Q2 2023 RF Industries Ltd Earnings Call
Participants
Peter Yin; Treasurer, CFO & Corporate Secretary; RF Industries, Ltd.
Robert D. Dawson; President, CEO & Director; RF Industries, Ltd.
Michael Joshua Nichols; Senior Analyst of Discovery Group; B. Riley Securities, Inc., Research Division
Jack W. Drapacz; SVP; Financial Profiles, Inc.
Presentation
Operator
Good day, everyone, and welcome to the RF Industries Second Quarter Fiscal 2023 Financial Results Conference Call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Jack Drapacz. Sir, the floor is yours.
Jack W. Drapacz
Thank you, operator. Good afternoon, and welcome to RF Industries Second Quarter Fiscal 2023 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 second quarter fiscal 2023 financial results. That results -- excuse me, 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 the 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 of 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 and 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 2 for the periods reported in the earnings release.
With that said, I will now turn the conference call over to Rob Dawson, President and Chief Executive Officer.
Robert D. Dawson
Thank you, Jack. Good afternoon, everyone. Thanks for joining our second quarter fiscal 2023 conference call. We had a solid quarter and delivered net sales of $22.3 million, a 3.7% increase against a strong Q2 last year. As anticipated, we shipped several customer orders that were delayed in the first quarter and our Optiflex hybrid fiber cable and interconnect products performed well.
I think our Q2 results show what's possible in our business even with a challenging backdrop. Over the last few years, we have achieved significant growth yet there's always some volatility quarter-to-quarter, which makes it difficult to take a snapshot every 90 days for a company our size, especially in a market like this. Our growth trend hasn't been a perfect (inaudible) up into the right chart every year. But directionally, we're doing the right things, and our #1 focus right now is getting back to higher profitability.
While we had a nice second quarter, the overall environment in the wireless carrier market hasn't really changed since our last call when we discussed a spending pause in wireless carrier CapEx and project delays. While our core interconnect offer, including custom cabling is performing well, DAC in small cell, our higher-margin and future growth drivers are being impacted by the sluggish CapEx spending as pressuring the consolidated gross margins and EBITDA in the short term. We expect a few more quarters of slower project spending and the related delays, but are optimistic that carriers will resume their build-outs, and we stand to benefit from that with our differentiated new higher-value solutions. Having navigated through several wireless spending cycles, we know how this works, and slow spots like this are normal.
We also know how to prepare for an upturn and feel strongly that the investments we made in our business will kick into gear when carriers refocus their attention on the 4G and 5G builds. Additionally, many of our products have applications beyond wireless. And we're thinking strategically about diversifying into other industries where we have a smaller presence that could grow much larger over time, including wireline, utilities, transportation and aerospace and defense.
Let me just say we're executing well and showing progress on what's in our control. In the second quarter, we continued to make progress on our strategic transformation of RF Industries. One key element imprinting a growth mindset throughout the company is redefining our value proposition in the market. To that end, we launched a rebranding initiative to better connect RF's well-established reputation to the current market. After 45 years in operation, we now have a new logo and fresh brand identity that embraces both our history and the significant evolution of the company and our product offerings. This was unveiled in early May at the Connectivity Expo event. And when fully completed by year-end, we'll have a new corporate image, redesign of the website and a new investor presentation. This rebranding reflects our strategy to target both current and new markets with a more cohesive corporate identity that connects our powerful product portfolio to our roots.
On our last call, I touched on our 2023 strategic plan to reduce operating expenses by consolidating and streamlining operations. I'm pleased to report that we're making solid progress. Last quarter, we moved our coaxial cable operation to our new San Diego facility with no production downtime. And this week, we're adding our faster and fiber optic lines to that same facility.
In July, we're consolidating some of our East Coast operations, which includes moving the Microlab production operations and then combining our small cell and DAC product lines later this summer. Moving production lines of the heavy lift. But so far, everything has gone smoothly without any disruption to our customers. The money that we're investing in consolidations will lead to significant efficiency gains and ultimately, cost savings. We expect these moving expenses will be largely behind us at the end of our third quarter.
