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Westell Technologies, Inc. (NASDAQ:WSTL)

F1Q10 (Qtr End 06/30/09) Earnings Call Transcript

July 22, 2009 9:30 am ET

Executives

Brian Cooper - SVP and CFO

Rick Gilbert - President and CEO

Analysts

Todd Koffman - Raymond James

Steven Becker - Greenway Capital

Jeff Linroth - Leaving it Better LLC

Peter Schleider - Peninsula Capital

Operator

Good morning, ladies and gentlemen, and welcome to the first quarter fiscal year 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. We will not be taking questions from the media. 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, John. And welcome everyone to the fiscal first quarter conference call for Westell Technologies. We issued our earnings release last night and you can find the copy posted on our website at westell.com. Today, Rick Gilbert and I will discuss our business and financial results.

Please note that our presentation and discussion contain forward-looking statements about future results, performance or achievements, financial and otherwise. Words such as believe, expect, estimate, plan 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 future results is provided in the company’s Form 10-K for the fiscal year ended March 31st, 2009 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.

In addition, this presentation includes certain non-GAAP financial measures. Reconciliations between non-GAAP financial measures and GAAP financial measures are included in our news release.

Now, it’s my pleasure to turn the call over to Rick Gilbert, President and Chief Executive Officer of Westell.

Rick Gilbert

Good morning, and thank you for joining Westell Technologies first quarter fiscal 2010 earnings conference call. I am Rick Gilbert, Westell’s CEO. During this call, I will briefly discuss the Q1 results and then turn the call over to Brian Cooper, who will discuss the results in more detail. At the end of the call, Brian and I will be happy to answer some of your questions.

At our last earnings call in May, I outlined two key goals for FY 2010, returning Westell to profitability and generating positive cash flow. I am happy to say that our results for the first quarter of fiscal year 2010 has shown good progress toward achieving both those goals.

Simply stated, Westell had excellent first quarter results. On both the GAAP and non-GAAP basis, we recorded net income for the first time since March of 2007. We also increased cash and cash equivalents to $49.2 million. These results were achieved by solid execution in all three divisions with unusually strong contributions from the team at Customer Networking Solutions.

In the year-to-year comparison, the first quarter gross margins were improved for all three divisions which when combined with lower operating expenses yielded positive operating income and cash flow on a consolidated basis. In effect, we achieved both of our primary goals for the annual operating plan during the first quarter of the plan.

Clearly, the first quarter results must set the bar higher in our expectations for the full year. That said, we remain cautious in our outlook for the remainder of FY 2010. Continued weakness in the general economy may lead to delayed or cancelled orders in our two equipment divisions and the less demand for services in our conferencing division. Therefore, our reactions to the current economy are, to remain conservative in the use of our cash, to stay focused on expense reduction and to maintain solid execution in sales and marketing.

Our tactical plan for FY 2010 will remain much as described during our last earnings call. A rigorous focus on the bottom line results even if the top line should suffer from the current economic slowdown.

Now I would like to conclude with a few comments about the divisional strategic plans. During the last quarter, senior teams from each of our three divisions completed formal strategic planning sessions with the following high-level results.

ConferencePlus recognizes that they are a very small player in a commodity service market where size matters. As such, they have developed a strategy to focus more on differentiated service offerings and vertical markets. They also envision the longer-term possibility of selective acquisitions to support those initiatives. This approach should allow ConferencePlus to maintain good profit margins, while building a much more defensible and valuable market position.

Our Outside Plant division has confirmed the strategy that they had already begun to execute last year to harvest legacy networking products, while focusing development and sales resources on emerging market opportunities including wireless backhaul and smart grid applications.

OSP management recognizes that the development of these new markets won’t be instantaneous, but they foresee potentially large volumes if their products in these new areas are accepted as standard solutions. OSP is also focused on finding opportunities to provide turnkey cabinet based products that can be packaged, tested and shipped as single high-value items. We believe that OSP has a well-defined strategic path toward growing the business in a profitable way.

