Aviat Networks Inc (AVNW) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Stratex Networks first-quarter fiscal 2007 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will open up the call for your questions and instructions for queuing up will be provided at that time. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mary McGowan of the Summit IR Group. Ms. McGowan, you may begin.

Thank you for joining Stratex Networks today to discuss financial results for the first quarter of fiscal 2007. On today's call will be Tom Waechter, Chuck Kissner and Carl Thomsen. They will review the results for the most recent quarter and our current business outlook followed by a Q&A session.

During this conference call, we may make forward-looking statements regarding our business and 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; breakeven and profitability; and future results of operations and cash usage. It is 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 of 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 and other risks, we refer you to our press release issued 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 August 2nd, 2006 and any forward-looking statements that we make today are based on assumptions 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 I would like to turn the call over to Mr. Carl Thomsen.

Thank you, Mary, and welcome to the folks that are listening on this call. First I'd like to provide a summary of our quarterly results for those of you who may not have had a chance to read our press release. As we have over the past couple of quarters, we included both GAAP non-GAAP results in the earnings release. We believe 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 $3 million non-cash stock charge related to the adoption of Financial Accounting Standards 123R and related to our restricted stock plan in the first quarter. [Reason] comparison to prior periods, I will be discussing the results based on the non-GAAP results, which were included with the press release.

Fiscal year 2007 first-quarter revenue was 66.2 million, a 21% increase from the same quarter last year and gross margins on a non-GAAP basis were 30.4% compared to 23.1% in the year-ago period. In the first quarter, we reported net income of 4.8 million or $0.05 a share and we're pleased again to report these positive results. This is a major improvement compared to the $3.9 million loss we reported in the first quarter of last fiscal years. These dramatically improved results were accomplished through the dedicated efforts of the employees of Stratex Networks worldwide.

Now I'd like to review some specifics related to the quarterly results. In the past, we provided detailed orders information. However, due to the lumpiness of orders on a quarter-to-quarter basis, as we have mentioned many times in the past, we're not pleased it's a good short-term predictor of business levels and as cycle times continue to decrease, it becomes less of a predictor. Going forward, we'll comment on book to bill ratios but not provide further orders details.

As a transition, I will say we did have a good orders quarter in the first quarter of fiscal year 2007 with positive book to bill and total orders in excess of $70 million.

Let me discuss revenue. By product line, the Eclipse revenue was 51.6 million. All of our legacy products were 7.6 million and on service were $7 million for a total of 66.2. By geographic area, North America was 3.5 million, South America 4.2, Europe 13.4 million, Middle East and Africa and we include Russia in that region is 30.5 million, and Asia-Pacific 14.6 million. Eclipse revenue was 87% of the total product revenue in the quarter, up from 51% of product revenue in the first quarter of last fiscal year.

Gross margins 30.4% in the first quarter. This compares with 23.1% in the first quarter of last year. Margins are substantially better than last fiscal year, about the same as the prior quarter due to the transition of the new product line and the related startup costs for this product. These results are in line with our forecast given in last quarter's conference call of 30 to 32% gross margins.

Based on current backlog and forecast product mix, I expect gross margin in the second quarter to be in the range of 31 to 33%. Tom will comment further on this -- using a 31 to 32%. Tom will comment further on this.

Now let's turn to operating expenses. Total operating expenses were 14.9 million, below the forecast provided at the beginning of the quarter and below the 15.5 million in the prior quarter. R&D expenses of 3.9 million were up compared to the 3.7 million in the fourth quarter, in line with the forecast provided at the beginning of the quarter.

Selling, general and administrative expenses were 11 million in the first quarter compared to 11.8 million in the prior quarter. The reduction in SG&A expense was primarily due to DAT expenses recorded in -- DAT expenses recorded in one of our foreign subsidiaries in Q4 as well as some year-end sales expenses. I'm forecasting both R&D and SG&A expense to increase in the second quarter in part due to salary increases that were effective as of July for employees worldwide.

Excluding charges for restricted stock and the stock option expense, I expect total operating expenses to be 15.5 to 16 million in the second quarter of fiscal year 2007.

Operating income on a non-GAAP basis was 5.3 million compared to an operating loss of 2.9 million in the comparable quarter last year, a 29% increase over the operating income of 4.1 million reported in the prior quarter.

Operating income for the quarter was 8% of revenue. This was a continued improvement over the 6.4% we reported in the fourth quarter and moves us closer to our target of 12 to 15% operating margin.

Interest and other was a net expense of 256,000 in the first quarter compared to a net expense of 542,000 in the prior quarter. Higher interest income accounts for this reduction in net expense. And tax expense for the quarter was $235,000.

Net income, as I mentioned, was 4.8 million for the quarter and earnings per share on a non-GAAP basis was $0.05.

