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Powerwave Technologies Inc. (NASDAQ:PWAV)

Q2 2008 Earnings Call

July 31, 2008 5:00 pm ET

Executives

Tom Spate - Treasurer

Ron Buschur - President and CEO

Kevin Michaels - CFO

Analysts

Michael Walkley - Piper Jaffray

George Iwanyc - Oppenheimer

Jeffrey Kvaal - Lehman Brothers

Kenneth Muth - Robert Baird

Kimberly Watkins - JPMorgan

Brian Modoff - Deutsche Bank

Thomas Lee - Goldman Sachs

Rich Valera - Needham and Company

Bill Choi - Jefferies

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Powerwave Technologies earnings conference call. (Operator Instructions).

I will now like to turn your presentation over to the Treasurer, Tom Spate. Please proceed.

Tom Spate

Thanks, Eric. Good afternoon and welcome to Powerwave Technologies Second Quarter 2008 Financial Results Conference Call. I am Tom Spate, Powerwave's Treasurer. Joining us today will be Ron Buschur, Powerwave's President and Chief Executive Officer and Kevin Michaels, Powerwave's Chief Financial Officer.

Before starting, I would like to point out that various remarks we make about future expectations, plans and prospects for Powerwave including but not limited to anticipated revenue and revenue growth rates, operating margins, gross profit margins, earnings per share levels, cash flow projections, revenue composition, improvements in cost structure, cost savings related to our facility consolidations, future cost savings related to our cost reduction activities, demand levels for the Company's product lines, projected growth in market share, trends in the wireless infrastructure market, the timing of product deliveries and future orders, the timing of the closing of our. Maryland manufacturing facility, the success of new products, expense levels, capital expenditures rates, inventory churns, tax rates, and day sales outstanding, are all forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause Powerwave's actual results to be materially different from those projected or implied.

Some of the risks and uncertainties include our ability to accurately forecast and anticipate customer orders, integrate acquisitions and realize anticipated cost savings and synergies, the potential negative impact on demand for our products due to industry consolidation among our major customers, fluctuations in foreign currencies, the ability to accurately forecast cash flows and credit collections, the impact of competitive products and pricing, economic and political conditions, and the loss of one or more significant customer accounts.

Please refer to our press release, Powerwave's current Form 10-Q, for the quarterly period ended March 30, 2008, and our Form 10-K for the fiscal year ended December 30, 2007, and other filings which are on file with the Securities and Exchange Commission for additional information on factors which could cause which could cause our actual results to be different from those projected or implied.

In addition, on this call we will discuss non-GAAP financial information. A reconciliation of the non-GAAP financial information to our financial statements as prepared under GAAP is included in our press release dated today which can be found on our web site at powerwave.com and on business wire. The press release also has detailed information concerning several of the significant items impacting our results and we urge you to review that information.

Now, I am going to turn the call over to Kevin Michaels, Powerwave's Chief Financial Officer.

Kevin Michaels

Thank you Tom, and good afternoon everyone. With all the risk factors in mind, I would like to start out by reviewing our financial results which are also summarized in our press release.

Net sales for the second quarter of 2008 were 245.6 million. And we reported a net loss of 10.2 million which equates to a GAAP net loss of $0.08 per share. The GAAP loss includes approximately 6.1 million of restructuring and impairment charges which includes charges related to the restructuring and consolidation of several of our facilities, as well as severance costs.

There was also an additional 8. 9 million of non-cash intangible asset amortization related to our prior acquisitions. All of these charges and amortization totaled approximately 15 million for the second quarter of 2008. On the pro forma basis, excluding all restructuring and impairment charges and an intangible asset amortization, we had pro forma net income of 5.2 million or pro forma net earnings of $0.04 per share.

I want to note that included in both our GAAP and pro forma results is the impact of approximately 1.3 million of pre-tax stock-based compensation expense due to FAS 123R, almost all of which is included in operating expenses. Excluding this expense from our reported results, adds approximately $0.01 to EPS for both GAAP and pro forma results. This is the same impact as in the prior year period.

On a geographic basis, our total America's revenue for the second quarter of 2008 was approximately 83.1 million or 34% of revenue. Total Asian sales were approximately 30% of revenue or 72.8 million and total European and other international revenues were 89.7 million or approximately 36% of revenue. We saw significant growth in both the European region, as well as the Asia Pacific region compared with the first quarter of this year.

In addition, while our Americas revenue was basically flat compared with the first quarter of this year, we did see good strength in our direct operator business in the Americas, which was offset by a decline in our OEM business in North America. Our second quarter revenue increased 32% over the second quarter a year ago, and was largely driven by increased demand across all of our markets.

We factor out the impact of changes in foreign exchange rates on our second quarter revenue, which equates to approximately 7.6% of our revenue. We still have an annual growth rate of 22% when compared with the prior year period.

In the second quarter, sales of products within our Antenna Systems product group totaled 68.5 million or 28% of total revenue. Base Station Subsystem sales totaled 148.8 million or 61% of revenue and Coverage Solution sales totaled 28.3 million or 11% of revenue.

Our total 3G-related sales were approximately 95.7 million or 39% of our total revenue. Our 2G and 2.5G-related sales were approximately 144.3 million or 59% of revenue and our WiMax sales were 5.6 million or 2% of revenue. In terms of our customer profile for the second quarter, total OEM sales accounted for approximately 56% of our total revenue and direct and operator sales accounted for 44%.

Moving on to gross margins, on a GAAP basis, our total consolidated gross profit margin was 20% for the second quarter. In our press release on page 3, there is a table with the reconciliation of the various factors impacting our gross margin for the quarter. On a pro forma basis excluding restructuring and impairment charges and non-cash intangible asset amortization totaling 11.4 million, our total gross profit margin was 24.7%.

