Aviat Networks Inc (AVNW) 2006 Q3 法說會逐字稿

Welcome to the Stratex Networks fiscal year 2006 financial results conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Carl Thomsen, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you. Thanks to all of you for dialing into our call this afternoon, and joining Stratex as we discuss the financial results for the third quarter of fiscal year 2006. Joining us today will of course, will be Chuck Kissner, our Chairman and Chief Executive Officer, who will review results of the most recent quarter and our business outlook followed by q and a.

During the conference call we may make forward looking statements regarding our business on the wireless industry in general, including statements related to our market share, future revenues, margins, operating expenses and, net income. Balance sheet improvements DSO, inventory turns, back log, our foreign tax situation and anticipated introduction performance, market acceptance and financial impact of new products particularly the Eclipse products, comments about break even and profitability, and future results of operation and cash usage. It's important to note that these forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially.

These risks include continuation or further tightening of global capital markets for telecommunication and global cellular products, economic and political instability in the Middle East and other markets in which we compete or which our products are manufactured. For further discussion of these and other risks I'll refer you to our press release dated today as well as other filings made with the Securities and Exchange Commission. In addition, please note that the date of this conference call is February 2, 2006. Any forward looking statements that we make today are based on assumption that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of future events.

Now, for the quarterly results. First, I 'd like to provide a summary of the quarterly results for those who may not have time to read our press release that was recently sent out. Beginning last quarter, we included both GAAP and non-GAAP results in our press release. We believe that these supplemental non-GAAP financial results reflect the basic operating results of the Company and facilitate comparison of operating results across reporting periods. There was a $300,000 noncash charge in the third quarter related to our restricted stock program and a $1.5 million charge on a year-to-date basis. For ease of comparison to prior periods, I'll be discussing the results based on the non-GAAP results which are included in the press release.

Fiscal year 2006 third quarter revenue is $55.5 million, about the same as reported last quarter and a 12% increase from the same quarter of last year. Gross margins on a non-GAAP basis were 29.3% compared to 20.4% in the same quarter last year, and 21% in the prior quarter-- 27% of the prior quarter. Orders for the third quarter were substantially higher than the prior quarter at almost $85 million. Back log ended the quarter at 85 million as well.

In the third quarter, we reported net income of $1.1 million. This is clearly a major milestone in the turn around effort that we began several years ago and is a major improvement compared to the $7 million loss we reported in the same period last year. We're delighted to be able to report that the numerous changes that have been implemented over the past several years at Stratex are now showing the positive financial results we had been forecasting. This has been accomplished through the dedicated efforts of the employees of Stratex worldwide.

Now I'd like to review some specifics related to the quarterly results. First, orders received for the quarter. By geographic area, in the Americas we had $7.8 million of orders. Europe was $15.5 million. Middle East and Africa region was $35 million and Asia/Pacific, $26.5 million and $84.8 manage, almost $85 million in new orders. By product line Eclipse orders were $64.7 million, the XP4 mid capacity and Velox products were $7.3 million. Altium product line was $1.7 million, DXR $1.8 million and services $9.3 million. Clearly this this is a dramatic increase in orders and a confirmation of the success of Eclipse. As we remind you each quarter, orders tend to be lumpy, and thus they could vary significantly from quarter to quarter. This is clearly evident in this quarter's bookings.

There were a number of large proposals that we had been working on for some time in a number of regions worldwide, that were concluded during the December quarter. Orders for Eclipse at $64.7 million doubled from the $32 million recorded in the prior quarter. Eclipse accounted for 86% of new product orders in the quarter. Orders for Velox declined significantly during the quarter as the one major customer that was buying this product over the past several quarters was in the process of switching to Eclipse though they have not yet placed any specific Eclipse orders. Orders for services at $9.3 million were about the same as the last quarter and a little bit higher than I initially expected.

For revenue, the Eclipse revenue is $33.3 million, the mid capacity XP4 and Velox revenue is $8 million. Altium was $2.9 million. DXR, $2million and services $9.3, again, for a total of $55.5 million. By geographic area, the Americas accounted for $11.6 million, Europe was $15.8 million, Middle East and Africa was $15 million, Asia/Pacific was $13.1 million. Eclipse revenue was 77% of total product revenue in the quarter up from 65% in the prior quarter. Eclipse will continue to increase as a percent of product revenue during the coming quarters. Gross margins in the quarter were 29.3% compared to 27.1% in the second quarter, 23.1% in the first quarter, and 20% in the third quarter of last fiscal year. This trend reflects the impact of Eclipse margins on the overall company margins, for the fourth quarter that's coming up we are forecasting continued improvement in gross margins, and based on the current back log and forecast product mix I expect gross margins in the fourth quarter to be in the range of 29% to 31%.

Now on operating expenses, R&D expense of 3.3 million was down slightly compared to 3.6 million in the second quarter. Selling, General and Administrative expenses was $10.8 million compared to -- in the third quarter compared with $11.5 million in the prior quarter. Decrease in SG&A is due to lower third-party agent commissions due to the mix of customer sales. I am forecasting R&D expense to increase slightly in the fourth quarter and SG&A expenses to increase as well due to higher revenue resulting from the higher selling expenses and agent commissions. Excluding charges for the restricted stock plan I expect total operating expenses in the fourth quarter to be between about $15 million and $15.5 million.

Operating income on a non-GAAP basis was $2.7 million in the third quarter compared to an operating loss of $7.3 million in the comparable quarter last year. That's a $10 million turn around. Other income and expense, net expense of $650,000 in the third quarter, compared to a net expense of $1 million in the second quarter. This decrease is mainly due to lower interest expense. Tax expense for the quarter, you can see from the release, was $619,000, higher than what was forecast due to taxes and certain foreign subsidiaries. But with improving results I would expect income tax expense to be $500,000 to $600,000 in the fourth quarter.

