Westell Technologies, Inc.
Q3 2018 Earnings Call Transcript

Published: 8 Feb 2018

[Operator:]

Good morning and welcome to the Westell Technologies’ Fiscal Year 2018 Third Quarter Earnings Call. My name is Christine, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference call is being recorded. I will now turn the call over to Tom Minichiello, Westell's Chief Financial Officer. Tom, you may begin.

[Thomas Minichiello:]

Thank you, Christine. Good morning and welcome to our conference call to discuss the fiscal year 2018 third quarter results for Westell Technologies. The news release we issued yesterday afternoon is posted on our new website, westell.com. On this call, Kirk Brannock, Westell's President and Chief Executive Officer, will begin with a discussion of our business and strategy. I will then update you on our financial results for the quarter and we will conclude by taking questions. Before we begin, please note that our presentation and discussion contain forward-looking statements about future results, performance or achievements, financial and otherwise. Words such as should, believe, expect, trend and similar expressions are intended to identify such forward-looking statements. These statements reflect management's current expectations, estimates and assumptions. These forward-looking statements are not guarantees of future performance and involve risks and uncertainties that may cause Westell's actual results, performance or achievements to differ materially from those discussed. A description of factors that may affect our future results is provided in the Company's SEC filings, including Form 10-K for the fiscal year ended March 31, 2017, under the section Risk Factors. The forward-looking statements made in this presentation are being made as of the date and time of this conference call. Westell disclaims any obligation to update or revise any forward-looking statements based on new information, future results or other factors. Please also note that we present non-GAAP financial information in our news releases, because we believe that non-GAAP measures provide meaningful supplemental information to both management and investors. The non-GAAP information reflects the Company's core ongoing operating performance and facilitates comparisons across reporting periods. Our discussion of results today will include non-GAAP financial measures. We provided reconciliations to the most comparable GAAP measures in our news release. I will now turn the call over to Kirk.

[Kirk Brannock:]

Thank you, Tom, and good morning, everyone. For our fiscal third quarter Westell continue to generate profits and cash, what was more impressive as we generated even higher profit margins and cash flow in as historically low revenue quarter. These positive results illustrate the tremendous operating leverage we now have in the business. Over the past year we have consistently met or exceeded key operating metrics for gross margin and operating expenses resulting not only in our fifth consecutive quarter a positive non-GAAP operating profit but also exceeding 10% for non-GAAP operating margin for the first time in four years. I consider these results to be an important indicator of the excellent work by the Westell team. Now let's talk a little bit of our revenue and growth opportunities and how we're pursuing – what we're pursuing across the business. While IBW business returned to a more anticipated level after several quarters of record performance we did see continued growth for our public safety solutions in the third quarter and are encouraged by the revenue growth opportunities we have in this market. In addition to our current set of public safety products we are working on rapid OEM initiatives to bring Westell certified solutions from third parties, which could result in increased market share quicker and more cost effectively than our internal development. If all goes well I would expect that we will bring additional public safety products to the market later this calendar year. We are also working on other potential OEM partners to expand our product offerings on the commercial side. Our focus is to look at all opportunities to grow topline in this segment. The ISMS business achieved its highest quarterly revenue level in two years, which partially offset the seasonal impact of our CNS business. Among the top customers for ISMS we are seeing a trend of increased focus and spending for remote monitoring and we are seeking new customers. We are also seeing progress with respect to revenue growth opportunities in wireless network densification applications, namely the emerging centralized radio access network or CRAN, architecture that has been embraced by the major service providers as well as small cell deployments. We expect our ISMS and CNS product portfolios to benefit as these network transitions continue to gain traction. In the CRAN space, our ISM Solution and our CNS offering such as power distribution have been key to our recent success in network build-outs. As the name implies, CRAN centralized efficiencies in the radio access network it allows flexibility of the networks, where as end users connect and it really lays the groundwork for small cell deployments and 5G rollouts. Organically, we continue to leverage the breadth of our current product portfolio to pursue deeper penetration with existing customers and win new customers including what I would characterize as tactical investments and product developments that can enhance our ability to meet evolving customer requirements and drive revenue growth. Inorganically, in addition to the rapid OEM initiatives for IBW that I mentioned earlier, we are constantly evaluating opportunities to expand our business through acquisition. The priority here would be small niche or bolt-on accretive businesses that can profitably grow our topline, while this could include acquiring products or solutions to increase market share within our current customer base. We would like to acquire businesses that would build on the customer diversification we've already achieved with our current business. Westell has a strong 30-year brand is known for high-quality and we have a great customer base and distribution channels in the U.S., Latin America, and Australia. That makes us attractive to do business with and we need to leverage that. On the leadership side, our board of directors is looking at options to increase shareholder value and is going through the process of reviewing CEO candidates. In the meantime, I am totally focused on the business and what we need to do to increase shareholder value. In summary, our growth strategy is to continue to focus in the growing markets including In-Building Wireless public safety and CRAN, also organically leverage and enhance our existing product portfolio to drive revenue growth and further expand the business inorganically through rapid OEM and accretive acquisitions. Now, let me turn it back over to Tom for our deeper review of our financial highlights. Tom?

