Harris Stratex Networks F2Q08 (Qtr End 12/28/07) Earnings Call Transcript

Jan.30.08 | About: Harris Stratex (HSTX)

Harris Stratex Networks, Inc. (HSTX) F2Q08 (Qtr End 12/28/07) Earnings Call January 30, 2008 5:30 AM ET

Executives

Mary McGowan - Co-Founder of Summit IR Group, Inc.

Guy Campbell - President and CEO

Sally Dudash - VP and CFO

Analysts

George Iwanyc - Oppenheimer & Company

Blaine Carroll - FTN Midwest Securities

Steve Ferranti - Stephens, Inc

Matthew Robison - Ferris, Baker Watts

Kevin Dede - Morgan Joseph

Operator

Welcome to the Harris Stratex Networks conference call. (Operator Instructions)

I'll now turn the conference over to Ms. Mary McGowan, of the Summit IR Group. Ms. McGowan, you may begin.

Mary McGowan

Thank you for joining us today to discuss the Harris Stratex Networks financial results for the second quarter of fiscal 2008. On today's call will be Guy Campbell, President and Chief Executive Officer; and Sally Dudash, Vice President and Chief Financial Officer.

During this conference call, we may make forward-looking statements regarding our business, including statements relating to projections of earnings and revenues, the volume, timing and mix of our product orders, continued network expansion by mobile and private network operators, the timing of expected synergies and operating efficiencies, and the successful integration of the operations of the former Microwave Communications Division of Harris Corporation, which we'll refer to as MCD, with those of the former Stratex Networks, we will refer to as Stratex. These and other forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. For more information, please see the press release and filings made by the company with the SEC.

In addition, in the tables of our press release and on this teleconference we may discuss certain information that is non-GAAP financial measure. Reconciliation from the comparable GAAP measures is included in the tables of our press release and on the Investor Relations section of our company website, www.harrisstratex.com. We believe the supplemental non-GAAP financial results, which are used by management, reflect the basic operating results of the company, and will facilitate comparison of operating results across reporting periods.

Now I would like to turn the call over to Guy Campbell.

Guy Campbell

Thank you, Mary and thanks to all of you for joining us today.

Our second quarter continued to demonstrate strong topline momentum. North America posted record second quarter revenues. The combined Asia Pacific, Latin America regions surged 54% over the prior year and network operations client, an impressive 30% year-over-year.

To be sure, we still have areas that need work and opportunities that need to be captured. But we are proud that we were able to meet customer demand, be the provider of choice for many operators around the world, and hold or increase our market share in key growth areas.

In the second quarter, we continued to see improvement in most financial metrics of the business. Let me share with you some of the highlights from our second quarter of fiscal 2008.

On a non-GAAP sequential basis, revenue for the December quarter increased 5% to $181 million. Gross margin improved 100 basis points to 31%. Net income increased 22% to $12 million and earnings per share increased $0.04 to $0.21.

By segment, North America revenue was solid, at roughly $64 million. International revenue was approximately $111 million. And network operations had another strong quarter with $6.5 million. We have realized the expected cost savings of $14 million from our merger in the first half of fiscal 2008, and we are on track to achieve our $35 million goal for the full year.

While gross margin improvement did not rebound as much as expected, our strategy is still aimed at achieving margin expansion, which we believe is a formula for delivering shareholders value. Later in the call, I will provide comments on our market and product positioning, as well as an update on our financial guidance for the year.

Now I'd like to turn the call over to Sally for a review of the quarter's financial details. Sally?

Sally Dudash

Thank you, Guy and good afternoon everyone. Let me start with a review of the GAAP financial performance of Harris Stratex Networks for the quarter ended December 28, 2007. Second quarter revenue was $181 million and we reported a net loss of $1 million or $0.02 per share.

We believe the supplemental non-GAAP financial results reflect the basic operating results of the company and will facilitate comparison of operating results across reporting periods. Our non-GAAP income statements exclude the charges that resulted from the merger transaction, integration costs, asset impairment and stock compensation expense. Please refer to our website for complete GAAP to non-GAAP reconciliation tables.

For the second quarter of fiscal 2008, these non-GAAP charges totaled $17.6 million and are composed of the following: $7.6 million for integration and restructuring charges, $3.8 million asset impairment, $3.6 million amortization of purchased intangibles, $1.9 million for stock compensation expense, and $700,000 amortization of fixed assets fair value step-up.

The following discussion is based on our non-GAAP results. Revenue for the quarter at $181 million was an increase of 5% compared to Q1 and also a 5% increase from the second quarter of fiscal 2007. New product revenue, which we define as revenue from products less than three years old, was 61% of total revenue.

By segment, North America microwave contributed a record $64 million of revenue, 13% higher than Q1 and increased over the year ago quarter. Q2 is traditionally our strongest quarter in this segment. North America revenue in Q2 saw strength from increased bandwidth demand, footprint expansion and 2 gigahertz microwave relocation for Advanced Wireless Services from mobile operators.

