Earnings Call Transcript - RFIL Q3 2022

Operator, Operator

Greetings ladies and gentlemen, welcome to the RF Industries Third Quarter Fiscal 2022 Financial Results Conference Call. At this time, all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments after the presentation. It’s now my pleasure to turn the floor over to your host, Jim Byers of MKR Investor Relations. Sir, the floor is yours.

Jim Byers, Investor Relations

Thank you, operator. Good afternoon and welcome to RF Industries’ third quarter fiscal 2022 financial results conference call. With me on today’s call are RF Industries’ President and CEO, Rob Dawson; and Senior Vice President and Chief Financial Officer, Peter Yin. Before I turn the call over to Rob and Peter, I’d like to cover a few quick items. This afternoon, RF Industries issued a press release announcing its third quarter fiscal 2022 financial results. That release is available on the Company’s website at rfindustries.com. This call is also being broadcast live over the internet for all interested parties and the webcast will be archived on the Investor Relations page of the Company’s website. I want to remind everyone that during today’s call management will make forward-looking statements that involve risks and uncertainties. Please note that except for the historical statements, statements on this call today may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. When used the words anticipate, believe, expect, intend, future, and other similar expressions, identify forward-looking statements. These forward-looking statements reflect management’s current views with respect to future events and financial performance and are subject to risks and uncertainties, and actual results may differ materially from outcomes contained in any forward-looking statements. Factors that could cause these forward-looking statements to differ from actual results, include delays in development, marketing, or sales or products, and other risks and uncertainties discussed in the Company’s periodic reports on Form 10-K and 10-Q and other filings with the Securities Exchange Commission. RF Industries undertakes no obligation to update or revise any forward-looking statements. Additionally, throughout this call, we will be discussing certain non-GAAP financial measures. Today’s earnings release and the related current report on Form 8-K describe the differences between our GAAP and non-GAAP reporting and present the reconciliation between the two for the periods reported in the earnings release. With that said, I will now turn the conference over to Rob Dawson, President and Chief Executive Officer.

