Aviat Networks Inc (AVNW) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stratex Networks third quarter fiscal year 2005 financial results conference call. [Operator Instructions]. I would now like to turn the conference over to Mary McGowan of the Summit IR Group. Miss McGowan, you may begin.

Thank you for joining Stratex Networks today to discuss financial results for the third quarter of fiscal 2005. Chuck Kissner, Chairman and Chief Executive Officer and Carl Thomsen Senior Vice President and Chief Financial Officer will review the results for the most recent quarter and our current business outlook.

During this conference call, we may make forward-looking statements regarding our business in the wireless industry in general, including statements relating to our market share, future revenues, margins, operating expenses and net income or loss. Balance sheet improvements, DSOs, and inventory turns, backlog, foreign taxes, anticipated introduction, performance, market acceptance and financial impact of new products, in particular the Eclipse product, break even and profitably and future results of operations and cash usage.

It is important to note that these forward-moving statements are subject to risks and uncertainties that could cause actual results to differ materially from those results stated in such forward-looking statements. These risks include the risk of increased competition, continuation or further tightening of global capital markets for telecommunications and mobile cellular projects, and economic and political instability in the Middle East and other markets in which we compete or in which our products are manufactured.

For a further discussion of these risks, as well as risks relating to our business in general, we refer you to the disclosures under heading factors that may affect future financial results in Form 10-Q to the period ending September 30, 2004 on file with the Securities and Exchange Commission. The press release will be furnished to the SEC as part of the Form 8-K. We will this information in a webcast replay of this presentation available on our Company's investor website.

In addition, please note that the date of this conference call is January 27, 2005 and any forward-looking statements that we may make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to upstate these statements as a result of future events. Lastly, this conference call is the property of Stratex Networks, Inc. and any recording, reproduction or rebroadcast of this conference call without the express written permission of Stratex Networks is strictly prohibited. I would now like to now turn the call over to Carl Thomsen.

Thank you Mary and good afternoon to those of you listening on this call. First I would like to provide a summary of our quarterly results for those who may not have had a chance to read our press release.

Fiscal year 2005 third quarter revenue was $49.5 million, so 14% increase over the prior quarter and a 23% increase over the same quarter of last fiscal year. As we announced in December, during the third fiscal quarter we implemented a major cost reduction and reorganization. These actions were a result in a reduction of approximately 25% of our worldwide employees, the outsourcing of manufacturing at our New Zealand and Cape Town locations, closure of our Cape Town operations and a reductions of engineering associated with Legacy products as we focus our efforts on the new Eclipse product line.

Engineering for the Eclipse product line will continuing to be performed in New Zealand and San Jose, California. As a result of these reductions and reorganization changes, we recorded a special charge for inventory write-downs of $2.6 million in charges for severance, lease obligations, fixed asset write-offs and related costs of $7.4 million. Including these charges, our loss according to generally accepted accounting principles was $17.9 million, or $0.19 a share. Excluding these charges, our loss on a non-GAAP basis is $7.9 million, or $0.8 a share.

Gross margins, excluding the charges noted above, were 20.4%, about one percentage point better than compared to the prior quarter. About what I indicated they would be on last quarter's conference call.

Orders were substantially stronger at $54.4 million, an 18% increase over the 45.9 million that we reported in the prior quarter. Eclipse product line is clearly having a positive impact on sequential orders. As we continue to remind you, orders tend to be lumpy, and this has proved to be true in the third quarter as compared to the second quarter. Backlog at the end of the quarter, $58.8 million. I would now like to review the orders that we received in the quarter in a bit more detail.

By geographic area, orders for the Americas were $11.2 million. For Europe, Middle East and Africa, $30 million and for Asia Pacific, $13.2 million. By product line, Eclipse orders were $22.3 million. The mid capacity XP4 and Velox line were $13.8 million, Altium was $5.6 million, DXR product line was $2.3 million and services were $10.4.

Orders for Eclipse increased 80% to 22.3 million compared to the 12.3 million in the prior quarter and accounted for 51% of product orders during the quarter. It's clear that this product is gaining excellent market acceptance. The new lower-cost version that we plan to begin shipping in the current quarter also allows us to bid on certain low capacity opportunities and be very cost competitive. The order pipeline for Eclipse continues to be very good and gives us confidence that Eclipse orders and revenue will continue to increase. Q3 orders were favorably impacted by a few significant orders in excess of $5 million each.

Revenue side, Eclipse accounted for $12.2 million. The mid capacity products were $20.9 million, Altium is $4.7 million and DXR product line is $4 million. Services totaled $7.7 million.