The network operations segment contributed $6.5 million in revenue in the quarter comparable to the first quarter of the year and 30% higher than Q2 of fiscal 2007. Increased demand for this segment's service assurance solution, with next-generation network customers is fueling revenue growth. Gross margins in both of these segments are on plan and delivering to our expected results.

The international microwave segment contributed $111 million of revenue in the second quarter, also comparable to Q1 and 7% higher than the year ago period. Strong gains were achieved in our combined Latin America and Asia Pacific region with a 57% sequential increase in revenue as the company's focus on capturing new customers, particularly in Asia Pacific, gained traction.

Revenue from EMEA was comparable to the first quarter, and Africa revenue decreased by 22%, compared to Q1, as a result of operator consolidations and slower implementation of 3G networks in these regions.

Gross margin was 31.1% compared to 33.9% in the second quarter of fiscal 2007 and up from 30.1% in the first quarter of fiscal 2008. Compared to the first quarter, we were able to recoup 1 percentage point in gross margin versus the 2% that we had anticipated. Product mix returned to more normal levels, which would have produced the 2% improvement.

However, overall gross margins were impacted unfavorably by a combination of a mix shift between the Africa region and Latin America, Asia Pacific, and an increase in the cost of services and freight compared to Q1 and our expectations. We are taking immediate steps to reduce the added cost to improve performance in the second half.

Total operating expenses declined from $40 million or 23% of revenue in the second quarter of fiscal 2007 to $39 million or 22% of revenue in Q2 of fiscal 2008. However, OpEx increased by $900,000 compared to the first quarter of the year.

Although expense synergies are being realized according to our plan, we have seen an increase in G&A, related primarily to ensuring SOX readiness for the new company that was not previously anticipated at the levels we have experienced. R&D spending was $11 million in the second quarter or 6% of sales. We are addressing the spending in G&A to return to planned levels in the second half of the year.

Depreciation and amortization of property, plant and equipment and capitalized software was $4 million. CapEx for the quarter was also $4 million.

Operating income was $16.8 million and net income was $12.1 million or $0.21 per share, an increase of 24% from Q1. Our pro forma tax rate remains at 26% and our cash tax rate remains at 2% to 3%. Employee headcount was reduced in the quarter from 1,410 to 1,400, and is in line with our integration plans for headcount reductions.

Moving on to the balance sheet Harris Stratex's cash balance, including short-term investments, was $83 million at the end of December compared to $79 million at the end of September. Operating cash flow for the quarter was $10 million, an improvement of $8 million from the first quarter.

Inventory and unbilled decreased by $12 million in the quarter, primarily from billing milestones being reached on several of our large North America's systems projects. Inventory turns, including unbilled, were 2.8 compared to 2.5 in Q1 of FY '08.

We had an increase in DSOs to 112 days in the second quarter compared to 107 days in Q1. But this was the result of the billing achieved on the North America jobs that moved into accounts receivable as noted above, and the fact that most of this occurred in December. We expect these receivables will be collected within the current quarter. We continue our initiative to decrease DSOs and improve inventory turns and are encouraged with the overall balance sheet progress in the quarter.

And now I will turn the call back over to Guy for a market and outlook discussion. Guy?

Guy Campbell

Thank you, Sally. Let me talk about our markets, our growth opportunities and some of the successes we are seeing. Mobile wireless momentum is indeed everywhere. Mobile networks will cover 90% of the world population by 2010. There is steady existing and new network growth. 3G subscriptions grew 90% in 2007 and traffic generated by mobile networks tripled. There is growing demand for greater bandwidth especially in backhaul networks.

This past quarter, we continued to see revenue momentum and strong customer demand across our major business segments. In North America, we saw record revenue this quarter. This is in a market typically dominated by leased lines, but we are increasingly leased line substitution, due to network footprint expansion and the need for more bandwidth is creating strong demand for our products and services.

In North America, we're seeing demand driven by the migration from 2G to 3G and we continue to see spending for 2 gigahertz microwave relocation for Advanced Wireless Services. We believe the utilization of new spectrum for the Advanced Wireless Services spectrum could provide an overall opportunity of up to $150 million in North America over the next two to three years.

In Q2, the split between mobile operators and private networks was 68% versus 32%. As you may recall, the split, taken over a 12-month period, is typically 50:50. We would not be surprised to see leased line substitution, and other North American mobile network revenue drivers continue to move the revenue distribution more heavily aligned towards mobile operators.

Despite this possible revenue shift, private and government networks remain an important part of our customer base. In Q2, we announced a contract with the Columbia River Inter-Tribal Fish Commission for our Constellation radios. This deployment will enhance Oregon's statewide communications and public safety backbone network. We also see the availability of homeland security funding, enabling increased growth in private networks.

I am pleased to announce that Harris Stratex has been selected by Boeing as a digital microwave subsystem provider for the Secure Border Initiative Network. At the local government level, we have been awarded a $7.7 million contract by the San Jose City Council, to furnish and install the ECOMM microwave interoperable communication system, carrying fast traffic for police, fire and emergency medical services.

