Aviat Networks, Inc.

good afternoon welcome to aviat network second quarter fiscal 2021 earnings call at this time all participants are in a listen-only mode a question and answer session will follow the formal presentation please note this conference is being recorded i will now turn the conference over to your host mr keith saneron vice president of global finance and investor relations thank you you may begin thank you and welcome to aviat network second quarter fiscal 2021

results conference call, and webcast. You can find our Form 10Q press release and updated investor presentation in the IR section of our website at www.aviatnetworks.com, along with a replay of today's call in approximately two hours. With me today are Pete Smith, Aviat's President and CEO, who will begin with opening remarks on the company's fiscal second quarter, followed by Eric Chang, our CFO, who will review the financial results for the quarter, and first half of fiscal 2021. Pete will then provide closing remarks on AVIAT's strategy and outlook, followed by Q&A. As a reminder, during today's call and webcast, management may make forward-looking statements regarding AVIAT's business, including but not limited to statements relating to financial projections, business drivers, new products, and expansions, the impact of COVID-19, and economic activity in different regions. These and other forward-looking statements reflect the company's opinions only as of the date of this call and webcast and involve assumptions, risks, and uncertainties that could cause actual results of different material from those statements. Additional information on the factors that could cause actual results of different material from statements made on this call can be found in our annual report on Form 10-K filed with the SEC on August 27, 2020. The company undertakes no obligations to revise or make public any revision of these forward-looking statements in light of new information or future events. Additionally, during today's call and webcast, management will reference both GAAP and non-GAAP financial measures. Please refer to our press release, which is available in the IR section of our website at www.avionnetworks.com and financial tables therein, which include a GAAP to non-GAAP reconciliation and other supplemental financial information. At this time, I'd like to turn the call over to Aviatz President and CEO, Pete Smith. Pete?

Thanks, Keith, and good afternoon, everyone. I hope everyone remains safe and well during this period of working remotely and managing through the COVID-19 pandemic. And I hope everyone is off to a great new year. Thanks for joining us to review a successful quarter across the business. the company continued to execute on our key long-term focus areas of growth, margin expansion, expense reductions, and meaningful bottom-line improvements. Focused commitment by all members of the Avia team resulted in our highest reported quarterly revenues in more than five years and expense reduction, record adjusted EBITDA margins, a solid balance sheet and liquidity position, and significant customer wins in our mobile, 5G, and rural broadband businesses. During the quarter, we benefited from improved sales, including increased software sales and overall mix, with revenues at $70.5 million. Revenue increased 6.4% sequentially from our first quarter fiscal year 2021 and 26% from the year-ago quarter. North American revenue increased over 34.8% year-over-year. International revenue improved 9.5% year-over-year. These strong second quarter revenues were driven primarily by our 5G, private networks, and rural broadband businesses. Adjusted EBITDA was 10.1 million for the second quarter, representing an improvement of $9.7 million versus the same period last year, and an improvement of 20.4% from our first quarter fiscal year 2021. Adjusted EBITDA margins were a record, 14.3% for the second quarter. During the quarter, we continued to demonstrate Aviat's differentiation in wireless transport products, software and services, and e-commerce. We've demonstrated the viability of these offerings with key wins in 5G, private networks, and rural broadband. As I've mentioned on prior calls, our high-capacity, single-box, multi-band radio platform provides the industry's simplest multi-band solution, which lowers a customer's total cost of ownership. Our unique multi-band hardware and software solutions recently led to Aviat being selected by a US-based Tier 1 5G operator as a key microwave transport vendor. We couldn't be more pleased to have been selected, and we believe this award further validates our position as a leader in wireless backhaul solutions for 5G networks. We look forward to sharing more on this soon. During the second quarter, Aviat was also awarded a multimillion-dollar contract with NexLink Internet for high-speed wireless backhaul to support rural broadband connectivity. NexLink, a leading U.S. Internet service provider, provides high-speed connectivity to commercial and residential subscribers in Texas, Oklahoma, Illinois, Kansas, and Nebraska. Both the U.S.-based Tier 1 5G operator And Nextlink wins are as a result of Aviat having the lowest total cost of ownership offering driven by the industry's only single box multi-band solution for optimum capacity, the highest system gain radios for small antennas, and better reliability. Design software that simplifies network planning. The Aviat store for simplified purchasing and reduced logistics costs and next day shipping. and AVIAT's local North American service and support. We remain excited about the 5G and rural broadband opportunities that lay ahead. 5G builds will drive new backhaul upgrades, and our rural broadband business will benefit from meaningful government funding, including the $9 billion 5G fund for rural America and the $20 billion Rural Digital Opportunity Fund. With respect to private networks, our business remains strong and is growing. Aviat has a highly differentiated offering. Our leading RF performance along with our software and services capabilities are keys to Aviat's success here. We continue to receive orders in the private network business for our frequency assurance software, or FAS, a unique software offering for interference monitoring and analysis, providing customers increased network reliability and uptime. Our software and services platform remains a key focus for long-term growth, and we look forward to announcing new innovative software solutions. At the outset, I mentioned the execution of the team. Our commercial and operations team are on continuous improvement trajectories. I want to recognize them for their results. In addition, we have strengthened the team with the additions of Spencer Stokely to lead our HR function, and Astrodel to lead our product development organization. These new additions will drive improvements in our talent and, in turn, differentiation in our products and services. Before turning the call over to Eric, let me provide a couple additional observations and insights. First, this was a very good quarter and first half of our fiscal year. We remain focused and continue to execute, and those collective efforts are reflected in our financial, and operational results. We've continued to demonstrate our ability to grow and to take share of demand. In addition, we must continue to lower our expenses to drive greater profitability and shareholder value. We've made significant progress on improving and optimizing our cost structure and remain on track to realize previously announced cost savings. Looking forward, we see three significant drivers, 5G, private networks, and rural broadband and believe we are well-positioned to capture significant opportunities with our differentiated product software and services offering. With that, let me turn the call over to Eric to review our financials before coming back for some final comments. Eric?

