Aviat Networks, Inc.

Good afternoon. Welcome to our Viet Network's third 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 Fanaran, Vice President of Global Finance and Investor Relations. Thank you. You may begin.

Thank you, and welcome to Aviat Network's third 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 third quarter, followed by Eric Chang, our CFO, who will review the financial results for the third quarter and first nine months 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 related 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 to differ material from these statements. Additional information on factors that could cause actual results to differ material from the 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 obligation 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.aviatnetworks.com, and financial tables therein, which include a gap to non-gap, reconciliation, and other supplemental financial information. At this time, I'd like to turn the call over to Avion's President and CEO, Pete Smith. Pete?

Thanks, Keith, and good afternoon, everyone. Thanks for joining us to review another successful colloquium. 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 third quarter and year-to-date revenue growth of 8.2% and 15.5% compared to the same periods last year. Third quarter and year-to-date adjusted EBITDA margins of 11.0% and 12.7%. A solid balance sheet and liquidity position. A significant customer win for our new software-as-a-service, SAS, offering. A five-year agreement with the U.S. state government provides Aviats FAS and other software via a hassle-free subscription service. North American third quarter revenue increased 12.8% year-over-year, and for the first nine months increased 20.4% compared to the same period last year. International third quarter revenue increased 1.1% year-over-year, and for the first nine months increased 6.5% compared to the same period last year. Adjusted EBITDA was $7.3 million for the third quarter, representing an improvement of $3.8 million versus the same period last year. Adjusted EBITDA margins improved to 11.0% for the third quarter compared to 5.7% for the same period last year. The improvement in revenue and adjusted EBITDA for the third quarter and year-to-date basis was primarily due to gross margin expansion from higher volume of private network business, increased sales through our Aviat store, which serves primarily the rural broadband space, improved international business driven by multiband winds, and an increase in software sales. We also benefited from previously announced restructuring. For the first nine months, non-GAAP operating expenses decreased 5.2% compared to the prior year. We continue to demonstrate Aviad's differentiation in our products, software and services, and e-commerce. We've demonstrated the viability of these offerings with recent 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. During the third quarter, as previously announced, Aviat was awarded a contract with DISH, where Aviat was selected as the wireless backhaul supplier for their nationwide 5G network. DISH has also placed their first orders with Aviat in the quarter. Along with DISH, during the quarter, Aviat also announced a new win with LTD Broadband for high-speed wireless back to support rural broadband connectivity. LTD Broadband, a leading U.S. Internet service provider, provides high-speed connectivity to commercial and residential subscribers in Iowa, Minnesota, Nebraska, South Dakota, and Wisconsin. In addition to... The NextLink internet win, we now have three out of the top 10 and nine of the top 30 Rural Digital Opportunity Fund winners in our customer base. The DISH and LTD broadband wins are the result of Aviat's 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. Aviat 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 ahead. We believe 5G builds will drive new backhaul upgrades and that our rural broadband business will benefit from meaningful government funding including 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. We also recently announced groundbreaking new software available on the Avia WTM 4000 radio platform. This new software, called A2C+, lowers customer cost by doubling the capacity with it. out additional equipment by combining two or four separate channels onto a single antenna, delivering the highest system gain, enabling smaller antennas, thus reducing tower labor and leasing costs, simplifying spares, and lowering power consumption. Increasing capacity for multiband enabling three plus zero in a single box and doubling the available microwave capacity. Competitive offerings require three or even four separate boxes with increased complexity and cost. Before turning the call over to Eric, let me provide a couple of additional observations. and insights. First, this was a very good quarter and first nine months 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. Looking forward, we see three significant drivers, 5G, private networks, and rural broadband. and we believe we are well-positioned to capture significant opportunities with our differentiated products, software, and services offerings. 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. To my remarks today, that will review some of the key third quarter and first nine months of 2021 financial highlights, noting our detailed financials can be found in our form tank and press release, both of which were filed this afternoon. As a reminder, all comparisons discussed today are between the third quarter of fiscal 2021 and the third quarter of fiscal 2020, and between the first nine months of fiscal 2021 and the first nine months of fiscal 2020, unless... For the third quarter, we reported total revenues of $66.4 million as compared to $61.4 million for the same period last year, an increase of $5 million, or 8.2%. During the quarter, the North American team continued to focus on expanding sales and seizing upon Avia's unique products and service differentiations. North America, which comprised 63% of total revenue for the third quarter, was $42 million, an increase of $4.8 million, or 12.8%, from $37.3 million for the same period last year, driven primarily by our private network business, rural broadband, and software licenses. For the nine months of fiscal 2021, our North America revenue was $136.7 million, an increase of $23.2 million, or 20.4%, from $113.5 million for the same period last year. International revenue for the third quarter came in at $24.4 million compared to $24.1 million for the same period last year. For the nine months of fiscal 2021, our international revenue was $66.5 million, an increase of $4 million, or 6.5%, from $62.5 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 1 telecom business, winning new Tier 2 accounts, expanding our reach 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 nine months of fiscal 2021 was $203.2 million compared to $176 million for the same year-ago period, an increase of 15.5%. Our book-to-bill ratio for the third quarter and the last 12 months is well above one, and we are again pleased that our backlog exiting the quarter continues to remain above $200 million. Third quarter gross margins remain strong at 38.5% and 38.7% on the GAAP basis and non-GAAP basis, respectively, as compared to 35.8% and 35.9% for the third quarter of last year. Key drivers to strong gross margin is driven by higher volume of private network business, increased sales through our RBI store, which serves primarily the rural broadband space, improved international business driven by multi-bandwinds, and an increase in software sales. Third quarter gap operating expenses were $21.5 million compared to $20.7 million for the same period last year, primarily due to restructuring charges and share-based compensation. Third quarter non-GAAP operating expenses, which exclude the impact of restructuring charges and share-based compensation, was flat at $19.7 million year-over-year. R&D expenses increased $0.3 million due to investment in software development. Sales expenses increased $0.5 million due to commission of higher bookings, while G&A expenses decreased by $0.8 million, primarily as a result of our previously announced restructuring. On a year-to-date basis, Both GAAP and non-GAAP operating expenses were favorably impacted due to restructuring plans announced in the second half of fiscal 2020 as well as in February 2021 and a slowdown in hiring and reduced travel. Moving on, third quarter non-GAAP net income was $5.8 million compared to $2.2 million for the same period last year, with third quarter non-GAAP EPS coming in at $0.49 per share compared to $0.20 per share for the same period last year. First nine months fiscal 2021 non-GAAP net income was $21.1 million compared to $4.2 million for the same period last year, with non-GAAP EPS coming in at $1.83 per share compared to $0.38 per share for the same period last year. Please note that our prior period EPS have been retroactively adjusted to reflect our 2-for-1 stock split in the form of stock dividends that was effected in early April 2021. From income tax standpoint, during the third quarter, we released our U.S. valuation allowance of approximately $92 million, associated with our U.S. NOLs of about $400 million, because we have been profitable in the U.S. for the past few years, and it is more likely than not that our U.S. operations will have sufficient future profits to utilize the deferred tax assets in the foreseeable future. Since we have NOLs offset income tax payments in the U.S., The non-GAAP reporting purpose or income tax expense will continue to be cash tax that we pay in our foreign jurisdictions under the respective transfer pricing agreements. Adjusted EBITDA for the third quarter was $7.3 million, a $3.8 million improvement from $3.5 million we reported for the same period last year, with adjusted EBITDA margin coming at 11% for the quarter. For the first nine months of fiscal 2021, our adjusted EBITDA was $25.8 million compared to $8 million for the same period last year. Adjusted EBITDA margins for the first nine months was 12.7% compared to 4.5% for the same period last year. Moving on to the balance sheet, our cash and cash equivalents at the end of the third quarter was $45.8 million with no loan outstanding. During the third quarter, our inventory increased by approximately $4 million to mitigate supply chain constraints. Despite the increased inventory, our net cash increased $2.8 million sequentially from the second quarter and $13.2 million year-to-date. So our balance sheet remains very solid, leaving us well-positioned to execute our long-term plans. With that, I'll turn it back to Pete for some final comments. Pete?

