Aviat Networks Inc (AVNW) 2007 Q2 法說會逐字稿

Welcome to the Stratex Networks 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. Instructions for queueing 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, please go ahead.

Thank you for joining Stratex Networks today to discuss financial results for the second quarter of fiscal 2007. On today's call will be Tom Waechter, President and CEO and Carl Thomsen, CFO of Stratex Networks. They'll review the results of 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 in the wireless industry in general, including statements relating to the pending merger with the Microwave Communications Division of Harris Corporation, the status on integration planning related to the pending merger, the future results of the combined companies, our market share, future revenues, margins, operating expense and net income or loss, balance sheet improvements, DSOs and inventory turns, foreign taxes, anticipated introduction, performance, market acceptance and financial impact of new products, in particular, the Eclipse product, future profit projections and future results of operations 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 telecommunications and mobile cellular projects, an economic and political instability in the Middle East and other markets in which we compete or in which our products are manufactured, risks related to the integration of Stratex for the Microwave Communications Division of Harris.

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 November 1, 2006 and any forward-looking statements that we may make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of future events.

Now I'd like to turn the call over to Mr. Carl Thomsen.

Thanks, Mary, and welcome to everyone that's listening in on this conference 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 in the past couple of quarters, we included both GAAP and non-GAAP results in our press release, which can be found on our Web site. We believe these supplemental non-GAAP financial results which are used by management reflect the basic operating results of the Company and facilitate comparison of operating results across reporting periods. For the $2.6 million non-cash charge related to stock option costs is calculated under Financial Accounting Standard 123R and related to our restricted stock plan in the second quarter.

In addition, including in selling, general and administrative expenses are about $1.5 million in third-party costs we incurred for legal expenses, a fairness opinion and due diligence costs directly related to the proposed merger with the Microwave Communication Division of Harris Corporation. Both the non-cash stock charge and the merger-related expenses are excluded from the non-GAAP reporting results. For ease in comparison to prior periods, I'll be discussing the results based on a non-GAAP results which were included with the press release and we also included a reconciliation to the GAAP results.

Now before I go into the specifics of the financial results, I'd like to take a few moments to talk about the regarding proposed merger of Stratex Networks with the Microwave Communication Division of Harris Corporation, which was announced on September 5th. Form S-4 was recently filed with the Securities and Exchange Commission and is under review. Hart-Scott-Rodino materials were provided to the Department of Justice and we were informed that their review has been completed and that the pre-merger notification period expired without action being taken by antitrust regulators. Once the SEC review is completed, we'll be mailing a proxy to our shareholders to vote on this proposed transaction.

We anticipate the transaction will close early in calendar 2007. As we indicated in the conference call when the proposed merger was announced, we believe this combination would create a stronger company with considerably greater scale. Tom will comment more on the status of the merger in a few minutes.

First, let me summarize the second quarter results. Fiscal year 2002 second quarter revenue was $67.3 million, a 19% increase from the same quarter last year, a sequential increase and above our guidance of 64 to $66 million. Gross margin on a non-GAAP basis were 31.1%, also a sequential increase and a significant increase compared to the 27.1% gross margins that were reported in the year-ago period. The second quarter we reported non-GAAP net income grew to $5.6 million, or $0.06 a share. We were pleased to again report positive results.

This is a major improvement compared to the $1.3 million loss we reported in the second quarter of last fiscal year. For the first six months of fiscal year 2007 we reported non-GAAP net income of $10.4 million compared to a net loss of $5.3 million in the first six months of last fiscal year. These continually significantly improving results reflect the significant progress we are making in many areas of the Company to increase sales, manage costs, and improve efficiencies.

I'll review some of the specifics related to the quarter. First on revenue, revenue by product line, Eclipse revenue is $50.8 million. The other legacy products, $7.0 million, and services totaled $9.5 million for a total of 67.3. By geography, the Americas were $7.2 million, Europe was $12.7, Middle East and Africa, which includes Russia, was $35.1 million and Asia-Pacific's $12.3 million. Eclipse revenue was 88% of total product revenue in the quarter, up from 65% of product revenue in the second quarter of last fiscal year.

Business in the Middle East, Africa, and Russia continues to be very strong as we were supporting major infrastructure buildouts in these regions. Gross margins were 31.1% in the second quarter compares to 27.1 in the second quarter of last fiscal year and 30.3% in the prior quarter. This result is in line with the forecast given in last quarter's conference call of 31 to 32%. Margins are continuing to move toward our stated goal of 38% and based on the current mix of anticipated business in Q3, we expect gross margins to increase again. Underlying product margins actually improved over 2% in the second quarter compared to the prior quarter, however, this favorable result was partially offset by lower absorption of manufacturing overhead cost as we substantially reduced inventory and inventory purchases during the quarter.

