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Westell Technologies Inc. (NASDAQ:WSTL)

F1Q13 Earnings Call

August 7, 2012 9:30 am ET

Executives

Brian Cooper – Senior Vice President and Chief Financial Officer

Richard S. Gilbert – Chairman and Chief Executive Officer

Analysts

Michael Latimore – Northland Capital Markets

Gregory Burns – Sidoti & Company, LLC

Peter A. Reed – MAST Capital Management, LLC

Mike Latimore – Northland Capital Markets

Operator

Welcome to the Westell Technologies’ First Quarter Fiscal Year 2013 Earnings Conference Call. My name is Christine and I’ll be your operator for today’s conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note today’s conference is being recorded.

I will now turn the call over to Brian Cooper. You may begin.

Brian Cooper

Thank you, Christine. I want to welcome everyone to our conference call covering the first quarter results for Westell Technologies during our fiscal year 2013. We issued our earnings news release last night and a copy is posted on our website westell.com. On this call, Rick Gilbert and I will update you on the business 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 should, believe, expect, 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 risks and uncertainties that may cause Westell’s actual results, performance or achievements to differ materially from those discussed.

A description 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, 2012 under the section risk factors. The forward-looking statements made in this presentation are being made as of the day 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 first quarter and I’ll reference the press release. I will then turn the call over to Rick Gilbert, Westell’s Chairman and Chief Executive Officer who will provide perspective on our performance and strategic progress, and we will conclude by taking questions.

As most of you know, we completed two major sales during fiscal 2012 as part of repositioning Westell. There are no impacts from these transactions in our 2013 financial results. However, the sales do affect the results under generally accepted accounting principles in the first quarter of fiscal 2012. We therefore provided non-GAAP adjustments to prior year earnings in order to facilitate comparison. The non-GAAP results are reconciled to GAAP results on the final page of the earnings news release.

For the first quarter of FY13, Westell Technologies reported consolidated revenue from continuing operations of $10.5 million, compared with $23.2 million in the first quarter year ago. The decline results from the planned reduction in CNS revenue which dropped by $7.2 million and lower revenue in the Westell division.

Net loss for the quarter was $1.7 million compared to GAAP net income of $21.1 million and non-GAAP net income of $1.2 million in the first quarter of FY12. This translates to EPS for the quarter that was a loss of $0.03 per share. It compares to GAAP income of $0.30 per diluted share in the prior year first quarter and to non-GAAP earnings of $0.02 per share.

From a divisional perspective, the Westell division reported revenues of $9.4 million for the first quarter. This is down $5.4 million compared with the first quarter of fiscal 2012. We continue to see steady demand for fuse panels, custom systems integration services and related enclosures, but our products remained under pressure in what still appears to be an unusually weak market for telecommunications equipment.

Gross profit for the Westell division was $2.8 million in the quarter on our gross margin of 29.4% compared with $6.5 million and a 43.8% margin in the FY12 first quarter. The lower gross profit and margin in the latest quarter resulted from lower revenues, higher charges for excess and obsolete inventory, and lower absorption of fixed costs. The inventory charges, which were approximately $0.5 million higher than in the prior year quarter, were driven primarily by lower demand for certain legacy products.

Westell division operating expenses increased from $3.7 million in the first quarter of FY12 to $4.9 million in the first quarter of FY13. Expenses that contributed to the increase include investment developed new products, cost to market and qualify new products with customers, and costs associated with the acquired ANTONE operations, and expense related to the consolidation of our Canadian operations. In addition, as we’ve previously discussed, the division is bearing costs that had historically been allocated to CNS.

With the combined effects from a soft top line and our investments in new products, the Westell division posted an operating loss of $2.1 million for the quarter, compared to operating income of $2.8 million for Q1 a year ago.

The CNS division had revenues of $1.1 million during the first quarter, predominantly from project-based software. This is a relatively strong performance given the on-going wind-down of the CNS gateways business with its one remaining customer and compares to $8.4 million of revenue in Q1 of fiscal 2012. Looking forward, we do not anticipate any additional software opportunities with our remaining customer and revenues from this linear services and ancillary products in future period should be limited.

CNS gross profit was $1 million for the quarter with a gross margin of 92% on the strength of the high margin software revenue. By comparison, gross margin was 22.2% in the first quarter a year ago. With the wind-down nearing completion, the main continuing activity in the CNS division is the development of our Homecloud product.

