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Anaren, Inc. (NASDAQ:ANEN)

F2Q10 (Qtr End 12/31/09) Earnings Call Transcript

January 28, 2010 5:00 pm ET

Executives

Lawrence Sala – Chairman, President and CEO

George Blanton – SVP, CFO and Treasurer

Analysts

Mike Walkley – Piper Jaffray

Rich Valera – Needham & Company

Chris McDonald – Kennedy Capital

Operator

Good day and welcome to the Anaren, Inc. second quarter earnings conference call. Today's call is being recorded. At this time, I'd like to turn the call over to today's speaker, Mr. Lawrence A. Sala, President, CEO, and Chairman. Please go ahead.

Lawrence Sala

Thank you. Good afternoon and thank you for participating in the Anaren fiscal 2010 second quarter conference call. I am joined again today by George Blanton, our CFO and by 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 our Annual Report for fiscal year 2009 and our other company SEC filings to learn more about the various risks and uncertainties facing our business and their potential impact on our net sales, our earnings and our stock price.

Net sales for the second quarter were $41 million, down 1% from the second quarter of second quarter of last year. An increase in Space & Defense Group net sales partially offset the decline in Wireless Group sales. Non-GAAP operating income for the quarter was $5.1 million or 12.5% of net sales. The increase in Space & Defense Group sales and our continued cost reduction efforts positively affected our profitability for the quarter.

Wireless Group net sales for the quarter were $12.4 million, down 26% from the second quarter of last year and down 14% sequentially from the first quarter of this year. Weaker demand for both and custom and standard infrastructure products was partially offset by an increase in shipments of consumer components. The continuing loss of custom assembly market share and the overall weak demand for infrastructure products in the first half of the quarter negatively impacted our net sales. The loss of custom assembly market share is a result of the company's decision to allocate our Wireless Group resources to more profitable and higher-growth potential standard component product opportunities.

Sales of consumer component products increased 56% from the second quarter of last year to $2.2 million as a result of increased demand for satellite television and cellular telephone applications. In addition, the group continued to capture new design wins for handset applications during the quarter. Customers that exceeded 10% of Wireless Group net sales for the quarter were Nokia, Huawei, and Richardson.

For the Space & Defense Group, net sales for the quarter were $28.6 million, up 16% from the second quarter of last year. Profit margins for the group continued to improve as a result of the increased production yields and an increase in sales volume. A number of programs successfully ramped to volume productions during the quarter and are anticipated to drive an increase in net sales for the group in the coming third quarter.

Product and technology development initiatives for the group remained focused on cost reduction of our LTCC technology, introduction of a new Rad-Hard hybrid electronic standard component product line for space applications and a number of manifold and hybrid electronic module opportunities for ground-based and airborne radar applications.

New orders for the quarter were $28.1 million and included contracts for components and assemblies for using satellite, radar, counter-IED and airborne jamming applications. Customers that generated greater than 10% of Space & Defense Group net sales for the quarter were Lockheed Martin, Raytheon, and Northrop Grumman. Space & Defense Group order backlog at December 31st was $85.1 million.

George?

George Blanton

The highlights of the second quarter income statement and the balance sheet at December 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 Q2 earnings release for a reconciliation of GAAP and non-GAAP measures.

Non-GAAP gross margin was 35.3% for the current quarter compared to 33.5% for the second quarter of last year. The increase in second quarter fiscal year 2010 gross margin resulted from improved yields on maturing production programs, reduced production overhead costs, and strong contributions from M.S. Kennedy and Unicircuit. We expect non-GAAP gross margins to be between 35% and 38% for the third quarter of fiscal 2010.

Investment in research and development was 8.6% of net sales in the second quarter compared to 7.3% of sales for the second quarter of last year. Current R&D spending is supporting a number of wireless infrastructure and consumer component product opportunities, as well as a number of projects in the Space & Defense Group and is not expected to decline in the near future. R&D expenditures have increased in the second quarter of 2010 versus the second quarter of 2009 due to the higher level of opportunities in the Space & Defense Group and wireless component products, which resulted in approximately $500,000 in additional spending.

Non-GAAP operating income was 12.5% of net sales for the second quarter, up 90 basis points from the second quarter of fiscal 2009. The increase was the result of sales declines for lower-margin wireless custom products, higher yields on new production programs, reduced operating costs, and higher sales levels for the Space & Defense Group.

Interest expense for the second quarter of fiscal 2010 was $138,000 compared to $622,000 for the second quarter of last year. The decrease resulted from a spike in the 90-day LIBOR at September 1st, 2008 compared to the rate in effect for the second quarter of fiscal 2010. The 90-day LIBOR has remained at levels comparable to the second quarter and we expect interest expense for the third quarter to be approximately $140,000.

