Anaren, Inc. (NASDAQ:ANEN)
Jefferies Global Industrial and A&D Conference Transcript
August 9, 2012 10:30 AM ET
Larry Sala - Chairman, President and CEO
Howard Rubel - Jefferies
Howard Rubel - Jefferies
Good afternoon or good morning. This is one of those days where you think good morning or good afternoon, so I apologize. Good morning. I’m Howard Rubel, and I’m a Managing Director in the Equity Research Department at Jefferies. I cover the aerospace and defense industry, and its great pleasure today to have with us Larry Sala, who is President, CEO and Chairman of Anaren. Thank you very much.
Howard Rubel - Jefferies
Thank you, Larry.
I appreciate you’re taking time today. So quick caution relative to any forward-looking statements we may make today.
Anaren is a 40 plus year old company. We’ve been focused in microwave electronics for more than 40 years. We’ve been a subsystem supplier in the Space & Defense industry since our founding for more than 10 years. We’ve been also supplying components into the wireless infrastructure market, where we supply base station manufacturers with microwave componentry.
Our fiscal year just ended, we just reported a couple days ago. Our fiscal ’12, we did a little under $50 million, that’s down a bit from the year before, I’ll talk about why that is, but we definitely have seen things turnaround in the last couple of quarters and we have expectations for growth and improved profitability in our fiscal ’13.
We are about 60% Space & Defense, and about 40% wireless. We got little under 1000 folks in five different locations, four here in the U.S., we also have our facility in Suzhou, China.
Our real core competency is our engineering expertise. We have over a 150 practicing engineers and about a third of those folks are microwave engineers, and we think the depths and breath of microwave talent stacks up with even a capability within our customer base.
We use those engineers to develop design to spec subsystems for the Space & Defense industries, as well as to do our own organic development of products for our wireless customers.
We can perform over a broad frequency range, which gives us a fairly large addressable market. And we use a couple of unique manufacturing technologies that we think give us some differentiation and integration, the amount of microwave circuit density that we can achieve any given package, and its often that size and performance that differentiates us in capturing an opportunity.
So we call that technology multilayer stripline, it's a multilayer high performance printed circuit board type of manufacturing technology. We use it for not only integration platform for complex, $0.5 million subsystems, but we also use it as a sub-straight technology for our wireless business, where we dice it up like a semiconductor products into tens of thousands of components that we may sale for less than a dollar. So it’s our ability to maintain tolerances to get integration control the microwave performance in this packaging technology that really differentiates us.
We also have some ceramic capabilities. We build thick film, ceramic substrates for medical applications and also military applications, and also do some multilayer ceramic for very advanced microwave circuit packaging for high performance radar applications and other types of optical receiver applications.
And then we integrate active devices typically from outside sources into multifunction assemblies and we do that for space applications, where we have space rate assembly capabilities and also for high performance military applications.
We’ve had a good steady growth. We typically focused our investment organically, developing technologies and products, and entering into new applications. We’ve also made some acquisitions, which I'll talk about, not too many recently, but we still look at acquisitions as way to expand our technology portfolio and be a bigger integrator.
So we had focus on customers where microwave signal performance matters. We to develop long-term technical relationships engineering, engineer relationships, and gain increasing dollar content in new generation of platform, and that's been true in the military space, well, I’ll talk about our subsystem technology. But also in the microwave components space and wireless where we gain increasing content on each new generation of base station platform.
So on the Space & Defense side, as I said, we are subsystem manufacturers. So we compete to win development contracts. Once we can capture development contract it typically turns into a long-term sole-source revenue stream.
We build subsystems for radars, receivers, jammers and satellite applications. We’d say the ASP of a product for us is something on the order of $100,000 or more. But we really look at programs and we are typically pursuing programs where we can capture content of $1 million to $10 million in opportunity a year on a program and those programs typically have five to 10-year life cycles.
So we compete with other subsystem manufacturers, people like car bomb or crane, those types of folks. And those development contracts we -- often times investing a long side OEM partnering, in order to capture those opportunities. But we once we capture the opportunities, they said we end up in the long-term supply arrangement.
Our business is quite diverse, as I said we play in receivers, in jammers on the EW side, electronic warfare side. We play extensively in the modernization of radars and I’ll talk more about, our technology fit in continuing trend of moving to electronically scanned array radars as opposed to the historical mechanically steered types of radars, as well as significantly in space applications. And our real focus is U.S. OEM suppliers, the Raytheon’s, Lockheed’s, Northrop Grumman’s of the world.
