Blaine Carroll - Avian Securities Barry Mccarver - Stephens Incorporated Rich Valera - Needham

Welcome to the Aviat Networks conference call. (Operator Instructions) I would now like to hand over the conference to Jennifer Graybeal, of Aviat Networks.

Good afternoon, everyone, and welcome to our first quarter 2013 earnings call. I am joined by Mike Pangia, President and Chief Executive Officer; and Ned Hayes, Senior Vice President and Chief Financial Officer. During this conference call, we may make forward-looking statements regarding our 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 region. These and other forward-looking statements involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. 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 our website, which is www.aviatnetworks.com. Now, I would like to turn the call over to Mike Pangia, President and CEO of Aviat Networks.

Thanks, Jennifer. And thank you all for joining us today. I'm very pleased to report another strong quarter and a great start to the new fiscal year. We had good topline momentum and another quarter where the orders book-to-bill ratio was at least one-to-one. Overall, I am encouraged by the way our order book is developing. Our forward visibility is improving and our backlog is in excellent shape, going into the second fiscal quarter. Revenue in the first quarter was at the top end of our guidance range at $115 million. Non-GAAP gross margin was at 29.6% of sales. Relative to our Q4 results, I am pleased with the Q1 margin performance as we are beginning to see some of the positive effects of the transition to new products. With volumes continuing to improve, we are moving beyond initial start cost and we remain confident that the trending of our gross margin will improve further in the coming quarters. Our focus on optimizing operating expenses continues. Our non-GAAP OpEx in Q1 was below the bottom end of our expected range, somewhat attributable to the timing of some items. As mentioned in the past, we are striving to be more efficient in our supply chain and back office processes, while we evaluate and make selective investments in products and go-to-market activities. The combination of improving margins and careful management of expenses will continue to have a favorable effect on our EPS. The one area where we felt short of our expectations for the quarter was in cash. The ending cash balance was at $85.1 million, which was $10.9 million below where we ended Q4 FY '12. But this was purely related to timing of deliveries that resulted in customer payments moving into the early part of Q2. Ned will discuss this…

Thanks, Mike. Our GAAP financial statements along with a reconciliation of non-GAAP financial measures are included in our press release issued today following the market close. I would like to take a few minutes to summarize our non-GAAP financial performance at a high level. As Mike previously mentioned, we had a strong quarter. The key highlights were, revenue for FQ1 came in at $115 million, which was towards the top end of our guidance range. Sales were particularly strong in our reported Middle East and Africa region at $49 million. And we saw a continued solid performance in North America at $38.7 million. In terms of product and services revenue mix, we saw a continued strength in our services business, with the split coming to 73% product and 27% service. Our services capabilities continue to be a key differentiator and winning and supporting deals worldwide. Our significant Tier 1 mobile operator in Africa, MTN was once again a 10% customer in the first fiscal quarter. As mike mentioned earlier, our total cost of ownership value proposition is truly resonating with this key customer, and we are expanding backlog and project scale across this carrier's operations and areas. Non-GAAP gross margins for the quarter were 29.6% of revenue, which is in the middle of our guidance range. The strong services topline performance led to improve margins and enabled a better spreading of some of our relatively fixed services cost. We are also more effectively in managing variable cost within projects from the bottomline perspective. And we are beginning to deliver the expected product margin benefits, as we transition customers to our new outdoor radio systems. All of these combined to deliver a full percentage point improvement over the previous sequential quarter. Non-GAAP operating expenses for the quarter totaled $30.6 million. And…

Thanks Ned. As mentioned earlier, we are very pleased with the first quarter results. My confidence in our business and the approach we are taking is growing. This is because of improved business result, the positive remarks I get from our customers and our renewed stability, a sharp contrast to the current challenges that most of our competitors are facing in various aspect of those businesses. In closing, our order backlog is strong and our visibility is improving. We are deploying new products and solutions to the market and we have more new products in the pipeline. Our competitive position as measured by total cost of ownership is as strong as it's ever been, and we are focused on continuing to improve it. We are making the right moves and trimming expenses, while investing in areas that will enhance the topline and bottomline. Our period of restructuring is behind us, unlike some of our competitors. We have more opportunities to improve our share in the business. Our sales force is confident that they have what they need to win. And last, but not least, we are well positioned for enhanced profitable growth, which should result in increased shareholder value. Now, I'd like to turn the call over for questions. Operator, you may proceed with the Q&A.

