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Westell Technologies, Inc. (NASDAQ:WSTL)

F4Q12 (Qtr End 03/31/2012) Earnings Call

May 17, 2012 9:30 am ET

Executives

Brian Cooper - CFO

Rick Gilbert - Chairman, President and CEO

Analysts

Mike Latimore - Northland Capital

Greg Burns - Sidoti & Company

Jeff Linroth - Leaving It Better

Todd Brady - Oppenheimer

Operator

Welcome to the fourth quarter fiscal 2012 earnings conference call. (Operator Instructions) I will now turn the call over to Brian Cooper. Mr. Cooper, please go ahead.

Brian Cooper

Thank you. I want to welcome everyone to our conference call covering the annual and fourth quarter results for Westell Technologies during our fiscal year 2012, which ended March 31.

We issued our earnings news release last night as well as a new release announcing our acquisition of ANTONE Wireless. We will refer to these news releases which are our posted on our website westell.com. On this call Rick Gilbert and I will update you on the business, our strategy and our financial results.

Before we begin please note that our presentation and discussion contain forward looking statements about future results, performance or achievements financial and otherwise. Words such as believe, expect, and anticipate, estimate, plan, outlook, trend and similar expressions are intended to identify such forward looking statements. These statements reflect management's current expectations, estimates and assumptions.

These forward looking statements are not guarantees of future performance and involve risk and uncertainties that may cause Westell's actual results, performance or achievements to differ materially from those discussed. Our descriptions of factors that may affect our future results is provided in the company's SEC filings including Form 10-K for the fiscal year ended March 31, 2011 under the section risk factors.

The forward looking statements made in this presentation are being made as of the date and time of this conference call. Westell disclaims any obligation to update or revise any forward-looking statements based on new information, future events or other factors. Our presentation today also will include non-GAAP financial measures. We have provided reconciliations to the most comparable GAAP measures in our earnings press release which is available on our website westell.com.

I will begin this morning with a review of the financial results for our fiscal fourth quarter and the full year ending March 31, 2012. I will then turn the call over to Rick Gilbert, Westell's Chairman and Chief Executive Officer who will provide some perspective on our performance and strategic direction.

Fiscal year 2012 was clearly a year of significant change for Westell and I'm happy to say that we ended the year on an up note. After an extraordinarily weak third quarter, we experienced a broad rebound in our fourth quarter across most of our products.

Customer buying patterns did not appear to be back to normal but they definitely improved. I will focus most of my comments about financial results today on that fourth quarter which is where the news is.

Before I get into specifics, please note that there are few factors including two major transactions that affect results and comparisons. First we completed the sales, most of the assets in operations of our Customer Networking Solutions division to NETGEAR.

This CNS sale transaction closed on April 15, 2011. Westell retained one customer and as planned and announced have been winding it's sales to that customer during the fiscal year.

Second, Westell sold its Conference Plus subsidiary on December 31, 2011. As a result of this sale transaction Conference Plus is reported as a discontinued operation and its results are no longer included in historical results for continuing operations.

Third, the prior year fourth quarter included about $53.2 million tax benefit as a result of releasing valuation allowance against deferred taxes. In fiscal 2012, fourth quarter contains some tax adjustments as well, albeit much smaller ones.

Also of note we have renamed the Outside Plant System division also known as OSP. It is now the Westell division. For the fourth quarter of FY '12, Westell Technologies reported consolidated revenue from continuing operations of $11.3 million compared with $38.5 million in the fourth quarter, a year ago.

Conference Plus revenues are not included in either period, the decline results from the plant reduction in CNS revenue which dropped by $22.7 million and from a $4.5 million dollar reduction in Westell division revenue.

EPS for the quarter under Generally Accepted Accounting Principles was a loss of $0.04 per diluted share. This compares with income of $0.79 per diluted share in the prior year fourth quarter. These results include impacts from the CNS and Conference Plus sale transactions, a one-time claim restructuring and income tax adjustments.