Now let me review the balance sheet status. On cash, we once again generated cash from operations during the quarter. The Company's cash balance was 61.3 million at the end of the first quarter of fiscal year 2007. This was an increase of 3.6 million from the end of the prior quarter. This increase in cash is net of a reduction in our term loans of approximately 2.8 million. Cash was favorably impacted by a decrease in DSOs to 55 days. At the beginning of the quarter, I indicated that we expected we would use cash during the quarter for increased working capital requirements as revenue was increasing. However, our credit and collections team once again did an outstanding job collecting cash and bringing DSOs down well below the target of 65 to 70 days. The increases in inventory were partly offset by an increase in accounts payable.

Total accounts receivable at 40.2 million decreased from the prior quarter despite higher revenue in the quarter. Timing of shipments, letter of credit discounting and focused attention on key account collections all contributed to the excellent DSOs.

Inventory increased to 46.5 million compared to 43.9 million reported at the end of the prior quarter due to increasing product demand. With the significant backlog, supply chain issues and rapid delivery requirements by our customers, we increased inventory levels slightly during the quarter. Inventory turns were 4.1 compared to 4.2 last quarter. I expect inventory will begin to decline in the second quarter and inventory turns to increase as we continue to improve supply chain status and the timing of deliveries. There is a major focus that this time in the Company on inventory management and inventory reduction.

Total liability decreased 2.2 million in the first quarter as increases in accounts payable were more than offset by decreases in other current liabilities and reduction in bank borrowings.

Now I will go over a forecast for the second quarter of fiscal year 2007. As you know, we're pleased with the progress we made during fiscal year 2006 and we are also pleased that the progress is continuing into fiscal year 2007. We expect the second quarter will continue to show improvement on our overall financial results and importantly in our supply chain capacity and ability to respond to customer requirements.

Based on our customer installation schedules and anticipated new orders in the second quarter, I'm forecasting total revenue of 63 to 66 million. Gross margins of 31 to 32% and earnings per share of 4 to 6% on a fully diluted basis, excluding the impact of non-cash stock-based expense, which I expect to be about 2.9 million in the second quarter. As we indicated on the call last quarter, for the full fiscal year, the overall market we serve is expected to grow 10 to 15% and we expect to do at least as well as the overall market.

I would now like to turn the call over to Tom Waechter for an operational summary and comments on the Company's market position, Eclipse status and some of the plans going forward.

Thank you, Carl, and good afternoon to everyone joining the call. I'd like to add to Carl's comments, Q1 was very successful based on the financial results compared to both our internal goals and comparable quarters. Once again, the Stratex employees met the challenge and delivered on their commitments. I would like to take this opportunity to thank the team for their efforts.

Top-line growth continued on a strong trend with 20% growth compared to the same quarter last year. The revenue generated by the Eclipse product line broke the $50 million mark and represented 85% to the total equipment revenue.

Gross margins were 7.3 percentage points higher than the same quarter last year. The new lower-cost version of Eclipse, the HP and SP models, made up a little over half of the total Eclipse shipments for the quarter. The balance of the Eclipse revenue was based on the earlier generation EP model.

Operating expenses remained under control but were down to 23% of revenue compared to 28% just a year ago. This will add to the non-GAAP bottom-line achievement of $0.05 per share, maintaining a profitable trend over the last three quarters and providing positive momentum for the start of this new fiscal year.

On the operational side, the prior concerns around supply chain constraints are easing, as shipments increased for the new HP and SP Eclipse products. New and improved processes have been defined around order fulfillment and will be implemented over the next couple of quarters. This effort combined with the improved efficiencies at our contract manufacturers as well as throughout the entire supply chain will provide targeted leadtimes that are in line with our customers' needs.

Inventory increased during the quarter as we created some buffer stock to ensure customer deliveries at the same time that we are refining the fulfillment process. We expect the inventory turns to improve in Q2 and the aggregate inventory value to decrease.

The new Eclipse HP and SP product rollout continues at a rapid pace with a number of new frequency bands being released this past quarter. The majority of these product introductions will be complete at the end of fiscal Q3. By Q4, most of the Eclipse product revenue will be from those two new lower-cost versions with EP volume decreasing to a minimum. As a reminder, the E300 HP is high-performance and the E300 SP is standard performance. The E300 HP used a new radio technology to create a new supply chain model for our high-end, high-capacity Eclipse product. The E300 SP covers the low-end, low-capacity range of our product line with a highly cost-effective and more capable solution than previous low-end products.

From a market perspective, the overall activity levels remain strong. Total orders in Q1 were in the mid 70 million range with continued heavy demand in the Middle East, Africa and Russia. These world regions continue to deploy mobile networks at a rapid pace with microwave backhaul the critical part of the network. We believe strong demand will remain in the Middle East, Africa and Russia over the next few quarters.

