Harris Stratex Networks F1Q08 (Qtr End 9/28/07) Earnings Call Transcript

Nov. 1.07 | About: Harris Stratex (HSTX)

Harris Stratex Networks, Inc. (HSTX) F1Q08 (Qtr End 9/28/07) EarningsCall November 1, 2007 5:30 PM ET

Executives

Mary McGowan - Summit IR Group

Guy Campbell - President and CEO

Sally Dudash - VP and CFO

Analysts

Ittai Kidron - CIBC World Markets

Blaine Carroll - FTN MidwestSecurities

Steve Ferranti - Stephens, Inc.

Matt Robison - Ferris Baker Watts

Rich Valera - Needham &Company

Santosh Rao - Broadpoint Capital

Kevin Dede - Morgan Joseph

Operator

Good afternoon, ladies andgentlemen. Thank you for standing by and welcome to Harris Stratex Networks ConferenceCall. At this time all participants are in a listen-only mode. Later we willopen the call for your questions. (Operator Instructions). As a reminder, thisconference call is being recorded for replay purposes. I would now like to turnthe call over to Mary McGowan, of Summit IR Group. Ms. McGowan, you may begin.

Mary McGowan - Summit IR Group

Thank you for joining us today todiscuss the Harris Stratex Networks financial results for the first quarter offiscal 2008. On today's call will be Guy Campbell, President and ChiefExecutive Officer; and Sally Dudash, Vice President and Chief FinancialOfficer.

During this conference call wemay make forward-looking statements regarding our business, includingstatements relating to projections of earnings and revenues, continued networkexpansion by mobile and private network operators, the timing of expectedsynergies and operating efficiencies, and the successful integration of theoperations of the former Microwave Communications Division of HarrisCorporation, which will we refer to as MCD, with those of the former StratexNetworks, which we will refer to as Stratex.

These and other forward-lookingstatements involve assumptions, risks and uncertainties that could cause actualresults to differ materially from those statements. For more information pleasesee the press release and filings made by the company with the SEC. Inaddition, in the tables of our press release and on this teleconference we maydiscuss certain information that is non-GAAP financial measure, areconciliation from the comparable GAAP measures is included in the tables ofour press release and on the Investor Relations section of our company website,which is www.harrisstratex.com. We believe the supplemental non-GAAP financialresults, which are used by management reflects the basic operating results ofthe company, and will facilitate comparison of operating results acrossreporting periods.

Now, I would like to turn thecall over to Guy Campbell.

Guy Campbell

Thank you, Mary. And thanks toall of you for joining us today. I am pleased to report that we entered our newfiscal year with strong orders and revenue momentum, an increasing validationof our leadership position in technology innovation, product and servicesbreadth and global reach. Let me share with you some of the highlights from ourfirst quarter of fiscal 2008. On a non-GAAP basis revenue for the Septemberquarter was $172 million.

Gross margin was 30.1%, net incomewas $10 million or $0.17 per share. By segment, North America revenue was $57 million, international revenue was $109million, and network operations had a strong quarter with revenue of $6.5million. Orders in Q1 increased for the third consecutive quarter, and the book-to-billratio for the quarter was greater than 1. We also captured the synergy costsavings we targeted for Q1, this underscores our confidence in meeting ourtargeted $35 million total cost savings in FY '08 from supply chain management,headcount reduction, and facility consolidation.

Later in the call, I will providecomments on our market and product positioning, as well as an update on ourfinancial guidance for the year. Now I would like to turn the call over toSally for a review of the quarter's financial details.

Sally Dudash

Thank you Guy, and good afternooneveryone. Let me start with a review of the GAAP financial performance ofHarris Stratex Networks for the quarter ended September 28, 2007. The GAAPresults are those of our new combined company, excluding the results forStratex prior to February 2007. For GAAP purposes all prior year comparisonsare against the results of MCD only.

First quarter revenue was $172million compared to $174 million in the fourth quarter of fiscal 2007, and $94million in the year ago period. We reported a net loss for the first quarter of$800,000. This compares to a loss of $5.3 million in the prior quarter and netincome of $4.8 million in the year ago period and we believe the supplementalnon-GAAP financial results, used by management reflect the basic operatingresults of the company and facilitate comparison of operating results acrossreporting periods.

Our non-GAAP income statementsexclude the charges that resulted from the merger transaction, integrationcosts, and stock compensation expense. Please refer to our website for completeGAAP to non-GAAP reconciliation tables. For the first quarter of fiscal 2008these non-GAAP charges totaled $14.3 million, and are composed of thefollowing, $7.6 million integration and restructuring charges, $3.6 millionamortization of purchased intangibles, $2.4 million of stock compensationexpense, and $700,000 amortization of fixed assets fair value step up. Thefollowing discussion is based on our non-GAAP results. Revenue at $172 millionwas an increase of 7% compared to the first quarter of fiscal 2007.

