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Edited Transcript of PCTI earnings conference call or presentation 8-Aug-19 8:30pm GMT

Q2 2019 PCTEL Inc Earnings Call

BLOOMINGDALE Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of PCTEL Inc earnings conference call or presentation Thursday, August 8, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David A. Neumann

PCTEL, Inc. - CEO & Director

* Kevin J. McGowan

PCTEL, Inc. - VP & CFO

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Conference Call Participants

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* Jaeson Allen Min Schmidt

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Marc Wiesenberger

B. Riley FBR, Inc., Research Division - Associate

* Tim O'Connell

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Presentation

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Operator [1]

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Welcome to the PCTEL Second Quarter 2019 Earnings Release Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I will now turn the call over to Kevin McGowan, the company's CFO.

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Kevin J. McGowan, PCTEL, Inc. - VP & CFO [2]

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Thank you for joining us on today's conference call to discuss PCTEL's Second Quarter 2019 Financial Results. With me today is David Neumann, the company's CEO.

Before we begin, let me remind you that this call may contain forward-looking statements. While these forward-looking statements reflect PCTEL's best current judgment, they are subject to risks and uncertainties that could cause actual results to differ materially from these forward-looking projections. Risk factors that could cause PCTEL's actual results to materially differ from its projections are discussed in the earnings press release which was issued today and in our most recent annual report on Form 10-K, both of which are available on our website.

Additionally, our commentary will include reference to the following non-GAAP measures: non-GAAP earnings per share and adjusted EBITDA. We believe these non-GAAP measures facilitate comparability of results over different periods. A full reconciliation of these non-GAAP measures to our GAAP measures is included in our quarterly earnings press release that was issued earlier today.

With that, it's now my pleasure to turn the call over to David Neumann.

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David A. Neumann, PCTEL, Inc. - CEO & Director [3]

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Thank you, Kevin. We're pleased with another strong quarter driven by sequential revenue and antenna margin improvements. Second quarter revenue, gross profit margin, adjusted EBITDA and non-GAAP earnings per share all improved both sequentially and compared to last year. The improved results over the last 3 quarters are attributed to the R&D investments and actions we took in 2018, a strong demand for 5G scanning receivers and increased industrial IoT antenna sales.

We issued a press release after the market closed announcing our results for the second quarter ended June 30, 2019. For the second quarter 2019, our revenues are $23.5 million. Increased sales of higher-margin scanning receivers and improved gross margins for antennas contributed to improved non-GAAP earnings per share for the quarter.

We achieved $0.13 in non-GAAP earnings per share for the second quarter and gross margins of 45.5%, up 3.5% over the first quarter and up 9.4% over last year. Our focus on higher-margin antenna solutions for intelligent transportation and industrial IoT, coupled with strong demand for 5G scanning receivers, contributed significantly to increased margins for the quarter. We expect to maintain margins at this level through 2019.

Operators have launched more than 20 5G networks in the U.S., Europe and Asia, with dozens more planned for the remainder of 2019. We believe 5G network construction will continue over the next several years to address capacity and, ultimately, to support more technically demanding wireless applications. Our R&D investment in 5G scanning receiver technology, which started almost 2 years ago, has positioned PCTEL as a leader in testing 5G networks.

Scanning receiver revenues in the second quarter benefited from continued demand for our 5G products. More than 50% of our scanning receiver revenue was from 5G sales for new units and upgrades. We hold a dominant position in the U.S. and believe the pending merger between T-Mobile and Sprint will accelerate their 5G rollout and increase the demand for our test and measurement tools. The new DISH 5G network will also provide additional opportunities.

We expanded our 5G scanning receiver portfolio in the second quarter by adding full 5G support to our MXflex. The MXflex is the fastest 5G scanning receiver on the market, the only scanner that supports 4x4 MIMO in 1 unit and the only scanner that measures 4G and 5G networks concurrently. In addition to purchasing new MXflex scanning receivers, customers have the option to purchase an upgrade for their existing units to add 5G measurements. Upgrading units reduces the cost to support testing 5G and it provides a higher margin revenue stream for PCTEL.

Public safety has always been an important market for PCTEL. The demand for our public safety antennas remains robust, and we continue to make progress in providing public safety testing solutions for first responders. The latest version of our in-building testing solution includes expanded capabilities to test P25 and LTE FirstNet networks to include signal quality measurements. We are pleased that a major public safety radio system provider has agreed to feature our public safety solutions in their product catalog which is distributed to our nationwide dealer network. We believe this is a growing market for performance-critical antennas and scanning receivers and that we have the best solution to verify in-building communications for first responders.