Demand for higher capacity Eclipse products continue to dominate at approximately 70% of total demand. We believe this is strong evidence of the popularity of the new E300 HP we introduced in January. Remember also that the E300 HP is a product selected by Alcatel as part of its four-year licensing agreement with Stratex.

Data-centric orders, pure data transmission business increased to the low 20% of total orders in Q1 compared to the FY '06 run rate of around 18%. Stratex Networks continues to build on its leadership position in this expanding market segment.

Q1 also saw an increase in the level of service related orders. This will become an increasingly important part of our business going forward as we provide our customers with more complete services and value-added support over the life of the network.

This being my first quarter at Stratex Networks, I am very excited about the results in Q1 of fiscal year 2007. In almost all aspects, the team exceeded plan while overcoming a number of obstacles, the largest being the supply chain constraints. In the short period of time that I have been in a leadership role here, my impressions of the team, technology and market have been very positive.

The team will continue to focus on broadening the customer acceptance of the Eclipse product line in the field with special concentration on completing the rollout of the remaining frequency band for the HP and SP models. We believe that ongoing improvements in the order fulfillment process will yield significant results over the next quarters, leading to reduced leadtimes and improved inventory turns.

I will now turn the call over to Chuck Kissner, Chairman of the Board, for some comments before moving to the Q&A session.

Thanks, Tom and Carl. We're obviously gratified with the results for Q1 '07. I'd like to put some perspective on the achievement of these results with respect to our overall long-term progress and plans.

The continued improvement in results we believe are validating our strategic plan to position Stratex as a valuable and relevant global player in our markets. Having the financial underpinnings that you're seeing has been a first step, obviously a large and critical one, toward the ultimate rollout of our long-range aspirations. Over the course of this fiscal year, we expect to continue to show the kind of progress that you've seen to date but also to begin the execution of the next phases of our long-term strategic plans.

One way to look at this is that our strategic plans have been -- there have been three major steps. First, achieving strong financial results; second, expanding our served markets; and third, significantly, expanding our scale. Let me touch on these three steps.

With regard to the financial underpinnings of our plan, many of you know that we are committed to a long-term financial model that achieves an operating margin of at least 12% return on sales. This is based on a gross margin in the mid to high 30's range. Looking at Q1, if we adjust for new product introduction and supply constraints that Tom and Carl mentioned, gross margins would've been between 32 and 33%. And with continuing new product introductions and improved supply chain and strong customer demand, we believe this reinforces that we will be able to achieve this target level.

Second, with regard to expanding our served markets. This is clearly making progress and it accounts for the strong top-line growth year-over-year. As an example, Tom indicated that our data transmission orders were a significant portion of the total and this is a business we weren't even in a couple of years ago. The data business, our licensing business, which we still expect to ramp in the second half of the fiscal year and other applications will allow us to achieve our stated objective that we told many of you to double our served markets from 2003 to the end of this calendar year 2006. So continue to fuel this growth and maintain our competitive advantage, we are currently planning a future generation of Eclipse products.

And third, the item of dramatically or significantly expanding our scale. When we introduced the Eclipse concept, we were at about $150 million a year in sales. Our revenue rate in the last quarter was 70% greater than that level of business and our growth was far greater than the market over that period. Clearly Stratex has resonated with a large global customer base. As we indicated on our previous call, our performance has enabled further opportunities for collaboration with others as we have with Alcatel. We are currently looking at a number of other possible collaborations that range from further expanding the applications that we serve to substantially increasing our presence in a global marketplace.

Now we're telling our shareholders about our plan at least in general for a couple of reasons. First, we want to remind people that the Eclipse concept when it was introduced was supposed to be far-reaching. It was obviously designed to help turn around the Company financially but it also had some longer-term strategic goals. Now that we're continuing to build traction, that's even more the case. Second, we want our shareholders to know that Stratex is continuing to look at leveraging this progress into further game-changing moves and that the opportunities are now expanding for us.

While we can't be specific about everything that we're working on, I want all of our stakeholders to know that we're totally committed to continuing the momentum that our team here has established. We are dedicated to improving further the operating leverage opportunity that we have now established and doing so in a fiscally conservative manner.

Now how about timing? Well with respect to executing on the first two elements of the strategic plan, that's the strong financial results and expanding our served market, the progress will continue to be reported in the quarterly results. With respect to scale expansion, we hope to be able to show demonstrable results during this fiscal year. Obviously, as this unfolds, we'll keep our stakeholders informed.

At this point, operator, we would like to open the call up to questions.

(OPERATOR INSTRUCTIONS). Ittai Kidron, CIBC World Markets.