Finally, our Customer Networking Solutions division is still dealing with difficult tactical issues, including margin improvement and resolution of a SOP 97-2 deferred revenue issue. However, CNS has also performed a formal analysis which produced two key strategic goals, to make the core business profitable and to gradually shift that core business to a software based model. Of our three business units, CNS certainly faces the most difficult strategic path, but they are making progress as demonstrated in the first quarter results.

With that, I would like to turn the call over to our CFO, Brian Cooper who will discuss our financial results before we open the call for your questions.

Brian Cooper

Thank you, Rick. I am pleased to be able to talk today about a very good first quarter. I am going to highlight some of the key financial results and of course our news release contains more detail.

Starting at the top with our results under generally accepted accounting principles, we reported consolidated revenue for the fiscal first quarter of $40.5 million. This is up 6.3% versus last year’s first quarter, primarily as a result of higher sales by Customer Networking Solutions.

More importantly, Westell was profitable, reporting net income of $1.6 million. We had a loss of $5.5 million in Q1 a year ago. On a per share basis, this is net income of $0.02 per share in the latest quarter, compared with the quarterly loss of $0.08 per share a year ago.

Our management also focuses on some non-GAAP financial measures that adjust GAAP results for unusual items. We think this provides a useful alternative perspective on company performance.

As noted in our news release, we have made non-GAAP adjustments for just two matters. As in the preceding two quarters, revenues and gross profit are adjusted to include the effects of the shipments of the CNS division’s UltraLine Series3 gateways. These shipments began in the fiscal third quarter of 2009 and are deferred for GAAP purposes. They totaled $13.3 million in the latest quarter and add $734,000 to non-GAAP net income.

The second adjustment removes $609,000 of restructuring expenses incurred during the quarter. This now covers the termination costs incurred upfront for 50 employees whose positions were eliminated. The eliminations are estimated to reduce the ongoing operating costs by about $4.5 million annually.

We also made a small non-GAAP adjustment for restructuring in Q1 of last year. On this adjusted non-GAAP basis, revenue for our first quarter was $53.8 million, up 41% compared against revenues of $38.1 million in Q1 last year. The CNS UltraLine Series3 shipments are the primary reason for the increase in revenue. CNS also shipped more modems and other gateways.

Outside Plants and ConferencePlus revenues were lower than in the prior year. The Outside Plant decline reflects customer inventory adjustments and softer demand. Softer demand also affected ConferencePlus, as did some customer loses about a year ago that were not fully reflected in the fiscal quarter – the first quarter of fiscal year of 2009.

Company non-GAAP gross margins declined 500 basis points year-over-year to 28.8%. This decline results from the inclusion of UltraLine Series3 revenue at low margins. However, gross margins were generally higher across other parts of the business, reflecting both pricing actions and cost reductions. And margin dollars were up significantly. Non-GAAP gross profit was $15.5 million, up $2.7 million compared with a year ago.

Operating expenses also moved significantly in the right direction. At $12.6 million, non-GAAP operating expenses were $5.5 million lower than in Q1 a year ago and well below Q4 of fiscal year 2009. Adjusted expenses benefited from our April restructuring, lower legal and consulting charges and lower amortization of intangibles.

Benefiting from both higher gross profit and lower expenses, Westell reported a net profit for Q1. Rick already made this point, but it bears repeating that this is the first profitable quarter since March of 2007. This is true on both the GAAP and non-GAAP basis. Non-GAAP net income was $2.9 million versus a loss of $5.6 million in Q1 of last year.

Given our heavy emphasis on being cash flow positive, I am also happy to highlight our cash balances which increased for the second consecutive quarter. Cash was $49.2 million at June 30, up $3.2 million from last quarter. We’ve included a balance sheet and cash flow statement in our news release. These should help address questions related to cash flow.

That concludes my remarks and I believe we are ready to open the line for questions. John?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator instructions). Our first question comes from Todd Koffman from Raymond James. Please go ahead.

