DragonWave's (DRWI) CEO Peter Allen on Q1 2018 Results - Earnings Call Transcript

DragonWave Inc. (NASDAQ:DRWI) Q1 2018 Earnings Conference Call July 13, 2017 8:30 AM ET

Executives

Patrick Houston - Chief Financial Officer

Peter Allen - President and Chief Executive Officer

Analysts

Kevin Dede - Rodman and Renshaw

Jim Kortan - LJK Investment Group

Todd Coupland - CIBC World Markets

Operator

Good day ladies and gentlemen and welcome to the DragonWave's First Quarter Fiscal Year 2018 Results Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded.

I would now like to turn the conference over to Patrick Houston, DragonWave's Chief Financial Officer. Sir, you may begin.

Patrick Houston

Thank you, Shannon. Good morning. I would like to welcome you to our first quarter fiscal year 2018 financial results conference call. Following our prepared remarks we will open up the call for questions.

As a reminder, today's call is being webcast live on the DragonWave’s investor relation 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’ve had the time to read the press release we issued on Wednesday after the close of market which provides detailed financial information on DragonWave's first quarter results for the 2018 fiscal year.

Slide 2, please. Today's call includes forward-looking statements as described 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 US dollars and were prepared in accordance with US Generally Accepted Accounting Principles, unless we specifically state otherwise.

Slide 3, please. Total revenue for the first quarter of fiscal year 2018 was $9 million, compared to $8 million in the fourth quarter of fiscal year 2017. Gross margin, excluding inventory provisions in the first quarter were 28%, compared to 22% in the fourth quarter. This margin improvement returns us to levels closer to our plan and we still expect to make further improvements to bring margins above 30% in coming quarters.

Please move to slide 4 which highlights comparable revenue, gross margin and operating expenses. Total expenses decreased by $0.1 million to $6.6 million in the first quarter, compared to $6.7 million in the previous quarter.

We’ve continued to seek operational expense synergies, reductions done towards the end of our first quarter will be seen in our second quarter. Further reductions are still planned once we address our liquidity position.

Net and comprehensive loss attributable to shareholders in the first quarter was $4.3 million, compared to $3.9 million in the fourth quarter.

Please move to Slide 5 which highlights some of the key balance sheet metrics. The company ended the quarter with $3.9 million of cash, compared to $4.1 million at the end of the fourth quarter and our debt facility balance remained unchanged at $17 million.

Adjusted cash flow from operations, which excludes non-cash items such as inventory provisions, stock compensation expense, and depreciation expense was $3.6 million in our first quarter, as compared to $4.3 million in our previous quarter. Please see our MD&A for a reconciliation of this non-GAAP measure.

Slide 6, please.

This concludes my prepared remarks. And I'll now turn it over to Peter Allen. Peter?

Peter Allen

Thanks, Patrick, and good morning, everybody. When we spoke to you last in late May, we communicated that we were in difficult operating conditions and this has continued with our current results.

Despite these difficulties, we are making some progress and we were recently awarded a product supply and installation services contract from SmartSky Networks, a North American 4G LTE inflight service provider. SmartSky will deploy DragonWave’s Harmony Enhanced Multi-Channel products to provide high capacity backhaul for its Ground-to-Air 4G LTE network.

Harmony Enhanced Multi-Channel was selected for the high capacity delivered through its 2048QAM and dual channel capabilities. In addition, the high system gain of the Harmony Enhanced Multi-Channel makes it ideally suited for the long path lengths in the SmartSky network.

Overall, the Americas remain our strongest area with 60% of our revenues coming from this region last quarter. We continued to see positive traction in this market as well as in some parts of EMEA and in both cases reflecting continuing interest in the capabilities that our products offer its customers in those areas.

As Patrick indicated, our operating expenses continued to be managed tightly and this quarter was slightly lower than last quarter and some 40% lower than the same quarter a year ago. And I am particularly pleased by how everybody at DragonWave is engaged in seeking out improved efficiency in our business.

