DragonWave Inc. (NASDAQ:DRWI) Q2 2017 Earnings Conference Call October 13, 2016 8:30 AM ET
Patrick Houston - CFO
Peter Allen - President & CEO
Kevin Dede - Rodman & Renshaw
James Kortan - LJK Investment Group
Good morning ladies and gentlemen and welcome to the DragonWave Second Quarter Fiscal Year 2017 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder this conference call is being recorded. I would now like to turn the call over to your host for today's conference Mr. Patrick Houston, Chief Financial Officer. Sir, you may begin.
Thank you, Bridgette and good morning. I would like to welcome you to our second quarter fiscal year 2017 financial results conference call. Following our prepared remarks we will open the call for questions, and we plan to finish the call by 9.30 AM.
As a reminder today's call is being webcast live on the DragonWave Investor Relations website at dragonwaveinc.com. You can access the presentation slides from the same site. The webcast will be archived on our site and available for replay shortly after we conclude the call. I hope you have had the opportunity to read the press release we issued yesterday after the close of markets, which provides detailed financial information on DragonWave's second quarter for the 2017 fiscal year.
Slide 2, please. Today's call includes forward-looking statements as defined by applicable securities laws. These statements are subject to risks and uncertainties. Please read the full disclaimer that is contained in the presentation slides. I would like to remind everyone that all currency figures are in U.S. dollars and were prepared in accordance with U.S. Generally Accepted Accounting Principles, unless we specifically state otherwise.
Slide 3, please. Total revenue for the second quarter of fiscal year 2017 was $13.2 million compared to $12.5 million in the first quarter of fiscal year 2017. Revenues on a direct basis and by this we mean excluding our Nokia channel grew 30% quarter-over-quarter as we continued to make progress on our various direct engagement strategies.
Revenues from the Nokia channel decreased from $4.8 million in the previous quarter to $3.2 million in the current quarter. We continued to sell equipment and deliver services through this channel as we support a significant install base. The gross margins excluding inventory provisions were up slightly in the second quarter to 31.9% compared to 31% in the previous quarter. Improving our gross margins continues to be a focus in order to narrow our quarterly cash usage. We still have room to improve as we continue to introduce our new more capable products into higher margin opportunities.
Please move to slide 4 which highlights comparative revenue, gross profit, and operating expenses. Total expenses were down to $6.9 million in the second quarter of fiscal year 2017 compared with $7.3 million in the first quarter of fiscal year 2017. This is the seventh consecutive quarter in which we’ve reduced operating expenses and have reduced expense to a total of 43% during that time. Net and comprehensive loss to both the shareholders in the second quarter was 3.9 million compared to 4.1 million in the previous quarter.
Please move to slide 5 which highlights some of the key balance sheet metrics and cash flow. The company ended the quarter with $7.5 million in cash compared to $4 million at the end of the first quarter. We completed an underwritten public offering in early August which resulted in net proceeds of $5.3 million. The transaction also included both short term and long term warrants which have not yet been exercised.
Our debt facility balance at the end of the quarter stood at $17 million. We’ve recently extended our debt agreement until April 2017 and continue to receive support from the company’s credit facility partner’s Comerica Bank and Export Development Canada as we execute a renewal strategy.
Adjusted capital from operations which excludes non-cash operating expenses such as inventory provisions, stock compensation, and depreciation expense was 2.1 million in our second quarter this is compared to 2.7 million in our previous quarter. See our MD&A for a reconciliation of this non-GAAP measure.
Slide 6, please. This concludes my remarks and I’ll now turn it over to Peter Allen.
Thanks Patrick and good morning everybody. Overall we are pleased with the progress that we made in our second quarter particularly with the 30% sequential revenue growth that we saw excluding the Nokia channel. Our backlog also suggests to us that we have the opportunity to build on this in Q3.
As expected following Nokia becoming a competitor we saw reductions in our revenues through that channel. I’d like to give you more color on this as well as provide an update on the progress against our renewal and restructuring activities that represent the transition plan for the business.
Firstly, our objective to extend our North American presence in both Tier 1 carrier and distribution business. I am pleased to report that we had a very strong quarter in North America which was 43% of our non Nokia business. If we take the Americas more broadly that rises to 63% of our non Nokia business. Overall the Americas grew 21% sequentially, carriers in the U.S., Canada, and Mexico all contributed to this performance.
