TESSCO Technologies Incorporated (NASDAQ:TESS) Q3 2023 Earnings Conference Call February 8, 2023 8:30 AM ET
Company Participants
David Calusdian – Sharon Merrill
Sandip Mukerjee – President and Chief Executive Officer
Aric Spitulnik – Chief Financial Officer
Conference Call Participants
Maggie Nolan – William Blair
Bill Dezellem – Tieton Capital
Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the TESSCO Technologies Incorporated Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
I would now like to turn the conference over to David Calusdian from Sharon Merrill. Please go ahead.
David Calusdian
Good morning, everyone, and thank you for joining TESSCO’s Q3 fiscal year 2023 conference call. Joining me today are Sandip Mukerjee, TESSCO’s President and Chief Executive Officer; and Aric Spitulnik, Company’s CFO.
Please note that the management discussion today will contain forward-looking statements about the anticipated results and future prospects. Forward-looking statements involve a number of risks and uncertainties, and TESSCO’s results may differ materially from those discussed today. Information concerning factors that may cause such a difference can be found in TESSCO’s public disclosures, including the company’s most recent Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Please note that the company will be referencing slides available through the webcast link, on the Events and Presentations page of the company’s Investor Relations Web site.
With that introduction, I’d like to turn the call over to Sandip Mukerjee, TESSCO’s President and CEO. Sandip, please go ahead.
Sandip Mukerjee
Thank you, David. Good morning, everyone, and thank you for joining us today. Q3 was another excellent quarter for TESSCO, as we continue to execute successfully on our strategy. Before we get to the specifics of Q3, let me start by recapping that strategy, which I have shared with you throughout this fiscal year.
Our goals have been to drive revenue by delivering excellent service and value, focus revenue opportunities on higher growth 5G and wireless infrastructure, improve gross margins by adding differentiated value through product mix, vendors, TESSCO observer, and operating discipline, launch a modern ERP, improving our operating efficiencies, and utilize TESSCO’s operating leverage to grow EBITDA faster than revenue.
We do not seek to be the lowest cost distributor. Our customers achieved full savings from the efficiencies gained through our optimized logistics, procurement, and project management expertise. Moreover, we leverage these value-added services and enhanced support resources to generate customer loyalty through improved execution, which has led to real partnerships with our customers.
Our Q3 demonstrate the successful execution of our strategy. We achieved double-digit year-over-year improvements in revenue, gross profit, and adjusted EBITDA. Both of our business segments, Carrier and Commercial contributed to a year-over-year increase in revenue of 12%. Our margins continue to improve as a result of pricing strategies, diversification of our supplier base, and focus on higher-margin business opportunities that have been central to our strategy.
This quarter, our gross margin was 20.6%, and up 1.5 percentage points year-over-year. Our adjusted EBITDA was $1.8 million, up $800,000 year-over-year. Furthermore, we see continued improvements in the global supply chain. This has improved product lead times and has resulted in bookings returning to more normal levels. We still ended the quarter with a strong sales backlog of $84 million. I will now walk you through the results and highlights of the past quarter, starting with our Carrier market.
In Q3, our Carrier revenue was up 12% year-over-year, and our gross profit increased 16%. Year-to-date revenues are up 8%, and gross profit is up 19%. We ended the quarter with a sales backlog of $41 million. Margin improvements are a result of what I had said earlier, our strategy to consistently add value for our customers. This quarter, we introduced new warehousing solutions that allow our customers to manage their general contractors more effectively. We recorded two significant wins this quarter, both related to 5G builds and upgrades.
The first is a project with our largest tower owner customer, and the second is a new relationship with one of the largest AT&T turf contractors. Together, these opportunities exceed $40 million, and will primarily be recognized in fiscal year 2024.
I will now turn to the commercial market which includes all wireless infrastructure business outside the Carrier ecosystem. In Q3, our commercial revenue was up 12% year-over-year, and our gross profit increased 23%. Year-to-date revenues are up 11%, and our gross profit is up 19%. We ended the quarter with a sales backlog of $43 million. Our scale, technical expertise, value-added services, program management support, and personalized account coverage continue to be the reasons why customers rely on TESSCO. Ventev and TESSCO Observer helped differentiate our offering, and enhanced our margin performance.
We continue to refocus on our end-user customers. As a result, our utility market grew 38% year-over-year. These strong results confirm our strategy of helping electric utilities modernize and assist with their overall grid automation projects. Our Q3 growth initiatives in this market included a Ventev business development campaign around automated metering infrastructure, which has already resulted in shipments across multiple investor-owned utilities. We continue to see strong demand in test equipment, and are positioning our Ventev universal broadband enclosure as a simple turnkey solution for utilities that are deploying wireless.
