Aviat Networks Inc (AVNW) 2024 Q3 法說會逐字稿

Good afternoon. Welcome to Aviat Networks third-quarter fiscal 2024 earnings call. (Operator Instructions) Please note, this conference is being recorded.

I will now turn the conference over to your host, Mr. Andrew Fredrickson, Director of Investor Relations. You may begin.

Thank you, and welcome to Aviat Networks third-quarter fiscal 2024 results conference call and webcast. You can find our press release and updated investor presentation in the IR section of our website at www.aviatnetworks.com, along with a replay of today's call.

With me today are Pete Smith, Aviat's President and CEO, who will begin with opening remarks on the company's fiscal third quarter, followed by David Gray, our CFO, who will review the financial results for the quarter. He will then provide closing remarks on Aviat's strategy and outlook followed by Q&A.

As a reminder, during today's call and webcast, management may make forward-looking statements regarding Aviat's business, including, but not limited to, statements relating to financial projections, business drivers, new products and expansions, and economic activity in different regions. These and other forward-looking statements reflect the company's opinions only as of the date of this call and webcast and involve assumptions, risks, and uncertainties that could cause actual results to differ materially from those statements. Additional information on factors that could cause actual results to differ materially from the statements made on this call can be found in our most recent annual report on Form 10-K filed with the SEC. The company undertakes no obligation to revise or make public any revision of these forward-looking statements in light of new information or future events.

Additionally, during today's call and webcast, management will reference both GAAP and non-GAAP financial measures. Please refer to our press release, which is available on the IR section of our website at www.aviatnetworks.com and financial tables therein, which include a GAAP to non-GAAP reconciliation and other supplemental financial information.

At this time, I would like to turn the call over to Aviat's President and CEO, Pete Smith.

Thanks, Andrew, and good afternoon, everyone. Let's review Aviat Network's results for the third quarter of fiscal year 2024. We are pleased to report that Aviat continued execution of its organic growth strategy and made further progress on its Pasolink acquisition. Highlights from the third quarter include total revenue of $111.6 million, which represents growth of 34% versus Q3 of last year. Core Aviat revenue growth of 7% versus the same period last year.

Non-GAAP gross margin of 35%, with core Aviat margins above 38%. Adjusted EBITDA of $12 million, 11% higher than the year-ago period. Non-GAAP EPS of $0.73. Strong cash generation in the quarter, with $59.2 million of cash and marketable securities on a balance sheet and a net cash balance of $10 million. These financial and operational results are driven by the continued implementation of Aviat's operating model and made possible thanks to the effort and execution of the Aviat team and our partners throughout the quarter.

Let's review key highlights of the third quarter. We continue to progress the integration of the Pasolink business. In our first full quarter of ownership, we accelerated the execution of cost structure optimization and approached our near-term profitability goals. These efforts will continue to accelerate over the next two quarters as Aviat moves away from transition services provided by NEC.

The Pasolink business was nearly break-even on an EBITDA basis in the quarter and was accretive to our pre-cash flow generation. As we have onboarded Pasolink customers, we have undertaken a customer profitability review to ensure margins are at sustainable levels. While work is still ongoing, we expect that this will result in a slower ramp to the target $140 million annual run rate contribution. However, this should translate to more attractive business for Aviat shareholders.

Beyond the existing Pasolink base, the sales teams continue to build cross-selling opportunities where we are introducing Pasolink products to historical Aviat customers and vice versa. We have already converted some of these into bookings and expect this will continue to grow in the quarters ahead.

From a cost perspective, we are tracking to our internal plan to reduce cost of goods sold and excess inventory from the Pasolink business. We had some wins in the quarter and anticipate beginning to realize some more significant savings in the current fiscal fourth quarter, primarily from inventory rationalization.

Further, inventory optimization and cost savings will materialize in fiscal year 2025. Overall, the transaction is tracking to an IRR in excess of 2.5 times Aviat's weighted average cost of capital.

Moving on to the core Aviat business. In private networks, investments and upgrades to networks both in the US and internationally continued to support growth in this segment. The recent US nationwide Tier 1 outage underscores the importance of private public safety and critical infrastructure networks. Our customers turn to Aviat for design and operation of networks that are engineered with a high degree of redundancy and reliability. Aviat's equipment enables first responders, utilities, and governments to continue communicating even when public networks are compromised.

Driving further investment in private networks is the recent authorization by the FCC at the end of February for companies to begin offering automated frequency coordination systems, or AFC, for spectrum in the 60-yard span. This is an exciting development that will likely lead to more fixed wireless access usage. However, concern persists among many of our private network customers as their microwave backhaul largely utilizes the 6 gigahertz band, creating the possibility for interference.