New product revenue, which wedefine as revenue from products less than three years old, was 56% of totalrevenue. By segment, North America microwavecontributed $57 million of revenue, increasing 8% compared to the first quarterof fiscal 2007. North American customer orders driving Q1 results were composedof 57% from mobile operators, and 43% from private operators. This is weightedmore this quarter towards the mobile customers than our average 50/50 split. Asthis segment continues to see strength, from increased bandwidth demand,footprint expansion, and 2 GHz microwave relocation for advanced wirelessservices from these public operators.

Private operator demand comesfrom network hardening, network interoperability, and homeland securityprojects. The international microwave segment contributed $109 million ofrevenue in the first quarter. An increase of 5% compared to the first quarterof fiscal 2007. Year-over-year gains in international were seen in almost allgeographies. The geographic breakdown of revenue was as follows.

Europe, Middle East and Russia at $33million, was an increase of 14% compared to the year ago period. Latin America and Asia Pac $24 million, an increase of 6%compared to the year ago period. And Africa at$52 million was flat year-over-year. Africa, Europe, the Middle East and Russia remainstrong growth areas. Opportunities in these regions continue to be driven byinfrastructure build-outs, the growth of IT networks and services, and 3Glicenses being awarded in Russia.Operators continue to expand their coverage and capacity across West Africa,East Africa, and the Middle East driving increasedbusiness activity.

The network operations segmentcontributed $6.5 million in revenue in the quarter, which is a 48% increasefrom the year ago period. Increased demand for this segment's Service AssuranceSolution with next generation network customers is fueling revenue growth. Grossmargin was 30.1% compared to 31.9% in the prior quarter, and 32.2% in the yearago period. Overall gross margins were impacted in the first quarter by the mixbetween international shipments of Eclipse high-capacity products, whichcommand a higher margin and low capacity products. On average the mix betweenthese products will be 60% high-capacity and 40% low-capacity.

Demand in this quarter was drivenby new mobile system wins that had a higher concentration of low-capacityproducts, which resulted in a mix of 50% high capacity and 50% low capacity.This 10 point shift in mix had an unfavorable impact on our margins and we seeno reason why the mix will not return to the historical average in futurequarters. Service revenue mix remains comparable with the prior quarter andprior year at 14% of total microwave revenue, total operating expenses declinedfrom $42 million, or 24% of revenue, in the fourth quarter to $39 million, or22% of revenue, in Q1. Expense synergies are being realized according to ourplan.

R&D spending was $12 millionin the first quarter, or 7% of sales, depreciation and amortization ofproperty, plant and equipment and capitalized software, was $5 million in thequarter. CapEx including additions for capitalized software and IT systems andtools, was $6 million, operating income was $13.3 million. Flat compared withthe year ago period and down sequentially from $13.8 million in the fourthquarter. Net income was $9.9 million in the quarter, or $0.17 per share,compared to $10.3 million or 18% in the fourth quarter. Our pro forma tax rateremains at 26%, and our cash tax rate is approximately 3%, employee headcountwas reduced in the quarter from 1,450 to 1,410 and is in line with ourintegration plans for headcount reductions.

Moving onto the balance sheet,Harris Stratex's cash balance, including short-term investments, was $79million at the end of September, compared to $90 million at the end of June. AsI mentioned previously, we had $6 million in capital expenditures for thequarter. $3.7 million of which was for improvements in our IT systems andtools, although our overall cash and investment balance declined, we didimprove operating cash flow from a negative $1.6 million in the fourth quarterto a positive $2.1 million in the first quarter.

Product inventory balances wereessentially flat compared to the fourth quarter, and we saw decreases in rawmaterials and finished goods as a result of our inventory managementinitiatives. Unbilled costs increased by $11 million as a result of continuedgrowth in system projects, these projects have longer cyclic times to cash thanproduct shipments. However, they are predominately with North Americancustomers, and they are scheduled to ship during the remainder of the fiscalyear. Inventory turns, including unbilled, where 2.5 compared to 2.6 in Q4 ofFY '07.

We had a four-day increase inDSOs to 107 in Q1 compared to 103 in Q4. Again influenced by the timing ofshipments during the quarter and initiatives are underway to decrease DSOs toless than 100 days within the next three to six months. And now I will turn thecall back over to Guy for market and outlook discussions.