These are clear examples of private networks seeking our expertise in designing and building transmission networks for mission critical applications. The record levels of revenue in North America were achieved with strong gross margin levels. We believe the strength can be attributed to our customer-centric focus, our end-to-end transmission capabilities, transport access carrier-grade Ethernet systems and software, network management solutions and turnkey professional services.

During Q2, we co-sponsored a survey of mobile operator's backhaul requirements with a leading market research firm. One of the findings applicable to all our markets, was that existing backhaul traffic capacity is increasingly stressed, but also that the operators must find ways of handling this capacity without significant increases in CapEx or OpEx budgets.

This provides Harris Stratex with an opportunity for traffic engineering in backhaul capacity management, using our service assurance tools, whether with wireless or other transmission technologies.

As I've said many times before, a key differentiator for us is the breadth of the product portfolio. We provide solutions for all types of wireless networks from low-capacity voice networks to high-capacity IP network supplying voice, video and data all on the same network. In addition, we offer services to help our customers, world-wide, monitor and manage their networks. In area, where we are seeing greater success with key network management wins.

That brings us to our network operation segment, whose impressive 30% year-over-year growth is driven by our NetBoss product suite. Our network management capability is not the typical element manager capability that many independents have in our space.

Our NetBoss product suite and turnkey services provide our customers with top level management systems to effectively operate all elements of their voice, data and video networks. We are increasingly seeing network operation opportunities in executing on them worldwide, especially in the Middle East and Africa.

As testimonial, we recently noted that due to a service provider in the United Arab Emirates, we purchased the services unit system for its network based on our NetBoss product suite. NetBoss will provide a comprehensive solution for these customers quad play network, which offers voice, data and video services over a converged fixed and mobile network.

Also in Q2, we announced the selection of NetBoss by Bahrain-based Batelco, a leading regional telecom provider, will deploy in advance NetBoss services assurance solution for Batelco's transport and next generation networks.

As Sally pointed out, our revenues in international increased 7% over the year ago period with strength across most major business segments. The drivers are new Greenfield Networks, continued subscriber growth, mobile network expansions and backhaul traffic increases and the transition to IP transport in operator networks.

It's worth noting that the pace of growth can be sporadic depending on the region. Variability, due to the timing of large network rollouts, as well as the impacts from civil unrest can and will occur. But we believe the scope of our operations enables us to maintain the trend of revenue momentum we have demonstrated.

In Asia Pacific and Latin America, we are clearly improving our market position. Revenue saw a jump of 54% year-over-year, which positions us well for the future. In Asia Pacific, we are gaining market share and we won new accounts in countries that include India, China, the Philippines, Sri Lanka and New Zealand.

And we are engaged in a number of 3G expansion rollouts with Eclipse Super-PDH radios. We believe these sales will provide us with the opportunity to improve our margins, as customers expand their capacity through software upgrades.

Earlier this month, we announced the win with iZZinet, a Malaysian service operator to provide Eclipse radios for its nationwide wireless broadband network rollout program. Our engineers from the Asia-Pacific region created a unique network design with all radio network-like transporting Carrier-grade Ethernet services for this innovative operator.

Africa remains a key growth area and we are seeing a pick up in activity as new orders and new partnerships emerge. Our position in this region to remains strong, even while the market is undergoing disruptions from mobile operator consolidation and to a lesser extent, civil unrest in some countries.

Earlier this month, we announced a multi-million dollar agreement with Starcomms, Nigeria's leading CDMA operator, to supply Eclipse radios as part of the 3G network expansion into new cities throughout Nigeria. Our continued selection to work with the largest operators throughout Africa is testimony to our strong reputation and long standing relationships in the region.

We were met with challenges in Europe, the Middle East and Russia in Q2. In Russia, we experienced a lag in sales due to slower implementation of 3G upgrades. But, we remain close to our customers here and see a number of opportunities in Russia on the horizon. In the Middle East, we saw a number of push outs to Q3 improving our backlog as we enter the quarter. In Europe, we secured some significant wins and there are number of opportunities that we are pursuing aggressively.

In December, we announced one such win with Sonaecom, a Portuguese operator. Here we'll connect base station transceivers across Northern Portugal, using the Eclipse platform in a range of services including network design, site surveys, installation commissioning and training.

In countries such as Portugal, where leased-line prices remain relatively high, there is a strong business case for using microwave radio in the access in backhaul network when deploying or upgrading wireless networks to offer new high-speed mobile internet services. Because of its carrier-grade Ethernet transport capability, Eclipse is quickly becoming the first choice backhaul solution for mobile broadband wireless providers.

Other areas of interest include WiMAX, while the adaptation continues to progress as networks are being deployed. The number of WiMAX networks we are participating in is increasing with opportunities extending into markets including Europe, Africa and the Middle East.

