Aviat Networks' CEO Discusses F1Q 2014 Results - Earnings Call Transcript

| About: Aviat Networks, (AVNW)

Aviat Networks, Inc. (NASDAQ:AVNW)

F1Q 2014 Earnings Conference Call

October 30, 2013 04:30 PM ET

Executives

Peter Salkowski - IR

Mike Pangia - President and CEO

Ned Hayes - SVP and CFO

Analysts

Rich Valera - Needham & Company

Operator

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Aviat Networks’ First Quarter of Fiscal 2014 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions). This conference is being recorded today, October 30, 2013.

I would now like to turn the conference over to Peter Salkowski, with Aviat Networks Investor Relations. Please go ahead, sir.

Peter Salkowski

Thank you. Good afternoon everyone and welcome to Aviat Networks fiscal first quarter 2014 earnings call. I am joined today by Mike Pangia, President and Chief Executive Officer and Ned Hayes, Senior Vice President and Chief Financial Officer.

During today’s call, management may make forward-looking statements regarding Aviat’s business, including statements relating to projections of earnings and revenues, business drivers, the timing and capabilities of new products, network expansions by mobile and private network operators and variations of economic recovery in different regions.

These and other forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. Please note that these forward-looking statements reflect the company’s opinions only as of the date of this call and the company undertakes no obligation to revise or publicly release the results of any revisions to these forward-looking statements in light of new information or future events.

For more information, please see the press release and filings made by the company with the SEC. These can be found on the Investor Relations section of Aviat Networks’ website at www.aviatnetworks.com.

In addition, during today's call, management will be referencing to both GAAP and non-GAAP financial measures, a copy of the press release and financial tables which include the GAAP to non-GAAP reconciliations and other supplemental financial information is available on the Investor Relations section of the company’s website.

I would now like to turn the call over to Mike Pangia.

Mike Pangia

Thanks Peter. Today we announced our first quarter of fiscal year 2014 results. Total revenue for the quarter was $93.4 million resulting in a non-GAAP EPS loss of $0.13. Revenue for the quarter was slightly below the bottom end of our revised guidance issued on October 3rd.

I want to be upfront in saying that I consider the first quarter mix relative to our guidance to be a serious issue and I am disappointed by the results. We’ll discuss reasons for the top-line shortfall, but in any case given our expectations for the near term we are actively formulating plans that further optimize our cost structure and lower the company’s revenue breakeven level. Ned will speak more to that later on the call.

That said I do not believe our fiscal first quarter performance is reflective of Aviat’s broader market opportunities. Our medium and long term outlooks for the global microwave industry are still strong based on the increasing availability smartphones, tablets and the accelerating demand for data and connectivity. And in non-mobile our positive outlook is based underneath for network modernizations across multiple segments. This is expected to drive demand from microwave backhaul on a global scale.

I first like to cover the reasons for the lower than expected first quarter results. Although we were already expecting a seasonally lower fiscal first quarter, the rebidding of a large contract with a new customer in Asia was anticipated to contribute revenue in the quarter. The contract valued in the mid to upper single digit millions is for a standalone order. Several small factors, primarily in North America also contributed to Aviat’s lower fiscal first quarter revenues.

Our first quarter revealed two things. First that sales cycles have lengthened. And second the amount of business to be booked and ship within the quarter had increased. While we expect to see improvements in our non-GAAP gross margin, as the fiscal year progresses, the top line performance and to some extent mix currently impacted profitability this quarter. Our non-GAAP gross margin was at 25.1% resulting in a non-GAAP EPS loss of $0.13. This is the first non-GAAP EPS loss in the last nine quarters. Ned will go into more details of both our revenue and margins in a few minutes.

Financial highlights for the first quarter include a book-to-bill ratio slightly above one. We were successful in decreasing non-GAAP OpEx spending compared to both the year ago quarter and the fiscal fourth quarter of 2013. We ended our fiscal first quarter with a healthy $73.3 million of net cash on the balance sheet.

Before turning the call over to Ned, I plan to discuss Aviat's operations in our two largest geographic segments and highlight the opportunities and improving visibility we have for these segments. Additionally, I will provide commentary on our new product initiatives, also within the past hour, we announced that Ola Gustafsson, a microwave industry veteran has joined Aviat Networks.

