, and they're pretty much spread across the carriers and across the country.

And we think that will continue on for a while.

Okay, thanks. And then can you actually talk about the linearity of that business? Did you see an influx? It sounds like you guys are seeing something that, frankly, other people are talking about more in 2013 than in the December quarter. So I'm just curious if you saw an influx toward the end of quarter. Or was it pretty -- kind of a straight line, pretty strong throughout the quarter?

It was fairly strong throughout the quarter. I think what may be happening is we're probably picking up a little more market share. So it may not be that they're doing that much more building, but we're also involved in more of it right now than we have been; and especially last year, which was a down year for us in that market.

And then, the margins have been pretty resilient on that business, despite some good revenue growth. Is there some kind of a mix shift that's going on, or is it just leverage? Or how are you maintaining that margin?

That margin has gone down a little bit in that carrier business around some of our infrastructure products. But we've been able to maintain pretty much everywhere else a pretty strong, consistent margins with the previous year. Some of the improvement on other things have been mixed, to offset a little bit of the leverage that we don't have on these bigger builds.

Got you. All right. And then, shifting gears to the 3PL relationship; looking forward to moving past this stuff, but I do have a few questions on it as it winds down. Is the $186 million -- you're saying that's the total relationship, and not just the 3PL? I just want to clarify that, first.

That is just the 3PL business.

Okay.

So, if you look at that as segments, where we list the Tier 1 carriers, that's a lot bigger than the $186 million. So the difference between that is what will continue on into next year -- other Tier 1 carriers plus the other components of that Tier 1 that will continue on.

So, what percentage of revenue was your largest customer?

I think it was 34% this quarter.

But then, when you take out that 3PL relationship, there is no customer bigger than, what?

Yes, about 8% is -- so far this year, has been our biggest customer if you take out that main customer.

Got you And then --

(Multiple speakers) on the remaining business, not 8% on the total today.

Yes. And can you give an idea, if you know -- it sounds like it's a little bit unpredictable -- but on the trajectory, are you expecting a linear progression through the end of March? Or is there a bigger step down in one quarter versus the next quarter?

Yes, I think this quarter will be stepped down from last quarter. And we are expecting it to be totally transitioned by the end of March, the end of the fiscal year. And just to reiterate what we said in the past -- is that all of the expenses are variable, other than some key talent that we have already re-deployed into the core market. And then the inventory receivables are in very good shape; so there won't be any major afterlife cost, if you will.

Yes, I was going to ask about that. More specifically on the OpEx levers that you have, you are basically saying it is variable. So it is kind of one-for-one, where you can quickly take out the 3PL OpEx out of the model as the revenue gets adjusted, or you adjust to that revenue trajectory.

Yes, absolutely. It is 100% variable by piece, so there is no fixed cost in that and all, other than that key talent that we have already re-deployed into the core.

Got you. And then, you just commented on it, but on the 3PL, is there -- there is some sort of agreement, or you are taking steps that will protect you from getting stuck with that inventory?

Absolutely. This has been a very mutually-agreed-to transition. We're working as partners on this transition; so inventory and receivables, there's no risk there at all.

Great. And then, bigger-picture on fiscal 2014 -- I assume we'll get a better picture of that next quarter -- but can you give an idea that one way to look at it is ranking the growth profile of each of the core businesses. Our review -- the way that the year-over-year trajectory was this quarter, is that indicative of what you are expecting in 2014, just ranking wise? So public carriers -- is that what you are most bullish on in fiscal 2014?

Yes, I'd say the public carriers and -- the user market -- there's the user market is combined with the government market. And the government market will continue to be challenging. There's not a whole lot of money in the government market right now. But the user market, we're still pretty bullish on that. It's had a bit of a down year after a really strong year, the year before. But we still think there is a ton of opportunity in that user space, and think the public carriers space will continue to be strong for us as well. Retail, we're looking at some decent growth there as well, but not explosive growth.

Got you. All right. Thanks a lot, guys.