Now let me turn to operating expenses. Total operating expenses were $15 million, about the same as the $14.9 million in the prior quarter. R&D expenses of 3.6 were down slightly compared to 3.9 in the first quarter due to lower material costs while selling, general and administrative expense was $11.4 million in the second quarter compared to $11 million in the prior quarter.

I expect total operating expense to be about the same in Q3 as in Q2, excluding charges for the restricted stock and stock option expense and costs directly related to the merger effort. Operating income on a non-GAAP basis was $5.9 million compared to $200,000 in Q2 of last fiscal year, and $5.3 million in the prior quarter. Operating income for the quarter was 8.8% of revenue. This continued improvement over the 8% reported in the first quarter moves closer to our 12 to 15% operating margin target. Operating margins both in absolute dollars and on a percent of revenue have improved every quarter since the beginning of last fiscal year.

Those of you that have followed Stratex for some time will appreciate how pleased we are to report these continuing improving results. Interest and other expenses was a net expense of $268,000 in the quarter compared to a net expense of $256,000 in the first quarter and tax expense for the quarter was $23,000. Net income for the quarter was $5.6 million. Earnings per share on a non-GAAP basis were $0.06 per share on the high end of the guidance given that the beginning of the quarter of $0.04 to $0.06 per share.

Now let me comment on the balance sheet. As I forecast at the beginning of the quarter, we did use cash for working capital during the quarter. Cash balance was $55.7 million at the end of the second quarter compared to $61.3 million at end of the first quarter. This decrease is a result of payments of $2.8 million to reduce our term loans as well as increases in working capital. Cash was impacted by an increase in DSOs to a more normal 69 days and this increase in DSO was partially offset by a decrease in inventory.

On the balance sheet we're showing restricted cash of $2.6 million this quarter. This is a short-term restriction related to VAT taxes in Europe and will be cleared during the third quarter. Total accounts receivable at $51.4 million increased in the prior quarter and DSOs are in line with the 65 to 70 days that I've been saying for some time is what I expect given our heavy international business.

As I indicated in last quarter's call, inventory management and inventory turns continue to be a major focus by management. I'm pleased to report that inventory decreased $7.5 million to $39 million from $46.5 million at the end of the prior quarter and inventory turns improved to 4.3 times. I expect inventory turns will continue to increase as we are focused on supply chain management and related process changes.

Our order to ship cycle times are continuing to improve and had a positive impact on our ability to meet customer delivery requirements and revenue objectives. Total liabilities decreased $5.1 million in the second quarter, primarily due to the regular quarterly pay down on the term loans as well as a decrease in accounts payable.

Now for our forecast for the third quarter of fiscal year 2007. As most of you know, we're very pleased with the continued progress we're making in 2007 compared to the -- building on the major turnaround in results in return to profitability that was accomplished in last fiscal year. As the merger with the Microwave Communication Division of Harris is expected to be completed prior to the time Stratex would report its third quarter results, it's unlikely that separate financial results for Stratex will be reported for the third quarter.

However, we do expect third quarter will continue to show improvement in financial results and, importantly, in our supply chain status and ability to respond rapidly to customer deliver requirements. Based on backlog going into the quarter, anticipated new orders shippable in the third quarter, we're forecasting revenue of 64 to $67 million in third quarter, a continued improvement in gross margin percentage and non-GAAP earnings per share of 5 to $0.07 per diluted share. I will say there's more risk or variability in the quarter outlook than there has been in the past for a couple of reasons.

One, we're moving more to a book and ship model within the quarter and we're more dependent as a result on new orders to meet our forecast. And two, while I've assumed some disruption related to the merger activities, it is clearly difficult to predict the specific magnitude that this might have on near-term guidance. I will say that we plan to hit the ground running once the merger is approved and are very positive about the overall Stratex outlook and the outlook for the merged companies.

I'd also like to note that similar to Stratex, the Microwave Communication Division of Harris reported excellent financial results for the September quarter with revenue increasing 24% over the prior year to $93.6 million and operating income increasing to 8.4% of revenue, up from 4% in the prior year. [This] total revenue for the combined company for the past 12 months was about $620 million. Clearly, as we stated at the time of the merger announcement, when approved, the Harris Stratex Networks will be a significant supplier in the markets we serve.