On a geographic basis, the Americas revenue totaled $8.6 million, Europe, Middle East and Africa was $31.3 million, Asia Pacific was $9.6 million. Eclipse revenue of $12.2 million was an increase of 50% from the prior quarter. Based on orders received during the quarter, the current backlog on our forecast new orders, we fully expect revenue for this product line to continue to accelerate in the fourth quarter. We're continually expanding features available in this product line and the new low capacity lower-cost version expands the market opportunities for this product, which Chuck will discuss in a few minutes.

Gross margins for the third quarter, excluding the special charges, as I mentioned were $20.4%, an improvement compared to the prior quarter as a result of higher proportion of Eclipse revenue. While we encountered continued pricing pressure on the older mid capacity product lines, the increase in Eclipse revenue offset this. The key to continued gross margin improvement is a ramp of Eclipse product line and the introduction of the lower-cost version of Eclipse, which is scheduled to begin shipping during the current quarter.

Now let me discuss operating expenses. R&D expenses increased slightly in the quarter to $4.4 million from $4.2 million in the prior quarter. SG&A and amortization of technology was up $2.1 million compared to the prior quarter. About half of this increase was due to the acceleration of the amortization of technology related to the Plessey acquisition and increased cost related to Sarbanes-Oxley documentation and testing. This impacted results by about $0.01 a share. The balance of the increase was primarily due to higher than normal third-party agent commissions due to the geographic mix of sales. In addition we recorded a restructuring cost related to severance, write up of fixed assets and vacated facility lease cost.

Other income and expense was a net expense of $523,000 in the third quarter, which is in line with the forecast that we provided at the beginning of the quarter. I expect this other expense to be in the range of $500,000 to $600,000 in the fourth quarter as well. Tax expense for the quarter was $119,000, this was again in line with our expectations, and I would expect this will be in the range of $100,000 to $200,000 in the fourth quarter as well, due to foreign taxes that we owe on certain operations.

Net loss for the quarter, excluding the special charges for inventory reserve, severance, facility leases and related charges was $7.8 million, $0.08 a share, which was in line with the guidance of the beginning of the quarter of $0.06 to $0.08 a share loss.

Now let me discuss the balance sheet status. The Company's cash balance at the end of third quarter was $52.3 million. There was a decrease of $10.4 million from the end of the prior quarter. It includes about $800,000 for severance payments that we made in the third quarter related to reduction of staff, as well as $1.5 million reduction in the term loan, as cash used in operation was about $8 million in the quarter.

We'll continue to use cash in the fourth quarter due to the payment of severance cost and the forecast losses. Expect cash usage in the fourth quarter to be in the range of 6 to 8 million of which about $3 million relates to severance and related payments and $1.5 million relates to the quarterly repayment of term loan. Cash usage is expected to decline further in the first quarter of fiscal year 2006, our June quarter, as losses are expected to continue to decline and the remaining severance payments at that point are minimal.

Accounts receivable were $40.9 million, which is a $3.5 million decline from the prior quarter on a higher revenue. DSOs were 74 days in the third quarter compared to the 89 days at the end of the second quarter. As I indicated, the end of the second quarter, receivables in that quarter were negatively impacted. Shipments during the quarter were back-end loaded due to the timing of new orders shippable in the quarter and the timing collections. Due to operational improvements, the third quarter was a more normal quarter, and as a result, DSOs improved significantly. I would also say that the collection organization at Stratex did an excellent job with collections during the holiday period. I expect DSOs in the fourth quarter to remain in the mid 70 day range.

Inventory was $36.3 million at about the same level as the end of the second quarter. However, we did provide inventory reserves related to the manufacturing, outsourcing and reorganization of the field service group. Thus, gross inventory increased about $1.8 million. This is due to the rapid rollout of the Eclipse product line and substantial increase in demand for that product. We don't expect inventory to continue to grow next quarter and turns should improve over the next several quarters.

Total liabilities decreased $700,000 from the second quarter, there was a $7 million decrease in accounts payable and that was partially offset by increases in accrued liabilities related to severance costs and in long-term liabilities related to facility leases.

Now, let me give you an outlook for the fourth quarter. Fourth quarter of fiscal year 2005, which ends in March 31, was a transition quarter with the employee reductions that were initiated in the third quarter, partially impacting Q4, and the initial rollout of the new Eclipse low capacity version. We are encouraged by the strong orders book for the Eclipse product line and the product transition from the older products to Eclipse is moving rapidly at this point. Expect that Eclipse volume will be up again in the fourth quarter. We're forecasting total revenue to be between $46 million and $50 million and the loss per share of $0.04 to $0.06.