Thank you, Pete, and good afternoon, everyone. During my remarks today, I will review some of the key second quarter and first half fiscal 2021 financial highlights noting our detailed financials can be found in our form 10Q and press release, both of which were filed earlier this afternoon. As a reminder, all comparisons discussed today are between the second quarter of fiscal 2021 and the second quarter of fiscal 2020, and between the first half of fiscal 2021 and first half of fiscal 2020, unless noted otherwise. For the second quarter, we reported total revenues of $70.5 million, as compared to $56 million for the same period last year, an increase of $14.5 million, or 26%, driven mainly by our U.S. private network business, as well as international sales growth. As Pete mentioned, our total revenue for the second quarter was the highest since the first quarter of fiscal 2016. During the quarter, the North American team continued to focus on expanding sales and seizing upon obvious unique products and services differentiations. North America, which comprised almost 70% of total revenue for the second quarter, was 49.2 million, an increase of 12.7 million, or 34.8% from the same period last year, driven primarily by our private network business. International revenue continued its return to growth for the second straight quarter, coming in at 21.4 million for the quarter as compared to 19.5 million for the same period last year. Our international team continues to implement our new commercial sales strategy, which as a reminder, includes defending tier one telecom business, winning new tier two accounts, expanding outreach through partnerships, and capturing value where we are differentiated. While still early in its execution, we continue to see the benefits of our international strategy paying off. Revenue for the first half of fiscal 2021 was $136.8 million, compared to $114.6 million for the same period last year. We are again pleased that our backlog continues to remain above $200 million, even after recognizing our highest quarterly revenue since the first fiscal quarter of 2016, all due to our laser-focused domestic and new international sales strategy. Second quarter gross margins remain strong at 38.2% and 38.3%, on a GAAP and non-GAAP basis, respectively, as compared to 32.7% and 32.8% for the second quarter of last year. Key drivers to the improvements in gross margin include a regional mix, product and service mix. Second quarter GAAP operating expenses were favorably impacted by approximately 4% year over year, coming in at 19 million compared to 19.8 million for the same period last year. Second quarter, Non-GAAP operating expenses, which exclude the impact of restructuring charges and share-based compensation, were favorably impacted by approximately 4.1% at $18.3 million compared to $19.1 million last year. Both GAAP and non-GAAP operating expenses were favorably impacted due to cost-saving initiatives implemented in the second half of fiscal 2020, including our previously announced restructuring plans and a slowdown in hiring and reduced travel. Moving on, second quarter non-GAAP net income was $8.4 million compared to a net loss of $0.9 million for the same period last year, with second quarter non-GAAP EPS coming in at $1.48 per share compared to $0.17 net loss per share for the same period last year. First half fiscal 2021 non-GAAP net income was $15.3 million compared to $2 million for the same period last year, with non-GAAP EPS coming in at $2.71 per share compared to $0.36 per share for the same period last year. Adjusted EBITDA for the second quarter was $10.1 million, a $9.7 million improvement from the $0.4 million we reported for the same period last year, with adjusted EBITDA margins coming in at a record 14.3% for the quarter. For the first half of fiscal 2021, our adjusted EBITDA was 18.5 million compared to 4.5 million for the same period last year and surpassed the 13.5 million for the full year fiscal 2020. First half fiscal 21 adjusted EBITDA margins was 13.5%. Moving on to the balance sheet, our cash and cash equivalents at the end of the second quarter were $43 million with no loan outstanding. Our net cash increased 6.8 million sequentially from the first quarter, and 10.4 million year-to-date. So our balance sheet remains very solid, leaving us well-positioned to execute our long-term plans while maintaining flexibility and security in the current COVID-19 environment. With that, I'll turn it back to Pete for some final comments. Pete?