So, as I said, we’ve made acquisitions to expand our technology base. We’ve allowed those acquisitions to standalone and continue to try to be state-of-the-art in their technology space to supply directly their component technology, if that’s the way and OEM wants to buy and integrate themselves.
We’ve also used their technologies to broaden our subsystem portfolio, to be a bit bigger integrator and gain larger dollar content. And we definitely see this as a trend in the industry, where OEMs are starting to be significantly focused on just being box integrators really developing software, their differentiation and system integration capabilities as their differentiation and looking to outsource larger and larger portions of systems to suppliers. So this is a continuing strategy of ours to continue to broaden our technology base and expand our addressable market as a subsystems supplier.
The radar space is an area where we, I think successfully executed the strategy, increasing our dollar content through broadening our technology base. We’ve historically played in the phased-array radar market for more than 10 years. This market developed and technology developed initially for ballistic missile, defense radars some 10-plus years ago. In those applications, we’ve captured as much as $5 million of content per radar, predominantly in the manifold, our distribution network of these radars.
Unfortunately, there is only one or two of these radars built a year and it is not a long-term growth platform for us. But over time, as this technology has been miniaturized and produced more cost-effectively, it's starting to be deployed in ground based radar applications.
We announced about a $15 million contract a few months go, where we captured about a $0.5 million in an army ground mobile radar. We expect several hundred of those radars to reproduce over the next few years and it’s going to be our largest program ever.
We also have other ground mobile radar applications where we have significant content. This technology has now being developed for the next-generation ship borne radars and we have significant content there as well, millions of dollars of content for a ship. And it’s also now being deployed in airborne applications. Joint Strike Fighter, F-16, 18 upgrades are all looking at deploying this phased-array radar technology.
Through the acquisitions, we’ve made -- we’ve been able to both miniaturized our technology, so that we can play in these smaller more cost driven applications, as well as gaining active technology to play across the whole radar array where we can not just only play in the manifold space, but in the transmit receive active module space where there is more dollar content and more opportunity.
We also are now starting to see this technology being deployed commercially for communicating with satellites from commercial aircraft and believe we have plays in that space as well.
So our Space & Defense business, it was a more challenging year from a revenue standpoint for us. We had some revenue in counter-IED applications back in our fiscal ‘10 and ’11, and that program was completed. So we knew coming into the year would be a challenging year, with no program to replace that in our fiscal ’12. We also made a decision late in our fiscal ‘11 to exit some ceramic technology applications we have there. It’s just weren't growth and profit generators for us.
But outside of that we had a very strong year. We had a year of record orders and record backlog at the end of the year. We are going into next year expecting organic growth in this business, something in the mid single-digit range and believe that we have the vast majority of that already booked in our order backlog.
So we are very optimistic about our prospects. Some of the larger contracts we've announced in the last couple of months, really start to drive revenue in November, December timeframe and we’ll have a much bigger impact on our fiscal ‘14 than they’ll even on our fiscal ‘13.
So we feel pretty good about our position. Obviously, we are concerned about spending in this market, in budgets in this market space. But both on the space side of the business, as well as the radar side of the business, we are still seeing a very robust opportunity environment.
So our customers are, who would you expect here? It’s the Lockheed’s, Northrop‘s, Raytheon’s of the world that drive the vast majority of our business here, whether it’s U.S. based or FMS sales through these OEM customers.
In the Wireless market, we play in a different place in the food chain. Here, we are a component supplier. We sell microwave splitting/combining signal, manipulating components, for predominantly today base stations, cellular telephone base station applications.
These are sub dollar components, but an area that we’ve had a strong leadership position for more than 15 years and then supplying into the leading OEMs in this space since the early beginning of the cellular industry.
It's a very high margin business for us since we’ve been the product leader in this space. It's much more like a semiconductor business, though low in ASP. It’s a very high margin business for us as you can see.
We had a challenging year here last year. About this time last year, we saw a significant slowdown and capital spending by service providers in the infrastructure market that rolled through our entire customer base. And we supply into all of the leading OEMs whether it’s an Ericsson, a Nokia, an Alcatel-Lucent or Huawei or ZTE or Samsung in Asia.
We have comparable content across all of the OEMs in the space and so we are typically pretty agonistic as to where dollars are being spent in the industry, whether it's in the U.S. and Europe or in Asia.
But last year, we saw a general global slowdown in spending and we started to see that spending pickup again in the March timeframe. And so, sequentially, we saw a big improvement in the June quarter in this business. It was up about 30% sequentially from the second quarter.
We gave guidance just the other day that we thought this quarter would be relatively flat with the June quarter, but forecasts are showing a fairly substantial pickup again in December quarter, as well as into calendar ’13.
