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Executives

Larry Sala - Chairman, President and CEO

George Blanton - SVP and CFO

Analysts

Steve Ferranti - Stephens, Inc.

Rich Valera - Needham & Company

Charles John - Piper Jaffray

Greg Weaver - Invicta Capital

Chris McDonald - Kennedy Capital

Anaren, Inc. (ANEN) F3Q09 (Qtr End 03/31/09) Earnings Call April 30, 2009 5:00 PM ET

Operator

Good day and welcome to the Anaren Inc. third quarter 2009 earnings conference call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Larry Sala, Chairman and CEO. Please go ahead.

Larry Sala

Thank you. Good afternoon and thank you for participating in the Anaren fiscal 2009 third quarter conference call. I am joined again today by George Blanton, our CFO, and Joe Porcello, our VP of Accounting.

I will provide a brief overview of the results of the 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 third quarter were $43.5 million, up 33% from the third quarter of last year and included $10.8 million of net sales from the M.S. Kennedy and Unicircuit acquisitions. The increase in net sales was driven by the Space and Defense Group.

Non-GAAP operating income for the quarter, excluding non-cash equity-based compensation and acquisition-related inventory step-up and intangible amortization was $5.8 million, or 13.3% of net sales. The increase in net sales, a very favorable sales mix and our continued cost containment efforts have positively impacted profitability for the quarter.

Wireless Group net sales for the quarter were $17.2 million, down 15% from the third quarter of last year but up 3% sequentially from the second quarter. Strong demand for standard component products, predominantly from customers in China, drove the increase in sales from the second quarter.

Sales of consumer components were $1.5 million for the quarter, up 75% from the third quarter of last year, due to the continued diversification of design wins in satellite television, laptop and cellular telephone applications. 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 Nokia, Richardson, and Huawei.

For the Space and Defense Group, net sales for the quarter were $26.3 million, up 112% from the third quarter of last year and included $10.8 million in net sales from the M.S. Kennedy and Unicircuit acquisitions.

The Space and Defense Group continued to deliver organic sales growth and the integration and performance of our recent acquisitions are progressing to plan.

Profit margins for the Group improved in the third quarter due to the completion of several development projects, increased production yields and a favorable sales mix.

New orders for the quarter were $26.5 million and were driven by contracts for radar, jamming and passive ranging applications.

Customers that generated greater than 10% of Space and Defense Group net sales for the quarter were Raytheon, Lockheed Martin, and SRC Tec. Space and Defense order backlog at March 31, 2009 was $87 million. George?

George Blanton

The highlights of the third quarter income statement and balance sheet at March 31, 2009 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 Q3 earnings release for a reconciliation of GAAP and non-GAAP measures.

Non-GAAP gross margin was 34.7% for the current quarter compared to 33.5% for the second quarter of fiscal 2009, and 31.7% for the third quarter of last year. The increase in third quarter fiscal 2009 gross margins resulted from a favorable product mix in the Wireless business, cost reductions efforts in Syracuse and lower manufacturing costs for our business transfer to China in the second quarter. We expect non-GAAP gross margins to fluctuate between 34% and 35% for the fourth quarter of fiscal 2009.

Investment in research and development was 7.8% of net sales in the third quarter compared to 7.3% of net sales in the second quarter of fiscal 2009, and 8.2% of sales for the third 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 13.3% of net sales for the third quarter, up 440 basis points from the third quarter of fiscal 2008 and up 180 basis points from 11.5% for the second quarter of 2009.

The third quarter of fiscal 2009 improvement was the result of a more favorable product mix, higher sales volumes and a continued improvement in operating profits at our new acquisitions.

Non-GAAP net income was 9.6% of sales, or $0.30 per diluted share, for the third quarter of fiscal 2009, including $311,000 of interest expense. This compares with non-GAAP net income for the second quarter of fiscal 2009 of 7.9% net sales, or $0.23 per diluted share, which included $622,000 of interest expense.

