Westell Technologies' CEO Presents at Acquisition of Kentrox, Inc. Conference (Transcript)

| About: Westell Technologies, (WSTL)

Westell Technologies Inc. (NASDAQ:WSTL)

Acquisition of Kentrox, Inc. Conference Call

March 19, 2013 9:30 am ET

Executives

Brian Cooper – Senior Vice President and Chief Financial Officer

Richard S. Gilbert – Chairman and Chief Executive Officer

Analysts

Mike Latimore – Northland Securities, Inc.

Greg Mesniaeff – Maxim Group LLC

Jeff S. Linroth – Leaving It Better LLC

Philip Lee – Mangrove Partners

Todd Brady – Oppenheimer Securities

Operator

Welcome to the Westell Investor Conference Call. My name is Sandra, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. Brian Cooper, Chief Financial Officer. Mr. Cooper, you may begin.

Brian Cooper

Thank you, Sandra. Good morning, everyone. On the call with me is Rick Gilbert, Westell’s Chairman and Chief Executive Officer. Our call this morning is focused on Westell’s announced acquisition of Kentrox, Inc. We’re very excited about the acquisition and we want to keep our prepared remarks brief, so that we can address your questions, which we welcome. I’ll address our Safe Harbor language and provide some key facts and we will then open the lines for Q&A.

Therefore, please note that our presentation and discussion contain forward-looking statements about future results, performance or achievements financial and otherwise. Words such as should, believe, expects, trend and similar expressions are intended to identify such forward-looking statements. These statements reflect management's current expectations, estimates and assumptions. These forward-looking statements are not guarantees of future performance and involve risks and uncertainties that may cause Westell’s actual results, performance, or achievements to differ materially from those discussed.

A description of factors that may affect our future results is provided in the Company’s SEC filings including Form 10-K for the fiscal year ended March 31, 2012, under the section Risk Factors.

The forward-looking statements made in this presentation are being made as of the date and time of this conference call. Westell disclaims any obligation to update or revise any forward-looking statements based on new information, future events or other factors. I would like to refer you to our news release and 8-K filing, both issued yesterday. I will try to answer some of the more obvious questions without repeating too much of that information.

First, key aspects of the transaction itself. Westell is acquiring the stock of Kentrox Inc. for $30 million in cash. We are assuming no debt and we are acquiring working capital sufficient to run the business. There is no earn-out or other similar payment from Westell and the transaction is targeted to close on April 1, which is the start of our fiscal year.

Some more information about Kentrox is just as important. Kentrox is a global leader in providing intelligent site management solutions, which includes remote site monitoring, management and control. It has significant customers in the telecommunications industry both in the U.S. and abroad. It has well engineered, high quality solutions. Its products and revenue streams fall into four main categories; these include first, intelligent monitoring and control devices including software that provide connectivity and functionality at managed remote sites. Second, a sophisticated centralized management system, which is a software solution named Optima.

Third, deployment services; and fourth, maintenance support services typically under annual contracts.

Kentrox also sell some unrelated legacy products, which generally are in decline and in small quantities. For the 12 months ended December 31, 2012, Kentrox reported approximately $29 million in revenue, which was up significantly over its prior fiscal year. Its products are high margin and Kentrox was solidly profitable in 2012. It also has excellent momentum in the marketplace. We expect Kentrox to produce a double-digit growth rate this year and sustain solid growth and profitability into the future.

We would also like to make a few points about the combination of Westell and Kentrox. First, Kentrox is a great fit with Westell’s growth strategy and existing products. We expect the combined operations to generate about $80 million in annual revenue. Even with some purchase accounting adjustments and integration costs that will hold down its first year contribution, the acquisition should be accretive to our earnings outlook for fiscal 2014. Including transaction cost, the combined business should be approximately cash flow neutral on the year.

The blended gross margin for the businesses should be above 40%. Our gross margin can also increase with top line growth in Westell’s existing operations. Westell’s main objective with the acquisition in the short-term is to maintain Kentrox’s excellent momentum on minimizing disruptions and continuing outstanding service to our customers.

That said, there were some excellent synergies between Kentrox’s products and the existing Westell product set and we look forward overtime to benefitting from cross-selling opportunities and some potential to source products more effectively. We expect to maintain a long-term presence in Dublin, Ohio.

In the longer run, we also hope to leverage Kentrox’s international experience with Westell products. There will be some limited cost savings opportunities over time, however at this point cost synergies are not a large part of our focus.

