Anaren Inc. F3Q10 (Qtr End 03/31/10) Earnings Call Transcript

| About: Anaren, Inc. (ANEN)

Anaren Inc. (NASDAQ:ANEN)

F3Q10 (Qtr End 03/31/10) Earnings Call

April 29, 2010 05:00 p.m. ET


Lawrence Sala – Chairman, President and CEO

George Blanton – SVP, CFO and Treasurer

Joe Porcello – VP of Accounting


Rich Valera - Needham & Company

Chris McDonald - Kennedy Capital


Good day ladies and gentlemen, and welcome to Anaren's third quarter earnings call. (Operator Instructions) I would now like to introduce your host for today's conference, Larry Sala, Chairman, President and CEO.

Lawrence Sala

Thank you. Good afternoon and thank you for participating in the Anaren fiscal 2010 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 our Annual Report for the fiscal year 2009 and other company SEC 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 $42.2 million, down 3% from the third quarter of last year, but up 3% sequentially from the second quarter. An increase in Wireless Group sales drove the overall increase in net sales from the second quarter.

Non-GAAP operating income for the quarter was a record $6.7 million, or 15.9% of net sales, up 15.7% from the third quarter of last year. The increase in Space & Defense Group net sales, a very favorable overall product mix, and our continuing cost reduction efforts positively impacted our profitability for the quarter.

Wireless Group net sales for the quarter were $14.2 million, down 18% from the third quarter last year, but up 15% sequentially from the second quarter of this year. Improved demand for standard infrastructure components drove an increase in net sales from the second quarter. Demand for standard component products remained robust throughout the quarter.

In addition, demand for CDMA related legacy custom assembly products increased during the quarter and is anticipated to continue into our fourth quarter. New product and technology development efforts remain focused on expanding our standard component product portfolio.

Customers that generated 10% of Wireless Group net sales for the quarter were E.G. Components, Huawei, Motorala, and Richardson.

For the Space & Defense Group, net sales for the quarter were $28 million, up 7% from the third quarter of last year. Profit margins for the group continued to improve as a result of increased production yields. The Space & Defense opportunity pipeline remained robust.

However, we had been experiencing increasing delays in finalizing some contracts and orders, but we do not anticipate that these delays will materially impact our net sales. We do believe that this trend may cause orders to be more volatile quarter-to-quarter than we have historically experienced.

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

New orders for the quarter were $22.3 million and included contracts for components and assemblies for use in satellite, radar, passive ranging, and airborne jamming applications. Customers that generated greater than 10% of Space & Defense Group net sales for the quarter were Lockheed Martin and Raytheon.

Space & Defense Group order backlog at March 31, 2010 was $79.4 million. George.

George Blanton

The highlights of the third quarter income statement in the balance sheet at March 31, 2010 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 $17.1 million or 40.5% for the current quarter, compared to a $15.1 million or 34.7% for the third quarter of last year. Gross profit as a percent of sales increased considerably in the third quarter of fiscal 2010 from the third quarter of last year due to a more favorable product sales mix in both the Wireless Group and Space & Defense Group.

Gross margins were enhanced by the decline in sales of lower margin, high material content custom wireless group products. Material content in cost of sales across both business segments fell an average of 4.4% of net sales, or over $1 million reduction in the current quarter compared to the third quarter of last year.

Additionally, margins were further enhanced by reduced overhead costs and improved yields on production programs. We expect non-GAAP gross margins to be between 37% and 41% for the fourth quarter of fiscal 2010.

Investment in Research and Development was 9.5% of the net sales in the current third quarter, compared to 7.8% of sales for the third 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 $600,000 in the third quarter of 2010 versus the third quarter of 2009 due to a number of opportunities in the Wireless Group for standard component products, and in the Space & Defense Group where our addressable market has increased.

Non-GAAP operating income was 15.9% of net sales through the third quarter, up 260 basis points from the third quarter of fiscal 2009. The increase was the result of favorable product mix resulting in a decline in material costs, higher yields on new production programs, and successful execution of cost reduction programs. Non-GAAP operating profits in excess of 15% were generated for both groups.