[Thomas Minichiello:]

Thank you, Kirk. Let me provide additional color on our results for the December quarter and I'll start with revenue. For the third fiscal quarter ended December 31, 2017, consolidated revenue was $13.7 million compared to $17.2 million in the prior quarter. The lower revenue was attributable to the seasonally low quarter for CNS and a sequential decrease for IBW which was coming off at September quarter in which it generated record revenue levels for two of its main product lines, the Universal DAS Interface Tray or UDIT active DAS conditioner and our in-building passive system components. On a fiscal year date basis, IBW revenue is up 6%. Highlighting our revenue performance in the quarter was ISMS which at $5.8 million was up 23% when compared to the quarter before. Driving the sequential revenue increase was higher support services revenue and increased sales a remote units which are the network devices used for onsite processing. As Kirk noted, it was the best quarterly revenue performance for ISMS since December 2015 and we are pleased to see a trend among our top service provider customers of increased focus and spending for remote monitoring. Back on the CNS front, it's important to note that these product lines within this segment are deployed primarily in the outdoor network resulting in seasonally low revenue in December quarters due to the approaching winter months. Nonetheless, on a fiscal year date basis, revenue is up for our two primary CNS product lines, integrated cabinets in which we continue to see good market demand associated with customer network expansion projects, and our temperature hardened power distribution products in which we continue to see new market demand in areas like CRAN. Moving on to the rest of the operating results, we continued for the fifth consecutive quarter to meet or beat key operating targets, including consolidated gross margin of 40% or greater and quarterly non-GAAP operating expenses of $6 million or lower. Third quarter consolidated gross margin was 44.4%, well above our target and up from the prior quarters 42.2%, largely driven by its favorable mix. Our year-to-date consolidated gross margin was 42.4%. Non-GAAP operating expenses for the quarter were $4.7 million, a substantial improvement when compared to $5.7 million just one quarter before and significantly beating the $6 million or lower target. The biggest improvement was in R&D expense for IBW, whereas Kirk noted, we are working on a more cost effective OEM model to bring to the market Westell certified public safety solutions. Other ongoing expense, management activities also assisted in lowering our SG&A expenses in the third quarter. Going forward, we will strive to keep non-GAAP OpEx at or below $5.5 million. Now let's talk bottom line performance. The efficiencies created over the past year have positioned Westell as a profit and cash maximizing entity. Our third quarter was clear evidence of this. The operating leverage we now have in the business allowed us to achieve a double-digit non-GAAP operating profit margin even in a seasonally low quarter. The 10.2% operating margin in 3Q 2018 was the highest in four years. On a year-to-date basis, our non-GAAP operating margin is 8%. Net income in EPS on a non-GAAP basis was $1.5 million and $0.09 per share for the quarter and $3.9 million and $0.25 for share fiscal year-to-date. The size of the profitability improvement in our business over the past year, especially over the past two quarters has now resulted in our second consecutive quarter of positive GAAP earnings. GAAP operating profit was positive in both fiscal 3Q and 2Q. Net income on a GAAP basis was $800,000 in 3Q and $700,000 in 2Q, and EPS was $0.05 per share in both quarters. Note below operating profit, there were one-time non-operating accounting credits of $700,000 and $600,000 in 3Q and 2Q respectively. However, these unusual items were simply additive to the already profitable GAAP results based on normal business operations. On an adjusted EBITDA basis, which is our non-GAAP operating profit less depreciation, Westell’s business in the December quarter generated adjusted EBITDA of 11.5% or $1.6 million, achieved positive EBITDA for the fifth consecutive quarter and over $1 million in each of the past four quarters. And on a trailing 12-month basis, i.e. calendar year 2017, the business has produced adjusted EBITDA of 8.9% or a total of $5.6 million. Turning to the balance sheet, during the quarter, we increased cash by $1.8 million further strengthening our already strong balance sheet. Our cash and short-term investments total $26 million at December 31, 2017 compared to $24.2 million at September 30. The fiscal 3Q cash increase consisted of $1.9 million in cash generated from operations, partly offset by $100,000 of cash used for capital expenditures and share repurchases. Over the past five quarters, our business has generated a total of $6 million in cash from operations. Under the stock repurchase program authorized by our Board of Directors in May of 2017, and is part of open market 10b5-1 plans, Westell has to-date repurchased 133,610 shares at an average price of $2.94 per share, for a total cash outlay of 392,571. Before we move on to Q&A, let me summarize. Over the past year, we have consistently met or beat key operating targets and have generated positive results at almost every aspect of the Company. We have a very healthy cost and expense structure that now positions the Company with tremendous operating leverage as we seek to grow topline and we have revenue growth strategies that include building on our early successes in wireless public safety and CRAN, further enhancing our current product portfolio to grow topline and working on inorganic initiatives like rapid OEM and accretive acquisitions to expand the business. So with that, we’d now like to open up the call for your questions. Christine?

