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Anaren, Inc. (NASDAQ:ANEN)

F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

October 30, 2008, 5:00 pm ET

Executives

Lawrence Sala – Chairman, President and CEO

George Blanton – SVP, CFO and Treasurer

Analysts

Steve Ferranti – Stephens, Inc.

Rich Valera – Needham & Company

Greg Weaver – Kern Capital

Chris McDonald – Kennedy Capital

Operator

Good afternoon. My name is Gina and I will be your conference operator today. At this time, I would like to welcome everyone to the Q1 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you.

Mr. Larry Sala, you may begin your conference.

Lawrence Sala

Thank you. Good afternoon and thank you for participating in the Anaren Fiscal 2009 First Quarter Conference Call. I am joined again today by George Blanton, our CFO as well as Joe Porcello, our Vice President of Accounting. I will provide a brief overview of the results of the first quarter, after which George will review the financial highlights. We will then take your questions.

Certain statements made during this conference call will be forward-looking statements. These statements involve risks and uncertainties that could cause actual results to differ materially from those discussed. You are encouraged to review Anaren's Securities and Exchange Commission filings to learn more about the various risks and uncertainties facing our business and their potential impact on our net sales, earnings, and stock price.

Net sales for the first quarter were $38.1 million, up 18.8% from the first quarter of last year and included two months of net sales from the M.S. Kennedy acquisition and one month of net sales from the Unicircuit acquisition. Total net sales for the quarter from the two acquisitions was $4.8 million.

An increase in Space and Defense Group net sales was partially offset by a decline in Wireless Group net sales for the quarter. Non-GAAP operating income for the quarter, excluding non-cash equity-based compensation and acquisition related inventory step-up, intangible amortization was $4.3 million or 11.3% of net sales. Profit margins improved from the fourth quarter of fiscal 2008 due to improved production yields and execution on development projects as well as a favorable overall product mix.

Wireless Group net sales for the quarter were $19.7 million, down 6.6% from the first quarter of last year, as a result of a decline in demand for custom assembly products, due to a platform transition at one customer, which was partially offset by increased demand for standard infrastructure and consumer components. Overall, demand for standard wireless infrastructure components remained robust throughout the quarter.

Demand for custom assembly products remained volatile and pricing pressure remains challenging. Sales of consumer component products were $1.4 million for the quarter, up 42% from the first quarter of last year, due to the continued diversification of design wins.

We continue to see numerous new design wins for a wide array of wireless consumer applications. Customers that exceeded 10% of Wireless Group net sales for the quarter were EG Components, who distributes mainly to Ericsson, to Nokia and to Richardson.

For the Space and Defense Group, net sales for the quarter were $18.4 million, up 67% from the first quarter of last year, and included $4.8 million in net sales from the M.S. Kennedy and Unicircuit acquisitions.

The Space and Defense Group continued to deliver strong organic sales growth in excess of 20% for the quarter, in addition to the growth in net sales as a result of the recent acquisitions. The improvement in performance on development programs within the Space and Defense Group during the quarter had a positive impact on profitability for the group.

New orders the quarter were $13.9 million and included contracts for passive ranging and radar sub systems, as well as assemblies for our counter IED application. New orders for the quarter were negatively impacted by orders received early in the fourth quarter of fiscal 2008 and by the delay in follow-on orders for our ground-based radar program.

During the first quarter, we completed the acquisition of limited – Littleton, Colorado-based Unicircuit Inc., a manufacturer of advanced high performance printed circuit boards for defense and aerospace applications. Unicircuit's technology will enhance our ability to capture integrated microwave assembly opportunities for advanced radar receiver and other space defense and aerospace applications.

Specifically, Unicircuit's technology will enable Anaren to pursue beamforming opportunities in airborne radar applications. Historically, our technology has limited our addressable market to ground and satellite-based applications. Unicircuit has an experienced management team that will continue to manage their business, and the company will continue to operate in their current facility.

Customers that generated greater than 10% of Space and Defense Group net sales for the quarter were ITT, Raytheon, Northrop Grumman, and Lockheed Martin. Space and Defense order backlog at September 30th 2008 was $77.6 million. George?

George Blanton

The highlights of the first quarter income statement and the balance sheet at September 30th 2008 are presented on a non-GAAP basis. These non-GAAP measures are each adjusted from GAAP results to exclude certain non-cash items, including equity-based compensation and acquisition related inventory step-up and intangible amortization.

The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with accounting principles generally accepted in the United States. Please refer to our Q1 earnings release and Form 10-Q for a reconciliation of GAAP and non-GAAP measures.

Non-GAAP gross margin was 33.9% for the current quarter compared to 28.1% for the fourth quarter of fiscal 2008, and 33.4% for the first quarter of last year. The increase in current first quarter gross margin resulted from improved yields as well as improved results at our Salem ceramic operation compared to the fourth quarter of last fiscal year. We expect non-GAAP gross margin to fluctuate between 33% and 36% during fiscal 2009.