Hopefully, this addresses some of the questions on your minds. We would now like to open the lines for questions and some dialogs. Sandra?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from Mike Latimore from Northland Capital. Please go ahead.

Mike Latimore – Northland Securities, Inc.

Great, thanks a lot. Congratulations on the acquisition there.

Brian Cooper

Yeah, thank you. Good morning.

Mike Latimore – Northland Securities, Inc.

Good morning, can you maybe talk about four product and service categories, anyway to kind of divide that up in terms of percent of revenue a little bit, maybe just even hardware verus software?

Brian Cooper

Well, the leading edge on their products are the remote devices. So they do make up the majority of the revenue base, the rest is split across the other three, but that is the large majority of the direct revenue.

Mike Latimore – Northland Securities, Inc.

Okay. And within the communication customers themselves, will you be selling Kentrox to the sort of same people that you’ve been selling the traditional Westell products or is it a new customer within those organizations to which you’ll be selling?

Richard S. Gilbert

Good morning, Mike, this is Rick. They share some of the same customers that we have, certainly the large North American carriers. They also bring some very important large customers that we have never sold to before, and that’s one of the fits we like a lot especially in the wireless area.

Mike Latimore – Northland Securities, Inc.

And who was – can you name some of the – sort of the top five customers maybe?

Richard S. Gilbert

Non-disclosures

Mike Latimore – Northland Securities, Inc.

All right.

Richard S. Gilbert

Contract non-disclosures, but these aren’t little guys.

Mike Latimore – Northland Securities, Inc.

Okay. I guess within those customers though is the purchaser of Kentrox’s product defined in the purchaser of the traditional Westell products generally.

Richard S. Gilbert

So I remember Westell sells wireline and wireless. The purchasers of Kentrox’s products are primarily on the wireless side, and so as I said, we know some of the same people in the purchasing organizations because we deal with some wireless products in the existing Westell products. But as I said there are certain new large customers that are coming in with Kentrox’s that we have never worked with before in the wireless side.

Mike Latimore – Northland Securities, Inc.

Yeah. And you talked about the Kentrox’s having significant growth last year. Can you bracket that a little bit as it’s 10% to 20%, or 10% to 15% and in terms of what significance is there?

Richard S. Gilbert

Well, Mike, we’re little reluctant to be too specific on that stuff. Kentrox’s business is growing very nicely, they have transition out of some legacy business which goes one direction and they’ve just grown this other business significantly. So I would just say strong double digits.

Mike Latimore – Northland Securities, Inc.

And what’s the – what roughly will your cash position be after the deal closes?

Richard S. Gilbert

Right around $80 million.

Mike Latimore – Northland Securities, Inc.

$80, great, thank you.

Operator

Thank you and the next question is coming from Greg Mesniaeff from Maxim Group. Please go ahead.

Greg Mesniaeff – Maxim Group LLC

Yes. Thank you and congratulations on the announcement.

Richard S. Gilbert

Thanks, Greg.

Greg Mesniaeff – Maxim Group LLC

Sure. Just a couple of quick questions, when you look at the new program called Kentrox, that you’re acquiring and you look at their operations and manufacturing and supply chain and everything else. How do you envision integrating that with yours, what do you envision happening in terms of which organization survives and takes precedence and how that plays out?

Brian Cooper

Sandra, this is Brian. Can you check the line to make sure that, it’s okay, we’re experiencing fair amount of noise in our end.

Operator

Yes, I apologize for inconvenience. We have muted that line. Thank you.

Brian Cooper

Okay, thank you.

Greg Mesniaeff – Maxim Group LLC

Did you hear my question or should I repeat it?

Richard S. Gilbert

I did hear your question Greg, and I refer you back to what Brian was saying, both companies are focused on growth right now and we don’t want to disrupt growth by trying to over integrate early, all right. We’ve said categorically that we will have a long-term presence in Dublin, Ohio and with the growth rates that Kentrox is experiencing right now, I think we really need to focus on not disrupting that moving forward and that means don’t make a lot of integration adjustments that aren’t necessary in the short-term. So in the long-term of course, as we work together with Kentrox, we’re going to look for ways to save money and one of the things Brian mentioned is a good one, I mean we obviously have more buying power at contract manufacturers as we take our sets of products to them versus one product from one group or one product from another. And we’ll look for stuff like that, obviously. But I would stress that, when you have that kind of growth rates that they have and the growth rates we have in our wireless products, I think we have to be very careful not to disrupt.

Greg Mesniaeff – Maxim Group LLC

Got you. Now, does Kentrox still maintain a presence on the West Coast or is it now all in Dublin, Ohio?

