Earnings Transcript for WTT - Q4 Fiscal Year 2021

Operator: Good day ladies and gentlemen, and welcome to the Wireless Telecom Group Q4 2021 and year-end earnings call. At this time, all participants have been placed on listen-only mode and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Mike Kandell. Sir, the floor is yours.

Michael Kandell: Thank you Operator. Good morning everyone and thank you for joining us on today’s conference call to discuss Wireless Telecom Group’s fourth quarter and full year 2021 financial results. With me today is Tim Whelan, the company’s CEO. Before we begin, I would like to remind everyone on the call that our remarks today could include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In some cases, such forward-looking statements may be identified by terms such as believe, expect, seek, may, will, intend, project, anticipate, plan, estimate, or similar words, as well as statements that do not related strictly to historical or current facts. The company’s forward-looking statements are based on management’s current expectations and assumptions regarding the company’s business and performance, the economy, and other future conditions and forecasts of future events, circumstances and results. Forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that could materially affect actual results. Important factors that could cause the company’s actual results to differ materially from those in its forward-looking statements include those risk factors set forth in the company’s 2021 annual report on Form 10-K filed this morning with the SEC. The company does not undertake any obligation to update or revised any forward-looking information to reflect changes in assumptions, the occurrence of unanticipated events or otherwise. Also, we want to point out that in addition to GAAP information, we will provide information relating to certain non-GAAP measures. We believe that presenting these non-GAAP or adjusted measures provides additional meaningful information to investors which reflect how management views the business. Detailed reconciliations of GAAP measures to non-GAAP measures are set forth in a reconciliation table in our press release issued earlier today and furnished with the Form 8-K filed today with the SEC. With that, it’s now my pleasure to turn the call over to Tim Whelan.

Timothy Whelan: Thank you Mike, and good morning everyone. 2021 was one of the most transformational years for the company, where we realized growth in revenues, bookings and backlog, gross margins, non-GAAP EBITDA margin and net income. Across the board, we believe every important metric showed not just a recovery from COVID but an improvement in the long term health of our business. Just as importantly, the sale of our Microlab business, which was signed in December 2021 and closed in March, allows us to strategically focus on a more streamlined business. We are exceptionally pleased and thankful for the hard work, resilience and invaluable contributions of our employees and senior leadership team to the success realized in 2021. Before I turn the call over to Mike to walk us through the financials in more detail, I’ll touch upon these further and provide some additional color. First is our revenue growth for the year ended December 31, 2021. Revenues increased 18% on a consolidated basis, almost all of which was driven by the results in our T&M and RBS product groups. Excluding Microlab, our revenues for test and measurement and RBS reflected even stronger growth of 31% in 2021 compared to 2020. Revenues were driven by higher legacy test and measurement product increases outside of our Holzworth products, which reflects success in three initiatives