Taking these impacts into account, EPS on a non-GAAP basis was a loss of $0.01 per share in the FY '12 fourth quarter compared to earnings per share income of $0.03 per share in the fourth quarter a year ago. Our non-GAAP results are reconciled to GAAP results on the final page of the earnings news release.

From a divisional perspective, the Westell division reported revenues of $10.7 million for the fourth quarter. This is down $4.5 million or 29% compared with the fourth quarter of FY '11. However, we did benefit from some rebound in the market during the quarter. Revenue for the division is $3 million higher on a sequential basis, up 40% compared to the third quarter of FY '12.

Compared to the third quarter, the fourth quarter benefited primarily from stronger demand for fuse penal, mountings and closures and custom systems integration services.

Gross profit for the Westell division was $4.2 million in the quarter, on a gross margin of 39.1% compared with $6.3 million and a 41.8% margin in the FY '11 fourth quarter. The lower gross profit in margin in the latest quarter resulted from lower revenues, lower absorption of fixed costs and changes in the mix of product sold.

Westell division operating expenses increased from $3.2 million in the fourth quarter of FY '11 to $3.8 million in the FY '12 fourth quarter reflecting higher costs incurred to develop new products, a higher share of allocated costs and a restructuring charge for termination benefits related to the consolidation of some of our Canadian operations into our Aurora location.

Lower selling cost in the FY '12 fourth quarter related to the lower revenues, partially offset these increases. The division therefore reported operating income of $346,000 for the quarter compared with operating income of $3.2 million a year ago.

The CNS division, had revenues of $625,000 during the fourth quarter from the sales, software, services and miscellaneous ancillary products related to it's gateways business because we have discussed many times that business is in wind-down mode, with it's sole remaining customer.

The fourth quarter of FY '11 which was before the CNS sale transaction had revenues of $23.3 million. However the operating losses for the division where about the same in both periods. Remaining CNS activity and operating expenses relate almost exclusively to Homecloud development.

On a consolidated basis, we had $1 million in unallocated corporate cost for the quarter, which brought the consolidated operating loss from continuing operations to $1.2 million.

Income taxes related to continuing operations were $1.7 million. As I noted at the beginning, there were tax adjustments during the fourth quarter including an increased evaluation allowances against deferred tax assets in a handful of states. What that means in essence, is that we expect some of our net operating loss carried forwards in those states to expire prior to our ability to offset them against future taxes. Aside from these sorts of adjustments, our underlying income tax rate is about 39% and our rate for cash taxes is about 3%.

For the full year, revenue from continuing operations was $69.7 million, compared to a $147.8 million in FY '11. Net income was $42 million compared to $67.9 million in FY '11. On a non-GAAP basis, as I previously described net income was $0.7 million for FY '12 compared to $14.5 million in FY' 11.

On the balance sheet, we had a $142.7 million in cash and short term investments at March 31, 2012. This compares to $86.9 million at March 31, 2011and $149.4 million at December 31, 2011. The large increase over the fiscal year is driven primarily by the proceeds from the CNS and Conference Plus sale transaction.

Our share repurchase program has also been active during FY '12 and represents the largest use of cash during the year. During the fourth quarter, we repurchased 2.1 million shares at a cost of $4.8 million bringing that annual total of purchases to 6.6 million shares at a cost of $17.4 million. It was approximately $12.5 million remaining as of March 31, for additional share repurchases under existing board authorizations.

With that overview of the financial results, I would now like to turn the call over to Rick Gilbert, Westell's Chairman, President and Chief Executive Officer. Rick?

Rick Gilbert

Thanks, Brian. During the last earnings call I reviewed our strategic plan and the progress we've made over the past three years to implement that plan. During this call, I'd like to focus on our market segments where Westell is active, especially those where we've introduced new Westell products.

Those of you who listen to our last call may recall that our goal is to sell differentiated products to a common set of customers through established sales channels. We specifically want to avoid selling commodity products or selling against the telecom giants.