At the same time, as I mentioned previously, we've been investing in product development, primarily within our Integrated Systems product offering. This spending has resulted in some higher operating expenses, which in turn has created a short-term drag on earnings until sales from these product lines ramp up as we expect in coming quarters. This important development cycle that keeps us competitive in the market is largely completed. As we strip out these costs and look to increase sales, we expect to be a much more profitable business in future quarters, So it's difficult to give specific timing in the short term.
Now let's take a few minutes to expand a bit on the current operating environment. We believe we'll see a few more quarters of the capital expenditure downturn among wireless carriers for the reasons I discussed earlier. Based on our experience, these down cycles usually last 3 to 4 quarters. Once capital expenditures pick up, we see significant leverage in our P&L that could have a favorable impact on gross margins either from higher sales or product mix shift or both. Plus, as we reduce expenses, any incremental sales should flow to the bottom line.
To better understand our business, the math is fairly straightforward. If we do $20 million in quarterly sales or 30% gross margin, we would deliver $6 million in gross profit. Our operating expenses have been hovering around $6 million per quarter. So that puts us roughly at GAAP breakeven around the $20 million sales level. Higher or lower sales will obviously change the operating profit number. So as we increase our focus on selling higher-margin products. The mix alone in the quarter can take our profitability up.
Looking at it from the expense side, we anticipate lower operating costs based on our facility consolidations and other initiatives and are also working hard to rationalize our inventory position while being careful to maintain our core business proposition of availability and fast turn. Lower OpEx and inventory would obviously also help us deliver higher profits. So far, fiscal 2023 has served up some new market challenges that are pressuring our top line growth. As I said earlier, based on our experience, we think these are near-term hurdles. Regardless, our focus on improving profitability is our top priority, and we've set a goal of achieving an adjusted EBITDA above 10% of sales through our margin improvement and expense reduction initiatives.
Regarding M&A, as a growth-oriented team, we'll be looking at potential acquisitions to complement our business. Right now, deal flow is relatively slow, but there are opportunities out there and valuations seem to be normalizing. While we continue to focus on organic growth with our existing infrastructure, some specialty sectors like aerospace and defense may require strategic M&A to make an impact. The overall environment remains challenging, but we're not standing still. We see tremendous growth opportunity ahead once the CapEx faucet turns on.
Our core business is strong and sustaining us and we're starting to see some green shoots of interest in our higher-value products and solutions, something that's been lacking over the last few quarters. In fact, some recent orders that we booked early in the third quarter give us more confidence that we're gaining traction with new products as we move through the rest of our fiscal year and into fiscal 2024. We think we're in a great position to generate solid returns for investors over the long term, and we're grateful for the ongoing support of our shareholders.
With that, I'll turn the call over to Peter to discuss our financials.
Peter Yin
Thank you, Rob, and good afternoon, everyone. Before I get into the comparisons, our second quarter of fiscal 2023 includes a full quarter of Microlab results compared to 2 months of Microlab results in the second quarter of fiscal 2022. We acquired Microlab in March of 2022.
As Rob mentioned, we do not really see a change in the wireless carrier market spend since our last call as we continue to see a delay in wireless carrier CapEx. Our offering that was most impacted was our DAC and small cell solutions as we did not receive orders we were expecting and shipments related to existing orders continue to be delayed.
Second quarter revenue was $22.3 million, up 3.7% compared to the same quarter last year. The increase is primarily related to our interconnect products and hybrid fiber cables, offset by a decrease in our small cell products. Second quarter gross profit margin was 27.4% as compared to 28.3% in the same quarter last year. The decrease is primarily related to lower revenue contribution from our small cell solutions, which have a higher margin profile compared to our blended gross margin rate.
Operating income was $489,000 compared to operating income of $746,000 in the second quarter of fiscal 2022, primarily related to lower gross profit contribution from our small cell solutions and therefore, less leverage to cover costs.