Michael Kandell: Thank you Tim. Good morning again everyone. I’ll review the results for the 12 months ended 2021 and then comment on our balance sheet as of December 31, 2021. All P&L comparisons are on a year-over-year basis and balance sheet comments are as of December 31, 2021 compared to year-end December 31, 2020 unless otherwise noted. The financial statements for fiscal 2021 and 2020 include the results of Microlab. Consolidated revenue for 2021 increased $7.5 million or 18% from the prior year period. RBS revenue increased $5.3 million or 150% on higher sales of our digital sales processing cards and software and services revenue due to new customer contracts. T&M revenue increased $2.1 million or 10% due to new product introductions, improved demand generation activities, and a rebound in customer spending particularly internationally due to relaxed COVID restrictions, and RF components revenues were flat with the prior year. Consolidated gross profit increased $4.1 million from the prior year on higher revenues at T&M and RBS. Consolidated gross profit margin increased marginally as higher gross profit margin at T&M was offset by lower margins at RFC and RBS due to mix. Specifically, RBS margin was impacted by a higher concentration of service revenue in 2021, which means more of our labor costs for software engineers are classified as costs of revenue rather than R&D. Turning to operating expenses, consolidated R&D expenses decreased $839,000 or 13.1% from the prior year because of lower third party material and consulting expenses, primarily related to our RBS and T&M product groups, and the aforementioned higher classification of labor costs in costs of revenue rather than R&D due to more service contracts in 2021 than 2020. This was only partially offset by favorable foreign exchange impacts. Consolidated sales and marketing expenses increased $214,000 or 3.1% due to higher commissions expense and unfavorable foreign exchange impacts. Consolidated general and administrative expenses increased approximately $2 million or 19.8% due to higher salaries and benefits due to increased headcount, higher professional fees associated with the Microlab divestiture, and consulting and other fees associated with our strategic review process. This was only partially offset by lower stock-based compensation expense due to the reversal of expense associated with certain performance-based stock options. Additionally within operating expenses, we recorded a non-cash impairment charge related to an indefinite live intangible asset as part of our annual review process and a loss on change in contingent consideration of $386,000 related to the Year 2 Holzworth earn-out. The Year 2 earn-out is based on the financial results for fiscal year ended 2021 and is payable in four equal installments beginning in March of 2022. Holzworth full year 2021 forecasted financial results have exceeded our initial estimates and accordingly, we recorded this charge through the P&L as the measurement period for purchase accounting has closed. The Year 2 earn-out is the final earn-out payment due under the Holzworth stock purchase agreement. Our total Holzworth earn-out accrual as of December 31 was $3 million and is payable quarterly in 2022 in either cash or stock. In 2021, we also recorded a gain on extinguishment of our PPP loan as the loan was forgiven in the second quarter. Other income and expense decreased $117,000 from the prior year due primarily to lower gains on foreign exchange transactions and other asset sales. Interest expense increased $158,000 from the prior year due primarily to our term loan with Muzinich. Overall, we generated net income in 2021 of $1.5 million as compared to a net loss of $8.1 million in the prior year due to higher gross profit and lower impairment and contingent consideration charges, and the gain recognized on extinguishment of the PPP loan in the current year, which were only partially offset by higher interest expense and a lower tax benefit in the current year. Non-GAAP adjusted EBITDA was $3.7 million for 2021 as compared to $1.8 million in the prior year period due primarily to higher income from operations. Turning to the balance sheet and cash flow, we generated $4.6 million in cash from operations in 2021, made $4.2 million in term debt payments and $1.1 million in contingent consideration payments in 2021, and had zero outstanding under our revolver as of December 31. On March 1, we closed the previously announced divestiture of Microlab. At close, we received $23.9 million in cash proceeds, of which $4.2 million was used to pay the outstanding principal and accrued interest related to the Muzinich term loan, $700,000 was used to pay the outstanding principal and accrued interest and fees related to the Bank of America credit facility, and $486,000 was used to pay our advisors. Overall, we received approximately $18 million in cash to the balance sheet at close. Both the Muzinich and Bank of America credit facilities were terminated on March 1. In Q1 of 2022, we expect to classify the stub period results of Microlab as a discontinued operation. Additionally, we expect to add additional disclosure around the T&M and RBS business units. I’ll now turn the call back over to Tim for some closing remarks.

Timothy Whelan: Thank you Mike. Going forward, we intend to manage and organize the business as two discrete operating segments

Operator: [Operator instructions] [Audio interference]

Josh Nichols: [Audio interference] 5G LTE investment cycle this year and the opportunities that provides for the company. Are you seeing a significant ramp-up already, do you think that’s going to be something that happens [audio interference]? If you could elaborate a little bit, that would be appreciated.

Operator: Ladies and gentlemen, please hold the line. We are going to reconnect the speaker line to improve sound quality. Once again, please hold the line. We will reconnect the speakers to improve sound quality. Please hold. Ladies and gentlemen, the speakers are reconnected. Josh from B. Riley, if you could please re-pose your question. Apologies for the delay, ladies and gentlemen.