So, we saw not only a rebound in revenue but a big rebound in margin, you can see in our fiscal ’11, we had about 21% operating margins in this business. This past year, our margins were only about 12.5%. For the fourth quarter, we just reported the operating margin bounce back to about 19% in this business.
And so we believe that we are headed into another cycle of growth here that the demand for 4G technology across all geographies is significant and will be long-term. So we're optimistic that we’ll see improving trends in this business throughout the next year and beyond.
Our customers here in the infrastructure space, as I said, our business really sells breakdown by OEM market share, Ericsson’s been our biggest customer for a long, long time. Huawei is another very large customer for us. We do business not only with the lead prime OEMs but also the second tier suppliers into the industry as well.
Both on the power side of the business, people who built products used in the transmit side of base station. But in the last two years, a lot of our dollar content growth has come from gaining share on the receive side in the radios, their process signals coming into the base station.
So with the growth in 4G as a technology, the complexity of those base stations and our broader product portfolio and gaining share on the receive side, we believe we have two to three times the dollar content in 4G base stations. And that has the opportunity to drive growth in our business far in excess of the overall industry.
We’ve also been investing for the last two years or so in a product line that we called AIR. These are small low cost and low power wireless radio modules. We do this in partnership with Texas Instruments.
We had been selling products into TI applications for a long time and they came to us with the concept of taking their semiconductor devices and putting them into FCC Certified modules to really streamline a design in process for all the folks who would like to have wireless capability in their product line but don’t have the RF or microwave expertise to implement it.
So because people who are struggling to implement these reference designs, we saw our market opportunity to really streamline that process, offer a product that was already certified by the FCC and could be easily dropped into any type of application.
We see a lot of different vertical market applications for this technology as you can imagine any type of remote sensing application where people are trying to gain information wirelessly, any type of wireless control whether its lighting or heating or any type of wireless industrial control, machine-to-machine communications, wireless metering.
All these applications are typically -- being implemented by people who are using RF and microwave technology for the very first time, don’t necessarily have the engineering expertise to deal with the challenges or even the test equipment and design modeling expertise in order to do it.
So we’ve had this product in the market for about 18 months now. We’ve got products supporting all the various standard here in the U.S. and Canada and Europe as well as various frequencies supporting the different range requirements to these various applications, it starting to gain some critical mass for us.
We believe its running today at about $1 million annualized run rate and we’ve given guidance that we think that fiscal '13, this will be a $2 million to $4 million product line for us, but very large addressable opportunity something that could have very meaningful impact on the long-term potential growth over our wireless business.
And so you’ll see over the next 12 months continuing flow of new product introductions here, really focused on broad standards. We announced recently our ZigBee product line but we are looking hard and we expect to be introducing products for low energy Bluetooth and Wi-Fi technology as well over the course of the next year.
So, our strategy is to really focus in areas where we have technological differentiation, where we can sustain long-term margins on the order of 15% operating margins, a wireless business is obviously a margin leader for us but we also focus in the space and defense side where we can have long-term differentiation.
We look at acquisitions as a way to continue to expand our technology portfolio. We continue to look for opportunities there. But we also have been very focused operationally trying to drive financial performance.
In a very challenging year last year, we put up double-digit operating margins that was done through significant operational improvements both gaining efficiencies across all of our locations but also more than $10 million of cost taken out of our business last year through both headcount reduction and expense reduction. And we really feel as though our business model is very attuned today with tremendous operating leverage with any growth that we see.
So we believe we have something on the order of 50%, 60% operating leverage in every increase in revenue dollar that we see, but obviously bigger potential from our wireless business given the margin profile there. But we continue to invest to drive growth organically. We continue to look for acquisitions opportunity as well.
So as you can see last year, it was first year of decline in a long-long time. Historically, our two businesses have had cycles that were aligned with each other and that’s been a benefit but because of the programs that had completed last year any unforecasted decline in wireless spending, we had a more challenging year. But through that, as you said we still put up 10% operating margins and we’ve started to see this business really turnaround and expect a better year in '13.
So our business model has really not changed for a long, long time. Our expectation is our gross margins in upper 30% to 40%, operating margins in the mid-teens. We’ve been pretty much operating this relative range for the last couple of years and expect as our business grows, we’ll start seeing our performance move to the high-end of this business model.
We spend about 4% a year on CapEx. We had good free cash flow for the last several years. Even this past year with a significant challenge on the sales side, we generated over $10 million in free cash flow. We’ve used that cash to make acquisitions. We’ve used that cash to buy back shares very aggressively.