Congratulations on a good quarter. Chuck, I had a couple of questions here. I think you mentioned in your speech that the gross margins would've been 32 to 33% without the supply chain constraints this quarter. If that is the case, why didn't -- are we expecting a decline in gross margin as we're going into the next quarter? I would assume some of the supply chain issues that existed in this --

I don't think we said we were expecting a decline, but I'll let --

Well the range guided by Carl is lower than what you mentioned.

I think Carl gave a higher range than that. I think he had 31 to 32% (multiple speakers) 33.

I don't think all of the supply of the lower cost product is expected to be fully opened up by that.

Right, I think it's going to take us through the rest of this calendar year to get that fully opened up and to be able to experience the maximum gross margins that we can form those products.

Is that what is limiting your upside as well on revenue going into the next quarter? I mean just taking the midpoint of your guidance, I mean you're expecting a down quarter in revenue and is that Eclipse related or is that just accelerated depreciation of your older platforms?

I think clearly our older platforms are decelerating or dropping down pretty rapidly now and Eclipse is taking over. We don't feel like we are necessarily constrained on the upper side of our revenue with the supply chain. We broke flood of log jams there this past quarter. There were some general shortages out there and I think we've knocked that down to a much smaller amount. There is some substitution going on as far as the previous EP product in the Eclipse range for some of the HP shipments. So it's allowing us to get those shipments out to the customer but not as high a margin as it would if it was all HP shipments.

Can you give us a little bit of color on what is the margin gap between the HP, SP and the older platform, the EP platform?

I think the differential in the deliveries of the EP product substituting for HP were in a range of 2.5 points this past quarter. That give you something.

Okay. And when we look at Alcatel and you've suggested in the past that Alcatel is going to be a "more meaningful contributor to your financial performance" in the second half of the year, are you still on track for that? And does second half mean September December calendar or fiscal December March?

The second half would be the second half of our fiscal year and yes, we do believe we are on track and we believe that relationship is going well. We see a lot of activity around that account.

Have there been sales to Alcatel this quarter already and if so can you qualify it?

There have been sales. We're not going to be qualifying though this quarter, but there were sales this past quarter.

Matt Robison, Ferris Baker Watts.

Good afternoon and I have to comment on your cash per share going up $0.06 a penny more than your adjusted earnings. So congratulations on that, Carl. A little bit more color on these mix issues that seem like they have got a fair number of moving parts. What was the -- how did Eclipse bookings compare to the March quarter?

The total orders were reasonably flat for Eclipse compared to the previous quarter.

Was that a function of supply chain and leadtimes?

That could have some impact on it. Again, our orders tend to be a bit lumpy and that may have something to do with it.

Where are you leadtimes these days, if you could characterize them?

We probably brought them down now, this past quarter down by a couple of weeks because as we mentioned, we were getting into the ten-week kind of timeframe, eight to ten weeks. We probably brought that down in the eight week or below range at this point depending on the exact product.

Where do you think they need to be, more like four to six?

Four to six I think would be the range that would please our customers and allow us to turn those orders much more quickly.

In terms of throwing out the frequency range, are we talking about higher frequency or lower frequency that you are going to have to be adding between now and the end of December?

We have at this point believe we have filled out most of the popular frequency ranges so it's a mixture as we go out over the next couple of quarters.

What was the headcount exiting the quarter?

Our headcount was 464 exiting the quarter.

So you took it down by I guess 21, it looks like.

No, we were at -- at end of Q4 fiscal Q4, we were right about 453.

Those are full-time folks. There are some contract folks that come in and out on top of that, but.

Oh, I guess I'm doing an apples and oranges comparison.

Okay what's -- can you talk about whether you had any cash from options exercised?

We had some. I don't have that number with me. There were certainly some option exercised during the quarter.

Do you happen to know with operating cash flow was?

I don't have that number with me at this point. I can get back to you on that. The options are -- I don't know. I can get that information.

What should we be thinking about for taxes for the next couple of quarters?

I would keep it in that same range? We've always said, you could assume sort of $500,000 a quarter. It sort of depends on the mix of revenue in each of those subsidiaries but I think that's still a good target tax number generally. As you know, we aren't paying U.S. taxes but our foreign subsidiaries (indiscernible) local service revenue, do have to pay local taxes so --.

What was the best region for bookings?

Middle East, Africa was the best region.

Okay, I will yield the floor and let somebody else ask a question.

Rich Valera, Needham & Co.

It sounds like you built some decent backlog during the quarter, probably bringing your backlog up to somewhere close to the mid $90 million level. Just wondering what's your comfort level with that level of backlog. I think I've had some discussions with you guys that maybe you really wanted to have backlog closer to where your revenue level was to really have adequate leadtimes. Can you just comment on how comfortable you are with that backlog and why do you think that needs to come down?