Net income was $581,000 for the second quarter or $0.06 per diluted share compared to $503,000 or $0.05 per diluted share in the same period last year. This is primarily due to an income tax benefit of $164,000 compared to an income tax provision of $136,000.
Non-GAAP net income was $1.3 million or $0.13 per diluted share for the second quarter compared to $1.5 million or $0.15 per diluted share for the same period last year. Adjusted EBITDA for the second quarter was $1.4 million compared to $1.9 million in the second quarter of 2022. The decrease is primarily related to product mix, as discussed earlier related to lower sales from our higher-margin products and therefore, less leverage to cover certain fixed costs.
We continue to focus on lowering expenses through consolidation and streamlining our operations and working to reduce ongoing operating expenses. We expect the cost saving benefits from the consolidation of our West Coast headquarters and facilities, which will be completed during our current fiscal third quarter, and the upcoming consolidation of some of our East Coast operations, which we expect to be completed in our fiscal fourth quarter. These related expense reductions will better position us to navigate the challenging economic environment helping to minimize our downside and increase our profitability when our product mix shifts to include a greater portion of high-margin solutions that are project-based and dependent upon carrier CapEx spend.
At the end of the second quarter, our cash and cash equivalents was $4.3 million, working capital of $25.1 million and the full $3 million available under our revolver. Subsequent to quarter end, we drew down our revolver by $1 million to cover leasehold improvements associated with the consolidation efforts mentioned earlier. Inventory was $20.4 million up from $19.1 million last year, primarily due to Microlab, which we have invested an additional $1.5 million since last year. On a sequential basis, we reduced inventory by $550,000 or approximately 3% as we work through some delayed project shipments from the first quarter. Looking ahead, we believe there is opportunity to further reduce and rationalize our inventory, which would help to increase our cash position. We understand this is a lever we can pull to help our liquidity and are actively monitoring our inventory levels such that our value proposition of being available to our customers is not negatively impacted.
Our backlog at the end of the second quarter was $18.9 million on second quarter bookings of $16.7 million. And as of today, our backlog stands at $17.6 million. The decrease in our backlog primarily relates to shipments against our hybrid fiber cables. This concludes my comments.
Operator, we are ready to open the line for questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question is coming from Josh Nichols from B. Riley.
Michael Joshua Nichols
Good to see the 2Q numbers, top and bottom line came in better than expected despite the challenging environment. I know visibility is probably fairly limited given the carrier CapEx slowdown, but any trajectory you could give us overall to what you're seeing in the business for the back half of the fiscal year relative to the first half?
Robert D. Dawson
Yes. Thanks, Josh. Good question. You're right. Visibility is pretty low. We're not alone in that. So it's -- if it's comforting to hear from others, I think it's something we're all kind of seeing and hearing in the space. I think all year, we've been saying we expected the back half of the year to be better than the first. We generally think that's right. I think the one thing that I would say related to our Q2 numbers is they came in a little better than what we had expected originally for the second quarter, largely due to some demand being pulled in on hybrid fiber cables.
So you look at that and how does that impact Q3 and/or Q4. It's not massive, but what numbers our size, it means quarter-to-quarter things can move around. So I think our general expectation is our back half should be better than the front. Putting that into 90-day increments, it Is really difficult to do this in a setting though.
Michael Joshua Nichols
Fair enough. And is it fair to assume that the kind of gross margin profile of the business around this like 27%, 28%. There's opportunity for that to improve incrementally in the back half, I would think if your revenue is going to be a little bit better, but probably still my guess is below the longer-term 30% target? Or what are you thinking?
Robert D. Dawson
Yes. I think it's -- so product mix is a big driver for us now. And that hasn't always been the big piece of our gross margin calculation. But it certainly is now because we have some definite higher value and higher-margin items in our portfolio. So the better those do, that can certainly have a positive impact, taking those margins up. You're probably looking at it right in the short term. And just sub 30% is probably where it makes sense to be. Although we're also taking out some -- expect to be taking out some meaningful expenses. So the timing of that happening over the next couple of quarters if we get that done earlier without impacting the business in a negative way, it could certainly help our gross margins as well. So those are kind of the 2 key pieces of it.