Non-GAAP net income for the third quarter of fiscal 2008 was 10.8% of net sales, or $0.24 per diluted share.

The effective income tax rate for the third quarter of fiscal 2009 was 25.7% and included one-time adjustments of approximately $165,000. This compared to a tax rate of 27.4% for the third quarter of last year and 18.2% for the second quarter of fiscal 2009 which included the reinstatement of the federal research and experimentation tax credit retroactive to January 1, 2008 resulting in a one-time federal tax benefit of $265,000 in that quarter.

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 in the second quarter, should be approximately 31%.

Interest expense for the third quarter of fiscal 2009 was $311,000 compared to $622,000 for the second quarter. This decrease resulted from a significant decline in the 90-day LIBOR at January 1, 2009 compared to the second quarter rate. The 90-day LIBOR has remained at lower levels and we expect interest expense for the fourth quarter to be approximately $286,000.

Balance sheet highlights include cash provided by operations was $8.6 million in the third quarter of fiscal 2009; capital expenditures were $1.8 million in the quarter; cash, cash equivalents and investments were approximately $50.4 million at March 31, 2009, up $6.3 million from June 30, 2008.

During the third quarter, we did not purchase any shares of Anaren common stock and year-to-date we have purchased 471,000 for $5 million. There are approximately 1 million shares remaining under the current board repurchase authorization at March 31, 2009.

Accounts receivable were $26.2 million at March 31, 2009, up $3.1 million from June 30, 2008 and included $7.3 million from the acquisition of M.S. Kennedy and Unicircuit.

Days sales outstanding were 54 days, down 61 days at June 30, 2008.

Inventories were $38.7 million at March 31, 2009, up 44% from $27 million at June 30, 2008, due to the acquisition of M.S. Kennedy and Unicircuit, which added $12.1 million in inventory.

Larry Sala

Thanks, George. For the fourth quarter of fiscal 2009, we expect comparable sales to our just completed third quarter with higher demand for Space and Defense Group products and lower demand for our Wireless Group products. As a result, we expect net sales to be in the range of $41 million to $46 million.

We expect GAAP net earnings per diluted share to be in the range of $0.19 to $0.23 using an anticipated tax rate of approximately 31% and accounting for approximately $0.05 to $0.06 per share in charges related to expected stock-based compensation expense and amortization of acquired intangibles related to the two acquisitions.

Non-GAAP net earnings per diluted share are expected to be in the range of $0.25 to $0.29 for the fourth quarter.

We will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions). We'll go first to Steve Ferranti with Stephens Inc.

Steve Ferranti - Stephens, Inc.

Nice job on the margin expansion during the quarter. I guess that leads sort of into my first question. Third quarter did see some nice operating margin expansion. It looks to me like your fourth quarter guidance might imply sort of flattish operating margins. Can you comment at all on that?

Larry Sala

Sure. There's a couple of factors. One is a little bit higher tax rate in quarter and the other is a mix shift for us that's definitely expected to be less favorable.

In our Wireless business, we saw significant demand for our standard component products out of China last quarter. We definitely expect that demand to be down relatively this quarter, driving a mix to more custom business in our Wireless business.

So yeah, both factors of tax rate and mix shift, we expect to have a little bit more pressure on our margins this quarter.

Steve Ferranti - Stephens, Inc.

Does the higher Space and Defense contribution in the fourth quarter, will that help or have a negative effect on margins?

George Blanton

In general it will help, but not to the extent of the margin benefit we get out of our standard component products. We also, on the positive side, expect to continue to get some benefit from the cost reduction activities we had in place for the fiscal year. So we saw a good portion of that benefit in the third quarter. We hope we continue to see incremental benefit in the fourth.

But to directly answer your question, generally Wireless to Space and Defense, we see comparable gross margins, but are replacing the standard component product revenue with Space and Defense. We definitely would see a decline in profitability as a result of that.

Steve Ferranti - Stephens, Inc.