I'd now like to turn the call over to Tom Waechter for an operational summary and comments on the Company's market position, on Eclipse status on the merger activities.

Thanks, Carl. With the strong financial results as reviewed by Carl, the Stratex Networks team continues to achieve its strategic goals. This was the fourth consecutive quarter of profit, which is a great achievement by our employees providing a clear signal that the Company and the market are on solid ground. The non-GAAP net earnings of $5.6 million are a significant turnaround from the $1.3 million loss from the same quarter last year. Robust, top line growth of 19% compared to last year and gross margin increasing to 31.1% of revenue were the direct result of the Eclipse product line growing to 88% of the total equipment sales.

The dynamic combination of strong Eclipse sales, which exceeded $50 million for the second quarter in a row, and the tight controls on operational expenses led to non-GAAP operating income that was 8.9% of revenue and a bottom line profit of $0.06 per share. Along with delivering these excellent financial results, our employees were able to continue to drive operational improvement and improved customer satisfaction. Volume shipments increased as the supply chain and manufacturing process improvement continued to take hold. Aged backlog and delivery lead times were further reduced during the quarter.

These lead times are starting to align well with customer expectations and future desires and place Stratex Networks in a much better competitive position to the point that in future periods a large percentage of orders will book and ship within the same quarter. Our objective, as we noted at the last earnings call, has been to leverage the latest Eclipse designs to move quickly into more of a turns business and less of a backlog-driven business. Although we don't publish orders any longer, we can say that per our expectations, the book-to-bill for the quarter was less than 1.

In the past, this may not have been good news, but with revenue continuing to be strong, it is a demonstration of our plan to use lead times as a competitive weapon is working. Although orders have been lumpy in the past, as this transition occurs over the next couple of quarters, we expect orders to be more closely match revenue. A key indicator of the improved operational performance in the quarter is that along with shrinking lead times, inventory levels were reduced by $7.5 million.

This resulted in improved overall inventory turns of 4.3 times. When calculated separately, Eclipse related inventory achieved approximately 7 turns. On the product development front, the engineering teams continued to fill out additional frequency bands for the Eclipse product family. There were four new ODUs and one new IDU released during the quarter. By the end of the calendar year we expect to have all of the high-volume frequency bands released for both the new, lower-cost Eclipse high-capacity and low-capacity product.

This should provide an even stronger competitive position in the market as well as improved gross margins. With respect to new technology and market opportunities, we see the advance of carrier-grade ethernet as a window of opportunity for Stratex Networks. We continue to be an innovator and leader in this area. Recent carrier-grade ethernet compatibility tests confirmed our strong capabilities in this area and the performance validated our patent pending technology known as Resilient Wireless Packet Ring.

Stratex Networks is chairing the mobile backhaul group that was recently formed by the Metro Ethernet Forum. The charter of this forum is to accelerate the worldwide adoption of carrier-class ethernet networks and services. The Metro Ethernet Forum develops technical specifications and implementation agreements to promote interoperability and deployment of carrier ethernet worldwide. Based on our technology and leadership role, we strongly believe that we are well positioned as the mobile market moves to ethernet.

Activity levels remain strong in the wireless transmission markets around the globe. Network buildouts in Africa, Middle East, Russia, and eastern Europe continue to be prime opportunities for Stratex Networks. We are seeing an acceleration of demand for IP-based microwave backhaul products. This is starting to drive additional demand across all regions, but especially in western Europe and North America. 3G-like services are starting to take hold.

Now I will give a brief update on the previously announced formation of the new company, Harris Stratex Networks through the combination of Stratex Networks and the Microwave Division of Harris Corporation. As you may recall, this announcement took place on September 5th. Earlier, Carl provided a status of the regulatory filings and approvals and the fact that the closure date, based on Stratex shareholder approval, is expected to take place in early calendar year 2007.

First of all, let me recap the strategic reasons for forming the new company from a combination of the two businesses. Harris Stratex Networks, the new company, will benefit from much greater scale, a robust and a leading edge product portfolio, distribution and sales channels in 135 countries, and significant annual cost synergies of approximately $35 million achieved by fiscal 2008. We expect that the majority of the integration-related costs will be incurred in the first half of calendar 2007.

The timing for the start of this new company is very good from a market perspective as the wireless transmission market is enjoying strong worldwide demand. Integration planning is well underway. Specific integration projects has been identified, which align with synergistic cost savings and other key objectives. Leaders and team members from both companies have been assigned to these projects and they are progressing rapidly in their planning process. With day one activities identified and detailed plans shaping up, confidence in achieving the operating plan for Harris Stratex Networks is high and we are all anxious to get started.