Steve Shaw, Sidoti & Company.

Hey, guys. How are you? Do you guys anticipate any major mobile device releases? And if so, any specific timetable you might have in mind?

Yes, the mobile devices -- the device accessories -- we'll continue with the full suite of charging and power devices, and also the protection and carry cases? So it's going to be more of a -- not a, let's say, a big bang, if you will, but a continued introduction of new products, new packaging, and new value for the retailer; as well as we're taking these products into the commercial market, as well as retail. So, you'll probably see more coming in through the commercial market in addition to the retail market.

Okay. All right. Thanks.

Bentley Offutt, Offutt Securities.

Good morning. A couple aspects of potential growth for next fiscal year. The first one is the -- what impact, or future impact -- not impact, or additional sales, will come from the result of Hurricane Sandy? I read in one of your recent notes that, roughly estimated, 25% of the towers were knocked out during that particular storm. And so I'm wondering what is it that TESSCO has been able to, or will be able to achieve as a result of the restoration of that damage?

Yes, we've already gotten some business. It's probably -- Sandy has probably delayed more than it has gained to date. But you are right. Is it one of our core hotspots, in terms of the opportunity, is helping with repair and maintenance of damaged sites. We really can't quantify it, but it's definitely going to be a source of business for us as we move into -- as they start to rebuild this infrastructure.

Okay. And the second thing is one of the areas of great excitement for TESSCO a year ago was positive train control. And I understand that -- according to Westinghouse Air Brake, which is big in that area -- they expect to see that start to really ramp up, as far as moving from the test area into the field this coming year. Have you had any successes to date with your relationship with General Electric?

Yes. We continue to, as you mentioned, get more test sites out. And we feel the same way, is that this mandate is by 2015 now. So they are going to start accelerating. But it probably won't be until the end of 2013 that you'll start to see it ramp up. But there is more test systems; there is more smaller systems; people are getting their feet on the ground with this.

But we also see increased opportunity from the railroads in general, for both their signaling as well as their communication needs. You're right, we were very excited about it; and then the government gave a delay on the requirement. So that kind of pushed everything back. But it's still going to be a good business as we go forward.

Okay. And, last but not least, is your proprietary business -- Ventev and TerraWave and -- has that shown significant growth? And where do you see that going next fiscal year?

Well, right now, once you take the 3PL relationships out, it's about 10% of revenues, and with much higher margins. And we expect both on the wireless infrastructure business, as well as the mobile accessory business, to see some impressive growth as we move through this quarter. Both have been slightly up --

Yes, yes. So, the 10% percentage has pretty much maintained from last year. So, in total, the dollars have gone up since the revenue has gone up.

But we expect those businesses to grow faster than the core, the total core. So our goals for Ventev, and our product road maps roadmaps for Ventev, is to have faster growth than the rest of the business.

Yes. We've made some big investments in that business this year, with the hope of some long-term growth -- marketing; people-wise; and also technology wise. So we're excited about what next year will bring for that business.

Is there a -- as far as the leadership within this group, has there been a change in the leadership of the Ventev effort?

Well, basically, we've split the wireless device business from the wireless infrastructure business into two pieces; staff them accordingly, so they have total focus on their area. And we've increased the amount of people. We also have a major initiative on the Ventev website. And then on the retail side or the consumer side, we will have a shopping cart experience where consumers can buy on a direct basis, as well as go through the trade.

So, your efforts in cooperative marketing, et cetera -- they are moving along at the level that you had anticipated?

Sorry. I don't quite understand --

Well, in other words, last spring there was a relationship you signed with one or two cooperative groups for online marketing. And I was just interested in your progress there.

The progress is not as quick as we would like it. We're still perfecting the website that will allow them to -- the co-ops to buy directly for the agency's needs; but then also to allow it to be an employee direct site. And just getting the contracts and getting all that straight has taken longer than we had anticipated. But it is going to create for us an offer that we can take into the other government agencies throughout the United States.

Okay. Well, listen, thank you very much.