Yes, I think what we said previously is where we are focused is to bring that backlog down some and bring our leadtimes down to the range discussed previously with Matt on a previous question. So we will continue to focus on bringing that down some. We don't feel completely uncomfortable with it sitting at its present level but do believe in order to get into those leadtime ranges that our customers would like, it needs to come down some.

And I mean with simple math, that would imply a book to bill of less than 1 to get there. Is that something we should sort of be on the lookout for over the next couple of quarters, potentially some book to bills of less than 1?

I don't know if necessarily it will happen in the next couple of quarters. Again we're pretty lumpy in our orders so that's a little bit difficult to predict over the next couple of quarters.

Okay. And on the inventory side, what's been the trend with the legacy products? I mean has that been trending down and are you comfortable with the amount of legacy inventory you have? In other words, is there any risk of write-offs of any of that legacy stuff?

It's been definitely trending down each of the quarters basically for the last year and it certainly trended down this last quarter as well. We're still shipping legacy products certainly through this fiscal year, although it's dropping off fairly rapidly certainly compared to a year ago. And we keep continuing to monitor that. We think we have it scoped out but we do -- there's always some risk certainly that as you get towards the end of the lifecycle some orders that you're taking you will get don't come in and so you have more inventory than you think. But it did certainly come down during the quarter and it's something we are paying close attention to certainly internally.

Tom, I just wanted to make sure I heard correctly. Did you say that the delta in margin between your new HP SP products and the legacy Eclipse was about 250 basis points? Is that what you said?

That was what the differential was in the total gross margins for all the products that we shipped last quarter. The differential from the difference between the EP and HP would be a bit higher than that.

Okay. Can you say how much revenue you did generate from the HP, SP, the new products this quarter?

I don't think we have broken that down specifically in the revenue break down.

Okay. But the plan is by the fourth calendar quarter I guess to have the -- I don't know what you said the large majority of the Eclipse revenue to be from the HP SP?

It will increase each quarter as we go out but it was the fourth fiscal quarter. As we enter into the fourth fiscal quarter, then we would expect the majority of it be from HP, SP and then a minority of it from EP. So it improves each quarter as far as percentage of HP and SP.

Right, okay. And once you are at 100% HP SP, how would you guys think of that gross margin? Is that still something in the sort of high 30 to 40% type of level?

It's what gets us to that target model, assuming the revenue is in that range of the target model, which was 70 to 75 million a quarter. That and the mix coincides with a mid to high 30% gross margin for the whole Company including all of service and so on. So to do that, you'd have to be up in the -- in around the 40% range.

For those products, right?

Yes.

Frank Marsala, First Albany Corporation.

A couple of questions. You talked about regions showing demand now, Middle East, Africa, Russia. Could you talk a little bit about India, your presence in India and what's going on there? And also maybe comment on what you might be able to do in the U.S. and then how does pricing look in any of these regions, whether those where you are seeing good demand or maybe those where you're not quite participating just yet?

I think in India, there is a lot of activity level going on and we're actively bidding on opportunities. That is probably the region where we're seeing some of the most aggressive pricing. So we're being somewhat selective on what we bid on and work on in that region.

I think as far as North America, we expect an increase over the quarter we just entered now and the following quarter from where we were running. Some of that has to do obviously with the data-centric products.

And pricing in general in terms of -- in the areas where you are seeing demand as well?

It has remained competitive. I don't think it has changed much from what we have seen over the last couple of quarters but it remains a pretty competitive environment.

Any 10% customers this quarter? Did I miss that?

Yes, we did have two customers -- actually three that were 10% customers, coming basically out of the region we found out that was strong, Middle East and Africa.

Okay. Then just the last question with Alcatel, any conversations, any updates regarding the consolidation of Lucent, anything that might fall out of the businesses getting together?

We have not seen anything that would detract from our agreement with Alcatel at this point.

Steve Ferranti, Stephens, Inc.

I was wondering if you could dig a little more into the product introduction factors that you had mentioned that affected gross margin in the quarter. And just playing around with some numbers, it looked like that might have been a couple of million in expenses. Can you shed some additional light on those?

Well as we had mentioned, we have been rapidly rolling out new frequency bands for the HP and SP product and there is definitely some costs around those introductions of those products and the number of releases that we have had this past quarter.

Okay, so it's just -- it's nothing out of the ordinary other than just normal product introduction issues.

Correct.

Okay. And can you reiterate, did you expect those to continue into the second quarter?

Yes, I mean we'll pretty well be through the frequency rollouts by the end of our third fiscal, quarter, so we would see that into Q2 and Q3, but it would obviously decline some as we get out into Q3.

Okay. And are there regions that you feel like there may be opportunity to improve your existing distribution arrangements, either through adding additional partners or other arrangements? Are there particular regions that you think could benefit from something like that? Or do you feel you have pretty good coverage at this point?