Josh Nichols: Yes, thanks for taking my question. I was just wondering if you could elaborate a little bit on what you’re seeing in terms of the 5G investment cycle and the implications that that could have for this year on the test and measurement business and RBS, and the opportunities that that presents.

Timothy Whelan: Sure, thank you for that, Josh. Good morning. In Q4, we announced two wins, and we’ve been on a pace of about one win per quarter. We’re certainly seeing some additional activity in the funnel. We were very enthused being back at Mobile World Congress this year. In that conference, we presented our 5G base station reference platform as well as a DU card, which is a part of the technology building blocks in the open radio access network architecture, so those solutions were well received and attracted attention we’re hopeful for. While the environment does remain fluid, we’re definitely seeing activity within the global markets and we think that spend will remain strong over the next several years.

Josh Nichols: Thanks. What are the--I guess if you were to think about the one or two biggest opportunities in terms of software sales for this year, next year, that could really move the needle, is there something that you’re already working on or had in mind, or what are some of the opportunities on that front to build that base from where it is today to a much more meaningful and high contribution margin?

Timothy Whelan: Sure. I’ll reflect on the two that we’ve announced, one with GENEViSiO which builds their Taiwanese ODM specializing in telecom infrastructure, so they’re going after that market, which is the private network 5G build-out, and that brings together the NXP Layerscape platform as well as our software. As the world is moving and you’re seeing some of the headlines of much larger enterprises starting to build out 5G private networks, we think that’s going to continue and we’re enthusiastic about the growth curve there and the potential market opportunity. The second is the HFCL. HFCL is an Indian telecom company. They’re looking to deploy a 5G indoor small cell solution in a specialized fashion as they think about what’s referred to FR1 and FR2, so again we’re partnering with them, and as more of the 5G private networks get built out, we think that creates that opportunity for us to continue to enlarge our opportunity.

Josh Nichols: Thanks. I know that there’s been a lot going on with the supply chain. Have you seen much impact to your business, or what’s the company doing to kind of mitigate any of those potential headwinds?

Timothy Whelan: Yes, so two observations there, Josh. One is the extension of lead times, lead times from 20 weeks have extended to 52 weeks - that’s causing us to rethink how much inventory we stock, and we’re starting to increase the amount of inventory we’ve positioned to provide for that. Second, costs are clearly increasing for hard-to-get components, and those cost increases are far beyond just percentages. We’re seeing multiples, so certain components that used to cost $15 going to certain boards in our T&M solutions now cost $600, just to give you one example of the magnitude of the shift. Right now, it’s not enough for us to change how we think about our gross margin profile because within test and measurement and RBS, there’s a level of pricing power that we also have, and so we’re trying to take a balance of buying ahead of time, increasing our inventory orders and accelerating some purchasing, as well as passing on price increases. We’re certainly seeing the impact, we’re spending a lot more cycles in managing and increasing visibility on a week to week, and we feel we’ll be able to manage it reasonably well at this time.

Josh Nichols: Thanks for the clarifier. Then could you talk a little bit on a pro forma basis, so the Microlab business is going to be moved to discontinued operations, so you effectively become a two-segment company, but I think everyone has an idea for the margin profile - that should be accretive, but what’s the expectation on the opex front for how that’s going to change?

Michael Kandell: Yes Josh, we have initiated a bunch of opex reductions as part of this year’s planning cycle, so obviously there’s certain opex expenses that are known with Microlab, and in addition to that there’s things we’re looking at to be more efficient here, so we do expect the opex obviously to decline going forward.

Josh Nichols: I guess, is it fair to assume that you would kind of maintain profitability, right, or is that going to change a little bit?

Michael Kandell: Obviously we’re managing the business to be profitable. That’s going to be dependent on several things, the biggest of which is some of the volatility that we’re seeing with our big RBS contracts and the complexity of the revenue recognition with each of those. These are big seven-figure type deals with complex deliveries and milestones and complex revenue recognition, so that’s going to impact our profitability going forward.