Investment in research and development was 7.6% of the net sales in the first quarter compared to 8% of net sales in the fourth quarter of fiscal 2008 and unchanged from 7.6% of sales from the first quarter of last year. Current R&D spending is supporting a number of wireless component and custom assembly product opportunities as well as a number of projects in the Space and Defense Group and is not expected to decline in the near future.

Non-GAAP operating income was 11.3% of net sales for the first quarter, 20 basis points lower from the first quarter of fiscal 2008, and up 540 basis points from 5.9% for the fourth quarter of 2008. This improvement resulted from improved production yields, cost savings realized, better execution on development programs, and a more favorable overall sales mix.

Non-GAAP net income was 7.8% of net sales or 21% per diluted share for the first quarter of fiscal 2009, including $266,000 in interest expense. This compares to non-GAAP net income for the fourth quarter of fiscal 2008 of 5.3% of net sales or $0.13 per diluted share, which included $27,000 in interest expense.

Non-GAAP net income for the first quarter of fiscal 2008 was 10.5% of net sales or $0.21 per diluted share. The effective income tax rate for the first quarter of fiscal 2009 was 35% compared to a tax rate of 22.9% for the first quarter of last year. The expected effective annual tax rate for fiscal 2009, absent one time events, and given the reinstatement of the research and experimentation tax credit, which occurred subsequent to the end of the current first quarter, should be approximately 31%.

During the first quarter, the Company announced it had completed the acquisition of M.S. Kennedy, located in Syracuse, New York, and Unicircuit Inc. located in Littleton, Colorado. The purchase price of M.S. Kennedy Corp. was $28 million on a cash-free, debt-free basis, while the purchase price for Unicircuit Inc. was approximately $21.7 million on a cash-free, debt-free basis. M.S. Kennedy and Unicircuit had combined annual sales of approximately $40 million in calendar 2007. These transactions were financed through a five-year, unsecured, $50 million revolving debt facility.

Earnings from M.S. Kennedy and Unicircuit adjusted for acquisition related inventory step-up and intangible amortization are expected to be accretive in fiscal 2009.

Balance sheet highlights include cash provided by operations was $5.1 million in the first quarter of fiscal 2009. Capital expenditures were $1.8 million in the quarter. Cash, cash equivalents and investments were approximately $45 million at September 30th 2008, up $1 million from June 30th 2008. During the first quarter, we purchased 471,000 shares of Anaren common stock for a cost of $5 million for treasury under the current authorization. There were approximately 1 million shares remaining under the current board repurchase authorization at September 30th 2008.

Accounts receivable were $27.2 million at September 30th 2008, up $4.1 million from June 30, 2008, including $6.6 million from the acquisition of M.S. Kennedy and Unicircuit.

Day sales outstanding were 58 days, down from 61 days at June 30. Inventories were $38.5 million at September 30th 2008, up 43% from $27 million at June 30th 2008 due to the acquisitions of M.S. Kennedy and Unicircuit, which added $10.1 million in inventory, including $1.2 million of related step-up.

Lawrence Sala

Thanks, George. For the second quarter of fiscal 2009, we expect an increase in sales for the Space and Defense Group, and comparable demand for Wireless Group products. As a result, we expect net sales to be in the range of $40 million to $45 million.

We expect GAAP earnings per diluted share to be in the range of $0.10 to $0.13, using an anticipated tax rate of approximately 31%, and accounting for approximately $0.11 per share in charges related to expected stock-based compensation expense and amortization of acquired intangibles, and inventory step-up related to the two recent acquisitions. Non-GAAP net earnings per diluted share are expected to be in the range of $0.21 to $0.24 for the second quarter.

We will now take questions.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Steve Ferranti.

Steve Ferranti – Stephens, Inc.

Thank you. Congratulations, guys, on a very nice quarter.

Lawrence Sala

Thank you.

Steve Ferranti – Stephens, Inc.

I just wanted you to clarify. Larry, did you say in your prepared remarks that the Space and Defense backlog was $77.6 million?

Lawrence Sala

Yes. And that includes the two acquisitions.

Steve Ferranti – Stephens, Inc.

I see. Okay. Do you have any sense for what the contribution from those acquisitions were?

Lawrence Sala

Yes, I believe it was something around $18 million.

Steve Ferranti – Stephens, Inc.

Okay. Got you. And are you starting to see – sounded like you're starting to see some order flow from SERC [ph]? Is any of that built into your backlog at this point?

Lawrence Sala

We do – we did during the quarter, I should say. We received partial funding for an initial production order. I believe it was something on the order of a little less than $2 million is actually in our backlog right now.

Steve Ferranti – Stephens, Inc.