Ali Motamed, Robeco.

Hi, guys. Can you talk a little about working capital and what kind of benefit we may get from the termination of the 3PL relationship?

Yes, there will be one. It will probably be mostly happening in this current quarter that were in now; some of it going into the final -- end of the first quarter of next year. And it will probably be in the $5 million to $10 million range.

Of net cash generation when we're done?

Yes.

Okay. And then on the margin side, this all falls underneath that segment? I think you had $209 million in sales and $22.8 million in gross profit. So you were saying it's under 10% gross margins. Can you elaborate a little more on -- is a fixed gross margin relationship? It seems like it's been remarkably consistent.

Yes, it has been fairly consistent, although it has gone down as we've gone through this year. It's a little different kind of pricing. So we make almost -- it's a slightly variable but more fixed per-unit kind of business. And what has happened this year is why the margins on that business have gone down -- is that we've been doing more of their bigger, high-dollar items like these expensive cases, these rugged cases; and stereo speakers and things like that, that have high revenues associated with them. But since it's a mostly fixed fee, the margins aren't very high. That's why it's sub-10%.

And are we bidding on any future similar type of business that could fill this for us?

We want to move to -- continue the aggressive focus on what we call the real merchant business rather than the fee-for-service business. As we've explained in past conferences, it originally started that way in terms of with the Tier 1 carrier as a true merchant business; and then, over the years, migrated to this 3PL. So our focus is to go after the higher-margin business, keep our concentration down with customers, and basically replace the profitability with that high-margin business and continue with the operating productivity as well.

Right. And then, you mentioned that 8% customer. Is that the type of thing where that's a regular 8% customer? Or is it a -- big carriers come and go; and then one the next quarter, you'll have another 8%. But it may not be the same.

Now, it's a steady customer. And then after that one customer, we're probably down to, what? 5%.

Yes, yes. The top 10 customers will move around a lot, but they are essentially the same top 10. The order shifts around. So, maybe the top 20 or so jump around into that one-through-10 spot. But none of them will be above 10% going forward.

Okay. Thank you very much.

(Operator Instructions). I would now like to turn the call over to management for closing remarks.

Thank you. Well, thank you all for joining us today. As always, we appreciate the opportunity to go over the results, give you an update on what we're doing, and answer your questions.

As we've said in the past, this convergence of wireless and Internet is really creating opportunities -- new opportunities to, we know, revolutionize the way we live, work and play. And the organizations that we serve are exploiting these opportunities by deploying new and diverse wireless systems. And we're there in the center of it, partnering with these people to help them make wireless work.

So, as we move towards fiscal year 2014, we expect the continued explosion of the mobile devices and required support accessories. We also, as we mentioned earlier, as we expect the accelerated expansion of the carriers networks that support the hunger for the broadband and the desire to be constantly connected.

But we really see the creation of new private systems -- the enterprise, transportation, healthcare. And these systems will be an important impetus for our new business. Our goal is to leverage all of these trends and provide the immediate reliability of the products that they need, plus the supply chain solutions at the lowest total cost.

I think, in closing, it's important to really look at the foundation that we have in place for growth. First, the extraordinary opportunities in wireless; the fact that we have broad and diverse expanding customer and manufacturer relationships. We are really the industry experts in the knowledge as well as the product delivery; certainly logistics. We are exiting from that concentrated high-revenue, low-margin 3PL business. We see our margins, both at the gross margin level as well as the operating level, continue to increase.

We've got the aggressive Internet database marketing system initiative; the expansion of our Ventev proprietary products. We also are ramping up our search for potential acquisitions of synergistic companies, where we can find new product and new customer to blend into our existing system. We've got a very strong balance sheet, and we've got a terrific leadership and team talent.

So, we're obviously excited and energized by the possibilities, and our strategic initiatives to make the results happen and drive this new level of success that we're expecting.

So, we thank you, and we look forward to talking to you again in three months, if not before. Thank you very much. Have a great day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.