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from [Greg Mesniaeff of Wakefield Advisors]. Please go ahead.

[Unidentified Analyst:]

Thank you, and good morning, and congrats on a good quarter for cost discipline and your steadily improving margins. I have one question about the In-Building Wireless, IBW segment. You mentioned on the call that you guys are focused increasingly on OEM opportunities and shifting some of your sales targets that way. Can you talk about any milestones in the quarter that you may have seen as far as potentially resulting in some revenue acceleration there? Thanks.

[Kirk Brannock:]

Yes. Greg, thanks for the comment. And I can speak to that. First of all in the IBW space, we are seeing some nice growth in public safety. If you look back a little over a year ago, we had very little if any revenue and the revenue this quarter was good. We don't get into detail on each of those individual segments, but first and foremost, we see the opportunity in public safety, so what we are doing, we are actively and when I say actively daily involved with a few OEM partners where we are looking at the technology and where the products need to go and we are trying to reach different agreements that would allow us to take those products and get them into the marketplace rapidly. And what we've seen over the last quarter is everything we do has to have an ROI on it. And so your balance what you do internally from a development perspective and what we maybe able to got in the market and actually market under the Westell brands. I think our strength is our brand, our distribution network, and our sales team and there are a lot of companies out there that have excellent products that don't have that presence here in the good old USA and we need to leverage that. So that's a long answer to your question, but that's kind of where we are in the IBW space right now. Did that answer it?

[Unidentified Analyst:]

Yes. Thank you. And my follow-on is a quick one. Were there any greater then 10% customers in the quarter that you can speak to? Thanks.

[Kirk Brannock:]

Yes. Tom can answer that.

[Thomas Minichiello:]

Yes. Good morning, Greg. We had three in the quarter over 10%. I can tell you that two are service providers and one was a neutral host operator. And then just as some additional color, there were also two pretty close to 10% both service providers. Year-to-date, we have four that are at 10% or greater.

[Unidentified Analyst:]

Great. Thank you.

[Operator:]

Thank you. Our next question is from [Bradley Nelson]. Please go ahead.

[Unidentified Analyst:]

Hey guys. Could you talk a little bit more about your efforts to reduce R&D expense and what levels we should expect going forward and should it be consistent with the current quarter's expense? And does any of that decrease have anything to do with the change in your rental costs?

[Thomas Minichiello:]

Actually Kirk was just touching upon that in the response to the first question by Greg. So you'll see that we're at around 1.5 on R&D expense non-GAAP in the quarter. We're probably going to stay close to that number in the foreseeable quarters that could change depending on what we do internal development versus pursuing our rapid OEM initiatives. So that's what we expect on R&D expense going forward. Again, it gets back to Kirk’s know that the effort whether it's internal or external needs to be focused targeted to meet the deliverables in the ROI that we need to have and needs to effectively address the evolving customer needs in the marketplace.

[Unidentified Analyst:]

Great. And none of that reduction had anything to do with the rental reduction…?

[Thomas Minichiello:]

No, the going back to that that the lease was we did a restructuring about a year and a half ago and took the P&L down to the space that we needed in our building and so it didn't affect the P&L at all it did help us on the cash front for sure because we had to continue to make the cash payments until the lease expired on September 30.

[Kirk Brannock:]

Yes, the leases are very favorable lease for us we believe we've got some flexibility there down the road it's a shorter term lease every lease that we have we're analyzing them to say what opportunities are there any opportunity where we can save cash and expense we're looking at that and we're continuing to look at that.

[Unidentified Analyst:]

Okay. Great.

[Operator:]

Thank you. Our next question is from Mike Latimore of Northland Capital. Please go ahead.