Thanks, Arik. Just a few additional comments before opening up for Q&A. I am extremely proud of the entire AVIAD team, for their significant contributions to our results. We recognize that there is a lot of work in front of us. We are on the right path to achieve our long-term objectives. Given our current view, the progress we've made during the first half of the year, and the overall environment, we are updating our guidance issued on November 5th, 2020. We currently expect revenue for fiscal year 2021 to be in the range of 255 to 265 million, and adjusted EBITDA to be in the range of 28 to 31 million. With that, operator, let's open it up for questions.

At this time, I'd like to inform everyone, in order to ask a question, press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Theodore O'Neill from Litchfield Research.

Thank you. Congratulations on a great quarter.

Thanks, Theo.

Yeah. Question for you on the broadband. My first question is on broadband. Last Thursday, Nextlink Internet announced they'd signed an agreement with American Tower to co-locate their equipment on 1,000 American Tower sites. to facilitate rapid deployment of fixed broadband, and I'm wondering, is that where your radios go to, and do you get to put something on all 1,000 towers?

You know, so we don't have the details of their deployment, but we think we're an important partner, and we haven't worked through that announcement and what it means for us, but net-net, it's neutral to positive.

Okay. Okay. In the queue, you say you've got a 12.5% state government customer, and I'm just kind of curious why you can't name the customer, and how many other sort of large government contract-type customers are out there for you?

Yeah, so this is Eric here. Yeah, so we haven't been given the permission to name the customer. It's a U.S. state government, right? It's about 12.5%. percentage for this quarter. But it is for private network. It is for public safety.

Okay. And then are there other states where there's an opportunity of the same kind?

So there could be future opportunities. And, you know, with the way government appropriations are taking place right now and the concern about the COVID situation, there can be kind of bringing in of demand. And we were, you know, through our supply chain excellence, we were able to satisfy that state government rather quickly. And, you know, not only without the urgency on the customer side and our supply chain, that demand would have been spread over a couple quarters. And we were really excited to to be able to satisfy their needs and, you know, put the revenue on the scoreboard this quarter.

Okay, great. Thanks very much.

Sure.

Your next question comes from the line of Sarkis Sherbetian from B Reilly Securities.

Hey, good afternoon. Thanks for taking my question, Pete, Eric, and Keith.

Great, Sarkis. Far away.

So first question, wanted to see if you can provide color on the run rate for software sales in the quarter.

So, go ahead, Art.