I also said, we will compete in two product categories, wireline and wireless. Finally, I said that we would invest in both internal development and acquisitions to create new product lines. Our acquisition of ANTONE Wireless announced yesterday is a good example of the latter approach.

However, before I describe the new products, I would like to touch on some of our existing market segments all of which are described on the Westell website.

On the wireline side of our business, we currently compete in seven distinct market segments. One is SONET/TDM Solutions, which include our T1 and T3 network interface units and T1 Repeaters.

Another is power distribution products, which include a wide variety of fuse and breaker panels. There are also copper and fiber connectivity products and remote site monitoring products. And an important fifth segment is composed of our cabinets, enclosures and mountings.

I would also add to this list Custom Systems Integration Services, which is a little newer to Westell. In this area we have leveraged our cabinets and enclosures business to sell equipment integration services that are performed here at our facility in Aurora, Illinois.

During our most recent quarter, we saw an increase in orders for the CSI services, a trend we expect will continue in the coming quarters. The last for the Wireline segments, which is also newer, is our Ethernet Solutions segment.

During the past two years, we've applied engineering, marketing and sales resources to develop a line of Ethernet products for using carrier and industrial applications.

Today, we've sold a few products in both areas, but overtime we've refined our focus to concentrate on the market for hardened Ethernet switches. A market that ARC Advisory Group sizes at about $180 million for North America, with the compound annual growth rate of about 7%. In this area, we've developed products that are truly differentiated in both function and cost.

Although, industrial Ethernet is a new market for Westell, we believe we're well positioned relative to the competition. By comparison, our carrier products appear to be functionally equivalent to those offered by vendors who already have established positions with major carriers. And we have more resources to bring the bear on developing these continually changing products.

For some applications that seems to us the carrier Ethernet is becoming the selling against telecom giant's scenario that we specifically wanted to avoid. Therefore looking forward, we expect to have more success in the industrial Ethernet market then in the carrier Ethernet market.

Now let's discuss the wireless side of our business. One of the most active wireless areas is the distributed antenna system or DAS market segment, which according to NPD In-Stat, is approximately a $3 billion market in the U.S. this year. That market estimate includes equipment, installation services and neutral host operator services.

During the fourth quarter, we've released production versions of our new DAS Interface Panels, which address an attractive opportunity within the DAS market. These products bring together key components including duplexers and variable attenuators to precisely tune the signal strength from the BTS or base transceiver systems for optimal performance of DAS installations.

Our current products cover all four frequency bands use to North America and are appropriate for both indoor and outdoor installations. We've already made our first sale of these products to a regional wireless service provider and our DAS Interface Panels are currently been evaluated by Tier 1 North American wireless operators.

Westell's newest products come from our acquisition of ANTONE Wireless which we announced yesterday. Cell-site optimization is the key market segment that we've targeted with the wireless strategy I described during our last earnings call.

As of today, Westell ANTONE products include Tower-Mounted Amplifiers often refer to as TMAs, Multi-Carrier Power Amplifier Boosters and cell-site Antenna Sharing Solutions. The outstanding development team at ANTONE has created products that are best-in-class and cover our market with significant growth potential.

For example, TMAs or Amplifiers that are mounted at the top of cell towers and used to enhance the cellular receive paths, thus eliminating many dropped calls and dropped data packets. The market for Tower-Mounted Amplifiers and Filters has been estimated by MOBILE Experts LLC at $260 million per year in North America, which is certainly significant from our perspective.

Finally, ANTONE TMAs have already been approved and are being deployed by major U.S. wireless operators for 4G/LTE site optimization. In short, these TMAs represent exactly the kind of differentiated wireless product that we wanted to add to our Westell portfolio.

Time doesn't permit reviewing all the new Westell, ANTONE products during this call. However, our website was updated yesterday to include the new products and suffice to say that we believe that cell-site optimization represents an attractive growth opportunity for Westell.

Although, this segment will require investment during the current fiscal year, we expect the ANTONE acquisition to be accretive by next year.