Interest expense for the third quarter of fiscal 2010 was $129,000, compared to $311,000 for the third quarter of last year. This decrease resulted from the decline in our outstanding debt and the significant decline in the 90-day LIBOR, compared to the rate in effect for the third quarter of fiscal 2009. The 90-day LIBOR has remained at levels comparable to the third quarter, and we expect interest expense for the fourth quarter to be approximately $130,000.

Non-GAAP net income was 12.9% of sales or $0.38 per diluted share for the third quarter of fiscal 2010, compared to 9.6% of net sales or $0.30 per diluted share for the third quarter of last year.

The effective income tax rate for the third quarter of fiscal 2010 was 13.4%. This compares to a tax rate of 25.7% for the third quarter of last year. Tax expense for the current quarter included the settlement of the IRS examination of Anaren's fiscal 2007 and fiscal 2008 returns and adjustments to balances for uncertain tax positions related to the results of the examination, amounting to a reduction in tax expense of approximately $1 million or $0.07 per diluted share.

The projected effective tax rate for all of fiscal 2010, absent one-time events, is expected to be approximately 32%.

Balance sheet highlights include: Cash provided by operations was $8.4 million in the third quarter of fiscal 2010; capital expenditures were $1.7 million in the quarter; cash, cash equivalents, and investments were approximately $65 million as of March 31, 2010, compared to approximately $64 million on June 30, 2009.

The company repurchased 244,000 shares of its common stock for a total of $3.4 million in the third quarter. There were approximately 520,000 shares remaining under the current Board repurchase authorization at March 31, 2010.

Accounts receivable were $28.1 million at March 31, 2010, up $1.9 million from March 31, 2009. Day Sales Outstanding was 60 days, up six days from March 31 last year. Inventories were $33.2 million at March 31, 2010, down $5.5 million compared to March 31, 2009.

Lawrence Sala

Thanks, George. For the fourth quarter of fiscal 2010, we expect comparable sales for the Wireless Group and an increase in sales for the Space & Defense Group from our just completed third 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 $0.22 to $0.26, using an anticipated tax rate of approximately 32% and accounting for approximately $0.06 per share in charges related to expected equity-based compensation expense and acquisition related amortization of intangibles. Non-GAAP net earnings per diluted share are expected to be in the range of $0.28 to $0.32 for the fourth quarter.

We will now take questions.

Question-and-Answer session


(Operator Instructions) Our first question comes from Steve Ferranti of Stephens.

Unidentified Analyst

Hey guys, this is Neal for Steve. Congratulations on the solid performance here. Glad to see the wireless business heading in the right direction here. Larry, could you just talk a little bit more about what drove the sequential improvement in the quarter?

Lawrence Sala

Yes, I mean it just saw a general pickup across the marketplace for our standard component products. We had discussed on our last call that we thought some of our large European OEMs were working through some inventory at the end of the calendar year and that their order patterns had improved, and that improvement has just continued.

We also saw in our wireless businesses, I mentioned in my notes, a general pickup in Legacy CDMA business, which has typically been related to U.S. carriers building out capacity, and we haven't seen that demand strengthen. Gosh, I bet it's been 18 months or more.

And so, that drove our pickup in business with Motorola and other OEMs who have a presence in that marketplace.

Unidentified Analyst

And then, I guess in the gross margins, really impressive job there. Is there any more color you might be able to provide on the gross margin results? How much of the increase was due to just improvement in the wireless business versus Space & Defense? And I guess too, you guys are coming at that lower end of that gross margin guides that you gave.

George Blanton

Well, there's a couple of factors involved there. One is just general mix and we don't anticipate, from what we can see, the fourth quarter to be dramatically different from the third quarter. So we expect a little downward pressure there.

The other factors are our R&D spending. We've been spending more and focusing our R&D resources more on our own initiatives and the opportunities we see to grow. And we've seen some of our engineering costs move from funded activities, which will result in those engineering expenses being in our cost of sales to being down below the line, the gross margin line, in the higher R&D spending that you see.

So that could move back and forth, but it's probably a percentage point or a percentage point and a half of cost moving out of cost of goods sold and into operating expenses. The other impact of our cost reduction initiatives, we've continued to actually reduce our workforce over the year and we're seeing the continuing impact of that, as well as just across the board tighter expense control.