Then just where are you guys in terms of some of the cost reduction efforts that you had going on? I mean I think we've seen some nice progress there on the operating margin side. Can you kind of talk us through what your plans are for fiscal '10? How we should think about the activities on that front?

Larry Sala

We've had some pretty good cost reduction efforts in some of our operating expenses in terms of some things like professional services and some of those expenses have been offset by some yield issues that we've had on some new development programs. We continue to see the cost reduction efforts in Q4 and they will continue into FY '10.

We had a goal of about a 5% reduction with a stretch goal of an additional 5% reduction in our Syracuse facility, which is a $2 million to $3 million in total. We think we'll be able to continue that into the first half of next fiscal year with some additional cost reductions, both in professional services and we should see some higher yields on our products that are maturing in our production cycles.

Steve Ferranti - Stephens, Inc.

I know you don't guide for full fiscal years, but directionally can you sort of help us think about fiscal year 2010 in terms of what you're seeing on the opportunity side? Just maybe broadly in terms of consumer Wireless and Space and Defense, maybe which one might grow the fastest, and kind of just walk us through how you're feeling about the opportunities in each of those segments?

Larry Sala

Sure. On this Wireless side, from the infrastructure side of the business, we feel real good about our progress on the standard component side in terms of our new product introductions, our retaining and gaining share. It's really going to be driven there by overall market demand.

But I would say our belief is given the evolution of amplifier architecture, the evolution of our product introductions, we should see gaining share and better than average corporate growth assuming the market demand holds up or grows off the base that it's been this year.

From our custom side, we feel like it's a fairly stable product line for us. We've got a couple of new products transitioning into production. Assuming we keep our share on the others, which we believe we will. We'll see some growth there due to the new business capture.

Overall, we continue to focus our R&D efforts and our business capture efforts more on our higher margin product lines, where we have better differentiation. So, I think '10 looks like a promising year for us on the custom product side because of these new product wins, but longer term, we don't expect that to be a large growth driver for us.

On the consumer component side, we're still pretty optimistic about the design wins we see, the level of continuing expansion of the product line and the addressable markets. We are, I believe, projecting dollar growth comparable to the dollar growth we saw in that product line this year. So from an overall growth standpoint, we hope to see better than average growth in that product line as well.

Again, very much driven by what happens in the platforms that we participate on and in the satellite television marketplace, which still drives a meaningful amount of revenue in our consumer business.

On the Space and Defense side, it's very much a backlog-driven business. We believe that both the acquisitions we made have reasonable growth prospects next year. We're thinking our Syracuse operation is a little flattish. We're going to go through a period of probably the first half of the fiscal year anyway where we have a lasting business with our IED business more quoting to the latest RFQ and requirements for that business, but we have not seen follow-on orders. Our customer there has not had follow-on orders for the last several months.

So our understanding is that, they should be quoting that business in the next couple of weeks here and that that business would be awarded sometime in August, and then go from there. So because of that, we'll probably see a little slower revenue rate in the Space and Defense Group in the first half, but we're pretty optimistic both from other programs that we have transitioning into production as well as the IED business that our Space and Defense Group will have a strong second half of the year next year. So, that's kind of our general view of where our business stands going into fiscal 2010.

Steve Ferranti - Stephens, Inc.

Just one housekeeping question before I turn it over. George, when you talk about the tax rate 31%, is that a GAAP tax rate? In other words apply to our GAAP pretax income number or is that adjusted?

George Blanton

That's the GAAP tax income rate.

Operator

We'll go next to Rich Valera with Needham & Co.

Rich Valera - Needham & Company

If I could just follow-up on the tax rate. What are you thinking about for taxes in fiscal 2010? Is that dependent on a reinstatement again of the R&D tax credit or how should we think about that?

Larry Sala

Assuming that it continues, the rate would probably be somewhere in the neighborhood of 31%, 32%. It depends on how much income ends up at the China facility. The rate in China is approximately 12% to 15% right now. So, depending on how the income breaks down. So it really depends on the Wireless product mix too, but somewhere in that neighborhood of 31%, 32%.

