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Anaren, Inc. (NASDAQ:ANEN)

F1Q2011 Earnings Conference Call

October 28, 2010 5 PM ET

Executives

Larry Sala – Chairman, President and CEO

George Blanton – CFO, SVP and Treasurer

Joe Porcello – VP of Accounting

Analysts

Matt Ramsey – Canaccord Genuity

Stephen Zaconne – Needham

Chris McDonald – Kennedy Capital

Operator

Good day, ladies and gentlemen, and welcome to the Anaren, Inc. Q1 Earnings Conference Call. (Operator Instructions). As a reminder today’s conference may be recorded. I would now like to turn the conference over to your host for today, Mr. Larry Sala, President and CEO. Sir, you may begin.

Larry Sala

Thank you. Good afternoon and thank you for participating in the Anaren Fiscal 2011 Q1 conference call. I’m joined again today by George Blanton, our CFO, and Joe Porcello, our VP of Accounting. I’ll provide a brief overview of the results of the Q1, after which Joe 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 SEC reports and exhibits to those reports to learn more about the various risks and uncertainties facing our business, and the potential impact on our net sales, earnings, and our stock price.

Net sales for the Q1 were $44.5 million, up 10% from the Q1 of last year. Increased demand for Wireless standard components and the strong order backlog for the Space and Defense Group drove the overall increase in net sales from the Q1 of last year. Non-GAAP operating income for the quarter was a record $7.6 million, or 17% of net sales, up 45% from the Q1 of last year. The strong sales of Wireless standard components and an exceptionally favorable mix of shipments for the Space and Defense Group drove the record profitability for the Q1.

Wireless Group net sales for the quarter were $15.5 million, up 8% from the first quarter of last year. Continuing strong demand for standard infrastructure and consumer components drove the increase in net sales from last year’s Q1. Demand for standard component products remained robust throughout the quarter, and customer forecasts remain strong.

New product and technology development efforts remain focused on expanding our standard component product portfolio. During the quarter the Group continued to expand the Xinger-III High Power Resistor and Consumer Component product lines. In addition, the Group formally launched the new Anaren Integrated Radio, or AIR, product line of low power wireless modules, and announced several distribution agreements. The FCC-compliant transceivers utilize Texas Instruments’ low power RF transceiver ICs and offer industry-leading size and performance. Initial market reaction to the AIR product line has been very favorable. Customers that exceeded 10% Wireless Group net sales for the quarter were EG Components, Whaway, and Richardson.

For the Space and Defense Group, net sales for the quarter were $29 million, up 12% from the first quarter of last year. Profit margins for the Group continued to improve as a result of increased sales volume and production yields. Product and technology development initiatives for the Group remain focused on cost reduction of our LTCC technology, introduction of our (inaudible) hybrid electronic standard product line for space applications, RF manifold and hybrid electronic module opportunities for ground, air, and ship-board radar applications, and the development of integrated microwave assembly technology.

New orders for the quarter were $18.3 million and included contracts for couplements and assemblies used in ground-based and airborne radar, as well as airborne jamming applications. The relatively low order rate for the quarter was mainly the result of order timing and the strong flow of orders we experienced in the Q4 fiscal 2010. The Space and Defense Group’s opportunity environment remains robust, and the Group continues to benefit from the expanded technology base resulting from the acquisitions of Unicircuit and MS Kennedy.

The Space and Defense Group order backlog at September 30, 2010, was $79 million. Customers that generated greater than 10% of Space and Defense Group’s net sales for the quarter were Lockheed Martin, Northrop Grumman, and Raytheon. George will now review the financial highlights.

George Blanton

The highlights of the Q1 income statement and the balance sheet at September 30, 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 Q1 earnings release for a reconciliation of GAAP and non-GAAP measures.