Okay. And I guess how do you see that opportunity? Do you have any more clarity on it in terms of how that opportunity plays out? I mean, it looks like they continue to win business related to crew. And I'm wondering what kind of visibility you might have there at this point.

Lawrence Sala

Well, I guess, in the near-term, what we have in front of us is partial funding on an order that if it's fully funded, should turn into about $5 million of initial orders. So that's what we have firm in front of us. We've been funded $2 million of what should be a $5 million order. We would expect that to be delivered this year.

In general, if the program goes forward as expected, if there is a one for one replacement with what's in the field, we would expect this project to be something on the order of about twice the size of the original true project for us. So that would be something on the order of about a $20 million program for us if that goes to a full one-for-one replacement or modification of the fielded systems. We don't have a good feel for time frame of that or when we would expect to see any follow-on orders beyond the one that we have so. As we get more clarity, we'll hopefully be able to give you some better guidance.

Steve Ferranti – Stephens, Inc.

Okay. And just to clarify, these orders are really related to upgrades of the existing systems that are in the field. And at the same time and I guess in parallel, SERC is working on sort of the next generation crew program, is that correct?

Lawrence Sala

That's our understanding and we believe that we are participating in that as well. But yes, that's our best understanding.

Steve Ferranti – Stephens, Inc.

Okay. Sounds great. And then just one last one for me. It seems like last quarter you had somewhat of a bubble of new programs going through the development process. Has that bubble sort of moved its way toward manufacturing to the extent that we could see maybe more normalized level of new programs starts in development?

Lawrence Sala

Yes, I guess the programs definitely continue to progress towards conclusion. Some of the bigger ones, ones we talked about like, the EQ-36 project we had accrued last quarter for all the remainder of the development activity that we needed to complete to deliver our initial prototype for development units. So those are being delivered and running on plan. We also got through some significant milestones for qualification and development on the Globalstar satellite program that we won about a year or so ago. So yes, some of them have moved beyond significant development milestones. But we are constantly capturing new programs that are moving into development. I think last quarter we tried to articulate was, we just had some difficulty on some complex programs that were more one time events for us. But our goal is to always have a significant robust pipeline of development work ongoing.

Steve Ferranti – Stephens, Inc.

Can you give us any sense for the amount of revenues within Space and Defense that's development related versus more production order?

Lawrence Sala

I'd say right now it's something on the order of maybe $2 million of development work, out of the total Space and Defense (inaudible).

Steve Ferranti – Stephens, Inc.

Okay. Great. That's it from me and I'll jump back in the queue. Thanks, guys.

Lawrence Sala

Thanks.

Operator

And your next question comes from the line of Rich Valera.

Rich Valera – Needham & Company

Thanks. Good evening, guys.

Lawrence Sala

Hi, Rich.

Rich Valera – Needham & Company

Larry, I was wondering if you could give us a little more color on where you stand with the platform transition with your largest customer. Have you pretty much at this point wound down on the old one? And you're spooled up on the new one, so we hopefully have effectively seen the bottom there? And where do you stand in terms of maybe getting some new or additional content qualified on the new platform as well?

Lawrence Sala

As of right now, I'd say, yes, we believe that the vast majority of the old platform production ramped down in July. So it's really been since the end of July that all of the revenue has been driven off of the new platform. And by sometime in the middle of the quarter, I would say we're fully ramped up and in relatively full volume production for the assembly that we build on the new platform. So yes, we definitely would think we bottomed out.

As far as the transition goes, whether or not their demand strengthens or weakens at any given point in time is very unpredictable. But we believe that that transition has stabilized for us. As far as new content, it's difficult for us to identify time line for new content on this specific platform, but as we've said in the past, we're optimistic that custom assembly opportunities in general – we hope to have one moving into production in the third quarter, as we spoke to for quite awhile as well as other opportunities that could come into production in the fourth quarter of this fiscal year. But as far as specific to this platform, we really don't have good visibility as to when we might gain more content on this application.

Rich Valera – Needham & Company

Okay, that's helpful. And I know you guys don't typically give annual guidance, but since you put it in a public filing, I guess I'll ask about it. In your proxy, there were some targets put out there with respect to, I guess, management comp. And there was sort of a minimum target and then a target to target I guess for full bonus. Is there anything you can say about those numbers – ?

Lawrence Sala

I can say quite a bit there, I guess. We state specifically in the proxy that those aren't meant to be guidance. We set those numbers based on growth objectives that we think are rationale for paying bonuses. So, on the upper end of that target range is typically set at 10% growth over total sales of the prior year not by what we expect to achieve. So our board believes that target, as far as paying a bonus, should be 10% annual growth over the prior year sales. So we don't intend that to be guidance in any way, shape, or form, but targets that our board believes are sufficient to warrant paying of bonus.

Rich Valera – Needham & Company

Okay, that's helpful.