In our last call, we also said that we had engaged Alvarez & Marsal Canada ULC to assist us with the identification and assessment of strategic alternatives in relation to short term liquidity requirements. We are pursuing what has emerged from this work and expect to be able to report on the forward plan in the near-term.

I’d also like to give you an update that the arbitration of our contract dispute with Bharti Airtel in India is reaching a late-stage with final arguments scheduled for next week and we expect a ruling from the panel before our next quarterly call.

I will reiterate what I have said previously that despite the challenges we are facing, we remain undeterred in our quest to ensure that DragonWave is able to support the market traction of our products and we look forward to being able to do so soon.

This concludes my short prepared remarks and I would now like to return the call to Shannon to start the question and answer session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Kevin Dede with Rodman and Renshaw. You may begin.

Kevin Dede

Hi, good morning Peter.

Peter Allen

Good morning, Kevin.

Kevin Dede

Yes. Well, so, a nice little pop back in – on the top-line, so congrats on that. Could you – I mean, Patrick alluded to a gross margin improvement in the coming quarters. Could you just speak to that a little bit?

Peter Allen

Yes, I think that – as I said, the strong region for us is the Americas and generally in the Americas they take advantage of the higher specifications of the products and a stronger mix for us and we believe that that will fuel as we make decisions about where we are going to focus our resources in the future, we certainly will be anchored around the Americas.

And we see that, because of that dynamic the overall margin mix and as we will improve and as Multi-Channel, Harmony Enhanced Multi-Channel forms a greater part of our overall revenue as a percentage, we expect to see that – effect to increase out our overall margins as well.

So it’s a combination of a geographical focus and an improved product mix, we think it is going to be the basis for that dynamic and of course underpinned by as Multi-Channel expands in terms of volume, we expect to see some improved cost performance on that product as well.

Kevin Dede

Okay. And I guess, part of that assumption is tied into the work that you expect to get with SmartSky, could you give us a little more insight on how you think they are able to deploy and how we will see it reflect in your results?

Peter Allen

Yes, I won’t get into any individual customer situation for confidentiality reasons. But what I will say is, I do think that in our North American customer base, particularly in North America, we see more and more people standardizing on Multi-Channel – on Harmony Enhanced Multi-Channel, because of the various differentiated features that product has and the forward deployments that we can – that we have visibility to, we will leverage that product greatly.

We also believe that as our opportunity expands in terms of being able to support more customers, there will be more broader interest in that product than we have from just today’s customers.

Kevin Dede

Okay. Fair enough. I know you prefaced your comments with no specific customer discussion, but there is another very large carrier in North America with which you’ve been working over the three years and I am just kind of curious where you see them. And I guess, I am also kind of interested in your perception of carriers’ view on 5G especially in North America and whether or not you think that’s going to influence rollout decisions. Maybe, I guess, I was thinking that maybe part of some of the delay might be tied to how they perceive standardization to proceed in 5G and what that influence might be?

Peter Allen

So, what I would say, I think that’s a very good directional question, and what I would say is that, undoubtedly, when any significant operator modernizes his network he wants to make sure that he is on a trajectory that will deliver the best possible environment for whatever base station environment he is deploying with that 4G or beyond to 5G.

And we know that the characteristics of that trajectory are, he needs to have better capacity, he needs to have better latency and we also know that [Indiscernible] is not an easy one either. So he wants to do it with a best cost performance both in terms of the cost of the product, but probably these days more importantly what the product does to the rest of its cost base.

And so, we think that drives the highest possible capacity, the best possible latency and the best leverage on his site economics and power has a system gain or power has a very significant impact in terms of enabling smaller size antennas, which in turn drives lower monthly or significantly lower monthly operating cost.

And so we think that he will want to take the biggest step possible in order to continue down that path of capacity, latency and cost and we think that Harmony Enhanced Multi-Channel represents that biggest step to that. I think that the site strategy in terms of how to modernize his existing networks and densify the network is a key issue for the operators. And I think the first step in that is leveraging their existing site base and modernizing that to the greatest extent possible and that will give them an environment we believe that will allow them to – for the next phase of their network develop applications and services that will – that are new and not available in the network’s today.

