Aviat Networks (NASDAQ:AVNW) Q2 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by, and welcome to the Aviat Network Fiscal 2020 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Glenn Weiner, Investor Relations. Thank you, sir. Please go ahead.

0:35 Thank you, and welcome to Aviat Networks Fiscal 2020 Second Quarter Results Conference Call. Our Form 10Q, press release, and our updated investor presentation can all be found on the Investor Relations section of our website, as can a replay of today's call approximately one hour after the call ends. will begin with opening remarks by Aviat's President and Chief Executive Officer, Pete Smith. He'll be followed by Stan Gallagher, Chief Operating Officer and Principal Financial Officer, and then Eric Chang, Senior Vice President and Principal Accounting Officer. After their prepared remarks, we'll open up the call for questions. Sean McFaul, Senior Vice President of Corporate Development, is also with us and will be available during the Q&A portion of the call. During today's call and webcast, management may make forward-looking statements regarding Aviat's business, including but not limited to statements relating to projections of earnings and revenue, business drivers, the timing and capabilities of new products, network expansion by mobile and private network operators, and economic activity 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.

1:39 Please note 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 revision of these forward-looking statements Thank you, Glenn.

2:20 It's been about five weeks since I took the role of CEO. I've spent the majority of my time traveling to our sites, getting to know our people, some of our customers, and reviewing our strategy to drive growth, improve profitability, and create value for all stakeholders. I did a lot of research before taking this role, and my initial assessment of Aviat is very much aligned with what I've learned thus far. We have industry-leading technology, a diverse global customer base and strong relationships with both our customers and our partners. Our position in North America is solid and should continue to be a catalyst for us in the future, specifically with private networks, public safety, and several vertical markets such as utilities, oil and gas, among others.

3:09 Additionally, demand for our solutions in North America should only intensify. Given the increased need for mission-critical networks, and the upcoming build out of networks in support of 5G. While we've done well over the past years building our foundation, expanding our customer footprint and developing new solutions for these customer segments, I believe there is significantly more we can do to drive growth and increase our share of demand. Internationally, we have strengths and weaknesses. On the positive side, our technology and customer footprint, however, while we have added accounts and grown in some regions, it's been inconsistent. And I believe we can do a better job of commercializing products for specific customers and regions while providing more value-added services that differentiate Aviat from the competition. With that said, we will look at each market we're in, others we can expand into and potentially align with other companies to lower our cost of entry while providing customers with a one-stop shop solution to make the buying cycle easier.

4:17 Throughout my career, I've been fortunate to have worked with strong leaders and teams. And in every position, no matter what industry, I've always focused on two things, commercial excellence and operational excellence. Again, I believe that we have good products that can go head to head with any competitor in the industry. How we incorporate customer feedback, assess the market opportunity and specific customer and prospect needs and how we launch, market and sell, to me, could be significant organic growth drivers within the next few years and that has nothing to do with future innovation. It's about leveraging what we have to do to do better service to the customer and what's commercial excellence is all about.

5:04 Operational excellence is underway and the team has done a great job of driving better efficiencies and collaboration on a global scale. We're continuing with the plans in place, looking to lower our fixed costs by improving yield, efficiency, and getting a better return on our investments in technology. Over the next couple quarters, more to share with respect to our strategy and vision. Better execution is critical, both on the commercial end and in operations. The strategy we have in North America has and should continue to drive results for Avia, and by working more closely with our customers to better understand their views and how we can support them, I see opportunities to grow organically and leverage our technology to expand beyond our installed base. International will be down this year.

6:00 We knew that coming in and took into account the current spending environment in Africa and the anticipated downturn in the APAC region. With respect to Asia, however this is timing only and we had a very strong fiscal year 19 and our new agreement with Globe should yield an even stronger fiscal year 21. There are also opportunities to expand in Asia beyond the regions we are in now and that is also something I and the team will be looking at. Our top line will be down a bit this year to the international markets but we're growing in North America and I expect that to continue. Margins are trending upwards and more excited to deliver results for you. Thank you and I'll now turn the call over to Stan.

