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Westell Technologies Inc. (NASDAQ:WSTL)

F1Q11 (Qtr End 06/30/2010) Earnings Call

July 22, 2010 09:30 pm ET

Executives

Brian Cooper - SVP and CFO

Rick Gilbert - Chairman and CEO

Analysts

Todd Koffman - Raymond James

Brian Horey - Aurelian Management

Jeff Linroth - Leaving It Better

Ali Hilali - Ingalls & Snyder

Operator

Welcome to the Westell Technologies First Quarter Fiscal Year 2011 earnings conference call. My name is Sandra and I will be your operator for today’s 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, Sandra. I want to welcome everyone to our conference call covering the results for Westell Technologies during our fiscal 2011 first quarter, which ended June 30.

We issued our earnings news release last night and you can find a 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 materially 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, 2010 under the section Risk Factors. The forward-looking statements made in this presentation are being made as of the date and time of this conference call. Westell disclaims any obligation to update or revise any forward-looking statements based on new information, future events or other factors.

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

Rick Gilbert

Good morning and thank you for joining Westell Technologies first quarter fiscal 2011 earnings conference call. I am Rick Gilbert, Westell’s Chairman and CEO.

During this call, I will discuss developments in the business and then turn the call over to Brian Cooper, who will discuss the first quarter financial results. At the end of the call Brian and I will answer questions.

By most measures our first quarter of the new fiscal year was clearly successful. During the first quarter we recorded earnings per share of $0.07 on a full diluted basis more than double our EPS for Q1 of last year.

Our consolidated revenues declined by 23% compared with Q1 of last year but the revenue increased by 9% on a sequential basis. Like last quarter, the year-to-year drop in revenue was due to very limited shipments of UltraLine Series3 products. However even with the revenue decline consolidated gross margins exceeded 37% and total operating expenses were down 12%. The result was an improvement in net income of 133%. During Q1 we also produced a small increase in cash and cash equivalents to $61.8 million.

I will focus the rest of my comments on the first quarter performance of our three business units as compared with their performance during the prior quarter. When compared to last quarter customer networking solutions experienced a 6% increase in revenue which was driven by strong demand for the profitable VersaLink DSL gateways offset by relatively weak shipments of the low profit UltraLine Series3 products. We also recorded high margin software revenue of approximately $900,000 during the quarter. This had the aggregate effect of increasing gross margin significantly.

With expenses also down, the CNS operating loss for the quarter dropped to $440,000 versus the loss of $1.7 million last quarter.

It’s important to note that it remains a key CCNS goal to exit on profitable segments of the business. As we succeed in migrating the way from unprofitable business, we expect CNS revenue will decline until we can successfully introduce replacement products. However in the short term, CNS may actually see increased but less profitable sales as we clear out remaining inventories associated with End-of-Life products.

On the strategic front for CNS, the Home Cloud project continues in the development phase. So far, we’ve been able to minimize incremental costs for this project, by redeploying resources from other CNS areas to fill some of our needs. Over time, investments in Home Cloud will likely increase.

Outside Plant Systems had an outstanding first quarter, with revenues up 18% over last quarter. This increase was primarily due to robust sales of products related to wireless backhaul. At this time, we expect to continue the good momentum from Q1 through Q2 followed by the typical seasonal slowdown for this business in Q3.

On the strategic front, the OSP team is tightly focused on expanding our role in the wireless backhaul market by working with customers to define more integrated solutions that allow migration from current TDM-based copper backhaul, the Ethernet based backhaul via copper or fiber. Projects associated with this approach have reached the stage where customer feedback has been soft to tune our final designs.

Outside Plant expenses already reflect added resources for these developments, and during the coming months, OSP will probably add additional hires to support the development of these promising programs.

In Q1, ConferencePlus experienced another solid quarter with increased revenues and slightly decreased profits compared to last quarter. During the quarter, the weak euro had a somewhat negative effect on the ConferencePlus global services’ performance.

In general, we still need to see significantly improved economic conditions before we can expect to see meaningful increases in demand for audio, video and web conferencing services.

In summary, I believe Westell has experienced a great start to the fiscal year. And furthermore, barring any unforeseen effects from the unsettled economy, I expect a solid second quarter as well. My primary focus for the coming months will be to find ways to go Outside Plant through the addition of profitable new products, while managing the tactical issues inherent in the low margin product volume sold through CNS.

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

Brian Cooper

Thank you, Rick. I will review our financial results for the fiscal first quarter. I mentioned at the start of the call that our earnings press release is posted on our website. The release contains further information in detail in addition to the numbers I’ll reference.