On bottom line net income, this is the first time I have been able to say net income as opposed to net loss since we began the turn around effort several years ago. For this quarter, we reported net income of $1.1 million or $0.01 a share. Now on to the balance sheet. On cash -- before I get into details the headline related to cash is that we moved from funding losses to funding higher than expected growth.

The company's cash balance was $40 million at the end of the third quarter, That is a decrease of $6 million from the previous quarter. However we did have net borrowing during the quarter of $11.4 million. Specifically, we borrowed $13 million at the end of December under our revolving credit arrangement. It's been in place for some time. The $13 million has already been repaid in January, 2006.

During the quarter cash was unfavorable impacted by increase in DSO to 83 days and inventory increases to accommodate the large order input which has caused higher product demand level than we had been anticipating. Expect DSOs to improve during the fourth quarter and to move more in line with the targeted DSOs of 70 days. Cash collections were very good in January. And as I indicated, the short term borrowing has been repaid.

We expect to continue to use cash in the current quarter due to the high demand of products and projected increase in sales and related receivables. We're discussing revising the existing credit facility with our bank to accommodate the increased working requirements and do not believe cash will be a constraint to our growth. Note that without working capital requirement for growth, we are now generating cash.

Accounts receivable, total accounts receivable were $51 million, an increase by $18 million for the prior quarter. DSOs, as I indicated, increased to 83 days compared to 53 at the end of Q2. We did not change payment terms with our customers during the quarter. Nor did the accounts receivable agent deteriorate. This change was due to the timing of shipments during the quarter and lower number of customers paying with letters of credit. As I mentioned I expect DSOs to decline in the fourth quarter but due to higher forecast shipments receivable balance may actually increase.

Inventory increased to $40.3 million compared to $35 million reported at the end of the prior quarter due to the increasing product demand. With the significant new orders, we began increasing the inventory pipeline to support projected sales increases. As a result inventory turns were 4.4 compared to 4.6 in the prior quarter. I expect inventory to increase somewhat in the fourth quarter reflecting continued growing demand for Eclipse. Liabilities may basically increase $13 million due to the bank borrowings that I already discussed. And as I have mentioned, this has been repaid.

For the forecast for the fourth quarter, we're certainly pleased with the steady progress we've made during fiscal year 2006. As you know, returning to profitability was a major milestone, a goal we have focused on since we started the Eclipse development. We certainly plan to continue the positive momentum as we finish fiscal year 2006 and begin to look into fiscal 2007. We expect Q4 will continue to show improvement in our overall financial results. Due to the order levels in Q3, the customer installation schedules and our key suppliers' anticipated ability to ramp production, we're forecasting total revenue of $61 million to $64 million in the fourth quarter, gross margins, as I mentioned, at 29% to 31%, and bottom line results of net income of $0.02 to $0.03 per diluted share. I'd now like to turn the call over the Chuck Kissner, our Chairman and CEO, for an operational summary and comments on the Company's market position, Eclipse status, and plans going forward.

Thanks, Carl. First, the entire team here at Stratex is delighted, obviously, to report to our investors that we achieved our goal of profitability as we had planned. We began a major reorientation of this company in almost every aspect, after the telecom downturn and focused on a profitable, sustainable, and valuable enterprise. We believe that changing our business model and taking the risk of a major innovation leap has paid off. We're also confident that this plan will continue to drive us to improving results as we do have more innovation and fundamental improvements planned, and the dramatic increase in the new orders is encouraging to say the least.

What I'd like to do is highlight a few items of importance and the outlook on our business going forward. First, with regard to customers and markets, the very large increase in orders was something we've expected for some time but not quite to this level so soon. You know, Eclipse products have been through several breakout phases since it was introduced but this is a big one. It's been clear over the past six months or so that the enthusiasm from our customers for Eclipse was growing both in the number of customers as well as the average order size and that demand would likely accelerate. I do want to remind you, as Carl did, that orders are lumpy, so we don't expect this at all consistently but clearly the trend is up.

The $85 million in total orders and the $65 million in Eclipse orders prepares the business, in our opinion, for the next phase of growth. The demand was significant in all of our traditionally strong geographic areas including western and eastern Europe, Africa, Russia, the Middle East and Asia. Ethernet applications continues to to do well They represented 20% of our revenue and they're on track for a record level for FY '06. And I'm sure you know from prior calls this is a relatively new market for us. This is one of the target markets of our newest Eclipse technology that was unknown a few days ago which I'll touch on in a moment.

We do expect this sharp increase in overall demand is going to influence revenue growth actually for the next couple of quarters. Besides the strength of Q3 orders we've also seen strong orders early in the current quarter, Q4. This has placed increased demands on working capital higher than we had anticipated. As Carl mentioned we don't anticipate this will be a constraint. We continue to see growth in software sales in Q3 at about $2.3 million which is up sharply from the $1 million plus that we did in Q2. And we're now providing our software upgrade in hours with a maximum turn around time of 24 hours.

On products. In the third quarter we introduced more new products than in any time in this company's history, all of which continued to expand our market footprint and/or drive down the cost. The most significant introduction was the first of a new generation of Eclipse radio units. We also, during the quarter, began sourcing from two new factories in China. All of this together was clearly a management challenge and it did contribute to more of back end loaded quarter than we had planned. and that impacted DSOs. However I think that by taking this aggressive approach, we took to rapidly introduce this new technology and also to bring lowering supply chain costs with the new sourcing we are positioned better for the next phase of the Company's progress a little bit ahead of schedule.

Let me touch on the next generation Eclipse products that we announced on Monday. Many of you know we ever been working on the rollout of next generation Eclipse as the second punch of this concept. We're tremendously pleased that we're able to introduce these first products and begin commercial shipments late during the third quarter. The first products are new outdoor units or outdoor units or ODUs called the E300 HP which is a new high performance, high capacity radio. We're able to expedite the introduction of these products by a quarter or so due to outstanding development progress from our employees.