Lawrence Sala

The lower end of that growth is something on the order of GEP growth year-over-year, so we wouldn't pay any bonus if we weren't able to at least achieve that level of growth. And then the targeted growth, we're paying a full bonus for meeting our sales objective is 10% annual growth.

Rich Valera – Needham & Company

Right. Okay. So –

Lawrence Sala

Similarly, in the earnings range, that's the range we would pay a bonus for operating in, with our target operating earnings being 15% of net sales, which is what we've always said is our targeted operating earnings. But it's not guidance that we expect to achieve 15% operating earnings.

Rich Valera – Needham & Company

Fair enough. We'll exclude that from the discussion then. But taking the second quarter as a baseline where you'll have a full quarter of contribution from M.S. Kennedy and Unicircuit, how should we think about that baseline both in terms of gross margin and revenue as we look into the second half? Should we expect some uplift in revenue in the second half? I mean you mentioned a handful of things that could be ramping as well. Could we expect any improvement on the gross margin front as through increased efficiencies, et cetera in the second half?

Lawrence Sala

I mean, we are certainly expecting currently to be able to continue to deliver sequential growth throughout the year. Right now, our Space and Defense business, all our segments are projecting growth in product lines. The Wireless Group obviously is an unpredictable piece for us because of the tremendous volatility. We also would expect to gain some leverage in the operating model as a result of that growth. We do have significant cost reduction efforts in place, both reducing, trying to reduce our operating expenses, trying to reduce material content in our sales. And the expected completion of all of the transfer of our resistor product line from our Salem operation to our China operation. So the vast majority of that has been completed, but there is still products left to complete their transfer and costs still to be taken out in that process. So I guess it's yes and yes. We do expect to see continued growth and improvement and profitability. Obviously, we're as cautious as everyone given the overall economic climate.

Rich Valera – Needham & Company

You mentioned your demand from your big customer really I guess in your custom assemblies has been volatile. In particular, there has been a fair amount of talk about that one big customer having a pretty weak December quarter for a number of suppliers to them. Have you seen anything specific like that, with like a kind of a sharp fall off yet from that customer? Or is it just around the ramp of this platform that's the volatility?

Lawrence Sala

We have heard that from others as well, but have not yet seen that in any forecast, which is why we said that we expected comparable mix and revenue levels in the Wireless Group. So no, we have not seen that in a forecast although we have heard that from other suppliers.

Rich Valera – Needham & Company

Okay. Well, that's it for me. Thanks. Nice guidance.

Lawrence Sala

Thank you.

Operator

(Operator instructions) Our next question comes from the line of Greg Weaver [ph].

Greg Weaver – Kern Capital

Good evening, guys. Nice job here. Just especially on the gross margin front, I was surprised that the guidance there, since you were rolling in Unicircuit, can you give us a sense of kind of what apples to apples gross margin ramp has been or improvement?

George Blanton

The improvement over the fourth quarter, obviously, was fairly significant. That was mainly scrap and yield. At this point, the gross margins at Unicircuit and M.S. Kennedy are pretty similar to where we are. What we would expect, as we said in the past, as the volume comes up, we would expect to see improvement. We haven't seen a significant increase in volume yet.

Greg Weaver – Kern Capital

Okay. And just on the defense side of things, what percent of your defense work kind of what Steve was asking would you say your upgrade related to existing systems versus new platforms altogether?

Lawrence Sala

I guess if I understood your question, what percentage of our sales is related to new programs? Ones that we say didn't ship on a year ago or– ?

Greg Weaver – Kern Capital

Let me try again here. Basically, some of these programs, EQ-36 or Cobra Judy are upgrading existing radar platforms on existing ships or vehicles or whatever. I'm trying to get an understanding of what portion of your business is going on like a new satellite or a new military ship or vehicle versus something that's a retrofit replacement for an existing airplane or – ?

George Blanton

I don't have that number off the top of my head. I'm just trying to think through. But I would say the vast majority, 90% of what we sell is some upgrade of an existing platforms capabilities and not going on to a brand new platform, trying to think of what's going on to a brand new platform. I mean, it's difficult because something like Cobra Judy, which is a meaningful part of our current net sales is a brand new radar platform. It may be installed as an upgrade on an existing ship, but as an entity, that is a brand new radar that's being developed so –

Greg Weaver – Kern Capital

That's what mean, though that the ship exists already, right, so if there's any big program cut backs, this isn't really a factor for you guys because it's stuff that's already out there?

Lawrence Sala

(inaudible) some of these things are deployed onto existing platforms as well as onto brand new ships that are being developed. I would say just off – very off the cuff that it's a very significant percentage of our net sales is in Space and Defense, close to probably 90% or more is something going on to an existing platform as an upgrade. (inaudible).

Greg Weaver – Kern Capital

And In terms of, let's say, like the Cobra Judy, is that a – so that's a single deliverable and kind of what's the time frame for the shipments there?