We've been preparing and have developed a comprehensive suite of solutions to protect these networks by detecting and correcting interference issues. Our frequency assurance software, or FAS, is patented software that analyzes customers' networks to detect interference and suggest remediation actions.

Working on Aviat radios and the radios of a leading competitor, FAS allows a network operator to have confidence in their network's reliability and performance even in the face of potential interference without having to move communication to a new band. Once interference is detected or for proactive customers who wish to avoid the possibility entirely, Aviat offers two solutions.

First is an ultra-high-power radio at 11 gigahertz to enable customers to move to a new band. We estimate upwards of 80% or more of the 90,000 6 gigahertz microwave links in the US can move to 11 gigahertz with this product.

Second is a new, innovative multiband solution operating at 6 and 11 gigahertz and utilizing the 11 gigahertz UHP radio specifically designed to protect longer link distances. These new offerings represent a large opportunity for Aviat to solve a growing problem for our customers and we believe we are several quarters ahead of our closest competitor with these products.

In the third quarter, we made several updates to our products to better address our private network customers. We released one-plus-one hardware protection on our WTM radio platform. This is important to open the all-outdoor radio market in mission-critical segments such as with public safety, federal, and utility customers.

We also released a new hardware variant of our CTR router to improve the interface and address the growing capacity needs of our router customers. These upgrades will help to sustain our leadership in the private network segment. Additionally, we want our first major LTE radio access network deal in an international military application which is an exciting adjacency market based on our redline acquisition.

In mobile networks, we continue to execute the server on global Tier 1 and Tier 2 operators where many cases are still in the middle of or just beginning to build out their microwave 5G networks. To enable pass-only customers to better manage their networks and to further expand the addressable market for our software, we will roll out support for our pass-only portfolio in our ProVision management platform in Q4 fiscal year 2024.

In India, we received our first orders for microwave backhaul radios. Previously, we have been selling only our eBand and multiband solutions. The microwave backhaul order is exciting as it represents Aviat's first sale into a $200 million Indian microwave segment that had previously been unaddressed by Aviat.

With that, I will turn it over to David to review our financials before coming back for some final comments. David?

Thank you, Pete, and good afternoon, everyone. During my remarks today, I'll review some of the key fiscal 2024 third-quarter financial highlights. Noting our detailed financials can be found in our press release and 10-Q file this afternoon. As a reminder, all comparisons discussed today are between the third quarter of fiscal 2024 and the third quarter of fiscal 2023, unless noted otherwise.

For the third quarter, we reported total revenues of $111.6 million as compared to $83.5 million for the same period last year, an increase of $28.1 million, or 33.7%. On a constant currency basis, our revenue would have been $114.5 million. North America, which comprised 40% of our total revenue for the quarter, was $44.4 million, a decrease of $3.6 million from the same period last year due to the near completion of a large Tier 1 project. For the first nine months of fiscal '24, North America is up 3% versus the prior year, and booking is in backlog to remain strong.

International revenue was $67.2 million for the quarter, an increase of $29.8 million, or 79.7% from the same period last year. The addition of the Pasolink business contributed $22.5 million of that growth, while the core Aviat business grew by $7.3 million, or 19.6%. The strong organic growth was driven by Latin America and Asia Pacific regions, offsetting weakness on the African continent.

Our trailing 12-month book-to-bill ratio remained above 1, as it has since fiscal 2018. Gross margins for the quarter were 32.7% on a GAAP basis and 35.2% on a non-GAAP basis, as compared to 35.7% GAAP and 35.9% non-GAAP in the prior year.

GAAP margins were impacted by $2 million write-down of Aviat inventory that will be replaced in the market by Pasolink products, as well as $0.6 million in amortization of the inventory step-up purchase accounting adjustment. Non-GAAP margins were diluted, as expected, by the impact of the Pasolink business. Core Aviat non-GAAP margins for the quarter were very strong at 38.4%, driven by product mix and operational productivity.

Third-quarter GAAP operating expenses were $31.5 million, an increase of $9.2 million from the prior year, driven by the addition of approximately $5.5 million in Pasolink-related OpEx, M&A expenses, and increased core R&D expenses. Non-GAAP operating expenses, which exclude the impact of restructuring charges, share-based compensation, and deal costs, were $28.5 million, an increase of $7.9 million, driven by Pasolink and increased R&D.

Third-quarter operating income was $5.0 million on a GAAP basis and $10.8 million on a non-GAAP basis, compared to prior year GAAP of $7.5 million and non-GAAP of $9.3 million, where a decrease of 32.9% and an increase of 16.2%, respectively.