The technology, the new technology, has three main goals. First,,t to enter new markets and channels. Second, to accelerate the software portion of our business and third, to raise the competitive bar again with the Eclipse platform. This new technology fundamentally changes how future radios that are part of Eclipse products are designed and then built. The design goal has been to take the magic out of microwave, which enables the radio portion of Eclipse to achieve dramatic reductions in cost and complexity.

So, what this means is the new technology permits now for the first time the supply of microwave radio units from high volume contract manufacturers rather than requiring specialized radio manufacturing techniques. The ability to meet expanded needs of new channels and markets is greatly enhanced with this technology with long-term targets to permit unit count volumes of triple the current levels and dramatic reductions in lead times. This lower reliance on hardware content also gives us an opportunity to provide a significantly higher portion of value through software. As new products continue to be deployed with this technology, we expect that our software business will grow at a faster rate than our overall business.

Remember that when we first introduced Eclipse, we also introduced the concept of software upgrades in this class of products. Now we're accelerating the emphasis on software. As we mentioned in Monday's press release in addition to improving our competitiveness in our traditional and our emerging markets and to migrating the software business model, one of the fundamental goals with this new technology was to drive Eclipse in the new markets and emerging applications and some markets we just really couldn't reach before.

So, as an example we expect the new Eclipse technology to win a significant place in this emerging ethernet transmission market over the next couple years. We see new market opportunities in carrier class ethernet as the IT transitions, and carrier networks accelerates. We also see other markets as being very well served by this new technology. But, I think, probably the most dramatic practical effect is the impact of opening the new channels of distribution to spread Eclipse technology into places that were not easily accessible to us in the past. The higher software content of this new technology gives us much more flexibility on how we deliver valuable through various channels.

And this technology is a positive impact on our channel strategy for three reasons. One, it does provide a new income stream for our product. Second, it allows us to increase hardware volumes to permit cost efficiencies, and third, it does positively impact Eclipse's market presence and recognition to the potential endorsement of other suppliers. And that brings us to the Alcatel agreement that we also announced on Monday. So, let me touch on that because it's a good illustration.

As the new Eclipse technology was in the latter phases of development last year, we met with a number of potential partners who could significantly expand the distribution channels for Eclipse. Our objective was to find a significant anchor partner to kick off this new approach to the market and to expand Eclipse's global influence. It became clear fairly early on that Alcatel was potentially such partner.

Because the addition of certain Eclipse products under an Alcatel-branded designation is going to clearly strengthen Alcatel's excellent product portfolio and the terms of the agreement should be financially advantageous to both companies. Alcatel will source software from Stratex networks and certain Eclipse hardware directly from one of our contract manufacturers. Stratex is going to receive volume-based fees subject to certain minimums. We're optimistic that over the term of this four-year agreement that unit volumes for Eclipse will expand significantly as a result of this agreement for both Stratex and Alcatel but not only because of the addition of Alcatel's volume, but even outside that channel because of a strong validation of Eclipse globally.

Obviously due to the nature of the transaction, there are limits on what information can be disclosed. However, I do say there are mutual restrictions that help ensure Eclipse product sales will be strong in both Stratex and Alcatel channels. I also want to point out that potential volumes with Alcatel were far more significant than any other opportunity that we assessed for the first application of this alternative distribution channel. Their commitment to this product as an important portion of their portfolio, especially because of their strength in the North America market, make them an outstanding channel for the start of this program.

We can't forecast sales from this agreement today but because there are minimum fees in the agreement, we expect the positive influence on earnings starting in FY '07 under every scenario that we can put together. Finally, I want to say that upon our proposing such a radical new approach to the market, we do appreciate the forward-looking attitude of Alcatel management and we found our discussions over the last few months quite encouraging. We're going to open it to questions in a moment but let me just use this opportunity to give you bit of a summary here.

Just in summary as planned, our long-term strategy is playing out as we had hoped a planned. The entire Eclipse product family is producing strong results. The business is ramping very quickly and we now see sustainable profitability. As Carl indicated, we expect continued growth based on the demand profile and a healthier business going forward as we continue to evolve the Company.

Let me talk a little bit about next year. Last fiscal year, FY'05 we grew about 15% or so. This fiscal year, FY '06 for the fourth quarter guidance that Carl provided earlier, our growth for this year would be in excess of 25%. Based on the market data that that we've seen, that growth suggests we have been building share as Eclipse has accelerated in its takeoff especially in the last year. The market forecast for next year seemed to be in the 10% to 15% growth range. I would expect that we should be able to grow at least as fast as the market based on momentum we have right now. So as we move from turn around stage to building sustainable value in the Company, I again, want to thank our great team here at Stratex and our supply chain partners and certainly the investors who believed in us. We're continuing to drive rapid innovation in our business and in our markets. We have a number of exciting new developments in the works as well. We're very enthusiastic about bringing these innovations to market over the next couple of years just as we have over the past couple of years since the Eclipse concept was originally brought to market. That concludes our formal remarks. Operator, we're now ready to take some questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from Ittai Kidron, with CIBC World Markets. Please, go ahead.

Hi, guys. Congratulations on the great results and good guidance.

Thanks.

First, on the new generation of Eclipse, can you tell us how quickly will that replace the old platform? Is the old platform completely going away and with respect to that, is there a gross margin gap difference associated between this platform and the older? If it is what would be a long-term gross margin target for you guys?

It's not going to immediately replace the current Eclipse products. One of the objectives, as we mentioned, was take it into some new markets. I think over the next couple of years it will eventually replace all of the radio units that we have in the design today. Or at least that technology will.

What you'll see is a whole series of products coming out over the next coupld of years, that you'll see just incorporate this technology. As far as the gross margins, as we said, the cost of these products is dramatically lower than the current cost. We also expect price degradation over that period of time. So, I think at this point in time, we would say this buys us at least insurance on the gross margin expectations that we have. And maybe better.