Rich Valera - Needham & Company

Larry, since you typically do get an annual forecast for most of your wireless customers, what's the current view you have in terms of the ebb and flow there, particularly from China where you saw it sounds like a real big surge late in the first quarter? Sounds like that's going to taper off in this quarter but I presume China is not done at this point. So just trying to get a feel for what you see for beyond the June quarter in terms of wireless demand at this point.

Larry Sala

I'd say right now from the forecast, the latest forecasts that we've been given which are fairly recent, it looks like things are going to stay at relatively lower levels here through June, and then starting in July and August, we should start to see a pretty material pickup in demand if you believe the forecasts that we're seeing right now. Then we're seeing that sort of pattern from multiple OEMs. So that's our best guess right now.

Rich Valera - Needham & Company

Just following up on your comments on the Space and Defense business, you said you thought Syracuse would be roughly flattish in 2010 I guess as you kind of transition to the next phase of the IED program there, but how about the acquisitions? I know MSK is doing well and I'm not sure as much about Unicircuit, but would we expect growth out of at least the acquisition portion of the business in Space and Defense in 2010?

Larry Sala

Yeah, definitely. We see good demand patterns, good backlog, good established programs for both of those entities. So yeah, we're optimistic we'll see good growth out of both of them.

Rich Valera - Needham & Company

In terms of the IED stuff, you obviously had the key program here with SRC that you are engaged on and will sort of be reengaged, but you'd been working on some other opportunities I thought within the IED area. Is there anything potentially imminent there on new IED programs?

Larry Sala

No, we are going to be introduced some standard component products for those applications that we think will give us a higher likelihood of participating. As far as assembly products, custom assembly types of products for other military OEMs in that space, we really don't see anything in the near term beyond what we're doing with SRC.

Rich Valera - Needham & Company

Sort of a bookkeeping one, but the amount of net acquisition-related intangible amortization per quarter, the actual net amount was quite small, I think around 60,000. Is that the right number to look at going forward?

George Blanton

No. There was an adjustment to the intangibles in the quarter.

Rich Valera - Needham & Company

Okay.

George Blanton

Going forward, it should be about $300,000 a quarter, $100,000 a month.

Operator

We'll go now to Mike Walkley with Piper Jaffray.

Charles John - Piper Jaffray

This is Charles sitting in for Mike Walkley. Just starting out maybe with the infrastructure side, looking specifically at China, just hearing a lot of positive data points from some of our other companies, but it's also being tempered by the comments and aggressive pricing. So just curious, how long do you think this China strength can continue and if Huawei remains a 10% customer for you guys for the foreseeable future?

Larry Sala

Well, as I said, we saw an aggressive push of demand and increasing forecast pretty much accelerating after Chinese New Year with a lot of pull-ins of demand and deliveries. It just seems as though things might have heated up a little excessively. As well, we often see this in our standard component lines with customers concerned with capacity allocations. So they tend to buy aggressively to make sure they get their shares of capacity and can fulfill their needs. When we do deliver, then they tend to back away to not want to take on too much inventory too quickly. So this is typical I would say of some of these bigger build-outs.

We don't have enough visibility to say that this surge of demand in July and August is real, but we do know that our customers want to sit back down with us as they usually do halfway through the year to talk about demand and pricing. That's the forecast that they are providing to do that on. So I think it's everybody's best forecast is that this second half of the year, demand will continue. That's what we're going to use to base our relationship with them for the second half of the year.

Charles John - Piper Jaffray

Then just between the infrastructure and the Space and Defense, looking at last quarter also, it's holding at a steady 60%-40% split. Just thinking about the model longer term, should we expect defense to become even a bigger part of the sales mix? Or does it stop from here and the strength in China and if infrastructure picks up, it starts reversing the other way?