Non-GAAP net income was 8% of net sales or $0.22 per diluted share for the second quarter of fiscal 2010 compared to 7.9% of net sales or $0.23 per diluted share for the second quarter of last year. The effective tax rate for the second quarter of fiscal 2010 was 34.5%. This compared to a tax rate of 18.2% for the second quarter of last year, which included the retroactive reinstatement of the federal R&D tax credit in October 2008. The expected effective annual tax rate for fiscal 2010 absent one-time events should be approximately 32%.

Balance sheet highlights include cash provided by operations was $4.7 million in the second quarter of fiscal 2010. Capital expenditures were $1 million in the quarter. Cash, cash equivalents, and investments were approximately $61 million at December 31, 2009 compared to approximately $64 million on June 30, 2009. The company repurchased approximately 284,000 shares of its common stock for a total of $4.2 million. There were approximately 764,000 shares remaining under the current Board repurchase authorization at December 31, 2009.

Accounts receivable were $25.8 million at December 31, 2009, up $1.3 million from June 30th, 2009. Day sales outstanding was 58 days, down one day from December 31, last year. Inventories were $33.2 million at December 31, 2009, down $5.4 million compared to December 31, 2008.

Lawrence Sala

Thanks, George. For the third quarter of fiscal 2010, we expect an increase in sales for both the Wireless Group and the Space & Defense Group from our just completed second quarter. As a result, we expect net sales to be in the range of $41 million to $45 million. We expect GAAP net earnings per diluted share to be in the range of $0.18 to $0.22, using an anticipated tax rate of approximately 32% and accounting for approximately $0.05 to $0.06 per diluted share in charges related to expected equity-based compensation expense and acquisition related amortization of acquired intangibles. Non-GAAP net earnings per diluted share are expected to be in the range of $0.23 to $0.27 for the third quarter.

We will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we'll go first to Mike Walkley with Piper Jaffray.

Mike Walkley – Piper Jaffray

Great, thank you. Congrats on the continued good execution on the Space & Defense side. I guess it's the wireless infrastructure that is a little below our estimates here. Larry, can you just walk us through maybe the competitive landscape and the trend of maybe some OEMs taking business in-house and maybe how we should think about the run rate of this business say for the next several quarters?

Lawrence Sala

Yes. We said last quarter that we were expecting to continue to see this decline and that we thought of the December quarter would be the low point and it's still our expectation. We think we will see some pickup this quarter, but not tremendous growth off of what we've seen.

The basic scenario is we've said for two years that the custom assembly business has been increasingly challenging with low differentiation, low margins, and very taxing on our engineering resources and as a result, we've been and it’s said we've been continuing to focus our investments on trying to develop new standard component products and expanding those portfolios. And that's just resulted in the continuing decline in this business.

We wouldn't say so much is going to OEMs taking business in-house, but just continuing to increase the competitive landscape of qualifying more suppliers to just create a more challenging pricing environment over time. So demand in general is, we would say, relatively flat in the marketplace and we are just continuing to lose share as we continue to focus our resources elsewhere.

Mike Walkley – Piper Jaffray

That makes sense. And March quarter isn’t usually a seasonal uptick for the infrastructure market. Is this – is your visibility maybe there has been some inventory work through in the channel and that gives you a better visibility into March, which tends to be seasonally down for the overall infrastructure spending patterns out there?

Lawrence Sala

Yes, that's correct. We wouldn't say we see much seasonality period, but definitely in our standard component product line, last quarter, one of our largest OEM customers was still working through inventory. And so in the second half of the last quarter, we finally started to see that turn around and see more typical order patterns and that's continuing into this quarter. So our expectation is that we should see some increase in sales, as well as a more favorable mix this quarter in wireless as we should see a pickup in our standard component sales.

Mike Walkley – Piper Jaffray

Okay, great. Maybe on the seasonality topic, it's nice to see consumer cross the $2 million mark. I think you've indicated this might be an $8 million annual business over time. Can you update us maybe how to think of that on seasonal patterns and does $8 million still seems like a good annual number for that business?

Lawrence Sala

Yes. The business in general is exceeding our expectations this year, largely from the diversity, no one particular segment – and two, three years ago, this was a heavily satellite television driven business and it’s still a big part of our sales, but it's much more diversified in a number of different handset and other wireless, typically wireless LAN applications that we participate in.