And those impacts continue to roll in as the year progresses. So we expect positive impact from that continuing in the fourth quarter, as we're still seeing the benefits of some of those initiatives rolling through our results as we progress through the year.

So, I think mix is the biggest concern. Obviously it's a factor for us. Volume, assuming volume hangs in here, but otherwise we think the trends are still relatively positive from a margin standpoint.

Unidentified Analyst

Okay that's really helpful. And then just one last question for me; it seems like there's been some positive news coming out the Syracuse Research regarding their crew program. Do you guys feel like that program is going to have a little bit more of a longer life cycle maybe than you had originally thought?

Lawrence Sala

Yes, that's the trend we currently believe. We did not see those orders flow through to us yet. A lot of those recent order announcements, which I think is some of what our Space & Defense order shortfall was in the quarter. We fully expect that those orders are coming; we are in discussions, and I think some of them have actually been booked already in the current fourth quarter.

But I'd say to-date we probably have order coverage through the October timeframe. I think we previously said we thought that this project would last through the end of the calendar year.

I would say from everything we're hearing and seeing now, we're probably thinking that this business is going to last at least through March at a minimum, but more likely through the end of our fiscal year. But we'll give more color on that I think as this quarter progresses. But yes, general trends I think from SRC is above our previous expectations.


Our next question comes from Rich Valera of Needham & Company.

Rich Valera - Needham & Company

Larry, I just caught the tail end of your remarks and you were saying something about you were expecting, you could see more volatile orders I think on the Space & Defense side. Could you explain what could drive that?

Lawrence Sala

Yes, it just seems like the government is dragging on finalizing contracts with our customers on a lot of these larger programs, asking for multi-year buying agreements that just seem to be taking a lot longer to get in place. I guess the positive is, our customers are reaching back to us and looking to sign multi-year supply agreements, which is something we've always advocated; it would help us plan and execute our business better.

But the downside is, it's just taking a lot longer to finalize contracts. So it's not as though we think our customers or we are losing any opportunities that we anticipated.

I would say in general, we feel a bit better about the order potential in our Space & Defense Group than we have in the last couple of quarters. It's just getting them closed and booked is taking longer than we have historically seen.

Rich Valera - Needham & Company

Now this wouldn't necessarily apply to programs that you have already gotten into production like EQ-36 (in sailings) for instance. This is more on somebody's longer term opportunities?

Lawrence Sala

No, I would say EQ-36 is a prime example of an order we would have expected to book. I think our original anticipation was before the end of the calendar year, and our customer just finalized that order we think in the last few weeks. So as we said, it's not as though this business is going away or going to someone else, it's just taking a lot longer to get contracted than we or our customers I think had originally anticipated.

Rich Valera - Needham & Company

Yes, we did see that that was awarded I guess at that prime level a couple of weeks ago, so hopefully that flows to you.

Lawrence Sala

The issue was that that would happen far prior to that, but quantity shifted around I think, and it just drove a long time in getting that finalized. So that's just one example, but we're seeing that in many places. Even in our IED business it seems as though as high a priority as it is, some of these contracts take much longer than anticipated to get finalized.

Rich Valera - Needham & Company

So I guess given that, how do you see the revenue contour over the next few quarters? Sounds like you expect it sequentially up in June. As we look in next fiscal year, how should we think about that?

Lawrence Sala

Our current expectation is that we'll see some sequential improvement in June and then our expectation is to be fairly stable from there. We've always tried to fairly level load our Space & Defense business in any fiscal year, since we are typically strongly backlog-driven. And that's what we expect right now; we'll see a pickup here and that'll be kind of our baseline rate into the next fiscal year.

Rich Valera - Needham & Company

And what would it take to sort of drive that up again? I mean, I'm presuming there's possibly some things in the pipeline that depending on the timing to take that level up to another level.

Lawrence Sala

The biggest drivers, we don't typically see a lot of near term volatility in our business, but there are programs that we're on that we are pursuing higher dollar content that could impact positively next year. So we're very comfortable with the content we currently have, and we're pursuing increased content on next buys. The IED business obviously could be stronger than it's been for us and drive some upside for us.

