AVIAT NETWORKS, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q, including “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they do not materialize or prove correct, could cause our results to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed to be forward-looking statements, including without limitation statements of, about, concerning or regarding: our plans, strategies and objectives for future operations, including with respect to growing our business and sustaining profitability; our restructuring efforts; our research and development efforts and new product releases and services; trends in revenue; drivers of our business and the markets in which we operate; future economic conditions, performance or outlook, and changes in our industry and the markets we serve; the outcome of contingencies; the value of our contract awards; beliefs or expectations; the sufficiency of our cash and our capital needs and expenditures; our intellectual property protection; our compliance with regulatory requirements and the associated expenses; expectations regarding litigation; our intention not to pay cash dividends; seasonality of our business; the impact of foreign exchange and inflation; taxes; and assumptions underlying any of the foregoing. Forward-looking statements may be identified by the use of forward-looking terminology, such as “anticipates,” “believes,” “expects,” “may,” “should,” “would,” “will,” “intends,” “plans,” “estimates,” “strategy,” “projects,” “targets,” “goals,” “seeing,” “delivering,” “continues,” “forecasts,” “future,” “predict,” “might,” “could,” “potential,” or the negative of these terms, and similar words or expressions. These forward-looking statements are based on estimates reflecting the current beliefs of the senior management of the Company. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Forward-looking statements should therefore be considered in light of various important factors, including those set forth in this Quarterly Report on Form 10-Q. Important factors that could cause actual results to differ materially from estimates or projections contained in the forward-looking statements include, but are not limited to, the following: • the impact of COVID-19 on our business, operations and cash flows; • continued price and margin erosion as a result of increased competition in the microwave transmission industry; • the impact of the volume, timing, and customer, product, and geographic mix of our product orders; • our ability to meet financial covenant requirements which could impact, among other things, our liquidity; • the timing of our receipt of payment for products or services from our customers; • our ability to meet projected new product development dates or anticipated cost reductions of new products; • our suppliers’ inability to perform and deliver on time as a result of their financial condition, component shortages, the effects of COVID-19 or other supply chain constraints; • customer acceptance of new products; • the ability of our subcontractors to timely perform; • weakness in the global economy affecting customer spending; • retention of our key personnel; • our ability to manage and maintain key customer relationships; • uncertain economic conditions in the telecommunications sector combined with operator and supplier consolidation; • our failure to protect our intellectual property rights or defend against intellectual property infringement claims by others; • the results of our restructuring efforts; • the ability to preserve and use our net operating loss carryforwards; • the effects of currency and interest rate risks; 24 • the effects of current and future government regulations, including the effects of current restrictions on various commercial and economic activities in response to the COVID-19 pandemic; • general economic conditions, including uncertainty regarding the timing, pace and extent of an economic recovery in the United States and other countries where we conduct business; • the conduct of unethical business practices in developing countries; • the impact of political turmoil in countries where we have significant business; • the impact of tariffs, the adoption of trade restrictions affecting our products or suppliers, a United States withdrawal from or significant renegotiation of trade agreements, the occurrence of trade wars, the closing of border crossings, and other changes in trade regulations or relationships; • our ability to meet financial covenant requirements which could impact, among other things, our liquidity; and • our ability to implement our stock repurchase program or the extent to which it enhances long-term stockholder value. Other factors besides those listed here could also adversely affect us. See “Item 1A. Risk Factors” in our fiscal 2021 Annual Report on Form 10-K filed with the SEC on August 25, 2021 for more information regarding factors that may cause our results to differ materially from those expressed or implied by the forward-looking