Westell Technologies, Inc.
Q1 2014 Earnings Call Transcript

Published: 2 Aug 2013

[Operator:]

Welcome to the first quarter, fiscal year 2014 earnings conference call. My name is Richard and I’ll 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 is being recorded. I will now turn the call over to Tom Minichiello. Mr. Minichiello, you may begin.

[Tom Minichiello:]

Thank you Richard. Good morning and welcome to our conference call to discuss the fiscal year 2014, first quarter results for Westell Technologies. The news release that we issued last night is posted on our website, www.westell.com. On this call Rick Gilbert and I will update you on the business and our financial results. 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, 2013 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 events or other factors. Our presentation today will also include non-GAAP financial measures. We have provided reconciliations to the most comparable GAAP measures in our news release. Before I begin with a review of our first quarter results, I would like to share a few thoughts with you. I am very excited to be part of the Westell team and about our prospects for the future. Westell has a heritage of well-respected brands, a reputation for high quality and strong relationships with top tier customers. We are highly focused on differentiated solutions in strategic markets and we have a management team with the experience and dedication to continue to grow and create value. I am very pleased to be here and look forward to working with the board and the senior leadership team to support these efforts, and look forward to meeting many of you on today’s call. Now, I’ll begin by discussing the financial results for our fiscal year 2014 first quarter ended June 30, 2013. Risk Gilbert, Westell’s Chairman and Chief Executive Officer will then provide his perspective and we’ll conclude by talking questions. For the first quarter of fiscal 2014, Westell Technologies reported consolidated revenue of $22.5 million. Revenue consisted of $12 million from the Kentrox acquisition, which was completed on April 1, 2013 and is reported as a separate segment and $10.5 million from the Westell segment. Both segments generated strong revenue in the first quarter, with the Westell segment reporting an increase in revenue of 11% compared to the first fiscal quarter a year ago. On a GAAP basis we reported a consolidated net loss for the quarter of $2.8 million or $0.05 per share, compared to a net loss of $1.7 million or $0.03 per share in the first quarter of fiscal 2013. Results were positive for Kentrox and improved for Westell. However not included this quarter were two favorable items in the year ago quarter

[Rick Gilbert:]

Thanks Tom and welcome to your first Westell earnings call as our CFO. I’ll make a few observations about our first quarter and then I’ll open the call for your questions. In short, we had a very solid quarter with both Kentrox and Westell segments performing well. Let me start with a few comments about the Kentrox segment of our business. When we completed the acquisition of Kentrox on April 1, we recognized that the integration of Westell and Kentrox could be challenging due to the fact that the two companies generate similar quarterly revenues and also that the integration with Kentrox would be critical to our success in the current fiscal year. I’m very happy to report that so far the integration process has been smooth and positive. Kentrox has continued the strong momentum it was experiencing at the time of the acquisition and has recorded an outstanding first quarter in terms of both revenue and bookings, obviously playing a big role in our consolidated Q1 results. In addition, we’ve already merged the functional areas of Westall and Kentrox into a single organization. This combined organization helps align our strategic efforts on products, sales and customers. The structure of the functional organization was driven in part by the addition of two key Kentrox executives to my staff; Ben Stump as CTO and Rich Cremona as COO. Lastly we are actively exploring product and customer synergies between Westell and Kentrox. Although still in the early stages of the investigation, we are excited by the obvious growth opportunities in this area. All that said, the integration process is not yet complete, as we continue to transition to common IT systems and back office processes. However, we made substantial progress and we expect to complete the integration by the end of the year. From a current business standpoint, Kentrox is tracking well ahead of plan due to several large-scale projects. We have solid bookings for the current quarter and I feel comfortable with the pace of the business in the Kentrox segment. When assessing risk, I recognize, like many of the product categories in the Westell segment, long term forecasting will be difficult due to the project-oriented nature of the Kentrox business model and customer concentrating. However, I believe both of those risks are mitigated by our strong sales team and potential cross selling opportunities with the broader Westell customer base. Moving on to our Westell segment, let me summarize our first quarter results by product category. The wireless product lines, including our DAS panels and TME’s continue to experience strong double-digit sequential growth rates. Cabinets, enclosures and power distribution products were up a bit sequentially. Legacy SONET/TDM products slowed down a bit quarter-to-quarter, and custom systems integration was also down during the first quarter due to the project oriented nature of that business. And finally, we are yet to see significant sales of our hardened Ethernet product, so we are actively refocusing that line towards our distribution channels. As Tom discussed earlier, the net result of these trends was that the Westell segment performed well above last year’s Q1 results. Furthermore, in the current quarter we continue to see significant sales growth in the wireless areas. In summary, I believe we had a great start to our fiscal year, which was driven by the successful acquisition and integration of Kentrox, combined with the continued growth of the Westell wireless product lines. During the last call I listed seven goals for the fiscal year; three of those goals were financial in nature

[Operator:]

Thank you. (Operator Instructions). Our first question on line comes from Mr. Mike Latimore from Northland Capital. Please go ahead.