Third-quarter tax provision was $0.6 million, compared to $2.2 million last year. Starting in Q3, we have increased our non-GAAP cash tax estimate from $0.3 million to $0.5 million per quarter as a result of the Pasolink acquisition. As a reminder, the company has nearly $500 million of NOLs that will continue to generate shareholder value via minimal cash tax payments for the foreseeable future.

Third-quarter GAAP net income was $3.4 million, down from $4.9 million last year, due to the previously mentioned M&A related expenses. Third quarter non-GAAP net income, which excludes restructuring charges, share-based compensation, M&A-related costs, and non-cash tax provision, was $9.4 million, compared to $8.9 million for the same period last year. An increase of $0.5 million, or 5.6%, driven by core revenue growth and margin expansion, partially offset by the additional R&D investment and modest dilution from the Pasolink business.

Third quarter non-GAAP EPS came in at $0.73 per share on a fully diluted basis, compared to $0.75 per share for the same period last year, a decrease of 2.7% as a result of the shares issued in connection with this Pasolink acquisition. Adjusted EBITDA for the quarter was $12.0 million, or 10.8% of revenue, an increase of $1.2 million, or 11.1% from the prior year.

Moving on to the balance sheet, our cash and marketable securities increased by $13.3 million to $59.2 million, driven by strong cash from operating activities of $15.3 million in the quarter. As a result, we moved from a net debt position of $3.6 million last quarter, to a net cash position of $10.2 million at the end of the third quarter. This strong cash generation was driven by core operating results and a positive contribution from the Pasolink business.

From a working capital standpoint, our DSOs and inventory returns continue to be impacted by the addition of the Pasolink assets, which added roughly 20 days to DSO for Q3, and reduced inventory returns from $7.8, excluding Pasolink, to $4.9 as reported. We expect these impacts to moderate over the coming quarters, as the Pasolink business ramps and working capital levels normalize.

Moving on to our fiscal 2024 guidance. We are updating our full year 2024 revenue guidance to be in the range of $408 million to $418 million, and our EBITDA guidance to remain within the previously announced range. The softened guidance is primarily attributable to the slower ramp in Pasolink revenue, cautious CapEx spends by Tier 1 customers, and African mobile network business. We expect our EBITDA for the fiscal year 2024 to approximate the current consensus estimate.

With that, I'll turn it back to Pete for some final comments.

Thanks, David. Before Q&A, I would like to briefly discuss our outlook. The Pasolink acquisition is ahead of plan from an EBITDA and free cash flow perspective, and we continue to expect it to be EPS accretive by September 2024 quarter.

Additionally, the acquisition is tracking well ahead of plan from an IRR perspective. We still believe the business will get to $140 million run rate level previously discussed, and our EBITDA margin goals for Pasolink are in sight. The core Aviat business executed in line with our expectations, and we're achieving sustained growth ahead of the overall market growth rate. With that, operator, let's open up for questions.

(Operator Instructions) Jaeson Schmidt, Lake Street.

I just want to start on the updated fiscal '24 guidance. Dave, I know you kind of laid out kind of three drivers from that, but if we think about, let's call it the $15 million delta at the midpoint between the two ranges, can you sort of rank order those three issues in terms of impact?

So let me rank order them, Jaeson. One is the Pasolink ramp, and then I would say two would be Africa, and three would be the Tier 1 environment.

Okay, that's really helpful. And I know you mentioned you guys are looking over sort of the Pasolink business from a margin perspective. Curious if this changes your thoughts, Pete, on how you're looking at fiscal '25. I think last quarter you thought sort of 515 to 520. Is that still achievable?

Look, I think, well, we got a little bit overly enthusiastic with respect to our number for FY25. We typically put that in the August session, and I think we will update that guidance in August, and I would say that 515 number will be probably the high end of the range, but we're not ready to do that. And look, we discovered some quote-unquote empty revenue in Pasolink, so we're not going to take that, and what we're really, really excited about is we're ahead of our plan on cash generation, and we expect by September to be EPS accretive, if not sooner.

Okay, that makes sense. And then just the last one from me, and I'll jump back into Q. I know you previously said that you never expected B to have a big impact on calendar '24, but curious if you could just update your thoughts on how you're thinking about some of these government funding initiatives, and what's our timetable to an impact to the P&L?

Yeah, so we've been consistent that B is a calendar year '25. We are seeing some incremental orders from the Rural Digital Opportunity Fund, and ARPA, the America Rescue Act, we know that that needs to be spent by the end of December 2026, and we are not forecasting anything, but we are well positioned to have a positive surprise, and when we get that, then we'll update you all.