Larry Sala

I wish we could say. It's all tied down to the overall wireless market demand. So we've got as I said a number of new product introductions, new content opportunities in our standard components and wireless, got some new products transitioning to production on the custom side. It's really what happens to this overall demand that's going to drive the real magnitude of growth or decline in our Wireless business and the percentage relative to our Space and Defense business. So that's hard to say.

When we look back historically, barring acquisitions, the split in our business has been relatively stable. These businesses have grown at relatively comfortable rates over the years.

Charles John - Piper Jaffray

George, maybe one for you. Just looking at the organic backlog versus inorganic, the organic has grown slightly but some of the acquisition, fallen from about 27 or 24. Anything we should read into that or maybe you can just give us some color on how we should think of backlog growth for the next couple of quarters?

George Blanton

I think Larry's statement about flattish for the Syracuse and we have some upside on the acquisitions, I think that trend will continue going forward.

Larry Sala

It's more just driven by the lumpiness of orders in that business. That trend is really just the fact that MSK had a just out-of-the-park order quarter in our second quarter. They're just not going to continue to book business at that rate or they're going to triple in size in a year. So their backlog of the acquisitions jumped way up for a short period time, but it will work its way back down to something more representative.

So yeah, it's just the fact that these are big contracts, the orders are lumpy. They can fall within any kind of six or nine month timeframe. We have unfortunately little control of getting some of those orders closed.

Charles John - Piper Jaffray

Final one, just on cash generation, when we look at some of the estimates that we have, we get to some pretty compelling numbers. Maybe if you could just give us some color on how you're thinking of cash flow just internally within the company?

How we should think of the risk to this cash generation, if there's any significant cash outlay that we're not thinking about or what fiscal '10 will bring from just a cash generation perspective?

George Blanton

We had a pretty aggressive program to improve our working capital. We focused a lot on both collections and inventory reductions. We've had significant success with our collection efforts. You can see our DSOs come down I think on the wireless side, where we have a lot of commercial customers.

We've been able to manage our customers and work through some difficult situations, but keep in touch with them and make sure they adhere to the terms and conditions of the contract. While we're also improving our collections in the Space and Defense side and our new acquisitions are improving their collections and doing quite well with some of their customers.

On the inventory side, we haven't had quite as much success as we'd like. It's been fairly flat. We think that we'll see some significant improvement in our inventory levels in the fourth quarter and we would expect that to continue in the next year. I think the cash flow could be in the fourth quarter similar along the lines of the third quarter.

Charles John - Piper Jaffray

Do you have any CapEx metrics, just a forecast for fiscal '10 overall similar to fiscal '09?

Larry Sala

Yeah, very similar. I mean we've historically been a 5% of sales CapEx spender. We kind of curtailed it a little bit below that, but that's our expectations. Barring some unforeseen or some opportunity that we choose to make an investment in, we'd expect to stay in those relative 4% to 5% of sales volumes.

Operator

We'll go next to Greg Weaver with Invicta Capital.

Greg Weaver - Invicta Capital

In terms of investments, could you give as little color in terms of what's been going on over at Anaren ceramics and how that's paying off for you?

Larry Sala

In the ceramics business, we made an investment a couple years ago. We started it and completed it a little over a year ago in LTCC multilayer ceramic technology. We've seen some very strong orders in that business this year. I want to say year-to-date, we probably have booked $5 million or more in LTCC-related orders. So that's up from nearly nothing the year before, a few hundred thousand dollars the year before.

We're trying to branch out and diversify our customer base and opportunity there. Some of the bigger single-platform opportunities that we are pursuing, we either got to get the cost of this technology down or find some other more diverse applications for it. So we are still very optimistic that there's a good solid revenue stream in both the Space and Defense market and the Medical market. We've got probably now 10 or more programs, where we're either delivering some level of production or doing some type of qualification and development on.

We're pleased with the progress we've made. The Joint Strike Fighter and others were big opportunities for us that we're still pursuing, but we are cautious of whether or not this technology can get to the cost and price points that those high, high volume programs need. So right now, that facility is a significant revenue driver for us. It's growing appreciably this quarter over what it's been running historically.