Starting with North America. Much of our fiscal first quarter revenue and margin weakness can be attributed to a decline in our North American mobile and non-mobile businesses. Aviat continues to be a key supplier to two large mobile operators. Although as anticipated, the combination the summer, seasonality and the maturing rollout of LTE resulted in lower volume and revenues from these customers.

In the public safety segment, we observed extended sales cycles and the conversions from bookings to revenue, taking longer as network complexities increase. During the first quarter, we did not close any significant individual public safety transactions. In addition, low legacy was not a major contributor to revenue in the quarter.

While our North America business do not perform well in the fiscal first quarter, our medium and long term outlooks are positive across both the mobile and non-mobile segments. In the North American mobile segment, we've had success expanding our footprint and service offerings to increase share of wallet and expect this trend to continue. Our pipeline for the North America mobile operator segment suggests an improvement as we move through the remainder of fiscal 2014.

Our pipeline of new domestic public safety microwave projects is increasing. In North America there are several major public safety opportunities that we believe we’re well positioned to win and that are nearing the end of the sales cycle. Our broad services offering, products that are built for mission critical applications and our strong balance sheet are key differentiators when competing for these projects. We're also excited about the opportunities that exist in the longer-term including the impact of the FirstNet initiative as we look to further strengthen our position in public safety.

Over the past year, a growing area for Aviat has been low latency. Aviat is emerging as one of the leading solutions providers in this space much due to our trusted and comprehensive architecture and our ability to design servers and run the networks. The business is still in the early stages and we expect it to be a more significant contributor to our top and bottom-line overtime.

Now looking at Africa. As mobile data traffic is expected to skyrocket, operators are focused on investing in LTE rollouts to improve the network quality and capacity. These scenarios strongly support the continuing demand for new and improved mobile backhaul. With MTN as our largest customer, Aviat continues to be a major player in the mobile operator segment in Africa. Despite experiencing the effects of reduced spending levels from MTN for the first nine months of calendar 2013, we have increased our footprint and have received orders for new territories, while at the same time have retained existing territories. Moving forward we have begun to see the signs of CapEx recovery and given the customer spending profile we expect orders, out of Africa, to continue to improve.

Finally in Africa, we’re in the process of strengthening our relationship with an existing key customer by implementing a higher level of professional services. This arrangement will allow us to build a more robust commercial relationship especially around value added services. These value added services may include network design, inventory management, final configuration and warehousing services, all of which bring a customer intimacy that will be at further level of differentiation and enhance the partnership that raises our competitive positioning. We believe that's arrangement positions us advantageously to increase our footprint with this customer. Overall, we are delighted with a long term opportunity this deeper relationship provides Aviat. In a few minutes, Ned will discuss the financial statement implications of this arrangement.

Now turning to progress on new products. Our most recently introduced products, as well as those nearing completion are allowing us to expand our existing customer relationships, reengage with former customers and acquire new customers.

STR 600 which addresses, very high capacity, longer distance applications was introduced earlier this calendar year and is key to a number of new opportunities in the pipeline and several emerging market areas. At STR 600 is designed to reduce indoor space and cooling requirements. It has a very compact cover mounted design to lower total cost of ownership while maintaining high performance and capacity.

By the end of the current quarter, we expect to make initial shipments of our new E-Band solution with WTM 3300 with its unique form factor and integrated antenna and only about the size of an iPad the WTM 3300 is attracting strong customer interest for variety applications or zoning requirements are driving the need for low visual impact solutions.

As you will recall back in August we were preparing product demos of our CTR platform. I am pleased to report that product demos have already taken place with several targeted customers and the feedback we have received so far has been excellent. We are now commencing lab and field trials with a combination of current, former and new customers which we expect to be ongoing into Q3.

As previously mentioned, the CTR has positive ramifications for Aviat Networks, not only does it have the potential to expand our footprint in existing mobile operator accounts but we believe it will enable us to engage with tier 1 mobile operators, including those we have never worked and those where we have an install base, but are no longer preferred vendor. We designed CTR have a significantly lower cost structure that will allow us to market an entry level, competitively priced version. The highly software driven products will provide numerous upsell of licensing opportunities that we expect will have a positive impact on both revenue and margin.

While we expect to see shipments before the end of fiscal 2014, the revenue and margin impacts will be more significant in fiscal year 2015.

