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Aviat Networks, Inc. (AVNW)

Q3 2015 Earnings Call· Fri, May 8, 2015

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Transcript

Operator

Operator

Good day, everyone and welcome to the Aviat Networks Q3 2015 Financial Results Conference. Today’s call is being recorded. At this time for opening remarks, I'd like to turn the conference over to Ms. Leslie Phillips, Investor Relations. Please go ahead, ma’am.

Leslie Phillips

Management

Thank you, Kelly. Good afternoon and welcome to Aviat Networks third quarter 2015 results conference call. I’m joined today by Mike Pangia, President and Chief Executive Officer; and Michael Shahbazian, Chief Financial Officer. This call is being broadcast live over the Internet for all interested parties and the webcast would be archived on the Investors Relations page of the company’s website. During today’s call, management may make forward-looking statements regarding Aviat’s business, including statements relating to projections of earnings and revenues, business drivers, the timing and capabilities of new products, network expansion by mobile and private network operators and variations of economic recovery in different regions. These and other forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. Please note that these forward-looking statements reflect the company’s opinions only as of the date of this call and the company undertakes no obligation to revise or publicly release the results of any revisions to these forward-looking statements in light of new information or future events. For more information, please see the press release and filings made by the company with the SEC. These can be found on the Investor Relations section of Aviat Networks website at www.aviatnetworks.com. In addition, during today’s call, management will be referencing both GAAP and non-GAAP financial measures. A copy of the press release and financial tables, which includes a GAAP to non-GAAP reconciliation and other supplemental financial information, is also available on the company’s website. With that, I will turn the call over to Mike Pangia. Mike?

Mike Pangia

Management

Thanks, Leslie and good afternoon to everyone listening on the phone as well as on the webcast. We've experienced good progress since our last earnings call in late January. In February, we announced key contract wins in Africa. In March, we premiered what we believe to be the world's most powerful microwave radio for mission-critical networks and throughout the quarter, our CTR product experienced a significant ramp in bookings and shipments. And today, I'm pleased to announce that a large North America mobile operator has selected Aviat to modernize its network. It was our technology offering combined with our strong services and network management capabilities that were instrumental in helping us secure this new customer win. I'll now provide an overview of our financial results followed by this quarter's customer and product activity. Mike Shahbazian will give a more in-depth review of our financial results and will provide our guidance for the upcoming quarter. I'll then close the call by discussing the actions we are taking to further optimize and improve our business model. Our fiscal third quarter financial results were largely as expected and we made progress with bookings and our expense reduction initiatives. Fiscal third quarter revenue was $74.8 million. We estimate that our revenue was reduced by approximately $1.4 million due to the strengthening of the US dollar against many of our international currencies. Q3 bookings improved significantly on a sequential basis and we have returned to reporting a book to bill above 1. We are seeing momentum in bookings across nearly every geographic segment, largely fuelled by our CTR product line. Non-GAAP gross margin was 23.7% and was impacted by a couple of one-time events that Mike will describe in greater detail in his comments. Demonstrating the progress we've already made with our expense reduction actions,…

Michael Shahbazian

Management

Thank you, Mike and thanks to all of you for joining us. If you've not already done so, I’d encourage you to download the financial press release from the investors section of our website that we posted earlier today. The release contains Aviat's unaudited GAAP financial statements along with a reconciliation of non-GAAP financial measures. My prepared remarks will be focused on the non-GAAP financial overview of our fiscal third quarter and the related business trends. Unless otherwise stated and other than revenue, all dollar figures I provide will be on a non-GAAP basis. I’ll then provide guidance for the fiscal fourth quarter. Revenue for the third quarter came in at $74.8 million compared to $92.5 million in the second quarter of fiscal 2015 and to $81.4 million in the third quarter of fiscal 2014. Product revenue was 63% of sales and services were 37% of sales, the same ratios as in the second quarter. Gross margin for the third quarter was 23.7% of sales, down from 27.2% of sales of our fiscal second quarter. The third quarter gross margin was impacted by less favourable absorption of fixed costs due to lower volumes and changes in currency that occurred in the quarter. As many other U.S.-based companies have reported, we’re affected by the continuing strengthening of the dollar. Margin was reduced by currency impact and additional realized foreign currencies losses, which added $1 million to our cost of sales, resulting in 130 basis point drop in our gross margin. For the fiscal third quarter, our operating expenses totaled $23.8 million, down from $27.2 million in the fiscal second quarter. This sequential decline was driven by a benefit from the change in currency rates and implementation of our expense reduction measures. Third quarter operating expenses were down approximately $7 million or…

Mike Pangia

Management

Thanks, Mike. We see momentum from our bookings this quarter, carrying over to higher revenue performance in Q4 and we will make further strides with our business model in other areas. The introduction of our new products, particularly the CTR platform, is proving to be instrumental, requiring new customers as well as increasing our footprint with existing customers. Our focus on simplifying the business has resulted in a significant reduction in our expenses, which puts us on a clear path to cash generation. As I look forward to fiscal year 2016, I'm increasingly confident that the actions we have taken are starting to pay off. I would like to thank all of Aviat’s employees for their hard work and efforts. Now, back to the operator for questions.