During the quarter, we added a number of key WiMAX customers. Let me tell you about two of them. TDF, a French converged service provider will deploy our Eclipse wireless transport platform to provide high-speed gigabit Ethernet connections for their WiMAX network.

As radio frequencies become more difficult to obtain in France, the ability to deploy high-capacity links in the minimum bandwidth enables TDF to deploy links in regions where frequencies may not otherwise be available. Our ability to provide scalable bandwidth from 10 megabits over 600 megabits per second in a single radio channel was a clear differentiator.

Another recent win with French WiMAX operator was Altitude. This network will also be based on our Eclipse microwave radio, which is ideally suited to support WiMAX backhaul traffic. Eclipse has proven to be the reliable product of choice for WiMAX backhaul, as the only radio to support carrier Ethernet transport with layer II quality of service.

We continue to be engaged in consulting for IP transport network design, traffic optimization, planning and turnkey implementation for WiMAX networks, in addition to providing backhaul solutions.

Now, let me talk about our products. Customers depend on us to develop differentiating technology and offer a breadth of solutions. Our investment in R&D remains as large as any in our industry, and will continue to fuel our product innovation. This engineering commitment enables us to maintain our technology leadership and offer our customers superior solutions and services.

In Q2, we introduced to begin shipments of a new Eclipse Gigabit Ethernet system, which also is TDM capable. In addition to meeting the needs for operators using pure IP transport, this new product delivers an IPO solution for operators requiring TDM services today with a software migration to gigabit Ethernet tomorrow.

Eclipse, Gigabit Ethernet is other Eclipse Ethernet offerings have superior throughput in packet handling capabilities, as well as highly competitive network features, and have been gaining momentum in pure IP segment of the market, as well as in applications using both TDM and IP.

As a reminder, TRuepoint 6400 and all indoor radio solution begin shipping in Q1 and North America for deployment of an all IP network in Kentucky. This introduction represents an opportunity for revenue and margin improvement in the high capacity transport segment of the market.

Product shipments increased in Q2 and will continue to ramp in the coming quarters. We will continue to rollout additional TRuepoint 6400 frequencies, capacities and software defined features in the coming quarters. Market feedback for the TRuepoint 6400 continues to be very positive and we expect these new future releases will help drive North America orders for the balance of fiscal 2008 and beyond.

We are now actively selling the TRuepoint 6500, which offers full featured long-haul trucking platform. We expect to start delivering this solution in the second half of the year.

Looking ahead to calendar 2009, we are working on our next generation Ethernet based product platform. This platform, which combines the best of the best from our TRuepoint and Eclipse platforms, plus new innovations, has exciting potential. We are prioritizing our development efforts into the largest growth areas. We expect this platform to deliver new levels of product performance in cost efficiency, while supporting our customers' network evolution to Ethernet transport.

As has been our practice in the past, we will continue to support our legacy products and to meet our customer needs. Our innovative product line is a clear differentiator and our professional and support services help us to create long-term customer relationships. We lead the industry in our commitment to customer service, engineering excellence and comprehensive field services.

Our services have covered the complete cycle of network implementation from analysis planning, design and system integration to site build, deployment, network monitoring and training. These service capabilities have enabled us to force sustainable long-term relationships with our customers.

Before going into the Q&A, I would like to provide an update on our company's guidance for the year. Based on our results for the first half of fiscal 2008, we have revised our outlook.

Demand remains strong and our targeted regions of the world are still growing, despite difficult environments from time to time. With North America's record revenue growth this past quarter and the gains in the combined Asia Pacific, Latin America region, which was targeted as a growth opportunity earlier in this fiscal year, we are confident that we are increasing our overall market share.

Network operations is quickly establishing itself as an important differentiator in our customer decision-making, and underscores our customer-centric approach to this business. We remain bullish on our outlook for topline growth through the second half of fiscal 2008 and beyond, as we expand into emerging markets. All of these factors give us confidence to increase our revenue expectations for fiscal 2008 from our original forecast of between $670 million and $702 million to between $700 million and $720 million.

As I already mentioned, we are on track to achieve our goal of $35 million in cost synergies by fiscal yearend. However, the full effect is flowing through to our bottomline. Factors such as customer, product and geographic mix continue to hamper our efforts to expand margins. We saw this in the first quarter, and while we did achieve 100 basis points improvement in Q2, it was not the 200 points we anticipated.

Our strategy is still aimed at achieving margin expansion, which we believe, is a formula for delivering shareholder value. We expect to accomplish this through continued operating efficiencies, additional product cost reductions and new product introductions.

However, we now believe that customer product in geographic mix that we experienced in the first half of the year will continue into the second half, and this will limit the rate at which we can expand margins this fiscal year. Therefore, we are adjusting our EPS expectations.

Non-GAAP earnings per share are now expected to range between $0.85 and $0.95 for fiscal 2008. While this EPS adjustment is a disappointment, the forecast and improvement of between 24% and 50% in the second half of fiscal 2008 versus the first half, does show solid sequential improvement and good momentum for Harris Stratex.