Greg Weaver - Invicta Capital

So just on the current 10 plus projects that you're working on and you can foresee some additional nice growth for next fiscal year?

Larry Sala

Yes, some of them are early-stage, some of them we have seen a couple lots of low volume production orders on. So, yeah, we'd expect to see good opportunities over the next several years given all the development work that we are doing.

Greg Weaver - Invicta Capital

On the MSK, it sounds like things are going well there, really well. Could you give a little more color in terms of what was the driver for these strong bookings?

Larry Sala

Well, they have had significant content on the new GPS program, GPS III. They are a customer there. They've had a long standing heritage with and high content. They have also been able to capture a number of other new space customers over the last six or nine months and are also bringing a couple of new product lines to the marketplace now with radiation hardened single devices.

So some of the new products as well as customers that they have had, some good heritage with winning some key programs has been a big driver of growth and stability for them.

Greg Weaver - Invicta Capital

How are your joint marketing efforts going?

Larry Sala

Going very well. We had a plan of investment in capability to move them higher in frequency this fiscal year. I think we have completed that. That equipment is in, up and running and capable of doing what we said.

We already are building some small volumes of RF Hybrids for some of our military customers. We are actually tomorrow have a customer into demonstrate these whole joint capability of our RF Design and M.S. Kennedy's RF manufacturing capability for a number of fairly significant programs with this customer. So I think we are probably ahead of plan from the integration of capabilities.

Greg Weaver - Invicta Capital

Is it realistic to consider some meaningful revenue out of these RF Hybrids within the next fiscal year or is that too really given the cycle time in defense?

Larry Sala

Well, I think that's very realistic. There's kind of two opportunity sets we go after. One would be just building RF Hybrids that our customers design and either just building them and delivering them or building them, and RF testing them here in our Syracuse facility, and delivering them to the customer. Those opportunities, we've already got, as I said a couple of small demonstration runs, qualification runs going and can turn to production very quickly for us.

The others would be with either earlier stage programs that are still in development or products, where we actually do some of the design ourselves and develop and qualify product for the customer. Those are certainly longer lead time. It's very much our expectation that we will be generating revenue from the RF Hybrid business next year.

These are little bit delicate in that. They're growing at a fairly healthy rate on their own and we're a little cautious not to overwhelm them with too much at one-time here.

Greg Weaver - Invicta Capital

On the defense side of things, have you seen any kind of hiccups in order flow as it relates to, I know some of the bigger contracts contractors are seeing stuff. Are you far enough up the food chain that it's a little smoother in your world?

Larry Sala

Well, I would say it's probably just the opposite. It's never smooth for us. It seems like it takes forever to get some of these orders closed out from our customers. I wouldn't say we've seen anything change significantly from status quo. It just seems like our customers have gotten in the habit over the last several years of just partially funding us to make us get going and the problem go away for the time being.

So what happens is we tend not to book immediately large multi-million dollar orders. They will give us some partial funding of $1 million, say, get started and the problem goes away for them for six or nine months or a year. Then they got all that time to finalize contractual terms and get things fully put in place. So that's been going on for us for a bit and it tends to just drag these contract closures on for extended periods of time.

Greg Weaver - Invicta Capital

You had good bookings in the quarter?

Larry Sala

We did, yeah, and we had the last couple of quarters. Then we're optimistic about our prospects this quarter as well. We've said many times there will be gaps, there will be lumpiness in this business that's just unavoidable.

Greg Weaver - Invicta Capital

Lastly on this EQ-36, I guess how are we doing there? You were bidding an extra piece of work and moreover it seems there was some news recently regarding a follow-on contract, I think it was $20 million, to Lockheed for spares. I don't know how many units that is.