On a GAAP basis, our reported cost of goods sold includes a credit of approximately 1.6 million related to the sales inventory to several customers that was previously determined to be excess and obsolete to our on going requirements. This represents a pick up of approximately 0.7% of gross margin.

And when you subtract that from our reported pro forma, our adjusted pro forma gross margin was 24%, which is up from an adjusted pro forma gross margin of 23.2% on a similar basis in the first quarter of 2008. Many factors impact our gross margin during a quarter. And during the second quarter, we experienced a significant increase in our transportation related costs, which we believe was directly related today the rapid rise in oil prices during the quarter.

Given our global manufacturing footprint, we rely heavily on various transportation methods which caused us to incur extra expense in the quarter, that we were not able to pass on to our customers. We have calculated that these increases had a negative impact of over 1% on our second quarter gross margins, when compared with just the first quarter of this year. While we are concerned about future oil prices and any related impact to our business, such as any increases in raw materials pricing and transportation costs.

We are taking actions to reduce our exposure to these costs when possible. This includes increasing local production where it is cost effective to do so. For the remainder of 2008, we continue to focus on improving our gross margins. We have additional work to do to finish both our supply chain consolidation activities and further reduce our manufacturing overhead costs, as well as driving sales of higher margin products within our business.

Next I will review our operating expenses for the second quarter.

Our sales and marketing expenses were 13.2 million, research and development expenses were 20.8 million and G&A expenses were 16 million. Excluding restructuring and impairment charges and intangible amortization for the second quarter, which totaled 3.6 million, our total operating expenses equaled approximately 50 million. This amount includes approximately 1.5 million of an employee bonus accrual for the second quarter. As a note, this is the first time we have accrued a bonus since fiscal year 2005.

We remain committed to our cost reduction plans and we will continue to execute on these plans in the quarters to come. As we have previously stated, our quarterly operating expense target of 45 million for the second half of this year, excludes any amortization of intangibles and restructuring and impairment costs, as well as any employee bonus accruals.

In terms of other income and expense, we recorded a total of approximately 4.7 million of other expense in the second quarter of 2008. The main contributors to this expense were two items, the first being the ongoing interest expense associated with our outstanding convertible notes and the second being the foreign exchange translation loss for the quarter.

The foreign exchange translation loss was approximately 2.6 million. This loss was due to significant changes in the value of the U.S. dollar versus several currencies, especially the Indian, Chinese and Hungarian currencies. For the second quarter our tax rate was impacted by some minor tax payments, and evaluations allowances on our deferred tax assets.

While we will continue to evaluate our future tax rate based upon our diverse international operations, we continue to estimate that our effective worldwide tax rate will be approximately 10% for fiscal 2008. I want to stress this estimate will fluctuate based upon our actual results. For the first six months on a full GAAP basis our rate was approximately 9%.

Next I will review our balance sheet. Total cash at June 29, 2008 was approximately 84.3 million, of which 3.2 million is restricted cash. Cash flow from operations was the use of cash of approximately 3 million. During the quarter, we paid approximately 10.2 million in relation to a Swedish tax claim that was included in the original LGP Allgon acquisition.

If you exclude this one time settlement payment from the cash flow calculation, we would have generated positive cash flow for the quarter of approximately 7 million. Our total capital spending was approximately 1.8 million for the quarter. We remain extremely focused on cash flow generation and believe that our operations will be cash flow positive for the remainder of the year.

During the current third quarter, we have a number of one-time items that will reduce our current cash balance. These include the repayment of the outstanding convertible notes that were due on July 15. The total amount outstanding including interest was 13.7 million and it was repaid in full on that date.

In addition, we have paid approximately 4.1 million as a deferred payment related to our VersaFlex acquisition. These items totaled approximately 18 million and have already been paid in the third quarter.

I do want to highlight that we now have paid all of the short term debt that was outstanding at the end of the second quarter and we have no other long-term debt coming due until 2011. We believe that we are well positioned from a balance sheet perspective and that our future cash flows should further strengthen our balance sheet.

Looking at other items on our balance sheet, our net inventory was 91.2 million, which represents inventory returns of approximately 8.1 times. We remain extremely focused on maintaining and improving our industry-leading inventory returns, which should overtime help us to free up some of the cash on the balance sheet. Our total net accounts receivable decreased slightly to 254.8 million resulting in our AR days sales outstanding decreasing to approximately 94 days from 103 days in the first quarter of 2008.

Before turning the call over to Ron, I would like to remind you that we do not provide quarterly guidance. We believe that our investors are better served by focusing on long-term trends as opposed to the short-term volatility that is inherent in the market that we compete in.

In terms of our guidance for fiscal year 2008, please note our guidance remains subject to a number of risks and uncertainties that could impact our future outlook results and many of these are detailed in our public filings with the SEC.

With all of that if mind, based upon our current expectations for this year, we are increasing our target fiscal year 2008 annual revenue range to 920 million to 960 million from our previous guidance range of 880 million to 920 million. While we are increasing our forecasted revenue for fiscal 2008, we want to stress that we remain conservative in our outlook for overall capital spending within the wireless infrastructure industry.

We realize that we are all in a tough economic environment, and we expect to see various operators control their overall capital spending in this type of environment. While these are factors that are not in our control, we believe that there are opportunities for Powerwave to continue to do well in this environment.

With that I'd like to turn the call over to Ron Buschur, Powerwave's President and Chief Executive Officer.

Ron Buschur

Thank you Kevin and good afternoon everyone. I am very proud and pleased with our results for the second quarter and I would like to recognize all the hard work of our employees and our suppliers who are helping us move towards our long-term goals. We are making significant progress and returning our Company to profitability.