Josh Nichols: Great, thank you.

Timothy Whelan: Thank you Josh.

Operator: Thank you. Once again ladies and gentlemen, if you wish to enter the queue to ask a question, please press star, one on your phone at this time. The next question is coming from Nick [indiscernible]. Nick, your line is live. Please announce your affiliation and pose your question.

Nick: Good morning. Happy St. Patrick’s Day to everyone.

Timothy Whelan: Good morning Nick, thank you. Same to you.

Nick: And Tim, good luck with our Wildcats, huh?

Timothy Whelan: Very good, thank you Nick.

Nick: Okay. I have a bunch of questions. First of all, can you break out the revenue for RBS, like software versus services in fourth quarter?

Michael Kandell: Nick, within the 10-K I’d point you to this aggregated revenue footnote - it’s not on the quarter, but if you look at for the 12 months ended December 31, the software licenses were about $1.9 million and the services were about $3.8 million. Of that $3.8 million, there is some calibration services for T&M within that number, which is generally between 1.3 and 1.5.

Nick: Okay, so as the fellow there from B. Riley asked, the cost structure going forward, can you say right now with any certainty that you’re going to generate cash this year without buying anything?

Michael Kandell: Yes, so we’re managing the company to be profitable and to generate cash flows. One of the big things that is going to impact our cash flows from a working capital perspective, or two big things, as Tim mentioned, one is the severity of these lead times and the supply chain issues that we have. To the extent that we determine we have to increase our inventory levels significantly for these hard-to-find components or long lead time components, that’s going to drive our inventory up, and then the second is the RBS projects, in addition to being complex from a rev rec perspective, they also tend to have disproportionate cash flows, meaning that if we can negotiate cash up front, we do that and it shows up as deferred revenue, but if negotiations are hard and cash is collected at the end of the project, that increases our unbilled receivables, so that is going to impact our cash flow going forward.

Nick: Right, but in other words do you have any degree of certainty that you’re going to generate cash this year? I mean, what can you--

Timothy Whelan: Nick, we’re operating on a budget that’s targeting EBITDA profitability, that’s for sure. I think what we called out is that there’s a couple large, close to seven figure, multiple seven figure contracts within RBS which are in the funnel and where we remain confident of the outcome, but the timing is less certain because our customers are still themselves building cases around the technology building blocks, so we feel comfortable in our position in, call it the stack of technology providers, but the timing of these large deals in terms of closing and then deployment of that is still a little uncertain. But we are certainly running the business internally, our budgetary targets are certainly designed to drive for EBITDA profitability at year end.

Nick: Okay. By the way, CommAgility, are they all located over in the U.K. still, or if I’m ignorant about that--

Timothy Whelan: No, a good portion of them are, call it 40% to 50% of the people are there, another 40% in the Duisberg, Germany location, and the rest are around the world.

Nick: Okay, so is there anything with regard to opex that can--I guess the word I’m looking for is affect CommAgility being located in the U.K. or anything, is there any way to consolidate that piece?

Timothy Whelan: We don’t think there’s necessarily downside. I mean, being distributed like that allows us to have deep relationships and customer contacts. Just think about one of the large wins we announced in Q4, which was with a company called ADVA but it was a U.K. funding, so our ability to have a presence in the U.K. positioned us for that win. Previously, we’ve won a German research project for 5G car connectivity, and we’re winning business around the world, so I think it’s a good thing that we have people in different technology hubs and presence around the world. I think it benefits us.

Nick: Okay, that’s fine. Then Tim, when we had our conversation, I really would like to understand better, and maybe you can highlight it more, the software business that you have, what is special about it? Look - there’s lots of big, big companies that could--you know, I just get the fear that they could crush you like a bug, so I would like to hear from someone, maybe even Mr. Rodriguez or something, and try to understand, I mean, why your solutions are superior. For example, SmartSky Networks put out a nice release. I don’t know how much the revenue was for that, but for some reason they chose your solution. I think we need to demonstrate to holders what it is, why this is a shining star.