Intelligent Transportation Systems, enabled by multiple wireless technologies, require precision RF engineering to provide gain and to limit interference in hostile RF environments. Our customized antenna systems will be deployed at approximately 15,000 traffic intersections in New York City, where urban canyons and reflecting signals can create a challenging RF environment.

This opportunity accounted for a significant portion of our incoming antenna orders in the second quarter. Antenna deliveries for this order will begin in the third quarter and continue into 2020, which gives us some visibility of antenna revenue going forward.

RF performance is important and, in many cases, custom mechanical engineering is just as important to meet form and fit requirements for demanding physical environments, such as for aircraft. We recently received an antenna order for specialized GPS antennas to be used for tracking in commercial aviation as well as for military aerial vehicles and helicopters.

With respect to the second quarter revenue, antenna revenue for industrial fleets, and specifically rail and precision agriculture, remained strong. The industrial IoT market for antennas, radio devices and systems is the largest long-term opportunity for PCTEL. Our products are used today in systems to provide wireless Internet access for utility smart grids, sensor networks and asset tracking. We won a significant order in the second quarter to support a new sensor that monitors high power lines. This is significant because PCTEL designed and will manufacture the entire IoT sensor device, not just the antenna. We expect to launch additional industrial IoT radio products in the second half of 2019.

These product releases will be another step toward our long-term goal of becoming a leading original design manufacturer, or ODM, of customized industrial IoT devices that include radio, antennas and supporting systems.

I'd like to spend a few moments to talk about China. We continue to support our customers in China and deliver products within the constraints of the executive order issued by the U.S. government. I note, however, that 75% of our second quarter revenue was generated in the United States, up from 67% for the second quarter of 2018, and we expect this trend to continue. Although our customer base is mainly in the U.S., China remains attractive for manufacturing our antenna products. We are in the process of transitioning a substantial portion of our manufacturing activities in China to contract manufacturers in order to increase flexibility and reduce geopolitical exposure. This transition is expected to be substantially complete in late 2020 and result in an estimated 35% reduction in the company's entire workforce.

Looking forward, I'm pleased with the increased rate and size of incoming orders driven by our high-quality engineered products and improved sales and marketing efforts to win business. Based on incoming orders in the second quarter and the global demand for 5G test and measurement tools, we believe the momentum will continue through 2019. As a reminder, incoming orders for antenna products provides some visibility for future quarters for larger projects. The scanning receiver business revenue cycle is normally much shorter so entering the third quarter with scanner backlog is significant.

This is our third quarter with improved sequential results, and I'm confident that we have the people and processes in place to drive consistent growth to increase shareholder value.

With that, I will now turn the call over to Kevin for a closer look at our second quarter. Kevin?

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Kevin J. McGowan, PCTEL, Inc. - VP & CFO [4]

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Thank you, David. I will address the financial results for the second quarter ended June 2019, and I will provide third quarter 2019 guidance.

Revenues were $23.5 million in the second quarter, up 9% compared to the second quarter of 2018. Similar to the first quarter of 2019, higher test and measurement revenues offset lower antenna product revenues in the second quarter compared to last year. Test and measurement revenues were $7.5 million in the second quarter, the second highest revenue quarter ever for this product line. As David mentioned, scanning receivers for 5G continue to drive the top line as revenues for test and measurement products were 82% higher in the second quarter of 2019 compared to the second quarter of 2018 and were 36% higher sequentially. Antenna product revenues were $16 million in the second quarter of 2019, 8% lower compared to the second quarter of 2018, but 6% higher sequentially.

Second quarter revenues were higher for antennas for public safety and fleet applications but declined compared to last year due to lower revenues for small cell antennas and because we completed a large nonrecurring enterprise WiFi project in the second quarter of 2018.

The second quarter 2019 gross profit margin improved by 9.4% to 45.5% due to the favorable product line mix of test and measurement products and improved antenna gross margin percentage. The gross margin percentage for antenna products was 6% better in the second quarter of 2019 compared to the prior year primarily due to a more profitable mix within the product line and also because of the cost reduction actions taken in 2018.

Adjusted EBITDA and non-GAAP earnings per share improved both sequentially and compared to last year primarily because of higher revenues and gross margins. Adjusted EBITDA margin as a percentage of revenue was 13% in the second quarter compared to 2% for the second quarter of 2018 and 7% in the first quarter of 2019. Non-GAAP diluted earnings per share improved to $0.13 in the second quarter compared to breakeven in the second quarter of 2018 and $0.04 in the first quarter of 2019.

