Anaren's CEO Discusses F3Q12 Results - Earnings Call Transcript

Apr.25.12 | About: Anaren, Inc. (ANEN)

Anaren Inc. (NASDAQ:ANEN)

F3Q12 (Qtr End 03/31/2012) Earnings Call

April 25, 2012 8:30 am ET

Executives

Larry Sala - President and CEO

George Blanton - CFO

Joe Porcello - VP of Accounting

Analyst

Richard Valera - Needham & Company

Mike Walkley - Canaccord

Chris McDonald - Kennedy Capital

Greg Garner - Singular Research

Operator

Good day, ladies and gentlemen, and welcome to the Anaren third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to your host, Larry Sala.

Larry Sala

Thank you. Good morning and thank you for participating in the interim fiscal 2012 third 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, earnings and our stock price.

Net sales for the third quarter were $34.7 million, down 21% from the third quarter of last year. The decline in sales for the quarter was due to the significant decline in demand from wireless infrastructure customers as well as a decline in sales of counter-IED related products within the space of Defense Group.

Non-GAAP operating income for the quarter was $3 million or 8.6% of net sales, down 47% from the third quarter of last year. Margins were negatively impacted by the overall decline in sales; however, third quarter non-GAAP operating margins improved 110 basis points from second quarter level despite a $1 million decline in net sales as a result of the aggressive cost reduction initiatives that were completed in the first half of the fiscal year. Additional cost reduction initiatives were also completed in the third quarter.

Wireless Group net sales for the quarter were $10.2 million, down 33% from the third quarter of last year due to the continuing weak demand from wireless infrastructure customers. The new orders were weak throughout the third quarter. We believe inventory levels at our customers and distributors declined substantially. Current customer order rates and forecasts are showing some strengthening which should result in an increase in Wireless Group sales in the fourth quarter.

During the third quarter, several new wireless infrastructure components and Anaren Integrated Radio or AIR modules were introduced and two new distributors were added to expand our sales channel. We continue to see a steady increase in AIR design activity and have a number of customers transitioning to volume production. Customers that exceeded 10% of Wireless Group net sales for the quarter were E.G. Components, Huawei and Richardson.

For the Space & Defense Group, net sales for the quarter were $24.5 million, down 15% from the third quarter of last year. The decline in net sales was driven largely by the decline in counter-IED related business. New orders for the quarter were $24.1 million and were driven largely by radar, passive ranging and satellite applications.

On April 9, we announced that we had received three contracts totaling in excess of $11.5 million in follow-on orders for passive ranging subsystems. Approximately $6 million of those contracts were recognized in our third quarter orders. In addition, based on contracts that were recently awarded to our customers late in the third quarter, we expect an increase in orders for our Space & Defense Group products in the fourth quarter.

Space & Defense Group order backlog at March 31, 2012, was $95 million. Customers that generated greater than 10% of Space & Defense Group net sales for the quarter were Lockheed Martin, Northrop Grumman and Raytheon.

George?

George Blanton

The highlights of the third quarter income statement from the balance sheet at March 31, 2012, are presented on a non-GAAP basis. These non-GAAP measures are each adjusted from GAAP results to exclude certain non-cash items including equity-based compensation and 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 third quarter earnings release for a reconciliation of GAAP and non-GAAP measures.

Non-GAAP gross margin was $11.9 million or 34.4% for the current quarter compared to $16.3 million or 37.1% for the third quarter of last year. Gross profit as a percent of sales decreased by 270 basis points compared to the third quarter of last year due to lower sales volume resulting from unfavorable market conditions and the completion of a significant Space & Defense program.

The company realized additional cost reductions in the third quarter, including manpower, overhead and operating expenditures. Given additional cost reduction initiatives and the expected increased sales volume in the fourth quarter, we expect company non-GAAP gross margins to be between 34% and 38% for the fourth quarter of fiscal 2012.

The investment in research and development was 9% of net sales in the third quarter compared to 10.6% of net sales from the third quarter of last year. Total R&D expenditures for the third quarter were $3.1 million compared to $4.7 million in the third quarter of fiscal 2011. The lower spending levels were due to a reduction in engineering personnel as a result of reduced design requirements and reassignments of a number of employees to funded non-recurring work for Space & Defense development efforts.