There's also a couple of fairly significant radar opportunities that we've been discounting and not expecting in our forecast, but we're feeling a little more positive on these days. That may happen, and have a positive impact of a few million dollars in our forecast next year.

So barring any of those unforeseens, we're expecting another year of fairly typical growth here in our Space & Defense Group, with right now at this moment feeling like there's a few more positive potential impacts than negatives.

Rich Valera - Needham & Company

Sure. And I think you probably indirectly alluded to the work you're doing on sort of the integrated LTTC substrates and modules. Any update there in terms of where some of those programs stand? Obviously you can't get too specific, but --

Lawrence Sala

Those efforts are all progressing. I guess it's both LTCC substrates, electronic modules, as well as manifolds of beamformer initiatives for various airborne and ground based radar programs. And we're seeing good progress in all those technology fronts, both in getting qualified for new opportunities, as well as capturing incremental content on programs where we've participated historically but now have the technology base to bid on more of the system than we could before.

As far as any one significant initiative, we're not highly optimistic that there is any one huge new opportunity that we will announce or will transform that business in the near term while we are continuing to be qualified, or work through qualification process with multiple OEMs. So we're quite optimistic about gaining more content on both the airborne and a ground based radar.

Rich Valera - Needham & Company

And then just folks on the wireless business a little bit, sounds like it sort of stabilized and you've seen some decent recovery on the standard products side. Just wondering how we should think about that business as we look into fiscal '11. It seems like you aren't necessarily expecting much recovery on the custom side, which probably is good for margins.

But how should we think about the overall standard products? And in fact Consumer which I think will grow pretty well, but how about sort of overall standard products or the overall business?

Lawrence Sala

Obviously, we've said for a number of quarters that our investment focus has really been on our standard component line. We don't have high expectations for our custom assembly business, and it's going to ebb and flow with demand for any particular platform in any particular quarter. But right now we would say 'stable' is probably the best adjective we could come up with for that business, which is the one we commonly use for that business. So that's interesting.

From a newer growth initiatives, we've got several; we've expanded what we call the consumer component product line, but a lot of the growth in what we've historically called 'consumer' is coming from new applications in infrastructure.

So whether it's in using consumer components in radio signal processing in the base station, the A to D product lines that we've been talking about, which are really used for base station signal processing or military radio signal processing are products that are really just starting to transition into production for us.

A number of new products in our Xinger-3 family for infrastructure, some of that's replacement revenue, but a number of those products are new functionality or new content in base station amplifier, both in the power chain as well as in the linearization techniques that are being used for the high-frequency high-bandwidth amplifiers.

And then we haven't talked much and we won't probably until next quarter, but we've been introducing a new module product line, standard low-power wireless module product line, and really we're just getting that ramped up now. And we'll be broadly introducing that product over the next few weeks.

So that's really what we think is the growth engine of late next fiscal year and beyond for our Wireless Group, products that again, standard components, higher margin profiles, broader customer base, and trying to continue to diversify beyond just the infrastructure and consumer market that we played in for the last few years.

Rich Valera - Needham & Company

Would it be fair to think about that business as perhaps relatively stable at the current level, the overall wireless business that is stable at current levels and maybe moving up in the latter portions of next year on some of these growth initiatives?

Lawrence Sala

That's our forecast. Our forecast is relatively stable over the next couple of quarters and then in the second half of next fiscal year, starting to see the impact of some of these new product introductions. But obviously, the end-market demand is the greatest influence on the infrastructure side.


Our next question comes from Chris McDonald of Kennedy Capital.

Chris McDonald - Kennedy Capital

In the wireless business, did the mix between standard and custom products deviate meaningfully from that 70-30 type run rate that we've seen over the last couple of quarters?

Lawrence Sala

It was certainly better than what we've seen in the last few quarters as far as being much more highly concentrated on the standard product side. I'd say sequentially, we probably saw maybe a 5 percentage point change from what it was the prior quarter. So whereas before it was a little bit below 70-30 this quarter it was a little bit above 70-30. So it wasn't a bit dramatic. But we did see more margin improvement within both the custom and standard component product lines.

So the standard components not only were higher percentage but were higher margin standard components. So we typically see higher margins in our standard components when we're selling more through our distribution channels to low volume users, than when we're selling to very highly concentrated, high volume users who have more pricing power.