In the government market, we have signed new state and local contracts. This market grew 19% year-over-year, and is now up 3% year-to-date. Our VAR market grew 13% year-over-year. We had a number of significant wins this past quarter, including a VAR that moved all of its microwave business to us, a large national service provider that awarded us several large projects for major theme parks, and another sizable win for a VAR to support automation for a large mining company. Furthermore, we continue to win public safety and cellular DAS opportunities due to our inventory stocking position and our technical and logistical expertise.
Turning now to Ventev, in Q3, our Ventev revenue was up 13% year-over-year. Year-to-date, revenues are up 19%. Ventev is growing faster than our distribution business. We have improved our Ventev margins and have a 30% year-over-year increase in sales backlog. Ventev’s increased market share with a wide range of existing and new customers, including a pioneer in inpatient tower health, providing them with antennas to enable Wi-Fi monitors in hospital rooms, a solution for an NFL stadium, cable assemblies for a VAR that is installing DAS into a subway system, antennas for a large cruise line, antennas to upgrade the Wi-Fi in scientific laboratories, and an innovative solution for a vineyard through the Cisco Design-In Program.
Regarding our sales channels, we continue to sell both direct and online through tessco.com and, in Q3, achieved quarterly revenue of $9.9 million, up 6% year-over-year. As a part of our ERP transformation, TESSCO launched a new tessco.com which provides many new features and capabilities for our customers. And as we announced last month, we formally launched our new ERP system. This project has been much more complex, and has taken longer than initially planned. But all our foundational capabilities are now in place, and the launch has been very, very smooth. We’re now in Hypercare, which will continue through Q4, along with higher non-depreciation expenses.
We’re expecting incremental depreciation of approximately $1.5 million in the fourth quarter, which will impact net income but not EBITDA. Expenses associated with ERP will significantly reduce in our next fiscal year, starting April. The new ERP system will provide us with considerable operating efficiencies over our legacy systems, including improved inventory management and freight capabilities. We expect to begin to achieve a strong return on our investment in our upcoming fiscal year, and a positive effect on EBITDA.
With that, I will turn the call over to Aric for the financial review. Aric?
Aric Spitulnik
Thank you, Sandip, and good morning, everyone. At the onset, please note that as the impact of our discontinued Retail segment is not significant for fiscal 2023, our current year results now include activity from our former retail business. For prior years, the retail business is still disclosed as discontinued operations. As Sandip mentioned, we had another strong revenue quarter for our combined Carrier and Commercial segments, totaling $114.9 million, up 12% year-over-year. Sales backlog at the end of the third quarter totaled $84 million, well higher than historical levels.
Sales bookings declined this quarter in both segments due to improvements in the supply chain, which means that customers no longer have to book orders as far in advance as they had over the last year. However, we continue to maintain a very large backlog that, for the most part, to expect to ship in the current fourth quarter, with a solid percentage of that business being Ventev. Moreover, our pipeline and customer activity remain strong. Gross profit was $23.7 million for the third quarter of fiscal 2023, compared with $19.6 million for the same quarter in fiscal 2022.
Gross margin was 20.6% of revenues for the third quarter of fiscal 2023, compared to 19.1% in the third quarter of the prior year. The improvements we have driven in gross margin throughout this entire fiscal year have been critical to our success. The gross margin gains are related to many strategic actions, including growth in Ventev sales, increased pricing to keep up with inflation, better customer mix driven by our focus on higher-margin opportunities, and vendor diversification efforts to focus on selling higher-margin alternatives. We have taken these actions while continuing to provide our customers with excellent customer service.
Third quarter fiscal ’23 selling, general, and administrative expenses increased 17% to $22.7 million. This increase is primarily due to a lower-than-normal amount of expenses in the prior-year quarter. This quarter’s SG&A is essentially flat from Q2. This overall SG&A expense as a percentage of revenue was 19.8% in the third quarter of fiscal ’23, compared to 18.9% in the prior-year quarter. This quarter’s variable SG&A as a percentage of revenue was up from 6.1% in last year’s third quarter to 6.4% this quarter as we continue to see freight charges from carriers increase, largely due to fuel surcharges and other accessorial charges.
Variable expenses consist of roughly 50% in freight-out expenses and the remaining 50% primarily in distribution center labor and sales commissions. Our operational and pricing discipline has enabled us to pass on the rising freight costs, which are a factor in the improved gross margins I mentioned early. Non-variable SG&A as a percentage of revenue is up from 12.8% to 13.3%. This increase is primarily due to full staffing of Ventev and IT teams, which had significant openings during last year’s third quarter.
