DragonWave, Inc. (DRGNF.PK) F1Q09 Earnings Call July 11, 2008 8:30 AM ET
Welcome to DragonWave, Inc. first quarter fiscal year 2009 financial results conference call. (Operator Instructions) Speaking this morning will be Russell Frederick, Chief Financial Officer and Peter Allen, Chief Executive Officer. At this point I would like to turn the call over to Russell Frederick, CFO.
Thank you for joining the DragonWave, Inc. first quarter fiscal year 2009 results conference call on this 11 day of July 2008. Our speakers today are myself; Russell Frederick, Vice President and Chief Financial Officer; and Peter Allen, President and Chief Executive Officer. Please note that our results for the quarter ended May 31, 2008, were issued via our wire service at the end of business day on Thursday, July 10, 2008.
I will review the financial results for the quarter and then Peter will provide a business update and discussion. We will then open the call for questions and we plan to finish by 9:30 this morning.
Before we begin I would like to remind everyone that this conference call contains forward looking statements that are based on current expectation, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. For a complete description of such risks and uncertainties see article four of our Annual Information Form dated May 7, 2008, which we filed with the Ontario Securities Commission.
At this time I would remind everyone that you may access our presentation today on our website at www.DragonWaveInc.com in the Investor Relations section.
I should mention at the outset that all references to dollars refer to Canadian currency unless we specifically mention otherwise. On Slide 4 you can see that revenues in our first quarter fiscal 2009 came in at $10.7 million. This represents an increase of 24% from the $8.6 million reported in the first quarter last year.
If you now turn to Slide 5 you will note that in Q1FY09 North American revenue grew to $8 million a 34% increase from $6 million in Q1 last year. Revenue from customers outside North America was $2.7 million in Q1 representing 25% of total revenue. During the quarter DragonWave sold to 56 customers of which 14 were new and 11 of these new customers were located outside of North America.
DragonWave had one key customer that generated more than 10% of revenue in Q1 fiscal ’09. This customer represented $4.2 million or 39% of revenue for the quarter. This compares to $1.9 million or 22% of revenue in Q1 of the previous fiscal year.
I will now address Slide 6 which shows our statement of operations. Having talked about the revenue I’d like to turn your attention to the remainder of the profit and loss statement. Gross margin for the first quarter was 41% this represents a 6% increase from the 35% gross margin reported in the first quarter of last year and consistent with the gross margin of 41% reported in Q4FY08. This increase is a result of continued cost reduction programs, a favorable product mix with increasing sales of our Horizon product line and in keeping with our strategy to increase gross margins.
You will see expenses overall in Q1 increased year to year by $1.9 million to $6.8 million. This resulted in an operating loss of $2.4 million for the quarter compared to a $1.9 million loss for Q1 in the previous year. R&D spending increased to $3.1 million in Q1FY09 from $2.4 million in Q1FY08.
The increase in R&D spending is mainly due to higher compensation related spending due to the growth in the number of R&D resources, investment in the Horizon product line, market driven R&D associated with major near term opportunities and market expansion activities along with the associated certification and approval processes.
Sales and marketing spending increased from $1.8 million in Q1FY08 to $2.6 million for Q1FY09. The increase in spending year over year was primarily a result of growth in sales headcount and increased sales in marketing activities such as travel and compensation expenses associated with the international expansion.
G&A spending increased to $1.1 million in Q1FY09 from $1 million in Q1FY08. This increase was driven by higher headcount related costs in head office functions as well as higher costs incurred to support a publicly traded company. At the net income level the company lost $1.9 million in Q1FY09 versus $2.7 million in Q1FY08. This loss included a foreign exchange gain of $0.3 million due to weakening of the Canadian dollar relative to the US dollar in the first quarter.
