Below is transcript of the TESSCO Technologies, Inc.(NASDAQ:TESS)’s Q3 2015 Earnings Conference Call, held on Friday, January 16, 2015, at 8:30 am EST. Royce & Associates, Renaissance Technologies and Springbok Capital was among TESSCO Technologies, Inc.(NASDAQ:TESS) shareholders at the end of the second quarter.
TESSCO Technologies, Inc.(NASDAQ:TESS) architects and delivers the product and value chain solutions to organizations responsible for building, operating and maintaining wireless broadband systems. The Company’s has two segments: commercial and retail.
Company Representative:
Bob Barnhill – Tessco Corporation.
Analyst:
David Kerdell – Brahman Capital.
Operator: Good Day Ladies and Gentlemen and welcome to 3rd Quarter 2015 Tessco Technologies incorporated news conference call and my name is Mathew and I will 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. If at any time during call you require assistance please press *0 and the operator will be happy to assist you. As a reminder this call is being recorded for replay purposes and now I would like to turn call over to Andrew Blaze here with Sheryl please proceed.
Good Morning! everyone and thank you for joining Tessco Technologies 3rd Quarter 2015 conference call joining me today are Robert Barnhill Tessco’s Chairman and chief executive officer and Erick [inaudible] company’s chief financial officer. Please note that management’s discussions today will contain forward looking statements about anticipated results and future prospects. Forward looking statements involve a number of risks and uncertainties and Tessco’s results may differ materially from those discussed today. Information concerning factors that may cause such a difference can be found in Tessco’s public discloser including the company most recent formed 10K and other periodic reports filed with the securities and exchange commission. With that introduction I would like to turn call over to Bob Barnhill Tessco Chairman and CEO. Bob…
Bob Barnhill: Thank you and Good Morning. Thank you all for joining us today on such short notice our earnings release call and this call is earlier than usual in order to communicate our results to you as soon as possible. I will give you summary and then Eric and I will give you more details. In summary a result of this quarter was disappointing, our lower-than-expected third-quarter earnings were largely the result of two primary factors. First, a carrier based sales which includes carriers, contractors, tower owners and some commercial resellers declined dramatically in the third quarter even more than we had expected and secondly we experienced higher than normal freight in and excess in obsolete inventory expenses. In addition we were not able to recognize significant revenue from our particular customer order. All of which accounted for 14 cent per share negative earnings impact. We continue to invest our growth initiatives while optimizing our organizational leadership and reducing our operating expenses.
Our value propositional strategies are sound and we’re well-positioned to capitalize in the future carrier bills and the overall opportunity despite being created by the convergence wireless Internet. Now let me explain more of what’s happening and what are we doing to regain profitable growth. I will discuss three areas that continue to climb for purposes from our cellular carrier customers, the growth of our private system operator and retail customers and our strategic growth initiatives and organizational changes. Erick will then discuss the gross profit and operational margin decline reducing fixed expenses, Tessco’s financial strength and her outlook.
The first area is critical what is happening to our carrier organization customers— sales to our carrier power owner contractor customers experienced 44% sequential decline this quarter and sales to our commercial reseller customers doing work for the carriers experienced 16% sequentially decline, the slowdown in carrier spending on 4G LTE and that infrastructure builds with even more significant than we anticipated with believe that the carrier spending had come close to bottoming out after the end of our fiscal second quarter but it did not.
We believe that carriers have been prioritizing their capital budgets that they spent $45 billion for frequency in the fourth quarter FCC auctions. They will return to aggressively building new infrastructure in order to utilize and monetize their licenses delivering coverage and bandwidth to their customers. Competitively all the carriers have a very strong incentive to accelerate their deployment while not projecting any significant acceleration of our carriers sales in our 4th quarter we do believe that they’re spending specifically around upgrading self sites, will pick up as we begin our new fiscal year in April. That is more uncertain and that we don’t currently expect to see a rebound in carrier dash spending until after midyear. To regain our growth in carrier space and to enhance our position to capitalize on rebound we automated our leadership team and add an experienced business development executives and realigned the organization to build deeper relationships and more effective products and supply chain solution.
