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 Aviat Networks, Inc. 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. See “Item 1A. Risk Factors” in the Company’s fiscal 2023 Annual Report on Form 10-K filed with the SEC on August 30, 2023 for more information regarding factors that may cause its 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 2024 and 2023 Results The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand Aviat’s results of operations and financial condition. MD&A is provided as a supplement to, and should be read in conjunction with, the Company’s unaudited condensed consolidated financial statements and accompanying notes. In the discussion herein, the fiscal year ending June 28 , 2024 is referred to as “fiscal 2024” or “2024” and the fiscal year ended June 30, 2023 is referred to as “fiscal 2023” or “2023.” Overview Aviat is a global supplier of microwave networking and access networking solutions, backed by an extensive suite of professional services and support. Aviat sells radios, routers, software and services integral to the functioning of data transport networks. Aviat has more than 3,000 customers and significant relationships with global service providers and private network operators. Aviat’s North America manufacturing base consists of a combination of contract manufacturing and assembly and testing operated in Austin, Texas by Aviat. Additionally, Aviat utilizes a contract manufacturer based in Asia for much of its international equipment demand. Aviat’s technology is underpinned by more than 500 patents. Aviat competes on the basis of total cost of ownership, microwave radio expertise and solutions for mission critical communications. Aviat has a global presence. 20 Acquisitions NEC’s Wireless Transport Business On May 9, 2023, the Company entered into the Purchase Agreement with NEC. Pursuant to the Purchase Agreement, the Company will purchase certain assets and liabilities from NEC relating to NEC’s wireless backhaul business. Initial consideration due at the closing of the NEC Transaction will be comprised of (i) an amount in cash equal to $45.0 million, subject to certain post-closing adjustments, and (ii) the issuance of $25.0 million in Company common stock. Aggregate consideration will be approximately $70.0 million. The Company has obtained permanent financing to fund the cash portion of the NEC Transaction. See Note 7. Credit Facility and Debt for further information. The Purchase Agreement contains certain customary termination rights, including, among others, (i) the right of the Company or NEC to terminate if all the conditions to closing have not been either waived or satisfied on or before February 9, 2024 and (ii) there is a final non-appealable order of a government entity prohibiting the consummation of the NEC Transaction. The NEC Transaction remains subject to, among other things, regulatory approvals and satisfaction of other customary closing conditions. NEC is a leader in wireless backhaul networks with an extensive installed base of their Pasolink series products. The Company expects to complete the NEC Transaction in the fourth quarter of calendar year 2023. Redline Communications Group Inc. In the first quarter of fiscal 2023, the Company acquired all of the issued and outstanding shares of Redline, for a purchase price of $ 20.4 million. Redline is a leading provider of mission-critical data infrastructure. Operations Review The market for mobile backhaul continued to be the Company’s primary addressable market segment globally in the first three months of fiscal 2024. In North America, the Company supported 5G and long-term evolution (“LTE”) deployments of its mobile operator customers, public safety network deployments for state and local governments, and private network implementations for utilities and other customers. In international markets, the Company’s business continued to rely on a combination of customers increasing their capacity to handle subscriber growth and the ongoing build-out of some large LTE and 5G deployments. Aviat’s position continues to be to support its customers for 5G and LTE readiness and ensure that its technology roadmap is well aligned with evolving market requirements. Aviat’s strength in turnkey and after-sale support services is a differentiating factor that wins business for the Company and enables it to expand its business with existing customers. Additionally, Aviat operates an e-commerce platform that provides low-cost services, simple experience, and fast delivery to mobile operators and private network customers. However, as disclosed above and in the “Risk Factors” section in Item 1A of its Annual Report on Form 10-K filed with the SEC on August 30, 2023, a number of factors could prevent the Company from achieving its objectives, including ongoing pricing pressures attributable to competition and macroeconomic conditions in the geographic markets that it serves. Revenue The Company manages its 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 29, 2023 and September 30, 2022 and the related changes were as follows: Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change North America $ 55,508 $ 48,848 $ 6,660 13.6 % Africa and the Middle East 9,953 10,984 (1,031) (9.4) % Europe 5,252 4,500 752 16.7 % Latin America and Asia Pacific 16,853 16,919 (66) (0.4) % Total revenue $ 87,566 $ 81,251 $ 6,315 7.8 % Revenue in North America increased by $6.7 million during the first quarter of fiscal 2024 compared with the same period of fiscal 2023, primarily due to strong private network and tier 1 demand. 