I will now turn to Slide 7 which highlights some balance sheet metrics. If we look at cash and cash equivalents you can see a decrease from $33.5 million at the end of Q4FY08 to $31 million at the end of Q1FY09. Cash was used during the quarter to support the cash adjusted loss in the quarter of $1.3 million, to fund working capital of $0.7 million and to purchase $0.3 million in capital assets. During the quarter the company’s bank exercised warrants in exchange for common shares which resulted in proceeds of $152,000 being paid to the company.
Day sales outstanding came in at 49 days at the end of Q1FY09 compared to 97 days at the end of Q4FY08. Inventory turnover came in at 2.4 times in Q1FY09 versus 3.2 times in Q4FY08. This concludes my remarks on the financial results and I will now turn it over to Peter Allen to provide the business update.
Starting on Slide 9 I’d like to provide an update on the progress made during the quarter on each of the strategic vectors that we have been tracking. If you look in the upper left hand corner of the chart for revenues you will see as Russell has pointed out that we have seen good revenue growth in Q1 of 24% over the previous year. In North America we were able to grow revenue by 34% year on year and continue to gain market share. International revenues grew slightly on a year over year basis and represented 25% of the business in Q1.
Moving to the customer quadrant DragonWave had 14 new customers in the quarter 11 of whom were from markets outside of North America. Two notable customer wins outside of North America during the quarter were Omnivision’s selection of DragonWave to supply license frequency wireless backhaul as it expands its WiMAX service offering into markets across Venezuela.
The first mobile WiMAX operating in Latin America, Omnivision introduced full banded services of up to 6 megabits to businesses and residential customers in Venezuela’s capital city Caracas in 2007. Omnivision subsequently has initiated a nationwide expansion of its service footprint with an announced target of 2.5 million subscribers by 2013.
M3 Wireless the Bermuda operated provider of cellular data and voice services announced that its cost effectively converting its WiMAX data and GSM voice services for business and residential customers on a DragonWave IP backhaul solution. DragonWave’s AirPair product interlinked 27 sites across M3’s meshed Ethernet network. M3 Wireless offered full backhaul activity to business and consumers and in 2006 a service provider extended its innovative WiMAX offerings to island wide deployment.
We’re also pleased with our margin improvement year over year with a 41% gross margin we achieved in Q1 which is up 6% from the 35% reported in Q1 of last year. This gross margin improvement is a result of our continued focus on cost reduction programs.
I would now like to address exciting announcement we made on Wednesday morning this week regarding Sprint’s selection of DragonWave for deployment in its own network in Baltimore, Washington and Chicago. This selection is a landmark win for DragonWave in the environment of a long and competitive selection process.
Horizon Compact as well as Horizon Duo configurations will be deployed and this represents I believe validation of the leadership position these solutions represent. The value proposition delivered by these products speaks directly to the critical importance of the efficiency and cost effectiveness of the backhaul element to the overall network being deployed.
With this announcement DragonWave is placed as the premier provider of equipment for wireless backhaul in North America. We are delighted to have been selected. Our focus now turns firmly to executing on Sprint’s requirements as those requirements evolve.
We find ourselves in a pre-launch period as we wait for the announced new Clearwire to be cleared by regulatory authorities and blast of into being. Clearwire recently provided their vision for a seamless nationwide 4G communications network during a presentation to investors in New York. We take away some key messages from their public statements.
Firstly, Clearwire are confident that they will have regulatory approval by the end of 2008. Secondly, the new company will hold the largest amount of 2.5 GHz spectrum in the United States. Their plans are aggressive as they seek to maximize a lead over their competitors. Clearwire currently covers 16.5 million people in 50 markets worldwide.
The new company expects to cover between 60 and 80 million people in the United States by the end of 2009 and between 120 and 140 million by the end of 2010. Clearly the $3.2 billion of committed new investment allows them to work towards these goals. We are extremely excited by the opportunity to participate in this network build when approval is reached. As we approach this we anticipate that we will then have a clear understanding of their build requirements.