On a pro forma basis we reached an operating margin of 4.3% and generated $0.04 in earnings. While these are strong results within a slow macro economic environment, we still have much more work to do and we remain extremely focused on our objective of reducing our overall cost structure in the manufacturing, supply chain, and operation expense areas.

We will continue to execute on our restructuring and cost reduction plans, in order to lower our operating expense. These actions will help lower our breakeven targets and improve our gross margins as well as drive increased profitability.

In terms of Powerwave's on going restructuring and cost reduction activities, we continue to believe that we can reach our initial target, pro forma gross margin range of 25% and reduce our quarterly operating expenses to 45 million in the second half of this year.

As Kevin, mentioned we are cautious about the overall demand for capital spending in the wireless industry. But we believe that we will be able to continue to increase demand from our direct operator markets, as well as certain of our OEM customers. We believe the wireless network operators throughout the world are looking for ways to improve their wireless network performance more cost effectively, using solutions like the ones we provide rather than investing in new base stations.

These solutions are where Powerwave, is well positioned and we have been investing and we will continue to invest our research and development dollars, enhancing our product and technological leadership position, with our customers providing them with cost effective solutions. But we believe there are great opportunities for us to expand our revenue, customer base, and market share, utilizing these solutions.

As I noted earlier, we still have a lot of work ahead of us, and we are extremely focused on improving Powerwave's profitability and performance which will generate the level of shareholder value you deserve. As I am sure, you're aware this remains a very competitive industry, with external factors like oil prices, raw material cost increases, transportation costs, adding to the complexity and challenges of our business.

Now I'd like to review some highlights and activities in the second quarter. In the wireless environment, in which many OEMs are experiencing slow down, Powerwave was able to grow our direct network operator sales by over 45% from the first quarter. While our largest OEM customers remain relatively steady, we did experience lower sales in our overall OEM business of almost 10% when compared to the first quarter. We believe that this performance helps validate our OEM and direct operator model strategy.

As we stated before, in a slow economic period operators would normally look to reduce their capital spend. But today, the demand for wireless services is strong and the operators are willing to invest in cost effective solutions to enhance and leverage their existing network operators, existing network and capital equipment. This is where Powerwave is focused, providing leading-edge, cost effective solutions for the global wireless infrastructure marketplace.

In terms of the product areas, we saw our Antenna Systems revenue increase by 32% sequentially and 77% year-over-year, far more than the overall industry growth rates that have been reported. In addition, our Coverage Solution product segment an area we have been focusing a lot of our attention, we saw a 29% sequential growth and 122% growth over the second quarter a year ago.

Looking at our top customers, for the second quarter, total revenues for Nokia-Siemens were approximately 68 million and accounted for approximately 28% of our total revenues. Revenue from Alcatel-Lucent was approximately 39 million, which represented approximately 6% of our revenue. AT&T Wireless revenue was approximately 25 million, which represented approximately 10% of our revenue. I want to note that we did see an increase in sales to AT&T with whom Powerwave has an excellent relationship with.

AT&T only represented 10% of our total revenue, and only 23% of our total direct network operator business. This certainly highlights that during the second quarter we have continued to diversify and expand our direct network operator customer base on a global basis.

At the end of the second quarter, we announced our plan to close our manufacturing operations in Maryland. We expect to have these production activities transferred from our Maryland location by the end of the third quarter. This production will be transferred to Asia, as well as to our location in Southern California.

As many long-term investors may recall, our corporate head quarters located in Southern California was one time our major manufacturing location. And this site will now be used as a low-volume, high mix production area, as well as final system integration for large solutions that will be delivered to customers in North America.

We do believe that these actions will further leverage and reduce our overall operating expenses by consolidating U.S. production capabilities, and help offset the steep increase in transportation costs that we have occurred over the last year.

From an overall market standpoint, we are optimistic about Powerwave's opportunities in 2008. And I believe we are well positioned with the network operators, with the right solutions, as well as the right personnel to gain market share. Our revised guidance for 2008 now reflects an annual growth rate of over 20% more than double of most industry analyst predictions for the total market growth in 2008.

Clearly we believe that Powerwave has one of the strongest portfolios, the best personnel, and engineering resources, as well as the most advanced leading edge technology solutions for the next generation of wireless products. I continue to believe in this team, these solutions, and the wireless industry creates exciting and growing opportunities for Powerwave Technologies investors and employees in the years ahead.

I would now like to the turn the call over to Eric the operator and address any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from line of Mike Walkley with Piper Jaffray. Please proceed.

Michael Walkley - Piper Jaffray

Okay, thank you. Congratulations on your strong results. Kevin, just a clarification question for you. In terms of the bonus accrual, is that something we would anticipate for the back half of the year, if you continue these types of trends on the top line or is this quarter what you think is enough for the year? And then I have some follow-up questions.

Kevin Michaels

No, if we can continue on an improving trend, we would expect to see additional accruals in the back half of the year.

Michael Walkley - Piper Jaffray

Okay, great. Thanks. And then in terms of your guidance, basically the midpoint would be basically flat in the second half of the year. Can you give us just a little granularity on the thought process there I know it is a tough macro environment. Are we assuming seasonally slower Europe like we usually get, which is a big piece of your business, is that the best way to think about Q3 into Q4?

Ron Buschur

That is correct, Mike. As you know, the seasonality that typically takes place and the slowness in the European market in the third quarter has made us a little bit more conservative in our view for the third quarter results. And quite frankly just the global macro environment allows us, I think to step back and maybe just be a little bit more prudent in our view. But, as we said, we still think there is a tremendous opportunity for growth yet and the demand that we are seeing in parts of the APAC region in Europe are very exciting for us and we're pleased with the opportunities that we see here in the short-term.