Operator

Operator

Thank you. [Operator Instructions] We will go first to Evan Dede with H.C. Wainwright.

Kevin Dede

Analyst

Good afternoon, gentlemen. It’s Kevin Dede. A bunch of things for you, Mike and no offence, Mr. Shahbazian, but I guess I was kind of wondering how you felt about life at Aviat and what your plans were?

Michael Shahbazian

Management

My plans, well, I've been a CFO, this is my ninth company and I started doing interim roles after about 40 years. So I enjoy doing this, but I immensely enjoyed my time period with Aviat. It's a very interesting organization with a very interesting executive and management team and I would say that it's an experience I’ll treasure going forward. So all of these have been experiences and this one is very unique along those lines.

Kevin Dede

Analyst

So how would you say the search for a permanent CFO is going?

Mike Pangia

Management

Is that question to Mr. Shahbazian or...

Michael Shahbazian

Management

It should be to Mike Pangia.

Kevin Dede

Analyst

Yeah. That’s sort of an open one.

Mike Pangia

Management

Yeah. It's going very, very well and we are getting very close. So notwithstanding that, again, I appreciate Mike being on board.

Kevin Dede

Analyst

Great. Okay. So Mr. Pangia, how would you characterize the integration of CTR and MTN and how are the network engineers there thinking about the evolution of their network going forward? And do you see it sort of I guess, their engineers are leveraging your platform to incorporate small-cell if necessary in densely populated areas, just give me some sort of 20,000 foot perspective on how you’re viewing the integration process?

Mike Pangia

Management

Well, first off, we feel very good about our position with MTN. We continue to be very focused on delivering value to them. As expressed in the recent press release, I think winning new business with them is an indication that we are continuing to deliver value. CTR is instrumental in that value proposition, both in terms of its capabilities from a layer 2 perspective as well as its networking capabilities. And we actually appreciate the business with MTN and we strive to exceed their expectations on a daily basis and we will continue focusing on delivering them value. Notwithstanding that, we also feel very good about the progress we've made with other customers in Africa, which also see value in what we’re providing, not only with respect to CTR but also our strong services and support capabilities in the region also are critical to delivering TCO or at least the best TCO relative to other providers and we will continue to strive for that.

Kevin Dede

Analyst

Okay. I guess sort of as a recall to layer 2, could you sort of take it up into another level of detail, what are they experiencing that you might be able to put the decision as a selling point for other operators?

Mike Pangia

Management

Yes. So we have a number of elements in the value proposition. In terms of the products capabilities from a layer 2 transmission perspective, its ability to do routing and other layer 3 capabilities which also helps as we look at the enterprise space and then on top of that, we have a very strong service capability and support capability, which in the broader scheme of things isn’t just about the pulling equipment and supporting it, but it’s also regarding the logistical elements of working in a region like Africa.

Kevin Dede

Analyst

So I guess Mike, what I was hoping you might be able to help me clarify is just through the evolution of mobile networks in general, I guess I'm kind of wondering I mean there has been, obviously there is a lot of talk about software defined network and it just seems to me that the CTR fits into that type of evolutionary thinking? I'm just kind of wondering how the engineers at MTN view that and how they see the CTR as an integral product in that evolutionary group?

Mike Pangia

Management

First off, I'm looking at the product’s capabilities and the other attributes that we provide beyond just MTN. So

Kevin Dede

Analyst

No, I understand. But I mean just wanted to see if the standout is sort of the leading customer on the curve of adoption?

Mike Pangia

Management

No, we've had must multiple customers adopting the product now. As I referred to earlier, we’ve seen a doubling of orders from the second quarter and the third and through the first five week, it’s already equalled the whole last quarter. This is much more than just MTN. So as we talk about the broad range of customers are looking at this product and as it relates to your comments earlier about SDN or software defined networks, this is a step in that direction from the standpoint that it does take products that are multiple products and it integrates that functionality into a product. It does provide more software in terms of the value and also another important element as we’re moving it into the software defined networking world is service capabilities have to be strong, because the OpEx part of the equation is also becoming even more critical to a customer and we are also addressing that with our service capabilities, network management tools and support.