Seasonality wise, this is typically a weaker quarter, but we still have good expectations because of the diversity. It's typically weak in the satellite space, because there is the big push through the holiday and then things tend to slow down a bit. But we saw good order patterns throughout last quarter and expect that we should have another good quarter of consumer component sales again.

Mike Walkley – Piper Jaffray

Okay, great. And just going to now the 70% of your business, Space & Defense, we've kind of been modeling thinking about a ramp in the second half of that year of your fiscal year coming up. Is that still kind of the way to think of that? Just trying to reconcile the guidance with Wireless up in the magnitude of maybe Space & Defense growth also.

Lawrence Sala

Yes. I mean, we've had – again, the Space & Defense Group has performed well and made up a lot of the shortfall in our Wireless business in the first half of the year. So again, we wouldn't expect to see excessive growth off of these rates. We said, I think, our Space & Defense Group expectations for the year would be about a 10% or so from last year and we are probably a little more optimistic than that halfway through. But in general, they are book in the business we expected, they are shipping pretty much to or ahead of our plan, and we expect to see some sequential growth each quarter for the next two quarters.

Mike Walkley – Piper Jaffray

Okay, great. Well, congratulations on executing in a tough environment and I'll pass the queue on.

Lawrence Sala

Thanks.

Operator

(Operator instructions) We'll go next to Rich Valera with Needham & Company.

Rich Valera – Needham & Company

Thank you. Just wanted to – just understand the gross margin dynamics. One, I guess, is surprised to see gross margin down over 100 basis points this quarter with higher revenue, seemingly more Space & Defense production, and presumably a better mix on the Wireless side since custom has gone to such a small number. So just wondering what's going on there and then what drives the expected – sounds like significant rebound you are projecting in the next quarter.

George Blanton

Well, I think what we've seen is the decline in the Wireless side, Rich, that even impacted our component side also. And so I think the mix was predominantly affected by that and I think that also impacted our gross profit margins. We feel pretty good about the margins though. We still see cost reduction efforts and I think as we see a little bit of a rebound in that Wireless portion of the business, I think they will come right back.

Rich Valera – Needham & Company

Great. And I was just trying to reconcile your – the various components of the guidance you've given with the EPS. It seems like if you have the revenue where you have it, at the midpoint, gross margins at the midpoint of 36.5%, you are hard-pressed to stay within the EPS guidance range you gave and I'm wondering are you expecting a significant increase – significant sequential increase in OpEx in Q3 versus Q2?

Lawrence Sala

No. We are just trying to be somewhat cautious as to mix. Not having not good visibility on the Wireless side has made it continuingly difficult for us to give guidance. So unfortunately, for the first two quarters of the year, we've kind of missed on our expectations in our Wireless Group, which has left us at the real low end of the revenue guidance we've given and that's made the EPS real challenging. So no, I think we are just trying to be conservative relative to what we've seen for the first six months.

Rich Valera – Needham & Company

But you – it sounds like you do expect a solid bounce-back in gross margin. Is there anything that would dissuade you from that notion?

George Blanton

No.

Rich Valera – Needham & Company

Okay. That's helpful. And then looking at the defense side, we've been talking about some opportunities to pursue some active arrays with much higher level of content and integration than you've had in the past and there was one in particular, land-based opportunity you've been pursuing at sort of the initial opportunity in that area. Any updates on where you stand there?

Lawrence Sala

No. I guess on both the land-based and the airborne side, we continue to provide quotations, work through qualifications, we had expected that we would get response on a more significant proposal that we had submitted, but now we are hearing that that's still probably another month away. But in general, we are still very optimistic about gaining share in a number of ground-based and airborne applications that we are pursuing, both on the beamforming side and electronic module side. So no, that's progressing well for us.

Rich Valera – Needham & Company

And you've talked about reducing the cost of your LTCC process – or substrates I should say, to make you more competitive with other lower-cost technologies. Can you give us an update on where you stand there and how far you might be from having a significantly lower cost offering there?

Lawrence Sala

Yes. That's a process we've been pursuing for probably the last six months. It's been our belief that the market for LTCC technology has been limited due to the cost of the technology. The performance is far superior than competitive alternatives, but the cost is just too high. And we believe that – we've completed our internal qualifications in that cost reduction effort. We would be supplying parts for customer qualifications within the next month or so.

So it's moving on relatively to plan. We are seeing it as a 30% or greater cost reduction in the technology and we think that will make it much more broadly applicable and competitive than it's historically been. So sometime over the course of this quarter, we ought to be delivering and working through qualifications with our customers.