Non-GAAP gross margin was $17.8 million, or 40.1%, for current quarter, compared to $14.8 million, or 36.6%, for the Q1 of last year. Gross profit as a percent of sales increased by 350 basis points from the Q1 of last year due to higher sales levels and a more favorable sales mix for both the Wireless and Space and Defense business segments. Wireless Group’s standard component sales increased 36% from the first quarter of last year and were partially offset by a decline in the sales of custom assembly products. Space and Defense shipments were 12% higher than the Q1 of last year and benefited from strong shipments of our counter-IED products. Manufacturing efficiencies improved manufacturing throughput as a result of our lean manufacturing efforts, and our cost reduction program contributed to the strong gross margin for the quarter. We expect non-GAAP gross margins to be between 37% and 41% for the Q2 of fiscal 2011.

Investment in research and development was 8.6% of net sales in the first quarter, compared to 9% of sales for the Q1 of last year. Current R&D spending is supporting Wireless standard component product development as well as a number of projects in the Space and Defense Group, and is not expected to decline in the near future.

Non-GAAP operating income was 17% of net sales for the Q1, up 410 basis points from 12.9% in the Q1 of fiscal 2010. The increase was a result of higher sales volume, very favorable product mix, overhead absorption, and manufacturing efficiencies. Interest expense for the Q1 of 2011 was $184,000 compared to $183,000 for the Q1 of last year. We expect interest expense for the Q2 to be approximately $130,000.

Non-GAAP net income was 11.2% of net sales, or $0.35 per diluted share for the Q1 of fiscal 2011, compared to 8.7% of net sales, or $0.24 per diluted share for the Q1 of last year. The effective income tax rate for the Q1 of fiscal 2011 was 32.8%. This compares to a tax rate of 31.3% for the Q1 of last year. The projected effective tax rate for all of fiscal 2011 absent one-time events is expected to be approximately 33%.

Balance sheet highlights include: cash provided by operations was $5.9 million for the Q1; capital expenditures were $1.4 million in the quarter; cash, cash equivalents and investments were approximately $68 million as of September 30th, 2010, compared to approximately $74 million on June 30th, 2010. Anaren paid down $10 million of our note in the Q1 which has reduced our outstanding debt to $30 million. The company repurchased approximately 40 million shares of its common stock for a total of 700,000 in the first quarter. There are approximately 477,000 shares remaining under the current board repurchase authorization at September 30, 2010.

Accounts receivable were $27.9 million at September 30th, down $1.2 million from June 30th, 2010. Days sales outstanding was 58 days, down one day from June 30th. Inventories were $33.4 million at September 30th, 2010, up $2 million compared to June 30th. The increase was a result of higher business levels and delays in two defense programs due to production issues. Inventory turnover improved at our Syracuse facility and reflects improved operating efficiencies resulting from investments in lean manufacturing activities and improvements in our scheduling and production flow.

Joe Porcello

Thanks, George. For the Q2 of fiscal 2011 we expect a decline in sales for our Wireless Group, and comparable sales for our Space and Defense Group from our just completed Q1. 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 $0.23 to $0.28, using an anticipated tax rate of approximately 33% and accounting for approximately $0.06 per diluted 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 $0.29 to $0.35 for the Q2. We will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions.) And our first question comes from Mike Walkley of Canaccord Genuity.

Matt Ramsey – Canaccord Genuity

Good afternoon, Larry and George. Can you hear me? This is Matt Ramsey on for Mike Walkley today.

Larry Sala

Yes we can.

Matt Ramsey – Canaccord Genuity

Thanks, great. I would just like to start with a couple of questions from the Wireless segment, given your strong sales in the quarter can you comment a bit more on the demand for Xinger-III, specifically your visibility into the channel and demand for the next few quarters versus your supply capacity. And also could you give us a little bit more color on your initial AIR products with TI? Given the large potential customer base you’re now getting exposed to with TI, can you give a little comment on how the customer reaction has been so far? And do you still expect volumes at all in the second half of fiscal ‘11, or is it still mostly a 2012 phenomenon? And then I’ll follow up.