Gross margins are expected to continue to improve, increasing 1 to 2 percentage points in the fourth quarter. Operating expenses are expected to decline between $2 million and $3 million from the third quarter and will decline further in the first quarter. We continue to be very optimistic and enthusiastic about the Eclipse product offering and believe that margins and overall financial results will steadily improve as Eclipse continues to phase into full production during the balance of fiscal year 2005 and into 2006. We're focusing our efforts on product cost reductions to address a broader range of applications and continue to review spending levels throughout the company to help ensure and to reach our break-even point as soon as possible.

In summary, our primary objective near term is a successful rollout of the new low-capacity Eclipse, ramping the entire Eclipse product line and the related improvements in gross margin. We'll also focus our attention on the successful implementation of the organizational changes that we announced and the restructuring that just occurred.

I would like now to turn the call over to Chuck Kissner for an operational summary and some comments on the company's plans going forward.

Thanks, Carl. I'll make some points along three areas, progress on Eclipse, some comments on operations and then the outlook as Carl indicated and then we can open it up to questions.

In terms of Eclipse, I think you can see, it continues to gain momentum in Q3 in orders, shipments, product coverage and customer acceptance. We've been saying for a while we were targeting continued increases in revenues and a sharp increase in orders for Q3 as the Eclipse product platform became more fully capable, serving larger portions of our market. Frequency bands and features have been released according to schedule and this is being reflected in the increasing Eclipse traction. Revenue increased 50% sequentially and orders jumped to $22 million, up 80%.

Let me give you a little character on the orders. Eclipse orders were from 46 customers around the world. Five customers ordered $2 million or greater. Of orders overall, 29% were from Europe, Middle East and Africa, 15% from the Americas, and 56% from Asia. A number of major clients moved beyond field testing in the quarter and in their evaluation process and began shifting from our Legacy products to Eclipse. We expect that to accelerate in Q4 and Q1.

Some customer and, or end user examples include Telephonica, TA Orange, France Telecom, Clearwire, Shell Oil, BPL Mobile in India, Lucent, and Polska Telephonia, and Vodacom. We shipped almost 1,000 Eclipse processors in 2003. Processor shipments were up 65%, that's the most rapid ramp of a new product in the entire 20 year history of the company. Yield experience continues to be positive, reliability out of box failures, installation experience all continue to reinforce that we're meeting the design goals of this new approach to doing wireless transmission.

Yield reliability numbers continue to indicate that we're likely to meet or exceed our goal of tripling the reliability or meantime between failure, compared to the point to point microwave radios we traditionally sold.

Last quarter I indicated to you that we introduced new features for Eclipse in the third quarter. We did introduce a significant capability that allows 100 megabit rings to be deployed without the need for expensive SDH or SONET synchronous structures. This was achieved with a new software release that provides performance improvements in what we call our super PDH feature, that's a non SONET method of receiving up to a 128 mega bits per second, and also in switching response time, so we can emulate SONET or SDH switch over when configured in self-healing rings. And that can be all done without a SONET or SDH synchronous structure. This is great fit in the data transmission market, far more cost effective than traditional solutions, as new capability is in service.

Also on the last earnings call, I said we were targeting the introduction of a new radio interface unit or outdoor unit to address the lower speed end of the market that's currently served by our XP4. As you probably know, margins on the XP4 are very poor and declining and the predominant reason for the low overall gross margins for the company. I'm very happy to report that this new major hardware development has been proceeding very well. Pilot production began in December and we've scheduled customer deliveries for the current March quarter. The first few frequency bands we'll ship this quarter with subsequent bands shipping over the next few quarters in order of customer priority. We're very excited about this new configuration since it better addresses a large portion of today's market.

The current Eclipse radio units, outdoor units work fine at lower speeds but these new versions we are introducing have more attractive pricing for installations that won't need to grow capacity to the higher end, while at the same time delivering significantly better financial performance to us. These new outdoor units are software upgradeable, just like the current versions but will not upgrade to as high a speed. Product margins right now on Eclipse are in the mid 30's. They're expected to grow as this new hardware ramps up.

Our data transmission features of Eclipse continue to build traction. Year to date our data network transmission business is up about 100% compared to the end of the last year. This is basically due to Eclipse and its pull-through of other products.