Kevin Dede

Analyst

Okay. Your new North American customer, the one that you announced here this evening, is it fair to say that that customer is a tier 1?

Mike Pangia

Management

It's a large North American mobile operator.

Kevin Dede

Analyst

Okay. The expense run rate you characterized and it’s at the $23 million range for the next quarter, but in your restructuring release, what was it, maybe a month or two ago, you commented that you hope to extract another $10 million to $12 million out of operating expenses and this evening, you seem to reiterate that and seeing expenses reduce further for the first half of the next fiscal year, I'm just wondering how you might rather characterize that expense reduction and how we might see it in the P&L?

Michael Shahbazian

Management

Okay. So first off, when I talked about a $23 million exit rate, to some extent, you can't look an individual quarter, especially our fourth quarter in anticipation of strong bookings, which we expect to continue. There is a variable element on our sales expense that usually increases in the fourth quarter related to, it’s one of the stronger quarters we normally have with respect to our bookings. And then notwithstanding that, we expect to see further improvements in that OpEx moving into fiscal year 2016 and that's when you will see further improvements, all other things being equal.

Kevin Dede

Analyst

Okay. But at this point you are not comfortable sort of giving us a ballpark on where you expect to see that?

Michael Shahbazian

Management

We expect it to be improved, it will be improved versus the $23 million. Again all things being equal, there is obviously variable expenses associated with our business as well and to the extent that our business is better than what one would expect from a run rate perspective, that number could be higher, but we’re very focused actually on reducing the fixed cost element of that even further than where we are at right now.

Kevin Dede

Analyst

Right. So on that fixed cost discussion, is there any of that that you think relates to cost of goods?

Michael Shahbazian

Management

Well, our reductions, I've only referred to the element associated with the OpEx side. But not referencing, first of all, I’m not referencing cost of goods here, I’m referencing the spending associated with delivering and supporting products and above and beyond the OpEx reductions, we’re also having reductions in terms of the overhead part of our business with respect to our supply chain, further signifying that, that benefit which show up as an improvement in our margins.

Kevin Dede

Analyst

Right. Okay. Can you shed any light on where you might expect gross margin to fall out in the June quarter?

Michael Shahbazian

Management

All I can say is that we’re very focused on improvements across the whole P&L. Our focus is on generating positive EBITDA and gross margins is one lever as part of that value proposition. So I would see -- I am expecting an improvement in gross margin in the fourth quarter, but I'm also expecting improvements in other areas and our focus going forward is [ph] on generating positive EBITDA on a consistent quarterly basis.

Kevin Dede

Analyst

Okay. Could you talk to sort of the overall pricing environment in North America, Africa and then I suppose, I guess, Asia and Europe as much as you can see?

Michael Shahbazian

Management

It's always difficult to provide pricing elements without -- again without reconciling it to total cost of ownership, because there is elements when we talk, when we think about pricing, we’re usually thinking just about the CapEx part of the equation. And that's different than providing value. So what I’m seeing in the industry is that there is obviously continued compression from a hardware perspective, it's more intensive in the international arena than it is in North America, but the perspective there is that’s continuing to be pressured and again that's why software defined network is an important element, but the other values we’re providing in terms of software capability, ability to improve the support, the service side, those are all attributes that lead to improving value to the customer, which ends up generating a benefit on our end in terms of margin and other elements.

Kevin Dede

Analyst

Can you talk a little bit about that pricing equation vis-a-vis CTR and the competitive offering that you see from Independence?

Michael Shahbazian

Management

So, the other element of pricing is there are certain markets where there is a focus primarily on just the CapEx side of the equation that are extremely price sensitive. And it's very difficult to drive value in those markets that are only looking at one element of the equation. Part of our restructuring efforts have been to focus our activities and where we see the opportunity for that value creation to be there, and that's where CTR fits in as well as all the other elements I discussed earlier with regards to our service and support capabilities. And that’s where our focus is in those markets with those customers. And it's not just about the mobile operator side as well. We have a significant amount of business in the public safety, private networks domain, in some cases, the sensitivity on price is not as high, it's about delivering value, the mission-critical capabilities of the product are important. So that's what I mean, the pricing equation is difficult to answer without getting reference to markets and verticals and where we are focused and where we are not focused.

Kevin Dede

Analyst

Okay. Fair enough. Could you give us the breakdown between product and service revenues for March versus December?