Michael Walkley - Piper Jaffray

Okay. Thanks. And just building on that, one of your largest customers exiting Q1 talked about they were disappointed in inventory levels. It sounds like that is improved. Any color in terms of your inventory with your leading OEM customers?

Ron Buschur

I really can not comment on what maybe Nokia or others are talking about their inventory levels. I mean we certainty have to continue to focus. I think as you can see our inventory returns have improved. We have had to bring in a little bit more raw material than what we would like just due to the ramp that we are on in our production facilities. But, I envision the inventories to continue to improve as we go into Q3. And at this point we are not alarmed with the inventory levels we are carrying.

Michael Walkley - Piper Jaffray

Okay, great. I will just ask one more for you Ron and then pass it on. In terms of the Coverage System, you mentioned the strong growth there and I know this business is also a lumpy type business. But as that 28 million as you look and over the next several quarters is that a type of level business, you think is sustainable for that higher margin PC portfolio?

Ron Buschur

Well, we will certainly want to continue, Mike as you know, to grow that segment of the business. You highlighted that it is a very lumpy market segment. I would like to say it is a longer sales cycle typically than more of a lumpy type of environment, because it is a pretty sophisticated system that you are selling.

So the sales cycles are typically longer. But, we have certainly invested a lot of R&D dollars into that market segment those products and solutions that support that area. So I want to continue to grow that market segment and we are going to be aggressive in pursuing those opportunities.

Michael Walkley - Piper Jaffray

I guess just to clarify then, was there a major contract that closed during the quarter or should we do you still have pretty good visibility into that business in the back half of the year?

Ron Buschur

I would not say there was one major contract. These are typically multiple smaller programs or contracts that you win in this in-building coverage or enterprise type of business. So there are multiple projects that we have in the queue, and we feel pretty good about our positioning for the rest of the year in these segments.

But, again, the sales cycles are just a little bit longer than what you have with the conventional products that Powerwave has.

Michael Walkley - Piper Jaffray

Okay, great. Well, good luck and continue to get that cost structure looking better.

Ron Buschur

We will, we will continue to focus on it. Thank you.

Operator

Your next question comes from the line of George Iwanyc with Oppenheimer.

George Iwanyc - Oppenheimer

Congratulations on the results guys. When you look at the direct carrier sales, you had a nice increase there. How sustainable do you think that is and what areas are really driving the growth? What type of products? In addition to AT&T what are you seeing in Europe and with other carriers?

Ron Buschur

Well, I think you can certainly see, George that we have had good success in the APAC region, as well as European with our network operator sales. I am glad you picked up on the point that obviously, we have expanded our customer base beyond just one operator to do that. And that was the point we were trying to make.

Looking at the product segments, when we look at what we have been successful with, obviously, our Antenna products have been a good product and solution that we have been able to offer, as well as our in-building coverage and repeater products, and our amplifier and some of our complete solutions were pretty effective as well. And then we have had some success with our remote radio head products. So we are pretty pleased across the product portfolio.

I think going forward, we are going to continue to focus on trying to sustain that operator business and actually grow that, that is our goal and our OEM customers are very important to us as well. So we want to continue to maintain that dual strategy. But, in this environment, as I had stated earlier, I certainly see a lot more willingness from the operators to try to buy and purchase solutions that are more cost effective and allow them to advance and leverage their and leverage their existing CapEx in their networks. And that really benefits Powerwave today.

George Iwanyc - Oppenheimer

How would you characterize the visibility into the carrier activity? Is it really near term or do you have a little bit longer visibility there?

Ron Buschur

Well, I guess the visibility it really depends on what you would call long-term. I would not tell you that there is a six months worth of visibility out in the network operator business. We certainly feel pretty comfortable that we have pretty good visibility of what is going on here in the next, let's say quarter or so and that we are comfortable with. Looking longer term, at least a spending patterns in the commitments that the operators have made gives us some comfort that at least for the remainder of the year, it still should be pretty healthy spend, that most of the operators are planning on spending and building out their networks towards.

George Iwanyc - Oppenheimer

Okay. And following up on the seasonality question, with the trends you are seeing right now, normally you see a second half larger than the first half. Is there anything that would make you outside of the macro economic situation, in your booking patterns that would suggest that one had happened this year?

Ron Buschur

No, but as we said Q3 is typically, you have a little bit slower period with the European holidays and what takes place in Europe. But, as a whole, the second half does appear to be on track for what we typically have seen in the previous years.

George Iwanyc - Oppenheimer

Okay. Thank you very much. Keep up the good work.

Ron Buschur

Thank you.

Operator

Your next question comes from the line of Jeff Kvaal with Lehman Brothers. Please proceed.

Jeffrey Kvaal - Lehman Brothers

Hello. Can you hear me okay?

Ron Buschur

Yes, we can, Jeff.

Jeffrey Kvaal - Lehman Brothers

Okay. Super. Ron for you my, question is along the lines of the sustainability of the great growth that you have. Obviously, 20% is well above you point out where the industry is. Do you feel like you should be in a position to grow faster than the industry or closer to the industry, over the next say 12 or 18 months?

Ron Buschur

Well, Jeff I will be honest. Right now I am very focused just to trying to deliver what we need to do for the remainder of this year. I do not think that anyone in this industry quite has a visibility of 12 or 18 months. As we stated at the beginning of the year, we believe that we can grow slightly faster, maybe than what the industry average was at that point, when we had given our initial guidance.

Obviously, at least through the first six months of this year, we have been able to maintain the growth that we had anticipated. We are going to continue to try to drive aggressively our solutions into the marketplace. And if the macro economic environment is not change at least the patterns we see today, I think we are going to be very successful in delivering the types of growth rates that we had outlined.