Thanks, Eric. Just a few additional comments before opening it up for Q&A. I am extremely proud of the entire Avia team for their significant contributions to our results. We recognize that there continues to be a lot of work in front of us. We are on the right path to achieve our long-term objectives. With that, operator, let's open it up for questions.

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then 1 on your touch-tone telephone. Again, if you'd like to ask a question, please press star then 1. Our first question comes from Theodore O'Neill of Litchfield Research. Your line is open.

Thank you very much. Congratulations on a great quarter.

Thank you.

Yeah. So, Pete, during this current earnings period, we've been hearing a lot about supply chain issues, part shortages in the semiconductors and other We heard a company actually having trouble getting labor in China because migration back to the cities isn't happening as robustly as it has in the past. And long lead times for parts and all this is driving up costs. Can you talk about how you've managed in this kind of environment?

Yeah. So, you know, the good news is our book-to-bill ratio is above one and our demand is strong. So we are facing with the supply shortages and freight problems like many other companies. But I would say that these incremental costs didn't have a material impact on our Q3. So the real credit goes to our supply chain. They've overcome a myriad of issues. We have challenges today. But what we really did from the beginning of COVID, we were the start of COVID, we were nervous. So we've been leveraging our balance sheet, since we're in a basic zero interest rate environment, to buy components ahead of demand. And we built up our inventory position, and that's allowed us to mostly meet our customers' demand delivery. So we're going to continue to do that. I don't want to be misleading their there are risks. But I think, you know, when we look at industry reports, they say that we're distinguishing ourselves with respect to supply chain, and we want to continue to do that. And fortunately, we have the balance sheet that allows us to navigate in that way. That's great.