In finalizing my remarks for today, I will quickly summarize the quarter. Stratex Networks team turned in the fourth consecutive quarter of profitability. Top line growth of 19% compared to the same quarter last year was strong with the Eclipse product line making up over 88% of equipment sales. Profitability on a non-GAAP basis reached $0.06 per share and is a huge recovery compared to $0.01 per share loss of a year ago. Operating expenses remained under control even though significant investment continues in R&D. The Eclipse product offering is quickly rounding out with the introduction of new frequency band.

Stratex Networks is strengthening its position in the quickly evolving carrier-grade ethernet market. Operational improvements have resulted in shorter lead times and a significant inventory reduction for the quarter. Rapid progress is taking place with respect to integration planning for the start-up of Harris Stratex Networks. The Stratex team is excited about this new opportunity and congratulates the Microwave Communications Division of Harris on their strong performance in the recently announce quarter.

I will now open up the conference for questions.

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

Congratulations, Tom and Carl. Looking as we get closer to the merger, can you give us an idea of what the customer reaction has been so far to the combined company or what they are telling you they believe will happen?

I think in general the reaction by the customer base has been positive. I think they do see the increased size as a result of the combined companies being a big benefit as well as our ability to continue to invest heavily in our innovative product platforms.

When you look at the supply chain improvement that you've been undergoing, can you give us an idea of how far along you are with the process changes and what we can anticipate going forward?

We spent last quarter and, I'm talking about Q1 and beginning of this quarter defining improved processes and scalability of those processes as our unit volume is going up pretty significantly. During this past quarter, during Q2, we actually started the implementation of some of those processes so we are underway with the implementation.

We believe we'll be at least 75, 80% through that as we end this December quarter. So we're moving quickly on it. I think we're making real good progress, and I think you've seen that in the results for the quarter.

Okay. And one final question. When you look at the gross margin target of 38% and where you are right now, how much of that improvement is coming from the supply chain in process and how much is moving to the newer products and product mix favoring Eclipse still?

A good percentage is the mix improvement around the Eclipse products as we're getting to the lower cost, newer generation of that product. So that's the bulk of it. We are, obviously, working with our suppliers to continue to get cost out the various parts of the supply chain.

By nature of getting our lead times down and the cycle times down, that also brings cost down. So there is a certain percentage related to supply chain improvements but, again, the bulk of it is related to the mix of improvements around Eclipse.

How much is coming from the newer HP/SP products versus the older EP product?

If I combine the EP and, excuse me, the HP/SP product along with what we call our E100, which is a low capacity, it was above 50% in the 55 to 58% range.

Thank you.

You're welcome.

Thank you. And Our next question comes from Matt Robison with Ferris Baker Watts. Please go ahead.

Hi, this is actually Michelle [Haw] for Matt Robison. A couple of housekeeping questions. First, what was your headcount this quarter?

Our headcount was about 540, I believe.

540.

About 570 I think [at] the end of the quarter. [multiple speakers]

I'm sorry, the final number was?

I'd say 570.

570. Thank you. Why was your R&D expense lower this quarter? You had mentioned that it was due to lower material costs. Could you explain that?

The material development cycle at some points in the process, you're buying a lot of material to do test products and design and so forth. This past quarter there wasn't that much new material being used up by engineering to build prototype products.

The engineering headcount's really stayed the same or went up a little bit. But the amount of material costs this last quarter really wasn't as great as it was in the prior quarter. I'd expect going forward it's going to be about -- it'll go up a little bit this coming quarter.

Okay.

It tends to go in cycles.

Okay. And why was tax down?

That's based on year-to-date for each of our, you know, we have a number of foreign subsidiaries, so it really depends where the profits are in each of those subsidiaries around the world. Some of those subsidiaries have tax loss carry forwards still so there really isn't any tax due.

And if you down on a year-to-date basis those are what the tax rates were in each of those jurisdictions. We've always said usually say taxes are 2 to $300,000 a quarter but they can vary depending on where the profits were in the particular quarter.

In the U.S., of course, which the bulk of the business is generated out of the U.S. in terms of profits, because that's where all the R&D is, there weren't -- we don't pay any taxes because of our tax loss carry forwards.

And why was share count down?