We're pretty happy with our coverage. We're constantly evaluating that. Latin America is one area that we're looking at at this point specifically if we can get some additional improvements. And basically with the distribution channels and the direct sales we have, we're pretty happy with that coverage today.

Has there been any additional discussions with Alcatel in terms of expanding the product offering that they are currently reselling from you guys?

Today, it's all focused on basically the HP product line. I think there are other opportunities to do some direct sales to Alcatel and we have seen some of that but the contract today covers the HP products. They can buy directly from us outside of that contractor. There has been some of that happening.

Right. Is that in any way tied to the regions where they are seeing the most demand? In other words, the SP product line, I would imagine is focused more towards lower-cost opportunities versus the HP product, which was focused at kind of higher end opportunities. Is that affecting their decision at all?

I think it's kind of early to say. I can't really tell a trend in that area at this point.

Lastly, just housekeeping -- can you walk us through the regional revenue breakdown one more time?

I can do that. On the revenue side, the regional breakdown of revenue was North America was 3.4 million, South America 4.2, Asia-Pacific 14.7; Europe was 13.4; and Middle East Africa, 30.5. While I've got the line, I'll follow up on Matt's comment earlier. We had about 1.2 million of cash that we received from stock option exercises during the quarter and employee stock purchase plan of course, which we have every quarter. So a total of that was a little bit over 1.2 million.

Richard [Grulich], [Wool MD Weir].

Good afternoon. Just a couple of questions. So I understand, when you book the revenues regarding from Alcatel I guess, is that with a one quarter lag, roughly?

No, it's not a one quarter lag. It happens to be on a different cycle than our quarter, so it's less than a one quarter (indiscernible); it's a one month lag basically.

Okay. And the minimum, was there a quarterly minimum associated with the agreement? And did that begin to take place in the June quarter?

Yes, we've said before, there was a quarterly minimum that started immediately on signing the order or the contract actually. Back in our fourth quarter we had some revenue from that. And that minimum was initially to cover our -- make sure (indiscernible) a positive results from the agreement because we did have some upfront costs to get the project organized and to support their requirements and so forth and then that minimum grows over time as the expected ramp is supposed to grow as well.

So roughly what is that in terms of size at this point?

We can't disclose the amount of that contract value.

And Chuck, when you talked about expanded scope and you seemed to allude that this year, there may be some developments you'll be able to talk with more specificity, I wasn't quite sure, are you talking about what sort of product categories or are you talking about geographies?

I would say it's both. What we're talking about here is there is a range of partnerships that we think will allow us to leverage what we have established there in terms of the product coverage and so on. Some of it is technology; some of it is additional geography; some of it is additional distribution channels. And I gave Alcatel as an example of the kind of thing we're talking about but they're all over the map, different potential arrangements.

Do acquisitions, do they figure into your thinking at this point, particularly as it relates to related product categories?

We have been looking at those for a long time but I think if you didn't catch it, one of the comments I made was about being physically conservative. What we really mean by that is that we've been profitable now for three quarters, which we're certainly happy about. But we have no intention of screwing up that path at this point. And clearly we don't have the kind of capital to go off and do something huge at this time in terms of acquisitions. So that's always a potential but it has to fit within some pretty restrictive parameters. In other words, it would have to be accretive and affordable and we would have to do something that we believe would not interrupt our path.

So if there were a huge execution associated with it and we felt we didn't have the bandwidth to carry it out, that would obviously dissuade us from doing something. But don't let me give the impression we're not thinking big. We are thinking big but we want to think in a way that clearly allows us to continue this path of growing profitability.

It was mentioned that service orders were starting to trend up. And is there anything particular about the nature of having Eclipse as the primary product now that would cause service margins to change much going forward?

Yes, we think by the nature of the nodal product and the nature of what we're doing with our customers, getting more involved in the network from the planning, implementation through the life of the network, we believe that that lends itself to more opportunities in that area and actually where we can be more proactive with the customer. We've found that when we are directly involved in those areas, we feel the performance of our product becomes quite obvious to the customer and brings us additional revenue and opportunities as we go down the road. So we believe that is an area that we'll continue to focus on to be proactive and it's becoming more and more important to our customer base.

So that would suggest that you may be into trying to grow that category again. But in terms of the actual profitability of that category, is there any reason to expect that to change much?

You know, it takes some time but as we grow that business to a larger business as we get out several quarters that could have a positive impact on the margin related to that particular business.

Kevin Dede, Merriman Curhan Ford & Co.

It's Kevin Dede. Gentlemen, nice job in the quarter. Very nice bookings number.

Thanks, Kevin.

I was hoping you would give us a little insight on pricing trends, PDH versus SDH. Specifically interested, obviously, in what's going on in the SDH market since that seems to be driving things for you.