As Rick has already commented, Westell had a very good quarter. We reported net income for the first quarter of $4.6 million or $0.07 per share. This compares against income in last year’s first quarter of $2 million or $0.03 per share. With this in context, the current result is an increase of 133%. It is our fifth profitable quarter in a row and it represents our best quarter since September of 2006, which was the last time our operating income topped $4 million.

Consolidated revenue for the quarter was $41 million, down 23% compared with $54 million in Q1 a year ago. We had revenues of $38 million in the quarter ended March 31, 2010. The largest part of the revenue reduction versus the first quarter of FY 2010 derives from CNS sales of the UltraLine Series3, which were $1.9 million during the latest quarter. It totaled $13.4 million in last year’s first quarter.

In total for the quarter, CNS revenues were $15 million, compared with $28.6 million in the year ago quarter. Excluding the UltraLine Series3, demand was strong for gateway devices and for the quarter, software for modems. The move from modems to gateways, it’ll likely be a longer term trend in our industry.

ConferencePlus revenue at $10.5 million was down about 5% versus the prior year quarter. As you know, ConferencePlus demand has suffered because of the weak economy, but we believe demand has leveled off. Revenues were up slightly on a sequential basis versus the March 31st, 2010 quarter. ConferencePlus is working diligently to retain and grow its revenues and customer base.

Outside Plant Systems revenue was up nicely in Q1. Revenues increased 14% at $15.7 million, compared with the year ago quarter. Outside Plant is benefiting from good demand for its products generally, and particularly for products which support wireless backhaul.

The gross margins which we earned on revenues were solid across the board. CNS margins reached 23.9%. This is almost 11 percentage points higher than a year ago. Sales of higher margin gateways were strong, while sales of the lower profit UltraLine Series3 were down. CNS also recognized about $900,000 of high margin software revenue for the quarter. This software revenue relates to a specific customer projects.

The gross margins in Outside Plant and ConferencePlus were stable at very solid levels. As a result, consolidated gross profit was up about $400,000, even though revenue was down by more than $12 million.

Consolidated operating expenses remained low too, at $11.5 million for the quarter. This isn’t about the same range as the last few quarters and is down $1.6 million versus the same quarter last year. We continued our tight focus on cost control. The latest quarter numbers also reflect some additional investment, and a shift of resources, further develop both, CNS’ Home Cloud initiative and Outside Plant’s Ethernet products that are targeted primarily at wireless backhaul applications.

Compared with the prior year, operating expenses therefore were down in CNS and ConferencePlus. Consistent with our investment plans, expenses were up modestly in Outside Plant. By business unit, the operating income changes for the quarter are all positive, compared with the year ago quarter. CNS reported an operating loss of $437,000, which was $1.1 million better than its quarterly loss of $1.5 million a year ago. Outside Plant Systems improved to $3.7 million of operating income, up about $300,000, and ConferencePlus earned $1.4 million for the quarter, up almost $500,000.

For comparison purposes, you may note that the year ago quarter contained a restructuring charge as well, which in total was about $600,000.

Rounding out the P&L, income taxes were positively impacted by changes in a contingency reserve and by the newly permitted full application of previous net operating losses against alternative minimum tax obligations. As a consequence, income taxes provided a net benefit of $473,000 in Q1. This compares with an income tax expense of $155,000 in the year ago quarter. Income taxes are largely sheltered by historical net operating losses.

The net result again within net income for the quarter of $4.6 million or $0.07 per share versus $2 million or $0.03 per share a year ago. I would also like to comment on our cash and our share repurchases. Cash and equivalents increased a modest $0.5 million during the quarter to $61.8 million. Two factors account for most of the smaller cash builds during this quarter compared with recent quarters. First, shifts in customer demand resulted in our acquiring inventories earlier than usual and paying for them earlier, which you can see in our lower accounts payable. We also paid out a larger share of accrued liabilities this quarter.

Share repurchases utilized only $370,000 to acquire approximately 247,000 shares. As of June 30, it was therefore $9.6 million remaining for share repurchases under our existing board authorization. I hope this has provided some additional insight on the quarter and I believe that we are ready to open the lines for questions. Sandra.

Question-and-Answer Session

Operator

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

Todd Koffman - Raymond James

Rick, in your prepared comments, you made some remarks regarding the CNS business where you’ve said you thought short-term revenue would actually pick up, although albeit less profitable. Then you said you thought that segment’s revenue longer term would continue to decline. Can you give a little bit more insight into how you see that business evolving over the next six to twelve months? And then just a clarification in the quarter, I think you called out a $900,000 software revenue capture in the quarter. What was that software for?