Ted Winslow VP has assumed the role of market director for our carrier organization unit and as a senior sales and business development leader with more than two decades of experience, had the proven track record of achieving exceptional results of strategic relationships with all levels Kleinwort organization. Ted joined Tessco in May 2014 and was previously with Canvas Communications and specially packaged products. His accountability is to guide the sales team to better serve decision-makers within the carrier organizations. Under Ted’s Leadership and our focus on product and supply-chain solution selling we believe we’re well positioned to improve our market share and drive growth when the market rebounce. The second topic is a private system operator and retail growth, a major priority is to continue to invest in and pursue new opportunities in the emerging industrial and enterprise private system operator market for making excellent progress. Revenues grew 22% over last year’s third quarter. However there has been some gross margin compression which Erick will address shortly, well we are pleased with the growth in the opportunities we are seeing in expected continued growth.
Retailers also performed well this year growing 19% over last year’s third quarter, new products in the iPhone six and the other smart phones that launches in our training and procurement assistance offering has generated new customers in sales. While it’s two markets are growing their contribution was not significant enough to offset the weakness in the carrier commercial reseller in government markets. The third key area that I want to review to you is our strategic growth initiatives and organizational changes. We continue to invest in talent and technology while improving efficiency, reducing expenses and optimizing our organization and leadership. As we discussed we have several important strategic growth initiatives underway we’ve made considerable progress but it’s taking more time than expected for these initiatives to generate the full benefits we expect. We are now prioritizing three key initiates to speed up execution and reduce cost. The first is a transitioning from reactive selling to proactive end-to-end solution selling. We believe this model will improve the customer experience while growing customer relationships in overall sales.
To accelerate the transition and better capitalize on market opportunities we have appointed Mark Weimer vice president to be the head of entire market development and sales group and to be a member of our senior leadership executive team reporting directly to me. Mark is tasked with developing marketing strategy and leading the sales organization to meet the corporate growth targets. Mark joined in May 2014 and was previously with AOL and use Network Systems. Mark has extensive background in business development and marketing operations with a proven track record of business growth. The second key initiative is to expand our offering to architect and deliver the knowledge and end-to-end product supply chain solutions that enable our customers to build, use and maintain voice data and video systems. Today we export a major cellular WiFi broadband connectivity two way systems and today we are also exploring new systems to support within our remote monitory petrol area, complete monitoring asset tracking and asset tracking. Within our mobile device performance area we are spending to the home automation and mobile device privacy through encryption.
Our objective is to ensure that we have the right products from the leading manufacturers to build the end-in solutions for these systems. We seek new manufacture partners, there could also be complementary acquisitions and organic growth opportunities for [inaudible] profiteer products units which designs and manufactures the unmet needs. In addition to expanding the systems we support and products we offer, we focus on deepening and broadening our relationship with our manufacturing partners. During the last few months new opportunities with two important partners have emerged. Our largest vendor ComScore has reduced its wireless distribution phase naming Tessco as its one of four preferred US wireless distributing partners. We expect this to present us with the opportunity to gain share from those distributors who no longer offer ComScore products. In addition Samsung selected Tessco as its primary partner to market and offer their mobile device accessories to our enterprise customers. These growing relationships demonstrate the value we provide to both our customers and our manufacturing partners and we expect them to yield long term benefits. The last initiative I want to review is the expansion and enhancement of our digital marketing system which includes Tessco and Ventiv.Com and the one to one communications and opportunity creation in the sales guidance system.
This entire system is improving customer experience and providing Tessco with new opportunities and enhance productivity. Results from the system are emerging and we expect to see increasing benefits from this initiative on a daily basis. To better execute our digital and online efforts as well as traditional marketing we reorganized this digit-marketing group and appointed Craig Owen Vice-President as the group’s head and as a member of our senior leadership executive team reporting directly to me. Craig has brought leadership to the marketing organization and gain momentum in transforming our digital experiences and capabilities. He has a proven track record developing e-commerce platforms within integrated marketing and advertising programs built on customer insights and competitive differentiators. Craig joined Tessco in March 2014 and has an extensive experience of telecommunications, insurance and financial services industry, having served previously at Sprint PCS Ameritech now AT&T, Zurich financial services and American Red Cross. So I will now turn it over to Eric to continue the discussion. Eric!
Eric: Thanks Bob. As Bob mentioned the public carriers revenue is way down this quarter. But excluding that market overall revenue is still increased 5%. Although along with the softness in the carrier space, we saw declines in gross profit and operating margin. Gross profit margin was down compared to last year’s third-quarter, declining from 24.9% to 24.1%. We experienced higher trading cost this quarter primarily associated with out ventiv products. These costs resulted from labor incapacity issues with the west coast ports as well as a constraint supply by iPhone connectors that are used in our chargers. The increase in inventory write-off reserves is due in parts to some aging inventory relating to the carrier slow-down and cell phone cases associated with older phone models.
Well both of these inventory categories are accessed, we believe we will sell through the vast majority out there but possibly at reduced cell prices. Outside of these two issues are the gross margin was essentially flat however we did see some variations with each individual market caused by product mix. Going forward our focus is squarely on selling complete solutions so that the lower margin product like [inaudible] and test equipment are offset by thousand higher margin products as we expect to accompany them. We are also intensely focused on insuring that we are compensated for the complete value that we deliver. Operating margins are also lower than historical levels, the lower gross profit and gross margin combined with higher talented technology investments we have been making reduced this quarter’s operating margin to 2% compared with 4.9% in last year’s third-quarter. In order to combat the higher expenses and lower margins we have undertaken an efficiency and cost reduction efforts. We are aggressively evaluation our business to identify unproductive or unnecessary activities and resources.
We have been taking and continue to take steps to address these areas including cost-cutting, process improvements and [inaudible] unprofitable initiatives. At the same time we are ensuring that we have the right mix of talent and experience in ourselves, marketing and [inaudible] to drive long-term profitable growth. As the result of these efforts we expect to see net future cost-saving of 3% to 5 % for our current fix expense level beginning in fiscal 2016. This would equate to approximately to 20% to 30% on annual earnings per share. Despite the soft market, our financial position is very strong. Last quarter we discussed a large inventory balance related to one tower on our customer. We are hoping to monetize that inventory this quarter and possibly recognize the revenue related to the sale. We did in fact received payment for the inventory however the customer requested that the inventory remain in our facility until they are ready to deploy it. Due to accounting rule in this area we are unable to recognize revenue on this transaction until the inventory is shift.
We now expect that to occur sometime after the beginning of fiscal 2016. Doing part to the cash received from that transaction we generated 13.6 million in cash from operations during the quarter. We also reduced both inventory and receivables by approximately 17 millions. Cash on hand was 9.5 million with no operational debt. We did buy back approximately a hundred and fifty thousand shares of stock for about 4.3 million during the quarter. We are committed to returning value to our share holders through our dividend and accordingly the dividend will continue at 20 cent per share with the record date of Feb 4th and payment date of Feb 18th. Turning to our outlook and guidance for the remainder of fiscal year during the continuous softness of the carriers space, we do not expect the carriers to renew spending until earlier in 2016 fiscal year. Accordingly we expect to see a decline in overall fourth-quarter revenue year by year. As the result of the challenging business environment and the short term crop associated with several cost reductions which that are underway, we are not provided specific training guidance for the fiscal 4th-quarter and we are withdrawing our fiscal 2015 guidance.
We also note that the 4th-quarter is traditionally our seasonally weakest of the year so we are expecting an earnings decline from the 3rd-quarter. We fully expect to issue earning guidance for fiscal year 2016 results. For the carrier slow-down has had a significant impact on our results this year. We are taking the right action and we are executing the right strategy to build long-term profitable group. Thank you for your continued support for Tessco. Operator! You can now open the call for some questions.
Operator: Thank you. Ladies and gentlemen if you wish to ask a question please press star followed by 1 on your touchtone telephone. Your question has been answered or you wish to withdraw your question press star followed by 2. Press star 1 to begin, please stand by for your first question. And your first question comes from Neal Seltzer – William Blair. Please proceed.
Matt Farrell: Hay guys! It’s Matt Farrell on for Neal. My first question is, could you two provide a little more color on the slower spending by the carriers, is it still the same particular customer that you guys had discussed and in the last earnings call?
Bob Barnhill : Yeah, the primary customer we are focused on that one supplier or one customer with the dash product and if you look at the overall pull back its basically AT&T stopped this spending mid year, Sprint did the same Verizon and Tmobile continued. We have a good presence with both. We are also part of this reorganization, we built a totally dedicated team for Verizon and we have a great sales leader that is from Verizon that is driving the Verizon customer segment. So we have business from all of the carriers and remember it is a huge Eco system that you got the contractors as well as the tower owners and carriers on a direct basis and we know we are gonna do some great things with all of these companies when they really start . One of the executives told me “ They were keeping their powder dry as they continue to go into the auctions for the spectrum”. So everybody is very [inaudible] in terms of how they allocate their capex expenses.
Matt: Okay and then kind of follow up to that is as you move into fiscal 16 and you see the spending gets to pick up at carriers, what rate would you expect the spending to return? Going back to historical rates or a more accelerated rate since they haven’t been spending recently?
Bob Barnhill : Yeah, that’s the real challenge. I mean they are already starting to release contracts to some of their contractors to do the work but as they tell us they are still in the dark in term of when the bills are going to begin. So I mean they have to deploy the spectrum, they didn’t buy all that stuff with the view of just sitting on it. And as I mentioned in the call, competitively they have to start to move out. We have seen [?] with the carriers over the years we have been doing business with them but never as dramatic as this has been. I believe we will see they are getting their plans together, as we mentioned I don’t think we are gonna see a whole lot of growth in this fourth quarter.
Matt: Okay and then kinda moving over into retail segment. Their partnership with Samsung, how do you see that playing out in fiscal 16 ? Is that a revenue opportunity similar to what you see at iPhone in Apple products or is that a much larger opportunity as you start to move through the process of partnership?
Bob Barnhill : You know I think its gonna be a part of whole offer, the thing that we think is bad is that they are focused on enterprise in addition to retail. And that’s what we are trying to do is take our accessories into the enterprise market as well as into the retail market and with the focus of Samsung, you know their marketing, their efforts. Its really gonna aid us in going into that market space.
Eric: Next particular trend that can show up in our private systems operators market is its not a retail play because its going after the end users and not through retailers.
Matt: Okay and then in regard to this reduction in fixed expense levels in 2016, just to clarify, is that 3 to 5% reduction in total expenses or is that terms like percentage of revenue or how should we kind of look at that as we move forward?
Eric: Yeah one clarification I think I misread 20 to 30 % Its 3 to 5 % [laughter]I think that to answer question that 3 to 5% is on fixed expenses which is not all expenses. We got certain variable expenses around compensations and some other things and so its around 90 million dollars give or take base of this years expenses if you pull those out.
Matt: If you pull after you pull that 3-5% out or before you pull 3-5% out ?
Eric: The base of fixed expenses is about 90 million so if you take 3-5% out.
Matt: Okay, alright. That makes sense. And then touching on the margins, as you see the carriers spending return in 2016, how should we look at gross margins moving throughout the fiscal year?
Eric: The carriers begin to pick up which we think we will probably see a ramp but not a huge ramp. The carriers are definitely a lower margin business for us, same time the private systems which is really where we are attacking even harder, that is a higher margin business for us. So we can see the two of those offset, as it usually does [inaudible] product next. Private systems was a little bit lower than it has been because they were buying test equipment. Just happened to be that some of their bigger deals were this quarter. It can change from quarter to quarter. We always see so significant fluctuation just based on product [inaudible]. In general I would think we are looking at private systems increasing decline margin if the carriers increase.
Eric: It is also important that this year a lot of our sales have been lower margin. The LTE has slowed and really pulled back so LTE comes in first as the margin is higher then it is for [?] but [?] business is quite good. $5 is the margin.
Matt: That’s all the questions I have. Thanks for answering them.
Operator: Question now from David Kerdell of Brahman Capital.
David Kerdell – Brahman Capital: When did you become comScore preferred supplier? And when did that begin to take effect for you guys and the criteria used to select the supplier list?
Bob Barnhill : We have been comScore partner for some time. This reduction of the distributor base was announced a couple of months ago and then effective from January 1st. We have the opportunity of that business that was going through the no longer distributors is sizeable and obviously its gonna be shared with remaining four distributor but totally we will get a bigger share.
David Kerdell – Brahman Capital: Good, thank you.
Operator: Thank you for your questions. I will now turn over the call to Bob Barnhill for the closing remarks.
Bob Barnhill: While disappointed with the third-quarter results, our value propositions and our strategies are sound and our foundations capabilities and capacities are strong. We are well positioned to capitalize in the rebounding period market and the overall opportunities being created by this convergence of YOC and internet. We look forward to executing on our initiative and completing the changes in this fourth-quarter and entering a new fiscal year with the expectations of growth. I really thank you for being on the call today and thank you for your continued support. I look forward to sharing great news in a couple of months. Thank you
Operator: Thank you for joining today’s conference ladies and gentlemen. This concludes the presentation. You may now disconnect. Good day.