Finally, I know there is a lot of investor interest in the Homecloud update. During the past three months, the Homecloud team has made very good progress, but the product is still not quite ready for first release. I can tell you however, that the development team continues to work diligently in preparations for an internal beta of release and planned limited external release.

I wish, I could be more definitive on the release dates but our previous attempts at publicly estimating Homecloud dates have simply not been reliable. I can say that is a very interested alpha tester, I personally use Homecloud everyday with both my office PC and my iPad.

In conclusion, as Brian said in his remarks, we saw a good sequential revenue growth during the fourth quarter of FY '12. I also believe that by actively competing in the 10 market segments I just listed, Westell is well position to continue growing revenue over the coming quarters, despite the challenging North American telecom marketplace.

We will continue to add new products through both organic development and acquisition. And we are strategically committed to increasing our product portfolio both in the Wireline and Wireless market segments over the long-term.

With that, I'd like to open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question is from Mike Latimore from Northland capital.

Mike Latimore - Northland Capital

Couple of questions here, you have a nice rebound in your Westell product sales of the quarter. With that kind of mix you now have been and maybe what you see going forward. And how should we think about the gross margin profile for the Westell group at this point?

Brian Cooper

Well, Mike, the two main categories are sort of our switches and plugs and our enclosures that sort of drive that. They have similar gross margins, but they're slightly lower in the enclosure side.

The real reason that we had some lower gross margins recently is because of the low volumes of sales and covering our fixed cost. So I think what you're seeing in the last quarter is representative of what it should be going forward in the 39% and low 40s is certainly reasonable.

Mike Latimore - Northland Capital

And then historically for the wireless Backhaul markets; it's been somewhat of a driver of the business, I guess, where would you say are some of the main macro drivers of your current products?

Rick Gilbert

Relative to Backhaul or in general?

Mike Latimore - Northland Capital

Just in general. In terms of what's driving the business down?

Rick Gilbert

As Brian said, most of the products on a sequential basis for most of our products we saw a rebound. In terms of what we're seeing a lot of interest in right now, the cabinets and closures area saw some significant sales in the last quarter and coming along with that we saw a significant increase also in the customer service integration programs that we're putting in place here.

Having said that as I said most of the other products certainly a saw a rebound from the previous quarter. And now that we are adding effectively two new market segments the DAS market segment and the cell-site optimization market segments, we're really going to be focusing also on the wireless side of our business.

By the way, we already made some sales in wireless with our fused panels. But this acquisition coupled with our new DAS panels, really gives us a running start in wireless and we're going to be focused on that going forward.

Brian Cooper

And Mike, just to the sort of if you're asking on a more of the macro basis, if you meant all kind of customer activities are driving the purchasing, I think, telecom is working on building up there wireless network. So they is probably more of our demand coming from that kind of activity directly or indirectly than in the past.

Rick Gilbert

And certainly, related to 4G/LTE which is the pretty hard for budgets right now.

Mike Latimore - Northland Capital

A lot of discussion about small cell initiatives at CTIA last week, assumes your various products here, the DAS products and ANTONE products kind of fit into that theme?

Brian Cooper

Exactly. The DAS panels are a niche market within DAS, but it's an important area, because it effectively standardizes stuff that used to be put together with a bunch of components and so we're thinking that's going to be a good start in the DAS base.

Mike Latimore - Northland Capital

Last question, so on the ANTONE acquisition, I know you have a pretty excessive acquisition strategies. Is it the type of acquisitions we should expect kind of small tuck-in or are you looking at some mid-size acquisitions too?

Rick Gilbert

We're trying to avoid categorizing our acquisition strategy as by size. We're really focused more on the type of product. The thing we liked about ANTONE, it's a very small company but it has just an outstanding RF engineering team.

We compare their products with the rest of the products in the market place and we think that they're clearly the best and the important thing from our perspective is that those products are dead-center on the mostly interesting piece of wireless from our perspective which is cell-site optimization because as the wireless carriers roll out these 4G/LTE networks.