Guy Campbell

Thanks Sally. Now I would like totalk about our market, its evolving demands, and why Harris Stratex ispositioned to compete and win. Our strength as a business begins with our focuson the fastest-growing, highest value markets we are targeting high-capacitybackhaul, nodal networking applications, IP transport, and network planning andoptimization as fast growth areas. This is in addition to the markets wetraditionally serve well, such as TDM cellular backhaul, network interconnection,and public safety.

In the mobile segment the rate ofbase station deployments is increasing in all market areas, and is expected todo so through 2008. The base station additions are a historical market driverfor new microwave backhaul. The move to deployment of 3G advanced services isclearly driving new levels of capacity and the requirement for increasedefficiency in backhaul. These market trends play to our strengths in bothproduct innovations with our scalable capacity products, and Ethernet migrationstrategies, along with our service delivery capability in all aspects fromplanning to implementation and support.

We see encouraging signs in theinterest for WiMAX network deployments, and continue to increase our customerbase in this area, in addition to providing backhaul solutions we are nowengaged in consulting for IP network design, traffic optimization planning andturnkey implementation for WiMAX networks. A key differentiator for us is the breadthof the product portfolio as we provide solutions for all types of wirelessnetworks. From low capacity voice networks to high capacity IP networkssupplying voice, video and data, all on the same network. In addition we offerservices to help customers, worldwide monitor and manage their networks. Anarea where we are seeing greater success with key network management wins.

Our customers span the globe. Werecently announced a contract with ONE, an Austrian mobile operator to upgradeits cellular backhaul network, our Eclipse microwave radios will increasebandwidth, reduce operating costs, and build an IP-ready infrastructure tosupport future network deployments. We also announced a multiphase award, toupgrade the Anchorage Alaska Public Safety Network used for the fire, police, medicaland emergency service communications. This project includes our TRuepoint andConstellation radios, and is the latest in several significant turnkey publicsafety network programs led by Harris Stratex.

These contracts are a testamentto our reach into different geographic and vertical markets we're taking anaggressive strategic approach to expanding into new markets, and leveraging ourstrong relationships with customers who are themselves expanding. For example,we are working with our long-term customer MTN in Nigeria,Ghana, Zambia and the Ivory Coast as they continue to expand across Africa and we'rewinning more work in Europe and Russia,having announced projects this quarter with VimpelCom, the leading mobileoperator in Russia, and MagtiComthe leading mobile operator in the Republic of Georgia.

Our objective is to generate newbusiness with current customers, through expanded product and service offeringsand to uncover new opportunities in growing markets this is particularly truein the case of microwave customers turning to us for network management andservices assurance solutions for next generation networks. We are committed tobeing close to our customers, living and working where they live and work. Thisis evident in our recent office expansions. Our new international headquartersin Singaporeis enabling us to better serve our customers in Asia-Pacific where we arerealizing orders and revenue expansion.

In September we announced theopening of a new office in Mexico City, whichwill optimize our sales and support efforts as regional headquarters for Latin America. In early October, we also expanded ouroffice in Romania to supportour client base in Southeast Europe. Where wehave a number of key contracts with mobile, broadcast, media and WiMAXoperators, our strategy is to selectively expand in regions with the strongestgrowth potential. Customers depend on us to develop differentiating technologyand offer a breadth of solutions. Our investment in R&D remains as large asany in our industry, and will continue to fuel our product innovation and thisengineering commitment enables us to maintain our technology leadership andoffer our customers superior solutions and services.

Now let me talk about ourproducts. TRuepoint 6000 began shipping in Q1, to the Commonwealth of Kentuckyfor deployment of its all-IP network and the equipment is installed and movingtraffic. The TRuepoint 6000 is the high capacity all-indoor radio solution forboth IP and TDM transport. This radio is positioned to extend our leadershipposition in North America in both medium andhigh-capacity transport and to grow our market share.

Our development program remainson track for subsequent frequency releases and capabilities throughout fiscal2008. We have continued to add features and functionality to NetBoss, ournetwork management suite, making the service increasingly valuable to our customersworldwide.

The NetBoss solution for serviceassurance saves installation and integration time, while reducing customers'operating expense through ease of operation. Our customers recognize thevalue-added of our network operations offering, which is reflected in the 48%year-over-year revenue increase we reported for Q1.

We had two key wins in thequarter to provide top-level management systems for next generation networkoperators in the Middle East.

In September, we were proud toannounce that our Eclipse carrier Ethernet wireless transport platform receivedcertification from the Metro Ethernet Forum, MEF, a global alliance of morethan 120 leading telecommunications vendors. The MEF certification programprovides service level benchmarks for manufacturers' equipment, and serviceprovider performance in complex Ethernet-based networks.