Very good. With respect to Alcatel can you give us a little more color on -- is that relationship in any way exclusive preventing you working with other OEMS? What exactly are the products that Alcatel is going to source from you? How would they pitch that business relative to their own existing products?

There are some cross exclusivities, as I mentioned, to ensure that we both have viable businesses with Eclipse. We can't get into the details of it, only to say, I think in our case, the restrictions that are on us would be with entities that there would be a low probability that we would do OEM deals with anyway. So, I guess that's the best I can say. The restrictions going back the other way, is to protect certain accounts that we are involved in, so that the technology doesn't compete with us in that part of the market. What was the second part of your question, Ittai?

How are they going to pitch this and combine it with their own existing products? I know obviously they're a big player in the microwave space as well. How does that work, exactly?

Yes, I think as they -- this of course is completely up to them but -- they are branding this or labeling this as SCH, or high capacity, product in the market place. And the products that are part of this agreement are strictly the new technology products because those are the only ones that fit this distribution channel. It will be private labeled so it will have an Alcatel designation. It won't say Eclipse. It won't say Stratex Networks on it.

Okay. Lastly with regard to your order intake-- very impressive jump. Can you give us a little more color into that order balance? Are there any major customers? How many customers does this order intake incorporate? How distributed it is and also if you can provide us little bit of geographical exposure. It looks like Asia was down in the quarter but from an order standpoint it was very significant. Any color you can provide in that?

We have -- there's no dominant customer there.

Maybe 10%?

Yeah, there are probably three in there that are 10%. But not much above that. So right around that range. There's probably -- I don't have an exact number in front of me, but it's probably about 110 or so customers. I guess the other color is the one I gave you, which was about 20% of the revenue was associated with data. So looking at the ethernet, given the ramp, I would say it's more than 20% on the orders side.

Okay. On the geographical?

Like I said, it was strong in all of the geographies. Asia actually was pretty strong even though it might have been sequentially -- actually it was good. Asia in Q2 was about $13 million in orders. And it jumped to $26.5 million So Asia was up. Middle East/Africa had a huge increase from $16 million to $35 million and that was really because of some transition that was going on with Eclipse that we mentioned at the last call.

All right. Very good. Carl, lastly, if you could give us some color on how should we think about taxes in your fiscal '07? Yeah. We're not going to be paying any U.S. taxes.

Our tax laws carry forward is pretty substantial in the U.S. So at this point I sort of continue with the 500,000, 600,000, 700,000 a quarter type rate, certainly based on service business internationally and that could go up a bit because of the increased numbers of units we would be doing larger numbers and installations. But at this point, that's sort of where I'm at with that. Likely a little higher than that.

Very good. Congratulations. Good luck, guys.

Thanks.

Our next question comes from Matt Robison with Ferris, Baker Watts.

I'll echo the congratulations. Quite a performance on the bookings there.

Thank you.

First of all I guess the Alcatel deal came after the quarter, so I guess for that and we should assume there was no Alcatel input on your bookings?

That's correct.

What do you think is the -- old product lines have a tendency to stick around for a long time. Is there some point where you just do an end of life deal or have you already done that with these older products? When should we expect Eclipse to be 100% or 95% plus of revenue?

We've done end of life announcements on XP4 DX4, and Altium, and all of those now, so. So, certainly by late fiscal '07 essentially, those will be gone. Velox will continue. That continues to be a current product. It continues to do reasonably well in the market place.

In your midrange you talked of orders of 7.3 million. Is that almost all Velox?

No. It's both Velox and XP. We're still certainly selling XP around the world.

All right. So maybe we should assume that at the end of the year given there's some Velox that you're into '07. Your product sales should be 90% Eclipse. Is that a good way to look at it?

Yes. I think so. Yes.

That's a good way to look at it. Velox runs around $1 million to $3 million around the quarter, has for some time. Other products will phase off, so.

The last couple quarters, your services revenue bookings have been exceptionally high. Should we expect that to continue and is there -- is the switch over to Eclipse part of that? What's the back drop?

Indirectly there's something to do with it. That's really mostly a function of large network builds. That's why it tends to be a little lumpy. I would say it's going to normalize back to around 7.

Yes. The 9's a little bit high. It's been running like 7 for a long time. Probably somewhere in between there. Because the higher revenue is driving some additional field service, so the repair business is pretty good. With 100 units out in the field, that repair business sort of continues on, or maintenance business. But Installation or front end support a little bit higher, with higher volumes. Not dramatic. Somewhere between 7 and 9, as a number.

But becoming, I guess sort of the R&D branch of an OEM customer like Alcatel, if I could make that leap, since they're taking the high-end product, what do you -- do you anticipate your business model evolving towards one where we would see significantly lower sales and marketing expenses as a percentage of revenue?

As a percentage revenue, I think a little bit lower. I think the way this works is we expect the software and license fees to be rather low-revenue numbers because of the nature of what they are. But very high contribution of the bottom line. I think one way to think about it, Matt, is that in general what will flow to the bottom line in terms of the licensing is roughly equivalent to the length over most of the life of that agreement to be the same as if we sold the product ourselves. But we won see obviously the hardware.

Yes, that's the software content.

Right. So it has a lift on it. It will have a lift on margins. Obviously that will become volume.

I guess where I was going is, can we see a scenario where you can start to -- pare back on your geographic customer support activities and utilize OEMS to do that? Or are you going to maintain that?

No. We're definitely going to maintain that. It's a very careful part of the strategy as to what products we make available for alternate distribution compared to the total. Remember, we have a number of other innovations in the works right now, besides what we announced today. So, we -- the trick obviously for us and we obviously tried to think this through as best we can is a balance between ultimate distribution and direct. We think our direct sales business is extremely lucrative in the model that we have right now. We intend to keep growing that.