But ultimately, they are going to have to get new sites and new – and increased efficiency in the network and as they do that, I think it’s not just going to be about products like Multi-Channel and capacity, it’s also going to be about products that evolve from Harmony Enhanced Single-Channel that are smaller, lighter, less power hungry and can be deployed in new site settings in a manner that [permissible] [ph] with local government, local municipal requirements.

And so, we think again that having a trajectory around an own outdoor radio that delivers the best possible performance in terms of power, capacity, power consumption, capacity, size and of course cost is another part of the journey towards 5G.

Kevin Dede

Okay. A little off the mark, what I was looking for, but helpful nonetheless. Thank you. One last question before I hop in the queue. Could you or maybe Pat, do you have or perhaps you are not speaking to this any longer, Nokia related business in the quarter versus fourth quarter?

Patrick Houston

Yes, we still have some minor Nokia business. There is still quite a installed base that exists and in fact they still service some of those customers through the Nokia channel. So, it has decreased. We expect it to continue kind of at those levels for another year or two.

Kevin Dede

Okay. So, are you breaking it out?

Patrick Houston

Sorry.

Kevin Dede

Yes, no, I apologize, Pat, are you breaking it out specifically or just speaking to it?

Patrick Houston

Just speaking to it. It was $1.2 million this quarter.

Kevin Dede

Okay. Was that flat with February?

Patrick Houston

Yes, it was – I think it was up maybe a 100k from Q4, but pretty flat.

Kevin Dede

Okay. Thank you. All right. I’ll hop back in the queue.

Patrick Houston

Thanks.

Operator

Thank you. [Operator Instructions] Our next question comes from Todd Coupland with CIBC. You may begin.

Todd Coupland

Oh, yes, good morning, Patrick and Peter. I just want a clarification if I could on that last line of questioning. So, is the update that Sprint’s upgrade is taking longer than expected for all those reasons and you will see a slower ramp up in demand to DragonWave?

Peter Allen

Yes, good morning, Todd. I think there is a few dynamics involved there is that are probably a bit sensitive with Sprint. But I think all I – what I would characterize on this reexamination of their site strategy in the early phase of the project, I think that has undoubtedly meant that the initial ramp of the project is a little bit slower than we expected.

But I think the opportunity is undiminished and I think that their game plan is clear. I think that because of the changes in the site strategy, we may see a greater leverage on the modernization of the existing footprint in Sprint, which is obviously dominated by products of microwave footprint in Sprint that is obviously dominated by products that were supplied by DragonWave.

So, we believe that we have a lot to offer in terms of an easier path to modernizing those sites than anybody else. So, we are continuing to be enthused about the opportunity in that carrier. And not – obviously because of the dynamic that I just talked about, but also about because of what I said to Kevin which was the leverage that our products bring to their overall site economics is a strong proposition. And – but undoubtedly, as you say the start of it’s been a little bit slower.

Todd Coupland

Okay, thanks, Peter for that. And then my second question was just on Bharti. I think you’d escrowed some cash and could you just remind us what that is? And would you expect that to come back to DragonWave given where the process is at?

Peter Allen

I am not sure I am familiar with the escrow aspect of that. The …

Todd Coupland

I think you provided – put some cash aside for this or did I missed – or maybe I’ve mistaken on that?

Peter Allen

No, we haven’t put cash aside and such. I mean, we – the dispute arises from the fact that we had supplied products and committed the supply chain on the entire contract which was, in our view canceled legally and the arbitration claim on our part addresses the recovery of that and the consequences of the legal – in our view a legal cancelation and…

Todd Coupland

How much was that potential recovery?

Peter Allen

It’s hard – it’s hard for me to judge how the panel will react. Obviously, we have been expensive in our articulation of the damages that have occurred. And so that number is probably – you shouldn’t get carried away with that number, because it is a very full number. But it’s…

Todd Coupland

I seem to recall in your 10 A B update that this is incorrect, that it was in the $5 million to $10 million range in terms of potential damages?

Peter Allen

No, no, no, it’s much more, it’s several tens of millions.