Jeffrey Kvaal - Lehman Brothers

Okay. Kevin, on the OpEx side, if we exclude the 1.5 million, even than, it seems that your OpEx is up a little bit sequentially. How should we think about that and what gives you the confidence that 45 million then is achievable by lets say the fourth quarter?

Kevin Michaels

Well, we were up, you are correct in that, we were up about 1.1 million from the first quarter. We did encounter some expenses that were a little higher than what we anticipated. Our focus is on driving, in addition to reducing our operating expenses and hitting our targets, it is also been to drive improvements in the gross margin.

On the operating expense side, we have taken a lot of actions. The latest that you can see is obviously, the decision to close our Salisbury plant. We also took some other actions during the quarter with some other facilities.

So we are taking actions that will drive lower operating expenses. We are doing things throughout our organization. We are renegotiating contracts; we're renegotiating what we spent throughout our operating expenses. We are pretty confident that by the end of the year we will hit our targets, if not sooner. We are very focused on that. We have not changed the target. We are going to continue to drive on that. So we know that we have got a ways to go, but we understand the leverage in that. Where the entire Company is focused and committed to that.

Ron Buschur

I think some of the actions that we have announced for Salisbury and some of the other facilities that we have already taken action around has, I think will overtime show that we are able to achieve that $45 million target from an operating expense perspective. As Kevin said, it takes a period of time until you see that effect, but you will see that here before the end of the year certainly.

Jeffrey Kvaal - Lehman Brothers

Okay. Great. Then my last question is, Kevin can you remind us how much of your debt is due in 2011?

Kevin Michaels

There is 200 million that comes due and then the other 150 comes due in 2014.

Jeffrey Kvaal - Lehman Brothers

Okay. So the plan would be to pay off some of that with cash flow and then you might issue some more debt to replace that?

Kevin Michaels

Yes. I mean, it is obviously it's over three years out there and our basic plan will be to generate cash flow over that period.

Jeffrey Kvaal - Lehman Brothers

Okay. Thank you.

Kevin Michaels

Thank you.

Operator

Your next question comes from the line of Ken Muth with Robert Baird. Please proceed.

Kenneth Muth - Robert Baird

Hi. On the Coverage Solution segment, do you expect so see any seasonality in the second half or should that trend that you put up around Q2?

Kevin Michaels

Well, Ken what we are looking at as I outlined earlier, it is a little longer sales cycle. So I do not really think that it is going to be a seasonal effect there. You will have the seasonal effect for some of the deployments and some of the sales that we are focusing in the European market. So that may have a slight impact. But, otherwise, we think it should be fairly linear.

Kenneth Muth - Robert Baird

Okay. Then a little bit surprised, just at the mix there and the base stations were a little bit better, obviously you just had really strong orders in the antenna group. Anything you are seeing on the base station side why that did not get the pick up as some of the other businesses in Q2?

Kevin Michaels

I think, Ken part of that is related to some of the OEM business, as traditionally most of the OEM business is in that base station category and we did see a little slowness in total OEM business. So that is probably the main impact there. We are very happy on the operator side we are selling a broad range of products, not just antenna, but a number of base station products it's very strong. We are very happy I think as Ron mentioned in North America the operator business there is doing quite well.

Kenneth Muth - Robert Baird

Okay. Then when would you expect any revenues from the 700 megahertz spectrum and the auction of that?

Ron Buschur

Well, I think that is going to be more toward next year, Ken than what you would expect to see here on the Q3 or even Q4. I think it is a little premature at that point to where we would speculate revenue. I would like to see revenue be first half let's say 2009.

Kevin Michaels

There is certainly is a lot of interest in those categories in terms on the engineering side. Do we have projects underway for various customers in those areas, and the answer is yes. As Ron mentioned we would not expect to see revenues this year.

Ron Buschur

Plus Ken, as you know, you were actually seen that I believe when you were at the show. We actually have current products, MCPAs and antennas today that do meet those requirements and our design for that protocol, in that frequency.

Kenneth Muth - Robert Baird

Right. Then on the in-building side again, is any of that go to the direct-to-carrier or what is the main customer base there?

Ron Buschur

No, there is some of that business does go direct-to-carrier. But the bulk of it right now is the enterprise.

Kevin Michaels

Well, actually Ken, almost all of that business is categorized. We categorize it in that direct channel. There is a little bit going to some OEMs but almost the entire business is categorized in our direct channel.

Kenneth Muth - Robert Baird

Okay. Then just the margin profile that covered solutions is that above the corporate average?

Kevin Michaels

Yes, generally it is.

Kenneth Muth - Robert Baird

Okay, great. Thank you very much.

Kevin Michaels

Thank you.

Operator

Your next question comes from the line of Kim Watkins with JPMorgan. Please proceed.

Kimberly Watkins - JPMorgan

Thank you. I just wanted today ask on linearity, I think last quarter, you guys saw a pretty big March third month of the quarter. DSOs obviously were down, suggesting it might not have been as back end loaded. Can you just talk us through how the quarter played out on a month-by-month basis?

Ron Buschur

Well Kim, I would answer that it definitely was not as back end loaded as the first quarter. It was more linear. I mean we are not going to breakout our details by month. We are very happy with the linearity throughout the quarter and it was good. Definitely a significant improvement over what we saw in the first quarter.

Kimberly Watkins - JPMorgan

Okay, okay, that is helpful. Then just talking about the OpEx targets for the second half of the year I think you mentioned 1.5 million bonus accrual, is that a reasonable rate to assume in addition to the 45 million target, or is that something that could fluctuate pretty significantly depending on how the second half of the year plays out?

Kevin Michaels

It could fluctuate some depending how the second half of the year. It is obviously going to be tied to performance metrics. So it can fluctuate a little bit and especially towards the end of the year.