statements contained in this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward-looking statements, which reflect our management’s opinions only as of the date of the filing of this Quarterly Report on Form 10-Q. Forward-looking statements are made in reliance upon the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), along with provisions of the Private Securities Litigation Reform Act of 1995, and we expressly disclaim any obligation, other than as required by law, to update any forward-looking statements to reflect further developments or information obtained after the date of filing of this Quarterly Report on Form 10-Q or, in the case of any document incorporated by reference, the date of that document. Overview of Business; Operating Environment and Key Factors Impacting Fiscal 2022 and 2021 Results The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand our results of operations and financial condition. MD&A is provided as a supplement to, and should be read in conjunction with, our unaudited condensed consolidated financial statements and the accompanying notes. In the discussion herein, our fiscal year ending July 1, 2022 is referred to as “fiscal 2022” or “2022” and our fiscal year ended July 2, 2021 is referred to as “fiscal 2021” or “2021.” On April 7, 2021, we effected a two-for-one split in the form of a stock dividend to shareholders of record as of April 1, 2021. Overview We anticipate growth in revenue in fiscal 2022. We continue to have a backlog entering the first quarter of fiscal 2022 and we anticipate continuing our strong momentum across all verticals. We have made inroads into the U.S. rural broadband and wireless internet service provider areas, and there is now further evidence of investment to support 5G deployments with our U.S. service provider customers. We have also seen further growth for our international regions. In March 2020, the World Health Organization characterized the current respiratory illness caused by novel coronavirus disease, known as COVID-19, as a pandemic. The pandemic has resulted in government authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place or stay-at-home orders, and business shutdowns. Our global operations expose us to risks associated with public health crises and epidemics/pandemics, such as the COVID-19 pandemic. The COVID-19 pandemic has had and is likely to continue to have an impact on our operations, supply chains and distribution systems. The COVID-19 pandemic has led to an increase in our expenses, including as a result of impacts associated with preventive and precautionary measures that we, other businesses and governments are taking or requiring. The extent to which the COVID-19 pandemic impacts our business, prospects and results of operations will depend on future developments, which are highly uncertain, including, but not limited 25 to, the duration and spread of the pandemic, its severity, the actions to contain the virus or treat its impact, including the ongoing vaccination efforts, any new variant strains of the underlying virus, and how quickly and to what extent normal economic and operating activities can resume. Management is actively monitoring the impact of the COVID-19 pandemic on our financial condition, liquidity, operations, suppliers, industry, and workforce. Our first priority remains the health and safety of our employees and their families. Employees whose tasks can be done offsite have been instructed to work from home. Our manufacturing sites remain operational, and we are maintaining social distancing and have enhanced cleaning protocols and usage of personal protective equipment, where appropriate. Our gross margin in the current quarter was negatively impacted by inflationary pressures incurred to overcome supply chain and logistical bottlenecks. These were partially offset by price increases and surcharges. We are monitoring, assessing and adapting to the situation and preparing for possible implications to our business, supply chain and customer demand. We expect the potential for these challenges to continue until business and economic activities return to more normal levels. The financial results for the three months ended October 1, 2021 reflect some of the reduced activity experienced during the period in various locations around the world and are not necessarily indicative of the results for the full year. Operations Review The market for mobile backhaul continued to be our primary addressable market segment globally in the first three months of fiscal 2022. In North America, we supported 5G and long-term evolution (“LTE”) deployments of our mobile operator customers, public safety network deployments for state and local governments, and private network implementations for utilities and other customers. In international markets, our business continued to rely on a combination of customers increasing their capacity to handle subscriber growth, the ongoing build-out of some large 3G deployments, and LTE deployments. Our