We believe that our topline growth will continue, aided by our planned new product introductions. The TRuepoint 6000 family, which has strong gross margins, will continue to ramp sales over the coming quarters. And the planned additions to the already extensive capabilities of the Eclipse product line will enable Harris Stratex to increase its position in the carrier Ethernet and IP networking space, which will further drive revenue with higher margins.

I believe these new, higher margin product introductions, in addition to continued value engineering and additional cost savings initiatives within operations will result in improvements in our earnings for the second half of 2008 and beyond. Once again, I'd like to thank the employees of Harris Stratex Networks around the world for their talent, dedication and efforts.

At this point, I will ask the operator to open the line for your questions.

Question-And-Answer-Session

Question-And-Answer-Session

Operator

(Operator Instructions)

Our first question is coming from George Iwanyc with Oppenheimer & Company. Please go ahead.

George Iwanyc - Oppenheimer & Company

Thank you for taking my questions, Guy and Sally. I'd like to dig in a little more into the gross margin and the OpEx numbers. On the gross margin side, can you explain a little bit more about how the product mix changed during the quarter, and expand on what is going on with the geographic mix that's really weighing on the margin right now?

Guy Campbell

First of all, just like we indicated in the prepared remarks, the product mix has normalized as we had expected during the quarter. So that return to a normalized level did produce what could have been a 2% uplift in the gross margins from the 30% we had in Q2.

Unfortunately, we had the impacts of the geographic mix shift from Africa to Asia Pacific. And with the differing gross margins between those two regions, coupled with the costs that we incurred on our service operations, created another point of gross margin degradation for the quarter. So I think that, in summary, it was geographic mix and the less than anticipated gross margin from our service operations due to higher cost.

George Iwanyc - Oppenheimer & Company

So when you look at Asia Pacific, is the lower gross margin, then, primarily the result of larger contracts and more aggressive pricing in that region?

Guy Campbell

Actually, I think that the gross margin impacts coming out of Asia Pacific were anticipated by us. The levels that were achieved were anticipated. It's just that ,when you have a movement in your revenue from a higher margin region, in this case being Africa to Asia Pacific, which typically has lower margins because of the competitive price nature there, there is nothing really much that you can do about it. And we had to live with that impact.

George Iwanyc - Oppenheimer & Company

Okay. Now if the mix is expected to stay somewhat normal to what it was like this past quarter, what gives you confidence that gross margin will start to improve looking into the second half of the year?

Guy Campbell

Well, first of all, we think that everything that we're doing to improve the gross margins on the services side of the business, which is a controllable element, we will do and that will have an impact in the second half of the year. So, as we said, we're actively taking action to improve our margins on the services business.

Another area we're actively taking action on is on managing the impacts of increasing freight costs that we've seen over the first half of the year to try and handle that, and control that cost. As far as the geographic mix, there is really not a lot that we can do about where customers will buy our products and what mix of products that they will need to meet their network needs. So that kind of falls into the non-controllable area.

But we think that by working on cost across the product lines, if we're able to improve our margins by lowering costs, that will have an impact no matter where the products are sold, and we feel that we need to take that approach. So, we need to work on things we control. And that's lowering the costs of the products, lowering the costs of the services, improving the situation that we have by freight by lowering those costs. And we think by doing these things, we can help with margin improvements.

The other thing we talked about was the introduction of new products. We think as we get more and more of the new products in our mix in the second half of the year, we will improve our margins also through that endeavor. We talked about the TRuepoint 6000 products are now ramping up. They've ramped up from Q1 to Q2, and they'll continue to do so throughout the second half of the year, and into the next fiscal year.

We also have enhancements coming that I mentioned in my remarks on the Eclipse product line that are directed towards the Ethernet and IP networking space, a space that typically has with it higher margins because of the typical applications that those product solutions address.

So, we'll get some margin improvement from new product introductions. We'll get some margin improvement through continuing to work on our cost to lower them in the areas that I mentioned. And I think that if we do these things, we'll continue to see gross margin expansion that we have in our plans. Of course, it wouldn't hurt if we would have more of our revenue coming out of the higher margin areas.

George Iwanyc - Oppenheimer & Company

Okay. And just one final area, Sally, can you give us an idea of the SOX cost that you're seeing that weren't expected, and how long you anticipate to hit G&A, and if there are any other cost in there that were a bit of a surprise?

Sally Dudash

No. It was the SOX compliance costs that were increased over what we an anticipated. I think I will say that SOX compliance, as you might imagine, is an expensive endeavor for any company. And consistent with our merger plans, we have streamlined, moved, combined, and created new processes at our various locations, all of which prompted the need for new documentation and testing.

This is a cost that we will get behind us in the next several quarters. My rough estimate is that it will cost our company approximately $3 million for the fiscal year.

George Iwanyc - Oppenheimer & Company

Okay. Thank you very much.