In the meantime visibility is restricted as Sprint and Clearwire are still by necessity operating as independent entities. Over the next two quarters or so we anticipate that visibility will remain difficult before the two companies can work to plan a successful conversion to a single operating entity. As we move towards this opportunity we have the right products at the right time for the new Clearwire and the wider global market.
The combination of capacity, scalability, network ability and cost effectiveness of our product line provides what we believe is the lowest cost network proposition for our service provider customers.
As we mentioned the North American market was very strong in the first quarter where we grew to $8 million in revenue up 34% over the previous year. Internationally there is an exciting and dynamic environment particularly in the Middle East. We continue to make good progress towards carrier wins in this region and we hope to be able to finalize some of these orders shortly.
Not withstanding this good progress visibility on timing is challenging in this area as well and the contract award and the implementation timelines can be long and variable. Overall for the regions both in North America and internationally we currently face the toughest visibility challenge we have encountered. I expect this to continue for the next two quarters or so and then we expect visibility to improve significantly.
At this stage we see the possibility of a similar revenue in Q2 to that that was achieved in Q1. However as an illustration of the volatile visibility that I had talked about, the range of possible outcomes is much wider than in any previous quarter and could be plus or minus by a couple of million.
As I said before in all markets I believe there is a growing appreciation that wireless backhaul economics performance and capacity is critical to the overall business case of WiMAX, 3G and LTE. We are starting to see the start of sale cycles to those carriers who are planning to deploy LTE technology and delivering value to these operators also represents a strong focus for DragonWave.
Even with the tricky short term dynamics we are confident there is a large market opportunity in front of us in 2009. We will continue to calibrate our activities to be a leadership player in that market. We have the cash resources to achieve this and we will focus on winning new customers and supporting existing ones fully so that we are in the best possible position in 2009.
This concludes my remarks and I would now like to ask the conference operator to open the bridge for questions.
(Operator Instructions) Your first question comes from James Faucette – Pacific Crest.
James Faucette – Pacific Crest
On the announcement with Sprint for Chicago and Washington DC do you know at this time if you will be the exclusive or sole microwave backhaul supplier into those markets or if not what kinds of situations are you expecting that they’ll deploy DragonWave equipment?
The arrangement we have at this time is that in those markets Sprint are using a number of technologies to achieve their goals during this initial launch phase. Some of that is non-microwave technology. To the extent that microwave technology is going to be deployed in those markets in 2008 and beyond DragonWave will be the provider of all of that microwave. Of course that’s dependent upon that we execute well and meet their needs for that microwave portion.
Your next question comes from Eric Kainer – ThinkEquity.
Eric Kainer – ThinkEquity
Could you talk a little bit about the orders that you’re seeing are those primarily for new sales sights or are they for transitioning backhaul from let’s say the traditional T1E1 over to IT backhaul or how could you categorize that for us?
Certainly at this stage I would say in the majority of operators, these are new sales sights, there isn’t the majority of the activity is not yet convergence between their existing network and the network that’s being put in place to carry new higher capacity services. One of the examples where that wasn’t the case and we did do some convergence with existing network was the M3 Wireless example from Bermuda. I would say by and large most of the activity at this time is new sales sights.
Your next question comes from Sera Kim – GMP Securities.
Sera Kim – GMP Securities
Could you talk about some of your progress that you’re seeing in the European market?
Yes, I would say overall Europe was a little quieter in the first quarter than usual. I think it will be much stronger in the second quarter and beyond. Areas that are going strongly for us, a good market at the moment is France where we have a lot of activity going on. Italy is coming on stream. Italy recently did its spectrum auction so we’re seeing the first opportunities to trial with new WiMAX spectrum licensees in Italy.
We’ve had a couple of good customer wins in Eastern Europe which I’m hoping that we’ll be able to talk about shortly more publicly. Markets are perhaps a little bit quieter at the moment than they’ve been in the past in Spain and Germany. They’ve been a little bit quieter but we’re bringing on as Russell indicated in the presentation most of our new customers in the quarter were from markets outside North America. Most of those were in Europe.