Timothy Whelan: Sure, so I’ll make two remarks there. The software typically comes in seven stacks, layer one through layer seven. That includes the FI [phon] layer, which is the closest to the silicon, the physical layer. It includes the protocol layers and then it includes the application layers, which is designed for really what the end application is. We specialize in L1 to L3 software - that’s where we distinguish ourselves, first key point. Second key point is that we’ve partnered and collaborated with NXP Semiconductor, and so we’re working to collaborate so that our software is working on the NXP Layerscape platform. That silicon partnership has been beneficial to us and has led to mutual sales engagements. We are distinguished amongst that L1 to L3, specifically in the L1 stack in our collaboration with NXP. That’s one key point. The second key takeaway to your question is how by having that expertise, we can then specialize in the end applications to allow the software and the silicon to work as designed in a specialized application. We don’t go after the end markets which are defined by millions of units - that’s more of a Qualcomm solution. We go after those that are defined as hundreds or perhaps thousands of units, which is what the SmartSky solution is, and we’ve also solved for what’s called the Doppler Shift, so the current standards require a signal to be handed off at up to speeds of approximately 200 miles per hour, but if you have devices moving at speeds faster than that, there has to be adjustment to the software that allows the silicon to work. Those are just two key takeaways of how we’re specializing in niches and competing against providers that either have not solved those problems or are not interested in the space that’s defined as less than millions and tens of millions of end units.

Nick: Okay, that’s fair enough. Again, everybody, I guess, hopes that we’re going to see some evidence in these contracts at some point this year where this--you know, it will manifest in revenue. Okay, one other thing--

Timothy Whelan: Nick, on that point, I think one of the key points we called out is the increase in the backlog, so that’s already manifesting itself in terms of our bookings and the increase in backlog.

Nick: All right, fair enough. By the way, on Holzworth, what was the final price?

Michael Kandell: About $13.5 million, Nick.

Nick: Okay, so how much--I’m just curious, are you going to pay the balance with cash or stock?

Michael Kandell: We have the option to pay with cash or stock, and I think we’ll make that decision in each of the quarters coming forward, each of the next four quarters. Certainly with the greater cash position on our balance sheet, we have greater flexibility in terms of how we think about that.

Nick: Okay, well I just--you know, with the stock at $1.80 or whatever, and cash $18 million or whatever, I don’t know why you would use stock at these levels, but I guess it’s a small amount, it’s no big deal.

Michael Kandell: No, I agree with you. Yes.

Nick: Okay. I don’t want to take up all your time, but just one thing, and I mentioned this to Tim, I’ve been doing this for 30 years and it’s not just positive all the time, but I don’t understand why there’s not more insider buying by board members. I own more shares than some of the board members - it’s not right, and I understand everybody has their own thing, but it really does send a signal, you know? I’ve been doing this a long time, and I’d just encourage anyone that--you know, if you think it’s a bargain, the old cliché is insiders sell for lots of reasons, but they buy for only one. Over my many years of doing this, it works, but I don’t need to convince you. Either you see the value and that’s that.

Timothy Whelan: Nick, one comment on that. The board and management, we are subject to an insider trading policy, which includes blackout periods where we are forbidden from trading in the stock, which--

Nick: Yes, well, when there’s not a blackout.

Timothy Whelan: When you look at the whole of the year, there’s more blackout periods than there are open windows.

Michael Kandell: Yes, especially given a period of time when we’re negotiating a transaction, Nick, and you’ll recall that I have made significant purchases of stock, so I am a significant shareholder, so.

Nick: I understand.

Timothy Whelan: Nick, thank you. I appreciate it, we do hear you, and appreciate that feedback, though. Thank you.