Yeah, so let me comment on that, right? So we generally don't disclose our software revenue. We wrote out a software back in Q4, and then we're ramping up that revenue. but we're not in a position right now to actually disclose that amount. It's definitely a lower percentage right now, but eventually when the percentage gets larger, then we'll at that point disclose that number.

So, Sarkis, let me jump in. I've been at the company a little over a year, and for the first couple quarters we said that we were going to invest more in software. We are starting to build our software business. When it reaches materiality, then we'll break it out. It's still small, but when we get our software wins, it is margin accretive and it's really exciting for us.

Okay, thanks for that. I guess given the trends of you know, the software investment relative to what you're expecting to garner from a sales trajectory. I guess, when do you think you'd reach a point of materiality to be able to break it out? Would it be within the next 12 months? Would it be within 18 months? Just kind of want to get a better handle on that.

So my hope is in the next two years to make it... to have a material level that we would report on. But I think it's, you know, two years away. And as we make that two-year journey, it will, as we have success, it'll show up in our gross margin and our EBITDA margin. So I would say two years.

Okay, that's fair and helpful. Thanks for that. I guess I want to go towards the guide, right? So for fiscal 21, Sales guidance was increased and we have a range of $255 to $265 million. And for adjusted EBITDA, I think you said a range of $28 million to $31 million. I suppose on the low end and top end from a margin perspective, that works out to 11% to 12%, right? Year-to-date, you're close to 14% from an EBITDA margin perspective. So I guess if I look at the back half of this fiscal year, and break down what you've done year-to-date versus what's remaining. Is it correct to think that your sales are going to drop off and inclusive of your EBITDA margins for the back half of the year? Just help me reconcile the guidance versus kind of the performance we've seen so far in the first half of the fiscal year.

Eric, do you want to start on that?

Right. So right now, based on even at the high end of the range for revenue and also at 265, and then the high end of the adjusted bid at 31, the second half, it is lower than the first half. But we need to get to Q3, and then at that point, if we need to up our guidance, at that point, we might.

So, Sir Keith, the way I would look at this is, You know, we did have some really good demand in Q2 and we were able to deliver on that. You know, we've raised our guidance. We, you know, we want to be conservative and we want to build a track record of delivering on our commitments. And if you roll the clock back, you know, five, six, seven, eight quarters, the company has had a history of of one good quarter, one bad quarter, and we feel like we're on a really good path. We do not want to get ahead of ourselves, and we want to be conservative with our approach, and that's why we want to be conservative both in the revenue range and the adjusted EBITDA range.

I appreciate the comment on the conservatism. I guess maybe it's just a little bit... you know, trying to parse out here why, you know, logically, right, if you're excited about the business, why the second half would be worse than what we've seen so far. I'm just trying to, you know, pencil those two thoughts together and try and get a reason for that. And it seems like, you know, conservatism is one thing and being reasonable is another. Just, you know, trying to get more color on what the second half looks like.

Yeah. Well, you know, I would also say I'll take those comments. We also see that the second half of the year will be better than the prior year, second and a half. We're on a growth trajectory. And if you want to be critical for our conservatism, we'll take that. And we're going to put out guidance that we're comfortable with.

Sounds great. That's all from me. Thank you.

All right. Thanks.

Your next question comes from the line of Oren Hirschman from AIGH Investment Partners.

Hi. Congratulations on the progress, both of you. In terms of rural broadband, you know, I don't know if you're breaking it out yet as a percent of revenues. If you're not, same kind of question, like the software question, and then I have a follow-up on rural broadband.

So the way, you know, in our investor presentation, we show that we're about two-thirds private network, one-third mobile network operators, and the rural broadband would be in the mobile network operator segment. So that's the level we break that out.

Can you just refresh on everybody, if I may ask the question, just where in the rural broadband networks do you play? When do you go with a microwave link versus, you know, a physical link versus some other types of links that exist?