Additionally, last year we adjusted our bonus accrual down based on the year-to-date results for the time. As a result, our bonus expense for this quarter is $1.1 million higher than the prior year quarter. We will continue to focus on fixed expense reductions. And the launch of the new ERP will enable us to do even more in fiscal ’24.
Third quarter fiscal ’23 net income was $0.4 million compared with $1.2 million in the third quarter of fiscal year 2022. Higher Q3 FY22 net income was impacted by a time $1 million income tax benefit. Adjusted EBITDA and adjusted EBITDA per share were $1.8 million and $0.19 respectively for the third quarter of fiscal ’23. This compares with adjusted EBITDA and adjusted EBITDA per share of $1 million and $0.11 respectively for the third quarter of last year.
Turning to the balance sheet, product inventory was essentially flat from the second quarter at $70.9 million. While we remained strategic in our inventory management, we are working on reducing our overall inventory levels. And expect to see a reduction in Q4. Accounts receivables decreased by $5.3 million in the third quarter to $79.5 million. Accounts payable decreased by almost $10 million as we paid down the amount related to the increase in inventory we saw in the second quarter.
We ended the quarter with an income tax receivable of $3.7 million. All of the associated tax returns have been filed. And the timing of receipts of these payments is dependent on the IRS in the State of Maryland. In December, we amended our credit agreement increasing it from $80 million to $105 million to support our sales growth and to address supply chain variability.
As a result of the working capital factors I just discussed as well as ERP implementation cost, the outstanding borrowings under our line of credit increased $8.1 million to $61.6 million at the end of Q3. We expect annualized improvements in our overall EBITDA performance along with reductions in ERP related cost to begin next fiscal year. Therefore, we expect our borrowings to trend down over the next 12 months.
However, due to continued variability in the supply chain, we expect significant fluctuations from quarter to quarter. I am very pleased with how we are executing on our strategy and the results we have achieved. We are encouraged by our year-to-date results, strong sales, and sales backlog. For the full fiscal ’23 year, we are on pace to meet our guidance ranges, specifically revenue of $450 million to $475 million which would represent a growth of 8% to 14%; adjusted EBITDA of between $4 million to $7 million which compares to a $0.3 million in fiscal year 2022, and a net loss of $5 million to $2.1 million which compares to a net loss of $3.3 million in fiscal year ’22.
With that, I will turn the call back over to Sandip.
Sandip Mukerjee
Thank you, Aric. Before we open the call to questions, I want to reiterate some of the highlights from this quarter. Our Q3 revenues were up 12% year-over-year. Our customer demand and revenue is strong. And we are carrying a sales backlog of $84 million. We successfully improved our gross margins. And we are live with our new ERP system. We expect this new ERP will further improve our operating leverage, which in turn will result in improved profitability.
With that, we will now open the call to questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question will come from the line of Maggie Nolan with William Blair. Please go ahead.
Maggie Nolan
Hi, thank you. Could you elaborate on the impact of product mix on margin this quarter? And then, how you expect that to look in the coming quarters?
Sandip Mukerjee
Hey, good morning, Maggie. Thanks for the question. Where we have flexibility, we are using — and products are spec’d in, we are using products that give us the most gross margin; a simple way to say what we are doing. And we are engineering that and preparing for that by supplier diversification, so not just single sourcing, giving ourselves more flexibility, and introducing new vendors, new products to customers. We expect to continue that. So, I expect this gross margin improvement that we have seen to continue.
Maggie Nolan
Very good. And then on the backlog, could you give a little bit more detail of the composition of the backlog?
Sandip Mukerjee
So, we broke out, during the call, how much of it was Carrier and how much of it was Commercial. So, total backlog is $84 million, $41 million of that is for our Carrier ecosystem, and $43 million is with the Commercial. Let me stop there; see if I answered your question?
Maggie Nolan
Yes. And then, okay, so for a third question, could you talk about what’s going right in the VAR segment? And then is this level of performance that you’ve seen in that segment going to be repeatable for the segment going forward? Thank you.
Sandip Mukerjee
Thank you, Maggie. Very, very pleased with our sales performance and focus. And it’s a result of all the improvements that we have put in place over the last several quarters; we’re seeing the benefits of that; that’s one. Second, from a value proposition perspective, being able to provide the complete solution, helping our VARs develop a BOM, bill of materials, that they can do on TESSCO’s Web site or working with our sales people, having better stocking position, right, so it’s not just the sales people driving, it’s also our supply chain people doing correct demand forecast with customers and having inventory available. And then, this might seem simple and mundane, but the whole benefit of helping our customers with program management with logistics, with being able to ship at — to the points they want at the time they want, that entire value proposition is playing very well with VAR. I am bullish about what our team has done, and I expect this trend to continue.
