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Executives

Brian Cooper – SVP and CFO

Rick Gilbert – President, Chairman and CEO

Analysts

Jeff Linroth – Leaving It Better

Brian Horey – Aurelian Management

Robert Zarkowski [ph] – Ruz Asset [ph]

Jim Zimmerman – Lowell Capital Management

Peter Schleider – RKB Capital

Ali Hilali – Ingalls & Snyder

Westell Technologies, Inc. (WSTL) F4Q10 (Qtr End 03/31/10) Earnings Call Transcript May 19, 2010 9:30 AM ET

Operator

Good morning ladies and gentlemen and welcome to the fourth quarter fiscal year 2010 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. We will not take 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, Hilda. I want to welcome everyone to our year end conference call covering the fiscal year and fourth quarter results for Westell Technologies. We issued our earnings news release last night and you can find the copy posted at Westell.com. This morning Rick Gilbert and I will update you on the business and our financial results.

Before we do, I want to point out 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”, “trend” 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 material from those discussed.

A description of factors that may affect our future results is provided in the company's SEC filings including Form 10-K for the fiscal year ended March 31, 2009, under the section "Risk Factors" and in our other SEC filings. 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.

Now I would like to turn the call to Rick Gilbert, Chairman, President and Chief Executive Officer of Westell.

Rick Gilbert

Good morning. And thank you for joining Westell Technologies fourth quarter fiscal 2010 earnings conference call. I am Rick Gilbert, Westell's Chairman and CEO. During this call, I will briefly discuss the fourth quarter and full year 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 answer the questions.

We have now completed our fiscal year 2010. We began the year focused on two goals; returning Westell to profitability and generating positive cash flow. In addition, we had a clearly defined and publicly stated emphasis on bottom line performance versus top line growth.

During the fourth quarter, we recorded earnings per share of $0.04 on a fully diluted basis, identical to our EPS for the prior quarter. The total EPS for FY 2010 was $0.15 per fully diluted share. During Q4 we also built cash and cash equivalents from $58.1 million to $61.3 million, an increase of more than $3 million.

The increase in cash and cash equivalents for the full fiscal year was $15.3 million, and that figure does not include the $1.4 million we used during the third quarter to repurchase Westell stock.

When we compare the financial metrics for Q4 FY 2010 to Q4 of last year, we see that the overall revenue declined by 32%. This was primarily due to virtually no shipments of UltraLine Series 3 product during the quarter.

However, even with the revenue decline, gross profit dollars were up 10% with gross margins exceeding 37% and total operating expenses were down 24%. This yields an EPS of $0.04 per share for this quarter versus a loss of $0.03 per share during the fourth quarter of FY 2009.

The 12 month year-to-year comparison shows a slight decrease in revenue of about 2%. An increase in gross profit dollars of 13% and a decrease in operating expenses of 30%. This combination led to a dramatic improvement in EPS from a loss of $0.24 per share in the 12 months ending on March 31, 2009, to a gain of $0.15 per share for the 12 months ending on March 31, 2010. An overall improvement of $0.39 per share.

Now I would like to make a few comments about the FY 2010 performance of our three business units. For the entire year, the customer networking solutions team has been focused on business opportunities that yield reasonable margins rather than trying to maximize revenues. It has been a key CNS goal to either execute a piece of business profitably or eventually exit that segment of the business. This approach has certainly affected the CNS revenue run rate.

For example, we began the year with a minority share of the Verizon FiOS business and we exited the year with a much smaller share of that low margin business. At the same time, we have significantly increased our modem and gateway market share with the other North American operators.

CNS completed the fiscal year by doing $87 million in revenue at an average gross margin of 16.4% as compared to the previous year where CNS did $84 million in revenue with a gross margin of only 9.7%. This dramatic increase in margin was an important goal for CNS in FY 2010 and the CNS team clearly accomplished that goal.

Looking forward, CNS will maintain its focus on winning profitable business and improving margins, even if revenue suffers as a result of this bottom line focus. From a strategic perspective CNS will continue to focus on the home cloud initiative which is under development as we speak.

Outside Plant Systems completed a very solid fiscal year with a total of $52.5 million in revenue at an average gross margin of nearly 44%. This compares well to last year's results of $56.5 [ph] million in revenue with a gross margin of 40%. Clearly OSP saw some slowdown in overall revenue due to economic conditions. But the majority of the revenue was sourced from new and expanding opportunities such as wireless back haul applications.

On the strategic front, OSP is well underway on developments to supplement its current offerings with Ethernet-based solutions that are targeted for both at wireless backhaul and smart grid applications.