Yeah, so let's make the most common comparison, fiber versus microwave. And microwave is... is faster to deploy. So when a rural broadband provider has new capacity requirements, let's say, due to work from home due to COVID, to set up a microwave link, it goes much, much faster than digging a trench and laying fiber. And, you know, our supply chain is well positioned to deliver on that. I think some industry analysts have said that our supply chain is outperforming our peers. So that's for rural broadband. Then also microwave winds in situations where there's water or mountainous or difficult terrain. So those are situations where microwave typically wins. And, you know, in the U.S. market, the split between fiber and microwave is three parts fiber, one part microwave. And internationally and in emerging economies, that breakdown is more favorable to microwave. So I thought I'd give you as much flavor as possible on the microwave fiber link competition, if you will.

One other follow-up on rural broadband. Is the formula for you right now to take the existing customers you've, you know, handheld and recruited and gotten to the point where they have the topology and they can put in their own orders, is the goal to just penetrate those customers more, or are you continuing to find new customers for both? Or which is more important?

Well, Both are very important. So we are continuing to add new customers. The next link win was a new customer or gain in demand share. And with our existing customers as well as our new customers, what we provide is, you know, on our website we'll call the AVI Cloud. The customer will be in the design environment designing their links. And they can design their own links. They can service their own links and procure their own links. And some of our internal metrics are how often we have to engage with a real live person. And as we improve that environment, we're satisfying our customers better and better with more and more no-touch, no... interaction, engagement, and that's an improvement to the customer's experience as well as the customer's economics. So we're really excited about our Aviat Cloud platform that goes from design through warranty and repair and procurement and delivery. It's really working, and we think that that provides the lowest cost to serve for rural broadband customers in the industry, and we expect to drive more growth going forward. And that will be with existing customers as well as new customers.

Okay, and my final question, just on a different topic, just You know, in terms of having a mega deal like that 12% deal, government deal, I mean, obviously it's a big deal to deliver it in one quarter and not spread it, but does that create lumpiness or potential lumpiness, and does that factor into the guidance for a second half?

So, yeah, so one of the things, you know, we, a lot of our business is project-based, and that does create some lumpiness. And, you know, one of the reasons our guidance is on an annual basis is because, you know, some quarters can be better than others because of, you know, a project getting pulled into a quarter or getting pushed out. And, you know, certainly this We haven't had a greater than 10% customer in a while, and we were really thankful for this customer to be in Q2. And we do have a good funnel for the back half, but certainly a big project like this would factor into this quarter. And, you know, look, we're hopeful to get more of these big projects, but we also want to be – conservative with respect to the guidance.

Okay, great. Thanks so much.

Your next question comes from Buzz Zane from Royce Investment Partners.

Hi. Just a quickie. Do you have any problem with the chip availability?

No. So we have not had any issues with chip availability. You know, we're watching the Taiwan-China supply chain. We may be a little heavy on inventory to hedge that, but so far we have not seen any supply chain interruptions or chip issues.

Okay. In the cost savings category over the last year, has that impacted marketing at all?

No. So we continue to invest our dollars in lead generation marketing. And, you know, one of the processes that we have in the company is our strategic marketing effort focused on value, and that's helped us grow top line and make sure that on our new products we've priced the value.

And how much of the business is direct?

Hmm. Eric, do you know how to answer that?

I say at least 80% plus are direct.

Yeah. Yeah. Yeah. So a small part of our business goes through distribution or resellers. Yes.

All right. Thank you very much.

As a reminder, to ask a question, press star 1. Your next question comes from Richard Grulich from REG Capital Advisors.

Good evening. Thank you for your work. I appreciate it as a shareholder. I have three questions. The first one is MTN as a customer, now obviously much smaller. Does it offer any upside at this point, or what is the outlook there?

So, you know, Richard, I don't want to comment on any specific customer. The history with MTN is, you know, they were a bigger customer and contracted. What I can say is Africa is an important region. Our funnel in Africa is growing. We had the previous win with Safari.com. So we're hopeful overall for Africa, and what I would say about MTN is an important player in Africa, and we hope to grow Africa going forward. I think that's about as far as I'd like to go on that question.

Is it fair to conclude that Africa is probably no longer going to be a decrement in any major way in terms of the revenues?

Yeah, I think that's fair to conclude. Yes.

And my other two questions regarding taxes. So your tax rate in the quarter was about, I don't know, 13%, 14%. How does that come about? Given you have large net operating carry-forwards, operating carry-forwards, Where are you paying taxes?