(Operator Instructions) And our first question comes from Blaine Carroll with Avian Securities.

Mike, can you talk a little bit more about Africa. You gave a fair amount of detail there, but your commentary is almost 180 degrees from one of your competitor that recorded earlier in the week. And I'm just wondering, if you can sort of talk about share gains or customer concentration or size of customers, and how you're wining in the Africa market?

Rather than discuss with perhaps a competitor say, I think we are pretty consistent in our views about Africa. It's an excellent market. We see opportunities for growth. There is a tremendous amount of activity going on in terms of migrating those networks, and we're very well position there. Probably using a better example around total cost of ownership with our largest customer been MTN. And that's what has led us to be in a position to actually expand our footprint with them. We are not the only provider of backhaul solutions in that accounts, so there is more opportunities for us. But it's key that we work very closely with our customer and are able to help them improve their business. And that has gone very well with MTN and others in Africa. So hopefully I've answered your question. We continue to see opportunities moving forward as well in that fantastic region

Is there anything that's changing in that market with the undersea fiber cable coming in or from a currency or a cash generation or the carriers over there that is responsible for that market being so strong for you?

I think if you look at examples, like countries like Nigeria where there has been quite a bit of new competitors coming in, it's important, that those that are leading in terms of subscribers, continue to have the best network possible in terms of reliability. That drives investment and the need to increase capacity from backhaul perspective. And I think that continues. Back to the point that I made just a few weeks ago, Jerry referred to me that one of the big positive effects for us as perhaps little different than a year ago, that are renewed stability, the customer see that clearly. We were probably not in the same place a year ago. Having still come off the renewals of some restructuring, but we're in a much better position, we're much more stable. Our services capability, that we offer in the region are really fantastic, and we have a number of resources in that region that have the capability for buying services. And as we've talked before, it's not just about the services in terms of limitation, but the whole logistics aspect of getting product into the country and doing it in a reliable manner is also important.

And then net on the receivables, it does sound if it was business that came in towards the end of quarter. But is there anything different going on within receivables. Are receivables lengthening, as maybe some of your customers are getting larger and getting more favorable terms. And what is the quality of the receivables. I thought it's a bad debt expense on the financial summary. Is there any concern within the receivables?

No, I don't think there is any meaningful change, whatsoever, Blaine, quarter-to-quarter. It was absolutely as we described. We had some very strong orders, some dictative customer shipments that ended up being towards the end of the quarter versus where the expectations were. We collected on the vast majority of those in the first weeks of October, in fact to add the additional color, our collections in the calendar month our October were $50 million, almost more than twice what we normally expect to see in the first month of an average quarter. The quality of receivables, stand absolutely, as they have in the past. We're not seeing as yet, any significant pressure to extend our payment terms of our customers. We're still very much enjoying quality customers out there, quality regions out there in terms of payment terms, and the bad debt expenses that we took were just prudent, $300,000 here, $100,000 there, and $100,000 there, nothing meaningful in terms of any tilting towards a worsening of the credit quality within our receivables portfolio.

Our next question comes from Barry Mccarver with Stephens Incorporated.

Back on Africa just for a minute, without targeting any specific customer, can you just talk broadly about the gross margins out of that market? Are those margins a little better than some of your other territories or kind of the average? I'm wondering how much success in that region and what that does to the overall margin profile?