Maggie Nolan
Very good. Thank you.
Sandip Mukerjee
Thanks, Maggie.
Aric Spitulnik
Thanks, Maggie.
Operator
[Operator Instructions] Your next question will come from the line of Bill Dezellem with Tieton Capital. Please go ahead.
Bill Dezellem
Thank you. Looking at your revenue guidance, the midpoint of that guidance would lead to flat revenues in the fourth quarter versus the quarter you just reported. And seasonally, if we look back over history, the fourth quarter is normally down from Q3. Should we be reading into that, that you are seeing stronger-than-normal seasonality or is that just happens to be the way the math works, and I’m picking one point within the guidance range?
Aric Spitulnik
Hey, Bill. This is Aric. It’s a good question. I think as far as the revenues that we’re seeing right now, as we sit here today with a strong backlog of $84 million, a lot of projects in the works here that will be shipping this quarter, we’re very optimistic about our fourth quarter revenue number. So, I would say it’s a combination of we do believe we’ll be in a better situation than we were last quarter, but there’s a fairly large range. And you are somewhat arbitrarily picking the midpoint, but I think we’ve very confident and optimistic about the fourth quarter revenues.
Bill Dezellem
So, you see the possibility of better-than-seasonal revenue in the fourth quarter, in part given the backlog that you have?
Aric Spitulnik
That’s right.
Bill Dezellem
And if we were to remove — I’m going to actually dive into that slightly more. If we were to remove that, the benefit from the backlog, which is a bit unfair, I recognize, but the — are you seeing better than normal strength out there? And maybe part of the question is that there is so many crosscurrents relative to the economy right now, just I’m trying to use this question as just one more data point as to what’s happening out there. So, are you feeling like the underlying activity level is normal? Is seasonally stronger than normal? And trying to pull out the backlog components? What can you do to help us there?
Sandip Mukerjee
So, Bill we used, we thought carefully about what examples to provide and what color to provide. So, I will point you back to sort of things I said, when we talked about VARs, when we talked about Ventev, when we talked about Carrier, the diversity of customers and the diversity of projects, right. So, if you think of our commercial business, examples we gave were projects in scientific laboratories, projects in telehealth, projects with theme parks, projects on cruise lines, so the diversity of projects is what is helping us here, the net-net of all of that is our demand is strong. So, we are very happy with customer demand. And we are not dependent on any one sector or any one segment, we are continuing to expand. That was the commentary behind utilities and government and diversifying away from big revenue pools that have — that can fluctuate quarter-to-quarter to have a more stable business performance.
Bill Dezellem
Thank you very much. Let me actually jump on the utility component of that, you mentioned automated meters, how replicable is the solution that you are providing there. And kind of with that, just the sort of thing where we could see you doing a lot more in the meter business and in the coming quarters?
Sandip Mukerjee
So, we won’t get ahead of what we said, but we think the solution we have with Ventev enclosures, it offers a turnkey solution. We’ve done that with a few utilities. We think it’s replicable. But we are working on many sales, business development efforts that I’d like to give the team time to work before I get ahead of things.
Bill Dezellem
And those enclosures, are they for electric, gas, or water meters?
Sandip Mukerjee
Primarily electric and gas at this point.
Bill Dezellem
Great, thank you. And then, one expense question, once your old — old system goes down and the new ERP system is at a normal, a normal expense level, what will be the expense, excuse me the expense reduction in the June quarter and beyond?
Aric Spitulnik
Yes, so you’ve got two different pieces of that, you have the depreciation that Sandip mentioned, which will be approximately $1.5 million a quarter. So, that will be a negative to SG&A and to net income, but no impact to EBITDA. And then, the offset to that is the benefits that we’re expecting to achieve both from lower costs related to the old system, as well as efficiencies and freight charges and other more better ways that we’re managing the business. We’re not specifically calling that number out, but last quarter, we did say it would be several million dollars over the course of the next year.
Bill Dezellem
Okay, thank you very much. Appreciate both of your time.
Aric Spitulnik
Thank you.
Sandip Mukerjee
Thank you, Bill.
Operator
We have no further questions. At this time, I’ll hand the conference back over to management.
Sandip Mukerjee
Thank you, Regina. Thank you everyone for joining the call today. We look forward to discussing our year-end results with you in May. Have a great day.
Operator
Ladies and gentlemen, that concludes today’s call. Thank you all for joining. You may now disconnect.
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