Richard S. Gilbert

Well, Kentrox has most of the people in Dublin, Ohio are in the field in terms of the sales and service organization. There are some people in New Jersey and there is at least one full-time person and a part time person in Oregon, but I think that’s it.

Greg Mesniaeff – Maxim Group LLC

Got you. I remember that Dublin, Ohio facility when there was a applied renovation in 1990s, it a very nice facility. Congratulations, thank you.

Richard S. Gilbert

Thanks, Greg.

Operator

Thank you. And we have a follow-up question from Mike Latimore from Northland Capital. Please go ahead.

Mike Latimore – Northland Securities, Inc.

Yeah, great, thanks. Just trying to get a better sense of the environment that Kentrox operates here I mean, who do you view as the kind of the closest competitor to Kentrox at this point?

Richard S. Gilbert

Well, there is a number of players that are trying to play in the remote side management field. One of the things we like about Kentrox is they clearly have one of the leading, if not the leading market share in intelligent site management. Remember there is a big difference Mike between the big central office or a NOC software products. That’s not what they are. What they are, are hardware and software products that actually go out into the remote sites to monitoring a number of capabilities along with software to go on to utilize that data. There is a list of smaller players that are trying to play in the game. I think C Squared access there are several players in other parts of the world, India, Africa, elsewhere that are trying to play in the area. But basically, I think Kentrox has a very substantial lead.

Mike Latimore – Northland Securities, Inc.

Okay. What percent of their business is outside the U.S.?

Richard S. Gilbert

About 50% last year.

Mike Latimore – Northland Securities, Inc.

Yeah. And how much is the visibility entering quarters, I assume it’s a little bit more of booking shift type of business, but how much visibility do you have entering every quarter?

Richard S. Gilbert

Well, put it this way. Their backlog visibility is about 10 times what our backlog visibility is. It’s very, very strong.

Brian Cooper

Yeah, it is different Mike. They get orders farther in advance and their business is a little lumpier. There are some large projects that they get involved in. So they see those and can see them in advance of the quarters, sometimes several quarters ahead.

Richard S. Gilbert

But it’s certainly one of the things we like about them.

Mike Latimore – Northland Securities, Inc.

These kind of core m-to-m offerings taken oftentimes be ported across the industries. Are you going to take this into other non-communications industries or is it going to really focus on communications?

Richard S. Gilbert

In the short-term, it will focus on communication. I think they’re drinking from a firehouse right now. and basically, you’re absolutely right, there are other applications outside communications where Remote Site Monitoring makes a whole lot of sense, they have an architecture that absolutely supports that. They have elements of their architecture that will already support that, but in terms of sales and service right now, they’re using all their people all the time just to service their communications site.

Mike Latimore – Northland Securities, Inc.

Got it, and I guess last question, I know this is only about the core Westell business, but last quarter, you had strong growth in the new product category. Maybe, can you talk a little bit about how the new product category is going, and also just a general view on the telecom spending environment?

Richard S. Gilbert

Well, the new product growth rates in the wireless areas are quite good. That’s continuing. We’re also seeing good growth rates in our custom systems integration business, and stuff that’s ancillary to that in terms of power products and cabinets. In terms of the legacy products as we’ve talked about in the past, those are sort of plateaued at a steady state right now.

Spending environment in telecom, I think it’s certainly improved from last year, but it’s project based, and I think that’s what it comes down to you. You need to be in the right projects. I will certainly say that the general trend is the budgets are as much, much stronger in wireless than wireline.

Brian Cooper

And anecdotally Mike, we are hearing that there are some of our customers that still don’t have budgets fully released and so forth. So there is a little drag there that at least we’re hearing about from time-to-time.

Mike Latimore – Northland Securities, Inc.

Yeah. Got it, great. Thanks a lot.

Operator

Thank you. And the next question is from Jeff Linroth from Leaving It Better. Please go ahead.

Jeff S. Linroth – Leaving It Better LLC

Good morning.

Richard S. Gilbert

Good morning, Jeff.

Jeff S. Linroth – Leaving It Better LLC

This is certainly exciting news. My first question is, they’re obviously there have been moves by Westell into other geographies in the past and could you talk about, I mean these are, talk about the most attractive opportunities that this represents to you geographically, and also a customer set or two that you’re being exposed to now that the integrated company will be exposed to the Westell was not exposed to before?

Richard S. Gilbert

Okay. And the second part of the question, as I said, there are some large, very large wireless based customers that we have never sold through before and those were exposed to, I’m sorry, I can’t give you names.