[Mike Latimore:]

Yes, good morning and great start to the year here.

[Rick Gilbert:]

Thank you Mike.

[Mike Latimore:]

On the Kentrox business, you know it sounds like you had a lot of success with some large domestic customers. I guess, what kind of visibility are they giving. Have they told you they want to continue to roll out by regions or are there specific projects that they are employing in the next quarter or two. What kind of visibility are they giving you at this point for kind of additional growth?

[Rick Gilbert:]

Well, its pretty good visibility actually Mike. Kentrox is project oriented, so it’s project by project. It’s not all domestic customers by the way. We have a fair amount of international business as well. That said, the bookings as I said in my part of the call were good, as well as the revenue and we have a much better visibility with the Kentrox products than we normally would have had with the older legacy Westell products. We are actually seeing a lot more visibility with the Westell lines as well. So we’re pretty satisfied with the bookings level. In terms of long term visibility as I said in the call, project based is project based and so when projects occur, these projects can sometimes be in the works for a couple of years before they happen and you can’t predict the exact moment when they happen, but right now to be honest, Kentrox is drinking from a fire hose, its great.

[Mike Latimore:]

Excellent. Certainly is it fair to think that you could see some sequential growth in the September quarter with Kentrox?

[Rick Gilbert:]

Well, we’re not going to give that kind of guidance as usual Mike, but as I think I said in my calls, I’m satisfied with the pace of business in the Kentrox area.

[Mike Latimore:]

Well, what are your customers telling you in terms of why they are buying your products. Is it just to save on OpEx or because they are deploying LTE or they have specific regions that they are rolling out. What are kind of the underlying drivers that you see from these larger customers?

[Rick Gilbert:]

Well, I think the underlying driver in general and the reason we ended up buying Kentrox is the whole area of intelligence, like management is becoming more and more important in all areas, especially in wireless deployments and I think when I talked to the customers, the reason they are buying Kentrox is because it’s the best product out there.

[Mike Latimore:]

Okay. Can you give a little color on the percent of revenue, maybe from your top three customers or something like that?

[Rick Gilbert:]

We’ll report the percent of revenue as we do on an annual basis. We are not going to go through that in this call, but we can tell you that we had three customers that were 10% or more.

[Mike Latimore:]

And then what’s your general view on OpEx. Do you see leverage in the model or do you want to add some additional expense to grow our sales momentum or how are you thinking about OpEx at this point?

[Rick Gilbert:]

Tom, you want to take that one?

[Tom Minichiello:]

Yes sure. Hi Mike, this is Tom. I think what your seeing in the first quarter is a good indication of where we’re at and likely where we’re going to be at this point.

[Mike Latimore:]

Okay, great.

[Rick Gilbert:]

If I just can add to that, when we talked about the acquisition of Kentrox last time, we made it clear that we had two businesses that were running strong. We only have 168 full time employees in this company and if you look at the annualized run rate of $90 million, if we multiply the last quarter, that’s more than $535,000 per employee. That’s not bad metrics. Its unlikely we’re going to have a lot of synergies.

[Mike Latimore:]

Okay, excellent. And Tom, its my last question. What was revenue contribution from your DAS and TMA products in the quarter and what could be the peak of growth margin at Kentrox. Those will be my last two; thanks.

[Rick Gilbert:]

Well, again I’m not going to break out individual product lines. I will say that the contribution from the DAS and TMA products was significant and growing as I said at strong double digit rates and continuing to grow. What was the second part of the question?

[Mike Latimore:]

What could be the peak gross margin you earn on Kentrox?

[Tom Minichiello:]

Mike, the gross margin, a couple of thoughts. It depends on the volumes of course and to a larger degree on the mix and so its likely to vary quarter-to-quarter, but on a consolidated basis, we are looking to be as I think Rick as mentioned in the past, better than 40% as a total company.

[Rick Gilbert:]

And then Mike, just to add to that, I mean when we look at individual product lines and individual opportunities, we do think in terms of consolidated gross margin. With that said, we also look at the individual gross margins on products and if we see a gross margin that falls far below 40%, its not a business we want to be in.