Eclipse is the first and onlywireless product to meet the requirements of both MEF 9 and MEF 14 technicalspecifications. These certifications are a testament that we lead the market indeveloping wireless transport systems for large-scale, multiservice Ethernetnetworks, including next generation mobile network infrastructure and networksdeploying WiMAX and other service delivery technologies. We believe our Eclipseproduct is fundamentally superior due to its advanced capability.

Layer 2 functionality isessential to provide the quality of service to support true carrier Ethernettransport. Examples include traffic segregation, privatization and monitoring,link aggregation, and our unique patent pending resilient wireless packet ringtechnology. The value of this intelligence inside the radio is in its abilityto remove or reduce the cost of external Ethernet switches.

Our innovative product line isclearly a strength. But any discussion of our products would be incompletewithout mentioning our comprehensive services suite. By providing a wide rangeof professional and support services, including network design andoptimization, site build, site maintenance and equipment installation, we canexpand the reach, capacity and management capability of existing networks, andsupport new build-outs in any region of the world. Our services drive strongercustomer relationships, resulting in sustainable long-term revenue.

New market applications, such asWiMAX, provide additional opportunities. At this juncture, WiMAX backhaulremains relatively small, but we are currently involved in more than 20 WiMAXdeployments around the world. Some where we're doing the site builds inaddition to providing the equipment.

During the quarter, we securedseveral new wins for WiMAX networks. Eclipse is ideally suited for WiMAXbackhaul traffic by enabling operators to support carrier Ethernet transport.Our WiMAX backhaul solution enables operators to fit more capacity in lessbandwidth than other solutions, resulting in significant overall savings. Andgives operators the ability to deploy high capacity links in the minimumbandwidth in regions where frequencies may not otherwise be available.

The wireless transmission marketcontinues to grow and expand, and there are a number of market trends in worldregions driving healthy growth. We will take advantage of these growthopportunities by delivering innovative solutions through continued R&Dinvestment, extending the breadth of our product and service portfolio, andleveraging our scale and global reach.

In looking at the year ahead, weare aware that the environment we operate in is highly competitive. However,our first quarter, which is seasonally one of the weaker quarters, deliveredstrong revenue and the third consecutive quarter of order increases. For thesereasons, we are reiterating our fiscal year 2008 guidance.

On a non-GAAP basis, we continueto expect revenue to range between $670 million and $702 million, and earningsper diluted share of $1.05 to $1.22. The leadership team is completely focusedon delivering the financial performance we have set forth for the company in fiscalyear 2008.

Once again, I would like to thankthe employees of Harris Stratex Networks around the world for their talents,dedication and efforts. At this point, I will ask the Operator to open thelines for your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen,at this time, we will begin the question-and-answer session. (OperatorInstructions). And our first question comes from Ittai Kidron with CIBC WorldMarkets. Please go ahead.

Ittai Kidron - CIBC World Markets

Thank you very and good results,guys. Guy, I had a few questions for you. First of all, can you tell us howmuch of your revenue is IP Ethernet driven? And can you tell us what's therelative gross margin of that product line versus your corporate average?

Guy Campbell

Ittai, I don't have a breakdownon how much of the total revenue was from IP. I can say that it has beensteadily increasing and becoming more significant, and that margins aretypically higher for that application.

Ittai Kidron - CIBC World Markets

Would you estimate though it isabove 10% of your revenue?

Guy Campbell

I would prefer to get back withyou on that. I can't validate that 10% is either high or low.

Ittai Kidron - CIBC World Markets

Okay. Now relative to your annualguidance, you mentioned a long list of opportunities and continued momentum andgrowing trial activity and book to bill greater to 1, yet, in order to get intoat least a midpoint of your guidance, if you want to say, conservative, itimplies flat three quarters ahead of us. I am kind of trying to scratch my heada little bit. Can you walk us through at least from a seasonality standpoint,between now and the end of June '08 of your fiscal year, how should we thinkabout seasonality? At least, if not from a percentage standpoint, at least froma directional standpoint quarter-over-quarter?

Guy Campbell

Well, I think previously weprovided seasonality associated with the guidance we had provided for therevenue outlook guidance. And I think that still holds true. While we arepleased with the orders and revenue performance from Q1, it is one quarter. Andwe believe that the ranges we provided for the revenue guidance are stillvalid, and we are not prepared to make any adjustments to those at this earlypoint in the year.

Ittai Kidron - CIBC World Markets

But should we at least assume asequential take down in March similar to what you had last year, at least froma directional standpoint?