New Space & Defense Group programs are anticipated to generate $10 million in funded engineering revenue over the next 12 months, which should drive comparable levels of Space & Defense Group R&D spending through the fourth quarter of the fiscal year.

Non-GAAP operating profit was 8.6% of net sales in the third quarter of fiscal 2012, down 420 basis points from 12.8% in the third quarter of fiscal 2011. The decrease was the result of lower overall sales volume in both the Wireless and Space & Defense segments and a less favorable mix of business.

Operating expenses were $1.7 million lower in the current quarter compared to the third quarter of fiscal 2011 as a result of the company's cost reduction efforts. The company continued to reduce cost in the third quarter at several operating locations, reduction personnel and operating expenses to improve profitability at the current lower sales levels. To date, personnel levels have been reduced approximately 19%, resulting in annualized payroll reductions in excess of $6.6 million including benefit cost compared to the third quarter of fiscal 2011. Total cost reductions are expected to exceed $11 million annually.

Non-GAAP net income was 8% of net sales or $0.19 per diluted share for the third quarter of 2012 compared to 9.7% of net sales or $0.28 per share for the third quarter of last year. The effective income tax rate for the third quarter of fiscal 2012 was negative 4.7% compared to a tax rate of 21.4% for the third quarter of last fiscal year. The tax benefit in the third quarter of fiscal 2012 results from a higher than anticipated federal research and experimentation credit. The overall projected effective tax rate for fiscal 2012 excluding one-time adjustments is expected to be approximately 27%.

Balance sheet highlights include cash provided by operations was $2.3 million in the quarter. Capital expenditures were $1.4 million. Cash, cash equivalents and investments were approximately $53 million as of March 31, 2012. The company repurchased 66,000 shares of its common stock in the third quarter. There were approximately 815 shares remaining under the current repurchase authorization as of March 31, 2012.

Accounts receivable were $29 million at March 31, 2012, down $2 million from June 30. Days sales outstanding was 76 days, up five days from last quarter. The accounts receivable includes over $3 million of unbilled receivables related to non-recurring engineering projects that are using percent of completion accounting methods. The unbilled receivables will be reduced significantly by the end of our fiscal year. DSO excluding the unbilled receivables was 68 days as of March 31, 2012.

Inventories were $38 million at quarter-end, up $4 million compared to June 30. The increase was due to additional inventory for long lead satellite programs in the Space & Defense Group, of which a significant portion will be consumed in the fourth quarter.

Larry Sala

Thanks, George. For the fourth quarter of fiscal 2012, we anticipate comparable sales for the Space & Defense Group and an increase in sales for the Wireless Group compared to third quarter levels. As a result, we expect net sales to be in the range of $35 million to $40 million.

We expect GAAP net earnings per diluted share to be in the range of $0.11 to $0.23 using an anticipated tax rate of approximately 27%, 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 $0.16 to $0.28 for the fourth quarter.

We'll now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Richard Valera with Needham & Company.

Richard Valera - Needham & Company

Larry, last quarter you talked about a change in distribution model with Ericsson, which you thought would hit you for perhaps $1 million to $1.5 million in the quarter. Do you think that is now done at this point?

Larry Sala

We've seen the vast majority of the impact of that transition. That transition is not fully completed. It wasn't our doing. It's our customer's doing that has dragged on and will happen this quarter, probably late sometime this quarter. But the vast majority of the impact was felt as we had a significant decline in the level of inventory being held at our third-party distributor. So I'd say our expectation of impact this quarter, if any, is less than $0.5 million.

Richard Valera - Needham & Company

And then can you give us any more color on how your monthly or weekly sort of demand levels have been trending in Wireless? It sounds like they might have been pretty flat through March, but more recently have been trending up. Any kind of color you can shed on that?

Larry Sala

Well, sales have been very different than order rates. So we've to be careful what we speak to. From an order rate standpoint, the dips have been much lower than what we have seen from a sales standpoint. I'd say generally we see orders rates running something on the order maybe 20% better than they were, maybe 25% better than they were in the last month, month-and-a-half. So we only started to see a pickup very late in the quarter. So we would expect to see that start to translate to sales as this quarter progresses. We typically have a four to six weekly time in our Wireless business.

