TESSCO Technologies Incorporated

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2021 Tesco Technologies, Inc. earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star then 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, David Kalustyan from Sharon Merrill. Thank you. Please go ahead.

Good morning, everyone, and thank you for joining Tesco's Q2 2021 conference call. Joining me today are Sandeep Mukherjee, Tesco's President and Chief Executive Officer, and Eric Sputulnik, the company CFO. Please note that management discussions today will contain forward-looking statements about anticipated results and future prospects. Please also note that during today's Q&A session, management will not be taking questions related to the recent proxy solicitation filings. Fuller-looking statements involve a number of risks and uncertainties, and Tesco's results may differ materially from those discussed today. Information concerning factors that may cause such a difference can be found in Tesco's public disclosures, including the company's most recent foreign 10-K and other periodic reports filed with the Securities and Exchange Commission. With that introduction, I'd like to turn the call over to Sandeep Mukherjee, Tesco's President and CEO. Sandeep?

Thank you, David. Good morning. And thank you all for joining us. I hope you and your families are staying safe during the ongoing pandemic. I continue to be extremely proud of the commitment and dedication of the Tesco team during this protracted health crisis. They have worked tirelessly to provide customers with vital communication services to fill the urgent needs of our clients, including first responders and public safety officers. For several quarters, I've been sharing with you my vision of a Tesco that is focused on our commercial infrastructure business, which offers the opportunity to drive revenue growth and shareholder value. To realize this vision, we made the decision to exit the retail business. Earlier this morning, we announced our plan to sell certain retail assets to VoiceCom, effectively divesting Tesco of that business. This milestone transaction enables us to focus on our higher margin, higher growth commercial business. We will now be solely dedicated to servicing customers in the wireless infrastructure construction space. We will deploy all of our assets to take advantage of a once-in-a-generation opportunity in the wireless industry, resulting from the unprecedented and concurrent rollout of new technologies. including 5G, private LTE in the CBRS brand, and IoT. And we intend to use some of the proceeds from the retail transaction to help us further capitalize on this opportunity. During the second fiscal quarter, we made excellent progress on our near-term performance improvement initiatives. We achieved the best quarterly bottom line performance in a year and improved gross margins sequentially despite flat revenues resulting from the economic downturn. We were able to report such strong bottom line results due to our ability to, first, drive higher margin sales through both our Ventive infrastructure brand and Tesco.com, second, Manage retail and commercial inventory effectively while lowering E&O expense. Third, reduce costs and implement additional operational efficiencies. Fourth, navigate pandemic-related challenges such that we were able to lower our reserves. And finally, effectively manage the decline of our retail business. During our call today, I'll report on the excellent progress we've made during the second quarter on our three-pillar strategy to drive growth and profitability. We have been pursuing this strategy since early in the year when it was approved by the board unanimously. This strategy includes, number one, growing our value-added distribution business and ensuring that we are the easiest company to do business with. Number two, industrializing our vent of operations, scaling our capabilities, and being an industry innovator. And third, investing in value-added and managed services offerings to resolve complexity and pain points for our customers. I'm going to talk about the significant progress we have made on this three-pillar strategy in a moment. But before I do that, I want to walk you through our performance in each of our reported segments. Let me start with the retail business. As we shared last quarter, our retail segment has been heavily impacted by COVID. Despite this ongoing challenge, we were able to sequentially increase revenue by 32% and significantly improve gross margin. In the quarter, revenue drivers included strong performance in key national accounts and continued momentum and success with new business development efforts. Margin improvement was primarily due to more proprietary ventive product sold into national partners and channel diversification that resulted in the sale of more high margin products. Additionally, we achieved cost efficiencies through team realignment and resource allocation to support the most critical needs of the business and enhanced operational and fulfillment discipline. Finally, we managed our mobile device accessory inventory through reduction of excess and obsolete inventory, more rigorous review and execution of inventory purchases, and vendor and SKU rationalization to focus on the highest-running, most profitable brands. Despite our improved performance in Q2, with the changing retail environment, this business no longer generates sufficient returns on capital to warrant continued investment. While we recognize that the retail business is part of Tesco's legacy, the sale of this business ensures we have enhanced financial flexibility and operational simplicity to drive profitable growth. The sale includes most of our retail inventory and the Ventiv brand as it relates to mobile device accessory products, as well as certain other retail-related assets. We will continue to fulfill orders and support the retail business customers and suppliers until the closing of the transaction. We expect the closing to take place later this quarter, and we'll work closely with our customers and our supplier partners until then to ensure a smooth transition. I'm grateful to our retail team who have worked hard to serve our customers and our suppliers. Their work and their reputation have made this transaction possible, and I wish them the best of success as they join VoiceCom. Within our commercial segment, our VAR and integrator business is extremely diverse and includes all wireless infrastructure business outside the carrier ecosystem. Tesco sells to VARs and integrators that service numerous industries and markets. Within this business, we also directly support private system operators and other end users. In fiscal Q1, we noted that we had seen a moderate COVID-related impact to this business. In Q2, it became clear that there was greater