Got it. Thanks a lot, guys.

Scott Searle, Roth Capital Partners.

Hey, good afternoon. Thanks for taking my questions. Hey, Pete, maybe to dive in on Pasolink, I think, back-of-the-napkin math, right, about $22 million or so in the quarter, gross margins in the 28% range. I'm wondering if you could address where you think Pasolink can get to. I think that the target number was getting $30 million to $35 million on the top line and being able to bring up gross margins more in line with Core Aviat. What are the current thoughts there? How big is the magnitude of called empty or hollow revenue that you were finding with Pasolink?

Yeah, so, Scott, you know, it's a matter of time on getting to the $140,000, and our view on getting to 33% gross margins remains intact. And one of the drags on the gross margin right now is the impact of the transition services, and that each quarter we progress, that will get less, less and less, and that, so that'll have a positive impact, and then we are working on reducing field service costs, as well as cost of goods sold, so we feel good about that.

Got you. And maybe to follow up from an OpEx standpoint, it seems like you guys have done a lot of rationalization at this point in time. Is there more to go on that front?

Yes. So, look, we're disappointed with our enthusiasm on the top line. We are very, very enthusiastic about our ability to remove costs and squeeze both the operating expense and the gross margin line that's really why we gave the hint about our IRR being 2.5 times our WAC, and I think we'll give some more color on that in six months, because we're really, really pleased with the returns we're projecting. Look, we -- the returns would be even better if we -- the faster we can get the -- some of the ramp issues out of the way, but net-net, we would still do this deal, and we're happy about the customer engagements. We're happy about the return, and we just need to be a little more circumspect with respect to the Pasolink ramp.

Got you. Well, last two items, I think core Aviat gross margin said 38%. Historically, that's tended to be a bit of an anomaly, so is that the sustained range going forward, or does that come in a little bit in the June quarter? And lastly, new products and opportunities, India, and then specifically some of the areas of router and 11 gigahertz. I was wondering if you could just give us a timeline of when you expect that to contribute. Thanks.

Yeah, Scott, I'll take the margin question first. So, yeah, our organic gross margins were very strong in the quarter at 38.4%, and year-to-date, we are right around 38%, which is, you know, a couple hundred basis points better than our initial guidance for the full year of FY24. We do expect probably a modest pullback in Q4, but we'll still be well ahead of what we were projecting on a full-year basis. So I think, you know, things are looking good from that standpoint. I think it kind of resets what the expectations should be going forward.

Okay. So, Scott, let me -- should I -- let me jump in with the product question. So the one-plus-one hardware protection on the WTM, right, that gives us a high-reliability, high-capacity outdoor radio. We think that that increases the addressable market by about $50 million. We also mentioned our frequency assurance on our leading private network competitor. That create -- that's available now, and we have received initial orders, and that's a high margin.

We see the 11 gigahertz radio. We have previously announced [TwoZero Energy]. That is in the market. We think the opportunity size there is $120 million, and then the long-distance link protection with the multiband 6 plus 11, that's a smaller market, say $30 million, and it's in our toolbox right now. And the reason we bring all that stuff up is because of the 6 gigahertz unlicensed band opportunity, which we think will drive more of the backhaul and is good for the fixed wireless folks.

Thank you.

Theodore O'Neill, Litchfield Hills Research.

Pete, you mentioned in your prepared remarks that you are seeing cross-selling and I was wondering, between the Pasolink and your products, are you seeing -- are there any surprises there that you weren't expecting?

So that's actually making it difficult to kind of keep the business separated, and we see opportunity in services to take -- to provide services where Aviat didn't have footprint and vice versa, so that's a pleasant surprise that's masked by our slower-than-expected ramp, but we're really excited about that, and I would say we're six months out from being able to bring some of the Aviat software and put it on top of the Pasolink radio, and what I would -- this doesn't show up in the financials, but we're enthused about the customer engagement and the desire for us to make things like FAS and HAS and our network management software work on the Pasolink radios.

Okay. And on the first India microwave backhaul order, did something unique happen in India that opened up this opportunity for you?

I think we proved ourselves with the eBand and multiband and our vendor-agnostic software, as well as our delivery, and what that was an opportunity to do was go after some of the incumbents, and the feedback that we've received, right, we did well when we got the small opportunity, and the feedback we're getting now on the microwave piece is they like the technical performance of our product, the simplicity of the design, and some of our key features, so we're -- we executed on the toehold, and it seems like it's going to pave the way for future growth.

Okay. And for David, on selling and admin expense, I'm wondering how it should trend from here. There's $1.7 million of M&A in the current quarter, and I'm wondering if that continues?