As I mentioned earlier, from a PDH standpoint, it's an aggressive market, tends to be the lower capacity areas like India today, which are quite aggressive. The SDH, the pricing arena is pretty much what we have seen over the last few quarters or so and I think it remains an aggressive environment but something that we have been able to manage, especially with getting the cost out of our products as we go forward.

Could you give us a little more insight as to maybe some of the other hangups you might see in the supply chain that you said you have ironed out, Tom, with regard to components and the relative relationship between Benchmark and Alcatel and you guys and sourcing?

I think you know with the Eclipse product, especially the HP, we are putting more and more volume through Thailand through Benchmark. I think there's been somewhat of a learning curve process there. We have really, as I mentioned, focused heavily on processes around that so they become more efficient and we reduce our cycle time. The reason we brought in as a consultant someone I have worked with in the past and they have been on board for several weeks or so now and have made tremendous progress in helping us to identify those key areas as far as processes, document them and start focusing on efficiencies and kind of cycle times of those processes. And as a result, we have started seeing some significant improvements and I think that will only accelerate as we go forward. So I think it's been a little bit of a learning curve.

We have done business with Benchmark in the past but this is a whole new arena with the product type and the volumes, very significant volume ramps in a lot of new frequency bands. So I think we're through the basics of that learning curve and now it's fully implementing those processes and refining them and that will just get better each quarter. As I mentioned, I don't see any major stumbling blocks in pulling us back from meeting customer commitments. It's a matter of how cost effectively we can do that. And that's obviously forefront on our focus.

Is Alcatel relying on you to work with Benchmark to make sure they are a source component for the product that they receive or their customers receive rather?

We look at their forecast and we look at the total capacity at Benchmark and in their supply chain. So I think from that extent, they do; they do place orders directly on the factory. But especially as we're going up this ramp, we have been assisting in that and evaluating that and making sure we've got enough capacity.

But there are no specific issues with regard to specific components?

I think there were very general forecasting and supply chain issues as we had entered into the quarter. I think as you can see by the numbers of what we shipped, we have broken through a lot of that. There'll be continued focus on certain areas to get it more efficient but I think it was more of a general problem as we've looked at it, as we entered into the Q1.

I'm going to fall back on one of my favorite questions. I know you folks have been shipping the Eclipse for awhile now. The EP has been out there. I was wondering if you could give us an indication on how many of those customers in that -- who have received the EP at this point have opted in for capacity increases and how that might be reflected in software sales?

We're going to pass that one over to Carl.

There certainly have been some. We don't have the exact number of upgrades that have been processed through the system. They come through the regional offices, but it definitely had a favorable impact. I'd say it hasn't ramped in the most recent quarter compared to where we have been but it's been a steady flow of software revenue.

A lot of what we are saying is -- I think we have said, Kevin, a long time that it comes -- it's a very lumpy thing; it depends on if someone's upgrading a whole network and that's clearly what we've seen. The trend is up. The last quarter was a little light I think on software upgrades. But there's no reason to believe the trend won't continue to go up.

Right. And at some point in the near future, you will share a number with us?

Well I think that's what we think will happen because we still think it's going to grow to be a significant part of the business.

While I have you back, Chuck, can you give us any sort of timeline on where you think you might have a strategic relationship to talk about?

I said within this fiscal year.

Thanks for taking my questions, gentlemen, and congratulations again on a great quarter.

John Barr, Buckingham Capital.

My question has been answered.

(OPERATOR INSTRUCTIONS). Rob Amman, RK Capital Partners.

Nice quarter. Can you provide some color on the linearity of shipments in the quarter?

They were pretty back-end loaded. Part of that is a result of getting through this supply chain log jam and that happened towards the middle to the end of the quarter so they were pretty severely back end loaded. We see that improving in this quarter and should be much better in the Q3, in our fiscal Q3.

I guess that makes the DSO performance all the more impressive given the back-end loaded shipments?

Those folks did an excellent job.

Carl, I think it was implied but should we expect the use of cash into this quarter given the expected increase in DSOs back toward a more normal level?

Yes, I'm expecting we're going to use some cash this quarter, as you say, mainly for that -- because the DSOs -- we are profitable. Cash isn't the critical -- certainly an ongoing focus but not quite as critical as it was maybe a year ago. But we do expect we will use some cash because of increased receivable balances. A little bit of an offset by I think inventory not going up this quarter. But related to that payables probably go down a bit because we had a lot of purchases right at the end of the quarter this last quarter. So I would say on a net number, it will definitely -- we expect we're going to use some cash this quarter.

And in terms of Alcatel, do you still have an expectation that whether an order flows through them and you get a license on it versus you shipping an order that has a pretty similar impact to the operating income line?

Yes, that still holds true.

Okay. Any color you can give us on what the gross margins were on legacy products in the quarter? Were they high single digits type gross margins?