Larry Sala

Okay, well if I miss any one of those parts of your question please come back at me. As far as standard component Xinger demand, we saw as I said a robust demand throughout the quarter. Our demand’s been very broad, both for Xinger-II as well as Xinger-III. Interest and order rates for Xinger-III are exceeding our expectations and look like they will continue to for the foreseeable future. We’re keeping up with production but it’s certainly challenging given the strong order flow that we’ve seen and the strong reception to that product line.

We’ve completed recently calendar year 2011 supply agreements with some of our largest customers for standard component products and those forecasts are quite strong relative to 2010 levels, so that’s what’s driving our expectations of continued strong demand across our standard component product line.

From a guidance standpoint, we typically see orders slow down a bit as we get to the end of the calendar year, as people are trying to manage inventory. So it’s typically relatively unforecasted. The forecast remains strong but orders tend to weaken a bit as we get to the end of the quarter and then pick up strongly in the 1st of the year. So that’s what’s kind of driven our more conservative guidance relative to our Wireless business. As of last quarter, more than 90% of our Wireless shipments were driven by our standard component products.

From an AIR product line, we introduced our first six products or so last quarter, formally introduced them here in the Q1 of 2011. We’ve been sampling customers for probably four months, maybe a little bit longer. Sample rates have been high. We’ve sampled I think more than 100 customers already. The basic transceiver products there appears to be quite high interest in. We’re working exclusively with Texas Instruments, utilizing their devices and would expect over the next six to twelve months that the product line will expand to something between a dozen and probably 20 different modules with different functionality based on different TI transceiver chips as well as complementary amplifiers that they provide.

And we still do expect that we’ll see revenue generation in the second half of fiscal 2011, and I don’t think our expectations have changed dramatically. It’s a new adjustable market for us so we’re not as clear as to how rapid the design-in process will be and how quickly production will pick up. But the broad interest is still driving us to be quite confident that we’ll see revenue generation in the second half of ‘11 and you know, a meaningful revenue contribution in fiscal ‘12. So I think that covers the question.

Matt Ramsey – Canaccord Genuity

Great, that’s really helpful. One little more thing on AIR. Can you comment at all about the potential ASP for those devices? I mean could it be as high as $12 or $15?

Larry Sala

Yeah, you know, we’ve got it in distribution now so you can get pricing in the marketplace from our distribution partners. In low volume quantity the initial product line we have out there is a $10 to $12 product. In high volume obviously prices are more aggressive than that, but next generations of products will have significantly more functionality and higher associated prices. So these initial products are just basic transceivers; future products will have either low noise amplifier or power amplifier capabilities embedded in the module as well as embedded microcontrollers as well. And so with those added functionalities and features the products will be both physically a little larger as well as higher priced.

Matt Ramsey – Canaccord Genuity

Great, that’s really helpful. And I guess coming into the call my one question was when can we have a 40% gross margin quarter, so I guess my new question is, is this sustainable? I mean I know you’ve given guidance but I mean how should we look at the longer-term gross margin? Is it now in the really high 30’s or is as high as 40 sustainable?

Larry Sala

Well we gave guidance for next quarter up in this range, in the upper 30’s or low 40’s. Assuming a comparable sales mix we’re quite confident that these margins are sustainable. And that’s really a mix between Space and Defense and our Wireless business, because we really don’t see a significant mix shift possibility in our Wireless business since it’s really all standard component driven today, and our expectation is that will continue. So going forward, we had a, I would say a more than favorable mix of business in our Space and Defense Group as well, but in general we’re reasonably confident we can sustain margins in the upper 30’s now or low 40’s as long as we’re at this kind of level of overall volume.

Matt Ramsey – Canaccord Genuity

Great. Thanks very much, guys. Congratulations on the results.

Larry Sala

Thank you.

Operator

(Operator Instructions.) Our next question comes from the line of Stephen Zaconne at Needham.

Stephen Zaconne – Needham

Yes, thank you for taking my question. I’m calling on behalf of Rich Valera. If we could just get back to the weakness in the Wireless segment guidance going forward, were there any specific vendors or geographies where you guys are seeing weakness?