Guy Campbell

Yeah. That would be appropriate.

Ittai Kidron - CIBC World Markets

Okay. Now, Sally, turning to theoperating expenses, great job on that side. Can you tell us sales, SG&A,how should we think about that number being reduced even further? What is thefloor that you expect that number to get to before it starts growing again withrevenues?

Sally Dudash

We still believe the guidance wegave last quarter holds. We have talked about OpEx on average should rangebetween 22% and 23% of revenue for the year. And we are executing to that planas evidenced by Q1. As you stated, quarterly, this may be impacted due torevenue volumes, with Q3 historically being a weaker quarter. But we stillbelieve for the year the 22 to 23% is a good number.

Ittai Kidron - CIBC World Markets

Okay. With regards to the grossmargin, it seems like you were caught a little bit by surprise by the mix thisquarter. Assuming the trends holds for the December quarter, why do you feelcomfortable that the margin issue is not going to be repeated? What gives youconfidence there about the increase in gross margin going forward?

Sally Dudash

Our prior guidance has been thatgross margin should improve modestly through the year. As I mentioned in thecall, we believe the mix impact in Q1 was atypical and we see no reason whythis should not return to a more normal mix in the future quarters. And on thatbasis, we feel comfortable, we're still on track for the overall earningsguidance that we provided.

Ittai Kidron - CIBC World Markets

Does that imply that the upsidein revenue you had this quarter, was that the element that was atypical -- thatincrease in revenue also came with a much lower gross margin?

Sally Dudash

As I mentioned, we had a higherpercentage of our new system wins with the low capacity products. So that diddrive the gross margins. So, yes.

Ittai Kidron - CIBC World Markets

Okay. And lastly on tax rate, canyou tell us how should we think about tax rate for the year?

Sally Dudash

26% pro forma tax rate is stillholding for us.

Ittai Kidron - CIBC World Markets

Thank you very much. Good luck,guys.

Guy Campbell

Thank you.

Operator

Thank you. Our next questioncomes from Blaine Carroll with FTN Midwest Securities. Please go ahead.

Blaine Carroll - FTN Midwest Securities

Yes. Thank you. Hello, everybody.Congratulations.

Guy Campbell

Thanks, Blaine.

Blaine Carroll - FTN Midwest Securities

Yeah. Nice quarter. Guy, anythingdifferent in the pricing environment that you're seeing out there?

Guy Campbell

No. The pricing environmentremains fairly constant from Q4 to Q1. We haven't seen any major changes thatweren't in our plans. The pricing environment is tough and has been tough, butwe haven't seen any radical changes from the past.

Blaine Carroll - FTN Midwest Securities

Okay. So, this was all mix. Ifyou look at the split between the international and the North American, thesplit was pretty much the same as it was last quarter. Were there more lowmargin radios selling into the US market or into the international market?

Guy Campbell

That was really in the internationalmarket. And as we said in our press release, and as Sally said in her comments,it really reflected some large system wins that we had. The particulararchitecture of the systems that we supported with products were, there wasjust a larger percentage of low capacity radios out at the edge than we hadhigh capacity radios in the core for those particular system implementations.However, it's not all bad. We think in the future that there will be capacityupgrades and expansions for these networks, and we're still happy with thatrevenue.

Blaine Carroll - FTN Midwest Securities

Okay. Guy, what type of radiosare going into the microwave relocation?

Guy Campbell

Those in North America would be a combination of both Constellation and TRuepointradios.

Blaine Carroll - FTN Midwest Securities

Okay. Low cap or the higher cap?

Guy Campbell

It has been mostly higher cap.

Blaine Carroll - FTN Midwest Securities

Okay. Let me see. Any impact withAlcatel-Lucent during the quarter? How was their revenue run rate just versuslast quarter or the quarter before?

Guy Campbell

The Alcatel-Lucent run rate istracking pretty much according to plan, not any real radical changes that wesaw or expect.

Blaine Carroll - FTN Midwest Securities

Okay. Is that pretty much 100%margin business?

Guy Campbell

No, it is a combination. There isa part that is licensees' fees and there are some that is equipment sales.

Blaine Carroll - FTN Midwest Securities

Okay. Great job. Thanks. I willpass it on.

Operator

Thank you. Our next questionscomes from Steve Ferranti with Stephens, Inc.

Steve Ferranti - Stephens, Inc.

Hi, guys. Thanks. A question onthe mix of products again during the quarter. Can you give us a sense forperhaps what geographic regions might be more heavily weighted towards edgeradio product versus higher capacity core radio products? Can you segment itout that way?