Do you expect this channel to get you into Alcatel's historical trucking long haul, high capacity trucking business?

We're not counting on that. I think the bigger impact would be whether there are system sales that would cost us a lot and we'd have to fight for. Especially in the North American market. We expect a pretty big lift there.

What was head count, Carl?

It was around 480.

Okay. Again, congratulations.

Thanks.

Our next question is from Kevin Dede with Merriman. Please, go ahead.

That 85 number, am I reading that right?

Yes. It isn't transposed. We promise.

Okay.

I don't know if you're reading it right but it's 85, the number.

Okay. I heard it a number of times. It's starting to sink in. Congrats on that.

Thanks.

So Chuck, can you give me the capacity range the 300 HP is addressing? Can you get to say a lower capacity point given lower IDU cost and still make your traditional margins?

Well, we're not positioning the product that way. We have other plans for the low end. So we're positioning it at the higher end of the capacity range. Remember, this is about new technology and the new technology is going to be applied, in other ways for other products over the --certainly over the course of the next year that will accelerate. Technology is going to find its way into the low end. But the 300 HP as branded and advertised and positioned and spec-ed is a high end product. It's very much oriented toward not only the high end of telephony but it is also oriented toward the ethernet market which we generally expect, obviously, to have higher capacities.

Okay.

You think about what we're saying here in terms of, it's not just the product. It's how we get to the market, delivery system, supply chain. We talk about short lead times. We ramp up into very large numbers. We're doing that because we're going to attack markets that will require those character is . The ethernet market is clearly one of those.

Okay. How big player is Alcatel there?

I guess, you'd have to ask them. But, I think, we see their strength right now in the microwave area, rather than the traditional back-haul market. But, clearly as a corporation Alcatel has banked on the IT transition and other areas that are visible of the business. I would expect eventually that's going to get put into the microwave business. I think, for us, we're doing quite well on the ethernet part of the business. It represents a significant portion of the growth from one year to the other and in terms of product positioning, direct sales, how we engineer these networks, and so on. I think we're carving out a leading position in that area.

But th HP still includes that flexibility to migrate from PDH to FDH and obviously ethernet? That's not going to change?

Yes. No change. It's the same. All of our outdoor units are universal. They can be configured to serve any of the applications. But from across delivery, size profile, some are better suited to others. That's called marketing.

Can you give us a rough guess on the bomb reduction in the new ODU?

Yes, we can give you a rough guess but we probably know better than that.

Well, yes. I wasn't sure how much you wanted to talk about publicly.

From a cross point of view, we're talking probably 40% to 50% reduction on a comparable high capacity product.

Okay. Are you talking about a gradual transition from Legacy Eclipse or initial versions of Eclipse into this one so we shouldn't expect inventory issue?

No there's no inventory issue on this. It's going to be introduced. We're not discontinuing the other ODU's right now. This is an additional ODU that fits other market applications, and that's how it being positioned. Again, let me reemphasize. It's not just about the E300 HP that we started shipping. It's about how this technology is applied across all of the radio stuff in Eclipse. Eventually it will find its way through a broad base of these products and serve various market needs. It just happens to be the first one,and we picked it because of the market impact not only in the current markets but the data market and ultimate distribution market like Alcatel.

Okay. Last question for me this time around. Can you sort of sum up what you would consider as software content that's being licensed? I mean obviously there's a lot of software involved in the handling of signal processing. I'm just curious as to what else in terms of liquid bandwidth and the other features that you've added.

It's -- our software is delivered on a memory card and that's what we're licensing. So, it includes a lot of features, not necessarily all the features that will be rolling out over the next year, but a broad set of features that allow Alcatel to market this product line in a very strong way.

Very good. Thanks for taking that, Chuck.

Sure.

Our next question is from Rich Valera from Needham and Company. Please go ahead.

Thank you. Congratulations on moving into positive earnings territory in style, there guys.

Thank you.

In terms of the model, you said that it sounds like the new E300 and the associated technology maybe gives you a little bit of cushion with respect to your previous gross margin targets. I guess, one, could you remind us Carl what is your previous operating model that you're looking at with respect to both gross and operating margins? And then just give us some sense of how this how this technology might be able to push those gross margins a little higher.

What we said for quite a while, is that our target operating model product margins, gross mar gins of mid to high 30%, and operating income of 12% 15%. That was when we were at 20% margins or less. So this -- all along we've said we were going to continue to reduce costs, and would reach those levels and make software a larger part of the revenue base, so it pushes those mid to high 30% margins. And so basically, we're saying this part of that expectation we've been building in for quite awhile. This doesn't change that expectation but I think that, as Chuck said, a little bit earlier release than expected. maybe but it still fits into that model.

I understand you're seeing sort of a hedge against future pricing pressure. With the E300 that you're going to be shipping over the near term, can you give us sense of where those gross margins will be? Are they over 40%?

On average, yes. With Eclipse generally.

Okay. So, why, with Eclipse close to 40%, and the new platform seemingly probably better than that. It seems mid to high 30% product gross margin is kind of conservative. It would seem like we're probably at least biased toward the high end of that. Am I missing something there?

I'd probably say you're missing competition.

Fair enough.

However, if you're right, we're very happy.

All right. I guess that's fair. Carl, could you just talk about the demand? I missed the early part of the call. But you had the strong bookings. One, can you give a sense of do you feel like you maybe pulled in some bookings in the next quarter and we should expect a big sequential downtick. And just also where's the demand coming from? You got your traditional free end market, sort of the back haul, private networks, data networks. Can you kind of give us a sense of is the demand spread sort of equally across those or is some area driving demand?

Okay, with regard to the first question, Rich. I don't think we pulled anything in. The numbers were large because we're working with larger contracts now. And some times, in fact, most times you can't predict exactly when they will close. we had a number of close we've been working on for sometime in Q4. That being said there's still a lot of other large deals in the pipeline. I don't expect Q4's orders to be at this level. But we never say that we expect a linear trend, or a linear progression, quarter to quarter.