6:45 Thank you, Pete, and good afternoon, everyone.

7:09 When Aviat first initiated its turnaround strategy in fiscal year 2016, our annual OPEX stood at approximately $85 million on $268 million of revenue, and non-GAAP gross margins were little less than 25%. Over the course of three years, even on revenue that is lower by approximately 10% compared to the end of fiscal year 2019, we have improved margins by over 760 points and reduced OPEX by approximately 12%. Over a three-year period, we have demonstrated substantial enhancement to bottom-line profitability while strengthening our balance sheet, yet there is still a lot more that can and will be done to improve. In fiscal year 20, we believe our financial results will continue to demonstrate our ability to deliver and the following years should be stronger, with more compelling market dynamics working in our favor and a much stronger product and service offering than in past years.

8:07 Our objective is to grow our market leading position in North America and we will accomplish this by continuing to invest in R&D to differentiate our offering versus the competition. We believe we can increase our share in NPLS for public safety networks, grow share with ISPs domestically and internationally with operators focused on developing new networks and help them lower their cost of ownership. As 5G is fast approaching, we have products that have been commercialized over the past year, which puts us in a great position to support both our installed base and capture new accounts. For example, our WTM4800 eBAN and multiband platform is a perfect example and interest in this solution is building. 5G should be a growth driver for us over the next two to three years and potentially sooner as operators are starting to invest now.

8:59 We also have several R&D initiatives underway and believe the new products introduced and those under development combined with more value-added services could enhance our gross margins even further. We have increased the intensity of our operational excellence programs this fiscal year, and as a result, investors should expect to see SG&A's percentage of revenue decline in future years. We have identified programs that will lower G&A specifically as we move through the second half of fiscal 2020. We have, however, incurred more sales-related expenses due to our strong bookings and expect this to continue given our bookings performance and outlook. Lowering fixed costs is a priority to enable investments in our products, services, and sales-related initiatives with a focus on driving growth.

9:46 We are not thinking about the status quo or modest growth. We want to capture the market. In the interim, we are challenging every cost in our business, every region, department, and transaction. This is not a restructuring program, rather it's a mindset to challenge and change what our core cost structure should be as we believe that there are probably a few million dollars of expenses that can be removed over time, even with growth anticipated. This ties back to my past comments on investing in automation tools and AI, which has also contributed to some of our expense increases in FY20. We have already achieved rapid deployment of a number of AI tools which we expect will generate savings in the early part of fiscal 2021. As previously communicated, our results were adversely affected due to bad actors launching a cyber attack at one of our contract manufacturers.

10:38 Although there was a short-term impact to our business, we got through it. Going forward, to limit risk in this area, we have invested in state-of-the-art solutions to protect our assets. for example, investments in the latest cybersecurity tools to withstand the continuous cyber intrusion attempts that every enterprise, both small and large, are exposed to each and every day. Our contract manufacturer has made like investments to protect itself moving forward. So to summarize, we have in place a team with the knowledge, skills, drive, and experience to take AVIAT to the next level. I'm confident in that. Our operational excellence culture is continuing to mature, and while costs will be up modestly this year, again, much has to do with expenses we are making now to improve our foundation and drive growth. There are also expenses in FY20 that are not anticipated to repeat next fiscal year. Commercial excellence is on deck, and with Pete's experience and guidance, we expect a meaningful payback in the quarters and years to come.

11:37 while revenue is expected to be down after a period of modest growth. Remember, Africa is one of the drivers and orders are anticipated to increase in the second half of the year. The APAC region is down, but that is solely timing related and is expected to increase next year and in the years that follow due to our new agreement to support GLOBE's 5G launch, which we expect to have a release on shortly. We may also look to expand into new APAC regions. We are winning new accounts, both domestically and abroad, and our pipeline is building because of our new products. As Pete mentioned earlier, beyond just public safety and private networks, the opportunities across multiple vertical segments in North America are growing, and this is where we believe we have the best offering in the industry to increase our share. I will now turn the call over to Eric, who will cover the financials.