As the networks roll out and once they are rolled out, it's going to be more and more emphasize the cell-sites. And the two areas that are most interesting frankly, one you already mentioned, the small cell-sites, the DAS. Those are extensions. And the other is optimizing the macro cell-sites.

And so a short answer to your question, we're not going to shy away from small acquisitions if they are dead-center on strategy. We're also going to be knocking those shy away from mid-size if they fit our strategy and I hope that helps to answer the question.

Operator

And the next question is from Greg Burns from Sidoti & Company.

Greg Burns - Sidoti & Company

Couple of more questions around ANTONE. Can you give us maybe a little more color about the profitability or the margin profile of that business? And it sounds like they have some cells currently at some of the tier-ones, could you just give an idea, may be what that the pipeline there looks like, maybe with the existing deployments that they have out there and potentially new carriers signing on?

Brian Cooper

Sure I think the gross margins for the kind of products they sell will be in the 40% to 50% range which matches our strategic goals for the Westell division. In terms of the sales to tier one, as our press release said, they only did $2 million effectively last year. But they were just beginning sales to one of the big tier ones and we'll see how we can ramp that.

I think that we have the ability and from our operations side of the business to very effectively build their products and take them to the marketplace with a much larger sales force. The good news is they are approved in every region. One of the tier ones relative to 4G/LTE self-side optimization use and they have already been beginning installations.

Greg Burns - Sidoti & Company

And how many employees were brought on with that acquisition?

Brian Cooper

Eight.

Greg Burns - Sidoti & Company

And in terms of carrier certification on the Ethernet products, any update on that timing wise?

Rick Gilbert

No, we're still banging away of that stuff. I mean, large carrier certification of any new products takes a lot of time and there is never a guarantee as we have said in the past. As I did say in my remarks, as that goes on, of course we're focusing more and more on the industrial Ethernet market where we see a clear path to selling product. but we're certainly not giving on getting carrier certification for our carrier products as well.

Greg Burns - Sidoti & Company

On the industrial side, could maybe highlight one or two used cases, gives the better idea of what the applications are and also you kind of talked about your functional cost advantage in that space. Could you just maybe, outline where your advantages are in that market as opposed to carrier Ethernet.

Brian Cooper

Greg, in the industrial space it's a pretty wide sort of applications. Anywhere you need to put an Ethernet product that is hardened and capable of withstanding severe elements and also capable of in our case, for instance powering devices off the Ethernet.

So you see security applications, you see utility application, you see energy sector applications. And in many cases, you see integrators or VARs, they're actually building up sets of products for a specific application that (inaudible) industrial Ethernet switch. And the advantage we have when we were building the products originally for the carrier market space cost was very, very important and so we ended up building a very low cost switch which we also built as a hardened switch.

And when we looked at the industrial Ethernet market that was out there, we were able to price it at far lower level than other players and even though we're brand new to the marketplace, we're getting attention on that basis and also on the basis that our products have some specific features relative to the power of Ethernet for instance that some of the others haven't implemented.

Greg Burns - Sidoti & Company

Who are some of the other players that you're seeing in that market?

Rick Gilbert

Well, there is Gericom. Obviously, RuggedCom in Canada is a big player. Sixnet is an industrial player that sells some Mil-spec devices. There is a lot of little players, but there not the telecom giants that we don't want to compete against. These are guys that we think we can compete very successfully against.

Greg Burns - Sidoti & Company

In terms of revenue contribution in this quarter, is it the minims?

Brian Cooper

In the quarter, we just announced it was the minims, but as I said we've made sales on both the carrier side and the industrial side this quarter, but small sales.

Operator

And the next question is from Jeff Linroth from Leaving It Better.

Jeff Linroth - Leaving It Better

Well, this new acquisition of ANTONE certainly fits the bill you've been describing. Couple of questions about that, among those people coming to Westell is Mr. Michael Eddy one of those people.

Brian Cooper

Yes. Mike Eddy and Greg Hey-Shipton are both coming to Westell.