Mike Pangia

Management

Sure, Mike.

Michael Shahbazian

Management

March versus December.

Mike Pangia

Management

The last I guess Q2

Kevin Dede

Analyst

Sequentially, yeah.

Michael Shahbazian

Management

Okay. I'm sorry, so you wanted the

Kevin Dede

Analyst

Yeah, Mike. I was just looking for product and service reps, percent [ph] of sales for December and March?

Michael Shahbazian

Management

Yeah. So as a breakout between services and product revenues for the quarter as a percentage of revenues, right. Is that what you’re looking for?

Kevin Dede

Analyst

Yeah. Right. It doesn't have to be percent, I mean if you have the real dollars, whatever you want to offer.

Michael Shahbazian

Management

Right. Kevin, I think that was covered in the script and it was 63% for services revenue -- product revenue and 37% for services revenue.

Mike Pangia

Management

We said it was pretty much even.

Michael Shahbazian

Management

Pretty much even with the same numbers we had for the second quarter.

Kevin Dede

Analyst

Okay, fair enough. Thank you. One last question for me Mike. There is a lot of chatter about Nokia and Alcatel and I guess there are people on both sides of it, right, whether or not the French government will go for it. I'm wondering what sort of disruption you think it may be causing now and how it might change the competitive landscape for you particularly going forward.

Mike Pangia

Management

Yes. So our focuses are on things that we can control and clearly any time there is something like that that takes place, it could provide an opportunity, based on the fact that there will be integration and there is probably lots of unknown factors. So we’ll look at that as an opportunity at least in the near term and we’ll continue to focus in on building our business moving forward.

Kevin Dede

Analyst

The win with the new North American carrier, who do you think you displaced there and why?

Mike Pangia

Management

I'm not going to answer that question. No comments on that question.

Kevin Dede

Analyst

Okay. Alright. Well, I’ll turn it over. Thank you for working with me, Mike. I appreciate it.

Mike Pangia

Management

[indiscernible] So I can't comment on who was displaced, but again I will reinforce that our winning there was a combination of our strong product offering and our service capabilities, including elements like network management. Those were the differentiators.

Kevin Dede

Analyst

Network management, okay. But not from say you're not, just helping them manage their own.

Mike Pangia

Management

Network management platform in combination with the products.

Kevin Dede

Analyst

Right, okay. Thank you.

Mike Pangia

Management

You’re welcome.

Operator

Operator

We’ll move next to Aaron Yu with Singular Research.

Aaron Yu

Analyst

Hey, good afternoon, guys.

Mike Pangia

Management

Good afternoon.

Aaron Yu

Analyst

So it sounds like the momentum acceleration in the bookings was pretty broad-based across a lot of geographies, wanted to see if you guys can give a little bit more color to whether there is some pent-up demand that's coming back in the market or was it more a function of adoption of CTR and product specific initiatives?

Mike Pangia

Management

Yeah. So I'm very pleased with the actions that we've taken with respect to what we are focusing, the ramp of our new products, continue to leverage our service capabilities, and a combination of all those actions is starting to bear fruit, with respect to new customer wins, which is showing up in terms of improvement in bookings. And I'm feeling increasingly more confident that we continue to see some great momentum, again largely fuelled by CTR which I did indicate already this quarter in the first five weeks in terms of the ramp there. So we’re feeling very good about the actions we've taken and the direction we are heading.

Aaron Yu

Analyst

And the repatriation of cash, was that just increase for your exposure to FX in any geographies for you guys and hedge or are there sort of other drivers in rationale behind that?

Michael Shahbazian

Management

Right, so we had built up -- this is Mike, we had built up some excess cash in a couple of our international units where it is very difficult to do currency transactions, so we made a decision to accelerate payments and enter in to a couple of swap transactions that allowed us to bring cash back to the US, that certainly helped us from a liquidity standpoint in the US, so that was essential for doing that but because the markets aren’t particularly well-developed, there is just no active foreign exchange market, you we have to do a swap with using bankers and intermediary and there was a cost of doing that and that was the impact that we had to deal with. At the same time, it did allow us to repatriate a significant amount of cash that we can use in the US.

Aaron Yu

Analyst

So that cost was that the million dollars you mentioned?

Michael Shahbazian

Management

That was a million dollars between foreign exchange and also withholding costs, so the foreign exchange was swap cost and we had some withholding taxes because of the country’s tax regulations.

Aaron Yu

Analyst

Okay, Thank you guys.

Mike Pangia

Management

Thank you.