Operator

All right. Thank you. Our next is coming from Blaine Carroll with FTN Midwest Securities. Please go ahead.

Blaine Carroll - FTN Midwest Securities

Yes. Hi, Guy. Hi, Sally.

Guy Campbell

Hi, Blaine.

Blaine Carroll - FTN Midwest Securities

Guy, can you talk about the demand side of the equitation, maybe the book-to-bill or where your backlog sits, and what type of seasonality do you expect to get from the December quarter into the March quarter?

Guy Campbell

Okay. The book-to-bill for the quarter was less than one, but the book-to-bill for the first half of the year was almost exactly one. Our backlog is still good as we look into the third quarter. Backlog is approximately $230 million. And entering the third quarter, we had about 70% of the revenue that we anticipate for the quarter in backlog. So it's actually a fairly good situation coming into Q3.

As far as the general market, we think the general market is still very strong. We're very happy with our situation in North America and the growth prospects there that we talked about. We're also happy about what we see in the development of market needs for the Ethernet and IT networking products that we have, and in general, just market growth that we see out there for backhaul requirements in mobile networks.

So we think that the market is still strong. And I think that was reflected in the fact that we increased our revenue expectations for the year.

Blaine Carroll - FTN Midwest Securities

Guy, do you expect the March quarter to be weaker than the December quarter because of installations in the winter geographies and so forth?

Guy Campbell

Well, we generally experience seasonality in the third quarter where the third quarter has been typically our weakest quarter of the four. And we anticipate that Q3 could be down from Q2, which it has been historically, but nothing outside the normal historical seasonality trends that we've always seen.

Blaine Carroll - FTN Midwest Securities

Okay. And then one of the markets that you talked about was India, and I thought commentary in the past was that India was a tough market to make money and therefore wasn't a big concentration for the company. I am wondering if you could give us an update on that.

Guy Campbell

Those statements from the past are still true and in the present, India is a tough place to make money and it hasn't been a strong area focus for us. However, we believe that in any other geographic markets where we see opportunity to drive revenues at reasonable margins, that we will pursue those activities. We did find a few of those situations in the second quarter and we're able to capitalize on them. But you are right from a significant standpoint, India is still not a significant market for us, but it is an area where we will take opportunities as they present themselves.

Blaine Carroll - FTN Midwest Securities

Okay. And then, one other thing that, Sally, you touched upon was the fact that the mix would have given you back the 200 basis points in margin, but these are the issues weighed on it. Can you give us any idea of how much the cost synergies would have added to gross margin?

Sally Dudash

Well, the cost synergies are executing according to plan.

Blaine Carroll - FTN Midwest Securities

Yes.

Sally Dudash

If you want to know what would have happened, if we had not incurred these added charges?

Blaine Carroll - FTN Midwest Securities

Yeah, that's fair.

Sally Dudash

So we have done that analysis and think that, if the other cost had not been incurred, we would have seen a 3% to 4% improvement in margins compared to Q1 versus the 1% that we did.

Blaine Carroll - FTN Midwest Securities

Okay.

Sally Dudash

And that might have translated to approximately $0.04 per share.

Blaine Carroll - FTN Midwest Securities

Okay. And then on the ESNA line, Sally do you expect it to stay at the level where it is now, the 39.5, because of the SarbOx? You sort of talked about that winding down over several months.

Sally Dudash

Well, what we see now is that based -- we should see a SG&A as a percentage of sales less than 22% for the year, but we are seeing higher revenue. So in prior calls and discussions I've talked about 22%. Now I would say 21% to 22% on our higher revenue guidance, and we think we can take actions to get the expenses back in line with our plan in the second half of the year, but not necessarily recoup what we saw happen for the first half.

Blaine Carroll - FTN Midwest Securities

Okay. Thank you.

Operator

I think your next question is coming from line of Steve Ferranti with Stephens, Inc. Please go ahead.

Steve Ferranti - Stephens, Inc

My questions, just to follow up on the previous set of questions, can you break out specifically what in terms of a dollar amount, what the freight and sort of one time type of costs were in the quarter that you incurred in your gross margin, cost of goods sold?

Sally Dudash

We didn't quantify that in dollars. We did more in percentages of margin impact. And as I had stated, we believe we did achieve the 2% improvement from Q1 base to getting our mix back to the 60% high capacity 40% low capacity level, but then lost percentage on 8% on the combination of the regional mix and services cost. So again its everything. If all the mix items had worked in our favor, we would have seen a 3% to 4% improvement from Q1 in margin.

Steve Ferranti - Stephens, Inc

I see. And you've alluded, I believe, in the scripts to some freight cost being contributed there. Can you kind of break out for us how -- it seems like you've kind of worked through some of these numbers. Can you break out for us, how much of it is attributed to region versus how much is attributed to freight cost? And the reason I am asking is, freight cost to me it seems like, I understand you might have some extradite in a given quarter, but that to me seems like it’s not something that would impact entire second half of the year.

Sally Dudash

We don't expect the freight cost to impact the second half of the year.