Rob Dawson, CEO

Thank you, Jim. Good afternoon, everyone. Welcome to our third quarter fiscal 2022 earnings conference call. I’d like to begin by reviewing our third quarter results and then discuss current market trends and our expectations moving forward, after which Peter will provide more details on the financials. In the third quarter, we are happy to announce our highest quarterly revenue in company history, demonstrating a strong revenue growth along with improved margins. Sales for the quarter reached a record $23.8 million, which is an 11% increase from Q2 and a 56% rise compared to the same quarter last year. This impressive growth is due to both an organic increase in our overall business and a higher-margin revenue contribution from our successful acquisition of Microlab, which performed very well this quarter. To put this in perspective, $23.8 million in sales equals the total sales RF Industries achieved in all of fiscal 2017, the year I joined the Company just before the fourth quarter. We are making strides in our growth story. On the bottom line in Q3, we reported GAAP net income of $771,000, non-GAAP net income of $1.2 million, and adjusted EBITDA of $2.1 million. Our gross margins have returned to over 30%, one of our key short-term objectives, reflecting ongoing improvement in our organic margins, along with contributions from the Microlab acquisition. While we are delighted by these outstanding results, I must acknowledge that we have not yet hit our full potential. Amid these record sales, we have been diligently working behind the scenes to transform the Company, and many of our key initiatives regarding consolidation, operational efficiencies, and technological advancements are still in various stages of completion. We believe these strategic initiatives will play a significant role in the next phase of the company's growth. Microlab is performing exceptionally well, with strong sales of its products during the quarter. This acquisition is living up to our expectations, or perhaps even exceeding them. As we mentioned when we finalized the deal, Microlab's sales in the 12 months leading up to the acquisition were approximately $17 million, and we achieved $6.5 million in sales of Microlab products in just the third quarter. We are excited about this business and are glad to have the team as part of RF Industries. As we integrate Microlab into our operations and market approach, we are uncovering opportunities to enhance Microlab sales through our distributors by simplifying the business process for them. Additionally, we are experiencing a strong demand for Microlab on bills of material in key wireless projects. This broader inclusion in the bill of materials has been a critical focus of our M&A strategy over recent years, and it is proving effective. Importantly, we are seeing this increase in sales even before completing major new initiatives that we anticipate will drive further sales growth, including new product development and expanded market channels. Now, let me briefly touch on other product areas and market segments and their performance in the quarter. Our core distribution business remains robust and continues to expand. Our RF coaxial cable and connector products, along with our C Enterprises faster and fiber products, represent our main offerings in distribution. Both of these key product segments reflected significant year-over-year growth during the quarter, and we expect steady growth to persist through the remainder of our fiscal year as we strengthen our core revenue base. Microlab aligns well with these product segments, and we are reaping benefits from shared customers and processes. Our custom cabling segment, including our OptiFlex hybrid fiber products, continues to deliver strong sales results. Our initial Tier 1 wireless carrier customer continues to utilize their existing purchase orders, and we recorded another solid quarter of shipments with them in Q3, including new smaller orders during this period. We are also actively pursuing new opportunities with other market customers. As I've mentioned previously, we now have multiple major customers deploying our OptiFlex hybrid fiber solution for next-generation wireless builds. Just last week, we announced multimillion-dollar follow-on orders from our latest North American Tier 1 wireless carrier customer for our hybrid fiber solution to support their 4G and 5G infrastructure expansion. We have received over $11 million in total orders related to this customer for hybrid fiber. These orders validate our growing market value, and our OptiFlex hybrid fiber solution is gaining traction in the North American wireless market. The team at our Cables Unlimited operation in Long Island is excelling with these increased sales and production levels of OptiFlex. While the supply chain and logistics environment remains challenging, the team is doing a commendable job of exceeding customer expectations. With our strong product offerings and unique market value proposition, we are well-positioned to capitalize on the ongoing increase in 4G and 5G spending. Our other custom cabling products maintain a healthy role in our business. With our diverse range of specialty products and our value proposition of rapid delivery of specialized cable assemblies, we are discovering new opportunities through enhanced sales and marketing efforts to grow our business with both existing customers and new partnerships with mid-tier players beyond the carrier market. Regarding our other offerings, small cell and DAC thermal cooling represent significant opportunities. Although small cell spending has not reached the anticipated levels for various reasons we have previously discussed, customer conversations indicate a shared belief that spending will increase next year. While the small cell market continues to lag behind expectations, it is only a matter of time before it accelerates. Projections from major players in the wireless ecosystem indicate substantial growth. For instance, in its second quarter 2022 earnings call, Crown Castle announced plans to double new small cell installations in 2023 from 5,000 to 10,000 as network operators conclude most macro tower upgrades and shift towards densifying their networks using small cells. Verizon has also suggested it will speed up its small cell buildout in 2023 after prior years of delays to focus on new mid-band spectrum utilizing