But we also feel like we're sort of at the -- from a CapEx perspective and what's going on, we're kind of at the bottom of the trough here, and we've been bumping along here for a few quarters. Sales still move around from a shipment perspective but from a timing of larger venue-based or project-based kind of opportunities, we still feel like we're kind of sitting here at the bottom and starting to see the light at the end of the tunnel a bit.
Michael Joshua Nichols
And then just on the SG&A front. So you're going to be down with the West Coast integration this quarter, East Coast by the end of this fiscal year. Your SG&A this year was the lowest it's been, right, for a few quarters. What type of impact is that going to have to the second half? Do you expect to remain around these levels or maybe come in a little bit? Or what's the expectation?
Robert D. Dawson
Yes. I think you'll see some onetime charges around some of these initiatives that we talked through to ultimately reduce our expenses. We'll be able to give some -- I think, some better specifics at the end of Q3 around what that means going forward, but we certainly would expect our go-forward OpEx SG&A to -- to come down in a meaningful way. We think it's going to be a real impact here. it's going to be confusing based on the onetime charges here for the next couple of quarters, but we'll give them a clearer sense of what that looks like as we get into our Q3 results.
Michael Joshua Nichols
Great. And then I think you mentioned -- 2 things to hit on, like, one, just like the cash flow. Is it fair to assume that your inventory was down here, you expect that to come down further? Is there any idea for what a normalized inventory level would look like or how long that may take? I'm just trying to think about the cash flow impact from the working capital side from just the operating improvements that you guys have already made?
Robert D. Dawson
Yes, that's fair. So I think we do believe there's room for inventory to come down more. We -- through the consolidation, it becomes really clear where we have duplicate inventory that maybe we didn't recognize before. So that's one focus area. The other is we're finally starting to see a little more normalized supply chain. So for us, sometimes it comes down to timing. There are some items that we ordered several weeks ago that had a 20- or 24-week lead time on them that are going to come in here shortly to address some projects that we have later in the year and early next year. So again, our number is small, so an order of a couple of hundred grand can move our inventory percentage point.
But we believe that as we get through the year, you should our inventory start to come down, whether it happens exactly in Q3 or Q4, it's hard to nail on timing there, but we're very focused on getting our liquidity up through rationalizing that inventory.
Michael Joshua Nichols
And then last question for me. You've talked about the backlog before. It was obviously very elevated with some of these large onetime orders that kind of had been delayed you're starting to see the beginning of a normalization. It looks like this quarter. Any visibility you have into like how much of the current backlog you expect to ship in like the back half of this year? I'm guessing you would expect the backlog to be materially lower from where it is today to more normalized levels unless you got some more large orders from some of the carriers.
Robert D. Dawson
Yes. We're -- And that last point is a big one that 1 or 2 meaningful orders of a few million bucks that are going to be drawn against over time, will artificially elevate that backlog, which we've been seeing. I've said in the past that backlog in the mid-teens is still a spectacular level for us and a huge amount of our day-to-day business really never hits the backlog. It comes in and goes out in a matter of (inaudible) hours, but certainly a matter of a few days. So it's really a snapshot of time.
We do expect it to continue trending down some. I think that's good. We need to work through some of this 15-month-old kind of stuff that's been on the -- from a bookings perspective that came in. It's good to work through that. I think it's helpful to see customers taking some of that inventory. So I would expect it to come down some more this year. The wildcard there being does someone show up in one of these projects and instead of placing it in chunks decide to place a blanket or something larger that could have a material impact to be positive on that too, which could [help].
Operator
(Operator Instructions) Thank you. That concludes our Q&A session. I will now hand the conference back to our host for closing remarks. Please go ahead.
Robert D. Dawson
Thank you, Matthew, and thanks, everyone, for joining our call today. We look forward to sharing our fiscal third quarter results with all of you in September. Have a good day.
Operator
Thank you, everyone. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.