In FY 2010, Conference Plus also experienced a small decrease in revenue combined with a healthy increase in average gross margins. Revenues were $41.7 million in FY 10 compared to $45.2 million last year, but the gross margins increased to 48.7% in FY 10 from 44.7% last year. It should be noted that many companies in the conferencing market segment saw a decrease in business last year which was almost certainly due to the prevailing economic conditions.

Looking forward, we anticipate an improving economy will be accompanied by an increase in demand for audio, video and web conferencing services and that we should have the opportunity to improve the Conference Plus business over the next few quarters.

As we began our new fiscal year, it seems appropriate to look back on the past year and ask the question, did we accomplish our primary goals of returning the company to profitability and generating positive cash flow? The answer is an emphatic yes. We were profitable and generated cash in each of the four quarters of FY 2010.

The fact that these goals were achieved during very challenging economic times is a credit to hard work of the whole team here at Westell. However, we are now fully engaged in a new fiscal year and I would like to provide an update of my view of the business units starting with Outside Plant Systems.

OSP continues to do well with excellent products invaluable customer relationships and rock solid performance. It wins with a rigorous solutions-based focus that often yields customized products. Its potential to expand into new markets while retaining its core focus continues to justify additional investments to grow this business unit.

CNS on the other hand does remain a challenge. In spite of its dramatic FY 2010 improvements I'm not satisfied with an unprofitable CNS business and we continue to work diligently to change that status. One avenue that we have taken is to attempt to shift toward products and markets that support more reasonable margins, and of course we have been very careful in managing costs. We believe that we can eventually supplement low margin devices with high margin software by fully developing the home cloud product family.

Conference Plus continues to show its ability to perform steadily in a very competitive marketplace. In general, this business unit has been quite effective within the market segments that it serves. I also like the new managed bridge offering which allows Conference Plus to provide a very high quality of service demanding corporate customers. While we have found it more difficult to justify additional investment in this business, we fully expect Conference Plus to remain a solid contributor to Westell's overall results.

In summary, our primary challenge going forward in all three business units to find ways to grow revenue while maintaining a solid bottom line to that end, we have increased spending in support of some specific initiatives within the business units notably the development of home cloud and Ethernet capabilities that I have mentioned, and we will continue to consider other strategic investments as the opportunity permits.

We will look forward to reporting on the progress of these initiatives in future calls.

With that I will turn the call back to Brian Cooper who will discuss the results in more detail before we open the call for questions. Brian?

Brian Cooper

Thank you, Rick. I will talk in a little more detail about our financial results for the fiscal fourth quarter and for the year as a whole. I mentioned at the start of our call that our earnings news release is posted on our website and I hope you will refer to it. We have tried to provide significant amount of useful information in the release and I will address only a portion of that in my comments.

As Rick has already noted, we reported net income for the fourth quarter of $2.7 million or $0.04 per share. This compares to a net loss in the prior Q4 of $1.9 million or a loss of $0.03 per share. Notably, Q4 is our fourth profitable quarter in a row. In round numbers fiscal year 2010 earnings by quarter were $2 million in Q1, $2.9 million in Q2, $2.7 million in Q3 and again $2.7 million in Q4 for a total net income of the year of $10.3 million. This is a profit of $0.15 per share which compares against a fiscal year 2009 loss of $0.24 per share.

Looking at the latest quarter, we are reporting consolidated revenue of $37.8 million. This is down 32% compared with $56 million in Q4 of the prior year. The lion's share of the reduction relates to CNS sales of UltraLine Series 3, which totaled only $500,000 in Q4; a total $14.6 million in the prior fourth quarter.

CNS and to a lesser extent Outside Plant Systems both experienced soft demand generally. This appeared to result from lagging effects of weak economic conditions as well as inventory rebalancing by our customers. Conference Plus reported a modest 2% top line decline compared with the prior Q4.

While we obviously would like to drive revenues higher there are few key points from our perspective. First, the UltraLine Series 3 is a narrow margin product. Lower sales of this product therefore have a limited bottom line impact. Second, we anticipated some softening of demand in our businesses which we experienced but both Outside Plant and Conference Plus showed some rebound in Q4. We believe that the improved top line trend for these businesses is continuing into the current quarter.

And finally, we have consistently emphasized bottom line over top line performance. In spite of the revenue decline, the gross profit dollars that we earned actually increased for all three businesses compared with the year ago quarter.

To complete the picture for the quarter, consolidated gross profit was $14.1 million and gross margin was 37.4%. In the prior year quarter, gross profit was $12.8 million on a margin of 22.9%. All three businesses delivered higher gross margins for the quarter compared with the prior year quarter.