Jeff S. Linroth – Leaving It Better LLC

It’s okay.

Richard S. Gilbert

That’s contractual.

Jeff S. Linroth – Leaving It Better LLC

I understand.

Richard S. Gilbert

All right, and as I said, they sell through our biggest customers as well in North America, but they also bring, which we don’t have as you point out is sales outside the North American area they’ve got significant sales last year in Africa, in Australia, and in Central America, and they’re working on South America. So those are areas that we like and if you listen to previous discussions on our strategy, one of the things we wanted to do is as we looked at acquisitions, find acquisitions that we’re already being successful in other parts of the world and leverage those channels. And so this meets that particular strategic plan for us quite well. And as Brian said, if we spent a long time looking for the right acquisition, and this is such a perfect fit to our strategy and that’s one upon the planks that falls in perfectly with what we are looking for.

Brian Cooper

Yeah. And Jeff, you asked about the geographies and the customers, but also on the product side, I mean this is not a departure from our core, this is building our core, we had like an older product set that a side view that is primarily succeeded lately as an element of other products rather than a standalone product. And this is exactly what Kentrox brings to the table is that standalone product in a leading position.

Richard S. Gilbert

And just add to that Jeff, what we haven’t talked about is some of the adjacencies, a lot of the product lines we sell everything from cabinets to the industrial Ethernet switches can be tied in to the Kentrox site management system very, very easily now. And so the area that we had, remember we had 10 product categories, one of our 10 product categories even before Kentrox was remote site management. Their products are so much stronger in that area that and they bring they are the software side, so well that I think it’s going to be an enhancement to probably five or six of our other product categories out of those 10 in terms of cross-selling. So it’s very exciting.

Jeff S. Linroth – Leaving It Better LLC

Yes, terrific. Just a quick follow-up on that, what is the, what would you of their growth, would you say that their growth in the last year or two outside the U.S. compared to U.S. growth is greater than or less than or somewhere in the same neighborhood?

Richard S. Gilbert

I actually think Kentrox is a very clever thing as they were developing this set of products, they started outside the U.S., made lot of their initial sales in this area outside the U.S. and developed those channels and developed a lot of credibility in this marketplace. And frankly in recent quarters, they focused more and more in North America and have won some of the larger customers in North America now with the contracts and I think what I would expect to see frankly as we go forward is some shift in revenue more towards the North American market, maintaining revenue in their geographic regions, possibly expanding into South American market more. But actually their rate of progress has been even more rapid now in North America.

Jeff S. Linroth – Leaving It Better LLC

And one other interesting thing I saw in your website, there is a whole page dedicated to Solution Partners Technology Alliances, can you talk about who one or two of those partners are and how those partnerships might be strengthened by the combination of Westell and Kentrox?

Brian Cooper

Well actually not up the top of my head to be honest. I don’t know the exact webpage you are referring to. I mean they do use – a lot of their Solution Partners are instrumental and helping them do deployment, so the installation of products and Kentrox manages that, but they don’t necessarily always use their own team to do all of the work.

Jeff S. Linroth – Leaving It Better LLC

I see, okay, that’s helpful. Okay, that’s all I have. Thank you very much.

Operator

Thank you. And the next question is from [Barry Pasternak from Rosement Capital]. Please go ahead.

Unidentified Analyst

Hey guys, it seems like a great fit. I was wondering, can you give us any estimate for the purchase accounting and integration costs for fiscal 2014?

Brian Cooper

Yeah. I mean I would like to be very specific here, but unfortunately I can’t be able to completely because a lot of the purchase accounting depends on the valuation and their opening balance sheet work that is not done yet. However we have two big items there, three if you count the amortization of intangibles. As we are looking at this right now, we see a fairly big impact coming from deferred revenue, which will need to write-down. There is a fairly large deferred revenue component to their balance sheet at closing and so that results in us not recognizing that revenue and similar profit on that business that we would recognize on an ongoing basis.

And then on the inventory side, we have to write that up to a so called fair market value and so our margin on the initial inventory that we acquired as it sells through will be a little lower. Overall, it will be several million dollars of impact on our fiscal 2014.

Unidentified Analyst

Probably about a 10% effect?

Brian Cooper

Yeah. It’s significant. But all of those specific numbers depend on the valuation and how those items are valued and how the total is valued to come up with goodwill and intangible values also.

Unidentified Analyst

Okay. And the 10% effect meaning 10% of what?

Brian Cooper

Of revenue.

Unidentified Analyst

Okay.

Brian Cooper

Probably north of $3 million.