CNS operating expenses were $390,000 for the quarter, almost all of which relate to Homecloud. This compares to operating expenses of $1.9 million in Q1 last year. CNS had operating income for the first quarter of $633,000 compared to a small loss in the first quarter last year.

Consolidated continuing operations generated an operating loss of $2.8 million for the first quarter, compared to operating income of $1.8 million in Q1 of FY12. FY13 results include unallocated corporate costs of $1.3 million compared to $1 million in the first quarter year ago. The increase in unallocated costs reflects our corporate development efforts, including cost for the acquisition for ANTONE. The results saw an increase in our net rental costs because NETGEAR is no longer a sub-tenant in our building.

Income taxes were $1 million benefit in the quarter, including a discrete item that lowered the tax rate. We continue to expect an underlying income tax rate of about 39% and our cash taxes on income are mostly shielded by our net operating loss carry forwards.

Turning to the balance sheet, we had $131.9 million in cash and short-term investments at June 30, 2012. This compares to $142.7 million in March 31, 2012. The largest use of cash during the quarter was for share repurchases, which totaled 2.3 million shares at a cost of $5.1 million. There was approximately $7.7 million remaining as of June 30 for additional share repurchases under our existing Board authorization. We also used about $2.5 million in the ANTONE acquisition.

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

Richard S. Gilbert

Thanks, Brian. During the last two calls, I reviewed our strategy, described the market segments were Westell is active and discussed several new products. During this call, I will focus on the North American telecom marketplace and what we are doing to address the current challenges of that market.

For those of you who have listened to recent earnings calls from telecom vendors, you’ve heard concerns voiced over the phase of orders from large operators, especially for wireline products. Westell has also seen this effect over the past several quarters.

Our T1 business which includes repeaters, network interface units and enclosures, is now running at a fraction of the rate we saw a couple of years ago. As discussed in previous calls, this is primarily due to a technology shift from T1 to Ethernet for cell backhaul applications. We addressed this shift by introducing cost effective Ethernet cards designed to be plug compatible with our T1 enclosures. However, it now appears the entire backhaul market T1 and Ethernet has slowed as operator budgets have been dramatically shifted from the wireline side to the wireless side of their businesses.

To address this budget shift, we have already introduced several new products focused on wireless applications including DAS trays, fuse panels, fiber distribution panels, custom cabinets as well as cell-site optimization products from our recent acquisition of ANTONE Wireless.

And as Brian noted, we did see good sales in the fuse panel custom systems integration and related cabinet segments during the first quarter. While our DAS products and some cell-site optimization products are still in early stages of acceptance, we have seen some initial purchasers and favorable customer feedback. We have not yet seen the wireless run rates needed to fully offset the drop in our T1 business, but I believe we’re on the right track, and remain confident in the growth potential of our wireless product portfolio.

That said, we still need to answer the obvious question. What is Westell’s plan to deal with the current slowdown in the North American telecom market? first, I want to assure our investors that we will stick to our strategic plan and sell differentiated products to a common set of customers to establish sales channels. we will avoid selling commodity products. We will focus on niche markets. And we will compete in both wireline and wireless product categories with an increasing focus on the wireless side of the business.

Second, we will continue to make targeted investments via both R&D and M&A in specific strategic market segments. We currently compete in nine market segments as described on our website and during our last call. and we expect to add a new market segment with the introduction of the Homecloud Digital Home Manager later on during the current quarter.

Finally, we have now added enough new products to justify some additional marketing and sales resources and to that end, we expect to add resources in the area of wireless accounts, distribution sales and sales management in order to support faster revenue growth.

In summary while it’s clear, we are in a transitional phase and facing a challenge in North American Telecom marketplace, the Westell team is fully committed to the continued execution of our strategic plan, and we are optimistic about increasing shareholder value.

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

Question-and-Answer Session

Operator

(Operator Instructions) our first question comes from Mike Latimore from Northland Capital. Please go ahead.

Michael Latimore – Northland Capital Markets

Right, thanks. Good morning Brian and Rick.

Brian Cooper

Good morning.

Michael Latimore – Northland Capital Markets

Good morning. I guess just on the Westell business just reported. Can you give a rough percentage to – how much revenue is coming from the traditional T1 area at this point?

Brian Cooper

I mean it’s obviously dropped off a lot Mike, depending on which products we put in there, it’s probably more or like a quarter of our sales today.