Cash and investments increased by $1.7 million to $36.8 million at the end of the second quarter of 2019, as free cash flow was $2.9 million during the second quarter of 2019.

Now let's turn to the third quarter 2019 guidance. We expect third quarter revenues will be between $23 million and $24 million, with higher sequential antenna product revenues. Gross margin percentage is projected to be in the range of 45% to 46%, and the non-GAAP earnings per share is projected to be in the range of $0.12 to $0.13.

Before we take questions, I would like to turn the call over to David to make a few closing remarks.

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David A. Neumann, PCTEL, Inc. - CEO & Director [5]

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Thank you, Kevin. We're pleased with our performance in the first half of 2019. We're seeing the benefits of the actions that we took in 2018 to reduce costs, realign talent and maintain a healthy R&D investment. Most importantly, I'm proud of our team for driving the necessary changes, executing on a daily basis and the success they have had in developing new products and winning business for both 5G scanning and industrial IoT opportunities. We look forward to meeting with investors at 2 conferences in August. Kevin and I will be attending the Intellisight investment conference in Minneapolis on August 14 and the Midwest IDEAS investor conference in Chicago on August 28.

With that, Kevin and I are available to answer questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jaeson Schmidt from Lake Street.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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Just curious if you could comment on the traction and momentum you're seeing in the enterprise Wi-Fi market.

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David A. Neumann, PCTEL, Inc. - CEO & Director [3]

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Enterprise WiFi hasn't been a strong revenue generator recently. We have had -- we have several antenna designs that are in work now. So we're anticipating some more opportunities, but it hasn't been a huge generator to this point.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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Okay. And then can you remind us, sort of, the cadence of the ramp, in this case, 5G, but what you saw in 4G from the scanning and the receiver business, should we expect the -- these continue -- continued elevated levels through the first half of 2020?

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David A. Neumann, PCTEL, Inc. - CEO & Director [5]

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Yes, that's a good question, Jaeson. So we've been through a number of these cycles already, 2G, 3G, 4G and now 5G. And typically, a new technology ramp is 8 to 10 years. But within that time, there's initial deployments. And then it tends to level off. So historically, using 4G as an example, we've seen the scanning receiver revenue around the $25 million mark. And then once you're through that peak, it goes back to what sometimes we refer to as a maintenance mode in the 20 -- $18 million to $20 million range. I think there's a couple of differences with 5G. And to some extent, we're going to have to see how this plays out. But one driver, I think we have in 5G that we haven't had in the past is 5G is linked pretty closely with the industrial IoT applications. And as companies can find ways to link items, link things to increase efficiencies, they are going -- there's going to be more of a drive and a need for capacity. So early on, I think if you read some of the reports across the industry, the 5G rollout's been a bit more aggressive than anyone's anticipated.

So we've enjoyed providing a test and measurement equipment for that, it's been very strong. It's also helped that we were probably about 6 months ahead of the competition for 5G product so we've been able to capture a significant portion of the market. Now one of the questions that we get is, is this a bump or is this a ramp? And I don't think we're at the peak of deployments just by looking at the number of markets that are deployed thus far. So in the short term, I think it's really a capacity issue where the operators want to deploy 5G to increase capacity and sort of hotspots. Keep in mind, with 5G, there's still additional features that aren't rolled out yet. So you have a low latency capabilities that aren't rolled out. And then you also have the massive machine-type communications, which are in later releases as well.

So I -- my personal opinion is that this is a ramp. We feel that, at least going into 2020 and through most of 2020, there's going to be a need for test and measurement equipment to test the capacity portion. And then once 5G starts to support more of the industrial IoT applications, it will be a good opportunity for test and measurement equipment. But then it's also going to be a good opportunity for the antennas and industrial IoT devices that will start to roll out later this year.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Okay. That's helpful. And finally, just given those comments, should we expect gross margin to remain in this mid-40% range, just given the mix?

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David A. Neumann, PCTEL, Inc. - CEO & Director [7]

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We do it. Obviously, what we guided in Q3 and for the remainder of the year, we're seeing that same kind of consistent mix. But we haven't really provided any guidance beyond that.

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Operator [8]

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Our next question comes from the line of [David Gray] from Henry Investment.

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Unidentified Analyst, [9]

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Where are you moving your China manufacturing to geographically?

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David A. Neumann, PCTEL, Inc. - CEO & Director [10]

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So we started this process in China almost a year ago. And it's not that we're moving the entire China manufacturing to one location, in fact, we do intend to keep a core group of manufacturing still at the PCTEL facility for the higher-margin, lower-runner antennas. For the high-runner products we've selected a few, we're evaluating others but most likely, we'll go to a group of contract manufacturers with the right specialty, depending on the antenna. As an example, if you're producing embedded antennas, the amount of capital you need to invest in that type of a factory is much different from doing public safety antennas. So it's not that we're moving all the manufacturing out of our factory to one CM, it will be a mix of a PCTEL factory plus several CMs.