I'll ask Ned to comment on whether or not there is any significant impact from a margin perspective in terms of either compared to other markets or changes we've seen relative to our own margin performance.

I think, Barry, quite honestly when you take a look at the composition in terms of ratio of revenues coming out of Africa, they've got to be pretty strong. We're not going to comment given competitive intelligence out there in terms of what we're getting from this, but what we are seeing is the value-add that we are providing in terms of product performance, product reliability, services capability, re-use of assets that margins are holding up, and despite the competitors coming in there with equipments for free. People understand that there is no such thing as a free lunch. And again that the overall total cost of ownership value proposition that we're delivering especially to our key customers in Africa are resonating and we're enjoying the benefits of that, not only with customer retention but good margin.

And then, Michael you just mentioned in your prepared remarks that how much better visibility was today than it ever has been in the past. If you were to look at that a couple of different ways, how much of that has to do with just the advancement and the rollout of unique product lines versus are you seeing any free amount of budgets for backhaul solutions?

True. I mean there are a number of drivers around improved visibility for us. In our largest markets, we've had very strong orders momentum, our backlog has improved, linearity of our orders has been better and that all leads to improved visibility and confidence going forward. We have our new products coming out. Our products have come out in terms of radios. There also have been, those have gone extremely long terms, the acceptance for those products into our customer base. We've got some exciting new verticals. The low-latency market, it's an exciting vertical for us. And we're now creating actually rather than pursuing, we're creating that market in many ways working with some of our customers. And that's growing from just North America internationally. Our services portfolio has always been one of our strength, but we've continued to add to the breadth of that portfolio. And that's improving our visibility, because of the demand for our services is allowing us to do a much better job of taking a look at what our outlooks might be in the coming quarters.

And then, last question just looking at the North American market over the last four quarters, we continue to hear about demand kind of building in this market, and yet revenues almost like clockwork of about $2 million, is there anything related to that anything changed kind of in depressing environment or it's just kind be more circumstantial that with the numbers look?

I think our business there has been pretty steady. You said dropping by $2 million or so quarter-to-quarter, I'm not quite sure about that. I actually think we're up year-over-year Q1-to-Q1, in North America, but notwithstanding that, you got to understand that in North Americas, two-thirds of our business is non-mobile. And as we've explained before the non-mobile segment has a characteristic associated with that is, you do a large project, you deploy it and then that next large project that customer could not bulk in the same calendar year or even the next calendar year. So we have to continuously have new customers, and that what we're seeing. We're seeing new large opportunities to emerge that allows us continue to keep the pace in North America and we do expect that as I think, that we continue to premise for improvement in growth going forward in North America.

The only other thing that I would add is given our venture into the low-latency vertical, we are literally building networks for our customers, with our customers and we're not seeing that revenue as yet. When we turned those turnkey projects over, then you'll see a nice annual flushing out of revenue based upon these low-latency projects. So that's got a somewhat differing mechanism on both revenue and cash, and we're managing through that very nicely, I think.

Our next question comes from Rich Valera with Needham.

Just a follow-up on the receivables question, one can you talk about the linearity of the just completed quarter. It sounds like the one year rent is really nice and linear and that should certainly help the collections side of things. How was the quarter you just completed, was that a little bit more of an backend loaded quarter?

With the couple of our key customers, the shipments was a little back-ended and therefore, that's why the invoicing was able to be completed within the quarter but the collections slipped literary days and weeks outside the quarter, Rich.

Sure, and I just wanted to make sure I understood exactly what your thoughts were on the cash performance in the quarter that we're currently in. I'm assuming you expect your receivables to be a source of cash in the current quarter, but do you think that will drive overall positive cash flow from operations in the current quarter?

Yes we do.

And then with respect to this CTR 8000, the Next-Gen platform, it sounds like you'll start, you have it in customers hands early this next calendar year, wondering if you could give us anymore color on how you expect that will rollout from a initial production and sort of volume production standpoint?