12:26 Eric?

12:29 Thank you, Stan, and good afternoon, everyone. All comparisons related to our fiscal 2020 and fiscal 2019 second quarter and six-month financial results are for the periods ended December 27, 2019 and December 28, 2018, respectively, unless otherwise noted. Fiscal 2020 second quarter revenue declined by $9.1 million, with North America revenue down approximately $800,000. International revenue was down $8.2 million, and within this, Africa and the Middle East declined by $5 million, and Latin America and the Asia Pacific region down by $2.5 million. As noted in our January 22 release and in today's announcement, the cybersecurity attack at one of our manufacturing vendors led to lower than anticipated revenue for the quarter.

13:23 For the fiscal 2020 six-month period, total revenue was down $11 million, with North America revenue up approximately $11 million while international revenue was down approximately $22 million. With respect to North America, strong bookings in the second half of last fiscal year contributed to our strong fiscal 2020 first half performance. Additionally, our North America bookings performance in the first half of fiscal 2020 was exceptionally strong which bodes well for our future. While international revenue was down in the first half and is expected to be down for the full fiscal year, it is important to note that our book-to-bill ratio for international was above one in the first half and is also expected to be above one in the second half of the fiscal year.

14:16 GAAP gross margin came in at 32.7% and non-GAAP gross margin at 32.8% for the fiscal 2020 second quarter. a decline of 190 and 180 basis points respectively. The decline in gross margin was primarily due to lower mix of product revenue and increased supply chain cost. For the six-month period, GAAP and non-GAAP gross margin were 35.7% and improvement of 350 basis points on both a GAAP and non-GAAP basis. Looking ahead, Based on the mix of business anticipated, we anticipate gross margin for the second half of the year to be roughly in line with the first half, representing an increase for the full fiscal year over fiscal 2019.

15:09 On the expense side, we reported gap operating expenses of $19.8 million for the fiscal 2020 second quarter, compared to $19.6 million for the comparable year-ago period. The net increase consisted primarily of an increase in restructuring charges of $400,000 and SG&A expenses of $200,000, offset in part by a decrease in R&D expenses of $300,000. On a non-GAAP basis, excluding the impact of restructuring charges and share-based compensation, total operating expenses were $19.1 million, relatively flat as compared to $19.2 million for the comparable year-ago period. For the six-month period, we reported gap operating expenses of $40.9 million in fiscal 2020 compared to $39 million for the comparable year-ago period. The net increase consisted primarily of an increase in SG&A expenses of $1.1 million and restructuring charges of $800,000.

16:14 The increase in SG&A expenses was primarily due to the other employee-related expenses while R&D expenses were essentially flat for the comparable periods. On a non-GAAP basis, excluding the impact of restructuring charges and share-based compensation, total operating expenses for the fiscal 2026 month period were $38.6 million as compared to $37.4 million for the comparable year-ago period. We reported a GAAP operating loss of $1.5 million compared to GAAP operating income of $2.9 million for the comparable year-ago period. For the six-month periods, we were essentially break-even in fiscal 2020 and reported GAAP operating income of $1.4 million for the comparable year-ago period.

17:07 On a non-GAAP basis, we reported an operating loss of $700,000 for the fiscal 2020 second quarter compared to operating income of $3.4 million in the comparable year-ago period. For the six months of fiscal 2020, we reported non-GAAP operating income of $2.4 million as compared to $3 million for the comparable year-ago period. Adjusted EBITDA for the fiscal 2020 second quarter was approximately $400,000, and for the fiscal 2020 six-month period was $4.5 million. This compares to adjusted EBITDA of $4.5 million for the fiscal 2019 second quarter and $5.4 million for the six-month period in fiscal 2019.