Todd Coupland

Okay. And so, this arbitration panel, they’ll give a ruling this quarter and then is that a – had both parties agreed to accept the outcome and that will be final or is there appeal? How does the process work?

Peter Allen

Yes, this is got from the Indian Arbitration Act and the Indian Arbitration Act does create constraints on what the parties can do following a judgment by the panel. The basis for appeal does – the ability to appeal does exist.

The basis for appeal will be that any party wishing to appeal will have show that the arbitration was conducted in a manner that was not correct. So I think it’s unlikely given that – so where we are seeing judicial figures invokes that. The other basis is it’s simply in the award is in some way against the public policy of India and so we can’t be sure what – whether an appeal would be filed or not, but we are not expecting.

Todd Coupland

And so, let’s say you are awarded some figure and then there is – I mean, I guess, you are probably not going to want to game this out publicly, but just for investors to understand, there is some sort of award at that point, does – do you go and make up with the client and restart business? Or do you push for the cash? I mean, is there any color you can provide on that?

Peter Allen

I would say, I think the difficulties that this arbitration have revealed would make it very, very difficult I think for – on the side of both parties to be able to work together in the future. There would need to be a degree of alignment and trust that simply doesn’t exist today. So, that’s not an outcome I am expecting.

Todd Coupland

No, do you think you have a credible, so the takeaway here, do you think you have a credible case and there will be some news on that this quarter and it’s – I mean, tens and millions is obviously multiple of your current market value and clearly a much needed development in terms of cash infusion et cetera. So, we’ll just stay tuned on this is I guess the way to think about it?

Peter Allen

Yes, and I think the process is a little – we would wish it to go faster. We think there are some boundary conditions as to when it has to complete by which is in – as to our understanding is that the parties could agree to take it a bit longer, but it’s certainly not in our interest we feel.

Todd Coupland

Sorry, you broke out - complete it. What you know right now is this completes in September?

Peter Allen

It should be completed in September, no later than September.

Todd Coupland

Okay.

Peter Allen

And that’s what we are expecting. But not everything goes as we expect. But at the moment that’s the boundary condition that we understand exists for this arbitration.

Todd Coupland

Okay. That’s helpful. That’s all my questions. Thank you.

Peter Allen

Thank you.

Operator

Thank you. Our next question comes from Jim Kortan with LJK Investor Group. You may begin.

Jim Kortan

Good morning, Peter.

Peter Allen

Good morning.

Jim Kortan

So, a couple follow-ups. On the North American carrier, you said it was taking a little longer than you forecasted. If you look out in the future, what do you see the wrap up? Is it going to be increasing in the next couple quarters or you are pushing out three quarters? What’s your pushback it was, where is the development of that business?

Peter Allen

Yes, so, I think that, when we came into this project, we saw a project that we expected to last over, probably something between 10 and 12 quarters. And we still think it’s going to take 10 or 12 quarters. We think that the ramp into – in any quarter is highly dependent upon the carrier presenting sites that they want to either modernize or develop for the first time.

And the rate of which they do that and the way they do that is not something that is in my control and I can’t be sure that it will happen smoothly. But I do know that they want to address the total problem and they all get addressed over that envelope of probably 10 to 12 quarters.

So, I can’t be absolutely sure about the ramp because as I said before, it’s not within our control. All we can do is be ready to serve them and make sure that whatever site they do want to get with, we are ready to do it. And – but overall, we think somewhere in that 10 to 12 quarter period it will all get done.

Jim Kortan

Okay. Do you believe this is the priority of that organization or is this something that they are just kind of doing as one of many?

Peter Allen

I think it’s a priority both in terms of expanding their ability to deliver better services to customers, but also in terms of helping them improve their cost base.

Jim Kortan

Okay, okay. And then another follow-up – couple follow-up questions. As you look out, have you developed any type of backlog or any type of forecast as far as what the other quarters look like from a revenue standpoint?

Peter Allen

Of course, we look at that constantly. It’s not something that we provide information on these calls, again for the reason that obviously the dynamics around customers – the work the customers have to do in order to receive our equipment can cause some variability. So, well, the way I would characterize it is, we have a backlog in place today that would support probably a slightly better quarter than the one we’ve just experienced.