Rick Gilbert

Okay I’m going to start with your first question, I want to remind everybody on the call, that I’ve said for the whole time I’ve been here that our philosophy is we want to do profitable business and not just do business for the sake of revenue. In the CNS area, obliviously, we have some profitable business and we have some less profitable business. In the areas that are less profitable we do want to exit from overtime, while meeting our contract requirements.

So really what I am saying is there is a transition period as you get out of End-of-Life products that are not profitable, you get rid of their inventories and clear those out, you might see some increase in revenues that is less profitable during that period of time, and we expect we will probably see some of that for the remaining part of this year. That said we then have to replace that revenue overtime, with stuff that is more profitable and some of that we’ve talked about in the last quarter that we’ve been wining new more profitable business with other operators, such as CenturyLink and Frontier and that’s good, so that’s good news.

The other thing we wanted here of course in Home Cloud as an example is to start seeing more software base revenue and that will take time to fully develop and to enter into the market and ramp up to the numbers we’d like to see. And so, I wouldn’t be surprised that there is a period of time when we do see lower revenues but good profit, better profit out of CNS, and that’s all I was saying.

In terms of the $900,000 that was mentioned, that’s not associated with Home Cloud. That $900,000 was associated with specific software loads that were requested by some of our newer customers to aid in their transition to these products.

Todd Koffman - Raymond James

As a follow-up with regard to the profitable products versus the unprofitable products in CNS, is it fair to say that its actually in some cases not the products that have profitable versus not profitable, but it’s the customers you’re selling those products to so that you could actually sell the same product to one customer and it’s profitable, like a CenturyLink or Frontier, and a very similar product to another customer is not profitable or that’s not the case at all?

Rick Gilbert

Well, the market’s pretty efficient actually. I think, first of all, the profits do vary by product. We do have some products that are simply low-margin products, so the UltraLine Series3 I have mentioned a number of times is a very low margin product, whereas the gateways are little bit better. All these products, the modems, the gateways and UltraLine Series3 though are commodity products and so there isn’t a radical difference in price from customer to customer, but there is some of that effect of course.

One of the things that Brian mentioned in his remarks is that we’re seeing a nice shift from modems to gateways in the whole industry, and we like that shift to be honest. Those gateway products and higher volumes of gateways are definitely good for us. So, I hope that helps to answer your question, Todd.

Operator

The next question is from Brian Horey from Aurelian Management. Please go ahead.

Brian Horey - Aurelian Management

Thanks. Nice quarter. Just a question about the software deal in CNS. I’m assuming that that was extremely high-margin revenue, most of that dropped to the bottom line. Is that a fair assumption?

Brian Cooper

That’s correct, yes.

Brian Horey - Aurelian Management

Okay. And is that sort of a one-off kind of revenue event or is it something that’s pretty episodic in terms of not necessarily repeating itself on a regular basis?

Brian Cooper

It’s more akin to a one-time sort of thing. We will have these opportunities over time, though. So, this specific one was a specific opportunity. These do recur and we will get them in larger amount in one quarter than others, perhaps.

Rick Gilbert

Brian, just to add to that. I would probably term it pretty episodic. We do get these requests. We’ve got these requests historically over time as well. The difference is that in years past, Westell would do it for free, all right. And now we charge for these things, and it’s obviously good margin.

Brian Cooper

That’s an excellent point.

Brian Horey - Aurelian Management

Yeah, that’s great. Do you still have the expectation that we’ll see some kind of revenue from Home Cloud by the end of this fiscal year? Is that still your thinking?

Rick Gilbert

Well, we still believe, as I said before, that the first revenue which will be small revenues because it’s just entering the market will be either at the very end of this fiscal year or the very beginning of next fiscal year, which is what I’ve said before.

Brian Horey - Aurelian Management

Okay. And with regard to OSP, can you give us a sense as to roughly what proportion of their revenue stream is coming from wireless backhaul at this point?

Rick Gilbert

Well, when you consider all the products that are associated with wireless backhaul, I believe that significantly more than 50% is coming from wireless backhaul and probably approaching more like 60% or 70%, is associated with wireless backhaul in one way or another. It’s a very hot area of the business right now and it’s certainly an area we are focused on.

Brian Horey - Aurelian Management

And then lastly, I wondered if you could comment at all on what you think the prospects are for inorganic growth in the OSP business and just kind of what the M&A environment looks like now versus 90 days ago for that business?

Rick Gilbert

Well, we certainly keep our finger on opportunity list in that business. I think the most important statement I can make is that where we do investments, the majority of those investments will be directed at Outside Plant, which I think is consistent with the statements we’ve made all along. We feel that we have to do both organic investments and inorganic. The organic investments are going quite well in Outside Plant in terms of the development of a full roadmap for ethernet-based backhaul. I am very happy with the progress they are making on that front.