17:55 To reiterate, capacity constraints for the cyber attack at one of our contract manufacturing vendors, along with higher sales commissions based on stronger than anticipated bookings, among others, had the biggest direct impact on non-GAAP operating income and adjusted EBITDA. As Stan noted earlier, for the full fiscal year, we are anticipating revenue to be down overall, but profitability to improve year-over-year. Gross margin is also anticipated to increase year-over-year, but spending may increase slightly, though we are continuing to look to reduce fixed costs and optimize our business further.

18:41 Moving on to the balance sheet, our cash and cash equivalents stood at $38.1 million at the end of the second quarter compared to $31.9 million at year end, an improvement of $6.1 million. This also represents a sequential increase of $3.6 million compared to the end of the first quarter. Our free cash was $29.1 million at the end of the fiscal 2020 second quarter compared to $22.9 million at year end. Our cash flow from operations was $10.8 million in the fiscal 2020 six-month period compared to cash used in operations of $600,000 in the fiscal 2019 six-month period, which was an improvement of $11.4 million. As we noted on our last earnings call, we are expecting to finish the fiscal year with a higher cash balance year-over-year.

19:40 Please note, during the second quarter, we spent $653,000 in shared repurchases, bringing the total to $1.4 million for the first six months of fiscal 2020. Under our $7.5 million repurchase program, $3.8 million remained available at the end of the second quarter. Inventory increased $4.7 million from year end and 2.2 million sequentially. But again, this was directly related to the capacity constraints as discussed earlier, which impacted production and shipments, as well as the result of the NEC channel partnership we announced last quarter.

20:26 With the capacity constraint issue now behind us, inventory is expected to decline. Lastly, capital expenditures in the second quarter and year to date total $1.1 million and $2.4 million respectively. We expect to spend approximately $4 million in the second half of the year with a full fiscal year in line with what we communicated last quarter. This concludes my remarks and operator at this time we are ready to open up the call for questions. Ladies and gentlemen, just as a reminder, if you would like to ask a question, Please press star and then the number one on your telephone keypad.

21:11 Once again, that is star and then the number one. We will pause for just a moment to compile the roster. Your first question comes from the line of Theodore O'Neill with Litchfield Hills.

21:34 Hi. The first question I have is about the contract manufacturer with the issue. Did they wait three weeks before they told you, or did it take them three weeks before they got things back online? Could you give us more color on that?

21:48 Hey, Theo. It's Stan. I'd be more than happy to. So I was actually called over the weekend when they actually identified the attack. It took them three weeks to actually do the recovery process. We offered all of our assistance for our entire IT team because of their experience, but that was primarily the remediation period to get back online and resume the production and shipments for us.

22:15 Now with what's going on in China right now, if people don't get back to work on Monday and it doesn't look like they're going to from what I've seen, does that interrupt any of your supply chain if this goes on for another through February or into March?

22:33 So we have six of our supply chain people in China and our head of operations is in the region working on that, right? our guidance reflects our best knowledge to date. If you go out and look at a variety of other companies' guidance, some think they'll be hurt badly, some think they won't be hurt very much, and what we have is our guidance reflects our knowledge right now. Some of that guidance does anticipate a delay in folks getting back to work if it's worse or there's more cases and they're less available workers, then we won't do as well. And if it's not as bad as we modeled, we can do better. So the big problem with us and everybody else who's giving guidance on the coronavirus is the uncertainty, right?

23:35 So we are doing everything that we can to control our operations and our suppliers to the best of our ability. but it does come down to the uncertainty of how many and how fast is the China employee base going to come back.

23:53 And do you have direct manufacturing there or contract manufacturing and are there parts coming from there?

24:01 So components are coming from China. We don't have our contract manufacturer nor are we present in China for manufacturing. So our Our risk around the uncertainty of the coronavirus is based on the component suppliers that we buy from or our contract manufacturer buys from us.