Consolidated operating expenses remained low too, at $11.5 million for the quarter. They were $15.2 million a year ago. As we discussed throughout the year the reductions range across all expense categories for all of the business units. And they reflect restructuring and personnel reductions that for the most part were completed by the first quarter of the fiscal year.

We have also maintained tight control of spending. There was a negligible contribution to expense during the quarter from the investments that we have begun in home cloud and Ethernet capabilities.

By business unit, the income changes for the quarter are all positive. CNS reported an operating loss of $1.7 million which was $2.4 million better than its quarterly loss of $4.1 million a year ago. Outside Plant Systems improved $1.1 million to $3.5 million of operating income. And Conference Plus was up $1.3 million to $1.6 million for the quarter.

The annual results reflect four solid quarters. In aggregate, revenues totaled $181.5 million for the fiscal year down 2% compared with $185.9 million in FY 2009. Gross profit was $57.7 million up $6.5 million versus the prior year.

Expenses were $47.9 million down $20.1 million. Taxes remained minimal as result of a third quarter tax refund and offsets against fully reserved historical net operating losses. The net result is $10.3 million of consolidated net income for the year, a whopping $26.9 million improvement over fiscal year 2009.

Turning to the segments, Rick has commented on annual revenues and gross margins by business unit. Annual business unit operating income results are very positive. Compared with fiscal year 2009, CNS improved annual results by $16.6 million; Outside Plant was up $4.4 million. And Conference Plus added $3.8 million. We also reduced unallocated costs by $1.8 million year-over-year.

Moving on, I would like to note our balance sheet remains extremely strong. Cash and equivalents now top $61 million, up $3.2 million during the quarter, and up $15.3 million during the fiscal year.

From a cash flow perspective, depreciation and amortization totaled $3.8 million for the year and capital expenditures were less than a $1 million. We bought no shares during the latest quarter and there is $10 million remaining for share repurchases under our existing Board authorization.

In conclusion, Rick and I believe our team is right to be proud of Westell's performance in fiscal year 2010. We clearly met the objectives we set and laid a solid foundation for the future.

As Rick described we now are focused on the challenge of growing the businesses profitably and delivering good results in FY 2011.

With that I believe we are ready to open the lines for questions. Hilda?

Question-And-Answer Session

Operator

Thank you. We will now begin the question and answer session. (Operator Instructions). Our first question comes from Jeff Linroth from Leaving It Better.

Jeff Linroth – Leaving It Better

Good morning.

Rick Gilbert

Good morning Jeff.

Jeff Linroth – Leaving It Better

Well, you certainly did what you talked about doing a year ago. You did it over the course of the last year. So congratulations on the bottom line results. Couple questions on – general questions. Inventory rebalancing among your customers do you sense their inventories are lean, adequate or maybe even a bit high? What's your sense of that?

Rick Gilbert

Obviously depends on the product you are talking about. They vary. Certainly the one you are probably referring to is the UltraLine Series 3 where we saw a pretty big effect here. I think the – there is pretty public statements from Verizon about the limited number of new customers they have been adding to the FiOS program.

I think they got into an over-inventory situation and have done some balancing, obviously. But that's not rare in our business. It does happen and a lot of our business in the CNS area does revolve around trying to get as accurate forecast as we can and managing inventory on our side and that's what we do.

Jeff Linroth – Leaving It Better

What is your outlook for the UltraLine Series 3?

Rick Gilbert

Well, I think 500,000 was a very little UltraLine Series 3. I'm a little less worried than perhaps most people are about it because it doesn't really contribute much to our bottom line. I'm more bottom line focused. And as I said all along, I rather have less revenue that's more profitable any day of the week.

That said, I'm sure we will sell more UltraLine Series 3 in the coming quarters than this quarter. The real question is long term, whether that's a business that's really a good business for us. And that's something we certainly spend some time thinking about.

Jeff Linroth – Leaving It Better

Okay. In terms of your market share for each of the segments, roughly where are you compared to a year ago and any developments that you mentioned throughout the year that contributes to that change I would be interested in?

Rick Gilbert

For a variety of reasons we never give percentage market share numbers on any of the segments. I will say that from a generic standpoint we certainly picked up market share with the other North American copper-based carriers during the last year and in fact, during the last couple quarters we have done quite well in terms of gaining ground in the areas of modems and gateways.

And I will say obviously we entered the year with more market share in the FiOS UltraLine Series 3 program than we are exiting the year on a quarter by quarter basis, anyway.

Jeff Linroth – Leaving It Better

That's exactly what I was looking for. Thank you for that. I would appreciate if you could add a little color in the year on year drop in OSP revenue.

Rick Gilbert

Well, I think the OSP both OSP and Conference Plus had pretty aggressive plans from a revenue standpoint. And we really drove them more on the bottom line focus as well. And the management did an extraordinarily good job working the bottom line.