Lawrence Sala

Well, a single deliverable, yes, in terms of I believe it's a radar or a radar and a halves worth of hardware we're delivering. It's thousands of units that we are building. So – And we are delivering daily and weekly on that project. Something that total program was $10 million, $11 million for us. And so it's running today at maybe $2 million, $2.5 million per quarter kind of run rate.

Greg Weaver – Kern Capital

Okay. And that began when?

Lawrence Sala

We ran at that rate at least last quarter and this current quarter we just completed. So we have been running at that rate for at least I'd guess the last six months. I'm not sure off the top of my head if it's still longer than that or not.

Greg Weaver – Kern Capital

So you got another at least six months, nine months on that one? And on this EQ-36, you – the five prototype radars, are those – those are done by the end of this calendar year?

Lawrence Sala

Correct. Yes, if we perform on schedule here, which we believe we will, we need to deliver by the end of the calendar year for these. I would say they are qualification units. We're expecting a low rate initial production order sometime soon as well.

Greg Weaver – Kern Capital

Right. I saw Lockheed got an order for 12 more systems a month or so ago?

Lawrence Sala

Correct.

Greg Weaver – Kern Capital

Okay. And your content there, is it like 350,000 per?

Lawrence Sala

It's something on that order of magnitude. We have multiple assemblies, which are in various stages of delivery for us. Some of them we were put on contract later than others. So our content is relatively in that range if we are able to capture all of the assemblies, which we believe is likely.

Greg Weaver – Kern Capital

Okay. So – and the profitability on these low rate production systems you think, given the issues on the start up phase has been solved?

Lawrence Sala

Yes, I mean we would certainly expect to bid these at our typical Space and Defense margins, although these first 12 will probably be more challenging than typical volume production work for us in the Space and Defense Group, since we're just really getting geared up here.

Greg Weaver – Kern Capital

Okay. And then from there out I mean, from looking at this, it seems like a pretty big program. I mean Lockheed stocking $6 billion opportunity?

Lawrence Sala

Yes, we believe it's a very significant program for us. Our expectation is certainly hundreds of radars. If you look at the installed base of radars that this potentially replaces, it's something on the order of 200 systems to maybe 500 systems, if you look at both domestically installed applications as well as foreign sales. So I don't know we have no insight into the likelihood of this getting approved for foreign sales and how long that might take. But it's still even at a couple hundred systems, a very material opportunity for us.

Greg Weaver – Kern Capital

Couple hundred – potentially up to hundreds of millions, then?

Lawrence Sala

For us, yes, you do the math. It's a few hundred thousand dollars times 200 systems to 500 systems. It's over a $500 million – I'm sorry, over a $100 million potential program for us.

Greg Weaver – Kern Capital

Okay. Great. And the – on the Jammer, you mentioned that the initial $5 million, assuming it's gets funded, will be completed this year, was that calendar or fiscal?

Lawrence Sala

No, fiscal year.

Greg Weaver – Kern Capital

Fiscal year, okay. And just in terms of the profitability on the large custom job, what's your sense of the outlook there, assuming that picks up?

Lawrence Sala

The new job that we are pursuing?

Greg Weaver – Kern Capital

No, (inaudible).

Lawrence Sala

The one that we expect to ramp up after the first of the year here?

Greg Weaver – Kern Capital

No, the current one you're working on now that you just got the full rate.

Lawrence Sala

That's a pretty challenging job for us still because we just ramped up this past quarter. So, our material content is still higher than we would like it to be and we are probably going to be spending the majority of this quarter working that material rate down. So right now it's a pretty poor margin program for us that we would expect to improve in the second half of the year.

Greg Weaver – Kern Capital

Okay. So that's another one you added is why you think gross margins are going to go up throughout the year?

Lawrence Sala

Correct.

Greg Weaver – Kern Capital

Got you. Okay. Thanks. Good job.

Operator

And your next question comes from the line of Chris McDonald [ph].

Chris McDonald – Kennedy Capital

Hi, good evening. Thanks for taking my question. Larry, I'm wondering if you just spend a minute or two talking about the pipeline of opportunities in the defense business and maybe how that looks different due to the recent acquisition if does look different?

Lawrence Sala

Well, the pipeline of business in the Space and Defense group currently as a result of these acquisitions is far more focused on radar applications than historically for us. I would say historically we had about half of our business coming from sub systems for jammers and receivers and about half of our business coming from mainly ground-based and ship foreign radar applications. The acquisition of M.S. Kennedy gives us the opportunity to pursue significantly higher dollar content in these active electronically scanned radar applications, both ground-based and airborne.

And then the acquisition of Unicircuit gives us the ability to capture the traditional beamforming network that we have always pursued in the airborne space, where historically we (inaudible) limited with our technology to the ground-based side of those applications. So because of that and because of the numerous numbers of opportunities for these active radar – electronically scanned radars being deployed in both ground-based and airborne applications, that's a much bigger part of our pipeline of opportunities than it's been in the past. So that's the biggest change in the types of programs we are pursuing and what our pipeline looks like.