That has to do with -- that's on a diluted basis so that has to do with what the stock price was at the end of this quarter compared to, or the average price for this quarter compared to last quarter, which was higher so there were fewer shares bought back under the treasury stock method than there were -- or it was a reverse, was lower this quarter than last quarter, there were more shares bought back under the treasury stock method.

Okay. That makes sense. Thank you. And final question before I get back in the queue. In the presentation that was given out regarding the merger, there was a target of 25% in your operating expenses as a percentage of sales. Is that a pro forma number? Does that include stock-based compensation?

That includes stock-based compensation.

It does include stock-based compensation?

Yes.

Okay. All right. I'll get back in the queue. Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Steve Ferranti with Stephens Incorporated. Please go ahead.

Hi, guys. Nice quarter.

Hi, Steve. Thanks.

Can you talk a little bit about where lead times where during the quarter?

We're now quoting 45-day lead times. Down pretty significantly from where we were about a quarter, quarter and a half ago.

Yes. Good. I'm wondering if you can maybe give us an idea of the $40 million in inventory that's on your books now, can you give us an idea of how much of that is legacy product versus a newer product?

The vast majority is newer products, let's say, somewhere in the range of 10% is legacy product, 15%.

Okay. And where are you targeting inventory turns to go? I think you talked about Eclipse north of 7 times in the quarter. Where do you think that number can go as you migrate more fully to this new business model?

I think with the new business model, we should get in the 6 plus range pretty comfortably. Getting above that today may be somewhat difficult, but I think the 6 plus range would be reasonable.

Okay. It's somewhat interesting that book-to-bill coming down is actually a positive thing in this case. At what point do you start getting nervous where the book-to-bill gets actually too low?

As we mentioned, if we get our lead times down to about 45 days, we're going to have to book and bill a fair amount of revenue during the quarter. So it's the nature of the model and competitiveness that we're driving to. We do expect that to start equalizing in a couple of quarters. If two to three quarters out we're seeing less bookings than billings then we'll start getting concerned about that.

Okay. And can you just give us an idea of where we are in terms of capacity utilization on the lines of benchmark?

The utilization in benchmark is approximately in the probably in the 70% kind of range. It varies somewhat during the quarter. We're still a bit hockey sticked at the end of the quarter, so it's much heavier utilization at the end of the quarter than the first two months. We're working on that and it is improving. But I'd say if you looked at that across the entire quarter, we're probably in that type of range.

And where do you like to see that ideally? You mentioned lower absorption of overhead as an impact on, a slight impact on gross margins this quarter. Where do you like to see that number?

I think if we were running consistently in the 75 to 80% range average across the quarter, that would be a reasonable efficiency or utilization type of factor.

Okay. Thanks for taking my questions.

Thank you.

Thank you. And our next question is a follow-up from Matt Robison, Ferris Baker Watts. Please go ahead.

Hi. Can you give us any milestones for the completion of the merger and timing?

The only really milestones we give, we did just get the -- or the Hart-Scott-Rodino, as we said, that issue's behind us at this point. So the next milestone will be when the SEC completes their review of the S-4 that we filed, and we filed that early last month, so second week in this month we should get any comments they have related to that filing and then, of course, we need to respond to those appropriately and then once those are resolved we can mail the proxy.

But at this point, we're dependent on the timing of the SEC completing their review. And then once the proxy's filed, there's a minimum of 20 days before the shareholder meeting can be held which is why we're expecting that all of that will take till late December or sometime in January to be completed.

And what was your Cap Ex this quarter?

Cap Ex year-to-date is about $3 million I think.

Around $2.4 million.

Yes, $2.2 year-to-date including some service parts that we include in capital.

That was about half of that we spent this quarter. So it's about 50% of that first quarter and 50% of it this quarter.

Great. Thank you.

Thank you.

At this time, we have no further questions in queue. I would like to turn the conference back to Tom Waechter for any concluding comments. Please go ahead, sir.

Thank you, operator. And thank you all for your questions and continuing interest in Stratex Networks. Please note that we plan to participate at the AEA Classic Financial Conference on November 6th and 7th in Monterrey and at the UBS Global Communications and Technology Conference on November 15th in New York.

We're also planning to present at the Needham Growth Conference in New York this coming January. We hope to see many of you at those events. Thanks and good day.

Ladies and gentlemen, that does conclude the Stratex Networks second quarter fiscal 2007 financial results conference call.

If you'd like to listen to a replay of today's conference you may dial 303-590-3000 and use pass code 11072669 pound to access the conference. We thank you again for your participation today and you may now disconnect.