What I like about the OSP revenue is that so much of it is coming from new products and new areas. We have certainly seen good results in general in the wireless back haul area and we have talked about that in the past. We have now received our first production orders for the utility markets and that was long time coming as you know we have been in trials for a long time.

And OSP, as Brian said, OSP and Conference Plus seem to have some nice momentum coming into the year. So I'm not too concerned about the small limitations and the revenue year-to-year on the Outside Plant and Conference Plus because I'm happy with what they did on the bottom line and that's what we asked them to do.

Jeff Linroth – Leaving It Better

Okay. Lastly, if I could just get an update on a couple things you mentioned last time on the call. In whatever terms you would like to characterize how the investment in the home cloud development has gone over the last 90 days.

Rick Gilbert

Well, most of the investments we made up to date. We are still in the process of hiring people for the program. From adding a few outside people as I said we would do. A lot of the investments we have made have been actually moving people from old programs to newer programs like home cloud so we have re-adjusted our existing personnel to have more people working on home cloud.

We are satisfied with the rate of progress. We seem to be doing just about what we expected in terms of the home cloud development and it looks pretty interesting. Very promising.

Jeff Linroth – Leaving It Better

All right, well thanks you very much. I will give some else the turn.

Rick Gilbert

Thanks, Jeff.

Operator

Thank you. (Operator Instructions). Our next question comes from Brian Horey from Aurelian Management. Please go ahead, sir.

Brian Horey – Aurelian Management

Thanks for taking my question and congrats on an excellent quarter. You mentioned there were I think you used word negligible increase in expenses in the Ethernet and home cloud initiative. Can you give us instances how they might ramp or trend going forward?

Rick Gilbert

Well, they will move up a bit. These are things that we did budget carefully and we have often said that we aren't taking our eye off the bottom line ball here. That's very important to us to run the company in an effective way. So I would not be looking for some dramatic increase in the expense structure of either Outside Plant or CNS.

These are programs that can be done with combination of current resources and limited additional resources. And so the expense was negligible last quarter. There will be a little bit more recorded in this – in these coming quarters but don't look for anything dramatic.

Brian Horey – Aurelian Management

Okay. And I think in the past the way you characterized the home cloud initiative is that that would be what's called a second half of the year point of getting to market or being in commercially ready in some fashion. Is that still a reasonable expectation?

Rick Gilbert

The first real revenue from home cloud will be in FY ‘11, all right? Beginning in FY ‘11 we started to see the real invest news. And we said quarter ago it would be a year before we saw revenue from that program. In terms of the Outside Plant, probably we will see some revenue in the Ethernet part of that a little earlier. But again some of the programs that we are doing for Ethernet are for alternative transport for some of the existing business we have. So in terms of net add revenue there will be some offset on that. I hope that helps Brian. Sorry.

Brian Horey – Aurelian Management

That's okay, that's okay. With respect to CNS and the gross margin that you achieved this quarter, can you comment at all how sustainable you think that level is going forward and obviously Verizon was a very small part of the mix. Generally is that part – is that a range you think you can hit on a relatively consistent basis going forward?

Rick Gilbert

Yes, I think relatively consistently. The problem we have with the old business and CNS , modems, gateways and things like the UltraLine Series 3, is that these products have sort of reached the point where they are so commoditized that it's hard to decrease the cost of building them anymore, all right?

And in so far as some customers expect continuous improvement in pricing, you have to start looking at the business customer-by-customer, product-by-product, and decide if that's really a good business to be in or not in the long term. And that's one of the challenges that management in CNS has, how do they best manage their business in order to produce more profit, all right? From the businesses they are gathering.

And, as I said, they have – they increased market share in a number of North American operators and by the way they have done that with reasonably profitable deals. That shows up in their gross margins. And that's the challenge that they have to continue with. And if a business any business becomes single-digit margins it's probably not something that the CNS management it’s going to be very interested and continuing on a long term basis, okay?

Brian Horey – Aurelian Management

Yeah, makes sense. Along those lines, is there a hope of the prospect that the Verizon business might move to a zone of profitability where it makes sense to either pursue that more aggressively or to invest in the business in some fashion so that that can become a larger portion of revenue stream or (inaudible) where we are with that?

Rick Gilbert

Well, remember we have a number of different products we sell to Verizon first of all. And again I think you're probably talking about the FiOS UltraLine Series 3.

Brian Horey – Aurelian Management

Right.

Rick Gilbert

And Brian, I will say that I'm a little skeptical that we can see the profits that we love to see long term on the UltraLine Series 3. And that said, we have a contract in place and a lot of it depends on the volumes they do. And we will watch that business closely. But I'm seeing much better margins in other pieces of business both at Verizon and from other customers.