Chris McDonald – Kennedy Capital

Great. Thanks. On the crew order, the $2 million or the – I guess the initial $2 million funding out of maybe a $5 million order, do you have a sense for the delivery timing on that initial piece?

Lawrence Sala

Yes, I guess, in general, it plays out as we would expect. We would probably complete that sometime in the third quarter of our fiscal year – late in the third quarter of our fiscal year. So this quarter and next we probably would have that order complete.

Chris McDonald – Kennedy Capital

Okay. The scrap issues that you had in the fourth quarter, certainly by the results it seems like everything has worked through the system there. Just wondering if there is anything left on that –

Lawrence Sala

Well, we've got two pieces to that. We have general yield that we continue to put resources and focus on trying to continue to improve our yields. And so that activity is kind of continuous and we are seeing good positive results from it. The fourth quarter, which we spoke to on the previous call, we had two different vendors of two different materials that we purchased, supply us with material that was mismarked or out of spec and misrepresented, which got into production, difficult for us to test the parameters that were out of spec on the raw material itself. So we had production ongoing with these materials that resulted in much higher scrap levels. Some of that hit our third quarter, when we finally realized what the issue was, we were significantly into the fourth quarter. And some of that also fell into this current first quarter that we are reporting now but not a significant amount in this quarter. So we are optimistic that going forward, that event driven high scrap should not be reoccurring on us. We've put controls in place to try to mitigate that type of event occurring again.

Chris McDonald – Kennedy Capital

Okay. Just shifting gears to the wireless side of the business, I'm wondering if there is anything in particular that drove the strength on the standard component side that you experienced this quarter?

Lawrence Sala

We try to gain insight to that ourselves. And from our view, the reason for that, the majority of that one was we believe there was higher spending by carriers in China that drove strength in this quarter for some of the Chinese vendors that we sell our Xinger products to, whereas traditionally, the second half of the calendar year, capital spending in China has typically been very low. But we think there was higher spending there and we saw some significant demand as a result of that. We also think that there was a shift in share of business in India, which led to higher Xinger content for us with one particular OEM than another. So we think that the shift in share for the quarter in India was favorable to our standard component product lines.

Chris McDonald – Kennedy Capital

Okay. And do new Xinger generations or transitions between the generations have a meaningful impact typically on revenue?

Lawrence Sala

For us, it typically evolves over time. When we transition from Xinger 1 to Xinger 2, we can take 9 months to 12 months for customers to really redesign, get that product into production and start driving meaningful revenue streams for us. And we did see share gains through that. Normally, our share gains in Xingers come from developing new opportunities where our Xingers are used, since we already have such a high market share in the existing applications where we play. We are in the process now of transitioning from Xinger 2 to Xinger 3, which we're in early introduction phases of right now. And we would hope and anticipate that we will see some additional usage of Xinger 3 in applications where people do not use our Xinger products currently. But that will evolve over 6 months to 12 months as the market adopts the new products.

Chris McDonald – Kennedy Capital

Is it that what just largely driven by the fact that you got a smaller footprint enabled to do applications for the product – share gain?

Lawrence Sala

It's driven as much by size as performance. Sometimes, a customer can print it inexpensively themselves on a circuit board itself, because they don't need the best performance. So there, if we can get this product small enough and cost-effective enough for them, they will redesign it in. In other areas, the performance advantage may allow them to say, buy a lower cost power transistor because our performance allows them to get the same end system performance as they would have, trying to pay – having to pay for a more expensive power transistor. So, in those cases, places where they may have, again, done something themselves, they might find it more economical to use our Xinger product. So, some are performance driven, some are science driven.

Chris McDonald – Kennedy Capital

Okay. And then just couple of quick ones as it relates to the custom assembly side. Has the pipeline of design wins changed at all over the course of the last quarter? I know you mentioned the expectation of ramp up in the third quarter on one custom assembly and then maybe some more opportunity in the fourth quarter, but I just wondering if you have had any other better clarity on that overall?

Lawrence Sala

Well, I would say, in general, we have seen more challenging environment on the pipeline for our custom assemblies. In several of the standard ferrite opportunities, mainly simple components as opposed to really assembly level products, we've seen some very challenging pricing in the last two months or three months. And that diminished somewhat, some of the opportunity pipeline that we had in the wireless custom products. So when we say custom assembly products that's both what we would say are actual multi-functional assemblies as well as just standard ferrite components, since they are custom to every application. And in those standard ferrite components, as we have said, we have seen a number of new Chinese competitors in the marketplace and price eroding more quickly than we had anticipated.