[Mike Latimore:]

Thanks. Nice job on the EBITDA there in the quarter on the screen. On the ISMS business you said you saw some good trends there? Is that one customer driving and or is it sort of broad-based improvement and then what's kind of driving that is other particular used cases?

[Thomas Minichiello:]

Yes, Mike, so we have three large customers in this segment. One is North American focused customer, one's a global customer and the other one's an international customer and we saw good performance domestically with the one large customer here in the U.S. and we see continued strength and the desire to spend more on remote monitoring here. We also saw a nice uptick with the international customer. And then the global customer who operates here in the U.S. and in international markets where we have the high market share with them we saw some nice bookings in the quarter and one of their international markets that will turn into revenue in the coming quarters.

[Mike Latimore:]

Okay. Got it. And then in terms of the OEM opportunity for public safety, can you just sort of characterize the type of customers you're talking to there are they talk on equipment guys are they data networking like what categories of OEM's really talking to?

[Kirk Brannock:]

Yes, I can answer that well first of all when you look at the public safety market. What is very important I think I mentioned it on previous calls understanding and getting embeds with the integrators? The integrators are tied to the building owners Mike that basically they are the ones that are driving the decisions as municipalities put in requirements as far as what sort of coverage is in those buildings it's really important that we get in with the integrators. So we sell a lot of our products through distributors and so what we're doing is we're looking at the marketplace. What goes integrators what and there's different flavors of public safety products depending upon what type of services the municipality uses. We tell you today that public safety offerings even though I'm really proud to say they've grown we need more product in that area and differentiated product and that's why we're working with partners to find that and I feel really good as I said in earlier that we will be launching a new products in that area this next coming year. And so that's kind of our strategy in that market.

[Mike Latimore:]

And then do you expect kind of the normal seasonal patterns in your March quarter as well and it's are there any sort of many indicators of that couple big telecom companies ordering anything like that?

[Thomas Minichiello:]

Yes, Mike, we expect to see the historical seasonality certainly a rebound in our CNS segment and like we said in the prepared remarks we are encouraged by what we're seeing in terms of demand for remote monitoring among our existing customers and we're certainly you know pursuing additional accounts on with ISMS and in IBW we can to continue the public safety growth track there, so.

[Mike Latimore:]

Great, and just last question for the CRAN opportunities, what types of customers are you looking at there? Are they sort of big Tier 1, Tier 2, Tier 3 just in general thought will be great?

[Kirk Brannock:]

They’re predominantly the Tier 1s Mike, and our success to-date has been in CNS and ISMS as you distribute the network out in the CRAN architecture fashion. There's demand for power and monitoring at these – where the traffic is going to get heavier coming through the distributed network.

[Mike Latimore:]

Got it, okay. Thanks a lot.

[Operator:]

Thank you. Our next question is from Steve Busch of Everglades. Please go ahead.

[Steven Busch:]

Hi, gentlemen. Thanks for taking my call. So I've been on Westell holder for a long time. I guess my first question is kind of what happened to our last CEO, I mean was kind of abrupt departure?

[Kirk Brannock:]

Let I'll address that because I hand in hiring Matt. I would just tell you from my perspective, Matt came in and he did some good things. And he made a decision that there was another opportunity that he felt he was more suited for and he took that opportunity and we left on great terms. I was a little astounded that he left so quickly. But I think the board did the right thing and that's really what I can say about it. We communicate with him and nothing astounding to cause him to leave. It's just a personal decision and he made that decision.

[Steven Busch:]

Okay, that's fine. So you're talking about making some acquisitions and I guess are your acquisitions going to be product lines from larger OEMs. Is that way you’re looking for? You’re trying to buy a little companies, what exactly are we trying to buy for an acquisition?

[Kirk Brannock:]

Okay, first we're looking at small. We believe that we're in good position cash wise and we're trying to balance our cash with what makes sense. Number one, they've got to be accretive. They've got to be accretive and there's got to be synergies. We will not look at anything that doesn't show accretion. I mean that's really…

[Steven Busch:]

From day one or from…?

[Kirk Brannock:]

Well yes, we're looking at things that look accretive day one maybe out a year or two, but nothing further than that and they've got to be small. They also have to sit some parameters where we see the synergies and there's not overlap with where we're at today. Now that doesn't mean, we're going to go out and get out of our niche. But for example we've got great a great customer base in the telecom space. But you don't ever hear us talk about the cable guys or the MSO guys and there's opportunities out there in that space. So we don't want to venture from what we think we do well in our three segments. So if we look at something, it's not going to be something that we have been done in the past and we're really looking at whether that's getting new product or assets, it’s got a system old and whatever we do, there is got to be synergies. So my background is with AT&T. I saw how AT&T did M&A. They had a great playbook from Ameritech to Bell South to buy in 2018. I mean they had a playbook and it had to meet certain criteria and so we're being very, very selective. But we have been actively looking to see what's out there.