Brian Horey – Aurelian Management

Okay. And then lastly, can you give us some sense as to, you know, on a ballpark basis what share of the revenue stream the wireless back haul opportunity is accounting for at this point?

Rick Gilbert

Well, in outside plant a lot of different elements get sold into the wireless back haul. So, it's not a single product. But I believe the last time I spoke to Brian on that topic, he said that more than 50% of the revenue was related one way or another to outside – to wireless back haul applications.

Brian Horey – Aurelian Management

Okay. Thanks very much and congrats again –

Rick Gilbert

By the way Brian I think is very good news.

Brian Horey – Aurelian Management

Yeah. I think so, too.

Rick Gilbert

Yeah.

Brian Horey – Aurelian Management

Thank you.

Rick Gilbert

Thank you.

Operator

Our next question comes from Robert Zarkowski [ph] from Ruz Asset [ph]. Please go ahead.

Robert Zarkowski – Ruz Asset

Good morning, Rick. Thanks for taking the call. On the CNS line again, the UltraLine, you talked about demand inventory rebalancing and market share impact. How much of the reduction in revenue on this Series 3 this quarter was due to market share change? Would you guess.

Rick Gilbert

A lot less than – again I'm not going to give exact percentage but a lot less than the inventory rebalancing aspect of it. Again, one of the challenges we had with this business and in fairness I suspect Verizon had accurately forecasting the take rate of FiOS. And so, we have also have long lead times to build these products and so managing that forecast has been a joint challenge for Verizon and CNS.

And I think they work together as well as they can possibly work together. But the bottom line comes to the point where if it Verizon has enough product in their inventory and don't need to buy it don't buy it. And that's the way the contract works. So again, it looks very dramatic on a quarter to quarter comparison. But that's not unusual in our business.

Robert Zarkowski – Ruz Asset

On the market share change, was that due to pricing alone or were there other factors.

Rick Gilbert

Well, again, I'm not – I can't speak for how Verizon makes its buying decisions. But I'm certain that pricing is important to them.

Robert Zarkowski – Ruz Asset

Okay. On the Conference Plus in the past you have talked about there are some of the challenges in that is probably just the volume and then some of the fixed costs you guys are having in the business and how that business looks on a long-term basis challenge-wise. Can you kind of talk a little bit more about that? Or update that?

Rick Gilbert

I mean, the challenge with Conference Plus in my mind has always been the fact that it's in a business that many people view as commoditized. When you go out to do a conference call a lot of times people feel that those costs should be almost free. Scale is important when you in a business like that and Conference Plus is a fairly small scaled business. It does 40 some million dollars in revenue per year.

What management at Conference Plus has done very well is focused on niche markets that are looking for the quality and are more profitable than some of the commoditized markets. A good example is investor relations calls. We have very high quality capability to do those kind of calls.

Another example are the managed bridge applications I talked about which are certainly more profitable and require a higher quality and more management than a lot of conferencing companies can do. The challenge, however, remains that when you are small scale you have to buy the underlying telecommunications services and it's hard to do at the price deals you would like to do going up against somebody that does a $ 1 billion in conferencing revenue.

So, it's a challenge. But again I think in the fiscal year we just completed the team at Conference Plus met that challenge pretty well. I mean, dramatically increasing their bottom line result from a year before. I mean, triple, at least tripling the bottom line. Isn't that right Brian?

Brian Cooper

Yes, right.

Robert Zarkowski – Ruz Asset

And final question, on the home cloud you talked about any revenues really coming in FY 2011, what particular areas do you think will be the first opportunity for revenues that you will see? Particular product?

Rick Gilbert

Well, there is a number of applications. I'm a little concerned about the competitive nature of giving too much information out. But one that we are quite interested in is a home cloud application that does stage backup and restore back to the macro cloud through a local device in a very smart fashion and we are excited about that application as one of the applications that I think is going to be more and more important being driven by some of the devices out there like the iPad and the net books and things with limited storage but a lot of medias.

Robert Zarkowski – Ruz Asset

How much of that will be filled through channels or existing partnerships?

Rick Gilbert

Well, it will be something that we will be taking through channels. It's not something that I think that we are going to do a lot of direct sales on in the long term. In the short term, as we develop the program we may do some direct sales as we roll it out.

But channels and partnerships, especially partnerships with not necessarily operators, especially partnerships with people that have the cloud-based back up farms that we need to be partnering with in order to do this the way we want to do it. So we are discussing those kind of things with those kind of companies.

Robert Zarkowski – Ruz Asset

All right, thanks. Congratulations on a great quarter.

Rick Gilbert

Thank you very much.