Rich Valera – Needham & Company

Great. And just one final one if I could. You've made reference in a couple of recent presentations including in early January to a new line of consumer products you expect to be rolling out, which – it sounds like you expect that they could have some pretty significant TEM [ph]. Can you put any – shed any light on what these are and the timing and potential magnitude of these new products?

Lawrence Sala

It’s a little early to try to provide too much detail. We said for, I guess, a year-and-a-half we've been investing in expanding our standard product lines. We talked about Xinger-III, which we are working through the introduction of now some new consumer component products addressing the analog-to-digital converter market, which we are also in the process of rolling through now.

And then we also have developed, I guess, you would say a level – a higher level of integration type of product for kind of following on to our consumer component product line, trying to provide a higher-level modular type of solution with multiple functions for folks, kind of in partnership with a semiconductor partner that we've been working with.

So sometime, either later this quarter or certainly before the end of this fiscal year, we will start the introduction of that and we will be able to speak a lot more clearly to what the product portfolio looks like, what the ASPs look like and our best guess in an addressable market. But it certainly – our expectation is substantially higher ASP products and a substantially larger addressable market than our consumer component market is today.

Rich Valera – Needham & Company

Great. That's helpful. Thank you.

Lawrence Sala

Yes.

Operator

And we'll go next to Chris McDonald with Kennedy Capital.

Chris McDonald – Kennedy Capital

Hi, Larry and George. Thanks for taking my question.

Lawrence Sala

Sure.

Chris McDonald – Kennedy Capital

I'm wondering, maybe you just touched on with the answer to Rich's last question, but as you divert resources away from the custom assemblies on the Wireless side, where – what are the targets you are going after with that development dollar?

Lawrence Sala

Sure. Obviously, like I said, we are trying to expand the addressable markets where we play, but we are also trying to find opportunities where we can gain more differentiation and in niche – more niche market segments than handsets were. It's a tremendously competitive marketplace from a price performance standpoint, size standpoint.

So we are trying to take advantage of the performance enhancement that we've been able to provide through our consumer components, but apply them to markets, like I said, outside of the handsets. So we've been working with one of the larger semiconductor partners that we've designed complementary parts for and try to provide – trying to develop higher-level solutions that smaller customers can use to implement wireless applications.

And so our goal is to find a relatively large addressable market where we can have a more highly value-added product offering and provide more differentiation than we are able to achieve in a super-competitive handset space.

Chris McDonald – Kennedy Capital

Okay. Thanks. I mean, it sounds like the end result is trying to shift some of that custom revenue to higher margin opportunities.

Lawrence Sala

Absolutely. Yes, that's absolutely our goal and we certainly believe that we have got opportunity to more than exceed the type of revenue that we've been generating out of our custom business with some of these new product lines that we are looking at.

Chris McDonald – Kennedy Capital

Was the mix – in the Wireless Group, was the mix in custom versus standard components meaningfully different than that 70-30 sort of run rate that we've been seeing over the last few quarters and just in this last reported quarter?

Lawrence Sala

In this last quarter, our Wireless mix was actually a little less favorable. So we certainly continue to see decline in custom, but we also saw a very soft standard component business in our traditional infrastructure standard components. I mean, as I said in my introduction, that was largely driven in the first half of the quarter. So by the December time frame, we started to see a pickup in our standard component orders, but it still was a less favorable overall mix than we've been experiencing in the second quarter.

Chris McDonald – Kennedy Capital

In relative to your expectations for the standard components in calendar 2010, do you still see opportunities for more bigger content in the infrastructure application, kind of independent of how end markets grow in 2010?

Lawrence Sala

Yes. Yes, we still have the same basic view that we have had for the last six or 12 months and we've completed all of our negotiations with our larger customers as far as allocations and expectations for calendar 2010 and based on those negotiations, our customers' expectations for volumes and the prices that we've settled on, we still expect to see an increase in our standard component sales in calendar 2010.

And we talked about something on the order of about 10% on our last call and we really haven't seen anything to change our opinion since.

Chris McDonald – Kennedy Capital

Okay, great. Do you – and just a couple on Space & Defense. Were margins actually up sequentially in Space & Defense? I now you would – I won't get to see that until you report it in the Q, but I'm just curious if – when we look at the gross margin degradation, how much of that was just Wireless really struggling this quarter profitability wise?

Lawrence Sala

I don't have the data in front of me, but I would say – I know on an operating margin basis, margins were up sequentially in the –

Chris McDonald – Kennedy Capital

Okay, that's fine, Larry. I can wait for the Q on that one. And then just one little – maybe a more broad question as it relates to some of the larger opportunities in the Space & Defense side. What – when you look at some of the manifold opportunities and other things that we've talked about, what – how does the timeline evolve there and what's the – what are the signposts that you are really looking to over the next few quarters to demonstrate progress on that front?