Also in North America we announced that we had delivered solutions to Blue Wireless who are based in New York State. This was notable because with DragonWave’s bandwidth accelerator payload compression technology deployed across the network, Blue Wireless is able to gain 40% greater capacity per channel than the alternative solutions allowing for multi-gigabit capacity for core and access links.
Eric Wong VP of Engineering and Network Operation at Blue Wireless said that their evaluation of microwave radios was thorough and based on finding a fiber-equivalent solution with the scalability to meet the growing capacity demands. DragonWave he said demonstrated the performance and reliability required to maintain the highest quality of service for their growing customer base.
We continue to believe that our revenue base in the Americas will be strengthened further when we are able to confirm a selection decision with a large existing North American Tier 1 customer. This would further overlay strong revenue probably now starting in Q4, to what is an already solid foundation in this region.
Second, is the renewal of our global presence through new non North American channel partnerships and as a part of this to leverage the global footprint of DragonWave products. Outside of the Americas our non Nokia revenue grew by 48% over the previous quarter with EMEA, India, and Asia Pacific all reporting sequential improvements. Revenue with Middle East customers were the strongest of all in the rest of the world.
Here a key part of our strategic focus is to restore the choice of DragonWave products to those operators who previously purchased our products through Nokia, a choice that we believe offers them access to differentiated value. As a part of this we have now have six customers for Harmony Care Services that will provide legacy support to the DragonWave installed base. We also have proposals in front of several carriers with large in store footprints.
Harmony Care permit our operator customers the ability to maximize the life cycle of their store to migrate base while allowing them flexibility to upgrade only when their network dynamics require it. We continue to have discussions with a number of new potential regional channel partners which we expect to finalize in the next quarter.
Next is to maintain our leadership innovation capability and further is to introduce new products that drive superior value for our customers. Last quarter I said we had already had significant traction in North America and outside we had considerable trial activity for new products that have been successfully completed in South Africa, Australia, Mexico, and Eastern Europe. In each case I believe that the radio's high capacity performance and the industry leading system gain and spectral efficiency are differentiating and represents a key growth engine in our renewal strategy.
As I have said before our objective is to offset the elimination of the sales pipeline that we have with Nokia with increased direct revenues and hand in hand with this strategy comes a focus on higher margin opportunities. This in turn brings me to our focus on cost efficiencies and we saw our operating expenses was used again this quarter by approximately 5% compared to the previous quarter and at 34% in the same quarter a year ago.
Q2 2017 represents the seventh straight quarter that we have reported -- recorded sequential reductions in our operating expense level which reflects the relentless approach by everybody in DragonWave to achieving cost efficiencies in our business. This also provides a stronger leverage as we post revenue growth in our direct business and the further reduction of the Nokia channel will have a less impact.
Also another quarter of sequential revenue growth while maintaining improved margins as we reported last quarter, strong sales push of new products and effective cost control shows I believe that we are executing on our strategy with positive results. This strategy renews DragonWave and restores the road to profitability and I hope to be able to report soon on further news that takes us along this path. That concludes my prepared remarks and I would like to turn the call back to Bridgette to start the question-and-answer session.
Thank you. [Operator Instructions]. Our first question is from Kevin Dede with Rodman. Your line is open.
Good morning, gentlemen. Thanks for taking my questions. So a few things for you Peter, I was wondering if you could talk a little bit more about the Blue Wireless in New York State. Congrats on that deal, just a little more detail. I mean you pointed to capacity as seeming to be the big factor in that win. I was wondering if that was the main criteria or do you think they looked at price and who were some of the other competitors? Any more insight you can offer on that and of course the big question is how much more business is there, do you think?
Yes, I think Blue Wireless is our regional carrier that operates nationally through roaming agreements. So, yes I think it is not going to -- Blue Wireless alone is not going to be a major revenue driver for DragonWave renewal strategy. But what I think is notable Kevin is because the differentiated solutions that we bring forward was certainly very attractive for their situation. And as they indicated they wanted to get as close to fiber-equivalent solution as possible. So capacity was very, very important for them. They obviously wanted to be reliable and dependable, because they are going to deliver -- they are delivering carrier grade services over these networks.
And if they could get additional capacity from our solution because of the unique payload compression technology that we deploy on our products which give some gains over the physics of the underlying solution. So all of that contributed to what they describe as a thorough selection process and of course at the end of the day that’s all going to be delivered in a cost effective manner. And we believe that dollars, gigabits per dollar were superior with our solutions and Blue Wireless agree.