Overall, we're extremely pleased with Eclipse. As Carl indicated we reached a milestone with Eclipse, now representing 50% of product orders for the first time ever. It's moving into the mainstream of our product mix now about when we anticipated it would.

Now, some comment on operations. In the second quarter, the quarter before the one we're reporting, we had certain operation issues that you may recall caused a totally unacceptable use of cash. This was mostly due to our transition to a drop-ship model, which caused logistical problems and resultant increases in our DSOs. I'm happy to report on this one, that our people addressed this very early in the third quarter and resolved many of the issues. On the last earnings call, I said we were confident we would correct this, and the DSOs would come down in Q3 and the fourth quarter. I'm pleased to tell you, we resolved most of our logistical problems, delivered the customer satisfaction that we are known for, collected on receivables and saw DSOs come down.

Our cash usage was down significantly. As Carl mentioned, cash usage from operations was $8 million, plus one time cash of almost $1 million for our restructuring, plus payments of $1.5 million on our term debt. When we look at the usage for Q3 and beyond we belief cash usage will continue to decline significantly. The restructure that we announced in our December quarter was obviously significant, but it was very necessary, given the softness in volume and pricing in our Legacy products. We accelerated the reduction of resources associated with our older product lines and restructured our sales effort in regions of the world where profitable sales were unlikely. We remain totally committed to returning to profitability soon and generating cash from operations. Our team clearly understands this.

Looking forward operationally, we are serving a growing customer base. Our $58.8 million in backlog that's mentioned in the press release represents now over 170 customers. This is a larger number than in recent history. To give you an idea of how our products are being used, about 60% are carrier and mobile back haul. About 40% are from data transmission, private networks and broadband wireless access back haul. This implies a significant shift from our traditionally 70% or 80% or greater mobile business. And that's happening fairly quickly.

As you can see, we've continued to make progress in general doing what we said we would do. Our competition does remain very tough in this market, but our competitive position continues to improve in Eclipse and the low-cost, low-end version I mentioned earlier is absolutely critical in this market, and we have high confidence that we'll be shipping it in volume this quarter.

Our penetration of the new market, the data transmission market is particularly encouraging. We expect most of the growth in this fiscal year will come from this new market and almost exclusively due to Eclipse. We plan to continue to increase our emphasis in this business in the coming fiscal year. I believe we'll see even more pressure on our Legacy products. So our next task will be to accelerate the conversion of our existing clients to Eclipse. This will provide them with a more coast effective state-of-the-art wireless platform and will allow our gross margin expansion to accelerate going into fiscal year 2006.

Our progress here is encouraging, as you can see, by the increase in Eclipse orders. One thing I'd like to say that our employees have worked very hard to make this major product transition possible and it's showing good signs of success now. We obviously would have preferred to avoid the forced reductions that we've implemented, but we, all as employees, are committed to a profitable business.

All in all, things seem to be coming together about as we had planned. When we started this transformation a couple of years ago, we didn't anticipate the average selling prices dropping as much as they have, but Eclipse has shown it has a power to do well in this very competitive environment. We hope you're as encouraged as we are. That concludes Carl and my formal remarks.

Operator, we're now ready to take questions.

[Operator Instructions]. First question comes from Kevin Dede with Merriman. Please, go ahead.

Hey guys. Carl, could you just give me an indication on where you say your Sarbanes-Oxley costs are going to go and what we should expect to see happen there? I mean, I know you said SG&A down about $2 million, right?

Total operating expenses. That includes R&D.

Okay. And can you give us a breakdown on the orders themselves, Chuck? What was low capacity versus high-capacity of the $22 million in Eclipse?

We don't break it down that way. Because, as you know, Eclipse can be upgraded in the field though software. We don't break it -- we were able to break orders down that way before because we had products that fit in the low and high capacity.

Right. I guess what I'm wondering is, how much of those orders were for the new product? Or are you not taking them yet?

No, we've booked orders for the new product. I don't know the answer to that. Because we don't show the bookings that way. We can do some research. We don't have it available here.

Okay. Thanks very much.

Thank you, sir. Next question comes from Matt Robison with Ferris, Baker, Watts. Please go ahead.

Thanks. You reported a flat inventory position. What percentage of the inventory is actually related to Eclipse?

We haven't broken out our inventory by product line in the past and I don't think we're going to do that. But the increase definitely is due to the Eclipse piece.

You did report some -- it seems at least some write-offs due to inventory on the other Legacy offerings. So I was just curious if you had any idea of what amount of that might we expect in the future.