Todd Koffman - Raymond James

Thank you. Rick, in your opening remarks, you said the CNS division has a difficult strategic task ahead. Could you elaborate on that why isn’t that the UltraLine Series3 is somewhat of a sustainable business as customers continue to move forward in that deployment?

Rick Gilbert

Yes, Todd, good question. It is a sustainable business. If they weren’t, we would be out of the business. That’s not the point. The point I was trying to make is that any time you move a division that’s primarily been working on a hardware model for the last 29 years or whatever to work more in a software model approach, you’ve got to make some pretty interesting transitions and you have to do it in a way where the division continues to perform. So that’s the tricky strategic move that Chris and his guys are working on and that’s what I intended to convey.

Todd Koffman - Raymond James

Just as a follow up to that, if you look at that business in terms of whatever your current annual shipment volumes are, as you look forward a year or so, is it likely those volumes will increase, stay the same, go down or you just have no idea?

Rick Gilbert

Well, I think the – generally speaking, I would expect those volumes to increase. The wild card of course is the economy in general and I think it affects as I said all the divisions. Are people going to keep buying at the rates? Are they going to manage inventory in the same way they have managed it before? Are we going to get the kind of an order coverage that we have seen in the past? The good news about CNS is that they are a division that has good backlog in orders out for many months. So we shouldn’t be too surprised.

But the real focus we have is not just the top line growth. What we want is top line growth with good margins. And so if it comes down to a trade off, I am going to go for the margin business rather than the top line and I think we have made that clear in the last couple of calls.

Todd Koffman - Raymond James

Just one last quick question. Could you give any customer mix or customer breakout data for the quarter?

Rick Gilbert

No, we don’t do that.

Brian Cooper

I can tell you that our top customers aren’t going to change significantly.

Todd Koffman - Raymond James

Thank you very much. Good luck.

Rick Gilbert

Thanks Todd.

Operator

Our next question is from Steven Becker from Greenway Capital. Please go ahead.

Steven Becker - Greenway Capital

Guys, terrific quarter. I guess my question would be, if I – it looks like the non-GAAP EBITDA for the quarter was something like $4 million. Is there – was there any – is there any seasonality to speak off in this quarter? Were there any stocking orders? Was there anything in the business at all that would make this quarter somehow unusual or an anomaly?

Rick Gilbert

Steve, the – it was a very good quarter. So I don’t want to underestimate that. But there is not a specific seasonality factor and aren’t any big one-time items going one way or the other. So it was a very good quarter, but not seasonally good. Is that what you are asking?

Steven Becker - Greenway Capital

Yes, I mean, I am just asking in other words, were you – were you stocking channel at all, did your major customers take particularly big orders? I mean, was there anything that you wouldn’t have – was there anything got out of the ordinary in the quarter?

Rick Gilbert

No. And in fact if anything, our customers were probably managing their inventories downward.

Steven Becker - Greenway Capital

Okay. And the second question is that, are my numbers about right on the non-GAAP basis. Was the EBITDA about $4 million?

Rick Gilbert

Well, we don’t calculate EBITDA, but I think it’s pretty easy to see on a GAAP basis or non-GAAP basis and we’ve included the D&A of about $1 million in the cash flow statements. So you are in the right ballpark. Yes.

Steven Becker - Greenway Capital

Okay, terrific. Okay, thank you very much. Once again, terrific quarter.

Operator

And our next question comes from Jeff Linroth from Leaving it Better LLC. Please go ahead.

Jeff Linroth - Leaving it Better LLC

Good morning.

Rick Gilbert

Good morning, Jeff.

Jeff Linroth - Leaving it Better LLC

Well, first, let me express my great appreciation not just for the quarter, but for the focus on margins and the trade offs that you have been mentioning in this call and the last call, I really appreciate hearing that. My first question is about the transition to what I will call the new set of products. This was discussed a fair amount last year and I just want to know, in your estimation to what degree is this transition complete?