traditional macro cell sites. We previously introduced an innovative next-generation small cell concealment solution called TruField, expanding our market opportunity with a proprietary product for our growing wireless carrier customer base to meet the increasing demands for 4G and 5G densification. We currently have TruField trials actively in the field and are developing a growing pipeline of opportunities. With our enhanced capabilities and product offerings, we are optimistic about our position in future small cell deployments. We also see significant growth potential as spending rises for our DAC thermal cooling product range. We are in discussions with Tier 1 carriers and others regarding our DAC offerings and anticipate finalizing those conversations in the upcoming quarters. As the DAC market opportunity expands and we position our unique offerings in the market, we believe it could become a significant contributor to our growth trajectory. We have already observed increased spending from our Tier 1 wireless customers. Given the extreme heat we have been experiencing, particularly in the western regions, interest in these solutions continues to grow. We have made substantial progress on product redesigns and long-term projects, and plan to announce updates related to that progress very soon. On the subject of acquisitions, while we concentrate on our organic growth plans, we also identify opportunities for strategic acquisitions. We are actively searching for larger acquisitions that align with our strategic goals. While nothing is imminent, we are experiencing robust deal flow and engaging in productive discussions. We aim to acquire quality companies with passive components that enable us to provide more of the bill of materials for critical applications, such as wireless deployments, along with add-ons to access new products for both our new and existing channels. We have effectively concluded the integration of Microlab, and they are now fully operational as part of our team. Simultaneously, recognizing the significant synergy potential within our business, we are undertaking major initiatives to consolidate our operations for improved efficiencies and capabilities. With most COVID-related constraints now behind us, we will be integrating C Enterprises and the RF cable and connector business into a single location in Southern California in January 2023. We are also planning to relocate the Microlab operation to a new facility in New Jersey later in 2023 and are exploring additional consolidation opportunities there. With the significant synergies we anticipate, we have invested in new facilities, systems, and equipment to scale our organization and capitalize on larger opportunities to increase our pipeline and streamline operations. We believe these strategic initiatives will enable us to fully leverage the increased earnings potential of our business. Meanwhile, despite these developments, we have managed to maintain our operating expenses almost flat, aside from the addition of Microlab, while achieving record sales results. I want to take a moment to reiterate some of our goals for the remainder of this year and for the future, which I mentioned in our last call. As I pointed out, due to the operational leverage in our business, we can achieve higher sales with minimal additional investment in SG&A. We are pleased to have increased our gross margins above 30% in the third quarter and believe we can grow margins further as we incorporate higher-margin revenue from our more significant products alongside the Microlab offering. Furthermore, our record sales and gross margin improvements in this quarter have brought our adjusted EBITDA margin to approximately 9%, moving us closer to our goal of achieving an adjusted EBITDA margin of 10% or more in the near future. Over the next three to five years, we aim to continue profitable growth through both organic and inorganic initiatives, elevating our adjusted EBITDA to even higher levels. As we conclude our fiscal year, we have secured strong bookings and maintain a backlog of $31 million, positioning us well for a successful fourth quarter to wrap up the year. Currently, we anticipate Q4 to mirror the performance of Q3, with sales in the low-$20 million range as we start to stabilize our historically volatile sales trajectory. Peter will provide additional details shortly. For the full year, we project total net sales between $83 million and $85 million. Looking ahead to fiscal 2023, we are experiencing strong momentum across all product categories while pursuing additional strategic projects in higher-margin areas. Additionally, we remain committed to engaging in M&A activities while strategically managing our capital allocation as a means to drive investor returns through increased revenue, scale, and profitability. Lastly, earlier this week, we announced changes to our Board of Directors, welcoming two new directors with extensive experience that aligns with our growth strategies. I am pleased to introduce Kay Tidwell, Executive Vice President, General Counsel, and Chief Risk Officer of Hudson Pacific Properties, who brings significant public company legal expertise, which will be invaluable for corporate governance matters. I also welcome Jason Cohenour to the Board, who offers years of executive leadership, sales, marketing, operations, and international M&A experience. Jason previously served as President, CEO, and Director at Sierra Wireless, where he successfully turned around the business, achieving nearly 800% revenue growth to an annualized sales run rate of $800 million. His successful track record in growth and leadership, along with a deep understanding of the wireless sector, will be a tremendous asset to our strategic guidance. At the same time, we also announce the retirement of our former Chairman of the Board and longstanding Board member Marvin Fink after over 20 years of dedicated service. Marv played a pivotal role in the Company's long-term growth, and we are immensely grateful for his contributions to our success throughout the years. On a personal note, I have appreciated his steady approach and will miss his insightful humor. It has been a privilege to serve alongside him on the Board; we are marking the end of an era, and I wish him all the best. I will now hand the call over to Peter for a review and discussion of our financial results for the quarter.