Operator

Our next question comes from Jim Zimmerman from Lowell capital management.

Jim Zimmerman – Lowell Capital Management

Yes, thanks for taking the call, appreciate it. Great quarter. Congratulations to you guys. I had a question on your cash generation has been incredibly impressive and I guess I was just wondering no one knows – no one knows crystal balls to what this year is going to look like. But, I mean, was there anything unusual going on vis-a-vis cash generation in the year we completed where you generated 15 or so million of free cash flow or something like that. Anything that I am missing there or what are your guys comments on that?

Brian Cooper

Obviously the biggest difference in the cash flow generation was in having good earnings.

Jim Zimmerman – Lowell Capital Management

Right.

Brian Cooper

I mean, that is the main source. There wasn't anything that I would point to and say that was unsustainable or unusual in the year. Obviously there was probably a little bit of movement in some balance sheet items and so forth. But nothing that I would say is out of line or unusual. So, it's kind of a real number. It represents a good performance and yeah, we did work on all aspects of cash generation but nothing outlandish in there.

Jim Zimmerman – Lowell Capital Management

Yeah, it looked like working capital was just a very small part of the overall cash. It's obviously impressive.

Brian Cooper

That's correct, yeah.

Jim Zimmerman – Lowell Capital Management

Your tax shield [ph] is that something that's available going forward to shield cash taxes? Or is there any issues with respect to that?

Brian Cooper

As we run the business today we have an asset that I think about $65 million or so. That's available until we use it up. I guess federal taxes at least.

Jim Zimmerman – Lowell Capital Management

And then just on – you have done a fantastic job – looks like you're managing gross profit dollars which I think makes a heck of a lot of sense when you are trying to keep the operating expenses down.

Are you – is there any further opportunity to reduce the operating expenses going forward? Or might even go up with some of these smaller investments you are talking about? Are we sort of where we need to be vis-a-vis those type of operating expenses in your guys mind?

Brian Cooper

I would say first of all the operating expenses are something we can manage. As the business performs we try to set those to correspond to that. As we are doing today, this is business that’s run through the past year, I would say the expense level is at a fairly good level. It's not easy to take out more costs. We have done a lot of work there and we will add back a little bit for some of these additional investments. But we are at a pretty good level in the last couple quarters.

Jim Zimmerman – Lowell Capital Management

And then the business you are winning on this CNS side away from the unprofitable or the low margin Verizon piece with the UltraLine, how are you winning that? What is it – can you talk a little bit about how you are sort of trying to replace the low margin business with the better margin business in that segment.

Rick Gilbert

Well, sure. And I have to say with all due humility Westell has an extraordinary reputation for quality and service in the North American marketplace. That's both CNS, Outside Plant and in Conference Plus. CNS has been able to win business from competitors who perhaps have not had the same record of quality and service and we have been able to demonstrate it quickly. Our references are impeccable.

And we had the opportunity to go into accounts that have had been using other suppliers and convince them we are the right people to use. And that's what any sales situation is about. The good news is that we are backed up with the kinds of products and service that people are looking for.

Jim Zimmerman – Lowell Capital Management

Is that an opportunity continuing opportunity going forward to sort of the focus on looking for better margin business on the CNS side that may not have fully played out in terms of growing market share away from the lower margin business in that segment.

Rick Gilbert

Yeah, it is in the following sense. None of the larger carriers and by the way we generally don't a lot of time with the real small IOC's because the volumes aren't – Independent Operating Companies, volumes are too small. But the larger IOCs and larger North American carriers such as AT&T and CentraLink and Frontier and Verizon, these are people that will always have at least a dual source supply for anything they buy.

And so, first of all once you are in the door with a reasonable market share on one of the product lines, I mean, fighting for the largest market share of a profitable product line that you can get is a good thing. But the other thing is once you are in the door with one product the real interesting thing is can you move now into some of the other product areas that you are not necessarily one of the two suppliers. And I think that's what we see as sort of the Holy Grail in some of these areas that we can build our market share not only within the products we have but in the new products.

Jim Zimmerman – Lowell Capital Management

What else can you sell them that you have in your array that allows you to expand your relationship with them.

Rick Gilbert

Well, remember we build modems. We build the smart gateways. We build devices like the UltraLine Series 3 and then we have these oncoming devices in the home cloud –

Jim Zimmerman – Lowell Capital Management

Okay.

Rick Gilbert

Family which are all very interesting. But the other thing we have, of course, is the cross between Outside Plant and CNS. The relationships that outside plant – sometimes generates sales in the modem gateway area and vice versa and since the reputation of both divisions is quite good with the carriers, there has been good interplay between the two as well.