The other thing I wanted to ask about was the margins were so good in the quarter. And I know your Aviate store is sort of a better margin way for customers to buy product. Is it still more headroom to go raise those margins higher if the Aviate store continues to grow?

So I think what drives our – if you go – I'd like us to look at a nine-month, right, to not get caught up in a – quarter-to-quarter because we have a project business. What's really driving the margin expansion is the store, our software sales, and we mentioned what we think is a bellwether win for us, the software as a service, frequency-assured service, where we could start to build a recurring revenue model. And then one of the things that I brought when I came to the company is a market-back approach, and we have our multi-band radio, which So it saves our customers tens of thousands of dollars a year. And for all the innovation that we put in there, we get a margin that's accreted. So to kind of put a bow on this, the store is driving an increase in margins. Our software and our aspiration, we have aspirations to make that software as a service. And then our hardware, where we're differentiated with products like multi-band and what I mentioned, our A2C, which really doubles capacity using some software algorithms. So those would be kind of three highlights with respect to the drivers of our gross margin expansion.

Okay, thanks very much.

Thank you.

Thank you. Our next question comes from Tim Savage of Northland Capital. Your line is open.

Hi, good afternoon, and congrats on the results. I wonder if you guys have an update. Oh, sorry about that. Launched into it a bit quick. Do you guys have an update on guidance for the year? I think you provided a range of both revenue and EBITDA last quarter.

Yeah, so, Tim, there's no update from the guidance we provided last quarter. Revenue-wise, it's going to be on an annual basis between $255 million to $265 million, so there's no change. Likewise, it's still between $28 million and $31 million for the full year.

So, Tim, just to add to that, we have a project-based business. Last quarter, we said that it was conservative. We still think it's conservative. But we want to stick to annual guidance and not get caught into quarterly guidance because last quarter we had a big – project. And if we start getting into quarter to quarter guidance, we won't manage the business as efficiently as we can. So, you know, since we're at the last quarter, we don't want to update guidance. And what Eric just said is we're competent in meeting the guidance. And last quarter, we acknowledged that it was conservative. So we would stand by that without getting into any specific numbers.

Fair enough. Maybe looking at it a bit further, and I think you mentioned you received initial orders from DISH. Correct me if I'm wrong there. I wonder if that's true of LTD as well. But if you look at these new wins, maybe we talk about DISH separately from the call it rural broadband backhaul, can you give us any metrics to try and size that opportunity as, as you look out, you know, to next year, you know, maybe in these, you know, kind of two buckets from an annualized perspective. And then, you know, beyond that, are you seeing more of those types of opportunities as carriers ramp up 5g builds and, and we get going with our often rural broadband.

Okay. So, all right. You asked, you asked, you asked for a, You asked a lot of questions there.

Well, two buckets, DISH slash Tier 1 and rural broadband, just a sense of the size of what you brought in to date and what might be out there.

So let me talk about Rural Digital Opportunity Fund. So we think that four cents, about let's say two to four cents of every dollar in the Rural Digital Opportunity Fund turns into – a microwave order. So that's what we think the size of it is. And we have three of the top 10 and nine of the top 30 RDOF winners. So that's kind of how we're starting to think about that opportunity. So we think it's pretty big. You know, DISH is a great customer. We, you know, we won that business because of our our network planning, our differentiated radios, and our e-commerce. We think that that's a Greenfield 5G application. The international customers have stepped up and taken notice. We think that this will be, you know, a small revenue lift next year, but it's a bellwether win, and we're seeing... interest from our international customer base based on that win. Is that helpful, Tim?

Thank you.

I was on mute there. Thank you.

Again, ladies and gentlemen, if you'd like to ask a question, please press star then 1 on your touch-tone telephone. Tim, are you back? Tim is back. One moment, please. Your line is open, sir.

Sorry, I was on mute there. Can you hear me?

Yeah.

Okay. I did want to follow up on just expanding on the 5G topic a little more. We've obviously seen a lot of momentum toward increased 5G builds, in particular C-band, from more incumbent versus Greenfield 5G operators, included among those some historical customers of yours. I wonder if you're seeing any opportunity coming out of the more traditional tier ones in the U.S. or, yeah, maybe just focus on the U.S.

We would say that as the networks build, we see the opportunities, right? And, you know, there's a mix between... the fiber deployment and the microwave deployment. And it seems like some quarters they're focused on fiber and some quarters they're focused on microwave. And when they're focused on microwave, we certainly enjoy the lift. And we're seeing that in the U.S. and we're also seeing that in certain international regions, Tim. Great. Thanks very much. Thank you.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then 1. Our next question comes from George Awang of Oppenheimer. Your line is open.