COVID-related impact than was first apparent. As with the last quarter, the greatest impact from COVID was primarily with venues and projects that required in-building access. As an example, one of our integrator customers was prepared to install an advanced wireless network in a facility, and due to COVID, the entire project was put on hold. However, other markets that we serve, such as the utility vertical, have continued their capital investments in wireless infrastructure. For example, we are working with utility market customers on advanced metering infrastructure, or AMI. Smart meters enabled by AMI let consumers see more comprehensive energy consumption data. In addition to AMI, we continue to receive orders from utility customers for fleet upgrades, providing mounting solutions for their new trucks and fleet vehicles. We have also seen demand from our utility customers for ventive custom power solutions. We saw good growth in this area in Q2 and have generated revenue growth in the utility sector in three of the past four quarters. The progress we are seeing in the utility vertical is a result of our sales strategy to renew focus on specific industry verticals. Recent actions we have taken include First, investing in a market executive to drive the offer, specific marketing efforts, and the overlay for our sales teams servicing regulated industries. And second, developing solutions for the numerous utilities that have won CBRS spectrum at the recent FCC auction. Looking at this business overall, we saw a 13% decline in revenue year over year and 2% decrease sequentially. At the same time, gross margins in this segment improved almost 100 basis points, primarily due to higher percentage of VAR and integrator sales being handled through our tesco.com website and a higher percentage of vendors' product sales. I shared in our Q2 earnings call a year ago that a key factor in the success of our VAR business was making improvements to our e-commerce website. In the past year, we have done just that, resulting in real financial contribution to the VAR business. Our total Tesco.com commercial revenue was up 9.5% sequentially, marking the first quarter of sequential growth in a year. This was also the highest revenue quarter for Tesco.com in the past year, with margins over 31%. VAR revenue realized through our website grew by 9.4% sequentially, and direct industry business revenue through Tesco.com grew 14% sequentially. We are continuing to improve Tesco.com, making it easier for customers to find information and place orders without having to consult a salesperson. In recent surveys, customers have rated our website's ease of use as either the best or among the best in the industry. In past calls, I've mentioned our investment in search engine optimization and paid search to attract more eyeballs to Tesco.com. While this is an ongoing effort, we have made significant improvement during the past several quarters, including doubling our average monthly visitors to the site. In addition to the positive impact that HigherTesco.com's spend had on revenue and margin, we also increased the percentage of our higher margin vented infrastructure products sold to our VAR customers. We generated 16% year-over-year revenue growth of vented infrastructure products, and that, combined with the HigherTesco.com revenue, contributed to the 100 basis point increase in gross margin in our VAR and integrator market. Some notable Ventiv wins in our VAR customer market include networking VARs continuing to utilize Ventiv solutions for Wi-Fi 6 upgrades in warehouses and offices. Purchase orders received for our Cisco machine builder solution, which provides a turnkey integrated wireless power system. Purchase orders received for our mining solution, which utilizes Tesco's Regen partnership for an installation in South America. a purchase order for a Ray-Jank solution installed in Australia, a vented floor panel solution for a multinational technology company, a ceiling tile solution sold to a U.S. military installation in Europe, and an enclosure to optimize the operations of a major fast food chain, making customer pickups more efficient. Our strategy to industrialize Ventiv has resulted in greater interest and more requests for Ventiv products from a broader range of our customers. This is leading to greater utilization of Ventiv solutions. Customers tell us that they select Ventiv due to enclosures that are able to withstand harsh environments such as weather, moisture, heat, and seismic activity, ease of installation, attractive aesthetics for our enclosure designs and power systems, and efficient small form factor antennas. Moreover, Ventiv is at the forefront of our sustainability efforts because so many wireless infrastructure projects are specifying environmentally friendly and aesthetically pleasing installations. In fact, as our customers say, Ventiv is really good at hiding things in plain sight. Turning to the public carrier market, I'd like to begin with some observations about the current status of the carrier ecosystem, including its impact on our customers and on Tesco. The carrier ecosystem is currently in a unique situation. On one hand, 5G technology represents the future of wireless communications. On the other hand, we have a near-term reality imposed by the current pandemic. We know from our customers, including significant construction partners of some of the major carriers, that our market share remains constant or is growing. This bodes extremely well for our business when carriers begin to increase the intensity of 5G infrastructure construction. For our part, we remain laser-focused on continuing to increase the breadth and depth of our relationships with customers in the carrier ecosystem through a combination of our technical and supply chain logistics capabilities. This positions us well to quickly grow revenue and gain share as the build-out of 5G infrastructure accelerates. Last quarter, we shared that the impact of the pandemic on our carrier business was related primarily to restricted access in certain venues for DAS installations and delays caused by the closure of government and municipal permitting offices. Much of this continues to be the case in Q2. On the positive side, we see increasing interest in edge data centers. designed to deliver on the latency requirements for emerging technologies like 5G and the AR, VR, and massive IOD applications that will follow. We are working closely with our customers and suppliers, and I'm pleased to say that we have received purchase orders this quarter for such deployments. This is a new area for DESCO. We expect more opportunities in this area, giving us the ability to introduce ventive enclosures and power solutions in the carrier ecosystem. We had significant wins with our customers, as well with CBRS applications in Q2. The government