Peter Yin, CFO

Thank you, Rob, and good afternoon, everyone. We are excited to announce our highest quarterly sales on record, demonstrating solid growth both sequentially and year-over-year, along with enhanced margins and profitability. In the third quarter, sales reached a record $23.8 million, an 11% increase from the second quarter and a 56% rise compared to the same quarter last year. Our gross profit margin was 30%, up from 28% in the second quarter and the same period last year, excluding the impact of the employee retention tax credit recognized in last year's Q3. The improved gross margins for this quarter reflect advancements in our core business, alongside a full quarter of higher margin revenue from Microlab, which contributed $6.5 million in sales in Q3. As previously mentioned, we have faced several cost pressures mainly related to the supply chain that have affected our margins. We are addressing these challenges by collaborating with both our vendors and customers, which includes placing larger orders earlier to secure current pricing and updating pricing agreements with our customers. Additionally, we are exploring internal synergies and efficiencies through consolidation efforts where applicable and automating or semi-automating traditionally labor-intensive processes. We are just starting this process and look forward to providing updates in future quarters. Turning to our balance sheet, our current inventory is at $19.2 million, an increase of over 80% or $8.7 million from Q3 last year. The addition of Microlab accounted for $4 million of this inventory increase. This inventory growth supports our value proposition of availability and aligns with our 56% sales growth compared to last year’s third quarter, or 14% excluding Microlab. We believe having available inventory is crucial in our markets, especially amid supply chain volatility and as sales rise. Our targeted inventory increases allow us to better meet customer needs and stay ahead of delays seen in similar products from competitors. At the end of the third quarter, cash and cash equivalents were $5.1 million, up from $3.7 million in the previous quarter, and working capital was $30.1 million. As of Q3, our term loan balance stands at $16,192,000, down from an initial balance of $17 million, with an interest rate of 3.76%. We have not drawn from our $3 million revolving credit facility obtained during the Microlab acquisition. Adjusted EBITDA in Q3 was $2.1 million, an increase from $1 million in the same quarter last year. Our adjusted EBITDA margin for the quarter was 8.7%, reflecting our progress towards our short-term goal of achieving a 10% sales margin or greater. During the quarter, we incurred one-time charges totaling $250,000 related to acquisition costs, including ERP implementation and synergy expenses. This amount includes a non-cash rent expense of $135,000 related to our new corporate headquarters in San Diego, where we started construction and renovation after taking possession of the building. We will continue to add this expense back to our adjusted EBITDA until the lease starts on December 1, 2022. In the fourth quarter, we anticipate around $390,000 in non-cash rent expense affecting our earnings, but this will be reflected in the adjusted EBITDA figures. Our backlog was $30.6 million as of July 31, 2022, with third-quarter bookings amounting to $26.8 million, up from $27.6 million in Q2. Currently, our backlog is a robust $31 million, indicating that even with record sales, we are actively booking and replenishing orders. Notable recently announced orders include follow-on orders for our hybrid fiber solution from a major North American Tier 1 wireless carrier totaling $3.5 million. Regarding our outlook, we expect Q4 net sales to be in the low-$20 million range, marking our third consecutive quarter with sales exceeding $20 million. As we move towards more consistent sales, we will be better equipped to plan and project operational needs, enhancing efficiencies and exploring synergies for improved profitability. We anticipate full-year net sales between $83 million and $85 million, reflecting at least 45% year-over-year growth, which encompasses eight months of Microlab revenue this fiscal year. Furthermore, we expect to see gross margin improvements for the full year as we capitalize on margin enhancement opportunities and optimize our product mix. Our adjusted EBITDA is also expected to grow as profitability improves throughout the remainder of the year, aiming for a 10% sales margin translating to adjusted EBITDA. Lastly, I would like to welcome Kay and Jason, who recently joined our Board. I am looking forward to their contributions. I also want to express our gratitude to Marvin Fink for his many years of service at RF Industries. Marv has been key in our Company’s growth and transformation, and we will miss him.

Operator, Operator

First question is coming from Josh Nichols with B. Riley. Josh, your line is live.

Josh Nichols, Analyst

Great. Great to see the second consecutive quarter of revenue north of $20 million and the backlog at the end of the quarter actually increasing sequentially. On that note, I’m just kind of curious, like how long do you think it’s going to take you to work through that backlog? And if you could talk a little bit longer about the visibility that you have into the next fiscal year, given where the backlog is today?