So, I think we've been pretty consistent. It has been deemed customer trials. As we get towards the backend of our fiscal year, we expect to start receiving some orders. We will go through a sale cycle stage, in fact we've already started beginning to position that and you'll have variants of the product as well. So given the nature of the product rollout, I would see that that taking some period of time difficult to predict, exactly when you're going to see an accelerated graph driven by that. But not withstanding that. We're in excellent position right now in terms of our current portfolio. And we do see the opportunity to grow our business with the current portfolio that we have. So in fact, I see the next generation platform allowing us to perhaps extend and accelerate the growth.

Just one final kind of big picture one. You noticed that pretty much everyone else, say, the telecom infrastructure seems to be struggling instead of noting, fairly meaningful slowdowns in their pieces of rollouts with service providers. And you guys are rather seemed kind of outperforming pretty nicely. I'm just trying to understand have you guys seen any change in the landscape, and just been sort of able to outperform because of various things like your service total cost of ownership, or in the specific area that you compete, have you just not really seen that much slowdown borrowing. I think Europe where you mentioned, you did see some slowdown. So just trying to understand how you guys seem to be, frankly performing quite well in an environment that most of your competitors and other providers see as quite challenging?

Not withstanding that, we're seeing a combination of things. I mean, in our current customer base or current addressable market, we continue to see opportunities, that all the drivers for those customers are there in terms of the devices and increased requirement to drive for our increased capacity, while migrating their networks more IP. As I mentioned using one of our large customers an example, our ability to expand our footprint in some of these large operators has been there for us. So I guess from non-perspective, our share is increasing. I would say, that we didn't lose market share. We went through a period of uncertainty there, and we've been able to regain some of the share that we've lost with some of those existing customers. On top of that we have seen increased demand for our services from customers that either use other companies or were doing things themselves or the increased breadth of our services including sources including our NOC has positioned us for some additional business. And the low-latency market, albeit, the revenue today has not been significant, we're seeing that as the further growth engine moving forward. I would say that a couple of things. The overall market, I would say that there's no indication that we've seen that that is growing probably. It's probably relatively flat. And there might be of many areas that we've already mentioned where it's significantly down that what's expected, Europe, Middle East has been examples. And we do expect that that will come back, because those underlying drivers are still there in that market. And just a last point, just in terms of the general macro, what may happen, we've been running this business cautiously, optimistically, if I can use all the words together since for a long time and we do that everyday. We are continuing to look at the drivers, we're going to look at the economic indicators, and be in a position where we can mange ourselves to be able to be profitable under pretty much any circumstance. But we're very much manage the business cautiously, optimistic day-to-day basis.

The only think I'd add would be the stability of the business. We have been through the wrung here over the last two to three years. And it's quite nice now to be able to get back to our core-competency where we've been successful over the last 50 years of being technology leader in microwave transmission, microwave networking products. That the restructuring that we've gone through is completely behind us and a number of our competitors are out there announcing that they need to embark down that slippery slope. Our balance sheet is extraordinarily strong, again versus some of our competitors out there. So actually when you take a look at relative DSOs and DPOs our revenue was growing as opposed to being tempered almost across the entire board of the space that we plan. So we find ourselves to be at a very I think strong and stable position, that some of our competitors can't talk about right now.

Sir, there are no further questions in the queue at this time. Please continue.

I'd like to thank everyone for your participation today. I do have quick update of our upcoming events for you. Our annual meeting of shareholder will be held on Tuesday, November 13 at 2:00 p.m. local time at our headquarters. That's located at 5200, Great America Parkway, in Santa Clara, California. In addition, we'll be attending the Needham Next-Gen Networks Conference on November 7, in New York, followed by the Stephens Fall Investment Conference on November 14, also in New York City. This concludes our call today.

Ladies and gentlemen, that does conclude the conference call. Thank you for participation. And you may now disconnect.