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Anaren, Inc. (NASDAQ:ANEN)

F1Q2012 Earnings Conference Call

October 25, 2011, 08:30 a.m. ET

Executives

Larry Sala - President, Chairman and CEO

George Blanton - SVP and CFO

Analysts

Mike Walkley - Piper Jaffray

Rich Valera - Needham & Company

James Fonda - Sidoti and Company

Craig Rosenblum - MMI Investments

Chris McDonald

Operator

Good morning. My name is Kanesia, and I will be your conference operator today. At this time welcome everyone to the Anaren Incorporated Q1 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) As a reminder this call is being recorded today, October 25, 2011.

I’d like to turn the conference over to your host for today, Mr. Larry Sala. You may begin your conference.

Larry Sala

Thank you. Good morning and thank you for participating in the interim fiscal 2012 first quarter 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 quarter after which George will review the financial highlights and 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 filings and exhibits to those reports to learn more about the various risks and uncertainties facing our business and a potential impact on our net sales, earnings and our stock price.

Net sales for the first quarter were $38.7 million down 13% from the first quarter of last year. The decline in counter-IED related business and delays in approvals per shipments within the Space & Defense group more than offset an increase in sales of our wireless products.

Non-GAAP operating income for the quarter was $4.8 million or 12.5% of net sales down 37% from the first quarter of last year. Margins were negatively impacted by the overall decline in net sales as well as unfavorable mix of business within our Space & Defense group.

Wireless group net sales for the quarter were $18.2 million up 17% from the first quarter of last year despite the very strong demand for the first half of calendar 2011, demand for our wireless infrastructure products declined significantly in the second half of the first quarter and its projected to remain at these lower levels throughout the second quarter. Despite this current decline in demand, our customers are forecasting strong demand for calendar 2012. Based on the results of our recent purchasing negotiations for calendar 2012 production, we believe that we continue to retain high market share for our wireless infrastructure products and that our current dollar content in 4G applications is significantly higher than our content and prior generations of base station equipment.

During the quarter several new Anaren integrated radio or air modules were introduced and the number of air product design-ins continues to increase. In the second quarter, we are launching a significant joint marketing initiative at the AIR product line in partnership with Texas Instruments that we believe will greatly increase customer awareness at the AIR product line as well as the number of potential new design-ins.

Our new product and technology development efforts remain focused on expanding our wireless product portfolio. Customers that exceeded 10% of wireless group net sales for the quarter were E.G. Components, Huawei, Nokia and Richardson.

For the Space & Defense group, net sales for the quarter were $20.5 million down 29% from the first quarter of last year. The decline in net sales is driven largely by the decline in counter-IED and LTCC related business as well as delays in approval for shipments on to subsystem contracts. The decline in sales and unfavorable sales mix and operating performance issues negatively impacted the group’s profitability for the quarter.

We anticipate improved sales and margins for the group in the second half of fiscal 2012 due to the strong order backlog of more favorable sales mix and improved operating performance. Product and technology development initiatives for the group remained focused on expanding the RAD-hard hybrid electronic module product lines for space applications and advancing our advancing our RF manifold and integrated microwave technology for defense applications.

New orders for the quarter were $25 million and were driven largely by radar and satellite applications. In addition, the group renewed its five-year supply agreement for Passive Ranging Subsystem or our PRSS which is deployed on numerous air-borne applications.

So, the defense market it has been slow, the opportunity environment for space applications remains robust. Space & Defense order backlog at September 30th, 2011 was $95 million. Customers has generated greater than 10% of Space & Defense net sales for the quarter were Lockheed Martin, Northrop and Raytheon. George?

George Blanton

The highlights for the first quarter income statement and balance sheet as of September 30, 2011 are presented on a non-GAAP basis. These non-GAAP measures are each adjusted from GAAP results and to exclude certain non-cash items including equity based compensation and intangible amortization. The presentation of this additional information should not be considered in isolation or the 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 14.8 million or 38.1% for the current quarter compared to 17.8 million or 40.1% for the first quarter of last year. Gross profit as a percent of sales decreased by 200 basis points compared to the first quarter of last year due to significantly lower sales volume and less favorable Space & Defense sales mix including lower margin startup program and lower yields at our circuit board facility.

Wireless gross margins improved as the mix for wireless products shifted to over 85% for standard components. We expect non-GAAP gross margins to be between 32 and 36% for the second quarter of fiscal 2012 due to lower sales volumes and a less favorable product mix.