Larry Sala

No, in general we really haven’t seen a tremendous amount of weakness, but our history has been that as this quarter progresses, order call-offs and shipment deferments happen as people try to manage their balance sheets as we get to the end of the year. So I would say the forecast remains relatively robust; next year’s forecast looks quite strong. And overall orders have started to I’d say slow down a little bit over the pace that they were at in July, August, and early September, but in general there’s no dramatic downturn that we’ve seen or no concentration with any one geography or customer.

Stephen Zaconne – Needham

Okay, great. That’s really helpful color. And then to just talk about two programs you guys have mentioned before, if you could give us any idea of the potential revenue from the EQ-36 program and where it stands in its production ramp, and also the Iridium program?

Larry Sala

Sure. EQ-36 is really just getting going for us. We’ve had various fits and starts over the last couple of years as we built out prototype qualifications, limited production runs. We got our first production order, it was either last quarter or the quarter before and we’re just starting to ramp that up now. So I’d say on average EQ-36 has probably been a $4 million to $5 million a year kind of program for us, and we would expect as we progress over the next quarter or two that it starts to become a $10 million program for us. And we think it has potential to get to a $15 million kind of annual run rate if the order flow is as we’re currently seeing projections from our customer. So we should see that continue to transition and pick up over the next two quarters.

You also asked about the Iridium program. We did two assemblies; we have not been awarded any Iridium neck contracts yet. Both are subassemblies used in the antenna of the Iridium neck satellites. The first contract we would expect to be awarded within the next month or so. It’s a fairly substantial contract, something on the order of $20 million or more potentially. And we’re hopeful that we can capture that. If we do it’ll start immediately. It’s a fairly significant development, funded NRE development contract followed by multiple years of production. The second assembly we don’t expect to be awarded until probably late this calendar year or early next calendar year. It’s also a fairly substantial contract, not quite as big as the first assembly but still well in excess of $10 million.

So we feel like we’re in a relatively strong position given our relationship with (inaudible) on similar space jobs with similar types of requirements, as well as our heritage building these types of networks for the original Iridium constellation.

Stephen Zaconne – Needham

Great, thank you.

Larry Sala

Yep.

Operator

Thank you. (Operator Instructions.) And our next question comes from Chris McDonald of Kennedy Capital.

Chris McDonald – Kennedy Capital

Good afternoon, thanks for taking my question.

Larry Sala

Sure.

Chris McDonald – Kennedy Capital

If the R&D tax credit is passed, would that have a meaningful impact on the reported tax rate?

Joe Porcello

Well, (inaudible) impact. I mean obviously a big consideration is whether it’s approved retroactively or not. It has magnitude if it’s retroactive.

George Blanton

Yeah, it has maybe 3%, three percentage points, somewhere in that neighborhood. It’s not really significant at this point, not with the volume and the level of income.

Chris McDonald – Kennedy Capital

And that would be on a go forward basis?

George Blanton

On a go forward business; backward it’d be twice that in the first year, and it’d be a large lump in the quarter that it actually passed.

Chris McDonald – Kennedy Capital

Yeah, okay. Great. And then when the AIR product line ramps up, would you anticipate that ramp up to have a significant impact on the Wireless margin that we’re seeing today? I mean once you get up to a decent volume level?

Larry Sala

We would expect that in general AIR would be above our corporate margins. Obviously, currently our Wireless business in the last quarter had very strong operating margins given it was so driven by our standard component line, but it certainly would be a positive contributor to our average corporate margins. And you know, depending on whether it was driven by a high number of smaller volume customers or one or two large volume customers would drive the specific margins, and whether they’re above our current Wireless margins or at or below our current Wireless margins. But in general, we’ve positioned it as above our corporate average operating gross margins.

Chris McDonald – Kennedy Capital

Okay, great. Thank you very much.

Larry Sala

Sure.

Operator

Thank you. I show no further questions in the queue and would like to turn the conference back over to Mr. Larry Sala for closing remarks.

Larry Sala

Well, we greatly appreciate your participation and we look forward to speaking with you again next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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