The only thing I could say is, I don't expect them to be as strong next quarter but I expect over time this does represent an upward trend. I don't think that is going to change. That's not answering your question directly, but I can't because there's such a high standard of deviation in orders.

I understand. In terms of another positive book to build which you can certainly have in the fourth quarter without being near your level of this quarter is that within a reasonable realm?

Yes, that's possible. Now, just let me also point out that one of the reasons the orders are up was as we introduce the new technology, we started taking orders. This new technology looks like it's going to be extremely popular. These orders are very large. They all spread over a couple quarters as we ramp the various frequencies out of the E300 HP and some other new products that we're rolling out. So that has some mitigating impact. There's only a certain amount of this demand that we can serve in a short term. But that also is why we have confidence in the long term in terms of the general demand profile. Because the demand appears to be, on that particular segment, on that particular product line appears to be whatever we ship we would be able to sell. In terms of your other question about the breakdown, as we said the revenue for the ethernet applications was about 20% of the total. That's been on a steady trend upwards. So on an order point of view, I don't know what the number is because we don't have the sort yet, but I expect given the rejections we have seen for data for the year, that has a positive book to build and therefore something higher than 20% in terms of the orders. On the other remaining 80%, I don't have the breakdown but I'm just giving you an educated guess that 10% to 15% of that was private network business and the rest would be back haul.

Great. Thanks. One final question. With respect to your sequential revenue trend, is there any reason to expect a sequentially down quarter in your first fiscal quarter of next year? Is there really any seasonality there or is it just more dependent on sort of how the orders flow over the next quarter?

There's seasonality all over our business. But it's really geographically oriented. So as long as we have a good spread of customers in both the Northern and Southern Hemisphere, we tend to not see the seasonality in terms of the revenue. On orders we see seasonality sometimes because incentives and so on. That's not a guarantee either. That's not a guarantee either. So, on the seasonality question at this point we don't see any in terms of what we see from Q1 that's beyond the realm of our guidance.

All right. Thank you guys.

Okay.

Our next question is from Steve Feronte [ph] with Stevens, Inc. Please, go ahead.

Hi, guys. Great quarter.

Thanks.

Could you talk a little bit about what you've seen in terms of the competitive response thus far and maybe talk about, you know, how that's kind of played out relative to your expectations with regards to Eclipse?

What we've seen for the last, since we introduced Eclipse, is mostly price competition to erase the economic value of Eclipse. That has-- so far has seemed to have abated somewhat in the last six months or so. There are -- we believe that there are people working on Eclipse types of products that might come out-- we're sure something will come out in calendar '06 sometime just based on everything that we're hearing and and certainly what we've heard from our discussions with some of the OEMS that we've had a chance to meet with them in the last six months. But that's pretty much as we expected. Actually it's a little later than we expected. For those of you following us we thought we would have seen Eclipse type products in the market place much more strongly by now. Certainly they've got to be coming because of the popularity of Eclipse.

So, that's why we were frankly paranoid about releasing the new technology as fast as we could. We said it would be early in calendar '06. Obviously we met that. We think that with advantages that the new technology brings on the first product and then ensuing advantages as we roll out other products that we've upped the competitive bargain. We'll probably still be competitive in the next couple of years.

So you could probably imagine we're now in paranoia about yet the next technology to go beyond the stuff we just introduced. There's been a lot of progress in that area. What we stand for right now, and what we decided four years, five years ago is we were going to be flooding the market with innovation, and clearly that's working now. I see a good pipeline of innovation out over the next two or three years, for sure.

So we expect to stay competitive. We certainly don't underestimate anyone in the market place. And I think that's why we tried to be as realistic as possible in our financial projections including the ones that led us up to turning profitable this quarter.

That's great. That's a good position to be in. And then with regard to the ethernet market particularly in the U.S., you talked about the potential for Alcatel to open up. Who would be the target customers there? Are we talking about wire line telcos? Or wireless carrier? Or enterprises? And then what technology would you be competing against? Would you be competing against other microwave solutions or more wire line type fiber solutions?

With regard to the carriers that would be mostly the wireless carriers, mobile carriers. And that would be competing against lease lines primarily, that's the most significant cross elastic solution. Once a decision is made to go microwave which is the minority of cases right now, but clearly growing because of the high capacity requirements of the new services for the mobile carriers. Then we'd be up against microwave solution.

And the most prominent microwave solutions to date have been microwave products from Alcatel and from Harrison United States, and we've had a very small position in that market. Obviously with this change we expect that the primary competition, if Alcatel is successful in doing that, would be with Harris, who is market leader in that area. The other significant target market would be state and local government market which has its own set of distribution characteristics.

Again, we have not been a large player in that but Alcatel is a large player in that market. We think they should do reasonably well with Eclipse solutions. Private network business. We're pretty well positioned within the United States. We have a growing set of bars in the U.S. That's representing a significant portion of business that we have in the U.S. Because of the uniqueness of Eclipse especially in carrier class, ethernet we expect we'll probably do well selling direct and so will Alcatel.

Okay great. Those are all I had. Thanks.

Yes. Our next question comes from Andy Schopick with Nutmeg Securities.

Please go ahead.

Thank you. Good afternoon. Just a follow-up question on the Alcatel relationship. Do I understand it to basically take the form of master supply agreement which you've established pricing in terms subject to annual renewal?

No. It's really a licensing agreement with them. So they source those products that are specified in the agreement directly from one of our contract manufacturers. Same one that we sourced it from and we both buy it at the same price. And in fact that's one of the advantages of the agreement. By ramping the volume up higher, we expect to lower the cost of that equipment from that supplier. But we would both be purchasing at the same price.

Okay. This is not the typical traditional sort of OEM relationship where they'll be rebranding the product?