Your next question comes from Kevin Dede – Morgan Joseph.
Kevin Dede – Morgan Joseph
Could you give us a little more insight on the development from a technology perspective in Sprint’s network on one hand while you using the compact and duo there and whether or not there are requirements for Legacy TDM coverage and maybe you could talk a little too about the initial stages of the LTE sales cycle what you’re seeing and what you see operators looking for.
Firstly I would say that the network that Sprint is deploying has the opportunity of taking advantage of our very latest products and our very latest products are Horizon Compact and most recently Horizon Duo. Because they became available they’ve taken advantage of their capabilities in the designs that we and they have come up with for these markets.
In terms of the convergence with Legacy services this is a difficult area I think even for Sprint to address because until shareholders between Sprint and Clearwater have voted they can’t get together and make too many plans for the combined entity. Clearly the issue of how much convergence they may wish to do or may not wish to do is a matter I think for the combined entity and probably not a decision that they’re going to try to make individually.
I certainly can’t speak to that; it’s one that I think you’d have to talk to Sprint about. What I will say is we stand ready to support the strategy that they want to deploy in any way they want to deploy it. We have products that support converged networking and of course we would be delighted to make those available.
In terms of the LTE part of the question I would say that it’s certainly a growing understanding of the importance of the economics, capacity planning in the backhaul to getting at any overall 4G value proposition or service offering into a place where it is cost effective. There have been lots spoken about that in the press by operators, most notably John Saw the CTO at Clearwire.
I think the LTE people now have recognized that and of course they’re placing discussions about the architectures that they may wish to deploy further out their plans than perhaps they were previously and we participated in a number of discussions in the ongoing activities with those service providers who have indicated they want to deploy LTE.
Your next question comes from Peter Misek – Canaccord Adams.
Peter Misek – Canaccord Adams
On market dynamics and pricing, have you seen any increased pricing pressures you talked about a quieter market have you seen the likes to Sargon, NEC or others really changing their pricing methodology and that follows through have you changed any gross margin or margin assumptions off of that.
I would say nothing that is out of the ordinary course of what we’ve seen over last year or longer. This is a high growth opportunity in front of us. It is a market that is going to attract fiercer competition I’m sure. Yes, there is price erosion in the market. I think we are doing a good job of improving the cost effectiveness of our products both in terms of the prices that we can offer our products at but also in terms of the impact that our products can have on the cost of ownership of the service providers.
The proof the pudding is that we’ve been able to improve our margins in a way that we have while simultaneously I would say delivering greater value to our customers. This will be a continuous journey for many, many months and years ahead and it’s a thrust that we will continue to place as a highest importance in our company.
We believe that we’ve got good plans to be able to continue to do what we’ve done and through that maintain the good improvement in margins that we’ve seen so far. Hopefully even improve upon them slightly I would say.
Your next question comes from James Faucette – Pacific Crest.
James Faucette – Pacific Crest
Looking at your non-Clearwire revenue it looked like it was quite a bit lower than it had been in the previous couple of quarters can you talk to the dynamic that may be taking place there and how you think that’s likely to develop. Secondly, obviously you’re taking advantage of opportunities to grow R&D and I’m wondering how we should think about the growth in R&D going forward over the next few quarters.
Finally, to wrap up my perspective can you talk about the input into the wide range of possibilities that you have for the August quarter we’re almost half way through that quarter and if you still see a wide range of outcomes what do you see that dependent on?
Firstly, as I’ve always indicated this business can be chunky or lumpy because it is dependent upon the city or market deployments any of our customers are doing at that particular time. You’re quite right, we had a very, very strong quarter from Clearwire in Q1 and it was less strong with other customers. I think you’ll see that reverse in Q2. I think that’s the nature of things in this business. If you track back over several quarters I think you can see that degree of lumpiness.