Larry Sala

I did see that and I have not heard from our folks here yet, whether or not we'll be a beneficiary of some piece of that or not. We have three different, I believe, assemblies on that system. We captured an order for the additional 12 radars that was awarded last quarter. We completed the first five units that we were originally under contract for and we're starting to deliver under the contract for 12.

So as production's smoothing out, we're expecting it to be a long program for us. We're working closely with the customer. We are pursuing, hopefully two other assemblies on the platform. We don't know our likelihood of success, but it could grow our content by maybe as much as 50% from what we already have.

We also expect the customer is going continually push us for some cost improvement on the project as well. So we believe we can continue to meet the requirements and it will be a good long-term program for us.

Greg Weaver - Invicta Capital

So there's a little more work that's potentially coming your way? Of the two, you are only chasing one before. I don't think the content addition was quite that big.

Larry Sala

Yeah, there's certainly two other opportunities. I don't want to misrepresent our likelihood of success, but there's certainly two other product opportunities for us where we certainly have the capability and wherewithal to compete. So we'll give it our best shot.

Greg Weaver - Invicta Capital

The yields there have gotten better as you said the things are smoothing out?

Larry Sala

Yeah. We've transitioned the product that we were having issues with is now being serviced by Unicircuit for us. They have done a great job for us in improving the yield and we've worked together well to try to make it more manufacturable. We're making good progress.

Operator

(Operator Instructions). We'll go next to Chris McDonald with Kennedy Capital.

Chris McDonald - Kennedy Capital

Larry, maybe you could just give an update on where the company stands as it relates to Joint Strike Fighter content just independent of the whole LTCC area, talk a little bit about where you are involved in that program?

Larry Sala

Sure. That's one that's still in a great state of flux for us. We have some assemblies that we're developing here for some of the EW applications. We got through our preliminary design reviews and we are moving to deliver preproduction type of hardware over the next couple of months.

At M.S. Kennedy, they have a number of different module applications from different types of flight control modules that they build and other products that they build for kind of control and signal processing on the platform.

The biggest opportunities for us are in the radar side of that application and its both feed networks, which are built by Unicircuit and here our Syracuse operation jointly. They do the full fabrication. We would do the assembly and test of those devices. That business we are still pursuing, and then, also, any type of opportunity for either the substrates or the modules used in those applications. So there is a number of different opportunities for us and a significant amount of content opportunity for us.

It's still a bit early for us to say exactly what we believe our dollar content will be. Given all the areas that we are pursuing, it certainly has the potential to be our largest program ever.

Chris McDonald - Kennedy Capital

So this is potentially $0.5 million per plane, if everything went well?

Larry Sala

Yes, that's probably aggressive. Like I said, it depends on how optimistic you want to be with our ability to get content in the radar. I'd say on the low side, it's at least $0.25 million probably per platform. On the high side, it's probably more in the range you are talking about. It really depends on how aggressive you want to be in projecting our ability to get content in the radar side.

Chris McDonald - Kennedy Capital

Just as it relates to the cost savings opportunity, I just want to get a little better handle on how much of that $3 million would be incremental to the run rate being experienced already. I don't know if you can try to...

Larry Sala

We'd say we captured a good percentage of that already in our current margin. So a good part of our margin expansion this year was some yield improvement, some mix shift and the benefit of these cost reductions. So we probably would say we have seen 70% of it or so this year, if you want to just take a guess.

We see another probably 1% of sales opportunity next year. We will certainly have a goal of probably that order of magnitude to continue to drive costs out of our business. So the bigger opportunity now is to improve our yield and improve our inventory obsolescence in those types of initiatives.

Chris McDonald - Kennedy Capital

How was that performance in the quarter? I mean you had great margin expansion, but I'm just curious how much of that was yield driven or through obsolescence driven?

Larry Sala

Yields were not still spectacular in the quarter. Our Wireless business, our yields have improved significantly this year and they have been pretty consistent in delivering good solid yields. Our Space and Defense business has been more erratic. So if I had to guess, I would say we probably got a percentage point improvement in our overall yields in the last couple of quarters. There's still probably a point to get in yields going forward.