That's correct. The whole idea of this thing when we starred the concept of new technology was that we didn't believe that OEM relationships in the traditional sense were sustainable in this market. There really isn't enough margin. So we decided to go at it a different way, which was to reduce the hardware content dramatically and more increase the software content. So we sell the software. We also license the ability for Alcatel to source from that contract manufacturer and then we share in the benefits of that.

Okay. Thank you.

Yes.

Our next question comes from James Cappello with Kern Capital. Please go ahead.

Hey. Good evening guys. My question kind of points towards the last question. So what's going through your PNL when you make a sale to Alcatel, so to speak.

We aren't making any sales to Alcatel. They're paying us a license. So the license fee goes through our PNL as revenue. And it becomes-- if all of the software license revenue becomes large enough then we break it out on a separate line. It will be currently included up in our revenue line.

So software and license go through your PNL?

The software license goes through our PNL as revenue.

Okay. And what's the average price of an Eclipse product that you're selling today on your own and what is the magnitude of the software license of that?

We don't have an average. We don't have that average price, and we're not at liberty to disclose what the license fee is.

Okay.

But, I did allude to that earlier when I said the impact on our bottom line during most of the life of the agreement would be roughly equivalent to us selling the product ourselves directly.

Okay. It just seems then the gross margin from anything derived from the Alcatel agreement is software margins?

Yes. It would be close to 100%margin.

Okay. So this might suggest that gross margins in the future, if this is a very successful; relationship, could be north of where you're thinking about today?

That could be, yes.

Okay.

Or as we indicated earlier it's also protection against degradation. But obviously we have high hopes.

Okay. Thanks.

Okay.

Our next question is from Jim Stone with PSK Advisers. Please go ahead.

Very nice quarter gentlemen.

Thank you.

In terms of the new product, can you give us some sort of feel of where -- excuse me, what its performance improvement is, where some of the technical issues are? And then also some sort of feel of where it lies in the price range?

The performance improvement is probably not that significant. It's certainly a performance improvement. It's really a significant as the improvement in cost and in supply chain. In terms of cost, we said it was a 40%, 50%reduction. In terms of -- certainly the size is smaller as well. The number of parts again is down dramatically.

The first Eclipse version was a huge reduction in parts count. This is another order of magnitude. Assembly times are reduced about roughly 80%. The lead time is dramatically less and the most important thing is because it is now a true contract manufacturer type product unlike previous microwave radios, we can run the volumes up very fast with less working capital requirement than we had before. So it's really a product that fits new distribution channels, as a really positive benefit, but it also makes us very much more competitive than our traditional channels

Does it contain a lot of proprietary parts or is it mostly generic?

It's mostly generic parts, and it's really an engineering approach as to how it is put together. A lot of it has to do with software that drives this product. And so there is quite a bit of intellectual property associated with this.

Great. With the new performance product, what does a pair of radios end up costing? What sort of price range are we talking about now? We don't sell it as a pair of radios normally.

It's a nodal-based transmission system, but if you convert to it the equivalent of a radio, of a microwave radio, at the high end a link on average might be in the $15,000 to $20,00 range. At the low end more in the $8,000 to $10,000 range. And the low end would be 32 megabits and below, 30 megabits per second and below, and the high end has-- we have a number of different configurations. We go up to 300 mega bits and higher now.

I heard somewhere NSC was getting stronger. Have you seen them? Or are they a problem?

NSC began getting very aggressive in the market about three years ago and used price as a weapon in the market place. And actually drove the average selling prices down quite dramatically. And so they did get a lot stronger during that period. We've seen less aggressiveness recently but we always assumed that there would be more to come and we've planned accordingly.

Okay. So, as far as your concerned, there's not much market share at this point in time between you and them?

No. I wouldn't say between us and them. I'm not sure we have that kind of granularity. We just know ours is increasing and I think we're just probably taking a little bit off everybody right now. Although there are others that are growing market share, for example. I think market share numbers we saw show Alcatel is going down a little bit. I would expect them to go up now with our help. We saw NSC and Ericsson going up, and then the rest were somewhere in between.

I recently heard a pitch by Gigabit. They claim that they're really going to kill the low end of the short haul-- very short haul types of market. Are you in that market?

I don't know what they mean by low end. We don't go really low. Our sweet spot is probably eight megabit per second and above. That's really where the low end of the mobile back haul business is. Obviously because we're in a lot of other markets now, the 3G we're rolling out. Vertical service on that, ethernet. Market tends to go higher than that because of speed. Traditionally, There have been all kinds of solutions that are going to supposedly wipe out the microwave back haul market. That's what's beautiful about investments. There's a lot of opinions out there.

What they're claiming-- this was an open meeting so I'm not saying anything unusual. They obviously current model would go off to a gigabit. They have one which they will have out next year which is a ten gigabit model. To ship 1,000 pairs of radio this year in '06. They charge in roundish numbers, 25,000 for a pair of radios.

That's great. Yes. That's great. I don't know what to say. I mean, I have been looking, though, for the perfect product for this industry. And I have been working on it for many years. And as soon as I find it, I'll announce it.

Okay. The main thing is they're not really competing in the market that you're after. Obviously they're in shorter haul types of things.

I guess so. [voices speaking at once]

Okay. Thank you very much. Keep up the great work.

Thanks.

Our next question is from Rob Allman [ph] from RK Capital. Please go ahead.

Nice quarter. Congratulations.

Hi Rob.

I didn't hear specifically, was the gross margin on the Eclipse in the quarter at 40% or above?

We didn't say, but certainly right around that range.

40? Maybe a little under. All right. Chuck, if you look at rolling out the new platform how do you duct the new releases? Should we think of the HP as addressing the largest market opportunity or should some of the future product releases address larger market opportunities?

It's addressing the high end and ethernet market, primarily, the first version of it. The technology eventually will go across the whole market. The largest part of the market in terms of unit counts is the low end of the market.