Kimberly Watkins - JPMorgan

Okay. Then one of the things that I did not hear you mention in the commentary about your direct, obviously that business was very, very strong. But, I did not hear a lot of comments about on the MCPAs. Can you just talk little bit about that business and interest-to-date from operators, maybe on a geographic basis where some of the deployment have occurred and how you expect that to shape up for the remainder of the year and into next?

Ron Buschur

Well, I mean we are very happy with the MCPA business. I guess we thought it was pretty obviously that that business was doing well and we were pleased with what we are able to provide as far as solutions and MCPAs to the network operators and to the OEMs as well. So that business has been pretty strong and it continues to be a good product line for Powerwave. What we were trying to do is show the diverse product segments and focus on the areas that have been of interest to everyone, Kimberly. We are very pleased with the power ramp.

Kimberly Watkins - JPMorgan

Okay. Thank you very much.

Ron Buschur

Thank you.

Kevin Michaels

Thank you.

Operator

Your next question comes from the line of Brian Modoff with Deutsche Bank. Please proceed.

Brian Modoff - Deutsche Bank

Hi. Can you hear me okay?

Ron Buschur

Yes, we can hear you, Brian.

Brian Modoff - Deutsche Bank

Hey guys. So, looking at seasonality in Europe but given the other parts of your business, could you see Q3 is down sequentially or do you think you can more than offset softness in Europe with the other regions and customers?

Ron Buschur

Well, that is a real difficult one. I would say traditionally, and you know Brian this industry, Europe is obviously a big part of our business. I would say conservatively we would have to assume overall it'll be down some because of the slowness that you traditionally see in Europe. Obviously if the other businesses continue on a very strong path as potentially have that could be offset. It is hard for us to predict.

So we would like to stay conservative, following traditional patterns out there, and especially in this macro economic environment. We a lot of people have been expressing concerns and lowering numbers and stuff. We think we are in that type of environment other than; there is a great opportunity for us. Where as we have been executing on it, and we think we can continue to execute on that.

Brian Modoff - Deutsche Bank

Okay, fair enough. Then on the margins, you had pretty good mix this quarter obviously with the antenna and in-building systems being higher and your direct business was higher. So I am curious about the gross margins and they did improve sequentially. Can you talk about overall were there any challenges in the quarter on the margin size side? How is pricing environment holding up for you guys?

Kevin Michaels

Sure, I will talk first about some of the challenges and let Ron talk about pricing. As I mentioned in my comments, we were hit by transportation costs, and clearly oil prices and I've mentioned that was over a 1% hit to our margin. That is just from the first quarter of this year. So we saw significant increases that really impacted us. I think if we have not had the oil price rises you would have saw our margins be significantly higher. So there are those kinds of raw material costs out there that are certainly impacting us. We have been able to offset some of that.

Also as you know, we are still working through restructuring activities, whereas we have got ongoing activities to drive our margins. So we think over the course of the next year you will see us continuing to improve our margins. In the short-term, there are a lot of factors out there that are impacting us that are challenging. We think we are doing a reasonable job of managing through those.

We are still committed to driving to that mid-to-high range on a longer-term basis being mid-to-high 20s. So the 25 to 29% range that is our long-term goal and we think on a long-term basis we can position ourselves there.

Ron Buschur

Perhaps. And may be let me expand a little bit. Kevin talked about the transportation cost increase and the surcharges that were applied. But keep in mind the petroleum has a big impact on our plastics, has a big impact on some of the other products from a raw material perspective that we use in our product design. So we have seen it multiple areas of our cost. Looking at the pricing, I certainly would say that as I said from the beginning it is still pretty competitive marketplace right now.

We are not seeing the types of declines that we were being forced to try to adhere to. Let's say a year ago, Brian. I certainly do not think that at this point we can say that things are flat or stable pricing wise. There is still a lot of pressure out there in the marketplace and you know, there is still a fair amount of supply that is sitting there in the market that is trying to go be utilized by some of our customers.

Brian Modoff - Deutsche Bank

Ron, could you give us an update on where you are at in terms of number of owned facilities? What do you think long-term is your target for internally produced versus external? Then maybe talk a little bit about some of the new products you have coming later in the year that might have a better margin profile on them? Thanks.

Ron Buschur

I will certainly touch base a little bit here as, you know, Brian we are putting a lot of emphasis on your in-building, our mesh network, repeater products that we want to put into the marketplace here at the end of the year and in 2009. We are very pleased with the progress and the acceptance that we are seeing with those products, as well as our NetWay management software or our software that allows the network operators to actually manage and control their network real-time and dynamically.

So that is been very good. So, those products we are optimistic about moving forward. We think they are going to offer us a good opportunity for expanding our market share and expanding our customer base.

The in-building coverage will allow us to expand into the enterprise market and sell those products and solutions into that market segment as well. As far as our mix on manufacturing I should not say mix, but the strategy around in-sourcing and outsourcing. We still have outsource partners that we are going to continue to utilize, as far as allowing us to flex our manufacturing capabilities, whether it is upward or downward, and we want to continue that strategy. We think that is a good strategy to keep us very aggressive and not become too complacent in our manufacturing sides as well. It is a good benchmark, but it also allows us to maybe leverage some of their spend and their buying power as well. So we are going to continue to utilize that.

As far as the operations that we currently have as far as our major manufacturing sites, we still have our major manufacturing sites in China, Estonia, and we will utilize Santa Ana, now here in North America, as we move products from Salisbury here to California for the low volume high mix.

The high volume products or higher volume products will go to the APAC region, and that will continue to be our manufacturing strategy at least for the remainder of this year. We may look at trying to have an additional site somewhere in the APAC region, so we have another area for manufacturing. So we are not quite so dependent on the one operation in China.