Chris McDonald – Kennedy Capital

Okay. And just one last question as it relates to the consumer side of the business. You had very nice growth again this quarter off of a small base. And I'm just wondering if you look at the opportunity pipeline there and your capacity, maybe you could walk through your outlook for that business over the course of the next couple of years here. Thanks.

Lawrence Sala

Yes. Sure. Couple of years is tough for us. We've said – I think I said last call, we expected that product line to grow 30% to 50% this year for us. And we are pretty well on pace to achieve that and fairly optimistic that, that can happen. The product line has grown at that sort of relative rate. And we're hopeful that we can continue to put up that kind of annual growth over the next couple of years. Certainly right now, the design pipeline continues to be very strong. Our transformer products that we have out there we believe are leading from a size, performance standpoint and continue to be adopted in many different wireless consumer applications. And on top of that, we continue to introduce new products for other applications as well. So we are fairly optimistic given the state of the pipeline that we can continue to deliver that kind of growth.

Chris McDonald – Kennedy Capital

Thanks. Nice results.

Lawrence Sala

Thank you.

Operator

And your next question is a follow-up question from the line of Steve Ferranti.

Steve Ferranti – Stephens, Inc.

Yes, hi. I wanted to see if you could just sort of contrast what you just described I guess in your standard ferrite products with sort of what you described in the consumer products, in the sense that it seems like, on the consumer side, you are winning on a performance level as well as size and potentially cost. Do I have it right that it sounds like on the standard ferrite business, it was more of a price as a winning factor?

Lawrence Sala

Yes, on the ferrite side, the infrastructure customers develop a specification, develop a form factor and go out with a design to spec requirement, which really limits the opportunity to innovate and differentiate. So there, their goal is to have vendors with common parts pitted against each other to achieve the lowest possible competitive price. On the consumer side, it's much more like the semiconductor business. We have free reign to design any product we desire and market it for any application we choose. And so there we are moving at our speed, using our innovation to try to create sustainable differentiation. And when we can, then we can get paid for it. So it's just the dynamics of the market segments that really drive our ability whether we're competing on price or we're competing on innovation.

Steve Ferranti – Stephens, Inc.

Got you. That's helpful. And then just getting back to the opportunities on the phased array radar side, can you describe for us a time line of sort of how you see your capabilities evolving over the next few quarters here, in terms of when you might actually be able to address some of these opportunities? I mean I understand that there is some investments that you have to make at MSK for you to bring their capability to a level where you can address the end-to-end solution and the phased array radar, particularly for airborne.

Lawrence Sala

Sure. I mean, from the specifics of each operation from M.S. Kennedy standpoint, they today can pursue control and single processing applications within these radars. And we're doing that and we're seeing some early success here. And we'd expect to see some base of revenue start to grow, even from the end of this current quarter we're in now I think end of this current second quarter. So we're hopeful we will start to capture business even this quarter for those types of applications. We are making an investment, as we said, in M.S. Kennedy to give them high frequency RF capabilities, which will allow them to go after a larger segment of those opportunities in the transmit receive module side of those radars. And we have put equipment on order. And we would expect to have their capability up and running by the end of this fiscal year. And would hope that we would have booked orders by then so that as we exit this fiscal year, we've got that revenue stream ramping up for us. So we don't anticipate it's going to take an exceptionally long time to get that in and going, given the skill set they already have at M.S. Kennedy and the RF knowledge that we have here.

From the Unicircuit side of it, we are currently jointly pursuing active beamformer or manifold applications for these radars. So between the technology we have here in Syracuse and what Unicircuit has, we can already go after these feed network types of applications for airborne radars. And again, we would hope over the next quarter or two that we'd start to see orders for those applications where substrates are built by Unicircuit and assembly, and testing work is done here in Syracuse.

Steve Ferranti – Stephens, Inc.

That's very helpful. And I guess just to kind of close that line of questioning, that's a market that's fairly substantially bigger than the feeder systems market that you had been in to-date, correct?

Lawrence Sala

Yes, absolutely. As I tried to articulate and probably didn't do a very good job of, we play in just the beamformer or manifold portion of the ground-based radar market today. With a technology portfolio we have now, we can play across the entire radar from the control and signal processing side all the way through the active TR modules. And we can do that for both the ground-based and the airborne segments of the market. So our addressable market grows substantially from where we were as just standalone Anaren technology.

Steve Ferranti – Stephens, Inc.

That's great. And just a couple of housekeeping questions I guess and then I'll be done. Can you give us the split in wireless between standard and custom for the quarter? And then I think you gave us some guidance on kind of second quarter tax rate. Any thoughts you can give us on sort of the tax rate for the remainder of the year?