Investment in research and development was 10.1% of net sales in the first quarter compared to 8.6% of net sales for the first quarter of last year driven by the decline in sales. The total actual R&D dollars spent in the first quarter were comparable to the first quarter of last year. New Space & Defense group programs are anticipated to generate 10 million in funded engineering revenue over the next 9 months which should result in a reduction in the Space & Defense group, R&D spending in the second half of the fiscal year. R&D efforts are supporting wireless standard component product development as well as a number of projects in Space & Defense group.

Non-GAAP operating income was 12.5% of net sales for the first quarter down 450 basis points from 17% in the first quarter of 2011. The decrease was the result of a lower overall sales volume and lower gross margins in the Space & Defense group which were partially offset by a higher percentage of wireless sales at higher gross margins.

Operating expenses were 500,000 lower in the quarter. Interest expense for the first quarter of fiscal 2011 was 80,000 compared to 184,000 in the first quarter of last year. We expect interest expense for the second quarter to be approximately 80,000.

Non-GAAP net income was 8.6% of net sales or $0.23 per diluted share for the first quarter of 2012 compared to 11.2% of net sales or 35% per diluted share for the first quarter of last year. The effective income tax rate for the first quarter of fiscal 2012 was 30.7%. This compares to a tax rate of 32.8% for the first quarter of last year. The projected effective tax rate for 2012 absent one-time event was expected to be approximately 31%.

Balance sheet highlights include cash provided by operations was 5.3 million for the quarter. Capital expenditures were 2 million in the quarter. The company used 10 million in a quarter to pay down debt. We currently have 20 million outstanding on our revolver.

Cash, cash equivalents and investments were approximately 75 million as of September 30th, 2011 down 5.7 million from 81 million at June 30th, 2011. The company repurchased 118,000 shares of its common stock in the first quarter; they were approximately 1.13 million shares remaining under the current or repurchased authorization as of September 30th, 2011.

The accounts receivable were 26 million at September 30th, 2011 down 5 million from June 30th, 2011. Days sales outstanding was 62 days up 2 days from the last year. Inventories were 36 million at quarter end up 3 million compared to last quarter, the increase was due to higher wireless group stocking levels as well as increased inventory from shipments that were delayed by approvals and increased inventory for long-term satellite programs in the Space & Defense group. Larry.

Larry Sala

Thanks George. For the second quarter of fiscal 2012, we anticipate a decline in sales for the wireless group and an increase in sales for the Space & Defense group compared to our first quarter levels. As a result we expect net sales to be in the range of 35 to $40 million. We expect GAAP net earnings per diluted share to be in the range of $0.03 to $0.07 using an anticipated tax rate of approximately 31% an inclusive of approximately $0.05 per share related to expected equity based compensation expense and amortization of intangibles. Non-GAAP net earnings per diluted share are expected to be in the range of $0.08 to $0.12 for the second quarter.

We will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mike Walkley [Piper Jaffray].

Mike Walkley - Piper Jaffray

Larry, just touching on your wireless business, there is some short-term delays that appear that some LTE projects in North America which Space & Defense are sequentially that your wireless guidance implied maybe down 15 to 20% sequentially, just trying to get a better color of your guidance between the two divisions?

Larry Sala

No, it's more substantial in that Mike. We are looking at our wireless business being down sequentially something on the order of about $6 million which is 30, 35% I won’t do the math, its top of my head and it’s something like 35% sequentially.

Mike Walkley - Piper Jaffray

Okay, great. That’s helpful. So, that explains the lower gross margin guidance given the mix change there. Larry maybe you can just help us little bit then in terms of the robust orders you have for 2012. Can you give us any color on to how to size that up, could we see wireless return maybe to that 20 million quarterly run rate next year?

Larry Sala

Certainly, from everything we see currently. 2012 demand versus 2011 demand looks to be up as much as 15% or more year-over-year, even given price reductions and negotiations we have had. Our estimate for the second half of the year is our wireless business will be running in those high teens probably not quite 20 million but close to that assuming these forecasts don’t change.

Mike Walkley - Piper Jaffray

Okay. Thanks. And then it sounds like a good co-marketing agreement coming up with Texas Instruments, can you give us add some color on AIR momentum and how we should maybe think about the size of this business in the fiscal ’13 timeframe.

Larry Sala

We continue to see very broad demand for the AIR product, we certainly have seen increasing support and interest from TI, through activities like these marketing initiatives where they are making a fairly substantial investment to get the AIR product line in front of large number of their customers. So, nothing has really changed from an opportunity and revenue projection standpoint, we are still hopeful it will be several million dollar product line in our fiscal 2013. We still expect late this quarter early next quarter we will start to see some meaningful customers transitioning to production. So, I’d say engagement wise we will continue to see a good growth in the number of what we define as design-ins, people who have designed our product into their application, that number today is probably pushing 50 up from 25 or 30 last quarter. So, we continue to see good momentum. Timing is always hard to project as far as when customers will transition to production, but our expectations of the overall opportunity for AIR remain the same as they have been for the last several quarters.

Mike Walkley - Piper Jaffray

George, just on the margins, assuming the wireless business gets back to the high teens. Any reasons why the margins wouldn’t recover to maybe the levels they were in the past couple of quarters on the gross margin side?

George Blanton

No, not really any reason we do have a stronger second half for the Space & Defense group and we think if wireless stands out like Larry said that will be similar to last year's levels.

Mike Walkley - Piper Jaffray

Just on Space & Defense, I think you had indicated before some lumpiness, but it sounds like a stronger back half of the year that still Q3 maybe down a little bit in Q4 or is it now the back half of the year stronger than the first half just given some of the delays you talked about?

George Blanton

I think we will continue, everything we can see now will continue to see sequential quarterly growth from here forward in our Space & Defense group. So, some of the things that we were concerned about booking, we were successful in booking in the first quarter, we continue to see, I could say a stronger than expected environment on the space side, still concern that some programs could get delayed on the defense side from what we are planning, but our expectations are we should see sequential growth throughout the rest of the year in our Space & Defense business.

Operator

Your next question comes from Rich Valera [Needham & Company].

Rich Valera - Needham & Company

Larry with respect to the Space & Defense business last quarter, I think you talked about that maybe being down about 5 to 10% in the current fiscal year. Has that number changed with some of the push-outs?

Larry Sala

We would say probably ore 10% than 5%, but it hasn’t changed dramatically. No, we had some revenues shift into the second half of the year that was always in the first. We need a couple of contract to happen over the next few months to solidify that very end of the year, but in general we can say that hasn’t changed significantly from what we were expecting.

Rich Valera - Needham & Company

And you mentioned (inaudible) some orders that you were hoping to get within the first quarter. Can you give us any color on what you received?

Larry Sala

We had some significant booking on the space side, GPS 3 as well as the Orion, the space exploration vehicle are two very significant orders between the two book more than $7 million in the first quarter. So, those were orders that we knew were out there, it was just very difficult to identify the timing of and should have a positive impact on the second half of the year for us.

Rich Valera - Needham & Company

That’s helpful. And then with respect to wireless demand, just wondering if you can give us any more color on, first of all what’s causing a fairly significant pause here, and what gives you the confidence it's coming back. Are there any indications from any of our customers suggesting when things might rebound, any color on that demand picture would be real helpful?

Larry Sala

Most of our end market demand is coming through analysts who likes to serves our customers, and we don’t have a lot of direct touch obviously to service providers. From what we can see, things seem stronger in China than they do in a rest of the world right now as far as demand through our customers that we can see. From a near-term expectations standpoint we can see our customers have relatively high inventory relative to their consumption rate. So, order will have remained very soft since the middle of July. So, that’s driving our expectations for the current quarter. As products being picking up in the second half of the year, from one, we look at our customers forecast for the March quarter and our bigger customer are forecasting their consumption to increase by more than 50% over their current rate of consumption. So, we get this updated near-term forecast, those forecasts are typically updated pretty much every week. They can change quickly, but they have been fairly consistent where a big pickup in the March. And then we just finalized negotiations with several of our largest customers and the rest were fairly long through that process already for 2012 demand versus what we supplied in 2011. And those negotiations results are implying that our overall sales for 2012 versus what we will have shipped by the end of 2011 should be up more than 15% from what we supplied this year. So, those are the data points we have, we continue to pull our distribution partners, our field sales folks and what customer context we can gain. But that’s pretty much what drives our view.

Rich Valera - Needham & Company

And then I know you had issues that Unicircuit that I think contributed to the issues just reported quarter. Can you give us an update on where things stand at Unicircuit?

Larry Sala

Sure, the biggest challenges we had there are really driven more by mix. We have been driving all of our new product development for our Space & Defense programs through Unicircuit. So, if we look at the activities that we run that facility last quarter and we will continue to this quarter. Is the (inaudible) next development work we are doing to secure communication satellite next generation development work we are doing and AMDR which is the next generation ship long radar. Those are three very complex next generation programs that are significant to our Space & Defense group there. With very critical delivery between now and the end of the calendar year in order to either retire significant risk of the development side or meet milestones on programs like AMDR for our significant customers. So, we have gone from being a fairly benign 10, 15% of Unicircuit’s demand overall to being more than 30% of their current demand. A very highly complex work on very short schedule timeframes. So, that mix has really distracted a significant portion of their process engineering talent and their senior management talent execute on this critical programs. So, we have got other resources that we deploy there in the last couple of months from our Syracuse operations to help offset the impact of this focus on our internal meetings. And a significant percentage of that work will diminish at the end of the calendar year when we make some of these other critical deliveries. So, our expectations are, we can drive improved mix throughout the rest of the calendar year here and that significant percentage of the problem should be alleviated as move into our third quarter.

Rich Valera - Needham & Company

Great. Maybe just on the operating expense, first on the short-term George, is there much expected ramp in SG&A for this AIR marketing program you talked about an how long would you expect that to go on for if there is. And then can you give us any feel for, you mentioned that in the prepared remarks you thought that R&D what expenses what actually dropped in the second half, if you could give us any more color on that, that would be helpful too. Thanks.

George Blanton

Sure. We plan to have roughly the same marketing expense for the AIR development and sales efforts that we need. We are in a position and we think we are staffed adequately, so that should remain fairly constant. We think our operating expenses will be fairly constant in Q2 and probably throughout the rest of the year for the most part. So, we don’t see any significant changes there. And I guess the R&D portion, we are certainly going to reevaluate R&D as we have said at the end of the first half and see where we are with AIR and make some decisions then. But I guess sequentially we have had a reduction in R&D in total spending and I think that number has gotten down by significant amount 5 or $600,000 sequentially. So, we’ve had significant reduction, that’s our engineers and Space & Defense transitioning on some of these non-recurring engineering jobs, which by the way are going quite well right now. We have passed through critical milestones with our two largest jobs. So, that’s gone quite well. So, I’d expect the R&D to stay at these levels or decline somewhat for the next quarter or two.

Operator

The next question comes from (inaudible).

Unidentified Analyst

Larry, you talked about delays in the couple of projects on the Space & Defense side, can you be a little bit more specific on those?

Larry Sala

Yes, can speak specific programs, but we have a couple of longer running significant revenue driving programs for us, where we had some specification non-conformancies and so we go to our customers and we have done this fairly regularly. And we request either waivers for requirements or we propose reworking or changing specifications and our customer has to make a decision of whether they want to rework a device or provide us specification waiver or agree to change in the specification requirement. And last quarter we have some of that are still challenging this quarter, our customer has elected to give waivers but didn’t supply those waivers and time for us to be able to meet our shipment requirements for the quarter. So, we have been negotiating some of these things for the last several months. We are still in the process of finalizing some of these agreements. We expect that will be in place before the end of this quarter and we should have this issues resolved and moving forward. But they could have some impact late this quarter we are not able to get these negotiations finalized. So, I wouldn’t say it's typical in this business but it's relatively common just for us it impacted too fairly large programs.

Unidentified Analyst

Okay. And you said that you do have a path forward on those now?

Larry Sala

Yes, we absolutely have a path forward, we have been working with both of these customers. One is actually relatively resolved, the other one we have a path forward it's just big companies with lots of people in the signature loop and it can take a month to get a document signed.

Unidentified Analyst

Great. Okay. And the secondly, are there any major pursuits that are likely to be signed between now and the end of the fiscal year that we should be keeping our eye on?

Larry Sala

In terms of programs we are pursuing?

Unidentified Analyst

Yes, exactly.

Larry Sala

We are expecting material contract for EQ-36 in the third quarter. So, our customer we would expect we will be finalizing their contract this quarter and we would be receiving our next. We have booked some significant ballistic missile defense business, we are hopeful and expecting that continues. And there is a big classified space program we would hope to book in the next quarter or so which would be large enough for us to disclose as a separate contract. Typically, we will disclose contracts over $5 million when they are booked. Those are the only things that jumped to mind. It's probably others.

Operator

Your next question comes from James Fonda [Sidoti and Company].

James Fonda - Sidoti and Company

I just had a question on what your use of the cash is going forward, do you plan to keep it on the books or buy back any stock or what’s further?

Larry Sala

We haven’t authorized buy back and certainly we have been actively repurchasing our shares over the years. So, it's always something that we’d consider. We also continue to look at acquisition opportunities primarily in our Space & Defense group for broadening our technology base in order to grow. So, I think primary use would be our acquisitions and opportunities to grow but also repurchasing our shares.