Brian Modoff - Deutsche Bank

Okay. Thank you very much.

Operator

Next question comes from the line of Thomas Lee with Goldman Sachs. Please proceed.

Thomas Lee - Goldman Sachs

Hi. Thanks for taking my call, a few questions. Just on the transportation costs, you talked about plans that kind of mitigate those. I mean if this was, to remain I guess for the foreseeable future, how long from a timing perspective, will it take you to implement some of those plans to help mitigate some of those costs?

Ron Buschur

Well I think some of the plans are happening over the latter half of this year. So I mean we are part of your consolidation with our Salisbury plant into California. We are also moving some larger bulky production back into California. So we don't have to transport across the ocean. So, those actions are currently underway. We are doing that across the globe and they should be fully in place by the end of the year.

Thomas Lee - Goldman Sachs

Got it. In terms of when you would see the impact here to your P&L is that more 2009 though?

Kevin Michaels

I think more in 2009. We should see hopefully some improvement by the fourth quarter but you know, more in 2009 I would say.

Thomas Lee - Goldman Sachs

Great. On the OpEx side, just curious to get your sense on, obviously, you were very clear in terms of explaining some of the increases, but if, as you think about your resource planning and as business conditions change, you guys clearly are doing a great job in terms of growing your top line. I mean do you, do you foresee a scenario where you perhaps need to reassess your resource planning, increasing head count or something to that affect or do you feel pretty comfortable with what you have laid out that there is not going to be any changes on that front?

Kevin Michaels

There are clearly no changes in this year. We are very comfortable with that. We will look long-term. I mean, obviously if things improve dramatically, there may be some impact on the longer term basis but clearly this year there is no changes.

Thomas Lee - Goldman Sachs

Great. Then I Just want to move on to your, to the OEM side. I just, can you help -- help us understand some of the decline in that business? Is it more a function of just market conditions or is it potentially some share losses involved and just how do you see that business segment trending?

Kevin Michaels

Well Thomas, obviously I think it is probably well known who the OEM customers that Powerwave supports and I think if you listen to some of their end operator customers and the fact that they have maybe stopped some of the spend of their network deployment and some of the commentary of the actions that they are taking internally to reduce spend, and the impact that that has on maybe one of these OEMs or possibly two, it is probably pretty apparent to where some of that softness came into play.

Now, with that said, we are confident and comfortable that this OEM is moving aggressively to win some other areas of business and we are there to support them to do that and they have been a good partner and we want to be there to help them grow as well throughout this period of time.

Thomas Lee - Goldman Sachs

Got it, great. Then just lastly, on the direct side, can you just, can you give us a sense in terms of maybe the balance from a geographic standpoint? I mean is it heavily obviously, North America was strong, but is it, is North America over 50% or anything, any color to help us get a better understanding of the different regions that are to help, driving that?

Kevin Michaels

The thing that we are really proud of is it is diverse globally. It is spread out across all of our major regions. North America is doing very good, but so is the European region and we are also doing very good in Asia and we are very good in developing markets around the world places like Eastern Europe, places like South America, other markets.

So it is really diverse, and that is what we are very happy about. It is not as we have noted, I mean clearly we are very excited with AT&T being a 10% customer, but that is only a quarter of the piece of the puzzle and we have got other stuff spread almost equally across the region. So, we are very confident that we have a good mix there and we are looking to drive that further and really drive all the markets. We really think we are well positioned for that.

Thomas Lee - Goldman Sachs

Great. Thank you.

Operator

Next question comes from the line of Rich Valera with Needham and Company. Please proceed.

Rich Valera - Needham and Company

Thank you. I was just wondering if you can give us a feel for where you see your long term mix between direct and OEM business.

Kevin Michaels

Well, I think Rich as we had talked about we would like to have about a 50-50 split between the two and we are getting close to that percentage and obviously depending on the environment, I think with the solutions we have today, we could possibly have maybe a higher operator percentage than that.

We certainly first have to hit the target that we first put in place; that is say have about 50% of our revenue driven through the operator as well as the OEM. It is going to vary from time to time depending on the type of network deployments being done.

When a carrier or operator today is looking to roll out a network, in many cases they are looking for one provider to be a complete turnkey solution provider with equipment, service and deployment. That will in many cases go to some of the larger OEMs, Powerwave has the service and support capabilities, but we certainly do not have the size of organization that can do a complete deployment today as the OEMs do.

Then there is going to be times like in this market, where they are looking to enhance and leverage the existing capital and network that they have deployed. They are going to buy solutions and products such as Powerwave's adding on to the existing network, not necessarily buying a complete new base station or architecture to redeploy their existing network.

Rich Valera - Needham and Company

Great. So if we were thinking about a longer term model for just really '09 for modeling purposes, should we think of direct continuing to increase as a percentage of sales say relative to where it would be grew up by the end of '08?

Kevin Michaels

I mean, that would certainly be a goal we are driving to try to move that up, yes.

Rich Valera - Needham and Company

Can you give us any sense of the margin differential on average between direct and OEM if and I am sure there is a lot of puts and take there, but is there any spread you could give us on average?

Kevin Michaels

Yes, as you have mentioned it is spreads all over the place. I mean, I would say it varies between equal to maybe up 1% to 2%. It really varies across the product. It is not comparing apples and oranges, and the other thing is I think I had point out that while we are a very excited with the growth we have seen there, part of as a percentage basis was a slow down in some OEMs.

So if they recover quicker it will pull that percentage back down. We think the operator business on absolute basis will continue strong and will grow, but obviously we hope to see some of our OEMs recover a little faster. That will pull that mix back down, but certainly from a long term range the targets Ron talked about is 50% is certainly something we are continuing to drive towards.