24:27 Okay, thanks very much. That clears it up for me. Thank you. Your next question comes from the line of Tim Savageau with Northland Capital Markets.

24:44 Hi, good afternoon. A couple questions. Logistically around the shortfall in fiscal Q2, do you expect to recover all of that in Q3, which I know historically, seasonally, is kind of a weaker period for you, and maybe expect perhaps to offset that? Or do you expect that to be stretched out through the second half? And and is there any regional bias that you can discern to the shipments that were unable to be made, whether they were headed North American or internationally or impacted that breakout at all? Thanks.

25:26 Yeah, sure, Tim. Hey, it's Stan. Glad to hear you on the call. So for what we had identified in the recovery process for the second quarter, We actually ended up having finished goods that got stranded before they could get proof of delivery. So a lot of that mess and shortfall was just timing. A few days after that, we recovered what we had planned for the second quarter. That was biased towards North America, which is where the margin impact came from, and I believe that We don't have any other remaining items that were associated with that that carried over to Q3 or to the second half.

26:13 Got it. And you'd mentioned, I think called out some extraordinary booking strength in North America. I wonder if you could be more Provide any more color on the nature of that. I mean, you obviously also discussed international book-to-bills being above one, so I assume extraordinary means way above one. But if there's any anecdotal color you might be able to provide on North America booking strength and maybe identify what the source of that might be.

26:50 So, Tim, I think the best way for me to answer that is to use some of the variable compensation expenses as a proxy. You can see from an OpEx perspective that we did have some upward pressure on that, but that was associated primarily to a lot of the orders performance that we had. What I'd say generally, without getting into too many specifics, is that it is an order flow that is substantially higher than what we have seen in the past, and it has been consistent over the past three quarters. With regards to specifics on those, you know, when we get our press release that's approved and comes out, you'll see it. Otherwise, there's significant strength in North America, and we also have some additional strength that's occurring in the international region, specific to Asia-Pac.

27:47 Got it. And a question for Pete, and I thought your initial commentary and I know your strategic view is still evolving here. But I thought the commentary around partnerships with others to kind of develop a one-stop shop approaching what I gather would be new international markets was interesting. I wonder if you might be able to provide any more commentary on that in terms of what stage those partnerships might be or What sort of players you might be looking to partnership? Are we talking about distributors here or other kind of end-to-end equipment suppliers or any more color on that would be welcome?

28:33 All right. So I'll give a little color, but maybe not as much color as you would like, right? So if you think about the international business, it's quote-unquote the rest of the world, and the rest of the world is a big place and difficult for us to cover. And we're in some active discussions for partnerships so we can extend our reach and drive more volume through indirect channels. So that would be one. We're always evaluating technology. I wouldn't say that we're close on any of those type partnerships, but we're close. Close doesn't really matter until you finalize it, but we're close on some distribution deals that, you know, hopefully we can land and announce and, you know, use it to drive growth internationally.

29:30 Is that helpful?

29:33 You're right, not quite as much as I was, you know, just kidding. I made my first forecast. Well, that's one for one. Last question for me, and speaking of forecasts, and I'm probably jumping the gun here. But you did make a number of comments about fiscal 21 or at least extending into that time that seemed to point to an expectation of at least revenue growth and expense declines, both of which sound reasonably good. Am I hearing that the right way or what are you kind of able to say about fiscal 21 here now that we're able, you know, halfway through fiscal 20?

30:15 So, you know, look, we want to do a bottoms-up plan on 21, but we see, you know, Stan mentioned the bookings, you know, the book-to-bill ratio improving, and we see that in North America we have that engine going. We also see an opportunity to lower our costs, so I think you've got it right for... 21, and, you know, directionally, and we need to do more work before we can be more specific. Great. Thanks very much. Sure. Your next question comes from the line of Mark Spado with Stanfill Capital.