Richard Valera - Needham & Company

I know it's very early in this recovery, but it sounds like you won't necessarily be getting the full impact of this rebound for the entirety of the June quarter. So if it were to sustain, would one sort of naturally expect that September might be better all things equal?

Larry Sala

Yes, from everything we see in demand forecast, that definitely appears to be the case. We'll see some improvement this quarter. We'll see continuing improvement in the first quarter. Again, as you mentioned, we see daily pull-ins and push-outs that can change significantly relative to any longer-term forecast we have. But based on current trends, we definitely see more pull-ins and very few push-outs. And from forecast, we see Q1 looking stronger than Q4 here.

Richard Valera - Needham & Company

Last quarter, I think we talked about your aggregate sort of OEM forecast looking for flattish year-over-year revenue in calendar '12 versus calendar '11, which would imply a significant rebound I guess in the latter portion of the year. Has that forecast changed to your knowledge?

Larry Sala

We don't really get significant updates of that annual forecast. So basically we'll see a new 2013 calendar forecast sometime in the early summer time. But once we negotiate those contracts, which was done like last year, November, early December, then they give us weekly updates of roughly about 12 to 15 week kind of forecast that just keeps rolling forward. They don't typically give us any kind of detailed update that goes out even six months. So even late first quarter is difficult for us to see, but we certainly have visibility into July and first half of August.

Richard Valera - Needham & Company

On the Space & Defense, Larry, you made some reference to expecting kind of like strong bookings in the June quarter. Any more color you can give on that in terms of perhaps magnitude?

Larry Sala

Given the contract we announced, we already had $5 million or $6 million booked very early this quarter from our PRSS contracts that we announced. Given the radar contracts, we believe we're expecting another $15 million to $16 million or $17 million in orders from a couple of radar contracts that our customers have announced, and we would expect to see that this month. And given all of that, we'd expect to see Space & Defense orders exceed $30 million for the quarter and maybe get it to the range of mid 30s if everything goes well. So a fairly strong book-to-bill for the quarter, and that would give us a strong book-to-bill for the year.

Operator

Our next question comes from Mike Walkley with Canaccord.

Mike Walkley - Canaccord

Nice job on the cost reductions. Larry and George, just building on Richard's questions with the wireless sales, sounded like they should recover again in June and then a little better in September. Can you talk about how that could impact the overall margin structure of your business?

George Blanton

We have had very good success and done a real good job I think of reducing our cost. In fact, in the third quarter, we had roughly $3 million lower cost than we did the prior year. So I think we are well on track.

In terms of increasing wireless sales, we think there is lot of leverage there. And the reason our EPS range is so wide is we're kind of in a transition period. If we go over a certain level, we'll have significant leverage. And we think that that leverage could be as much as 50%. So our range is significantly wider. And so that $3 million to $5 million increase in wireless sales would generate significant operating profit growth.

Mike Walkley - Canaccord

So if it grows again, maybe that leverage in the September quarter, could we see gross margins back for the combined company in the higher 30% range?

George Blanton

Absolutely.

Mike Walkley - Canaccord

And also, George, just the 27% tax rate for fiscal 2012, would this be the rate we should use for model for fiscal 2013 or you think it goes back to the higher levels than prior years?

George Blanton

I think that's probably a reasonable estimate. It's dependant on the non-recurring engineering effort we get in the second half of fiscal '13, but I think for now that would be a good estimate.

Mike Walkley - Canaccord

Larry, you talked about some momentum in orders for the AIR business, can you update us on just talks for this business and maybe sizing it up for the opportunity on a calendar 2013 type basis?

Larry Sala

I guess we are a little hesitant to do it, because we haven't very good at it so far. Generally, we're probably tracking something on the order of close to 100 design-ins now. So that number continues to progress. We've probably got something on the order of maybe 10 customers that are transitioning to some sort of volume production and about half of those that have already purchased more than 1,000 units from us. So we finally have some real momentum going that's clearly brought.