Rob Dawson, CEO

Yes. Thank you for your questions, Josh. Regarding our backlog, we have shared information in various ways to illustrate the situation. The positive aspect is that despite achieving some significant sales, our bookings have exceeded those sales, allowing our backlog to increase this quarter to around the low-30 millions. This figure includes items we can anticipate shipping in the next 90 to 180 days, as well as some longer-term products, particularly in our integrated cabling line. While we are pleased with the high backlog, we would also be comfortable with it being in the range of $20 million to $22 million, as those figures would still support substantial quarterly sales. It's important to note that the backlog does not capture the book and ship business derived from our distribution center offerings. This represents a snapshot in time for us, providing good visibility over the next few months. As we look to the fourth quarter, we expect it to resemble Q3, though slight variations in order timing can significantly impact our numbers, particularly with larger orders. We are optimistic about the fourth quarter based on what we know halfway through. Looking ahead to next year, we need to maintain our booking levels and continue pursuing larger opportunities. However, the small cell and DAC orders have not performed as we anticipated. The small cell market has been somewhat unpredictable, while we are working on enhancing our DAC product offerings to generate more opportunities. We believe both areas will yield positive results in the upcoming quarters. Once we approach next year, we will discuss further in about three months, but we expect ongoing growth. Our outlook is geared towards maintaining organic growth regardless of our ending figures this year, and the addition of the Microlab business should provide some further benefits for next year. Although I don't expect every quarter to mirror the exceptional performance of Q3, it is within the realm of possibility that we can achieve similar results as we integrate that business into RF Industries.

Josh Nichols, Analyst

Thanks. And then, you talked about margins, both on the gross margin front and then EBITDA margins. Is it fair to say that you think gross margins would be up sequentially in Q4? And you mentioned a 10% EBITDA margin target. Do you think that you’d be able to hit that target in Q4 or do you think that’s more of a fiscal year ‘23 goal to be at or above that level for the full year?

Rob Dawson, CEO

Yes, that's a good question. Regarding our gross profit, we've managed to stabilize our mix quite effectively. We're now able to forecast it much better, especially when sales numbers fluctuate between the low twenties or high teens, around $12 million or $15 million. This variability makes it challenging for us to pinpoint our numbers because we need to account for the labor involved in producing all this. Overall, we're satisfied with our current position, just above the 30% mark. We definitely see potential for improvement, primarily through mix in the short term. We also have initiatives aimed at streamlining operations and creating synergies that will enhance our gross margin over time. We're pleased with reaching the 30% threshold, which was great to observe both organically and with the acquisition of Microlab. The focus now is on maintaining this level and exploring ways to achieve additional growth, which we believe is achievable in the near future. As for adjusted EBITDA, reaching 10% seems attainable in the short term. We do have some miscellaneous implementation costs and other factors, some of which we can account for and some we cannot. So, getting close to that 9% mark felt encouraging. I genuinely believe hitting that target in the near future is possible, but looking ahead to next year, we fully expect to exceed 10%, with potential for even better performance as our initiatives start to take effect.

Josh Nichols, Analyst

It was a strong quarter with free cash flow of approximately $2.6 million, particularly in relation to the Company's market cap or enterprise value of around $80 million. Do you believe that maintaining free cash flow of over $2 million is feasible in the near term? Additionally, what are your plans for that cash aside from mergers and acquisitions or potential debt repayments?

Peter Yin, CFO

Hey Josh, it’s Peter. Thanks for the question. A lot of the cash flow there is due to timing of just the collections of how AR falls, right? And as we talked about, there are initiatives that are going on that will require some cash outlay from us. But we’re servicing the debt fine with the Microlab acquisition there. And assuming there were no big initiatives, these types of cash flow, I think it’s something you can expect. But what we have kind of coming down just a little bit, in the positive is kind of something I would expect.