Okay, so you think it really boils down to that ratio, the gigabits per dollar, just a full breadth of capacity?
The per dollar is slightly less important but it is never not important and that was part of the reason, this is part of rural New York State deploying fiber solution could be very, very expensive. So, that’s why people turn to microwave and then they want the very best microwave that they can get and we think we deliver that. And why I thought it was notable is whilst Blue Wireless is our regional carrier their needs our not dissimilar from the many others around the world and I thought it was a good example to showcase the differentiated technology that DragonWave is bringing forward to a range of potential customers.
Okay, one last question on that point, where were they in their deployment cycle, were they pushing from 2G to 3G, 3G to 4G, and I guess what I'm wondering is, not that I disagree with your assessment, I'm just wondering how much you'd be able to use this as a test or a showcase for some of your other customers?
Well I think in one sense it really doesn’t matter where people are on that curve. Particularly I would say North America the cost of spectrum relative to the rest of the world is relatively cheap. Backhaul spectrum is fairly inexpensive in North America, so the ability to get the capacity, the ability to get the capacity of the right dollars is of course important. But the cost of Backhaul spectrum in the United States in particular is relatively inexpensive.
Now if you take that scenario to other countries that’s not the case and that 40%, the people that we talked about here in terms of the additional capacity is 40% without incurring additional -- a very expensive spectrum cost in some countries. And so I think the advantage is actually even greater in other places and that advantage is irrespective of where you are in that cycle of 3G, 4G, heading towards 5G because it can be downscaled to narrow a channel. You can get more out of a narrower channel or you can get more out of a wider channel depending on where you are on that evolution curve.
Okay, fair enough. You also touched on the backlog, Peter, but you didn't quantify it so much, could you talk to what you see in it that gives you so much confidence that -- I guess that you'll see that Tier 1 contribution in North America in the fourth quarter?
I think the two things are separate. Certainly we posted good strong sequential growth in our non Nokia business now for a couple of quarters and our backlog in that area suggests to us whether its sufficient momentum though we can do that again in Q3. I am not going to get into reporting backlog and the timing of backlog because that’s as difficult sometimes as forecasting revenue. So, I just want to convey that we think that the momentum that we’ve shown for the last two quarters can continue. It’s a separate matter in terms of the Tier 1 customer we think. We remain very confident that we will be able to announce something related to that in the near future.
Okay. But did I misinterpret your comments, i.e. in your noting of Q4 and that's your Q4, correct?
Okay. Well, that's great news. We'll look forward to that. Your new operating expense level, maybe this was the better one for Patrick, but given your seventh straight quarter of reduction, do you continue to see more reductions going forward or are you pretty comfortable that you'll stabilize at this level?
Yes obviously we said for the last couple of quarters that we felt we’d stabilize but were able to find some additional efficiency and reduce it again. So we’ll continue to do that. I don’t think there is any significant increases in the short term and to the extent we can find more efficiencies then will put those in place.
Kevin, if I may add to that what I’d like to convey is this is not a one-off exercise from our part. I think there is a relentless pursuit of cost efficiencies in our business and I think that leaves room for the possibility the team will come up with further ideas and we will be able to achieve more in the future as we have in the previous seven quarters. So, that remains to be seen. We’ll see if we can do it but certainly there is a focus in the business on looking for further improvements.
Okay, fair enough. Last question from me, and then I'll hop back in the queue. Your Nokia business down just a little bit, so I guess in percentage terms that's pretty substantial, but sequentially that seems to be something that continues and I'm wondering if you think it might sit at this level or how you see your business there, given that there are customers on that end that have become reliant on your technology?
I think it’s a very good question. I think from our standpoint, our visibility on that is very, very limited these days and I am sure that Nokia is trying to persuade those customers that they would be better served with trying all of their legacy network on building the new network with Nokia's current products. Economically that’s not going to be very attractive to great many of those customers because their motivation is to maximize their investment in their footprint.
Moreover of course the cost of changing vendors is a significant one unless you are going to do a major renewal of your network. So we think that to the point of your question, I think there is an opportunity whether it’s through Nokia or through other potential partners all direct, there is the opportunity to help those operators maximize the investment in the network and continue to help them build out without the cost of churn.
But our visibility on that is limited. So we are not counting on that. We are anticipating declines but the rate of decline is one that is very difficult for us to assess and it will be -- we’ll have to see region-by-region, customer-by-customer.