Unidentified Analyst

Okay.

Brian Cooper

On deferred and inventory.

Unidentified Analyst

Okay. But there would be a small cash impact, right? The cash impact would be pretty nominal?

Brian Cooper

So Barry the way I think about this, the ongoing business is not really effected by this. The cash flow really isn’t effected. Obviously deferred revenue in general and in this case for the most part means that the company was paid for some services in advance, but most of those are on a contractual basis that repeat, it’s recurring.

So as we look at the business, the cash flow is not very effected and we will disclose publicly the impacts of those amounts as we are able to do that. So and that we are going to see how much of that is sort of the one-time or first year sorts of adjustments versus what the underlying business is doing.

Unidentified Analyst

Okay, great. And then just lastly can you quantify all their maintenance revenue as a percentage of their total revenue?

Brian Cooper

I think it’s in the double digits, but I don’t know the exact number.

Unidentified Analyst

Okay, great. Thanks.

Brian Cooper

I don’t think it’s 20%. I think it’s probably south of that.

Unidentified Analyst

Okay, all right. Thanks a lot.

Operator

Thank you. And the next question is from Philip Lee from Mangrove. Please go ahead.

Philip Lee – Mangrove Partners

Hi, actually all of my questions have been answered. Thank you.

Brian Cooper

Thanks, Philip.

Operator

Thank you. The next question is from Todd Brady from Oppenheimer. Please go ahead.

Todd Brady – Oppenheimer Securities

Good morning guys, congratulations. I apologize I did hop on the call late. What’s the net cash position after the acquisition?

Brian Cooper

It will be about $80 million, maybe a little more.

Todd Brady – Oppenheimer Securities

Okay. And did you guys elaborate how many total customers are you guys adding with this acquisition. Can you guys break out total number of customers last year versus the year before so we can maybe get some metrics of the not only growth rate of the revenues, but the growth rate of the customer base?

Brian Cooper

Yeah, I mean Todd, this is Brian. The customer base is fairly diversified, I don’t want to get into the specific numbers, but they are right there, the concentration of there are four five customers that make up a large percentage of their opportunity side and their sales, and they’ve grown a lot with those customers.

So I don’t think it’s really a measure of the number of customers that really more how they are performing with the existing customers, and they are winning some new customers over time of course, but it’s a lot of performing and delivering with existing customers.

Todd Brady – Oppenheimer Securities

Okay, but their top four five customers would comfortably represent north of 50% to 60% of the revenues, would that be fair.

Brian Cooper

Yes.

Unidentified Analyst

It’s okay.

Richard S. Gilbert

But I think, this is Rick. I think it’s important to note that in telecom especially wireless telecom, it’s not the question of the number of customers, whether you have eight out of the top 10 buying from you in wireless, that’s what’s important, and Kentrox is really focused on the biggest wireless players, and I think that’s why they where at, where they are.

Todd Brady – Oppenheimer Securities

Outstanding, great job guys keep up the good work.

Richard S. Gilbert

Thank you.

Operator

(Operator Instructions) And we have another follow-up question from Greg Mesniaeff from Maxim Group. Please go ahead.

Greg Mesniaeff – Maxim Group LLC

Yes, thank you. I was wondering if you can comment on the kind of sales force that Kentrox brings to the table obviously with a high backlog component in a high visibility in the lumpiness it’s more of a relationship type direct sales, and I’m wondering how you plan to integrate that sales force into the Westell organization. Thanks.

Richard S. Gilbert

Yes, Greg. This is Rick. That’s a great question. Again the integration of the sales forces in the Kentrox’s is not our short term will. They’re very experienced sales force that are very well tied into their customers, and they are making a lot of progress right now. So what we don’t want to do is getting the whole sale force together, and more apparently what we don’t want to do is distract either our sale force or their sales force from on going product progress, so we’re going to keep the two sales forces independent for the time being, let them keep while working on their independent plans, we will be getting the sale forces together in the middle of April for a joint meetings, so that we can look at cross selling opportunities, but we won’t be cross commissioning and things like that we’re going to keep them independent. Does that help to answer your question?

Greg Mesniaeff – Maxim Group LLC

Yes. Thank you.

Operator

Thank you. This concludes the question-and-answer session of today’s conference. I will now turn the call over to Mr. Brian Cooper for any closing remarks.

Brian Cooper

Thank you all for joining us, again we’ve very excited about this transaction, and I hope we answered all your questions, and look forward to talking to you on our next call. Thanks.

Richard S. Gilbert

Thank you.

Operator

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

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