We certainly increased our R&D primarily last year as we thrust more strongly our biggest thrust into international markets than we’d done previously by bringing forward our Horizon Duo products and now our products to support converged networks our service delivery unit and AirPair Unite. We think those platforms have been developed now, they’re obviously announcements to be done but largely we think that there our R&D baseline now is steady.
We think it will increase, it will be held what I’m describing as flattish. There will be a little bit of R&D increase at the margin as we enter new markets internationally there is always something to do when you enter a new country. Generally we think this R&D will held flattish so rate of inflation and a little bit of market driven R&D only is what I think you can expect to see from our R&D run rate.
The things that are causing the visibility challenging in Q2 is the plans of Clearwire and Sprint are impacted by the emergence of the new Clearwire and they are optimizing their position of what they want to do before the new company comes into existence and those things that they want to do after the company comes into existence.
We’re also seeing orders still in the Middle East that still have to be converted. We’re seeing some existing orders where there call off of our shipments are dependent upon their progress in securing sights and developing sights where the equipment is to be deployed. All of those things are causing us this visibility challenge in a much greater measure than we’ve seen it before and that’s why I’m indicating a wider range of possibilities than we’ve seen previously.
Your next question comes from Dennis Fong – Macquarie.
Dennis Fong – Macquarie
At the end of last year you talked about a goal of growing at a similar rate this year as you did last and given that there’s some visibility challenges next quarter do you expect some growth in Q3 and Q4, do you still think that’s an attainable target this year?
I’d like to say yes but frankly it’s really difficult to tell. A lot of the reason I say that is the timing around, if you look at the new Clearwire as an example, if they want to go from a coverage level today of 16.5 million pops internationally to between 60 and 80 million pops by the end of 2009 in the US alone by any measure that’s a four fold increase over the cumulative deployments today. That’s pretty aggressive. I’m imagining that they will want to get going at the earliest possible point in order to have a shot at achieving that goal.
The problem comes we simply don’t know when the earliest possible point is because it’s certainly out of our control, probably at this stage out of their control. I’m imagining they’ll do some planning and be ready to fire the gun so to speak as soon as the new entity comes into being. They want to maximize their advantage of the lead that WiMAX has at this time over LTE technologies.
If that comes sooner we will see I hope a very strong initial period which could fall into the fourth quarter of our year. If it comes later and it falls outside the year things will be more difficult. It really is very difficult to judge. What I will say is absent the new Clearwire situation we still see strong momentum in other parts of the world particularly in the Middle East where operators are indicating that they plan to build considerable size networks and again those are opportunities that would allow us to meet the goal that I’d indicated.
The cycle times on closing these orders is clearly variable and that’s the level of uncertainty that I’m reflecting here when I talk about challenging visibility.
Your next question comes from Todd Coupland – CIBC.
Todd Coupland – CIBC
Can you tell us whether or not you will have to enter a new bidding process for new Clearwire so you need to go through an expensive competitive process and if so when would that begin?
Firstly again I’ll the make the point that new Clearwire hasn’t come into being yet so how it will behave is hard to represent in the sense is there’s nobody there to ask. They’ve appointed a couple of the senior executives but at this stage the company has yet to come into being. Nonetheless I think it’s fair to say that as I indicated earlier the competition in this market will be fierce and I certainly couldn’t rule out the possibility that we would have to go through some competitive dynamic in the new Clearwire at any time in the future.
Having said that of course I’ll also make the point that the timeline that they’ve set themselves is very aggressive and they have worked very strongly with us I would argue that very successfully and certainly I hope to continue to improve as I’ve said before we’ve improved our costs while simultaneously we pass some of that on to our customers we’ve improved the value we deliver while simultaneously improving our own margins.
We will continue to do that and we hope that the combination of our track record and our position in the network today along with our ability to continue to deliver improved value gives us the opportunity to participate the most strongly in their forward network build.
Your next question comes from Sera Kim – GMP Securities.