The CMs that we're evaluating are in China and also out of China.

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Unidentified Analyst, [11]

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Right. Is out of China, Asia? North America?

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David A. Neumann, PCTEL, Inc. - CEO & Director [12]

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I think it's early to really make comments on that, but just along those lines. Keep in mind that most of the supply chain for technology is coming out of Asia so it does make sense to keep manufacturing close to the supply chain.

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Unidentified Analyst, [13]

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Okay. And can you give some commentary around why general and administrative expense is up?

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Kevin J. McGowan, PCTEL, Inc. - VP & CFO [14]

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Sequentially, because of the CSD revenues and EBITDA that we've enjoyed from the test and measurement business. We have increased some of our variable compensation during the year.

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Unidentified Analyst, [15]

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So it's mostly related to compensation?

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Kevin J. McGowan, PCTEL, Inc. - VP & CFO [16]

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Correct.

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Operator [17]

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Our next question comes from the line of Marc Wiesenberger from B. Riley.

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [18]

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I'm wondering if you could comment a little bit more on the win for your IoT related to monitoring power lines and maybe how your redefined business development team played a factor in that win? And then a clarification on the cadence of those revenues.

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David A. Neumann, PCTEL, Inc. - CEO & Director [19]

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Yes. So for the industrial IoT win, this is related to smart grid utilities. And I think what's important to note too is that this is the second system we did for the same customer. So the first system that we worked on was specifically just for the antenna. Because of the success of the relationship, I would say a mix of business development efforts but also a lot of work from our product line management team and engineering to develop the prototypes. We were asked to bid on this next type of sensor, and this one included antenna and other devices, including infrared support and LEDs to monitor the units.

We -- I think we were -- we came in with a very good position because, one, we had the RF expertise so we were able to develop the antenna elements. But just as important for this specific opportunity, there was a unique configuration, which we really can't go into a lot of detail, but there were additional challenges on the mechanical engineering side, which our team did a great job of solving those issues. And as a result, we won the order, gives us all the more visibility because it's not going to be delivered all in 1 quarter. And most importantly, it keeps us -- gives us good -- a good win in the industrial IoT space.

And I'm sorry, Marc, what was the second part of your question?

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [20]

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Just the cadence of those revenues we should expect?

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David A. Neumann, PCTEL, Inc. - CEO & Director [21]

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So industrial IoT is definitely important, and we're putting a lot of our focus. The antenna business, we have some good opportunities. We have the one in New York. We've developed other solutions that are in the markets. I think where this really becomes interesting is when we start to release our new radio products, which will be in the second half of this year because then we can address opportunities where we're not only supplying the antenna or the mechanicals but we also can provide a radio solution, whether that be a transmission device to monitor IoT sensors or the actual RF components that go into the devices that have the sensors.

So long term, this is definitely a focus. I'd like to see that revenue component grow as a portion of overall revenue. And it's definitely -- industrial IoT is definitely the largest market segment in terms of opportunities, and we'll continue to focus on those.

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [22]

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That's great. Just a follow-up on that specific one. You mentioned that you'll be manufacturing the entire product line. Since you're going to be realigning some of your manufacturing facilities, do you anticipate that causing any delays with this product release at all or you're comfortable that -- with everything there?

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David A. Neumann, PCTEL, Inc. - CEO & Director [23]

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No. And we don't anticipate any delays. If you look at the transition for some of the manufacturing, this isn't something that you do overnight. It's -- there's a lot of planning that goes into this. And this is why we think it's going to go through 2020. And we'll make the decisions to transition products once the CM's chosen, once the CM is ready. In a lot of cases, we need approval from -- in almost all cases, we need approval from the end customer to make those changes. So it's a very controlled and methodical approach to the transition. So we're not anticipating any product issues or delivery issues for that product or for any of the other products as well.

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Kevin J. McGowan, PCTEL, Inc. - VP & CFO [24]

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And Marc, since we already do have relationships with some of our contract manufacturers that we're going to increase business and transfer business to, that will also help with the transition.

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [25]

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Understood. Additionally, are you seeing any changes in some of the competitive dynamics when you're going after the Tier 1 OEMs?

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David A. Neumann, PCTEL, Inc. - CEO & Director [26]

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For the test and measurement business? What business are you talking about?

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [27]

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Maybe some of the Wi-Fi access points.