position continues to be to support our customers for 5G and LTE readiness and ensure that our technology roadmap is well aligned with evolving market requirements. We continue to find that our strength in turnkey and after-sale support services is a differentiating factor that wins business for us and enables us to expand our business with existing customers in all markets. However, as disclosed above and in the “Risk Factors” section in Item 1A of our Annual Report on Form 10-K filed with the SEC on August 25, 2021, a number of factors could prevent us from achieving our objectives, including ongoing pricing pressures attributable to competition and macroeconomic conditions in the geographic markets that we serve. Revenue We manage our sales activities primarily on a geographic basis in North America and three international geographic regions: (1) Africa and the Middle East, (2) Europe and Russia, and (3) Latin America and Asia Pacific. Revenue by region for the three months ended October 1, 2021 and October 2, 2020 and the related changes were as follows: Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change North America $ 50,937 $ 45,499 $ 5,438 12.0 % Africa and the Middle East 10,702 10,571 131 1.2 % Europe and Russia 2,703 2,262 441 19.5 % Latin America and Asia Pacific 8,816 7,958 858 10.8 % Total revenue $ 73,158 $ 66,290 $ 6,868 10.4 % Our revenue in North America increased by $5.4 million, or 12.0%, during the first quarter of fiscal 2022 compared with the same period of fiscal 2021. The increase in North America revenue during the first three months of fiscal 2022 was primarily due to an increase in revenue from private network projects and rural broadband sales. Our revenue in Africa and the Middle East increased by $0.1 million or 1.2% during the first quarter of fiscal 2022 compared with the same period of fiscal 2021. This increase in revenue during the first three months of fiscal 2022 was primarily due to increased sales to mobile operators in the region. Revenue in Europe and Russia increased by $0.4 million, or 19.5%, for the first quarter of fiscal 2022 compared with the same period of fiscal 2021. This increase during the first three months of fiscal 2022 was primarily due to increased sales to private networks in the region. 26 Revenue in Latin America and Asia Pacific increased by $0.9 million, or 10.8%, during the first quarter of fiscal 2022 compared with the same period of fiscal 2021. The increase during the first three months of fiscal 2022 was primarily due to increased sales to mobile operators in the region. Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Product sales $ 50,847 $ 44,464 $ 6,383 14.4 % Services 22,311 21,826 485 2.2 % Total revenue $ 73,158 $ 66,290 $ 6,868 10.4 % Our revenue from product sales increased by $6.4 million, or 14.4%, for the first quarter of fiscal 2022 compared with the same quarter of fiscal 2021. Our services revenue increased by $0.5 million, or 2.2%, during the first quarter of fiscal 2022 compared with the same quarter of fiscal 2021. Gross Margin Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Revenue $ 73,158 $ 66,290 $ 6,868 10.4 % Cost of revenue 47,077 42,041 5,036 12.0 % Gross margin $ 26,081 $ 24,249 $ 1,832 7.6 % % of revenue 35.7 % 36.6 % Product margin % 37.2 % 37.2 % Service margin % 32.1 % 35.3 % Gross margin for the first quarter of fiscal 2022 increased by $1.8 million, or 7.6% compared with the same quarter of fiscal 2021. Our gross margin in the current quarter was negatively impacted by inflationary pressures incurred to overcome supply chain and logistical bottlenecks. These were partially offset by price increases and surcharges. Product margin as a percentage of product revenue was flat compared to the same period in 2021. While first quarter fiscal 2022 product sales volume increased in higher margin segments, increased supply chain costs offset those margin gains, holding margin rates even with the first quarter of fiscal 2021. Service margin rates decreased in North America and in the international markets compared to the first quarter of fiscal 2021. Research and Development Expenses Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Research and development $ 5,910 $ 4,847 $ 1,063 21.9 % % of revenue 8.1 % 7.3 % Our research and development expenses increased by $1.1 million or 21.9% in the first three months of fiscal 2022 compared with the same periods of fiscal 2021 primarily due to increased product development activities. 