[Mike Latimore:]

Thanks. Congratulations again.

[Rick Gilbert:]

Thanks Mike.

[Tom Minichiello:]

Thanks.

[Operator:]

Thank you. Our next question on line comes from Mr. Brian Horey from Aurelian Management. Please go ahead.

[Brian Horey:]

Hi, thanks for taking my questions. Can you just may be give a little color on some of the acquisition adjustments that were broken out. The inventory fair value step-up, is that likely to be just a one-quarter event of is there some additional inventory that’s effected by that will get taken through the system in the next quarter or two.

[Tom Minichiello:]

Hi Brian, this is Tom. So the accounting rules require, the value of the acquiring company’s asset to fair value. So there was this inventory step-up that certainly impacted the margin. But that will likely – it will still be in a couple or more quarters and it’s likely to go away after that, as we sell off the inventory we acquired. This quarter is probably the largest size of the adjustment that we should see.

[Brian Horey:]

Okay, and for the differed revenue adjustment, is that likely to be a kind of four quarter event until the three years worth of differed revenue gets on the balance sheet or whatever fraction thereof. Its watched through or there are longer-term contractions that fall into that .

[Tom Minichiello:]

That one will be around longer. It will tail off over time. But it will be mover than a year; it will go out further than that. But it will get smaller and smaller as we move into the future.

[Brian Horey:]

Okay. Is there any kind of a backlog number for Kentrox, give the project nature of the business that you talked about?

[Rick Gilbert:]

Yes, Brian this is Rick, there’s a significant backlog, but I’m not giving you the number.

[Brian Horey:]

Okay, and how much of the revenue is international at this point, Kentrox?

[Tom Minichiello:]

I think on a total basis, we had somewhere in the 10% of total revenue international for this particular quarter.

[Brian Horey:]

Okay. Would you expect that to be higher in other quarters, just kind of given the mix of domestic projects this quarter.

[Rick Gilbert:]

Its been higher is the past. I expect it will be higher in future quarters. As Tom mentioned it remarks the – the quarter was driven by some especially larger domestic deals, continuing domestic deals and so it will vary, but probably not much less than this quarter.

[Brian Horey:]

And then the last question I had is, how do you see the prospects for operating profitability and the Westell division and kind of what’s the outlook for operating expenses there next quarter too.

[Rick Gilbert:]

Do you want to take that Tom?

[Tom Minichiello:]

Sure. Overall you can look at the facts in the first quarter, right. We were at $22.5 million in 1Q. We were profitable on a non-GAAP bases, right. So annualizing that, the $90 million annualized run rate, everything else being equally, it would obviously suggest that we would be profitable non-GAAP at that annualized run rate. Our goal is to get to a $100 million annualized run rate.

[Brian Horey:]

I was trying to focus specifically on the Westell division.

[Tom Minichiello:]

Well, I think if we look at the total and we are at those run rates for the total company, I think that’s going to lift up the Westell segment profitability and at that amount of total company revenue, we get pretty close on the Westell segment.

[Rick Gilbert:]

Well, let me answer. Talk a little specifically about the Westell segment, because I think where Brian’s going is, he is saying that the Kentrox segment is obviously profitably. When does the Westell segment get profitable? The profitability of the Westell segment will depend on continued growth in the Westell segment, and as we said in our remarks, there are areas of our business, the new products that we’ve added that are growing extremely rapidly right now and those are profitable, the product line, so that’s part of the answer. However that said, if you listened to the earlier calls Brian, which I know you have, you know that we said we are going to continue investing in the business in general, both at Kentrox and at Westell and some of the things I talked about for instance were some of the more obvious synergies between the Kentrox division and Westell division; that will take more engineering. But when we look at those synergies, we look at things like smart cabinets that are set up for remotes side management has cabinets. We look at things like smart power systems and a number of other options that integrate the Kentrox technology into our existing product lines. That will take investment, and so we are balancing investment with the need to get profitability. And we do look at it, as Tom pointed out, we do look at it in terms of consolidated profitability and I guess the way we see it right now is that if we maintain a $90 million annualized run rate, I mean we’re going to be pretty close on a non-GAAP basis to profitable all the way through. If we get that up to more like the $100 million, we get very close to GAAP profitability and that’s really our target.

[Brian Horey:]

Okay. I know Rick, referencing those calls in the past few quarters, you guys had talked about the need to invest in sales resources for the Antone products in particular, given some of their financial constants before the acquisition. Do you feel like you guys now are kind of hit stride with that efforts or is there incremental productivity and upside to come from that effort.