I am hopeful that we'll end this year at a run rate of $1 million a year kind of order run rate and now would drive expectations next year of maybe $2 million to $3 million of orders, if nothing else pops up. But it's very hard for us to predict as we got so many customers engaged that are all on different development cycles, have different program issues and product introduction issues that we continue to be surprised. People we expect are going to get going, disappoint us. And others we never even heard of are jumping and ordering thousands from us without much notice. So tough to predict, but general trends have been positive and definitely meeting our expectations.

Mike Walkley - Canaccord

Just on the Space & Defense business, certainly good order momentum exiting the fiscal year here. Can you kind of update us what you think the run rate for the business might be on quarterly basis or if you think fiscal 2013 could grow versus fiscal 2012?

Larry Sala

Yes, this year has fallen a little bit short of our expectations. We had a very weak quarter earlier this year and we're not really making that up. But generally given order patterns, we'd expect this business to run next fiscal year a little over kind of $100 million run rate. So kind of mid-single digit growth, higher single-digit growth depending on how much we see in terms of booking shipped in the year. We don't see a lot of that, but we do see some of that.

And I'd say right now given what's going on in our main programs, we expect that similar kind of growth rate to continue. That's been kind of a historical growth rate of this business if you take out the volatility of the IED business, which has kind of come and gone. And I guess our expectations are that that should continue.

Mike Walkley - Canaccord

Are there any seasonal patterns that we should think about in terms of the Space & Defense business?

Larry Sala

There really is no seasonality to the business. I was just looking, comparing for this, it does seem like this is historically a strong order quarter for us and it's probably because budgets get finalized in the fall and the programs we're on tend to get settled out and we start to see orders six months later, but no other real seasonality to it. It's fairly lumpy orders, but fairly steady shipments.

Operator

Our next question comes from Chris McDonald with Kennedy Capital.

Chris McDonald - Kennedy Capital

I'm trying to get a better handle on just the inventory effect at your customers in the wireless business. And if I go back and look at the last six or eight quarters, it seems like there has been a pretty significant inventory build and then in clearing here in the last couple of quarters. How good is your visibility around that? And if you were to normalize for that, the business has done about $10 million, $11 million in revenue in the last couple of quarters, I'm just wondering if you could give a sense for the ballpark of what the inventory effect may have been or how much inventory clearing on these last couple of quarters if you have any visibility at all?

Larry Sala

Well, the difficulty we have is we have excellent visibility with our distribution partners and in the distribution channel. We get regular updates. But we have no real visibility of actual inventory that resides within our customers' warehouses. So that is challenging for us. So you can see somewhat obviously their pull rates from our distribution channel, but we don't see what they set on.

So our inventory at our distribution channel has dropped substantially throughout the quarter. In fact, it's down more than 50% from the beginning of the quarter to the end of the quarter. And that's pretty consistent across the vast majority of our distributors. We really don't see any pockets of high inventory levels anymore.

But it's hard to tell what that means in terms of a terminal run rate, where do we think things might peak out at. We get back to same or normalized state. That's a tough number for us.

George Blanton

It may be $1.5 million to $2 million more in shipments in the third quarter we would have achieved. That's roughly the decline in the inventory levels in the distribution channel.

Chris McDonald - Kennedy Capital

I know this is an area where visibility is also tough, but maybe just anecdotally, the mix between 2G, 3G and 4G type applications in what you're selling, has that changed noticeably here over the last quarter or two?

Larry Sala

We have little to no visibility of that. Given how much has been sitting in the channel and where our customers are, that's a very difficult number for us to try to peg.

Chris McDonald - Kennedy Capital

And then my last question is just on Space & Defense margins. So you started the year off with a pretty tough quarter. I would expect you would think that the margin as we go into fiscal '13 and Space & Defense ought to normalize or ought to alt least work its way back up towards historical levels absent IED business, is that fair?

Larry Sala

Yes, I think we should see continuing improvement in margins in our Space & Defense Group. We should see both a bit better mix and hopefully continuing improvement in execution. So we continue to try to get more efficient in that business. As well as, they've been unfairly penalized because of the significant drop off in sales in wireless. They've been absorbing more total overhead as a result of that. And so as we start to see growth and better absorption in Wireless Group, that should take a little bit of pressure off the margins in Space & Defense as well.