Adding to the anticipation of our product launches, we announced today that Ola Gustafsson has joined Aviat Networks as Senior Vice President, Product and Services Portfolio Management. The timing of Ola’s appointment is ideal as we undergo a deep evaluation of our markets and product positioning. Ola spent the last 20 years as the Senior Executive at Ericsson where he led their microwave business. At Aviat, Ola will be responsible for maximizing the value of Aviat Networks’ product and services portfolio and assessing key areas for success and increased shareholder value.

I would now like to turn the call over to Ned for the overview of financial results. Ned?

Ned Hayes

Thanks Mike. Aviat’s GAAP financial statements along with the reconciliation of non-GAAP financial measures are included in the company’s press release issued today following the markets closed. I would like to take a few minutes to summarize our non-GAAP financial performance at a high level.

The key figures were; the company’s book-to-bill ratio in the fiscal first quarter was slightly above one. Revenue for the first fiscal quarter came in at $93.4 million, slightly below the revised guidance range provided on October 03, 2013. 68% of revenue was derived from product sales and 32% from services.

During our first fiscal quarter, we saw significant quarter over sequential quarter revenue declines in North America and Europe with some sequential quarterly growth in our Middle East Africa region. In North America we saw revenues decline sequentially from $47.5 million in FQ4 of last year to $33.7 million this quarter with sequential declines largely seen in our mobile and public safety businesses.

These declines were observed in both our product and services revenues and I will speak more in a few minutes regarding how this revenue decline in North America adversely impacted our overall margins for the quarter.

On the mobile side, operators step back from the very high levels of LTE network deployments we observed in the second half of our fiscal year 2013. Further, in the North America region, we do not have the usual large non-mobile transactions delivered into revenue as we have seen in recent quarters. In the public safety vertical, we saw a number of projects and their associated revenues deferred due to project complexity, customer acceptances and revenue recognition criteria.

In Europe, revenues were down sharply, sequentially from $17 million in FQ4 of last year to $8.6 million in our first fiscal quarter. This decrease was largely due to significant deferred revenues recognized on projects delivered and accepted in the last quarter of fiscal year ‘13 that were not replicated in this fiscal first quarter.

Africa and Middle East region has begun to rebound from revenues observed in fiscal Q4 of last year. Revenue was up sequentially from $31.5 million FQ4 of last fiscal year to $37 million in the first quarter. MTN our key account in Africa was once again a 10% plus customer in the quarter.

Non-GAAP gross margin for the quarter was 25.1% of sales significantly below what we have observed historically. There were two significant contributors to the margin decline relative to the fiscal fourth quarter. First and foremost, North American product and services revenues were down significantly in both absolute dollars and percentage of total revenues versus previous quarter. Our North America business typically delivers significantly higher gross margins than the rest of the world.

Second, the lower revenue volumes had a significant negative margin rate impact caused by lower absorption of both fixed period cost on the product margin side and certain fixed cost on the services margin side. So all-in-all, we saw non-GAAP product margin rates in the quarter of 25.5% and non-GAAP services margin rates of 24.1%.

For the fiscal first quarter, non-GAAP operating expenses totaled $30.5 million which compares to $32.7 million spent on OpEx in the previous sequential quarter. I'll have more to say on our fixed cost structures going forward here shortly.

Fiscal first quarter adjusted EBITDA was a negative $5.7 million compared to a positive $5.3 million for the year ago quarter in fiscal year ‘13. Non-GAAP income from continuing operations in our first quarter was a loss of $7.8 million or a loss of $0.13 per share. The company ended the quarter with the cash and equivalents balance of $79.3 million. We had several one-time payments in the quarter that contributed to the overall use of cash, including fiscal year 2013 bonuses paid to employees, capitalized expenditures relating to our Oracle R12 implementation and the payback of $2.8 million in term loan debt. This leaves us with a healthy $1.20 per share in net cash, which is cash less debt.

Cash used by operating activities was $4.6 million in the fiscal first quarter. CapEx was $3.8 million again reflecting capitalized expenditures relating to our Oracle R12 implementation and equipment supporting our development efforts. We expect CapEx to continue at roughly these levels for one more quarter and then settle back down to historical norms. Free cash flow in the quarter came in at a negative $8.4 million.

On the working capital front, including benefits from several actions taken recently to reduce inventories, our inventory turns rate was 5.7 turns. Receivables were 85 days of sales and days payable stood at 65 days. At the end of our fiscal first quarter, our book value was $2.26 per share.