[Rick Gilbert:]

Well, I think what we’ve done is, a key hire for us was bring bringing Richard Cremona on who was their previous CEO of Kentrox on as our COO. Rich runs the sales, marketing and operations area, sales and operation areas for us and he has already integrated the very strong sales team from Kentrox with the team we had here at Westell, and organized it in such a way that I think the sales effort on the Antone products is being extremely well covered and aggressively covered right now and we are seeing the results. I’m very happy with the integrated effort there, and of course if you look at Rich’s background, he comes from a marketing and sales history; very strong player. His team is very strong. I hope I made that point in my formal remarks and I believe we are already seeing results of that combined organization.

[Brian Horey:]

Okay. Thanks a lot.

[Operator:]

(Operator Instructions). Our next question online comes from Mr. Todd Brady from Oppenheimer. Please go ahead.

[Todd Brady:]

Hi, good morning guys.

[Rick Gilbert:]

Hi Todd.

[Todd Brady:]

Hi, a couple of things. First of all, Rick you had talked about in previous calls, your level of excitement about Kentrox international business. It appears that Kentrox is experiencing some strength domestically. Should we assume that the enthusiasm you shared in previous calls about the international opportunities are still there? Has that been tampered? Are we still on track on the international side? That’s my first question. Secondly, the DAS panels qualified at two carriers. Are these U.S. tier one carriers that the DAS panels have been qualified at? Third question, the integration of the legacy part of your business with the reset and the Ethernet switch division, can you kindly outline to us how you’re taking a legacy segment of your business, integrating it into new opportunities. Kindly use the New York City transit department, also the recent achievement of the GR-487 compliance with your boxes and cabinets, and your Ethernet switches and how that’s translated into current business and opportunities going forward. And what type of interest and RFPs are you currently receiving based upon the integration on those two segments. Thank you.

[Rick Gilbert:]

Okay Todd, I’m trying to remember your questions as long as I can here. The first one relative to international business, I’m still very excited about the international business and the opportunities at Kentrox and we are still making good progress there. We are deliberately focusing on specific areas that we want to do business. Again, that’s Latin America, South America and Australia and we are doing good business there. Its just that we are doing extremely good business domestically as well and so don’t read into that, that we are walking away from international. By any stretched imagination, we have a strong team there and they are making progress. Your second question were the DAS panels approved by the two tier ones, yes, all right; that’s as far as I can go there. The third question in terms of the legacy, yes, you are focusing in on the right stuff. I mean when we look at the legacy, the turn legacy stuff we have of course is the SONET TDM stuff. That stuff will continue over time to slowly decline. But that stuff remember, before we get too upset about it is, is part of what Kevin gave us, the long term reputation we have with those big carriers, and so that’s the true legacy stuff. Then we have things like the cabinet business and the power business and things like that, that are applicable not only to wire line but wireless, and as you correctly noted, you watched some pretty interesting announcements. GR-487 is a required certification for very large-scale deployments with tier ones. I mean if you don’t have that, you’re not going to be in those RFPs and so we are seeing more action in that area. So long-term projects, you don’t know when they are going to hit, but we are playing in the game at a much bigger level than we have before in terms of going after some of these deals. Transit Wireless is a great example of a full CSI deal that we’ve done and we are very happy with the results of that deal. I think Transit Wireless is very happy with the results and we expect to see more business in those kinds of areas. And then of course you mentioned the hardened Ethernet. I mean that is the kind of thing that was integrated into the Transit Wireless cabinets. Those are the kinds of deals we look for and that is where we have been selling our harden Ethernet as our own CSI pack of deals. But the other things we want to do and I’ll mention it again, is leverage the Kentrox technology in what you would consider some of our legacy businesses like power, like cabinets, along with the other products that we produced to just get into a lot of deals and then we see visibility to that. We are going in that direction, and that’s one of the reasons we keep investing in engineering and places like the Westell Division; one of the reasons why the Westell Division isn’t instantaneously profitably. Does that help?

[Todd Brady:]

Most definitely, most definitely and a couple of last housekeeping questions. What are your NOLs currently, and it appears your cash level continues to remain stubbornly high. I know that the company has not announced a stock buyback program or any new program. Any thoughts or ideas about use of cash for the company going forward.

[Tom Minichiello:]

Okay the first question was the number of NOLs, how much do we have. We are looking that up here, it’s around $75 million.

[Todd Brady:]

NOLs, I think you guys were around $38 million.