Sera Kim – GMP Securities
If Clearwire decides if the earliest possible point is a little bit later than expected would you have the capacity to meet their requirements as well as the potential demands that could come out of the Middle East.
We believe we’re very well placed on being able to scale. At the heart of DragonWave the reason the company came into existence was there was a belief that these products could be designed to be easily manufacturable than perhaps microwave products have been previously. The strong design for manufacturability personality in our DNA we have a couple contract manufacturers that we work with, the product is designed for implementation on standard surface mount lines so we actually think we’re better placed than anybody through the fact that we are not vertically integrated.
We believe we have the best line up in order to be able to scale of really anybody in the industry. We’re very confident that we can meet the needs of all of the requirements that existing and potential customers can throw at us.
Your next question comes from Rich Valera – Needham & Company.
Rich Valera – Needham & Company
Could you talk about what you think it was that enabled you to win the bake off at zome that recently more competitive differentiation you have that enabled that win?
I talked earlier about the attributes of our products in terms of our capacity, in terms of scalability, in terms of cost effectiveness and most importantly in terms of their networkability. The products themselves are great products and they’re priced very competitively when compared to the products of others. We have the highest amount of capacity available of any single product on the market today. We have attributes with our Horizon Compact that are also unmatched by anybody else in terms of being able to deploy in an all out configuration.
The think I probably want to point to a lot is we can support ring and mesh architectures and through those ring and mesh architectures with the right technical performance with the right network availability you can get some nice attributes in terms of the amount of coverage you can get to the cell sights in a given geography so we generally can support very high coverage capability.
We can also support a good ratio between the number of sights you can cover from any given fiber point or presence. Our product, because it is deployed in this way often supports smaller antennae size than some of our competitors. Smaller antennae size in turn supports a lower operating cost by the operator. It supports sometimes an easier route to approval in terms of zoning and planning and negotiating with sight owners.
This all turns into a very strong cost of ownership equation for operators. These are some of the benefits that I think that Sprint is seeing from the attributes of the solutions that we have brought forward.
Your next question comes from Eyal Ofir – Canaccord Adams.
Eyal Ofir – Canaccord Adams
In Pakistan we recently heard of some movements there, I’m wondering if you’re seeing any increased activity out of Mobilink.
There’s nothing I could really be specific about. What I will say is Mobilink are very active in Pakistan at the moment and very visionary about the opportunity that they see to deploy advanced services to the Pakistani population. Pakistan is an interesting market, 160 million people, I think somebody said to me that the average age is only 21 so a very young population. The number of broadband connections in that country last year was only 128,000. There is a huge opportunity to get basic broadband services to a very young population who are very ready to receive it.
Mobilink have been very active and visionary about the services they want to bring to a number of cities. We’ve certainly been rolled out in five or six cities with them. I believe they are going to focus very strongly on a couple of those cities to really try and dominate is the right word in those cities. Yes, I would expect to see some future phases with Mobilink but it’s nothing I can be specific about with you at this time.
However, I would also say that because of the market dynamics that we’ve seen that I just talked about in Pakistan Mobilink has competition and there are other operators who are deploying and ones who are we think soon to deploy and we are working also very hard trying to win those as customers in that market as well.
Your next question comes from Dennis Fong – Macquarie.
Dennis Fong – Macquarie
On the mix of Horizon sales it has been pretty stable for the past couple quarters and could you just tell us is that more a function of their preference between all outdoor versus indoor configurations is that the mix you would see and that you would see more Horizon product from the Duo sale or what’s the dynamic there?
It has been stable for the last couple quarters. I think you’ll see increase significantly in Q2. As people see some of the advantages that I talked about earlier from the solution set. There will always be those who want slip mount configurations but certainly we have been delighted with the take up of our Horizon Compact configuration and as I say I think you’ll see that it will dominate requirements in our second quarter.
There are currently no further questions in the question queue.
If there are no more questions I’d like to thank everybody for participating this morning and have a great day.
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