Guy Campbell

We expect to mitigate the impacts that we've seen going forward.

Steve Ferranti - Stephens, Inc

And if I kind of walk through the model to get to sort of guidance level that you are talking about really, it seems like relatively minimal margin -- gross margin particular expansion in the second half of the year, is that fairly accurate?

Sally Dudash

That is accurate. Last time we had talked, our guidance suggested that we would average a 33% or mid 30% margins for the year. What we think now, is that we can exit the year at that level. Second half of the year improving modestly over the first half, but not as we had previously thought due to these number of mix issues that we have seen over the first two quarters.

Steve Ferranti - Stephens Inc.

Okay. And, and of course, we've been talking about, in longer term, a target of 40% margins for this business. Do you believe it's still capable of that? And I guess what type of geographical mix will that assume?

Guy Campbell

Well, first of all, it's going to assume that we are going to be taking to the market new product introductions that will come with higher price points, and more favorable cost associated with those products.

So what we're now planning on as we move forward is to expand the overall product margins by lowering the cost on an overall basis, and selling into the high capacity segment in the market and the IP transport segment of the market as a greater percent of the overall business. And I think we've seen the potential that this will happen, in some ways helped by the market itself, a higher appetite for those types of products, and our ability to deliver to the market the products that the market needs for networks as they evolve.

So I think that a lot of our plans relative to gross margin expansion have to do with the new products coming on line and coming to market, and then second, our continued effort to reduce costs and improve efficiencies across the organization, and we have plans to continue to do that. So I think, in summary, it’s new products with higher margins, because of their needs in the market, and the cost points at which it will deliver those products. And then, continual improvements in operations going forward, which we have plans for, to continue to take our own cost down.

Sally Dudash

If I can add a point of clarification on my comments, this margin issue was in our international business, not across our whole company. So, when I am discussing the 3% to 4% margin it's on our international revenue.

Steve Ferranti - Stephens, Inc

Okay. I guess one last follow up on the gross margin question, you still got obviously in the second half some costs synergies that would obviously help your cost of goods sold, but you are still seeing sort of only 100-200 basis points of improvement during in the second half of the year, which would imply really no change in product margins themselves outside of the synergy improvement for the back half. Is that fair? And then I guess, looking ahead into '09, are the new product introductions what we are waiting for to see the lift outside of the synergies improvement?

Guy Campbell

Well, I think that we are going to be working on additional improvements going forward, beyond what we do in fiscal '08. And we’ve started putting those or solidifying those plans at this point, so even though we will run through our synergies, our $35 million that we targeted for this year, by the end of this year, we are already working on plans for further cost efficiencies that we expect to achieve next year, and we'll talk about those more specifically at the next earnings call when we intend to deal to give you an indication of guidance for the next fiscal year.

So we are working on our plans and we don't intend to stop with the $35 million that we targeted for this year. We are working aggressively on next year to see how we can continue to drive operating efficiencies. I think one of the things we haven't talked about, and a question came up in Asia-Pacific and what we think about that and growth there and the margins that are there. Well, at the margins in Asia-Pacific today, we are selling network solutions at a certain capacity that are effectively hardware sales going into these network operators.

All of the hardware solutions that we are putting will be capacity upgradeable with software in the future, and we believe that our software sales over time will also ramp, which will help our gross margins as we look out in the future. So I think there are a number of elements. We've got a lot of actions, and even though we, as you pointed looking at, we have the modest improvement for the remainder of fiscal 2008 of 100 to 200 basis points, I would hope that we can do better and we will do better as we go forward and we'll continue to show margin expansion. The difference between what we anticipated and where we are now is the rate of that expansion, but we will continue to expand gross margins.

Steve Ferranti - Stephens, Inc

Okay. Thanks. That’s all I had. I will turn it over from here. Thanks.

Operator

All right. Thank you. Matthew Robison with Ferris, Baker Watts. Please go ahead with your question.

Matthew Robison - Ferris, Baker Watts

Yeah. Thanks for taking my question. When in the quarter did you know that your gross margins were going to be light?

Guy Campbell

Well, I think that until we get to the end of the quarter, we're still not sure. And the reason for that is that the quarters, as you know, matter extremely backend loaded. And until we see the actual revenue that we will record in the quarter and what products and what geographies, we don't actually have a clear indication of what the final gross margins will be.

That coupled with the fact that we had a push out of revenues from Q2 to Q3, and as Murphy's Law would normally have it, it's generally the higher margin opportunities that move when this occurs. So, I mean it's really when we close the quarters is when we know that we're going to have a margin miss. And as Sally said, this cost us a point, which was a couple cents per share.

Matthew Robison - Ferris, Baker Watts

Do you typically see the book-to-bill less than one going into your March quarter because of the seasonality and the usual decline and sequential decline in revenue for the March quarter?

Guy Campbell

It can happen. It has happened in the past.

Matthew Robison - Ferris, Baker Watts

It happened last year, or I guess you probably -- that was a tough comparison last year because of the transition.