[Tom Minichiello:]

Okay, the number we are looking it up and we got, that’s $75 million tax effected for NOLs – excuse me, before tax.

[Todd Brady:]

Okay, post tax.

[Tom Minichiello:]

Well, we’ll have to get that number for you.

[Todd Brady:]

Okay, great.

[Tom Minichiello:]

Hang on, we’ll look that up.

[Rick Gilbert:]

Its about half that.

[Tom Minichiello:]

Yes.

[Rick Gilbert:]

In actually NOLs it’s in the high 30’s, 38.

[Todd Brady:]

38, okay great.

[Tom Minichiello:]

Its actually 40, so right around that number.

[Rick Gilbert:]

Okay. All right, and your other part of the question was…

[Todd Brady:]

Use of cash, your cash has come down congratulations. I know this is ..

[Rick Gilbert:]

Let me answer that question, since I think I answer it most calls. The best use of cash we see of course is investment in the company in ways that will be valuable to our shareholders and so that’s our first thought. Second use of cash is that when we get into situations where we don’t have enterprise value of have negative enterprise value, its about stock buyback’s not a stupid to do. As you know, we’ve done $30 million worth of stock buybacks last year. We do not have a current authorization for stock purchase buyback plan. It is discussed at pretty much every board meeting and I can’t predict whether we’ll do another one to be honest.

[Todd Brady:]

Great. I appreciate the time. Keep up the good work. Thank you.

[Rick Gilbert:]

Thanks.

[Tom Minichiello:]

Thank you.

[Operator:]

Our next question on line comes from Mohannad Aama from Beam Capital. Please go ahead.

[Mohannad Aama:]

Good morning gentlemen.

[Rick Gilbert:]

Yes, good morning Mohannad.

[Mohannad Aama:]

Basically it’s a follow up on the last question. Has your appetite for M&A increased, given the nice momentum that Kentrox is showing in addition to the promising potential? Is there anything in the pipeline in terms of M&A and how open are you to the idea.

[Rick Gilbert:]

Well, my appetite for M&A of the sort that we got with Antone and Kentrox certainly has increased. We are really happy with both those acquisitions. As I think I’ve said before, we looked at something like 65 to70 companies before we picked those two. We are continuing to look at opportunities. We do have more cash than we need to run the company clearly, and we have stated publicly that we like to get to a $200 million run rate by the end of next fiscal year, FY ’15, which means some of that will be organic clearly, but we will need to do other acquisitions. We do have a full time member of my staff, and remember I only have five people on my staff; a full time member of my staff Naveed Bandukwala, who has focused much of his time on surviving companies and looking for opportunities. He is our VP of Corporate Development and it’s important to us.

[Mohannad Aama:]

Sounds good. Thanks for the answer.

[Rick Gilbert:]

Thank you.

[Tom Minichiello:]

Just one, on the previous question from Todd, on the tax question on NOLs. Just to clarify, the $40 million was our total differed tax assets, of which about $25 million of that are NOLs.

[Operator:]

Thank you. (Operator Instructions). Our next question on line comes from Mr. Eugene Robin from Cove Street Capital. Please go ahead.

[Eugene Robin:]

Yes. Well, I guess most of my questions have defiantly been asked, but I just wanted to touch on the project revenue for Kentrox, so just so I’m clear, its all like the 100% product and there is no recurring at all or is there a small piece of that showing at the license phase.

[Rick Gilbert:]

In terms of Kentrox, there is some recurring revenue in terms of maintenance and service agreements. We also additional license fees that are paid when somebody expands their installation, so we can view those things are recurring revenue. But the majority of Kentrox business of course are the hardware instrumentation that goes out into the intelligent side, management situations, and the other sources as I said, maintenance and services, issuing licenses and also some EFNI installation services that we contract. Does that help Eugene?

[Eugene Robin:]

Yes, that’s perfect. And another thing, just going kind of back to the envelope, look at the returns of basically 25%-ish before taxes. That’s a decent hurdle rate for your M&A activates in the future.

[Rick Gilbert:]

I don’t have the same envelope that you are doing the back of the envelope thing on. I’m not sure that I can answer that. We can certainly have a separate off line discussion with you if you want to go through that in more debt.

[Eugene Robin:]

Okay. That will be perfect, fine. That’s all from me, thanks.

[Rick Gilbert:]

It appears that’s the questions that we had. Thank you very much for joining us for the call. I look forward to the next call. Again, we are very happy with the start of the year and we’re happy with the momentum. So we’ll see you at the next call. Thank you very much.

[Operator:]

Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect. Speakers, please stand by for your post conference.