George Blanton

Yes, the 31% is really the annual rate for the whole year at this point. With the R&D credit being reinstated at the beginning of October, we can't go backwards into the first quarter with that, so it's all going to fall into the second quarter. Part of what we're going to see in the second quarter, although the rate will be 31% for the whole years, we're going to have a one-timer that flows through of about $200,000 that really relates back to fiscal '08, the second half of fiscal '08, which would be the R&D credits for that year. So that rate probably in the second quarter will be closer to 25%. And the annual rate for the whole year will end up at 31%.

Steve Ferranti – Stephens, Inc.

Okay. Great.

George Blanton

Does that make sense?

Steve Ferranti – Stephens, Inc.

Yes, absolutely.

George Blanton

Okay.

Lawrence Sala

And then on a split, yes, it was something on the order of 60/40, about 60% being standard and 40% being custom.

Steve Ferranti – Stephens, Inc.

Okay, so not too much different than what has been historically?

Lawrence Sala

No.

Steve Ferranti – Stephens, Inc.

Okay. Great. Thanks, guys and congrats again.

Lawrence Sala

Thank you.

Operator

The next question is a follow-up question from the line of Greg Weaver.

Greg Weaver – Kern Capital

Could you give us a little more color on the Globalstar opportunity?

Lawrence Sala

Yes. That's an opportunity that we booked gosh, it had to be a year and a half ago, maybe a little longer.

George Blanton

Longer.

Lawrence Sala

It was something on the order of $12 million worth of business?

George Blanton

Total was about $11 million, $12 million somewhere.

Lawrence Sala

And so there was a good more than year development phase, which we completed and got through qualification. And then we provide all the qualification units that we had to and then it moves into production. And we're right at that stage now where we're transitioning into the volume production phase of that program. So, so far, we have been able to achieve all of our milestones (inaudible) that reasonably successfully.

Greg Weaver – Kern Capital

So in terms of a revenue opportunity in a given quarter, how big is that?

George Blanton

I think it's going to continue at the rate it's been. I think it's been like about $1 million a quarter, something like that.

Lawrence Sala

Yes, it will be something between $1 million to $2 million per quarter.

George Blanton

There was a lot of development dollars involved in this contract, over $2 million in development, I believe the prototype.

Greg Weaver – Kern Capital

So the only implications then is it potentially a better margin opportunity as you move to production versus development?

George Blanton

No, it's going out on account of percentage completion. So the margin's pretty much fixed in place.

Greg Weaver – Kern Capital

I got you. Okay. And just lastly, anything new on the standard component front in terms of products coming out or new applications?

Lawrence Sala

Only what I mentioned, we've got our Xinger 3 product line, which we are introducing right now as well as a pretty steady array of consumer component applications, products that we're introducing for different applications. But nothing of significant note other than that.

Greg Weaver – Kern Capital

Okay. Thank you.

George Blanton

Thanks.

Operator

And your next question is a follow-up question from the line of Rich Valera.

Rich Valera – Needham & Company

Thanks. I'm just trying to make sure I understand the run rates for your intangible amortization going forward and for your stock comp. Should we see the first quarter levels as a baseline run rate or could that change?

George Blanton

Second quarter, the inventory step-up in the second quarter will be approximately $1.1 million. That's pretty much set in concrete at this point. When the purchase accounting is not totally complete, but it should fall out somewhere in that neighborhood. The amortization based on the preliminary numbers from the valuation guide is about $450,000 a quarter. Now, we have a year to finish the purchase accounting so that may fluctuate somewhat between now. I would expect it should settle out pretty much by the end of the second quarter.

Rich Valera – Needham & Company

The inventory step-up though was complete after –?

George Blanton

Yes, the inventory step-up I believe will be complete by the end of the second quarter, given the inventory turns we are seeing now with the two acquisitions.

Rich Valera – Needham & Company

And is the amortization tax effected or not?

George Blanton

Yes, it is.

Rich Valera – Needham & Company

Okay. And when you talk about the 31% – or your run rate – your tax rates in general, are you thinking about that for both pro forma and for GAAP?

George Blanton

Yes.

Lawrence Sala

That's a GAAP tax rate.

Rich Valera – Needham & Company

That's a GAAP tax rate.

George Blanton

Pro forma tax is a – pro forma tax rate that you see in that table at the bottom is approximately 32% – or 38%, excuse me – 38%. That is because there is still some ISOs floating around out there, original ISOs that are not tax effective. So it's a little higher than the overall rate.

Rich Valera – Needham & Company

The pro forma tax rate. And how should we think about that pro forma tax rate going forward?

George Blanton

That same kind of rate.

Rich Valera – Needham & Company

So pro forma is closer to 38%?

George Blanton

Yes. If you look at whatever the rate in the table compared to the total expense within the table, the rate is approximately 38%.

Rich Valera – Needham & Company

Okay. Alright. Thank you.

Operator

(Operator instructions) And there are no further questions at this time.

Lawrence Sala

Thank you. We really appreciate your participation and we look forward to speaking with you again next quarter.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Anaren, Inc. F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

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