27 Selling and Administrative Expenses Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Selling and administrative $ 12,698 $ 12,837 $ (139) (1.1) % % of revenue 17.4 % 19.4 % Our selling and administrative expenses decreased by $0.1 million, or 1.1%, in the first quarter of fiscal 2022 compared with the same period in fiscal 2021. The decreases for the first three months of fiscal 2022 compared to comparable periods of fiscal 2021 were primarily due to restructuring savings. Restructuring Charges Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Restructuring charges $ 659 $ — $ 659 100.0 % In the first quarter of fiscal 2022, we recognized restructuring charges of $0.7 million primarily related to the restructuring plan (the “Fiscal 2021 Plan”) approved by our Board of Directors in the third and fourth quarters of fiscal 2021. The Fiscal 2021 Plan is anticipated to entail a reduction in force of approximately 30 employees to be implemented through the second quarter of fiscal year 2022, with a certain number of positions being consolidated and/or relocated. Interest Income and Interest Expense Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Interest income, net $ 28 $ 35 $ (7) (20.0) % Interest income, net reflect interest earned on our cash equivalents, which were comprised of money market funds and bank certificates of deposit. Income Taxes Three Months Ended (In thousands, except percentages) October 1, 2021 October 2, 2020 $ Change % Change Income before income taxes $ 6,842 $ 6,600 $ 242 3.7 % Provision for income taxes $ 2,160 $ 664 $ 1,496 225.3 % We estimate our annual effective tax rate at the end of each quarterly period, and we record the tax effect of certain discrete items in the interim period in which they occur, including changes in judgment about uncertain tax positions and deferred tax valuation allowances. The tax benefit for the first quarter of fiscal 2022 was primarily due to the tax expense related to U.S. profitable subsidiaries. The tax expense for the first quarter of fiscal 2021 was primarily related to profitable subsidiaries. 28 Liquidity, Capital Resources, and Financial Strategies Sources of Cash As of October 1, 2021, our total cash and cash equivalents were $47.3 million. Approximately $24.2 million, or 51.1%, was held in the United States. The remaining balance of $23.2 million, or 48.9%, was held by entities outside the United States. Of the amount of cash and cash equivalents held by our foreign subsidiaries on October 1, 2021, $20.9 million was held in jurisdictions where our undistributed earnings are indefinitely reinvested, and if repatriated, would be subject to foreign withholding taxes. Operating Activities Cash provided by or used in operating activities is presented as net income adjusted for non-cash items and changes in operating assets and liabilities. Net cash provided by operating activities was $0.7 million for the first three months of fiscal 2022, compared to $4.2 million for the first three months of fiscal 2021; this difference was primarily related to a net change in Accounts receivable and partially offset by the net change in Accounts payable. Net cash provided by noncash items was $3.9 million for the first three months of 2022. The net changes in operating assets and liabilities resulted in a net use of cash of $7.9 million for the first three months of fiscal 2022, compared to net use of cash $4.5 million for the same period in fiscal 2021. Changes in operating assets and liabilities resulted in a net use of cash for the first three months of fiscal 2022 primarily related to the timing of payments of Accounts payable offset by the use of cash by Accounts receivable that fluctuate from period to period, depending on the amount, timing of sales and billing activities and cash collections. Investing Activities Net cash used in investing activities was $0.3 million and $1.0 million for the first three months of fiscal 2022 and 2021, respectively, which consisted of capital expenditures. During the remainder of fiscal year 2022, we expect to spend approximately $1 million to $2 million for capital expenditures, primarily on equipment for development and manufacturing of new products and IT infrastructure. Financing Activities Financing cash flows consist primarily of proceeds from and repayments of short-term debt, repurchase of stock and proceeds from the sale of shares of common stock through employee equity plans. Net cash used in financing activities was $0.8 million for the first three months of fiscal 2022, primarily due to the purchase of treasury stock of $0.7 million. As of October 1, 2021, our principal sources of liquidity consisted of $47.3 million in cash and cash equivalents and $22.5 million of available credit under our $25.0 million SVB Credit Facility, which matures on June 28, 2024, and future collections of receivables from customers. We regularly require letters of credit from certain customers, and, from time to time, these letters of credit are discounted without recourse shortly after shipment occurs in order to meet immediate liquidity requirements and to reduce our credit and sovereign risk. Historically, our primary sources of liquidity have been cash flows from operations and credit facilities. Additionally, we have an effective shelf registration statement on Form S-3 allowing us to offer and sell, either individually or in combination, in one or more offerings, up to a total dollar amount of $200 million of any combination of the securities described in the shelf