Guy Campbell

For the first quarter we can giveyou an indication that we had probably more in Asia-Pacific than in other regions,but it can move around. We had some new operator wins in Africa that also had anumber of lower capacity requirements or a larger percentage, let's say, thanhigh capacity.

Steve Ferranti - Stephens, Inc.

And when we're talking about theedge radios, I would assume that is the Stratex product. Is that right?

Guy Campbell

That was the Eclipse product.

Steve Ferranti -Stephens, Inc.

Okay. If you mentioned in your scripttargeting Asia-Pac as a strategic growth region. If you look at the market there,obviously a price competitive market, entrenched suppliers. I mean, what is thestrategy for dealing with the cost structure going into those markets?

Guy Campbell

Well, first of all, we thinkwe've got a very good total product offering for meeting operator demands inAsia-Pacific. However, we do recognize that it's probably the most pricecompetitive market also. But we do have a cost structure that allows us tocompete and to win business, and to win it at a margin that is reasonable. Weintend to continue to expand our business in Asia-Pacific going forward.

Steve Ferranti -Stephens, Inc.

Okay. Then the last one for me, to whatextent do you think the supply chain efficiency that you hope to gain in thesecond half of the year might help you along those lines in terms of bringingdown the cost structure, particularly on the low end product?

Sally Dudash

We're on track with our supplychain savings. And as we have stated in prior calls, that is a significant partof our synergies for the second half of the year. So, it will provide us withgood benefit in that regard.

Steve Ferranti - Stephens, Inc.

Can you give us a sense as towhat margins look like on the lower end product versus higher and products?

Guy Campbell

Well, they are generally 10% to15% lower than on the higher products, on the higher capacity products.

Steve Ferranti - Stephens, Inc.

Okay, very helpful. Thank you/

Operator

Thank you. Next question comesfrom Matt Robison with Ferris Baker Watts. Please go ahead.

Matt Robison - Ferris Baker Watts

Hi. So, those low cap productsyou mentioned Eclipse, should we take away that the Eclipse margins are thatlow? There was a time, at least when Stratex was reporting those products, thatthey were actually gross margin drivers. And I recognize that the low cap stuffyou're competing with a lot more -- you have got a lot more competitors. But ispart of the story also that you were selling legacy MCD low capacity stuff, ordid you mean to say it was all Eclipse?

Guy Campbell

No, I think we said it was allEclipse and it was predominately Eclipse. But I think you maybe got the wrongmessage. We don't want to imply that Eclipse products are low margin products.It is really the difference in margin between high capacity products and lowcapacity products. And that is really what impacted us. It wasn't that theywere Eclipse versus legacy MCD or any other products. It was strictly the mixbetween high cap and low cap.

Matt Robison - Ferris Baker Watts

I know you made some investment inIT and you're working that through the system. When do you expect have anexecutive dashboard that allows you to see where your margins are intraquarter?

Sally Dudash

We still have a lot of work to doon our IT integration initiatives. We talked about the investment that we havemade in the design of the new system. I would say the implementation of thenext phase of implementation will come in over the next couple of quarters. Wewill begin to see the benefits of this towards the end of the fiscal year andinto next fiscal year.

Matt Robison - Ferris Baker Watts

Guy, how come you don't have theIT mix, it seems like that would be a pretty standard straightforwardstatistic. Is it just that you sell IP and TDM products to customers, you don'tnecessarily know which features they use, or is there a reporting difficultythat might not be obvious there?

Guy Campbell

There is really no reportingdifficulty. We just haven't singled that out as something that we want to trackgoing forward from the standpoint of looking at specific numbers. We cancertainly do that in Q2 going forward in future quarters. Meaning, the thingthat we're happy about is the fact that we know that without counting theabsolute numbers, that that area is expanding for us based on the number ofwins and the activity that we have in that particular area. So, I mean you'reright, we probably should start to segment it out, take a look at it in moredetail.

Matt Robison - Ferris Baker Watts

So, do you think that you had allthis revenue from the access products. Normally you have stronger seasonalityin the December quarter. Was this a circumstance where we might be likely tosee a flatter sequential revenue comparison, but maybe make it up on the grossprofit dollar line with better mix in the December quarter?

Guy Campbell

We don't see any change in theseasonality guidance that we provided you before. Q2 is typically a strongerquarter then Q1. And I think that will probably be the case in Q2 of thisfiscal year. I wouldn't lead you to believe that it is going to be flat ordown.