And then, within the custom assembly business, the legacy products that we've been selling to many, again, smaller custom assembly customers have higher margin profiles than selling custom assemblies to one very highly concentrated customer where we see a lot more pricing pressure and a lot lower margin profile.

So was both the mix of custom to standard, but also the mix within those product groups that was all favorable for us in the quarter.

Chris McDonald - Kennedy Capital

Rich brought up EQ-36, and I think we all saw the order at the prime this quarter. My understanding is that that order at a significantly larger volume of (systems) would likely drive the company's build rate on that product up rather meaningfully kind of over the course of the next couple of quarters. Is that a fair assessment of how you (look at that)?

Lawrence Sala

Right, we finished our prior production I think a quarter or two or more ago. So we do not have a lot of EQ-36 production going on right now. The number of systems, I think it was 17 systems, would be a fairly more significant rate of production than what we've seen in the last year or two.

And our expectation is that that rate of production will continue to increase in future year buys I think, to speak to the forecast that the government has right now. So that's an opportunity. We have I think relatively strong positions on some of the sub-assemblies within that radar. We share some production with others on other assemblies in that radar, and we're very aggressively trying to capture as much content as we possibly can as this is starting to ramp up to be a meaningful production program now.

Chris McDonald - Kennedy Capital

The dollar value per system that I remember was somewhere between maybe a quarter and $0.5 million per system. Is that still --?

Lawrence Sala

I think that's a relatively good rough order magnitude. Historically I would say, we feel fairly confident of about $0.25 million of content is kind of historically where we've been.

Chris McDonald - Kennedy Capital

One thing that you mentioned Larry was just more confidence in the pipeline on the defense side in particular. This might be a little bit repetitive with some of the other better opportunities that you said were looking a little more promising. But I just didn’t know if there was anything else going on there that was bringing that confidence to your view on what pipeline --

Lawrence Sala

(Inaudible) number of things. You know, we talked about a lot of them, some of these bigger system programs that we've participated on, finally getting contracted and at quantities that are at the upper end of our expectations. Seeing the, I would say stronger order flow and expectation on the IED side has been incrementally positive for our outlook.

We're also seeing more positive indications in some of the legacy, ballistic missile defense radar activity that we've had. Right now we're feeling a little more positive about that than we have historically.

We are seeing more strength out of our (inaudible) customer for the ship-borne and airborne jamming systems that we provide that we didn’t really expect to continue to have as much strength as we're seeing from them right now. So just a number of pockets of opportunities where we have a strong supply position.

We have been forecasting declines, and now it's looking like some of those programs might have a lot more life to them than we had expected.

Chris McDonald - Kennedy Capital

And just one last one from me. You touched briefly on the low-power wireless opportunities and products that are likely to just start rolling out here over the course of the next few months. I don’t know if you are in a position to elaborate a little bit more on either the timeline or the potential magnitude of what you think that opportunity might hold for the company?

Lawrence Sala

Yes, I mean as far as timeline, we already started to sample customers and work with customers on design ends. We have to work through not only the product introduction and our internal qualification, but get FCC certifications as well. We would expect all that to be in place for the initial set of a handful of products that we're introducing over the next month or two.

So you ought to see within that timeframe this product portfolio showing up on our website and all the application notes and datasheets that go along with that happening over the next month or two.

As far as our outlook, we're expecting that this is a product line that has the potential to generate $10 million, $20 million, $30 million revenue a year for us if we're successful. So from the insights we've gained from our semiconductor component partners we're working with and the customers that we engage with, that's our best estimate of what we think this product line could be.

We don't expect the design cycle to be too long; we're thinking that six to nine month timeframe, we ought to be ramping up some material production. We're producing at rates now to be able to support all of the sampling and customer prototype development and qualification.

And that's been going on for only the last few weeks that we've been able to really produce a meaningful number of parts to get into people's hands.


(Operator Instructions) Our next question comes from Mark (inaudible).

Unidentified Analyst

I'm sorry gents, my question was answered.


(Operator Instructions) I'm not showing any further questions. Would you like to continue with any further remarks?

Lawrence Sala

We appreciate your participation and we look forward to speaking to you again next quarter. Thank you.


Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect.

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