Not dollars?

Dollars it's probably half and half, right now.

Okay because the early release probably represents half market or so.

No, I don't think so. We also have a product, an outdoor unit that's even higher performance than this one. It's much more pricey though.

Okay.

I think between the two of those they have exceptional coverage.

Should we look for new partnership agreements as you release new product intros on this platform, or would Alcatel be a partner on future releases as well?

There's certainly that ability in the agreement. I think our experience so far is that the interest probably is broader than the agreement we had. But that may take on a more traditional OEM relationship on things that are outside the scope of the new technology. But I think in general, we're committed to broadening our distribution channels. We liked to do just this agreement first. This is obviously going to have a huge impact on the Company over the next few years, and we want to make sure we get this right.

This is a new way of doing things. This is a new way for our industry and definitely new for us. We're very committed to making it as successful as possible. We're going to do this in a very orderly way. We're not going to run out and make a bunch of announcements. I wouldn't expect that in the near term. But, certainly in the long term we expect to get Eclipse spread as far and wide as possible around the world in a rational way.

All right. To the extent Alcatel is successful and you're going to about the same contribution per unit, it's sold in the market whether they sell it or you, you're talking about 40% of the dollar value going through as gross profit, basically, or software licenses fees, I'd think you can get to 10% mix of software license sales pretty quickly in the next fiscal year. Is that a pretty safe bet?

I don't think so. Because we don't really have a forecast right now from Alcatel. And as I said, the way it's structured there are minimum fees associated with it. That's why we're confident it will have a positive impact on the business in FY07. What we don't understand yet is what the lift is going to be. We're also rolling out the various frequency bands of the new E300 HP and that somewhat gauges what the ramp is going to be.

And the third reason is Alcatel's a huge company and they're in the process of rolling this out from a marketing point of view to their sales force. It takes time to get the machine rolling. All of that contributes to I think a great deal of confidence from both companies from what I can tell that this is going to be very successful. I can't tell you what the ramp's going to be only that I know that we'll make money on it.

Alcatel is pretty well positioned in North America as for shares. Do you have a sense of the breakdown of shares between the two?

We do. I don't have the exact numbers here. They have been equal for a great number of years. I think between the two of them they probably have 80% of the market or so. In the last year, Alcatel has slipped somewhat to the number two position but not dramatically behind Harris, at least with the data I have reviewed, and you know market data can vary depending on who's doing the analysis.

North America is probably the largest opportunity for for sales with the Alcatel relationship?

I think from the contribution of the bottom line, sort of in the short term.

And then a general comment on the rest of the associated contract meetings actual partners. How do you feel about their ability to ramp and fill without too many hiccups the orders that you're seeing?

I think the process around the new technology that contract manufacturer we're probably less -- we're not concerned about. The new supply chain points that we have in China, there's two of them, have just started up. So I think it's early days. We always tend to be conservative about that. So I think those -- we're trying to keep our eyes on those, right now. Because those are both new factories. Those are a little bit higher risk. Those have nothing to do with the new technology though.

Okay great. Thank you.

Our next question is from Richard Grillig with William Dean Wittier

Hi Chuck and Carl. There's one thing I absolutely detest is the back slapping congratulatory call ins but I've got to tell you --

I know you do.

--after watching you guys for nine years I'm more excited than I have ever been before being an owner of the stock.

Great. That's good to hear.

What you've done with Alcatel thing is absolutely unbelievable. Could you hazard a guess as to if you approach it from the standpoint of a more traditional--l how much have you increased the addressable market, what do you think that estimate would be because of the Alcatel relationship?

I think it's too early to say. The microwave business, they're probably 2 1/2 times to 3 times bigger than ours. And now their position is the high capacity end of the market which is for them, they're low capacity and high capacity. It's about one-third of their business. Potentially, the kind of hope we have is eventually over the next few years they might double our penetration. But, again it's early.

What is the visibility that you expect to be getting from them? I assume almost none, right? Because they'll be ordering directly from the contract manufacturer?

That's correct. We don't -- this does not represent a collaboration in marketing and sales.

What is your role going to be in terms of bringing up to speed their sales people in terms of their understanding of the product?

We've provided, as part of the agreement, selling tools, documentation, and so on for them to do all of their own rollout. We have a certain level of support that's required. Anything beyond that is provided on a global basis. So, it really depends on what their needs are and what our capacity is. That's not covered within the realm of the licensing agreement.

Were they working on a similar type of product and then they decided to ditch that for working with you instead?

You'd have to ask them that.

Okay. What do you think the impact is going to be in terms of competitive pricing pressure because of this?

It's hard to say. I don't think it will have any impact at all. What we're hoping is the kind of validation that this gives for Eclipse will allow us to position it much more strongly in the market place.

Thank you very much.

You're welcome.

Ladies and gentlemen, we have --

I think we have time for one more if there is one more.

Yes, sir. Our final question is is a followup from Rich Valera with Needham and Company. Please go ahead.

Very quickly, Carl I think in the past you may have talked about a 20% tax rate and just wanted to clarify that going forward we really should be looking at 600k to 700 k per quarter.

Yes, I don't think I talked about 20% tax. We're just at that turning profitable phase and so we haven't put out any percentages. At this point I'd say we certainly put together next year's detailed plan and so forth when we define that. At this point I don't have anything better than that.

Okay. Thank you.

I would like to turn the conference back over to management for any closing comments.

Okay, thanks, operator. This is Chuck Kissner. Just thanks for all of your questions and your continued interest in our progress. Just want to note we plan to participate at that time CIBC World Markets' Best Ideas Small and Midcap One On One Conference/ West Coast Division, so it's close to us, on March 9th, and we look forward to seeing many of you there. Otherwise, hopefully we'll see most of you over the course of the next year at various conferences. So thanks very much. Have a good evening.