Matt Robison - Ferris Baker Watts

So, I guess the backdrop for thatis always also you have given some percentage of revenue as far as the years goin the past. And now with such a strong first quarter, it would imply that youhave either your revenue number you expect to be very close to the high end ofyour range, or maybe higher, in order to demonstrate the kind of typicalpatterns that you have? Or maybe it would be flat in the December quarter? I guessthat is where I'm coming from. Can you shed the light at all that there mightbe incremental versus your prior discussion of revenue patterns?

Guy Campbell

I would prefer not to get intothat because it has been our policy about not giving quarterly guidance onthings. And I really don't want to do that.

Matt Robison - Ferris Baker Watts

How about half to half, becauseyou have done that? What percentage of revenue do you think will be in thesecond half this year?

Guy Campbell

Well, we had said before that weexpected to get 45% of the revenue in the first half and 55% in the secondhalf. We may do better than that in the first half by some small amount. It ishard to determine. I guess the first quarter results would lead us to believethat we should be confident that that would happen. But as you saw in the firstquarter, while revenue was higher, we had gross margin lower. I mean nextquarter, it could turn out that revenues would be low and gross margins will behigher.

If you look at the business overthe entire fiscal year, we expect to be in the brackets that we provided forthe guidance. We believe the year is unfolding the way we had envisioned it.And we expect to be within the range we provided for guidance for both revenueand for earnings.

Matt Robison - Ferris Baker Watts

Very good. Thanks for answeringfor questions.

Operator

Thank you. And our next questioncomes from Rich Valera with Needham & Company. Please go ahead.

Rich Valera - Needham & Company

Thank you. The question on thegross margin, it seems to me to make the low end of your EPS guidance that youwould need to be comfortably over the 33% gross margin level for the year,which would imply, I would characterize there's a more than a gradual grossmargin improvement going through the year. I just want to check if that is yourmath too, that you need 33% or better gross margin just in any commentary interms of the trajectory to get to that type of gross margin overall for theyear?

Guy Campbell

I think your look at it isessential in line with ours switch. I think that what Sally said is we expectgross margins to return to a more normal point in Q2. And from Q2 forward, weexpect to see moderate growth, probably up for the year to average out at anaround 33% or somewhere in that area, maybe a little higher.

Rich Valera - Needham & Company

Okay. Sally, I don't know if youcan help me on this one. Could you say where the gross margin would have beenin the quarter if you had had that 50/50 mix that you typically have?

Sally Dudash

Yes. It was 60/40 mix that wetypically have. And we have estimated that that was about a 2% percentageimpact on margin, the 10 point shift downwards.

Rich Valera - Needham & Company

Okay. That is helpful. And Guy, atechnology question. Pseudo-Wire seems to be coming up as a hot topic inbackhaul engagements. And some radio providers are actually talking aboutembedding Pseudo-Wire capability into their radios. Are you seeing any demandfor that? And if so, do you have any plans to build Pseudo-Wire capability intoyour radios?

Guy Campbell

We have heard of it coming up insome discussions that we've had with operators. It hasn't been a strong trendin the market at this point. And we are looking at it and have been evaluatingwhether it is worthwhile for us to include that in our offering. We haven'tdetermined whether or not we will go forward with that or not, but it has beenvaluated.

Rich Valera - Needham & Company

Great. And a final one for me.Just how do you feel about the current sales situation, just in general, yoursales force structure, sales force management? I believe Paul Kennard has beenmoved into sort of VP of International Sales role. If you could just commenthow you feel about that sales structure. Are there any holes that need to befilled or do you feel like you've pretty much got a full bench there now?

Guy Campbell

I feel pretty good about thesales situation in general. I think that is reflected to some degree in theorders and revenue that we reported for Q1. While we don't have any holes, wewill continue to make adjustments and improvements throughout the fiscal yearto try and drive even higher performance out of our total sales organization.So, while we are pleased, we think we can do better and we will continue tomake adjustments.

Rich Valera - Needham & Company

Okay. Thanks for taking thequestions.

Operator

Thank you. (OperatorInstructions). And our next question comes from Santosh Rao with BroadpointCapital. Please go ahead.

Santosh Rao - Broadpoint Capital

Hi. Thanks. Thanks for taking myquestion. Just a few questions. Just on the competitive landscape, can you justtalk a little bit about that? Who are you bumping into the most and who are youbeating out in the bids?

Guy Campbell

Well, from a competitiveposition, we run into predominantly the same list of characters. It's Ericsson,it's NEC, it's Nokia Siemens and Alcatel-Lucent are the primary competitorsthat we see around the globe. And some we see more heavily in one geographicarea than the other, but that is the list of competitors we see mostfrequently.

Santosh Rao - Broadpoint Capital

How about the smaller ones? Dothey impact you on the margins like the Ceragons and the DragonWaves?