conducted a significant auction of CBRS spectrum around the country, resulting in hundreds of successful awards. Here again, the build-out has not yet ramped up. The process is in motion with a number of companies now in a position to invest in building out the necessary infrastructure needed to capitalize on their acquired spectrum. One of our largest customers was awarded a contract by the Defense Department to deploy sensors along the U.S. coastline. Tesco was selected by this contractor to supply a number of components, including proprietary solutions from our rental division. This provides us with a high margin, sole source piece of business that we expect to deliver on throughout the remainder of this fiscal year and into fiscal 2022. Another carrier ecosystem customer selected Tesco to supply an array of products for a monitoring and telemetry solution for their tower sites. And it, too, includes a proprietary Ventiv component. This sole source position will result in deployments across several thousand of this customer's towers. These are two prime examples of the strategy we detailed two quarters ago, where I committed to a transition of our Ventiv organization from a custom engineering focus to an industrialized organization capable of innovative design and large volume production. I'd also shared my belief that the value provided by Ventiv could be utilized across all customer markets, not just VARs and integrators. These carrier wins demonstrate early proof that our strategy is working. All of this gives me great confidence that as the inevitable steep ramp of the carrier ecosystem infrastructure commences, Tesco is well positioned in three key areas. proven logistics management capabilities that are so important in the carrier space. Second, proprietary engineering and production capabilities to respond to needs unmet by other manufacturers. And third, outstanding relationships with numerous companies most critical to the construction of the nation's wireless infrastructure. Last quarter, I shared that one of the immediate initiatives to improve our performance was completing the necessary IT transformation to securely position Tesco to capitalize on our future growth opportunities. We have made excellent progress by modernizing our systems, enhancing our digital platforms. We continue to enhance our core systems and updating our demand planning tools. I would now like to give you a brief update on our three pillar strategy that I mentioned earlier in the call. We are executing on this strategy in an effort to transform Tesco, improve our top line and margins, and to ensure Tesco remains well positioned to compete in the industry. First, we are growing our value added distribution business and ensuring that we are the easiest company to do business with. Over the last few quarters, Tesco has taken steps to become more intimate with our customers. We have redesigned our sales support operations to have smaller teams focused on specific sets of customers. This has led to stronger relationships and a deeper understanding of our customers' specific processes and needs. We are providing more sophisticated materials management services for telecom general contractors. We also provide scalable services from timely fulfillment of products to design and engineering for our value-added resellers. Our VARs are servicing a wide variety of end customers, and our value-added services enable them to fill gaps in their own capabilities and extend their reach. We have developed a keen understanding of the vertical markets we serve. Our long heritage in utility, public safety, and other industries have been a long-standing strength and differentiator for us, and we have been making investments to ensure that we continue to lead the market. For example, we have added vertical market executives to cover regulated industries, such as utilities, intermodal transportation, and natural resources, such as forestry, mining, oil, and gas, and public sector, including federal, state, and local government, education, and public safety. The addition of these resources have been well received by our customers, suppliers, and internal departments to enhance collaboration and solve complex problems for our customers. Second, we are industrializing our rental operations, scaling our capabilities, and driving innovation. We have done the following. Rationalized SKUs and reduced inventory to focus on products with significant demand. Instituted modular, flexible, and agile product designs. Added engineering resources, both internally and through third parties. Added product management and manufacturing resources. Created an advisory council, working with key customers and industry influencers. And invested in an innovation process receiving information from internal and external teams to vet innovative ideas to bring to market, and taking existing products with market acceptance and enhancing them to be applicable to a larger number of customers. The new process will allow the innovation team to more quickly move products through ideation, acceptance, and testing phases, and then into production. This industrialization and innovation has already led to increased sales in the VAR channel. And for the first time, we have successfully sold ventive enclosure products into the carrier ecosystem. Third, we are investing in value-added and managed services offerings to resolve complexity and pain points for our customers. Capitalizing on our unique place in the industry, where we stand at the confluence of a multi-vendor, multi-technology industry, combined with advanced logistics management and engineering and design capabilities, we are building out an array of services which will ultimately provide a source of high margin revenue. Our design services are utilized throughout the Tesco customer base, and our efforts to grow this business have been on three fronts. Maximizing the monetization of these services, or in other words, sell the true value of the services to the customers rather than effectively giving them away to help secure lower margin product revenue. Accelerating our efforts to productize and promote design services to increase the number of engagements and focus on engaging our customers in the use of our design services. In certain areas, we can bring new service offerings to the market more quickly by using technology partners. The design of our first such new offering is in proof of concept stage, and we will share more details next quarter. We've also established beta customers to provide us with feedback to help maximize the value and the saleability of the final product. These capabilities will help Tesco provide our VAR customers with additional capabilities to sell and differentiate themselves with their end customers. With that, I will turn the call over to Eric for the financial review. Eric?