Jim Kortan

Okay, good. Thank you. And then, one follow-up final question is, on your consultants that you are going to have some information that you are going to decide on in the future, what’s the timing of that? Is that this next quarter or is that further out?

Peter Allen

It would certainly be within the next quarter.

Jim Kortan

And that’s something you disclose publicly?

Peter Allen

As soon as we have something that is firm and melt down, absolutely, we will communicate it.

Jim Kortan

And can you disclose what options you are looking at?

Peter Allen

No, I think it would be prejudicial to those options if I add them today.

Jim Kortan

Okay, all right. Well, thank you very much and good luck.

Peter Allen

Thank you.

Operator

Thank you. Our next question is a follow-up from Kevin Dede with Rodman and Renshaw. You may begin.

Kevin Dede

Hi, yes. Pat, I was just hoping you could give us a little insight on inventory and payables and the balances seem to remain high and I just was wondering what was tied in there and what you were thinking about how to manage them?

Patrick Houston

Yes, so, inventory we made them some good reductions about – last year, we went from about 30 down to the low 20s. Last couple of quarters we’re stalled a bit in terms of moving it, but this quarter we did a good job and turned it down over $2 million. That helped us certainly on the cash burn this quarter. So, that was a good performance.

Obviously, our target is still to get the inventory down, target would probably be by the end of this fiscal year hopefully have it in at $15 million or lower and that would help again on our working capital. Accounts payable, we are still working with our suppliers as much as possible to help them with their balances, but at the same time continue to move materials to our customers to fulfill their needs.

So, that was a moving target a bit. But it involves working with each of our suppliers on an individual basis.

Kevin Dede

Is it – would it – how would you characterize the product in inventory? Is it mostly MC and Enhanced or no?

Patrick Houston

MC no, because as Peter said, the demand for that product is so high that we – as soon as we make them, we ship them to customers immediately. So right now we don’t have any MC inventory just because of the overwhelming demand for that product. So what you have in inventory is, a mix of different products, Enhanced obviously which is our all outdoor single carrier, latest generation. We also have some FPMR leftover from – and still have several other products. Hub 800s that we have for Nokia and other customers from those legacy products. So it’s a mix, but certainly some Enhanced and HC+s in the majority.

Kevin Dede

Okay. Fair enough. Thanks. Peter, just back to the India situation. Can you just refresh us on DragonWave’s status there? I mean, I know that the company has made a pretty substantial investment in trying to open opportunities and I am wondering what you think that status is now and whether or not any of that business could be resurrected?

Peter Allen

Well, I think that there are possibilities, as I indicated on the answer to Todd, I don’t think – I don’t anticipate it doesn’t – we are not including any opportunity to work with Airtel in the future in India. I think that, what’s going on in the Indian market is, because of the impact that Reliance JIO is having in the market, there is a – as you know, there are – a merger planned between Idea and Vodafone. And I think during that time, while that merger is being examined, they are looking at what the network synergies are and that’s obviously slowing down I think some purchases in that carrier – in those carriers.

So, I don’t anticipate there being a significant demand from those customers. Idea of course, is a historical customer of DragonWave in India. Reliance JIO, I think we have a situation that was a casualty of the situation in Airtel in the – because of our weakened position, JIO took the view that they didn’t want to include us in the second phase of their build out.

But I don’t believe that if we are able to resolve that situation, I don’t believe that that is insurmountable and there would be an opportunity to return into that network probably with the next generation product Multi-Channel. We are having some discussions as to whether or not they want to do testing on that product and others. But I think it’s far too early to say that we will resume product sales into India.

Kevin Dede

Okay. Fair enough. Thank you so much for the additional color. Much appreciated.

Peter Allen

Thank you.

Operator

Thank you. I am showing no further questions at this time. I’d like to turn the call back over to Peter Allen for closing remarks.

Peter Allen

Yes, thank you, Shannon. Thank you everybody for joining us today and we look forward to communicating our forward plans in the near term. Please everybody enjoy the rest of the day. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation. Have a wonderful day today.