Michael Latimore – Northland Capital Markets

Okay. And then on the ANTONE, can you just give an update there where you are in terms of the sales process; I believe you are approved to do a large career, maybe a little bit update on just kind of the sales process around ANTONE products?

Richard S. Gilbert

Right, this is Rick. Basically with ANTONE, we are approved in all the regions with the major wireless carrier in the U.S. for the Tower-Mounted Amplifiers. But again, approval and volume purchases are two entirely different things. And so we’re out actively selling in each region we have – there have been some purchases. I mean there’s additional test installs going to get the results of the performance and all the regions are watching the various tests that are on-going in the field. One of the things with ANTONE is that, at the time we purchased them, they haven’t really been too active in the sales for the last quarter or so and so we’ve had to really ramp that up and we have a lot of people in the field selling at this point.

Michael Latimore – Northland Capital Markets

And then about the DAS panels, I think you were in two trials I believe may be update on how those trials are going?

Richard S. Gilbert

Yeah, the DAS panels are doing quite well actually. It’s obviously a long process with both of major careers in the U.S. have been testing the panels. The feedback has been excellent and we’ve already made some initial sales at the large carriers.

Michael Latimore – Northland Capital Markets

So basically does that mean you are out of trial there and approved?

Richard S. Gilbert

Well, we were very, very close.

Michael Latimore – Northland Capital Markets

Okay, got it, great. And just on the OpEx, should we assume overall operating expense kind of stay at this level going forward?

Brian Cooper

I think that’s a fair assumption, Mike. We have some unusual one-time items in the quarter, but we are also adding a little bit more in resources as we move forward. So it’s about right.

Michael Latimore – Northland Capital Markets

Just last question, I guess the inventory write-offs whatever in the quarter, what’s your gross – you think about as gross margin in the quarter?

Brian Cooper

We still are selling our products at our normal prices. Our costs have not really moved. We have fixed costs that are factoring in and that’s the wildcard is – it goes with the top-line a little bit. But we are pricing ourselves to be in a 40% or higher gross margin range, newer products were actually in the higher-end and obviously to compensate us for the investment we make to bring those to market.

Michael Latimore – Northland Capital Markets

Okay, great. Thanks a lot.

Operator

The next question comes from Greg Burns from Sidoti & Company. Please go ahead.

Gregory Burns – Sidoti & Company, LLC

Good morning, thanks for taking the questions. Certainly, the Homecloud introduction, could you just kind of give us may be little more color around what plan for this quarter in kind of roadmap going forward. And maybe what the incremental operating expense is going to be as you kind of make this product up?

Richard S. Gilbert

Well, first of all, I think we’re all happy to see Homecloud probably getting ready to hit the market this quarter. It’s been a long-haul to get to where we are. we’re very excited about the product. What we are going to do this quarter is make available several hundred Homecloud DHMs, so that we can (inaudible), we sold through our website or filled by Amazon. And our goal is to get feedback to customers, and also frankly to get it out to the development community, because Homecloud has the software developers toolkit where you can build additional applications. And so we’d like to get it out there and get the feedback and get the developers working on some stuff. And in terms of operating expense relative to that, I don’t think there’ll be significant additional operating expense, we have our Homecloud team that’s capable of the engineering and support of that number of units, and at this point, we’d like to get them out there before the end of the quarter and get some feedback.

Gregory Burns – Sidoti & Company, LLC

No incremental sales and marketing around…

Richard S. Gilbert

It will be a minor incremental if any, to be honest.

Gregory Burns – Sidoti & Company, LLC

Okay.

Richard S. Gilbert

Yeah.

Gregory Burns – Sidoti & Company, LLC

And bunch of a little cash this quarter, how should we think about that for the remainder of the year?

Brian Cooper

I don't see any major changes in our working capital requirements. so it will be driven primarily by share repurchases, and obviously if you were to do any acquisitions those are bigger movements.

Gregory Burns – Sidoti & Company, LLC

Okay, thank you

Operator

(Operator Instructions) The next question comes from Peter Reed MAST Capital. Please go ahead

Peter A. Reed – MAST Capital Management, LLC

Good morning

Richard S. Gilbert

Good morning, Peter.

