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; • our ability to realize the anticipated benefits of any proposed or recent acquisitions within the anticipated timeframe or at all, including the risk that proposed or recent acquisitions will not be integrated successfully; • 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; • continued 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; and • our ability to implement our stock repurchase program or that it will enhance long-term stockholder value. Other factors besides those listed here could also adversely affect us. See “Item 1A. Risk Factors” in our fiscal 2022 Annual Report on Form 10-K filed with the SEC on September 14, 2022 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 2023 and 2022 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 June 30, 2023 is referred to as “fiscal 2023” or “2023” and our fiscal year ended July 1, 2022 is referred to as “fiscal 2022” or “2022.” Overview Aviat sells radios, routers, software and services. We have more than 3,000 customers and significant relationships with global service providers and private network operators. Our manufacturing base in North America consists of a combination of contract manufacturing and assembly and test operated in Austin, Texas by Aviat. Our technology is underpinned by more than 200 patents. We compete on the basis of total cost of ownership, microwave radio expertise and solutions for mission critical communications. We have a global presence. The COVID-19 pandemic related disruptions to our business, operations, customers and suppliers lessened over the course of fiscal 2022. While supply chain lead-times remain extended and difficult to manage, the impact on our ability to fulfill orders for the year ended July 1, 2022 was minimal. Depending on the progression of pandemic-related factors such as supply constraints, potential for temporary manufacturing restrictions and our ability to perform field services during shelter in place orders, we could experience constraints and delays in fulfilling customer orders in future periods. We are monitoring, assessing and adapting to the situation to mitigate impacts on 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. 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. We continue to be impacted by inflationary pressures incurred to overcome supply chain and logistical bottlenecks. We will monitor, assess and adapt to the situation and prepare for implications to our business, supply chain and customer demand. We expect these challenges to continue until business and economic activities return to more normal levels. 25 Business Combination with Redline Communications On April 13, 2022, Aviat and Redline Communications, Inc. (“Redline”), a leading provider of mission-critical data infrastructure, signed a definitive agreement for Aviat to acquire all outstanding common stock of Redline. The transaction closed on July 5, 2022. Redline allows Aviat to expand its Private Networks Offering with Private LTE/5G, Unlicensed Wireless Access Solutions, by creating an integrated end-to-end offering for wireless access and transport in the Private Networks segment, leveraging Aviat's sales channel to address a large dollar Private LTE/5G addressable market and increasing Aviat’s reach in mission-critical industrial Private Networks. Operations Review The market for mobile backhaul continued to be our primary addressable market segment globally in the first three months of fiscal 2023. 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 LTE deployments, and 5G 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 September 14, 2022, 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 (3) Latin America and Asia Pacific. Revenue by region for the three months ended September 30, 2022 and October 1, 2021 and the related changes were as follows: Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change North America $ 48,848 $ 50,937 $ (2,089) (4.1) % Africa and the Middle East 10,984 10,702 282 2.6 % Europe 4,500 2,703 1,797 66.5 % Latin America and Asia Pacific 16,919 8,816 8,103 91.9 % Total revenue $ 81,251 $ 73,158 $ 8,093 11.1 % Our revenue in North America decreased by $2.1 million, or 4.1%, during the first quarter of fiscal 2023 compared with the same period of fiscal 2022. The decrease in North America revenue during the three months of fiscal 2023 was primarily due to timing of private network projects. Our revenue in Africa and the Middle East increased by $0.3 million or 2.6% during the first quarter of fiscal 2023 compared with the same period of fiscal 2022. This increase in revenue during the three months of fiscal 2023 was primarily due to increased sales to mobile operators in the region. Revenue in Europe increased by $1.8 million, or 66.5%, for the first quarter of fiscal 2023 compared with the same period of fiscal 2022. This increase during the three months of fiscal 2023 was primarily due to increased sales to mobile operators in the region. Revenue in Latin America and Asia Pacific increased by $8.1 million, or 91.9%, during the first quarter of fiscal 2023 compared with the same period of fiscal 2022. The increase during the three months of fiscal 2023 was primarily due to increased sales to mobile operator customers. 26 Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Product sales $ 55,101 $ 50,847 $ 4,254 8.4 % Services 26,150 22,311 3,839 17.2 % Total revenue $ 81,251 $ 73,158 $ 8,093 11.1 % Our revenue from product sales increased by $4.3 million, or 8.4%, for the first quarter of fiscal 2023 compared with the same quarter of fiscal 2022. This is driven by strong growth in Asia Pacific and Latin America as well as the contribution from the Redline acquisition. Our services revenue increased by $3.8 million, or 17.2%, during the first quarter of fiscal 2023 compared with the same quarter of fiscal 2022. Gross Margin Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Revenue $ 81,251 $ 73,158 $ 8,093 11.1 % Cost of revenue 51,797 47,077 4,720 10.0 % Gross margin $ 29,454 $ 26,081 $ 3,373 12.9 % % of revenue 36.3 % 35.7 % Product margin % 36.0 % 37.2 % Service margin % 36.7 % 32.1 % Gross margin for the first quarter of fiscal 2023 increased by $3.4 million, or 12.9% compared with the same quarter of fiscal 2022. For the first three months of fiscal 2023, gross margin improved over the same period in fiscal 2022 primarily due to higher volume of Private Network business and increased sales through the Aviat Store which serves primarily the Rural Broadband space. Gross margins continue to be pressured by expedite fees and inflation as we work to overcome supply chain issues. However, our pricing actions to offset higher costs continue to gain momentum, as well as the accretive contribution of the Redline business. Product margin as a percentage