As we announced on September 27th, we amended our credit facility with Silicon Valley Bank. With our line of credit increased to $15 million and more favorable terms, we believe the amended facility to be as good as if not better than the credit facility previously in place. And this provides us with improved financial flexibility.

Now let me conclude the financial session of the call with our guidance for the second fiscal quarter. The quarter just closed depicts in stock detail the object volatility we see in geographic markets, product and services volumes and mix, choppiness of the buying patterns of key customers, lengthening sale cycles and the end quarter linearity of bookings.

Further, as Mike mentioned early in the call, we are in the process of finalizing a more robust commercial relationship with a key customer, providing a broader set of value added services, including network design, inventory management, final configuration and warehousing services.

Once finalize, the arrangement may give rise to a change in revenue recognition timing, as products move in and out of our warehouse. We will provide an update regarding deferred revenue and earnings in the quarter if and when appropriate. But we thought it prudent to mention this possibility as we finalize the arrangement. We believe everything else to be the status quo with the commercial terms and conditions with this key account.

For the second fiscal quarter, we’ll provide top and bottom-line guidance reflecting how we would traditionally view our results. The company expects fiscal second quarter revenue to be in the range of a $100 million to $107 million without any impacts dictated by the arrangement just referred to.

The company expects stronger seasonal spending in both bookings and revenue in the second fiscal quarter primarily driven by an improved level of business generated at North America. Non-GAAP gross margins should improve from those observed in the fiscal Q1. And we see both top-line revenue and margin improving in the second half of fiscal year as well as we directionally benefit from market introductions of our new products.

Non-GAAP earnings per share for fiscal second quarter should be in the range of a loss of $0.08 per share to a loss of $0.03 per share without any impacts dictated by the aforementioned arrangement.

Now in response to the first quarter’s results, we are undertaking a rigorous review of the overall business and portfolio. We have been chasing by our fiscal Q1 revenue and earnings performance. And we have every intention of reducing our breakeven level over the next several quarters to the point where we expect to be profitable at $100 million of quarterly revenue.

We will be paying special attention to our fixed cost structure both above and below the gross margin line. Nothing, either in our period cost or operating expenses will be left unexamined under this initiative.

Now having said that one should not assume that we see our revenues actually settling in at $100 million a quarter long-term, we are simply taking a more conservative approach to our breakeven levels and our intent on having a more flexible cost structure that leverage will allow for even greater profit potential on higher revenue levels.

In the second quarter of fiscal year 2013, the company increased its reserve for uncertain tax positions mostly related to orders of past years in several foreign jurisdictions. We expect to receive an assessment from one jurisdiction for approximately $4 million in the near future. The company continues to vigorously defend its position and expects to take part in the appeals process with these jurisdictions. Aviat is confident that the company will be able to absorb these upfront payments without any disruption to the business.

And finally, as we did in last fiscal year, we are including our estimated cash tax expenses in our non-GAAP results this coming fiscal year. For FQ2, we estimate approximately $650,000 in cash tax expenses and business models should include the similar amount, excluding any financial settlements arising from the aforementioned foreign tax audits.

So with that update, I'll turn the call back over to Mike for his executive summary. Mike?

Mike Pangia

Thanks, Ned. Despite a disappointing fiscal first quarter, the guidance has provided by Ned indicates a sequential improvement from the first quarter to the second quarter and we anticipate a stronger second half. The growing demand for connectivity and capacity worldwide combined with the company’s leading position in non-mobile segments, brand recognition, and relative financial strength we believe the medium and longer-term prospects for Aviat Networks remain promising.

Notwithstanding we understand that this is a top business. We are conservatively planning for a slow telecom CapEx recoveries and longer sales cycles. As a result, we are undergoing a deep dive review of our revenue and investment opportunities, including evaluating the structure of our business, the markets we’re operating in and the next steps to take in product development once the refresh is complete. The outcome will be leveraging our strongest attributes towards the highest probability of success.

Now I’d like to turn the call over for questions. Operator, you may now proceed with the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Rich Valera with Needham & Company. Please go ahead.