Rick Gilbert

Yes, Jeff, first of all, thanks for your comment on margins. It’s something that we are very focused on obviously. In terms of your question, I assume you are talking primarily about the CNS division and some of the initiatives that we were being worked on in the past. The big difference is instead of having sort of a shotgun approach of multiple new initiatives in the areas where we haven’t had big business in the pasts in the cable space and some of the wireless space and things like that. We have really, as I said in the comments just now and I apologize for them being as brief as they are. But what we have done is focus on the core business and our current customers and the volume business that we already have.

What we want to do is migrate from essentially a hardware focused business in that area to one that has a mix of hardware and software with more and more software emphasis and we want to get paid for this software, okay? Because we are becoming more of a software company as features are added to those core products. So the big difference between some of the previous initiatives and this year is, we are focusing on our current customers, our large customers, our fundamental product lines, but trying to move the model to a higher margin software based model from a lower margin hardware-only model. Does that make sense, Jeff?

Jeff Linroth - Leaving it Better LLC

Yes, it does and especially in the context of – especially coupled with the notion of focus on margins, I would be well pleased if, obviously, we won’t hear about this and I don’t need to hear about this. But I would be well pleased to imagine you walking away from business when that's the financially healthy thing to do. Second question, in the OSP, you mentioned there was a little bit of softness in the quarter as much as you think is prudent, would you comment on what areas and even more importantly, whether anything, any of that softness represents what you imagine to be a trend or whether it might just be temporal, just a blip?

Rick Gilbert

Yes. Well, I would say that, I wouldn’t specialize that answer on OSP only. I think we are seeing and by the way, in talking to other CEOs, I think the general feeling out there is the buyers are being very, very careful right now in managing their inventories and making their orders.

And you see some cases where orders are that we know are going to eventually happen are delayed or happening in little slower than we expect. But I think if you look at the numbers, the weakness was pretty minimal in OSP and they did pretty well and as did ConferencePlus and they both did extremely well in the bottom line, which is what we asked them to focus on. Do you have anything to add to that?

Brian Cooper

No. I mean, we talked a little bit about where the different customer mix was on Outside Plant and there was some softness on the enterprise side compared to the backhaul business. But –

Rick Gilbert

I think it’s really a case of just being aware that we don’t control the economy, we live in it. And these things are expected and to the extent we can’t plan for. So we weren’t surprised by anything really in last quarter.

Jeff Linroth - Leaving it Better LLC

Great. Thanks for that. I will stop now and give someone else the chance.

Rick Gilbert

Thanks Jeff.

Operator

(Operator instructions). And our next question comes from Peter Schleider from Peninsula Capital. Please go ahead.

Peter Schleider - Peninsula Capital

Yes, I am curious – I am a little bit out of touch with where Westell is right now. But I am curious about the UltraLine 3 – the UltraLine 3 is the $13 million that you did in the quarter. I am wondering, number one, is that kind of a pent up demand that occurred in the quarter that’s an unusual event? And secondly, what’s the feature set that’s driving that, is it DSL-2, MoCA? And have you won any new customers in that business that would drive it incrementally going forward?

Rick Gilbert

Well, the UltraLine Series3 is a product that was actually introduced in volume a couple of quarters ago. The volumes have grown in a very satisfactory way for us. And it’s essentially a multi based product that is triple play kind of product. It’s a very solid, high-performing, high-quality product. It’s certainly one of the best products Westell has ever built. And it’s a product that’s most interesting from my perspective, because it has the ability to add software applications in the future and it is the platform that – one of the platforms that we will really be focusing our software deployment efforts on. We sell it to multiple customers and I won’t go into the details, but certainly it’s a popular product.

Peter Schleider - Peninsula Capital

Was the way you recognized revenue in that product an unusual event? In other words, the $13 million that you did from deferred revenue or is that – should we expect to see that kind of event happen in the future?

Rick Gilbert

Yes, I think – the – Peter, the deferral has been growing each quarter, so we have on a non-GAAP basis not recognized revenue from that product since it was introduced. It will continue that way until our contract changes or until we would deliver substantially all of the software that is potentially called for in the arrangement selling that product. So it will probably continue for sometime.