Jeff Linroth - Leaving It Better

How big a factor were the company's patents and your decision to acquire and would you consider them incremental to your existing portfolio or something of leap forward?

Rick Gilbert

In terms of patents and intellectual property in general, I mean we've really focus more on the products when we value our company. Patents are obviously potentially valuable, but to smaller players like Westell they're often more valuable in the defense of manner rather than an offense of manner.

So I think what we liked best, to be honest about ANTONE is just a fantastically good RF engineering team and the products they have already built are very impressive.

All right, and that's where we really wanted to focus on. And as you've pointed out yourself, Jeff, I mean we've talked about a strategy for a long time that had a central point for wireless cell-site optimization and these products just fit perfectly.

Jeff Linroth - Leaving It Better

That's exactly how it works. In terms of their cash flow in last three years, it's been negative, neutral or positive and most importantly in what direction has it been trending?

Rick Gilbert

Well, it's been a startup, right. And so as startups are up and down and very cash constrained. But as we've said in the remarks, I mean the product exists. The TMAs exists, the booster amplifier exists. And at this point, I think what they really need is an injection of operational in sales efforts to sale those products and build them in larger volumes.

And the fact that a startup of their size got the kind of attention they have gotten from major carriers is actually remarkable, if not unprecedented. And the fact that Westell now is selling those products, I think will be a very helpful to the sales picture. So I think they made great progress as a startup. It was a six-year old startup and a lot of great engineering work went into that.

Jeff Linroth - Leaving It Better

And I snooped as much as I could to try to identify competitors and as you were speaking earlier in the call about I think another product group. It seems that the competitors are mostly small, the only one I recognized was Texas Instruments. Who are the stronger two or three competitors you would identify for this new acquisitions products.

Brian Cooper

Well, I mean in the area of some for instances, Tower-Mounted Amplifiers are the biggest competitors are power way which is having a lot of issues as you know. Nothing to do with having Tower-Mounted Amplifiers and ADC, Tyco builds TMAs. Those are the kinds of players, but this is certainly a case where the nature of the product is what sells the product and if you have the best one, to helps them which we do.

Jeff Linroth - Leaving It Better

And then just lastly, if you don't mind, how did you discover and become interested in ANTONE?

Rick Gilbert

Well, one of our board members was aware of ANTONE, and introduced them to us. And we were very impressed as I said with the team and the products. And we've been talking all for the last six or eight months.

Operator

(Operator Instructions) And the next question is from Todd Brady from Oppenheimer.

Todd Brady - Oppenheimer

I apologize for hopping on the call a little bit late and the majority of my questions have already been answered. It has been a couple of quarters since I have listened to your call. Are you offering any guidance on where you see cash over the next couple of quarters or because you have potential acquisitions on your plate, visibility and talking about where you see cash flow and net cash and these sorts of things and what type of revenue growth you might be seeing are off the plate?

Brian Cooper

We don't really give guidance on where the business is going financially. Our cash generation over the years has been up and down, but it's been up for the last couple of years. So we've got cash in the bank and it really depends on where we're investing and so forth.

Todd Brady - Oppenheimer

I noticed that you guys have a share repurchase program. And you guys repurchased couple of million shares this most recent quarter, when does the share buyback program expire?

Brian Cooper

It doesn't have a stated expiration. It has about $12.5 million remaining on the authorization.

Operator

And we have a follow-up question from Greg Burns from Sidoti & Company.

Greg Burns - Sidoti & Company

I was just wondering if you could share this, where your cash balance is as of today?

Rick Gilbert

We really don't do that, for mid-quarter.

Operator

This does concludes the Q&A session of today's call. I'll turn it over to Mr. Gilbert for closing remarks.

Rick Gilbert

I would like to thank everybody for joining us for this call. And we look forward to next earnings call with a lot of interest. Thanks very much. Bye.

Operator

Thank you, ladies and gentlemen. This does conclude today's conference. Thank you for participating. You may now disconnect.

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