Nick: Okay. The other question I have is can you give us a sense of timing in terms of--you know, I’m sure you’re looking at things to buy, acquisitions, but as I said to you, Tim, when you go back and you look at CommAgility - I mean, this is a company with a $40 million market cap now [indiscernible], you look at what you paid for CommAgility, and again the future may be bright but if you look at what it’s worth now, just did not build value with that acquisition, so I think in general shareholders might be nervous that we’re going to go down that road again of buying something and destroying value, so can you assure us--

Timothy Whelan: Listen Nick, I think the CommAgility acquisition generated significant EBITDA cash flow in the early years. The hardware declined at a faster rate than anticipated, but we went into that eyes wide open and we’re excited about the software opportunity that’s building today. We’re still very--

Nick: Yes, but wait a minute - you spent $19 million--

Timothy Whelan: We’re still very bullish about that acquisition. We are optimistic about the opportunities ahead. The EBITDA results do not include the cash tax refund we get at every year from that, and we feel very good about the opportunity. As we think about the future, as we said in our press releases, we’re going to remain committed to looking at the use of cash and use of excess cash and how we think about acquisitions going forward.

Nick: Okay, but not to argue the point now, but you paid $18 million and the market cap of the whole company is 40. Go look at what you paid for Holzworth, going well--

Michael Kandell: We didn’t pay $18 million for CommAgility, Nick. We paid $14.6 million.

Nick: When it was all said and done with cash and stock, wasn’t it higher than 14?

Michael Kandell: No.

Nick: Okay, all right. I stand corrected. But still, if those values--four years ago, if it’s still worth $14 million or $15 million, then go through the math of what Holzworth’s worth, what cash you have and what that’s worth, you ought to be buying back stock left and right - in other words, something doesn’t--

Timothy Whelan: Nick, I definitely get it. We hear you, we do appreciate your feedback. We’re very, very contemplative as we think about acquisitions. We have a deep diligence process, we have a gated process with our board, we’re very, very careful on how we do our acquisitions. We’re very pleased with the two that we’ve done. We think that the growth opportunity ahead for CommAgility has allowed the company a tremendous opportunity that didn’t exist a few years back. We’re also very pleased with Holzworth. Keep in mind, we have almost doubled the revenue from the Holzworth business, and that’s opening new opportunities for us as we think about common customers where we have been successful leveraging other brand into Holzworth customers, and then also leveraging Holzworth solutions into our existing customers. I definitely hear you, Nick. I definitely appreciate your feedback.

Nick: I agree what you’re saying, that makes a good point. Just final point and I’ll let you go - I appreciate this time. What are you going to do in terms of getting additional--I know it’s a micro cap, but additional research coverage or going out and telling the story, because you just laid out a story again where, if you did a sum of the parts on this company, it doesn’t make sense, or we’re missing something.

Timothy Whelan: Yes, I agree that a sum of the parts valuation shows that there’s a gap in the current valuation in the market, so I definitely agree with that.

Nick: And that’s with share repurchase--

Timothy Whelan: A key point too, Nick, is that we are working on analyst coverage, as we always have. It’s always a challenge as a small cap, or even a micro cap, but as we think about the transaction of Microlab just getting closed, we are now working hard to see what we can do to extend some of that analyst coverage. Again, we get it, Nick, we’re working on that amongst many other things, and we hear you and again appreciate your feedback.

Nick: Okay, well I do appreciate the time, and good luck. This is a long term situation, but shareholders would like to just see some more manifestation of these good things. And by the way, if there’s a gap that you believe between the value of the company and the share price, that’s exactly what share repurchases are meant for. I’ll leave it at that.

Timothy Whelan: Very good, thank you Nick.

Nick: Thanks.

Operator: Thank you, and there are no other questions in queue at this time.

Timothy Whelan: Great. Thank you everyone for joining us today. We look forward to speaking with you again in the near future. Have a great day.

Operator: Thank you ladies and gentlemen. This does conclude today’s conference call. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.