[Steven Busch:]

Okay. So I guess just as a follow-up to that. First of all, I like creative acquisitions. I know about two years, but less than a year is nice. So right now we have about $1.65 of sharing cash, our current assets are around $38 million. We're trading less than two times sales right now. I mean why we wouldn’t buy our own stock instead? I’m just asking general question were pretty cheaper?

[Thomas Minichiello:]

Yes Steve, this is Tom. What we have been and we are and – we have 10b5-1 plans out in the open market to do just that and we have a bought, we have an authorization and we have bought off of that authorization close to $400,000 of our own stock over the past call it five or six months. So we are doing that at the same time we just talked about acquisitions and growing the topline which is going to take with our current portfolio we've got room for growth but in organically with OEM and acquisitions those are things that we are looking at seriously. So we need to be prepared to pull the trigger on any of those that make sense for us to do. So it's a balance right, it's a balance between deploying cash for buyback at the current prices or having it ready for future growth and reinvestment in the business.

[Steven Busch:]

Right. Right and I guess my follow-ups to that would be that our stock price is low and if our stock price is higher you could perhaps make acquisitions with stock. I don’t know how likely that is. But I do think you know this gets hammered on a few times every year. But in our Class B structure is not helping our stock price. So I don't know of you talk to them about you know what's good for everybody to have one share class in let it right. I mean so cheap it's ridiculous.

[Kirk Brannock:]

Yes, I think we have tremendous operating leverage. We have tremendous operating leverage with what we've done in the cost side. We have to grow revenue. We're very focused on what are we got to do to grow revenue. I mean when you look at this quarter and you look at last year and you compare our revenue to our results and the operating leverage in this business now is very good. So we have to find a way how do you grow that topline and I think a lot of investors want that and that's really what we're turning our focus on now. But your point regarding share repurchase makes a lot of sense. We're trying to do the balancing act. I'm glad to see our cash has grown $1.8 million this quarter. And as Tom mentioned earlier, we've grown cash $6 million. So we need to put that to use in the best way possible to drive overall shareholder value. I don't like our stock price. I'd like to see it higher. And I think if we do the right things, good things happen with good results.

[Operator:]

Thank you. Our next question is from [Greg Mesniaeff of Wakefield Advisors]. Please go ahead.

[Unidentified Analyst:]

Yes. Thanks. Just a two-part follow-on question for either Tom or Kirk. Some of your telecom equipment peers in the last several quarters have seen a significant increase and their focus on service and support that's being called upon by their key customers. Are you guys seeing any of that as well? That's part one. And part two, as you focusing solely on an OEM model, what kind of feedback are you getting from your key customers on that shift in focus? Thanks.

[Thomas Minichiello:]

Yes. Greg I'll take the first one. So we are seeing good business with services in the ISMS, the final S stands for services, an Intelligent Site Management and Services. It's a combination of support and maintenance agreements with customers almost all of them that we've sold product to there have support agreements and then we also do some EFNI, what's called deployment services for a few of those customers who still like us to do that because we know the products and how to install them fast. So that's where most of our services business is today. And the second question was on the OEM side…?

[Kirk Brannock:]

Yes. One of the key is with the OEM providers is to ensure that we have input in the product, what features that product has and then how we make sure that the customers like those features. And on the OEM side for example, a number of our products do have grease and so one of the things we want to make sure we do is design that and ensure that if we do sell a product that those interfaces meet their needs. Depends on the customer on how we charge for that feature or those features sets. Sometimes it helps you retain and sell more hardware. Other times we try to package it in a fashion where those services help obviously our margin. One of the reasons are ISMS margins is good as they are, is because I believe the ISMS team led by Joel Tamkin, who I think is on this call. They do a very good job of trying to balance the deployment services with the cost of initiating those services. So it's a balance, but it is an area that we like to be in simply because the margins are better.

[Unidentified Analyst:]

Thank you. That's very helpful. End of Q&A

[Operator:]

Thank you. I will now turn the call back to Kirk Brannock for closing remarks.

[Kirk Brannock:]

Thanks, Christine. I want to thank everybody for joining us today. We're pleased about the progress and as I said before, we do have tremendous operating leverage in this business. We're far from done. Our focus is on growing revenue and we're going to continue to step up that focus to try to grow our topline. We look forward to speaking with you again and thank you for joining the call.

[Operator:]

And ladies and gentlemen, this concludes today's conference call. Thank you for joining. You may now disconnect.