Jim Zimmerman – Lowell Capital Management

Do you guys feel like you have a bit of a barrier of entry in that it takes a long time to qualify and there is only a limited number of players that can qualify with some of these huge telecom players. And is there some of that issue there or is it still really competitive?

Rick Gilbert

It's very competitive from a price standpoint. As I said these are commoditized products in some areas. There is a barrier. You are right though, there is a barrier to entry because these are large volume sales situations and if you are an incumbent and doing a good job servicing your customer, it is pretty unusual to be replaced or to lose.

Jim Zimmerman – Lowell Capital Management

The business is kind of yours.

Rick Gilbert

It’s exactly right. In some cases I should say in some cases you might want to lose it if it's a low margin. But the one thing that is a little frustrating in the CNS business, anyway, is that you have a lot of people that I don't think it can actually truly service the business that are bidding [ph] ridiculous prices for the business. And you see that with some of the Chinese vendors, for instance. But I don't think we will ever, ever win a big share of the business but it does cause issues when these RFPs are out there.

Jim Zimmerman – Lowell Capital Management

And my last question, just on valuation of your company, it looks like your enterprise value is below 40 million and you got a business that seems to throw off 12, 15 million of cash a year if things were to continue like they did this past year, I mean, how do you feel about the stock buyback and what are your thoughts on – I know we are going through horrific economy here and you want to keep your powder dry and you probably have some investment opportunities. What are the sort of thoughts on share holder value enhancement? How we get there?

Brian Cooper

I like the way you do your math. We do that math as well. And we do think that there is value in our stock. Frankly, the reason that we didn't buy stock in the last quarter had more to do with process than setting specific targets for what we were trying to accomplish. We still think buying back shares is an attractive thing for us to do.

As you know we are limited in how we can act in the marketplace and we have some times fairly narrow windows when we are allowed to be in the market directly. We set up – we have actually set up a 10B51 [ph] plan to execute and this last quarter where we just set it up a little too conservatively and it didn't acquire shares for us.

But we still see that as an attractive way to deploy some of our cash. But also as you said we do want to have dry powder and want to have some cash to manage the business and take on opportunities.

Jim Zimmerman – Lowell Capital Management

Okay. Well I think you guys – congratulations. I think you did a fantastic job and I hope you are able to keep up the great work.

Brian Cooper

Yeah. And as you know, we still do a share authorization outstanding for $10 million share repurchase authorization from our Board.

Jim Zimmerman – Lowell Capital Management

Yeah. I mean, at some point you might want to consider Dutch auction or something aggressive because if you could actually generate 15 or 12 or $15 million of cash on a steady state and the market is going to value you at this kind of enterprise value your existing business is much more valuable in my opinion than some of the smaller companies.

You can sort of maintain an appropriate amount of cash and shrink – increase the size of everyone's piece of the pie after the buy back. But I'm sure you guys are thinking about that. Well thank you very much. I appreciate it and congratulations again on a great job.

Rick Gilbert

Thank you.

Operator

Our next question comes from Peter Schleider from RKB Capital.

Peter Schleider – RKB Capital

Yeah, most of my questions were answered. I guess just to embellish a little bit more on the stock buyback. Is part of your plan are you able to do negotiated transactions? So if you had some sellers that were large seller you can take them directly? Or do you have to do a percent of the volume approach?

Rick Gilbert

We have some flexibility to do those kinds of transactions. I would tell you that hasn't been our focus.

Peter Schleider – RKB Capital

Okay. And then one other question with relationship to home cloud. My understanding and maybe you haven't really explained it a whole lot about it. But my understanding was that there was a piece of this that was based on the UltraLine 3. Is that correct? Or does it also have part of that home cloud incorporate products from OSP as well?

Rick Gilbert

Peter, on the home cloud, when we first started looking at home cloud which really realistically people were looking at this 18 months ago. There was some hope that we could run the applications we wanted in an UltraLine Series 3 Class line product with more memory. It's true that some set of the applications can run in that kind of a product.

However, the more interesting applications, the ones that we were excited about require a new device. And a new network appliance that sits in next to the Broadband source in the home or business. So we are building that new device.

And it is quite capable of running some very sophisticated applications. The other advantage of it, of course, is that it's not limited to just DSL. Any Broadband source whether it's cable or copper or satellite can be utilized with this sort of an approach. And so again some applications you can run in the UltraLine 3 class like products. Interesting ones, ones we are most excited about require the new device.

Peter Schleider – RKB Capital

You said in your comments you thought it would be revenue in fiscal 2011. You probably meant 2012?

Brian Cooper

The very end of 2011 and the beginning of 2012 is what I meant. I'm sorry.

Peter Schleider – RKB Capital

From a fiscal year standpoint.