Guy Campbell

Right.

Matthew Robison - Ferris, Baker Watts

Do you have numbers for the year-over-year comparisons for Latin America, APAC, EMEA and Africa?

Sally Dudash

I think they are in the earnings release.

Matthew Robison - Ferris, Baker Watts

No, they are not.

Sally Dudash

They are not?

Matthew Robison - Ferris, Baker Watts

Not for the individual regions, unless I just missed it.

Guy Campbell

If you want to follow-up, Matt, we can certainly do that.

Matthew Robison - Ferris, Baker Watts

On the cost savings that you talked about that we really don't see, is that where we're going to see the moderate improvement you're talking about in the back half to get to the low end of your guidance? Is it going to come out of OpEx because you mentioned, I think I heard you say, you are looking for a couple of hundred basis points a quarter such that not moving the needle too much on the gross margin line, right?

Guy Campbell

Well, it will help and there will be also improvements in OpEx in the second half of the year that will help the earnings situation. But I'd say the improvement on gross margin is certainly a good part of it, and then some improvements in OpEx.

Matthew Robison - Ferris, Baker Watts

Well, we saw the R&D go down sequentially. Is that where we're going to see it since you're having these challenges with Sarbox?

Sally Dudash

Our R&D should continue to show improvement based on the synergy plan, And we do have challenges on the Sarbox that will show up on the SG&A line, so yes.

Matthew Robison - Ferris, Baker Watts

Do you define improvement as decline in percentage expenses or absolute dollar amounts in expenses?

Sally Dudash

Absolute dollar amounts and percentages.

Matthew Robison - Ferris, Baker Watts

One leads to the other, right.

Sally Dudash

Yeah.

Matthew Robison - Ferris, Baker Watts

Okay.

Operator

(Operator Instructions)

Kevin Dede with Morgan Joseph, please go ahead.

Kevin Dede - Morgan Joseph

Thanks. Good afternoon, guys. Question just on the overall global environment, Guy, as you see it with regard to the credit crunch, and how you think that might impact some of your fledgling customers in emerging markets?

Guy Campbell

Well, Kevin I can't speak for the future. Up to this point in time, we haven't seen any impact from any of our markets. That doesn’t mean that something can't happen during the quarter or next quarter or in the next fiscal year. But up to this point we haven’t seen any impacts and the only thing we can say is, time will tell.

Kevin Dede - Morgan Joseph

All right. What do you think would be first indication for you?

Guy Campbell

Well, it depends upon which market it is. If it’s North America, I would say I would be looking to what's happened to the federal, state, and local budgets, which could come under pressure due to lower revenues and in those areas coming from slower spending and taxes and so on. So I think that would be one indication and that could have an impact on our governmental business in North America.

Internationally, I think what will happen is, then we see more requests for financing than what we’ve seen in the past and more difficult terms on contracts that we're negotiating. So again those would be the indicators and I guess the third thing would be is, if in any other regions we start to see push outs of major projects and they could be budget related where CapEx is not available for whatever reason, because of sensitivity to credit.

Kevin Dede - Morgan Joseph

Okay. And would you mind giving us an update on the manufacturing situation? Is the TRuepoint 6000 completely overseas and parallel in similar manufacturing process as the Eclipse products, and or do you still expecting to make those moves and extract cost efficiencies there.

Guy Campbell

Those are the TRuepoint 6000 products. In fact, all of the indoor radio products have not moved yet and they are definitely on the radar for future cost efficiencies, as we look in to the next fiscal year and beyond. Additionally, although we started to move the TRuepoint 5000 product offshore, that transition is not completed yet and there are more opportunities to put that into the Eclipse product model. So, I think we've got a number of efficiencies left in our operations that we can still execute on and lower our costs in the manufacturing environment.

Kevin Dede - Morgan Joseph

All right. Last question from me, can you just sort of give us an update on what your personal plans are and how the pipelines looks to sort of replace your position?

Guy Campbell

Okay. Yeah, my personal plans, I think we announced those back in December. I intend to retire by the 27 of June. Plans are underway. There is a subcommittee of the board that's executing on a search for my replacement. I am fully engaged and intend to stay engaged right up until there's a successor here that can come in and take my place and do a reasonable transition. And I know that the board is actively working on that. Today, there is not a candidate that's standing in the wings, waiting to come on the stage and takeover, but I anticipate that we will have a proper candidate available to fit into my personal time schedule. So, I think the things are moving along and there's nothing more to report than that.

Kevin Dede - Morgan Joseph

Great, okay, thanks guy.

Operator

All right, thank you. And that concludes our question-and-answer session. Management please continue with any closing comments.

Mary McGowan

Okay. This concludes our conference call. Thank you all for joining us on this call and on the webcast today.

Operator

All right, ladies and gentlemen, this does conclude the Harris Stratex Networks conference call. This time you may disconnect. We thank you for using ACT conferencing and very pleasant rest of your day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!