of product revenue decreased in the first quarter of fiscal 2023 compared with the same period of fiscal 2022 primarily due to increased supply chain costs. Service margin as a percentage of service revenue increased in the first quarter of fiscal 2023 compared to the same period in fiscal 2022. Research and Development Expenses Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Research and development $ 6,087 $ 5,910 $ 177 3.0 % % of revenue 7.5 % 8.1 % Our research and development expenses increased by $0.2 million, or 3.0%, in the three months of fiscal 2023 compared with the same period of fiscal 2022 primarily due to the increased product development activities. Selling and Administrative Expenses Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Selling and administrative $ 17,504 $ 12,698 $ 4,806 37.8 % % of revenue 21.5 % 17.4 % 27 Our selling and administrative expenses increased by $4.8 million, or 37.8%, in the first quarter of fiscal 2023 compared with the same period in fiscal 2022. The increase for the three months of fiscal 2023 compared to comparable period of fiscal 2022 was primarily due to variable compensation and Redline related integration costs. Restructuring charges Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Restructuring charges $ 1,950 $ 659 $ 1,291 195.9 % In the first quarter of fiscal 2023, we recorded restructuring charges of $2.0 million primarily related to the restructuring plan (the “Fiscal 2023 Plan”). As of September 30, 2022, the accrual balance of $1.5 million was in short-term restructuring liabilities on our unaudited condensed consolidated balance sheets. Included in the plans for which we were carrying a provision were positions identified for termination that have not been executed from a restructuring perspective. Other Expense/Income, net Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Other expense (income), net $ 2,782 $ (28) $ 2,810 * * percentage not meaningful Our other expenses (income), net increased by $2.8 million in the three months of fiscal 2023, compared with the same period of fiscal 2022 primarily due to loss of value related to the marketable securities and the movement in foreign exchange . Income Taxes Three Months Ended (In thousands, except percentages) September 30, 2022 October 1, 2021 $ Change % Change Income before income taxes $ 1,131 $ 6,842 $ (5,711) (83.5) % Provision for income taxes $ 3,877 $ 2,160 $ 1,717 79.5 % 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 expense for the first three months of fiscal 2023 was primarily due to the tax expense related to U.S. and profitable foreign subsidiaries, including deferred tax expense associated with our acquisition of Redline in July 2022 and subsequent restructuring impact. See Note 10: Acquisition. The tax expense for the first quarter of fiscal 2022 was primarily due to tax expense related to U.S. and profitable subsidiaries. 28 Liquidity, Capital Resources, and Financial Strategies Sources of Cash As of September 30, 2022, our total cash and cash equivalents were $21.6 million. Approximately $8.2 million, or 38.0%, was held in the United States. The remaining balance of $13.4 million, or 62.0%, was held by entities outside the United States. Of the amount of cash and cash equivalents held by our foreign subsidiaries on September 30, 2022, $12.1 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 used in operating activities was $6.3 million for the first three months of fiscal 2023, compared to $0.7 million cash provided from operations for the first three months of fiscal 2022; 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 $9.2 million for the first three months of 2023. The net changes in operating assets and liabilities resulted in a net use of cash of $12.7 million for the first three months of fiscal 2023, compared to net use of cash of $7.9 million for the same period in fiscal 2022. Changes in operating assets and liabilities resulted in a net use of cash for the first three months of fiscal 2023 primarily related to Accounts receivable that fluctuate from period to period, depending on the amount, timing of sales and billing activities and cash collections; and an increase in certain levels of inventories primarily to mitigate supply chain constraints. The use of cash from assets and liabilities was partially offset by the timing of payments from Accounts payable and by customer Advance payments and unearned revenue. Investing Activities Net cash used in investing activities was $8.3 million for the first three months of fiscal 2023, consisting of payment for acquisition net of cash and cash equivalent, and investment in property, plant, and equipment, less consideration received from sale of marketable securities. Net cash used in investing activities was $0.5 million for the first three months of fiscal 2022, driven by investments in property, plant, and equipment. Financing Activities Financing cash flows consist primarily from 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 $0.3 million for the first three months of fiscal 2023, due to payments for taxes related to settlement of equity awards of $0.7 million partially offset by the issuance of common stock under employee stock plans of $0.4 million. 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 September 30, 2022, our principal sources of liquidity consisted of $21.6 million in cash and cash equivalents; $22.0 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 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 29 accounts receivable formula-based revolving credit facility can also be utilized to issue letters of credit with a $12.0 million sub-limit. As of September 30, 2022, available credit under the SVB Credit Facility was $22.0 million, reflecting the lower available limit of $25.0 million less outstanding letters of credit of $3.0 million. We borrowed and repaid $15.0 million against the SVB Credit Facility during the fiscal quarter and the interest rate was 5.83%.. As of September 30, 2022 there was no borrowing outstanding. As of September 30, 2022, 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. Restructuring Payments We had liabilities for restructuring activities totaling $1.5 million as of September 30, 2022, 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 2022 Annual Report on Form 10-K filed with the SEC on September 14, 2022 include our commercial commitments and contractual obligations. During the first three months of fiscal 2023, 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 2022 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 September 30, 2022, 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 September 30, 2022, we had commercial commitments of $64.3 million. Please refer to “Note 13 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 2022 Annual Report on Form 10-K.