That should go down significantly from here on out. I wouldn't expect there to be some straggling costs as we tackle certain things, but no, like Pete mentioned, that would help the margins. It would also help our OpEx is the reduction in some of the transition services costs quarter over quarter as we go forward, so we expect to be getting more of those costs out going forward, so that should be working in our favor.

Okay. And my last question, Pete, I think every company should be filing -- do you have three shelf filings of however much money they can get, but I was wondering if you could share your thoughts on putting that in place for Aviat?

Yeah. So, we have an existing shelf from three years ago that expires on May 4, and know that some investors get concerned about -- I think we've been a prudent deployer of capital, and so us just putting the shelf in place is good corporate housekeeping. If some opportunity were to present itself, we're in a position to capitalize on it, but I want to be clear, we currently have no active deal in our M&A pipeline that would necessitate pulling down the shelf, but we just wanted the flexibility, and then a couple investors put in some questions since that filing came out about our firepower, and we were comfortable using debt up to three times our 12-month trailing EBITDA, three times the pro forma combined EBITDA. So, we think we have some significant firepower, and then an additional question was, if you use that debt, what would the rate be? And we think it would be in the SOFR plus 250 to SOFR plus 300 basis points.

Okay. Thanks very much.

Tim Savageaux, Northland Capital Markets.

You mentioned 7% organic growth for Aviat in fiscal Q3. I wonder if you can give us a similar estimate, not a similar number, but the same type of estimate for organic growth that you're implying here for Q4, and I think that brings you in, right, likely bring you in somewhere around 5% for the year. Is that sort of rate maybe a little bit below your historic growth rate, but would you expect, at least as you look at it now, would you expect that to persist into fiscal '25 or maybe something more typical, kind of mid- to high single digits in terms of organic growth rate for Aviat?

Thanks. Yeah. I think in that mid-single digits where we would end this year would carry forward into 25. We're not going to estimate in the high single digits at this point.

Look, for modeling purposes, put it at mid-single digits, and we -- of course, we're going to try and do better than that. And, look, we talked about two other headwinds, Tier 1 and Africa. We think that the Africa is really at a bottom, and that's largely interest rates.

And another data point that I'd like to add is on our cost of currency basis, our revenue was down 4%. It would have been 4% higher if we didn't have the emerging market currency issue, and we would have had about $1.9 million more EBITDA. So we beat the consensus on the bottom line despite that. So our number-one focus is to drive the Pasolink revenue up quicker. And we -- I would say the Africa currency issue, that's beyond the control of Aviat, but we're well positioned when that dam breaks.

Okay, thanks. And maybe I was going to follow up with that with hopefully a discussion on some of the puts and takes around that organic growth rate. You mentioned Africa, although that sounds like it's impacting this year, and if it's bottoming, maybe that could be a tailwind. I imagine the rural broadband growth drivers could get stronger next year. Then again, you mentioned finishing up a Tier 1 project, and maybe that's a tough compare. So, Pete, I wonder if you might just go through some of those puts and takes around that mid-single-digit growth rate and what could drive it either way.

Yeah, so the Tier 1 project is a tough compare. We think we have about 35%, share of rural broadband, and if the RDOF kicks in a meaningful way, that's going to be very, very positive for us. A reversal in the currency with respect to Africa is going to be good.

And then so let me come back to the US Tier 1. This is a question that we've gotten in an acquired period. It's about some multi-dwelling unit trials that we can't disclose to the customer, but we'd acknowledge those, and if that were to get across the goal line, that would be a significant uplift to offset the completion of the project. So, we're pretty happy with our funnel, and we think that the future is rather bullish for us. And so, the puts and takes -- the put is the completion of the US Tier 1. We see new projects with our major US Tier 1 customer that could be a lift for us. We see African currency at the bottom, and we need, as interest rates moderate, that's going to reverse, and we need to get the Pasolink ramped up to where it should be.

And that's a good place to end for my last question, which is, would you hope to have that up to the target run rate by the end of fiscal '25? And that's it for me. Thanks.

Yes. Yes. Yeah. That's funny. Tim, you usually give me a hard time for not being direct in my answers, and rightfully so from your perspective. My answer on that is a clear, crystal clear yes.

When received in crystal clear fashion. Thanks, Pete. Thank you.

(Operator Instructions) At this time, I'd like to turn the conference back to Pete Smith for closing remarks.

All right. Thanks, everyone, for joining us. We're looking forward to updating you in about 90 days. We remain enthusiastic about the business. We think our products, customers, and our cost reduction program are on track, and we're certainly bullish about the future. Thanks, everyone.

This concludes today's conference call. Thank you for participating, and you may now disconnect.