Operator

We'll now take a follow-up from Steve Ferranti with Stephens Inc.

Steve Ferranti - Stephens, Inc.

Just a follow-up to one of the prior questions. You were talking about RF Hybrids. Just want to clarify that those are sort of the components that would be targeted at some of these integrated TR modules for the phased array radar opportunity?

Larry Sala

We really can't say all of the places that applies, but this RF Hybrid technology is used all over these platforms from the EW system to radars to jammers. So yeah, we're not certain what portion of the technology our customers are willing to go outside for and what they'll keep inside, but there is certainly opportunity in all of those applications.

Steve Ferranti - Stephens, Inc.

Then you talked about in terms of the fiscal '10 landscape I guess, some potential strength in the second half in Space and Defense. Are there any specific programs you can attach to that that you expect to be sort of picking up in the second half? I know you mentioned the counter-IED program. Are there any other ones that you have visibility to at this point that you think might lead the charge?

Larry Sala

Yeah. We've got a couple here. One is two programs that we captured in the last quarter or two had then this upgrade of the Phalanx radar system which we talked about for the last couple of quarters were just starting to gear things up now. It will take a quarter or two till that's up and really running in volume production. Then we expect that to be a long and multi-year product for us.

There's an upgrade of the B-2 as well that we captured an order on this past quarter. That's comparably got a fairly long lead time to it. So I guess late summer, we will start to see ramping up and become a material revenue stream for us. So there is a couple of orders beyond the IED that we have, that aren't going to have as big an impact in this quarter and the next one or two, but should start ramping up as we move into the end of calendar '09 here.

Steve Ferranti - Stephens, Inc.

Last one for me. Just touching back on the cash flow, can you give us some sense for how you think about cash usage going forward outside of sort of normal CapEx and working capital needs? The business is throwing off rather nice cash flow. Any sense you can give us for how you think about potentially returning that to shareholders going forward?

Larry Sala

Sure. This year has been a year, where we have been more focused on our indigenous growth opportunities and integrating these acquisitions. We're starting to feel the capacity to start looking again at ways in which we could expand our technology base and enhance our growth. So, acquisitions are something that we are always contemplating and considering, but not the first priority of investment for us.

So as far as priorities of capital, we'd like to pay our debt down. We haven't had debt for a long time and it's something we're not super comfortable with culturally. We'd like to continue to have the ability to invest in our internal opportunities. So that would certainly be a top priority for us. With some of these radar opportunities, certainly if we're successful, we will drive capital requirements for us to have the capacity for some fairly high volume opportunities. So, we definitely want to have the balance sheet strength to be able to do that as needed.

Then it would be looking at acquisitions and lastly if anything significantly negative happened in our stock price, we certainly have a Board authorization and would be active. I would say in general, we feel like we have the business space and the profit generating ability to drive meaningful earnings on our share counts. So, we don't feel like we've got an excessive number of shares outstanding. When we see value there, we've tended to take action there as well.

Steve Ferranti - Stephens, Inc.

What's the potential that we could see sort of an accelerated debt pay down schedule? I think you've got a five-year declining balance if I remember correctly.

Larry Sala

No. With LIBOR at 1%, there's not a lot of motivation to pay that down at an accelerated rate. That rate can move quickly as it has on us already. We lock in on the first day of every quarter, so we know we have a very low rate this quarter. We're fairly optimistic that it's not going to go anywhere quickly here. At that kind of rate, it's not a big motivation to pay that down. We'll probably just build up our cash balance.

Operator

There are no further questions in the question queue at this time, so I'd like to turn the call back over to management for any additional or closing remarks.

Larry Sala

We greatly thank you for your participation and we look forward to speaking with you again next quarter.

Operator

This does conclude today's conference. Thank you for your participation.

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Source: Anaren, Inc. F3Q09 (Qtr End 03/31/09) Earnings Call Transcript
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