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David A. Neumann, PCTEL, Inc. - CEO & Director [28]

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There's always -- I mean, there's a set of competitors that doesn't -- they don't change a lot. And sometimes bid to bid, one company will win, the next company wins the next one, then it comes back and forth. So like, I don't know if the landscape has changed. I think it's the same group and it's really up to us to win the deals.

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [29]

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Okay. And based on your significant win in New York to connect all the traffic signals, has that helped spur maybe some additional demand from other cities?

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David A. Neumann, PCTEL, Inc. - CEO & Director [30]

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That's the hope. So yes, we're working with a couple vendors that want to replicate this system in other cities in the U.S. The antenna is not easy to copy. We don't want to get -- be overconfident, but we put a lot of work into this antenna system and the 2 vendors that are trying to replicate this both decided to use PCTEL antennas. So we're -- and we're fully supporting that.

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Marc Wiesenberger, B. Riley FBR, Inc., Research Division - Associate [31]

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Very good. Some of your competitors have talked about their -- some of their larger customers may be pushing out the timing of some of their product -- projects, maybe based on either internal or macro factors. Are you seeing anything across some of your larger customers?

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David A. Neumann, PCTEL, Inc. - CEO & Director [32]

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Not that I'm aware of, no.

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Operator [33]

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(Operator Instructions) The next question comes from the line of Tim O'Connell, Chain of Lakes Investment.

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Tim O'Connell, [34]

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Congratulations on the good quarter. First comment or question is around the small cell antennas and what your business looks like there and maybe positioning?

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David A. Neumann, PCTEL, Inc. - CEO & Director [35]

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Yes. So small cell, I think everyone knows, our largest customers in China definitely have some challenges with the geopolitical situation. We're still supporting that customer per the terms of the executive order. Still and important customer, we're doing everything that we can. One of the challenges that we have there with that specific small cell opportunity is even though we can provide the antennas, the antenna is only one component of a larger system. So there has been a bit of a slowdown because our customer can't necessarily get all the components that they need. So that's definitely a factor.

Now we also supply small cells to some of the other large OEMs. That business -- the small cell business typically goes through a cycle with new designs. So we continue to bid on those designs and win some of those designs. And this is one area where we've really asked our new business development team that we put together last year to focus on some of the other large OEMs for small cells. So we know that's going to take some time to really -- to get in, get qualified and have an opportunity to bid on that business. But the small cell market is not going away, especially for the 4G networks. Some on the 5G side, some of it -- especially with millimeter wave. It's a little bit different approach than a small cell antenna. But small cells are important. We continue to work in that area. But given that -- one of our largest customers there is based in China, it's been a challenge recently.

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Tim O'Connell, [36]

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Okay. That's helpful. And then just in terms of the balance sheet, any comments there in terms of creating some shareholder value? I know you referenced in the last call in response to a question that you've -- you're looking at that?

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David A. Neumann, PCTEL, Inc. - CEO & Director [37]

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Yes. So we continue to look at it. And I think we've talked about this before, our Board looks at capital allocation at every Board meeting. We've just had a Board meeting yesterday. So we went through the process again, looking at ways to best use our cash. And we've talked about this in other calls, in other investor conferences. We believe that there are opportunities to do acquisitions that would help us grow the business, especially in the industrial IoT space and then also in distribution in Europe. There's no reason -- the antennas that we manufacture here, in most of our business in the U.S., a lot of those antennas can be sold in Europe if you have the right distribution channels. So we're looking at opportunities to expand in Europe through an acquisition, looking at ways to expand our antenna portfolio through acquisitions in industrial IoT.

So we have an active campaign. We looked at -- we look at companies all the time. So that's definitely on the radar. We talked about stock buybacks and dividends at the Board meeting as well. It's really up to the Board to make those calls but there are active discussions, and we've made the commitment that we would share publicly what our capital allocation plan is this year. So we had additional discussions yesterday, and we will share that before the end of the year.

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Operator [38]

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There are no questions at this time. I would now like to turn the call back to Kevin McGowan.

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Kevin J. McGowan, PCTEL, Inc. - VP & CFO [39]

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Thank you. We're pleased with the results to date in 2019, and we look forward to finishing the second half just as strong. It's really a pleasure to see the team win with best-in-class antennas, scanning receiver products. I'd like to thank the entire PCTEL team for their dedication and hard work. And I've said before that we're in the right markets. We're developing the right products. It comes down to execution, and I'm pleased to see that the hard work is paying off for all stakeholders. So with that, I'd like to thank everyone, and have a great afternoon.

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Operator [40]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.