registration statement or a related prospectus supplement. We believe that our existing cash and cash equivalents, the available line of credit under the SVB Credit Facility, potential issuances of debt or equity securities and future cash collections from customers will be sufficient to provide for our anticipated requirements for working capital and capital expenditures for at least the next 12 months. On May 17, 2021, we entered into Amendment No. 4 to Third Amended and Restated Loan and Security Agreement to extend the maturity date to June 28, 2024. The SVB Credit Facility provides for a $25.0 million accounts receivable formula-based revolving credit facility that can be borrowed by the U.S. company, with a $25.0 million sub-limit that can be borrowed by our U.S. and Singapore entities. Loans may be advanced under the SVB Credit Facility based on a borrowing base equal to a specified percentage of the value of eligible accounts of all borrowers under the SVB Credit Facility. The borrowing base is subject to certain eligibility criteria. Availability under the accounts receivable formula-based revolving credit facility can also be utilized to issue letters of credit with a $12.0 million sub-limit. We may prepay loans under the SVB Credit Facility in whole or in part at any time without premium or penalty. As of October 1, 2021, available credit under the SVB Credit Facility was $22.5 million reflecting the calculated borrowing base of $25.0 million less outstanding letters of credit of $2.5 million. We 29 did not borrow against the SVB Credit Facility during the first quarter of fiscal 2022 and there was no borrowing outstanding as of October 1, 2021 or July 2, 2021. As of October 1, 2021, we were in compliance with the quarterly financial covenants, as amended, contained in the SVB Credit Facility and there was no amount outstanding under the SVB Credit Facility. In addition, we have an uncommitted short-term line of credit of $0.4 million from a bank in New Zealand to support the operations of our subsidiary located there. This line of credit provides for $0.3 million in short-term advances at various interest rates, all of which was available as of October 1, 2021 and July 2, 2021. The line of credit also provides for the issuance of standby letters of credit and company credit cards, of which $0.1 million was outstanding as of October 1, 2021 and July 2, 2021. This facility may be terminated upon notice, is reviewed annually for renewal or modification, and is supported by a corporate guarantee. Restructuring Payments We had liabilities for restructuring activities totaling $3.0 million as of October 1, 2021, which were classified as current liabilities and expected to be paid out in cash over the next 12 months. We expect to fund these future payments with available cash and cash provided by operations. Contractual Obligations The amounts disclosed in our fiscal 2021 Annual Report on Form 10-K filed with the SEC on August 25, 2021 include our commercial commitments and contractual obligations. During the first three months of fiscal 2022, no material changes occurred in our contractual obligations to purchase goods and services or to make payments under operating leases or our contingent liabilities on outstanding letters of credit, guarantees, and other arrangements as disclosed in our fiscal 2021 Annual Report on Form 10-K. Off-Balance Sheet Arrangements We consider the following items to qualify as off-balance sheet arrangements: • any obligation under certain guarantee contracts; • a retained or contingent interest in assets transferred to an unconsolidated entity or similar entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; • any obligation, including a contingent obligation, under certain derivative instruments; and • any obligation, including a contingent obligation, arising out of a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or engages in leasing, hedging or research and development services with us. Currently we are not participating in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities, and we do not have any material retained or contingent interest in assets as defined above. As of October 1, 2021, we did not have material financial guarantees or other contractual commitments that are reasonably likely to adversely affect our current or future financial condition. In addition, we are not currently a party to any related party transactions that materially affect our results of operations, cash flows or financial condition. As of October 1, 2021, we had commercial commitments of $64.0 million. Please refer to “Note 12 Commitments and Contingencies” of the Notes to unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q for Contractual Obligations and Off-Balance Sheet Arrangements. Critical Accounting Estimates For information about our critical accounting estimates, see the “Critical Accounting Estimates” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our fiscal 2021 Annual Report on Form 10-K. 30