Peter A. Reed – MAST Capital Management, LLC

My first question is one ANTONE, which is – if I have it, right you had about 45 days in the quarter from when you had closed on the acquisition, you’ve characterized the revenue from ANTONE is not meaningful. And if I recall from the last call, I think ANTONE had done about $2 million top line in 2011. So on a very simple basis, that I seem that may be $250,000, if you just carve that into 45-day period, is that a number you would characterized as not meaningful to the quarter or it was revenue, sort of worse than you may have expected because of the – they hadn’t been active in sales.

Brian Cooper

Peter this is Brian, I guess, first I’d say, I think we said that won’t material, because we think all of the sales are meaningful, or we're very excited about the product, because of the acquisition activity, and because they are such a small organization. We knew, we had them destructive while we completed the transaction, so we did run at a lower rate than that in the quarter, and we had largely anticipated that, so that's where we were for the quarter.

Richard S. Gilbert

I’d add Peter, this is Rick, ANTONE has also been very useful in the DAS sales, all right, that are occurring. And there are expertise and extremely handy in terms of tuning the final product and such, so they’ve been also involved in other aspects of business other than simply the ANTONE product line that we acquired.

Peter A. Reed – MAST Capital Management, LLC

And when would you expect to hit a run rate quarterly I guess that sort of revenue for the ANTONE product line that exceeds sort of where had been performing prior to purchasing it?

Richard S. Gilbert

My answer will be as soon as possible. And I don't mean that in a [serious] way, I mean we have people out selling, these are large carriers, they buy when – I’ve said this before they buy when they're ready to buy, the feedback has been very positive. And we simply need to get through the sales process and we are suddenly resourcing it right now, so that it should happen.

Peter A. Reed – MAST Capital Management, LLC

And how far is your visibility as far as the way that those products are ordered and sold before you. So do you have much of an outlook ended beyond 30 days or not really?

Richard S. Gilbert

At this point, tends to be a project-by-project or region-by-region sales. So it's not a case where a major national wireless carrier makes a decision at the central sourcing organization in its each region. And we’re active in multiple regions. We have equipment installed in multiple regions. And so, I mean, I think we see it is a project-by-project basis and there’s limited visibility to that to be honest, because they happen pretty quickly when the carriers are ready to go.

Brian Cooper

Yeah, and we see the projects coming, but we don't necessarily know when the triggers are going to get pulled.

Peter A. Reed – MAST Capital Management, LLC

Gotcha. So...

Richard S. Gilbert

And this is beyond just the ANTONE. In the wireless area in general, what we’ve seen is very short lead times on projects, because they’re moving very fast, the wireless budgets have been shifted dramatically as I’ve said, and a good example is that you may for instance in the DAS area, which has nothing to do specifically with ANTONE, we may get two weeks warning on DAS installation, whereas in a wireline area, we might have heard about a stuff eight months in advance.

Peter A. Reed – MAST Capital Management, LLC

Gotcha, okay. Thank you.

Operator

The next question comes from Mike Latimore from Northland Capital. Please go ahead.

Mike Latimore – Northland Capital Markets

Thanks. Yeah, just I guess since acquisitions are part of the strategy or any additional color you can provide on your acquisition strategy, I mean have you seen kind of valuations in the space changed much over the last year for better or worse or are you looking at smaller or larger acquisitions, product categories you’re thinking about anything on the acquisition strategy would be helpful?

Richard S. Gilbert

Well, the way I’d answer that is we have a full-time senior corporate development guy that’s working on a continuous basis on the acquisition front. To answer your question on size, I would think that when and if we do our next acquisition, it will be larger than ANTONE. I mean we’re targeting a higher revenue number than where ANTONE was. That was a special case where they had very specific technology we wanted. And in terms of valuations, I don’t know whether – Brian, do you have any comments on that at this point?

Brian Cooper

I think it’s too early to comment on that.

Richard S. Gilbert

Yeah.

Mike Latimore – Northland Capital Markets

And obviously the North American telco market has been – CapEx has been weak, I guess how do view the spending patterns or do you feel like second half of calendar year spending would be higher than first half?

Richard S. Gilbert

That’s hard to predict to be honest. In talking to senior people at the large telecom thinks the main thing I can say for sure is that the budgets have been shifted from wireline to wireless. I mean that’s certainly not a surprise to any of you out there at this point. The wireless stuff is being driven hard but I will say that when we talk to senior people about general rollouts of wireless services and for instance some of the oral programs that are being done and things like that, those are being talked about us next year. So the remainder this year is a bit of a question mark to be honest, and as I said in my previous answer, one of the reasons for that is that suddenly projects will appear with two weeks warning, that we didn’t see it all, right. So it's hard to predict to be honest, Mike.