Those write-offs were due to the outsourcing of our manufacturing. So the outsourcing of manufacturing. there were some parts that weren't usable by our outsourced new company. So they are lower level assemblies and so forth that are difficult to incorporate. Because some changes in the field organization that the field inventory as well are difficult to recover the value for.

I see. Okay. On just one other note, given the strong relative product portfolios of your competitors. How do you really anticipate combating the pricing and margin pressure on the Eclipse product?

Well, that's why we're introducing -- first of all, the cost profile on this product in general -- is dramatically lower than the Legacy products in general. At the lower end of the market where the pricing is particularly competitive, the cost of goods on those low-end -- the outdoor unit we're reintroducing in the third quarter is dramatically lower than what the prior Eclipse low-end would be configured to. So we believe that we're going to have an extremely competitive cost structure on this product. In addition to that, because of the architecture of Eclipse, it's not really just a point to point radio. The way it can be configured in a network also brings its own efficiencies in terms of cost. So far, less equipment has to be deployed in order to provide actually greater functionality. So that represents, I think, incremental values to customers and that's been proven where Eclipse has been evaluated.

Okay. Do you anticipate that the R&D level would stay pretty constant or down in the future as a result of the single platform?

Yes. It's dramatically more efficient. And also it reflects on our -- it will reflect on our inventory returns going forward as Eclipse becomes a dominant piece of revenue. Also the simplicity of managing the supply chain.

Okay, thanks a lot.

Thank you. Our next question comes from Rich Valera with Needham & Company. Please, go ahead.

This is actually Andrew Spinola (ph) calling in for Rich. One question I had was, if you could give us any color around the decline in accounts payable in the third quarter. Anything specific that caused that?

No, nothing specific that caused that. That relates to the timing of receipts of inventory from suppliers and making sure we're keeping our supplier accounts current and so forth. We expected them to decline in the quarter, but we ended up paying down a little bit more than we thought we would.

The best way I would answer is that the quarter prior to that they were too high.

Okay.

We were correcting some issues that we had from the quarter before.

My other question is probably just longer term on gross margins to what you could say. In the second quarter, it actually jumped, I think, 4.3% gross margins. It was more like 1% this quarter. Was there a step down in the gross margins in the XP4 that would hopefully flatten out going forward? Or do you think over the next few quarters it's going to be a big ramp that should help the margins in the lower cost Eclipse product?

I think we would say the general trend of XP4 is, it has been coming down and will continue to come down on gross margins. So as long as it's in the mix, it's going to affect it in a negative way. Let's say in general the legacy products are that way. So that works against us. What works for us obviously is Eclipse, it has much stronger margins. When we introduce new hardware versions of Eclipse, if they're major, then there are start-up costs associated with that. So the equation gets somewhat complex.

I see.

But in general, what we have said is, our target blending gross margins are in the mid to high 30's with a high percentage mix in the 70% or 80% Eclipse. That still looks like that will be achievable.

Okay. Probably sometime in the next fiscal year?

We haven't set a time for that. We have given some parameters around the financial model in terms of the top line and what the mix would be. It's also a part of the transition to -- into some of the other markets that we are in like data gives us a higher yields on margin than the back haul market, for example.

Okay. Thanks a lot.

Thank you.[Operator Instructions]. And our next question is a follow-up question from Matt Robison. Please go ahead.

Yes. In the past, you've said that your break-even was about $55 to $60 million is that holding or do you believe that's coming down as a result of these cost reductions?

We actually -- we brought it down -- it will be coming down as a result of these reductions that we did.

Okay.

There's always an assumption, we've been saying it's $50 to $55 now. But there's also an assumption in there that there's a fairly high percentage of Eclipse sales in there. So at this kind of a mix where we had $12 million in Eclipse in sales on a $50 million number, we wouldn't call $50 million a break even point. But in a normalized situation as Eclipse picks up, we now believe it's $50 to $55.

Great, thank you.

Thank you. And at this time, I show no further questions. I would like to turn the conference back over to Chuck Kissner for any further comments.

Thank you, Operator. And thank all of you for your questions and continuing interest in Stratex Networks. We look forward to talking with you again when we report our fourth quarter and our full year financial results in early May. Thank you very much.

Thank you. Ladies and gentlemen, this concludes the Stratex Network's third quarter fiscal 2005 financial results conference call. If you'd like to listen to the replay of today's conference, please dial 303-590-3000 and you will need to enter the access code of 11021239 followed by the pound sign. Once again thank you for participating in today's conference. At this time you may now disconnect.