They were pretty consistent with where they've gone over the last couple quarters. There wasn't any big change. On legacy product, basically, people are buying them because they have a large installed base and want to continue to buy for a little bit longer. So on a margin percent basis, they didn't change as much as I -- I will look in a second but I don't think they changed much from the prior quarter.

And then service gross margins, I think last year, they were somewhere around 18% or so. Is that a good expectation going forward?

They were in that range, kind of range. Going forward -- I mean they were in that kind of range this past quarter; then going forward we expect those to improve.

Okay, great. And then just in terms of metrics, we should use to track success on the supply chain initiatives that -- other than I guess leadtimes would be one of the most critical ones, obviously gross margin improvement and inventory levels. Is there anything else we should be thinking about, something that you could provide to give us quarter to quarter color on the improvements in the supply chain?

That and I think as you -- the question earlier was linearity. That would be probably the additional metric, look at how much we shipped each week during the quarter.

Then last question, as you attempt to wean us off of getting an orders number here, what should we expect next quarter? Just maybe color in terms of whether the book to pill is positive or negative or will you frame it the same way you did this quarter in terms of saying something like mid '70s or whatever the number might be?

Yes, I think what we said is, this is going forward, we'll probably talk about whether it's positive book to bill or if it's negative book to bill. But in terms of getting into specific dollars, we use the dollars this quarter to do sort of a transition for folks. But really next quarter will just be a positive book to bill or not, (multiple speakers) had some major implication; we talked about that.

Matt Robison, Ferris Baker Watts.

I was wondering if yields were a factor in your negative margin variance for the ramp?

No, not necessarily. We didn't have any significant scrap as a result. Obviously, as we go through the ramp, we expect the yields to continue to improve. But we really didn't have anything like significant scrappage. There's a little bit of rework but that's mostly labor and it's pretty insignificant.

So it was all really about expediting?

A lot of that around the supply chain, correct. The administrative costs around the supply chain and expediting parts and that type of thing.

Rich Valera, Needham & Co.

Thank you. Could you give the split of your business right now between SDH and PDH?

Yes, the SDH was about 70% and PDH was approximately 30%.

Great and --

Let me just add something to that, Rich. Because we're in also non-traditional businesses, like the data transmission business, we use SDH and PDH because most companies use that to classify it. But you're probably well aware that that's not (inaudible) -- because Eclipse is a somewhat unique product. We are really talking about high capacity versus low capacity in the split that Tom mentioned. At the high end, high-capacity may actually be PDH for us just because of the unique capabilities called super PDH in the Eclipse and also in the data transmission business and the Ethernet market. So that's shorthand so that everybody understands just to compare to other people. But it isn't really the case with Eclipse.

In terms of the portion of your business, that would be in that sort of low capacity relatively high priced pressure market? Was that still be sort of a 70/30 split between the high end and the low end?

It would be the 30 number that Tom was talking about.

Okay, that's great. And then just following up on the sole issue of sort of the startup costs, sounds like roughly 200 basis points. Is it fair to assume those sort of go to zero over some time period, maybe the next couple of quarters? Is that the way we should look at that?

It definitely decreases over the next couple quarters and I think as we get into our third fiscal quarter, it becomes much less than it was in Q1.

Okay. And then given the sort of historical philosophy of the Company of almost continuous product introductions, what is to stop some kind of startup costs again as you come up with a successor product to the current HP, SP? I mean, you are kind of -- you've talked about being in this continuous innovation mode and obviously if you have startup costs all the time, we're never going to achieve these sort of idealized margins.

I think the big focus is around the process itself and making it scalable. I think we grew very quickly in number of units shipped, the new product introduction, so we somewhat outstripped our processes that were in place and well-documented now. As I mentioned, we've got a pretty much an expert in helping us with reviewing that, getting those reidentified and documented and then people trained on them. And I think with that in hand, that should allow us to handle those introductions more efficiently as we go forward. There's always some cost there, but I think we can pull those to a reasonable level.

The other thing I would comment on, we have been doing introductions all through the last -- as you know, through the last, certainly the last year pretty aggressively and the margins have gone from 23 to over 30% during that time frame. So we have been able to handle those cost impacts pretty well during that whole period. Last quarter was a little bit flat quarter to quarter, but nonetheless, if you look at the trend line, it's certainly very positive.

This concludes the question-and-answer session. I would now like to turn the conference over to Tom Waechter for any closing statements.

Thank you, operator, and thank you all for your questions and continuing interest in Stratex Networks. We plan to participate at the CIBC World Markets Wireless Technology 1-on-1 Conference on August 3rd, which obviously is tomorrow in New York. We are also scheduled to present at the Merriman Curhan Ford & Co. Investor Summit in San Francisco on September 20th. We hope to see many of you at these events. Thank you and good bye.

Thank you. Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect.