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Anaren Inc. (NASDAQ:ANEN)

F2Q 2012 (Qtr End 12/31/2011) Earnings Call

January 26, 2012 8:30 am ET


Larry Sala - Chairman, President and CEO

George Blanton - CFO

Joe Porcello - VP of Accounting


Matt Ramsey - Canaccord Genuity

Rich Valera - Needham & Company

Chris McDonald - Kennedy Capital


Good day, ladies and gentlemen, and welcome to Anaren's second quarter earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Mr. Larry Sala.

Larry Sala

Thank you. Good morning and thank you for participating in the interim fiscal 2012 second quarter conference call. I'm joined again today by George Blanton, our CFO; and by Joe Porcello, our Vice President of Accounting.

I'll provide a brief overview of the results for 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're encouraged to review our SEC filings and exhibits to those reports to learn more about the various risks and uncertainties facing our business and their potential impact on our net sales, our earnings and our stock price.

Net sales for the second quarter were $35.7 million, down 18% from the second quarter of last year. The decline in sales for the quarter was due to the significant decline in demand for wireless infrastructure products as well as the decline in counter-IED related business within the space of Defense Group.

Non-GAAP operating income for the quarter was $2.7 million or 7.5% of net sales, down 61% from the second quarter of last year. Margins were negatively impacted by the overall decline in net sales and a less favorable business mix. But we believe that demand from wireless infrastructure customers will begin to increase.

In our fourth quarter, we have taken actions to significantly reduce our operating cost, improve our operating performance at these current business levels. We'll continue to monitor the wireless infrastructure market conditions and adjust our business model accordingly.

Wireless Group net sales for the quarter were $10.8 million, down 31% from the second quarter of last year. Despite the very strong demand for the first half of calendar 2011, demand from wireless infrastructure customers has declined significantly and is projected to remain at these low levels throughout the fiscal third quarter.

We're also transitioning to a vendor-managed inventory arrangement with our largest wireless customer, Ericsson, in the third quarter, which will have a negative one-time impact on our net sales for the quarter.

Our customers continue to forecast strong demand for all of calendar 2012, and we currently believe that demand will begin increasing in our fiscal fourth quarter.

During the second quarter, several new Anaren Integrated Radio or AIR modules were introduced, and the number of AIR product designs continues to increase. Also in the quarter, we launched the AIR BoosterPack development kit, which is promoted and sold through Texas Instruments and enables potential AIR customers to efficiently and cost effectively evaluate the AIR module performance in their specific applications. We believe that nearly 1,000 AIR BoosterPacks have been sold to date.

New product and technology development efforts may focus on expanding our wireless product portfolio and completing the development of our AIR-related software tools.

Customers that exceeded 10% of Wireless Group net sales for the quarter were EG Components who we sell through to Ericsson, Huawei and Nokia.

For the Space & Defense Group, net sales for the quarter were $24.9 million, down 10% from the second quarter of last year. The decline in net sales was due to largely by the decline in counter-IED related business.

Net sales for the Space & Defense Group improved from first quarter levels as operational and customer issues that negatively impacted deliveries in the first quarter were resolved in the second quarter. Profitability for the Group also improved from first quarter levels as a result of the increase in net sales and more favorable business mix and improved operating performance.

New orders for the quarter were $26.4 million and were driven largely by radar Passive Ranging and satellite applications. We're benefiting from the increase in global demand for ballistic missile defense radars and for satellite-based applications.

Product and technology development initiatives for the Group remain focused on expanding our RAD-hard hybrid electronic module product lines for space applications and advancing our RF manifold in integrated microwave assembly technology for defense applications.

Our Space & Defense order backlog at December 31, 2011, was $96 million. Customers that generated greater than 10% of the Space & Defense Group net sales for the quarter were Lockheed Martin, Northrop Grumman and Raytheon.


George Blanton

Highlights for the second quarter income statement and balance sheet at December 31, 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 as a substitute for results prepared in accordance with accounting principles generally accepted in the United States. Please refer to our Q2 earnings release for a reconciliation of GAAP and non-GAAP measures.

Non-GAAP gross margin was $11.6 million or 32.4% for the current quarter compared to $16.5 million or 38% for the second quarter of last year. Gross profit as a percent of sales decreased by 560 basis points compared to the second quarter of last year due to significantly lower sales volume which resulted in non-favorable overhead absorption for the quarter and a less favorable Space & Defense sales product mix.

The company took significant actions to reduce costs in the quarter, including manpower and operating expenditures. We expect company non-GAAP gross margins to be between 30% and 34% for the third quarter of fiscal 2012, due to the expected lower level of sales and a less favorable product mix.

Investment in research and development was 8.7% of net sales in the second quarter compared to 8.1% of net sales from the second quarter of last year. Total R&D expenditures for the second quarter totaled $3.1 million compared to $3.5 million for the second quarter of fiscal 2011.

The lower spending levels were due to a reduction in engineering personnel as a result of reduced design requirement and reassignment of a number of employees to funded non-recurring work for Space & Defense development efforts.

New Space & Defense Group programs are anticipated to generate $11 million in funded engineering revenue over the next 12 months, which should continue to drive comparable levels of Space & Defense Group R&D spending on the second half of the fiscal year. Overall, we expect R&D spending in the second half of the fiscal year to be lower than the first half.

Non-GAAP operating income was 7.5% of net sales for the second quarter of fiscal 2012, down 840 basis points from 15.9% in the second quarter of fiscal 2011. The decrease was the result of lower overall sales in both the wireless and Space & Defense segment and a less favorable mix of business.

Operating expenses in the quarter were $800,000 lower than in the current quarter compared to the second quarter of fiscal 2011, as a result of the company's cost reduction efforts. The company took action in the first half of fiscal 2012 at several operating locations, reducing personnel and operating expense to improve profitability at the current lower sales level. To date personnel levels have been reduced to approximately 15%, resulting in an annual payroll reduction of approximately $5 million, including benefit cost from the July 2011 levels.

Interest expense for the second quarter of fiscal 2012 was $53,000 compared to $105,000 for the second quarter of last year. The company repaid the remaining $20 million due on its revolving credit facility and currently has no outstanding balance under the credit line. No interest expense is anticipated in the third quarter other than unused line fees.

Non-GAAP net income was 5.6% of net sales or $0.13 per diluted share for the second quarter of fiscal 2012 compared to 12.7% of net sales or $0.38 per share for the second quarter of last year. The effective income tax rate for the second quarter of fiscal '12 was 21.4%. This compares to a tax rate of 17% for the second quarter of last year, which was caused by the reinstatement of the federal research and experimentation credit retroactive to January 1, 2010. The projected effective tax rate for fiscal 2012 absent one-time event is expected to be approximately 28.5%.

Balance sheet highlights include cash provided by operations was $2.5 million in the second quarter. Capital expenditures were $2.4 million in the quarter. Cash, cash equivalents and investments were approximately $53 million as of December 31, down $28 million from $81 million at June 30, 2011. The company repurchased 256,000 shares of its common stock in the second quarter. There were approximately 880,000 shares remaining under the current or repurchased authorization as of December 31, 2011.

Accounts receivable were $27 million at December 31, 2011, down $4 million from June 30, 2011. Day sales outstanding was 71 days, up 9 days from last year. The accounts receivable includes over $4 million of unbilled receivables related to non-recurring engineering projects that are using percentage-of-completion accounting methods. The unbilled receivables will be reduced significantly by the end of our fiscal year. Day sales outstanding excluding the unbilled receivables was 60 days as of December 31, 2012.

Inventories were $37 million at quarter end, up $1 million compared to last quarter. The increase was due to additional inventory for long lead satellite programs in the Space & Defense Group. Larry.

Larry Sala

For the third quarter of fiscal 2012, we anticipate comparable sales for both the Wireless Group and the Space & Defense Group compared to our second quarter levels. As a result, we expect net sales to be in the range of $34 million to $39 million.

We expect GAAP net earnings per diluted share to be in the range of $0.06 to $0.10 using an anticipated tax rate of 28.5%, 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 $0.11 to $0.15 for the third quarter.

We'll now take questions.

Question-and-Answer Session


(Operator Instructions) Our first question is from Matt Ramsey with Canaccord Genuity.

Matt Ramsey - Canaccord Genuity

Larry, a couple of questions for you first. I wondered if you could talk a little bit more about the unfavorable mix you talked about in Space & Defense. And maybe give some more color into margin differences, profitability differences between those two businesses?

Larry Sala

Well, we've had obviously a significant shift between our Wireless Group sales and Space & Defense Group sales due to the sharp decline that we've seen in sales of Wireless shipment products. Those two groups historically have had probably 10 points of difference in margins, historically. So we've had this overall negative mix generally in business.

And the Space & Defense group, we've gone from couple of high production volume job, like our counter-IED business, and some jamming subsystem business that we've had to some startup activities with projects, reinitiating our ballistic missile defense radar production again.

And so that project is just getting back up to kind of production volumes and profitability should improve as the year progress this year. But replacing those high volume production jobs with development work and to startup a production on ballistic missile defense radar work has negatively impacted the margins in general for our Space & Defense group as well. Those things should improve as we get into the third quarter and fourth quarter here.

Matt Ramsey - Canaccord Genuity

And obviously, you talked about in your prepared comments that kind of dynamics and the recovery of the wireless business and your visibility into that for your fiscal fourth quarter. The use on the re-ramp of that business change it all post Ericsson's disastrous results yesterday and Nokia's guidance for losses in the same business for the first half of next year?

Larry Sala

Like I said, we're only expecting that things start to pick up in the fourth quarter. We're not expecting some significant transformation in the fourth quarter. We get weekly forecast from all these customers, those weekly forecast for the last probably a month or more and then fairly consistent. And that sometime in the late spring we should start to see demand increasing. We should also see just the general increase in demand from working off inventory that's in the channel. So that works it way through this quarter, is well.

So even if we didn't see a significant end market demand pickup we should see a pickup just from working through inventory in the channel and seeing more real time end market demand again by our fourth quarter.

Matt Ramsey - Canaccord Genuity

And a couple for George, real quick. You guys talked about on the call George, your gross margin basically being down big in the quarter, most of which was due to lower fix cost leverage on the wireless business. I think that's a true statement. And today's I guess it will be around for a while but were there any dynamics in the gross margin other than mix in that, maybe pricing pressure or new dynamics that you guys didn't point on the call. So just trying to get an idea about how we should model that gross margin expansion as your wireless business recovers?

George Blanton

Right, obviously we had some absorption issues because of the lower volume levels and that partially it had affected wireless but it also affect Space & Defense, because we share our facility with one of our larger production facility. We also had an adjustment based on our year end inventory levels, with our largest customer where we made a pricing adjustment for inventory at that customer. And we had to adjust based on newer pricing levels which was a couple of hundred thousand dollars of impact to us from an expense standpoint. So that's also included.

So we think that that adjustment will approximate any kind of price adjustments going forward. So we think we've really got the price adjustment quarter early as a result of higher inventory levels in the chain.

Matt Ramsey - Canaccord Genuity

Year before you talked about on your prepared comment that the significantly lower OpEx when you have adjusted the cost structure of the business to the new revenue run rate. How much of the cost that you guys took out of the business in the quarter, it's going to be permanent versus temporary. And would that be something that we should look at as a new run rate. And where should the new run rate be for potential leverage in fiscal '13 as your wireless sales rebound?

George Blanton

I think that we would say that a portion of savings were achieved in the second quarter. Some of the reductions in force were done in the second quarter, a good portion. In fact, since the beginning of the fiscal year, we reduced the work force, as I said, about 15%. And we think that we do have a deduction in compensation from a bonus accrual standpoint which most likely will be a run rate through the end of the fiscal year. So those would be the things that would be going forward. We would see some margin improvement as a result of the reductions that took place. Some of the reductions just offset some of the loss in the lower volume levels too.

Larry Sala

$0.5 million of savings in the quarter was temporary with return in future fiscal years as the potential to achieve our bonus targets returns.


(Operator Instructions) Our next question is from Rich Valera with Needham & Company.

Rich Valera - Needham & Company

Larry, in previous calls, you have talked about your OEM customers looking for growth I guess in calendar '12 versus calendar '11. And at one point, I think you talked about fairly meaningful growth. Can you give us an update on where their forecasts stand right now relative to calendar '11?

Larry Sala

Yes, forecast still remained strong. I'd say they've come back a bit since we started negotiations in the fall. But still with the price reductions that we offered for the year, we're still looking at annual sales in '12 being equal to or slightly above they were annually in our calendar 2011. So calendar year to calendar year, the volume is still up reasonably. With the price reductions that we've provided, we are still looking comparable year-over-year dollars or some dollar growth.

Rich Valera - Needham & Company

So just doing kind of simple math there, I mean if you were to be sequentially flat in the March quarter, I think the balance of the year that the remaining three quarters would have to be kind of in the high-teens millions, which is obviously a pretty significant jump from where you were now. So just wondering from where you sit now. Is there any sense if that seems reasonable or likely?

Larry Sala

It's difficult to say. Obviously, we are adjusting our business model with caution and that doesn't happen, and we don't get back to those kind of levels as quickly as they're forecasting or as aggressively as they're forecasting in the second half of the year. But we really don't have any other visibility to say.

Certainly we see forecast of the change in business mix being advantageous to us where we continue to gain higher dollar content across our OEM customer base. So as these 4G systems start to increase as a percentage of our customer sales, that should have a bigger impact on our revenue potential since we have higher dollar content in those systems.

So that transition, not only overall demand, but the pace of that transition will have a meaningful impact on how fast our sales ramp back up again.

Rich Valera - Needham & Company

And then you mentioned a one-time hit in the quarter from a change in how you manage the inventory of largest customer. Can you give us a sense of the magnitude of that impact?

Larry Sala

Yes, something near about $1 million. It's going to depend on how fast they consume existing inventory that's in the channel. So we were selling through our third-party distributors. Our third-party distributors sometime late in the quarter were transitioning to holding our inventory at Ericsson's designated distribution partner. And we won't recognize sales until Ericsson actually pulls product out of that channel.

So we go from selling-in to selling-out of the distribution channel. Our estimate is something like $1 million and $1.5 million. It may too get pushed out in time a month or two, but we think it's most likely to happen late this quarter.

Rich Valera - Needham & Company

And just wondered do you have any sense of where things stand on a regional basis demand-wise, sort of what areas might be stronger or weaker than others?

Larry Sala

All we're doing is repeating what we're hearing. We used to have a high percentage of custom products. We should ship then to the geographies where they were being consumed, and we have better visibility. But with just our standard component products, virtually everything we sell those to someone in Asia, that's a contract manufacturer or agent-based manufacturing location for one of our customers. We really don't have a great feel for end market consumption.

We will say the customers we deal directly with like Huawei and others seems to be more stable. And so we would say in general, China has been stronger than the rest of the world has been through the last quarter. It looks like it will continue to be this quarter. But beyond that, we just don't have enough visibility to give a lot of detail.

Rich Valera - Needham & Company

And then on Space & Defense, we saw a nice sequential pickup there. Just wondering how you think about the second half of the fiscal year. And I think at one point, we had thought about that business in aggregate being down, around 10% for all of fiscal '12. Does that still seem like a reasonable number or is that maybe ambitious at this point?

Larry Sala

It might be a little ambitious. Our feeling though is that we're going to be in this relative run rate for the foreseeable future. We think for the remainder of this year, likely the majority or all of next year, we're going to be somewhere in this $100 million to $105 million or $110 million run rate. So somewhere in the $25 million to $27 million or $28 million quarterly run rate looks very sustainable to us, given the backlog that we have and the visibility we have of programs that we participate on.

Rich Valera - Needham & Company

Are there any programs that you've seen any material changes in? I think we had thought there might be some that would be ramping and maybe bump up that level a little in the second half of the fiscal year. Have there been some puts and takes there?

Larry Sala

I guess on the positive side, we signed a five-year supply agreement on our PRSS technology with Lockheed Martin, our customer. And they've had a lot of success in foreign sales of that system over the last several months. And so our expectations are that that will run at a higher rate than what we were expecting likely for the next five years. So that looks like it will be several million dollars a year, stronger than what we're forecasting.

We also last month saw the announcement of the UAE purchasing ballistic missile defense radars from the U.S. and we have fairly substantial content in those systems, and U.S. government procured two systems at the same time. So that will increase our ballistic missile defense radar production to likely a couple of systems a year as oppose to one system a year or less run rate we were at. That's a $3 million or $4 million positive impact for us going forward.

And then we've seen good strong demand on the space side in general of the business. We're still waiting to see what happens here with the EQ-36 program and our customers negotiating that contract right now, we expect to have clarity in the next month or so, so we know the exact volume this year.

And it's really the future of that program that's probably the biggest swinger for us. And our expectations were, we would be at 20 to 30 system a year run rate by now. And we're looking at it more like a 10 to 15 system run rate based on what we expect this year's purchase to be. So if that system continues to increase in rates of production over the next couple of years, that's probably the biggest positive catalyst we see in the business right now.

Rich Valera - Needham & Company

And finally it's for George, just wanted to try to get a sense of what we should think up for the ongoing OpEx level. It sounds like you didn't get the full impact of all your cost reductions in this current quarter, which one would think might imply a lower run rate on an ongoing basis ex any significant rebound in demand. I just wanted to know how we should think about that going forward George?

George Blanton

Yes, we made some reduction of which some were apparent in the quarter. And we think there will be some further reductions in terms of OpEx. We've reduced our R&D spending significantly since the end of the fiscal year and it's down maybe $800,000 since last quarter, so we've made some adjustments there. We think there maybe $300,000 less OpEx next quarter versus this quarter. And that probably will be the rate for the final quarter of the year.


Our next question is from Chris McDonald with Kennedy Capital.

Chris McDonald - Kennedy Capital

One more follow up relative to the cost reduction action, just going to ask in a different way. So the $5 million run rate that's been taken out, can you just split that by what's in the fixed cost area versus what's variable. I think, Larry, you mentioned that maybe $0.5 million in quarter related to bonus that could come back. Are there other variable components in there?

George Blanton

No, the $5 million that we talked about is primarily employee-related and fringe-related compared to the end of the fiscal year. There is probably another $4 million or $5 million that we have reduced that we'll be showing up over next quarter. But I think that the guidance would be OpEx that I talked about that's probably most likely.

The biggest variable, two of them have been compensation and R&D expense. And we think they will remain at lower levels in the second half of the year. In terms of the next fiscal year we'll have to take a look at that, but at these levels it's about where we would be running to these sales levels.

Chris McDonald - Kennedy Capital

And for that cost to come back, I mean it sounds like, one, bonus' would either go up or; two, you'd be hiring back people. Those are the two elements.

George Blanton


Chris McDonald - Kennedy Capital

And then, my other question is related to inventory in the channel. So, Larry, you mentioned that you thought certainly a portion of the softness in wireless demand was just inventory clearing. Anyway to put a number on what that impact might be relative to this $10 million, $11 million revenue run rate that we'll see in wireless here last quarter than in the current quarter?

Larry Sala

Just generally, we'd say something on the order of $1 million or $2 million, probably impact just from having a lot of inventory in the channel. And obviously, on top of that this quarter we've got this transition in a way we're dealing with our largest customer on top of that. But if we said no other variables, we probably have seen $1 million, the $2 million impact from just inventory in the channel.

Chris McDonald - Kennedy Capital

And then, one final question with Space & Defense and the run rates that you talked about earlier for the foreseeable future. How do you view the targeted segment margin or EBIT margin out of that business, if it's earnings $28 million a quarter?

Larry Sala

We would expect to be as we were this quarter, somewhere in the low-to-mid teens operating margins. I mean we're trying to manage that business to be as profitable as to get back to the kind of targeted profitability at these kind of levels. Obviously, mix is going to have an impact, but our goal is from that business segment standpoint to be in the low-to-mid teens.

We're still working on some improvements at our circuit board manufacturing facility. We're seeing some improvements there and also we're reevaluating our engineering and design efforts and search use. And we'll continue to monitor production levels there and continue to adjust where we find improvements in productivity levels.


(Operator Instructions) I am showing no additional questions in queue at this time. I would now like to turn the conference back over to you, sir.

Larry Sala

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


Ladies and gentlemen, thank you for participation. That concludes the presentation. You may disconnect and have a wonderful day.

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