Rick Gilbert

Fiscal year standpoint. Right.

Peter Schleider – RKB Capital

Great. All right, thank you very much.

Rick Gilbert

Thank you.

Operator

Our next question comes from Ali Hilali from Ingalls & Snyder.

Ali Hilali – Ingalls & Snyder

Hi, guys. First of all I want to say truly remarkable turnaround and congratulations. The other question I have is do you know how much inventory is related to CNS?

Rick Gilbert

Off the top of my head –

Ali Hilali – Ingalls & Snyder

Ballpark. Most of it? Some of it? All of it?

Brian Cooper

Probably more than half. We haven't looked at it that way recently.

Ali Hilali – Ingalls & Snyder

I was thinking, what really is the future of CNS and I'm sure you are thinking about that a lot. And I was thinking that perhaps it's just something that has tied up a lot of the capital and maybe the future for CNS is simply rather than being a $6 million annualized drag on earnings plus 10, 12, $15 million in capital, whether it's inventory receivables or payables or whatever. Maybe the right thing to do will be to not do it anymore.

Rick Gilbert

I can understand that perspective and I can tell you that I'm sure that there are some set of investors that feel impatient why aren't we moving faster on other strategic alternatives.

Like you are mentioning, I should point out, our approach, were to come in and run the company as efficiently as we possibly could during FY 2010. To learn will the strengths and weaknesses about the business and fine ways to make those assets more valuable. I will state that I believe all three assets all three of our business units are more valuable than they were a year ago. That was one of our goals. We go forward, we were open to other strategic alternatives. We are not closed to the ideas.

But we want to continue running the company effectively and without being closed minded about it. That's basically where we are. Obviously this is isn't the form to discuss lots of strategic different alternatives but the kinds of things you are discussing are things that we have to be considering.

Ali Hilali – Ingalls & Snyder

Great. Other question is how long is the contract with Verizon for the UltraLine where they can pretty much buy the stuff and not really have to pay anything more than what it costs you to make it?

Rick Gilbert

All our contracts with Verizon for that matter most of our carriers are multiyear contracts. We recently signed a new version of the contract for the UltraLine Series 3. There is a few years to go.

Ali Hilali – Ingalls & Snyder

Would I be correct in assuming it would be difficult just to say sorry we aren't selling this anymore, good-bye?

Rick Gilbert

All contracts have termination options that said, probably not the best which to do business.

Ali Hilali – Ingalls & Snyder

Unless you aren't in the business any more in which case that would be fine. The other thing I think everybody has mentioned the economics and I would throw my hat in with the whole map on the enterprise value and repurchase and unfortunate that the 10B51 plan did not kick in.

But today is another day. Hopefully more opportunities will arise. And I would suggest perhaps with 60 odd million in cash, 10 million is a small amount of that, perhaps that might be looked at to be increased. Otherwise really I have to say this is – the speed with which this turnaround has been executed hats off to you guys. Congratulations and that's all have I. Thank you.

Rick Gilbert

Thanks very much.

Brian Cooper

I think we have time perhaps for one more question.

Operator

Next question comes from the line of (inaudible).

Unidentified Analyst

Hi, thank you. I'm wondering if you could elaborate on the new product that you folks mentioned and markets utility and back hauling the OSP segment, what are these products and how do you see outlook standpoint so far for sales, generally bought in volume? Or is it a lot of customers if you can maybe put some color on it that could be helpful. Thank you.

Rick Gilbert

Outside Plant area the wireless back haul essentially are products that generally sit up near the wireless tower sites. Those sites sometimes have multiple operators on them and you have to groom the back haul traffic from multiple operators. From the one side to multiple operators.

There are various aspects of doing the demark which requires cabinets that have various devices built in and that gets into the semi-customized device area. Now what drives wireless back haul right now is all the new Smartphones and the iPads and things like that that are generating all kinds of data traffic and it's a growing business. That business is a volume business. It's a business that a lot of people see as attractive and outside plant has done a good job of capturing some of that business. The smart grid business is more ancient in nature. There is a lot of trials. Again, think of it as a communications demark between the utility and the grid and there is various things you can do with that demark. It attempts to be in the cabinet with a variety of devices built into the cabinet.

Attempts to be fully customized per utility. We just started seeing our first production revenue coming out of that that area. So the size of the market is hard to predict. But it's an intriguing market for us so we are pretty excited about that and that's about all I can really say at this point.

Unidentified Analyst

Thank you.

Brian Cooper

I think that's all the questions today. Thank you very much for joining us and we look forward to our next conference call.

Operator

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

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Source: Westell Technologies, Inc. F4Q10 (Qtr End 03/31/10) Earnings Call Transcript
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