Rich Valera - Needham & Company

The question around your backlog and the amount of turns business you expect to have to do. You obviously got a pretty good run there. We had many quarters of positive book-to-bill frankly at revenue level much higher than this which might have led one to believe you are actually building up some backlog, a bit of a cushion if you will. So just trying to understand how the revenue drop so quickly, have you lost any backlog or is anything happened to that or is it just sort of there is always an upturn in business that could happen?

And secondly, I think you said some of the effects (inaudible) that you expect a higher level of turns business going forward. I wasn't sure what that was referring to, is that just in the next quarter or two? Or do you see the business changing structurally where it's you just expect to get fewer long-term orders going forward? Thanks.

Mike Pangia

Yes. So Rich, I think your point about the backlog, again our backlog is when we talk about backlog, we talk about backlog in terms of entering the quarter and when there is backlog associated with turning over a much longer period. So the backlog entering a quarter has declined over the course of the last several quarters. In particular, it entering a quarter probably drop a couple of quarters ago and as a result, I think you saw the revenues starting to decline as a result of that.

It does also lend itself to the conversion from bookings to revenue also has extended and the combination of the two is what has put us into our current revenue situation. Now having said that, we do expect the backlog to start growing again with the pipeline from opportunities in front us, and to the extent that that’s non-mobile, then the conversion rate will also be extended so that does means that the recovery will be a slower progress going forward.

The only other point I'll make is bookings that Ned had mentioned. We have seen in the last couple of quarters more of a back ended bookings which makes it more difficult to book and ship in the quarter.

Rich Valera - Needham & Company

So I guess going forward at least for the foreseeable future you kind of expect to be running with more of a turns driven model maybe than you would have several quarters ago before this phenomenon started happening, is that fair?

Mike Pangia

Yes.

Rich Valera - Needham & Company

And then I hear your commentary on the $100 million trying to get a sense of and maybe this is too early, but how do you get cut yourselves. You have taken a couple of major cuts with the expense structure since you guys have been there and obviously if you don’t do it right, you can really impact the growth. So I am just wondering where if you can say where you hope to kind of trim if you will to get down to that $100 million breakeven level?

Mike Pangia

Ned, I want you to start it out.

Ned Hayes

So I think Rich there are a number of different levers and I don’t think you should necessarily think that it’s all going to be coming out of operating expense. So we certainly do see improvement in gross margins and that’s going to help us to some extent.

But we also do have relatively high fixed cost structure above the gross margin line in terms of operations and services. And then again with the implementation of Oracle R12 here, we've actually got a number of overlap in resources that will be tailing off and actually leaving the cost structure here between now and the end of the year.

We’ll also be looking very surgically at where our go-to-market model. We want to make sure that the monies that we’re replacing are going to have the return on investment that we believe and that return on investment isn’t just top line, but also margin. We want to make sure that those new markets have the commercial attributes that we wish to have.

We’ll be taking a look at that. And then as we finally come to the completion of the refresh of our overall product line, I think we have opportunities to revisit what that cost structure looks like, especially from productivity standpoint.

Mike Pangia

Got it. I think just to make it clear that clearly we will not be taking any actions that would put any of our new product introductions at risk. So preserving our investment in R&D until such time that we can then look at opportunities to either be more productive or efficient or get smarter on what we do versus partnering opportunities. We’ll make sure that that remains intact.

Ned Hayes

But I think the real key here is more flexibility versus fixed nature of our cost structure that we see today, which again had a very negative impact on our margin rates in the last quarter with the volume downturn.

Rich Valera - Needham & Company

Understood. That does make sense gentlemen. Certainly good luck on your implementation of those plans. Thank you.

Operator

(Operator Instructions). Mr. Peter, there are no further questions at this time, please continue with any closing remarks.

Peter Salkowski

Thank you, Operator. Before closing the call, I would like to everyone know that Mike and Ned will be at the Needham Growth Conference being held in New York, January 14 to the 16th in Palace Hotel. We will publish it probably in December with the exact date and time of the company presentation.

With that, I would like to thank everyone for participating today and thank you much for your interest in Aviat Networks. Operator, you can close the call.

Operator

Ladies and gentlemen, this concludes the Aviat Networks first quarter of fiscal 2014 earnings conference call. This conference will be available for replay after 6:30 PM today through November 6, 2013 at midnight Eastern Time. You may access the replay system at anytime by dialing 1800-406-7325 and entering the access code of 4644146. Thank you for your participation. You may now disconnect.

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