Mike Latimore – Northland Capital Markets

And then just last on the Ethernet switches, are you getting some traction outside of telco for those?

Richard S. Gilbert

Yes, I mean we're focusing on – remember the Ethernet program really has two branches, one is the plug in cards for existing chassis and those were really targeted primarily for wireless backhaul or for delivery to a wireless services to enterprise or oral applications for instance and those are ongoing interest areas for U.S. The other area is industrial hardened Ethernet applications, and we have a whole series of products in that area and in fact, we are out in a very new product in that area this month. And we are seeing pipeline of fair amount of interest in those products, but we're watching it carefully. We still haven’t seen the revenue ramp rate we’d like to see on the Ethernet side, but we’re pretty happy with the products.

Mike Latimore – Northland Capital Markets

I guess on that topic, what other new products we might be seeing in the next year through internal developments?

Richard S. Gilbert

I think the way to answer that is in terms of internal development, we have plenty of new opportunities within the market segments we've already outlined, and that’s where we have our people primarily working. in terms of new market segments, our primary focus would be probably to acquisition for additional market segments, and obviously I’m not going to go through the specific strategic segments that we’d like, because that would tip the hands of the competition.

Mike Latimore – Northland Capital Markets

Right, thank you.

Richard S. Gilbert

Thanks, Mike.

Operator

Our next question comes from Peter Reed from MAST Capital. Please go ahead.

Peter A. Reed – MAST Capital Management, LLC

Thanks. A follow-up question on ANTONE, could you walk us through the hurdles or the breakpoints and the metrics for the contingent consideration to kick in where you would have to pay somewhere all of that obligation?

Richard S. Gilbert

Yeah, Peter it’s structured in our fairly straightforward way. it’s tied to our sales of products going forward. and with some potential offsets to it. So it really will go with sales.

Peter A. Reed – MAST Capital Management, LLC

Okay. And is that merger agreement or asset purchase agreement is that going to be filed as an appendix to one of your [10-K] or 10-Q or something like that?

Richard S. Gilbert

No, we’re not planning to do that.

Peter A. Reed – MAST Capital Management, LLC

Okay. So you can’t, you’re unwilling to give more granularity on how much ANTONE products can be sold before that kicks in.

Brian Cooper

Well, I think if you look at our balance sheet, you’ll see that we anticipate paying out most of that contingent consideration.

Peter A. Reed – MAST Capital Management, LLC

Sure.

Brian Cooper

Because we expect to sell the product, and I can tell you it’s tied to sort of the gross profit dollars that we would generate from the specific products that we acquired from them. I’m not trying to hide anything, there’s just small transaction and we do want to get into too many of the details.

Peter A. Reed – MAST Capital Management, LLC

Gotcha. Okay, maybe asking, if for example, if you expected 40% gross margins and $2 million of annual revenues so far $800,000 of growth profit. It wouldn't seem like a fantastic purchase to paid $6 million for that. So would it be fair to say that for at least for all of that to kick in that you would expect a higher revenue run rate and where it was before you acquired it?

Richard S. Gilbert

If you're asking, is there a specific hurdle that they have to get to before we start earning the contingent consideration, is that the question?

Peter A. Reed – MAST Capital Management, LLC

It's more of I'm trying to – would they have to grow before you paid in of three and change million of contingent consideration?

Richard S. Gilbert

Absolutely

Peter A. Reed – MAST Capital Management, LLC

Okay. Thank you. Sorry, one more question. The fuse panels and custom systems integration that you’ve highlighted as sort of working well, are those revenues growing year-over-year?

Richard S. Gilbert

Yes.

Peter A. Reed – MAST Capital Management, LLC

And with that true as well last quarter when you highlighted that?

Brian Cooper

Yes.

Richard S. Gilbert

Yes.

Peter A. Reed – MAST Capital Management, LLC

Okay. Any reason to think that won't continue?

Richard S. Gilbert

No.

Peter A. Reed – MAST Capital Management, LLC

Great. That's it. Thank you.

Operator

There are no additional questions at this time. Thank you all for participating in the Westell Technologies first quarter fiscal year 2013 earnings conference call. This concludes the conference for today. You may all disconnect at this time.

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