James Fonda - Sidoti and Company

And where is the margin is better, are they better on the wireless side or the Space & Defense side?

Larry Sala

For the last year, since our wireless business has been predominantly focused in standard components, our wireless operating margins have been anything from 5 to 10 points higher than our Space & Defense business.

Operator

Your next question comes from Jerome Lande [MMI Investments].

Craig Rosenblum - MMI Investments

Hi, it's actually Craig Rosenblum from MMI here for Jerome. So, just on the wireless demand environment, are you seeing weakness across the board or is it focused on specific customers. How pervasive is the environment?

Larry Sala

We see it absolutely across the board, so we are seeing weakness from every customer and every geography. Today it's been a little less concentrated in China, we have got customers in China, then our customers in Europe, but it’s definitely weak across the board.

Craig Rosenblum - MMI Investments

Okay. And you are comfortable there is no competitive or market share issues going on.

Larry Sala

Yes, as I said in the last three weeks we have finalized negotiations with two of our larger customer and we don’t believe that we lost any meaning share. I mean those negotiations and with our customers telling us exactly how much allocation we are going to get of every art number that we supply to them. And based on the results this year comparing to any prior year we really haven’t lost any meaningful market share that we are aware of. So, yes we feel as good about that as we probably ever could.

Craig Rosenblum - MMI Investments

Okay. That’s helpful. And then I just wanted to clarify at that point, when you said you finalized negotiations several of your large customers for 2012 demand. And I think I heard you say, it's slightly to be up 15%, I wasn’t clear was that the volume or is that the revenue taking into account price decline.

Larry Sala

That’s revenue taking into account price decline versus what we would expect our total sales to be by end of this year. So, we look at what we are forecasting to ship this quarter. Total dollar sales next year versus 2011 look to be up 15% or more.

Operator

The next question comes from Chris McDonald.

Chris McDonald

The couple of programs were you needed to get the waivers in order to ship. Can you just give us the revenue associated with those programs that was expected is now fit out into the December quarter.

George Blanton

Yes, generally it's about $2 million between the two.

Chris McDonald

Okay. And just from a margin perspective, I mean clearly there was a thick variable leverage component with defense sales being so low in the quarter. Can you just maybe walk through the margin progression in defense and where we kind of how you see that shaking out overtime, it may be getting back to the low double-digit. Is that going to be more challenging in the intermediate term, just walk through the thought process in general on how defense margin are to trend here in the near to intermediate term.

George Blanton

Yes, Chris, the declines in margin in Q4 because of the end of the IED business which was favorable and we filled in with some other business that was less favorable. In Q1 we saw decline in volume which did impact the margins. And we had a mix of business that was less favorable than the IED business and we had our challenges that our circuit board facility that impacted our margins also. In this the forward-looking Q2, we still see a less favorable mix of business and volumes that aren’t adequate to support higher margins, but we do think that in the second half of the year the margins will be in the mid to upper 30s as we return to higher levels and better product mix in that part of the year.

Chris McDonald

In the mid to upper 30s George, help me work that down to an EBIT run rate, that gets you close to the double-digit EBIT, we have seen the company do over the years, right.

George Blanton

Yes, correct, yes we think we will be closer to what we saw last fiscal year and the second half of the year.

Chris McDonald

So, we see that in Space & Defense, if I think through wireless and the type of growth that you think getting back to upper teens type revenue run rates and second half of fiscal ’12. I mean that’s the wireless performance that we see north of 20% EBIT margin that segment. Is there anything that would make you think that’s too aggressive when you think about later in the year trending towards that 20% plus type EBIT margin to wireless?

George Blanton

No, not at all. It's strictly driven by volume at this point. We feel that we are doing our work to reduce cost where we can and like Larry said we finalized some contract negotiations so that would lock that and with the volume increasing we would obviously see some good leverage with the wireless product.

Chris McDonald

And it sounds like the bulk of the Unicircuit related issues are likely to be naturally resolved just by the inclusion of some of the heavy duty development work that’s going on. Is that fair there are other more Unicircuit specific execution issues that are still question marks at this point.

Larry Sala

Yes, there is some execution issues as well. I’d say more of its driven by the challenging work we put in and the abstraction of their resources than issues, but I think there is some contribution from both. So, as I said we got a team of folks out there full time for the rest of the calendar year focused mainly on execution issues, driving our expectation that we should see some material improvement by the third quarter.

Operator

There are no further questions at this time.

Larry Sala

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

Operator

This concludes today’s conference call, you may now disconnect.

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