Peter Schleider - Peninsula Capital

And how do you make money on an installed product that you are selling software too? How do you get paid for that? Does the contracts read that your customer will pay you incrementally for new features, that new software features that are delivered to the product?

Rick Gilbert

Well, Peter, I am going to get into the details of our contracts with any customer and this wouldn’t be appropriate and we are under nondisclosure on those. But what I can tell you in a general sense is the way you make money selling software to install products is to be paid for it, okay? So if you have new software applications that are requested by the customer that for instance are not covered in the contract, I mean that’s something that obviously we should be paid for developing and that’s our intention, you know.

Peter Schleider - Peninsula Capital

But that’s a change from what you all have done in the past. Those were usually been called software updates or fixes or maintenance. You have a new business model that you haven’t had in the past. Is that accurate to this product?

Rick Gilbert

That’s exactly accurate. Yes. In the past – but in fairness, in the past, the lot of the products were Westell build where primarily and hardware products were very little software content other than the real-time operating systems. This product is a departure and as are some of the new gateway products that we have where you would really have the ability to load to those software applications at the application level.

And that’s – it’s very exciting, because when you look at the kinds of a products you expect to see in the home in the future, you will start seeing these very sophisticated home gateways that have the ability for a significant expansion of functionality via software and that’s exactly what we have built with the UltraLine Series3 for instance.

Peter Schleider - Peninsula Capital

Finally, where is the product built?

Rick Gilbert

China.

Peter Schleider - Peninsula Capital

Great. All right, I will call you back later. Thank you very much.

Rick Gilbert

Thanks Peter.

Operator

Our next question comes from Jeff Linroth from Leaving it Better LLC. Please go ahead.

Jeff Linroth - Leaving it Better LLC

Yes, just a quick follow-up. The development – the development process obviously is evolving as the model evolves. Would you talk about how – I am sure there are some things the risk factors that are amplified and become more of a challenge and I am hopeful that there are some things that you’d feel some risk factors that ease in terms of possibly you being more agile at different points during the process and also software perhaps being easily modified, relatively easily modified. So can you talk about those different risk factors, once that maybe amplified and once that maybe decreasing existing model?

Rick Gilbert

Well, I mean, the risk factor if anytime you change a model is that the – you need to adjust the nature of the internal business and the externally negotiations to go along with that model. So the risk factors – obviously, we have to negotiate new aspects or addendums to contracts in order to cover the software. The risk factors internally are that you want to make sure you have the right engineering team in place to be able to develop some of the software.

The good news is that Chris Shaver, who runs that division has worked extensively in both hardware and software in his career. He comes from an engineering background. He’s got some very solid engineers on that team who has software experience. So I have little doubt that they will be able to move into the software world, but it is a change. And anytime you make change, there is risk. But that’s our job, is to manage risk. And I think we are comfortable that we can do that.

Jeff Linroth - Leaving it Better LLC

Okay. Thanks for that. And lastly, would you describe in efforts that you are making now or that you expect to make to just in general improve the relationship with the Street and in any terms you have cared to comment on?

Rick Gilbert

Well, with what we are is being very straightforward in what we are doing. These calls are I think very open and direct. I think we have been very consistent in our message. I think that’s important. For the Street, I hope that as we make additional progress, that we are able to get out to some of the investor conferences and things in the future to talk more about what we are doing. And I don’t know, do you have anything you want to add, Brian?

Brian Cooper

No, I think part of the way you satisfy the Street is to deliver on results and we are very focused on that too. So hopefully that will help. But yes –

Jeff Linroth - Leaving it Better LLC

I sure do appreciate that very last comment if for no other reason then I think it’s – I think giving a reasonable forecast about what you are going to do and going out and doing it reasonably close to what you said you were going to do is probably more than three quarters of the battle. And based on what’s going on so far, I’ll particularly look forward for the rest of this year and wish you good luck. Thank you.

Rick Gilbert

Thanks Jeff. We look forward to the rest of the year as well. And I think on that point, we should end this call. And I want to thank everybody for joining us today. We'll see you next quarter.

Operator

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

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