Lawrence Sala

Well, that's – the difficulty is we don't see a lot of one absolute goalpost that's going to drive some big announcement for us. Our customers across all these different applications have varying timelines to design and qualify and transition into production. And on some of those, there are new programs where we are supplying and they are ramping up over time that we've talked about, programs like EQ-36, which is one of those that we are qualified. It is evolving and it's more driven by how many systems the government orders and those things can move around six months at a whim.

And there is other programs that are in various stages of development or qualification or ramping up into production that we maybe on or we maybe trying to gain a position because our products performed better or it's a cost reduction initiative and it's very difficult for us to say, here is the milestone and phase in data when that's going to happen because there is alternatives and timelines and qualifications can take six months, they can take 12 months.

So for us, we have said that there is a couple of more significant opportunities that we feel like over the next – this fiscal year between now and June will get good insight as to are we succeeding in getting selected and getting qualified, both on the module side as well as the beamforming side. And that's progressing. It's – we have a couple where we have submitted large proposals and we are – our expectation is we will hear back in the next month or two. But those things could get pushed out as well, those proposals could get spun back, and they could ask for other approaches or delay the timing of or the paths could not be quite as clear as we would like them to be.

So I would say each quarter, we are delivering hardware, we are getting through qualification steps on various programs, and we've yet to see the door closed on anything that we've been pursuing to our capability. So I would say if anything, typical, as it takes longer than we expect most of the times for these things to happen, but we feel like we are continuing to make positive progress.

Chris McDonald – Kennedy Capital

Okay. Thanks for taking my question.

Lawrence Sala

Yes.

Operator

And at this time – actually, it looks like we will take a follow-up now from Rich Valera with Needham & Company.

Rich Valera – Needham & Company

Great, thanks. Just wanted to clarify on the Wireless growth for calendar 2010. Sounds like standard products, and I'm assuming that includes your consumer which is largely standard, you are expecting to be up say double digits. Your custom which is, let's say 30%, I'm assuming is expected to be down some material amount. So just wondering how we should think about the overall Wireless business for calendar 2010. I would presume up somewhat, but just wondering if we could get anymore granularity on that.

Lawrence Sala

Yes, I mean, like I said, we expect to see some increase in sales this quarter and – our best guess from all the visibility we have is that we should see some level of continuing growth in our fourth quarter as well. But we don't have high expectations for significant sequential growth over the next couple of quarters. So somewhat higher than the run rate we were at last quarter, but hard for us to say much beyond that with the visibility that we have.

When we say standard components, it does incorporate our Xinger product line for infrastructure, our resistive product line for infrastructure, our consumer component product line, as well as our medical product line which is wrapped up in that as well. So there are a number of pieces that make up what we call standard components on the Wireless Group.

Rich Valera – Needham & Company

Okay, that's helpful. Thank you.

Lawrence Sala

Yes.

Operator

And we'll now take a follow-up from Chris McDonald with Kennedy Capital.

Chris McDonald – Kennedy Capital

I forgot clarity on this. So when we think about maybe some modest Wireless growth off of the just reported quarter, that's almost exclusively driven by a standard component revenue, correct?

Lawrence Sala

Correct.

Chris McDonald – Kennedy Capital

Okay. So we should see good positive mix impact of that going forward, but if – we just might not see big top line growth off of this one.

Lawrence Sala

Correct. We may see continuing decline in some of the custom business that we have. So yes, that's correct.

Chris McDonald – Kennedy Capital

Okay. And the – just so I think about this longer term, the idea is to sort to dovetail the decline in the custom business with the ramp-up in maybe some of these new opportunities, and the end result is revenue growth kind of from the starting point, which was some element of custom business as part of the Wireless sales, but just much more favorable business mix, favorable order return on sales as it relates to that new business.

Lawrence Sala

Yes, that's – that's correct. On a perfect world, we were – would have hoped that our custom decline would have been six months later than it's been. And some of these new things that we have been working on, we really feel like are going to start to kick-in in our fiscal '11 more significantly. Unfortunately, this custom business just eroded pretty quickly on us and so it hasn't been a smoother transition as we had hoped it would be, but that's our overall strategy.

Chris McDonald – Kennedy Capital

Okay. Thanks a lot.

Lawrence Sala

Sure.

Operator

And at this time, we have no further questions from the phone. So I will turn the call back over to management for any additional or closing remarks.

Lawrence Sala

Well, we greatly appreciate you taking the time to participate on our call 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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