Guy Campbell

Not really. We run into them fromtime to time, but haven't had I would say a lot of head-on confrontations.

Santosh Rao - Broadpoint Capital

Okay. Now just moving on, on theWiMAX question. Are you trialing any of your equipment with Sprint? And do youexpect to be part of their ecosystem down the road?

Guy Campbell

Actually, we have a contract withSprint as a preferred supplier of microwave radios. We secured that contractabout two years ago, and it is a four-year contract.

Santosh Rao - Broadpoint Capital

Okay. I didn't know that. Andthen one last question. Just on your acquisition strategy, I know right nowyou're into integrating your Stratex and Harris portion. But are you open tolooking at filling some holes, making opportunistic acquisitions here andthere?

Guy Campbell

I would say that we're open tothat. If we find an opportunistic acquisition that fits our overall strategy,we would certainly take a hard look at it.

Santosh Rao - Broadpoint Capital

Okay. All right. Thanks. That'sit for me.

Operator

Thank you. Our next questioncomes from Kevin Dede with Morgan Joseph. Please go ahead.

Kevin Dede - Morgan Joseph

Let me offer my congrats on anice quarter, Guy and Sally.

Guy Campbell

Thank you.

Kevin Dede - Morgan Joseph

I was hoping you could give me alittle more insight on the gross margin trend. I guess I'm a little confusedbecause given the progress you hope to make on integrating the supply chain,you would think there would be some improvement there. And I'm just kind ofwondering where you think you are on that process and how much of the grossmargin improvement that you see going forward will be mix related versusintegration of supply chain management?

Guy Campbell

I would say first of all, as wesaid, we expect the mix situation to normalize in Q2, which as Sally pointedout, would take our gross margin up by about 2 percentage points. And we wereat about 30%, that would move us to about 32. Then we expect the supply chainand other initiatives that we have underway with regard to our cost synergyprogram to continue to increase gross margins throughout the year such that wewould exit the year moderately up from that, let's say by 1.5 to maybe 2points.

Kevin Dede - MorganJoseph

Okay. That is very helpful. How aboutmanufacturing facilities, Guy. Can you give me an update on where you are inthe integration process there?

Guy Campbell

Well, as far as manufacturingfacilities, we are fairly well integrated right now, at least for the initialphase. We have moved our microwave components organization from California towhere it was in Redwood Shores over to San Jose. We have co-located with theremainder of our California organization. So, we have made that move. We havemoved more of the product into contract manufacturing than what we had beforethe merger.

So, I would say that we have madea number of actions and moves up to this point and we will continue throughoutthis year with our complete synergy program with manufacturing, which wouldtake more product offshore. We have one major manufacturing facility, which isin San Antonio, Texas, and that will continue to operate. Ithas been quite valuable to us in doing system integrations and working on ourtransport products.

Kevin Dede - Morgan Joseph

That is the center for theConstellation too, if I'm not mistaken?

Guy Campbell

That's right.

Kevin Dede - Morgan Joseph

So, on a product roadmap andintroduction view, I think you alluded to having an upgrade to theConstellation coming now that TRuepoint 6000 is out. Can you refresh my memoryon that?

Guy Campbell

That's correct. The first releaseon TRuepoint 6000 is an enhancement to the Constellation product line. And as Istated, we started to ship the first radios in the first quarter. We willcontinue with our rollout plan throughout the fiscal year where we willcontinue to add frequencies and capabilities to that product to enhance itsvalue to our customers.

Kevin Dede - Morgan Joseph

And what is on the blackboardafter the 6000?

Guy Campbell

Well, we have an integration of thetwo radio platforms which came out of Stratex and the Harris MicrowaveCommunications Division, where we will take and integrate those platforms andadd some new technology capabilities to it to get to a single platform for thenext generation of products. And that work has already started. But we're alittle early to get into what that will mean in the way of features andfunctions and costs for that product, because it is quite a ways out on atimeframe.

Kevin Dede - MorganJoseph

Okay. Fair enough. I guess we will justkeep badgering you as time goes on.

Guy Campbell

I understand.

Kevin Dede - MorganJoseph

Okay. Thanks for taking the questions.

Operator

Thank you. And there are nofurther questions. I will turn it back to you, Ms. McGowan for closingcomments.

Mary Mcgowan

This includes our conferencecall. Please note that we are scheduled to present at the AeA Classic InvestorConference in Monterey, California on November 5th and 6th. And we look forwardto seeing many of you there. Thank you all for joining us on this call and thewebcast today.

Operator

Thank you. Ladies and gentlemen,we thank you again for your participation. And at this time, you maydisconnect.

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