All right. Thank you for taking my question. Pete, maybe digging into the international opportunity a little bit more, can you give us a sense of where you're displacing people? You know, how much of a differentiation the obvious store is when you go into the these markets? Really, how long of a conversation are you having with the carriers and the operators as far as getting in? Are you displacing vendors? Are you normally getting new build opportunities?

Let's talk about the store internationally. We have that going in Europe. We will roll it out in later this year, this calendar year, in AsiaPAC. And what we're finding, particularly for Tier 2 operators, they like the inventory management, that they don't have excess and obsolete. And what it often is is a different – it's the whole package between our network planning, our high-capacity radios, sometimes our software, and then our delivery platform, the store. So that's helping us win new accounts in Asia-Pac, in Africa, and in Europe. So that's kind of stuff that's in the pipeline that hasn't hit. Is that helpful? So where the store plays internationally is particularly in tier two operators.

Alright, and then when you do look at the gains that you are seeing, are you displacing vendors? Are you seeing expansion and kind of new networks and that's where you're getting the bigger opportunity to drive your growth?

So DISH was a new network. We would say the bulk of our growth is due to share gains. So

All right, and then maybe just one last question. Do you feel the vertical strength that you're seeing here in the U.S., is that something you can replicate in other parts of the world? Is that opportunity just as robust?

So we're in the beginning of that. I think in EMEA, our leader in EMEA has deep telecom experience from Cisco, and he sees that, that we're going to be able to move into the private network's in the EMEA region step by step. So we're pretty hopeful over the next couple of years that we can land some design wins and talk to you about it. So we think it is a capability that we can replicate. And our international sales leadership is starting to see that opportunity. the number of private network sales funnel opportunities is increasing internationally.

All right. I know I said that was my last one, but one last one. Just on the pricing environment, do you, you know, given how tight the supply chain is, is pricing pretty firm and do you have the ability to actually go to your customers and say, hey, you were able to hold pricing either where it is and not kind of follow the normal price curve down?

Yeah, so here's how I'd like to answer that. That we're actively managing this and we believe we can maintain our margins.

Is that it?

So is that helpful enough?

Yes, thank you very much.

Thank you. Our next question comes from Tom Diffley of DA Davidson. Your line is open.

Yeah, good afternoon. I appreciate you taking the question. Another question on the Rural Development Opportunity Fund. What is the timing of that and some of the other programs that you're seeing? And is there time for you to expand beyond three of the top 10 or none of the top 30 that you're currently involved with?

Well, we sure hope that we can get more of the top 10 and more of the top 30. And we would say it's early days in terms of the deployment of the RDOF funding. And, you know, it's really hard to track this. the precise timing of the disbursement, but we're not sure that any of the RDoF funds has flowed from the government to our customers to us. So we're really happy with our position in rural broadband, and we just think that there's going to be growth ahead from that.

Okay, that's helpful. And then just a quick follow-up on the gross margin. You said there is some lumpiness on a quarterly basis. So if I look at the nearly 300 basis point improvement on a year-over-year basis, is that fairly true progression from what you've done?

Yeah, so as Pete mentioned earlier, right, what's driving the gross margin expansion is coming from sales through our e-commerce platform, right? There's also more software sales year over year, as well as private networks still at about two-thirds of our business, and we're still expanding that from a margin standpoint. So we're in the high 30s when it comes to gross margin. I think it's something that we can maintain.

And Tom, just, yeah, so I think we can maintain it. In previous calls, we've been asked if we can turn up 40 gross margin. That's our aspirations, but we haven't. haven't guided to that. But the way to think about it is as we get more multi-band wins, as we get more software and we leverage the e-commerce platform, our margins will go up. And then one caveat I'd like to put in there is, you know, what I say to the team is we don't get paid in percentage. We get paid in dollars. So if we have a chance to do a share gain of a big customer at a lower margin with a plan to mix up over time, we will do that. But I think for modeling purposes, what Eric said, you know, keeping it flat when we come out next year, we'll think more about our margin and our mix. But we think taking the nine-month view is a safe assumption.

Okay, that makes sense. It's the margin dollars that pay the bills. Okay, I appreciate your time today.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then 1 on your touchdown telephone. One moment, please. I'm showing no further questions at this time. I'd like to turn the call back over to Pete Smith for any closing remarks.

All right, thanks, everyone, for joining. Aviat continues on its continuous improvement journey. We look forward to speaking next quarter. Next quarter will illustrate our full year progress and take some more time to discuss our products and differentiation. Thanks again. Take care.

Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may all disconnect. Have a great day.