Okay, I appreciate how difficult it is to manage that. I also clearly know exactly where you have to go and who you have to talk to, or at least I would think that would be the case and there's a -- while there is an economic disincentive, I would think there would also be a technological disincentive to flip over to something that Alcatel designed 20 years ago. Of course, I'm being a little sarcastic there. It just seems to me that it shouldn't be too difficult to chase that business down. I was wondering if you could give us a little more insight on the marketing and sales aspect of it?
So let me give you a perfect example of some of the challenges. If you look at our relationship with Nokia it was not uniform across the world. Historically all of our revenues in the Americas have been executed directly by DragonWave or without a channel partner. So the Nokia content in the Americas is hardly affected by the fact that we are not working with Nokia. If you look at Europe compared to Middle East you would have seen and India you would have seen a different balance. You would have seen maybe without being specific about numbers let's say for the point that I am making here, 50% of the revenues came through the Nokia channel, 50% came direct.
But the time you get in to Asia Pacific the trend is very much the other way. The vast majority, 95% or more of our revenues in Asia Pacific was executed through Nokia and Nokia we don’t do that through Nokia anymore. And so our ability to serve customers in Asia Pacific is limited from a direct standpoint. And what we are trying to do to provide those customers with the choice to continue to take advantage of DragonWave products is to establish new regional partnerships that would allow those customers in Indonesia, and Indonesia is a very big base of products. It is best to use Indonesia as an example, customers in Indonesia continues to take advantage of DragonWave products even though DragonWave today doesn’t have a presence in Indonesia. And the only way that we can replace Nokia is to insert a new partner in order that the Indonesian customers as an example could continue to take advantage and avoid disruption in their network and that’s a strategy that we’re trying to pursue at this time.
Okay Peter, thank you so much for the color and we will talk to you again.
And you, Kevin. Thanks.
Thank you our next question is from Jim Kortan with LJK Investments. Your line is open.
Good morning Peter.
Good morning Jim.
I have really two questions. One I feel obligated to ask it again since I've asked the last two quarters. Can you shed some light on why a Tier 1 customer would take three quarters when we expect them to take one to make a decision, what goes into that process that causes such a delay?
I don’t think I am qualified to really tell you the inner workings of any of it -- of the Tier 1 customers. I think you are referring to Sprint and so I will make some comments about Sprint. I know that Sprint is a different animal today than it has been in the past. It has a new owner and I am sure that new owner is involved in major investment decisions on how Sprint decides to execute their strategy going forward. So I think that’s a different factor from the past. I think that Sprint in particular have been keen to look at their balance sheet and they’ve taken a number of actions in the market and yesterday we heard I think that they just raised $3 billion of additional funding. So, I am sure that plays -- the dynamics around them getting access to funding is another part of the dynamic of course is them to take whatever time they feel they need.
So, I think those are -- there is a couple of comments that I have got here relating to that particular carrier. But I am not really in a position to know all of the inner considerations that they are going through in order to make a deployment decision. I believe that towards the end of all of their processes but that will only be proven out when we are able to confirm that which I said in my prepared remarks, we are not able to do at this time.
Okay, well thank you. And then I have one follow-up question. Given the fourth quarter that you're saying some decision may be made, from a liquidity standpoint you are burning looks like $2 million a quarter, you're going to be in negotiation of your debt facility about the same time, what are your plans as far as additional liquidity and how can you go do your cash flow going forward?
Certainly our plan would be to continue to work with our debt providers and extend it again further which is what we have been doing with these two partners for close to 10 years now on the debt side. So certainly that is our first priority to extend that further and continue to utilize that. So at this facility that is around 30 million now and we would like to have that in place to help us flex as some of this new demand comes in line.
And I think, we have posted -- we made good progress in the last couple of quarters in terms of our renewal strategy. As I have indicated I think we feel that we can take further steps along that path in Q3 and hopefully we will sell in Q4. And we think that the -- that will hearten the financial progress and we think that as a result of that the great support that we received from them to date we will be able to continue with that.
Okay, alright thank you Peter.
Thank you. I am not showing any further questions. I will now turn the call back over to Peter Allen, Chief Executive Officer.
Thank you everybody for joining us on the call. We are very pleased to share with you our progress that these set of results represent and we look forward to being able to communicate more news with you soon. So, thanks everybody and have a good day.
Ladies and gentlemen this does conclude the program. You may now disconnect. Everybody have a great day.
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