Rob Dawson, CEO

And Josh, from a use perspective of what do we want to do with the cash, the initiatives we have ahead of us are not small to real estate related. There are things that we need to do in order to take some synergies in this business and really start to drive some of these major opportunities to get dollars to fall through to the bottom-line. So, in the immediate, there are some organic things we’re doing internal to the business to invest, to make it stronger and a lot of the integration work that we’re now able to do that we haven’t been. As cash builds and we get back to that level, then it’s a different discussion of should we be paying down debt, should we be looking at other opportunities to deploy that capital? But I think in the short-term, we’ve got organic initiatives that make sense for us. And we’re not really looking at little tiny acquisitions where that level of cash would do us much good. So, it’s probably not a focus point for that, at least as it stands today.

Josh Nichols, Analyst

Thanks. I don’t want to monopolize the mic. So, I just have one question here that kind of close off on. It seems like the Company’s doing quite well when you look at the backlog. But I do want to touch on the small cell and DAC opportunities, because those have not been big drivers this year, but maybe it sounds like they could next year. If you could help quantify, like how much of the revenue guidance for this year is related to small cell and DAC, and how could that compare to what type of revenue opportunities that could be next year, based on what you’re seeing, to give people a little bit of an opportunity for the upside there?

Rob Dawson, CEO

Yes, that's a great question. If you review our guidance for this year and our expectations for the fourth quarter and the full year, small cell and DAC represent a very small portion of our total sales. We believe these segments will become more significant next year, as the small cell market begins to recover and grow again. Our team has also made improvements to the DAC offering, making it easier to market and better aligned with current demands, particularly around green initiatives and operating cost reductions for major carriers with equipment on the edge of their networks. This is an important area that needs cooling, presenting a substantial opportunity for us. While small cell has experienced some timing challenges with closing deals, it is still on an upward trajectory, along with the DAC’s thermal cooling solutions. Both areas are seeing increasing potential as we refine our offerings. Looking ahead to next year, when I mention growth, I’m not factoring in significant contributions from small cell and DAC at this point; those would be additional benefits to our overall projections. As we move forward, we hope to provide more clarity on certain items by our December call, which will offer further insight into the potential impact of these two product areas on our annual sales.

Operator, Operator

Next, we have Orin Hirschman with AIGH Investment Partners. Orin, your line is live.

Orin Hirschman, Analyst

HI. Thank you. I try to do a quick back of the envelope with the best data we can on estimates, but was there progress on the gross margin and the rest of the business, if you pull out the Microlab business?

Rob Dawson, CEO

Yes. There was organic margin growth on our legacy business, and then the adder of Microlab helps pushes up over that 30% number.

Orin Hirschman, Analyst

Okay, great. What will it really take for the cooling business to succeed? This is clearly a significant issue. People are recognizing it. When does it become truly critical?

Rob Dawson, CEO

Yes. Our expectation is during fiscal ‘23, we’re going to have some really real numbers to talk about and the contribution from it. We’re selling it now, it’s happening, even this week we’ve seen some pretty meaningful orders from a large carrier based on West Coast heat needs. Okay, cool. So, we’re seeing that happen. It’s not out of the question to have some things to talk about in the very short term around that. But these orders are in the tens or hundreds of thousands. We think that opportunity obviously is way larger than that as we start to break into some of the more nationwide footprint opportunities. But in ‘23, we’d be disappointed if there was not a material contribution from that business.

Orin Hirschman, Analyst

Okay, great. And that carries very good gross margins, correct?

Rob Dawson, CEO

It does. Yes. Thanks, Orin.

Operator, Operator

Okay. We have no more questions at this time. I will now hand the call back to management for their closing remarks.

Rob Dawson, CEO

Thanks, John. Yes. I’ll make a final comment. That sounds good. So, thanks everyone for joining our call today. We appreciate your support of RF Industries. I’d like to thank our team for their hard work in helping us achieve these new levels of performance and our customers for allowing us to partner with them. We’re excited about our continued positive momentum as we move toward year end and the significant opportunities that lie ahead. Peter and I look forward to reporting our fiscal 2022 fourth quarter and full-year results in December. Thank you again. And have a great day.

Operator, Operator

Thank you. Ladies and gentlemen, this does conclude today’s conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.