Inorganic investments, I guess Brian and I are certainly very cautious about. I think it’s something we will eventually do, but we want to pick our target carefully, our targets carefully and we want to make sure we can integrate them in a timely fashion, and so we are probably pretty cautious. In terms of the economy, it’s not a bad time to do it.

Operator

(Operator Instructions). The next question is from Jeff Linroth from Leaving It Better. Please go ahead.

Jeff Linroth - Leaving It Better

I think this question is really for Brian. I like your opinion about a risk. If the Board of Directors chose to begin paying a modest dividend, say maybe $0.01 per quarter or something like that, what would be the top two risks associated with that in your mind?

Brian Cooper

Well Jeff, I guess I would see it as more of a strategic issue than a risk issue frankly, and a policy issue. I don’t think for a company like Westell that dividends are necessarily a good fit, and I think our Board is probably of a like mind and of course you know it’s up to the Board and overtime things could change. But we don’t really see dividends as part of what we are aiming to do.

Jeff Linroth - Leaving It Better

The next question is, how has the relationship with AT&T changed compared to a year ago, say?

Rick Gilbert

Well, I think the relationship with AT&T; it has been continuously improving over the last year. We’ve had a great relationship with AT&T at all levels, and I think at both the Outside Plant and CNS, the people we work with are, you know we have a very co-operative customer-vendor relationship and we are very happy with the improvement in business in general with AT&T over the last year and a half.

Operator

The next question is from Ali Hilali from Ingalls & Snyder. Please go ahead.

Ali Hilali - Ingalls & Snyder

My one question is, and this is not to be uncharitable, given how much you guys have done but the share repurchase was really pretty small and I guess on our last quarter, we had discussed it, and it would have to do with basically your expectations to what the shares would be worth different from where they ended up being. I just wanted to get your take on where we stand now.

Rick Gilbert

Ali, I think first of all I can say and all honestly that I wish we had purchased more shares when the price was lower but I suspect there is a lot of people on this call that feel the same. I think our primary focus as a management team has been making the company more valuable rather than trading in our own stock and so we purchased what we could, given the limits that we had set on the program and I freely admit I wish I had purchased one.

Ali Hilali - Ingalls & Snyder

Well, you are right, and I guess I also wished that I had purchased more. The next question I had was follow-on from the earlier question with respect to dividends. And can you perhaps, Brian, expand a little bit when you said that, I guess I didn’t think I heard of, I wouldn’t call it necessarily a good reason I didn’t hear a concrete reason as to why dividends didn’t work, given your balance sheet.

Rick Gilbert

Well may be I’ll answer it from my prospective. I think dividends are an interesting thing that I understand from an investor standpoint, companies who pay dividends are interesting companies. However, we are still a very small company. We have limited resources and the question is can that penny a share or two pennies a share or $0.10 a share or whatever people want as dividends be better invested in our company in terms of growth and increasing shareholder value. Basically, the belief of the management and the Board at this point is that at this point anyway, that’s probably a more appropriate use of the cash is to invest in the company. Will that remain true forever? Never say never. But at this point, I think we feel pretty comfortable not paying dividends and using the cash in a different way.

Ali Hilali - Ingalls & Snyder

I understand, and I appreciate that. That is certainly a valid perspective for some people to have. I guess my question is you’re generating, yes, you’ve changed this, there are some working capital changes in the quarter, but what is essentially a very long-term tax-protected, roughly $5 million a quarter of income. And I’m just wondering if the goal is to use that. I just don’t see how you plan to, given how much your CapEx is, unless you go to buy something really large, what you’re going to do with the extra $5 million a quarter? That is just my logical thinking.

Rick Gilbert

Yes, I can understand that logic. But I have said in the past that if we do buy something, it probably won’t be a mom and pop business. When we try to build Outside Plant, I would like to make larger substantial acquisitions because I think will have a much bigger effect. And so, the fact that we have a lot of cash in the books right now shouldn’t be construed as we’re just going to be Bank of Aurora here. When the right opportunity occurs, we’ll probably use some of that cash and then we’ll have probably a different conversation at the next earnings call. So, I think we are generating cash. I think that’s good, but I would not make the assumption that we are generating cash just to sit on it.

Operator

(Operator Instructions)

Rick Gilbert

Well it seems like we have answered the questions and we look forward to seeing you at the next earnings call. Thank you very much for joining us today.

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. F1Q11 (Qtr End 06/30/2010) Earnings Call Transcript
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