31:03 Yeah, hi. Two questions. First one is, does the Huawei ban mean anything for you guys in rural infrastructure? I think I read somewhere that they're being banned there.

31:13 That came out in the last two days?

31:16 No, no, this was a couple of months ago.

31:21 All right, well, it was actually in the Wall Street Journal article again, I guess, in the last couple of days, and there was a lawsuit. Look, I think that that can only be good for us, right?

31:32 Yeah, well, part of it is a Pentagon thing, but I thought there was a separate directive for rural telecoms, so I was wondering if that Is there anything you've had any effect from yet? No, that's what you're saying.

31:47 Not significant. And part of that is that Huawei didn't really have a huge install base, or at least in our category, to go after. I wouldn't say zero. I think we do see some opportunity there. I think we will be a beneficiary to some extent. But I don't think it's a big opportunity.

32:08 Okay, fair enough. And then the second one, and it's really a softball question, but Trump did say in his State of the Union address that he wanted to spend $20 billion on rural broadband infrastructure and that was one of the few things that the Democrats actually stood up and applauded, which makes me think that it can get passed. Are you guys going to be able to get a piece of that?

32:34 Yeah, I think that's an area we've been active in. We've had some new products there, and we've been achieving some success with rural internet and broadband customers over the last year or so. And, you know, that's another area where we are actively looking to expand our reach a little bit with some other activities there as well. So generally, whatever trickle-down effect there is from that into our area, generally we see that as a positive.

33:05 Okay, great. My other questions were answered, so thank you very much. Thank you. And ladies and gentlemen, just as a reminder, if you'd like to ask a question, please press star and then the number 1 on your telephone keypad. Our next question comes from the line of Steve Bush with Everglades Resources.

33:25 Hi, guys. Thanks for taking my call. Hi, Steve. Good to see you. We're progressing on the fronts we can control. Does it make any sense to just jettison some of these African businesses and just focus on North America given our growth rates here, or is that not really something you want to go towards?

33:44 Well, I think, you know, really the Africa business is a bit volatile, and what we've talked about over the last month has been how do we modulate our cost structure to match the demand, and that's You know, when we do have business, you know, it's positive contribution margin and we need to manage it better. And, you know, long term, Africa perhaps has the least amount of infrastructure in the world. So we think having a presence in Africa and simultaneously managing our cost structure with the, you know, current period demand is the way to go. We have more work to do in that regard, but that's That's the perspective that we have currently.

34:33 Okay, that's fair enough. I mean, I know MTN is looking to sell off some Nigerian assets. I don't know how that affects you. Are they still a 10% customer or where do they stand now?

34:46 No, they're not a 10% customer anymore. We had de-risked our plan as far as our annual operating plan and budget for Africa this year. It's actually performing a little bit better than the de-risk right now and the activities that we have in place are, as Pete said, we're modulating that business and matching the cost structure so that we have the most favorable outcome. But no, they're not that large, and I don't anticipate them to grow into a 10% customer in the foreseeable near future. Okay.

35:22 And how many 10% customers do we have this quarter?

35:27 So we didn't have any in the second quarter of our fiscal year. Motorola still was a 10% customer for the first half. Right. Okay.

35:35 And so how's the Motorola rollout going in Florida?

35:41 Well, as you know, Motorola stepped back a little bit towards the end of the year and did not sign. So we are now waiting for how the state of Florida is going to go and address that. We still believe our prospects are intact and very strong, but we're going to have to let the state play that one out.

36:02 All right. Okay. All right. And how many CRs did you buy back this quarter, by the way? I know you gave a dollar number, but how many CRs was that?

36:10 It's almost $700K. And $1.4 million for the year to date. All right. Okay.

36:18 Thank you. Good luck.

36:21 All right. Thanks. and there are no further questions at this time. I'd like to turn it back over for any closing remarks.

36:38 Very good. Thanks, everybody, for joining the call. We'll see you in 90 days. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.