Rich Valera - Needham and Company

Great. Just one final one for me. On the gross margin from your 24% baseline level in 2Q, just wondering how should we think about Q3, I think it sounds like you would expect to have lower revenue, maybe not as favorable mix on the direct side, but you apparently have implemented some actions on that to mitigate the transportation costs, so net-net should we think about that maybe being down a bit quarter-over-quarter in Q3?

Kevin Michaels

Well, I do not want to get into having to predict Q3. I mean, I think, obviously it is going to factor of all those things you mentioned, what the revenue base comes in at, how we were at mitigating those cost factors, what is the price of oil do in the next three months? All those factors in there, I mean obviously I think we should be broadening that range. We are not looking for huge movements either up or down in the very short-term but we expect to continue to see improvement by the end of the year.

Rich Valera - Needham and Company

Fair enough. Thank you.

Kevin Michaels

Thank you.

Operator

Your final question comes from Bill Choi with Jefferies. Please proceed.

Bill Choi - Jefferies

Thanks. First of all, quick question here, just curious when you use the pro forma $0.04, what was the fully diluted share count?

Kevin Michaels

It is the same as the basic share count, because it is the 131, 131 million shares. The fully diluted would be anti-dilutive because of the add back. So it does not kick in even at the $0.04 level.

Bill Choi - Jefferies

Okay. So probably need to be above $0.07 or so right?

Kevin Michaels

Yes, roughly up around there.

Bill Choi - Jefferies

Then, you are probably looking at something closer to 169 million shares or so?

Kevin Michaels

Yes, roughly around there.

Bill Choi - Jefferies

Okay. Then in terms of looking at the regional breakout here, I guess prior quarters we have kept separate segment also called other international. Where does that category get lumped into in this three category break up?

Kevin Michaels

It is European and other international. Then, I think in our Q we break it out. The other international is not a large piece, but I think it is broken out in the Q. I do not have it breakout handy.

Bill Choi - Jefferies

Okay. So, the Asia and North America component does not change here.

Kevin Michaels

Those should not change. That is correct.

Bill Choi - Jefferies

Okay. So in terms of Asia, can you give a little color as to which countries in particular were strong?

Kevin Michaels

Well, we have certainly seen some growth in parts of Indonesia. We have seen growth China, we have seen growth in other regions around Thailand and Australia, but I certainly do not want to give much more granularity Bill, because I think still pretty competitive for everyone trying to improve their sales, but those regions have been pretty good. India has been a good area as well.

Bill Choi - Jefferies

How do you look at China just with the moratorium around the Olympics and potentially some stalling here ahead of restructuring and maybe '09 might be a better year, but second half and so far as China and how relevant is China as a country for you?

Kevin Michaels

Well I guess it depends on where you want to look. If you want be very optimistic, China is a great market for growth. We have always been very conservative on what we believe the roll out will be in China from the last couple of years Bill as you know.

I am not optimistic that that is going to change here in the next six to eight months. But with that said, there is a lot of good business on the existing network, rolling out GSM products and certainly, you know, there is an initiative now for a 3G type of network and Powerwave as you know has many trials and products and solutions to support that type of protocol and that type of build out. So we should be able to benefit from it. But, we are not being aggressive in our forecast for China to be that catalyst for growth.

Bill Choi - Jefferies

Okay. Then Kevin, the earn out on the VersaFlex, can you remind us what the trigger was and what is VersaFlex doing in terms of quarterly revenue?

Kevin Michaels

Well we do not break it out. It falls into our base station category. That was you know that thing was almost 1.5 years ago the acquisition and that was the remaining payment. There was a tie-to; there was an earn-out that they had reached, there is not I think that is the last one. There isn't any additional. That is the final one.

Bill Choi - Jefferies

Okay. Is it meaningful? I mean as in meaning above 5% of revenue?

Kevin Michaels

It fluctuates.

Bill Choi - Jefferies

Okay.

Kevin Michaels

At times it has been, in current quarter it is been below that, but it is product line that we are still very excited about and we think there is some great opportunities there.

Bill Choi - Jefferies

Okay. One last question just on following up on the pricing trend question, as a benchmark, I remember talking to you guys about 10% to 15% expectations for this year. How does that fair now and just in terms of antenna, you actually heard a rumbling there might have been actually price increase out there in the market, just if you could talk about those two areas, please?

Kevin Michaels

Well I will tell you, if you are seeing the price increase I would love to see that. I have heard that story, but I certainly have not seen that in action, and being deployed. I do think, and I am not sure about the 8% to 10% number Bill, but I still do believe that we have some pretty aggressive pricing pressure here. Yet that is been taking place this year. It has not been to the double digit level though.

That is good news for us and the industry, and I think consolidation is driven some of that. But, I still do believe that there is room for us to still try to figure out how to stabilize pricing little bit, because it is a pretty difficult environment with all of the different components looking at raw material transportation costs to realistically come down that curve.

I think some times we have to do a better job of showing and having discussions with our customers to demonstrate the value we are bringing and the pressure and the cost pressure that we are not even passing on to them today and that is something that we are going to continue to focus on here the second half of the year, and if we could raise prices on the antennas, I think that would be great. I do not see that Bill and if you know who is doing that I would like to have that discussion, that would be great.

Bill Choi - Jefferies

Okay. Thanks.

Kevin Michaels

Thank you.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the call over for closing remarks.

Ron Buschur

I would like to thank everyone for joining you today, and your continued interest in Powerwave Technologies. As many of you noted, we have engaged Tapleton Communications to assist us in investor relations activities and we would encourage you to contact them. In the meantime, we look forward to sharing with you our results for the third quarter of 2008.

Operator

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a good day.

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Source: Powerwave Technologies Inc. Q2 2008 Earnings Call Transcript
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