As you can see in the chart over the last several years, we bought back nearly 50% of our outstanding sharecount. We still have a very active buyback. We announced this quarter just couple of days ago that we bought back almost $1 million shares last quarter. We still have almost a $1 million shares authorize for buyback.
We’ve got about $44 million in cash. We have no debt. And we expect this year to be a good strong cash flow year for us as well. So, that’s all I had presentation. I’ve got couple of minutes left, if we take question too here that will be great, before we go breakout.
Howard Rubel - Jefferies
I’ll start with one or two Larry and go on. Could you talk for a moment about size of the two markets you operate. And I mean, seems my guess is defense market probably that $3 billion?
Yeah. I mean that the big question our business is, we have very large addressable markets that’s never been a challenge for us. Our wireless market, if you look at -- really look at where our technology is addressing in our infrastructure business we are a big player. It’s a large addressable market but we really focus in areas where we have significant differentiation. And so we believe in the components we supply in wireless today. In infrastructure, we have something in the order of 90% market share. But with our AIR product line in the introduction there, we were addressing a multi billion dollar addressable market on the wireless side as well.
Howard Rubel - Jefferies
You know, am I right on defense side, is it roughly $3 billion?
Yeah. That order of magnitude. Yeah. And growing for us is our technology portfolio expense and we see it expanding technology in this electronically scanned radar market.
Howard Rubel - Jefferies
And in fact, let’s talk about that for a moment, I mean, there is two things happening. One is the air forces’ issue there and RFP for these two markets for the -- on F-16 and Northrop and Raytheon product. I know, it won’t happen immediately but I think that probably opens some doors for you for other people to look at opportunities that are fair. What do you think about it?
I mean, any of these new radar contract announcements or program announcements are all moving to this electronically scanned array. We have opportunity in virtually all of them. So F-16, F-18, Joint Strike Fighter already uses this technology, F-22 already uses this technology.
In the airborne side, we have hundreds of thousands of dollars of content opportunity. Ground mobile radar, TPQ-63, the army just awarded very large contract and that looks like a 10-year program. Gator, the marines are also kicking in, moving into development and production of their ground mobile radar.
Listedness of defense radar is now being deployed globally. So we’ve seen the first half of that sales, the listedness of defense radars and then there is same technology is used in the communication satellite world. So Iridium, Globalstar, as well as secured military communications satellites use this electronically scanned array technology as well.
Howard Rubel - Jefferies
So just to kind of conclude on the defense question I’ll open up is an interesting way to think about it is, this new technology offers more capability lower power and creates some opportunities to really replace some - lot of systems that are 2013 and 40 years old.
Correct. So not only the advancement on the radar side but it allows systems to do a lot of other electronic worker applications simultaneously.
Howard Rubel - Jefferies
If there is any questions, we have a minute or two.
Yeah. On your wireless infrastructure business, you heard for a while now about the potential for the growth in that market but it seems to be elusive to your customer base so far. Can you offer us any insight since you have 90% of the market that would reinforce your view that it begins to grow again.
Sure. I think we can speak to our exposure to it. Obviously, we are selling it to OEMs or selling it to service providers. And their service providers are really ones who control the dollar spend in the market. So we are bit removed from it.’
If we go back and look at what happened for us, about the first calendar ‘11, a little before that we started to see the first deployments of 4G technology and we saw tremendous escalation across the industry whether it was in Asia, whether it was in Europe, whether it was in U.S. probably more driven in the U.S.
We saw this 4G deployments start to really drive industry spending. We also saw just general global spending for increasing 2G and 3G cellular capacity.
The forecast that we were seeing about this time last year or indicating the debt spending trend was going to continue late through calendar ‘12 and ‘13. At the rate of something on you orders about 20% per year compound annual growth.
So this time, last year we were adding capacity to address that demand for more vacancy. And we don’t have perfect visibility. A lot of it was increasing percentage of 4G sales and everyone expectations, that technology was going to be significantly deployed here in the U.S. and that we would see spending in that technology starting in Asia as well. And we really haven't seen that happen.
We are now starting to see those forecast pick up again. From what we hear, again second hand in many cases, these 4G devices have not yet hit the market in any significant manner.
So there is really no need for carriers to be spending out, expanding 4G capacity yet. And there is no reason that they would want to be deploying 3G capacity in this environment given that this new technology deployment is just around the corner.
So we’re seeing forecast improve. We believe that as 4G devices start to proliferate capacity from, will be necessary everywhere. And we’ll start to see this growth profile pick up again.
But that our view looking through OEMs and trying to get inside into what service provider plans are.
Howard Rubel - Jefferies
Thank you, all very much and Larry.
Appreciate your time. We’ll see in the break out. Thank you.
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