Yeah, so let me explain. So we don't pay tax in the U.S. because we have those NOLs, right? It's almost $400 million. Where we do pay tax are at the international locations where we have a transfer pricing arrangement with each of the legal entities, right? What are the legal entities doing? Service for our customers or is it marketing or is it for R&D? That's where when there's transfer pricing, we basically have to guarantee a profit for those legal entities. And that's what we pay taxes.

As I figured, yeah. So in the U.S., on the net operating loss carry forward, you've fully reserved against the value for that because it doesn't appear on the balance sheet. Is that correct?

That's correct. That's correct. We did a partial release. Sorry, let me explain. We did a small partial release probably a couple years ago. It was about $7.5 million. We haven't done a partial release recently just because with COVID, there's a lot of uncertainties. Yep. So that's where we stand, yeah.

But going forward, given that you're really on a much better trajectory than you've been for a while, at what point would you likely release some of that reserve back into the balance sheet?

We're looking at it right now.

Okay. No, that's fair. I mean, I think you should, you know. Yeah. And, again, have you been able to fully protect against the, you know, the – not being able to use much of it. You've had a couple of different programs over the last two years, I think, to be able to do that. Are you still confident that you can protect most of that?

You mean protect NOL? Yes, we have this NOL preservation plan, right? For any investor that wants to go above on the 4.9% threshold, it will require us to issue an exemption. So that's how we protect our NOL.

Okay, great. Thank you very much.

Thank you. Your next question comes from Orin Hirschman from EIGH Investment Partners.

Hi. Just one quick follow-up on the last question. If you do a non-GAAP, assuming you're a taxpayer but not obviously a cash taxpayer in the U.S., what would the fictitious rate look like, so to speak, the rate that you would apply for non-GAAP purposes? Do you have any idea either on U.S. or on the company as a whole, some guesstimate?

Yes. So if you look at our non-GAAP financials in the press release, we estimate our total cash tax on an annual basis about $1.2 million. So basically we do $300,000 per quarter.

But if you did it, let's assume that you look like you're going to maintain profitability and you've got to apply on a non-GAAP basis a real tax rate, what would the company look like? Any idea what the company would look like at that point?

Well, that's only after we exhaust all the NOLs in the U.S. first, right? At that point, we'll have to worry about what that rate is going to be. But for the time being, the only cash tax that we pay are for international companies. and then the run rate is about $1.2 million a year.

Right. No, no, I'm with you on that. I'm saying for non-GAAP purposes, the accountants, you know, for non-GAAP purposes, if you're on non-GAAP purposes, if you decide that you want to start applying a full tax rate, so, you know, knowing full well you're not paying the cash tax, but what would that full tax rate look like, or have you not even done that analysis?

Yeah. We haven't done that, so... Yeah.

Okay. Because we have... The magnitude of our NOLs are pretty big, so that's probably beyond any investor's modeling. Okay, thanks very much.

Your next question comes from Richard Grillage from REG Capital Advisors.

Not to beat a dead horse, but... Have you thought outside the box at all about how you can utilize more of your NOL going forward? Either acquisitions or something like that?

Yeah. So we are looking at acquisitions. We want to be pretty careful and make sure that the acquisitions fit our core and we're going to be able to extract synergies and make it accretive to the overall business. A long time ago, I learned that tax is not a reason to do a deal, but if we were to do a deal, we would certainly structure it in a way that would be most favorable so that we could get the leverage out of the NOLs. It's certainly a consideration. I wouldn't go so far as to say it's a driver. Sure.

Yeah, I appreciate that. Well, in a lighter note, the fact is, if under the Biden administration, corporate tax rates do go up from 21 to 28 percent, you just your NOLs become much more valuable.

I agree. I agree.

Thank you very much.

Thank you. Thank you. That was our last question at this time. I will turn the call back over to the presenters.

All right. Thanks, everyone, for attending. It was a very, very good quarter for Aviat. I don't want to take any more time from anyone. We're going to go back to work, work on Q3. Everyone should please stay safe and stay healthy, and we'll talk to you in about 90 days. Thanks, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.