Operator

We have a follow-up question from Richard Valera with Needham & Company.

Richard Valera - Needham & Company

George, just referring back to your prepared remarks with respect to cost cuts, you gave us two different numbers. One was $6.6 million and one was $11 million with respect to annualized expense. Can you clarify what those two numbers are?

George Blanton

The $11 million is the annualized savings that we would expect.

Larry Sala

$6.6 was just a personnel part of that. So out of the $11 million, $6.6 million came from payroll and benefits. The other was from other expense reductions that we've incurred.

Richard Valera - Needham & Company

And what would be the baseline year or quarter that we would reference that against?

George Blanton

Well, March 2011 is what we're referencing against. That's when we started our reductions and our focus on cost cutting.

Richard Valera - Needham & Company

And then just with respect to ongoing OpEx from here relative to the March quarter levels, can you just say how we should expect OpEx to trend? Is it flattish sequentially into June?

George Blanton

We do think it will be flattish sequentially going forward. We think our R&D is roughly where it will be and our G&A expenses and marketing expenses, which should be consistent going forward. One exception, we did reduce our bonus accrual in the current fiscal year. That could come back in the next fiscal year.

Richard Valera - Needham & Company

And would that be something you would then accrue linearly throughout the year or would hit all in the fourth quarter?

George Blanton

No, it'd be next fiscal year in a linear type accrual.

Richard Valera - Needham & Company

Can you give us any sense of how much that might impact the annual number?

George Blanton

Yes, might be a couple of million dollars annually.

Operator

Our next question comes from Greg Garner with Singular Research.

Greg Garner - Singular Research

I wanted to ask you about the wireless, and you mentioned that there is a visibility for like 13 week. I believe you mentioned forecast from your customers. And yet, there is such a wide range for the range in Q4 based on where the wireless orders might come in. So I'm just trying to put those two together. And they seem to be pointing at different items that would be driving the forecast. Can you give us a more clarity at to the reasoning for the range?

Larry Sala

The range is basically driven from the fact that we could see $1 million plus or minus in our Space & Defense Group just depending upon customers who want orders within the period or not. We see that kind of pulls and pushes and execution as well. And then in wireless, we easily see $1 million to $2 million of demand volatility just whether customers are pulling in or pushing out in any given day, week or month.

So that's what drives the kind of $5 million range in revenue. Our expectation is always to come in, in the middle. But again, with those pushes and pulls, it could be a couple of million higher, a couple of million low.

If you just take that $5 million of revenue variability and look at the fact that we are at the point that our operating model has significant amount of leverage and we might see as much as 50% contribution from an incremental million dollars of revenue, that drives a fairly wide EPS range for us. So we believe very strongly if we see revenue at the high end of our revenue range, we'll see significant operating leverage whether it's driven from our Space & Defense Group or Wireless Group.

Obviously, we're seeing more leverage in our Wireless Group. But either one at the current position we are operating will drive real strong operating leverage for us.

Greg Garner - Singular Research

In the AIR products, is there any potential for greater visibility in that product line as we move forward when there is more of those products are in production?

Larry Sala

Yes, absolutely. So as we see customers transitioning into production, we are getting annual usage forecast from them. So once we have customers that are actually starting to consume at these higher levels monthly, we will have much more visibility as to what the year should look like. But we're still in this position of people transitioning. We're getting those demand forecasts. It's just when is it really going to pick up. And those move around month or two and almost no notice.

So yes, we would expect as we exit this quarter that we have got a couple of customers on more actually in volume production and will have better predictability and visibility there.

Greg Garner - Singular Research

And the timeframe associated with the couple of customers at the end of fourth quarter would give you the $1 million run rate?

George Blanton

Yes.

Greg Garner - Singular Research

And the $2 million to $3 million order rate for next year that you're referencing in the fiscal year?

George Blanton

Correct.

Operator

Thank you. I am showing no further questions at this time. I would now like to turn the conference back over to Larry Sala for closing remarks.

Larry Sala

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

Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.

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