21 Revenue in Africa and the Middle East decreased by $(1.0) million during the first quarter of fiscal 2024 compared with the same period of fiscal 2023, primarily due to cyclical softness in the capital expenditure plans of large mobile operators in the region. Revenue in Europe increased by $0.8 million for the first quarter of fiscal 2024 compared with the same period of fiscal 2023, primarily due to increased sales to mobile operators in the region. Revenue in Latin America and Asia Pacific decreased by $0.1 million during the first quarter of fiscal 2024 compared with the same period of fiscal 2023, primarily due to timing of projects with mobile operators. Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Product sales $ 59,545 $ 55,101 $ 4,444 8.1 % Services 28,021 26,150 1,871 7.2 % Total revenue $ 87,566 $ 81,251 $ 6,315 7.8 % Revenue from product sales and services increased by 8.1% and 7.2%, respectively for the first quarter of fiscal 2024 compared with the same quarter of fiscal 2023. The relatively proportionate increases were driven by the same overall factors of revenue growth discussed previously. Gross Margin Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Revenue $ 87,566 $ 81,251 $ 6,315 7.8 % Cost of revenue 55,714 51,797 3,917 7.6 % Gross margin $ 31,852 $ 29,454 $ 2,398 8.1 % % of revenue 36.4 % 36.3 % Product margin % 39.0 % 36.0 % Service margin % 30.8 % 36.7 % Gross margin for the first quarter of fiscal 2024 increased by $2.4 million compared with the same quarter of fiscal 2023, primarily due to a higher proportion of sales to North American customers where the Company’s margins are historically strongest. Research and Development Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Research and development $ 6,424 $ 6,087 $ 337 5.5 % % of revenue 7.3 % 7.5 % Research and development expenses increased by $0.3 million in the first quarter of fiscal 2024 compared with the same period of fiscal 2023, primarily due to increased product development activities. Selling and Administrative Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Selling and administrative $ 19,237 $ 17,504 $ 1,733 9.9 % % of revenue 22.0 % 21.5 % Selling and administrative expenses increased by $1.7 million in the first quarter of fiscal 2024 compared with the same period in fiscal 2023, primarily due to variable compensation and merger and acquisition related expenses. Restructuring 22 Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Restructuring charges $ 644 $ 1,950 $ (1,306) (67.0) % In the first quarter of fiscal 2024, restructuring charges were $0.6 million, a decrease of $(1.3) million compared to the same period in fiscal 2023. The prior year includes non-recurring restructuring charges primarily associated with the Redline acquisition completed in the first quarter of fiscal 2023. The Company’s successfully executed restructuring initiatives have enabled it to restructure specific groups to optimize skill sets and align its organizational structure to execute on strategic deliverables, in addition to aligning cost structure with the core of the business. Other Expense, net Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Other expense, net $ 901 $ 2,782 $ (1,881) (67.6) % Other expense, net decreased by $(1.9) million in the first quarter of fiscal 2024, compared with the same period of fiscal 2023, primarily due to non-recurring losses of $1.7 million recognized on the sale of marketable securities included in the prior year. Income Taxes Three Months Ended (In thousands, except percentages) September 29, 2023 September 30, 2022 $ Change % Change Income before income taxes $ 4,646 $ 1,131 $ 3,515 310.8 % Provision for income taxes $ 641 $ 3,877 $ (3,236) (83.5) % The Company estimates its annual effective tax rate at the end of each quarterly period, and records 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. Tax expense for the first quarter of fiscal 2024 was primarily attributable to tax expense for the U.S. entity and profitable foreign subsidiaries. Tax expense for the first quarter of fiscal 2023 was primarily attributable to tax expense for the U.S. entity and profitable foreign subsidiaries, including deferred tax expense associated with the acquisition of Redline in July 2022 and the subsequent multi-step restructuring, in which two Canadian Redline corporations converted to unlimited liability companies and then amalgamated by the end of September 2022. Liquidity, Capital Resources, and Financial Strategies Sources of Cash As of September 29, 2023, the Company’s total cash and cash equivalents were $35.5 million. Approximately $19.0 million was held in the United States. The remaining balance of $16.5 million was held by entities outside the United States. Of the amount of cash and cash equivalents held by the Company’s foreign subsidiaries on September 29, 2023, $15.6 million was held in jurisdictions where its undistributed earnings are indefinitely reinvested, and if repatriated, would be subject to foreign withholding taxes. Operating Activities Operating cash flows is presented as net income adjusted for certain non-cash items and changes in operating assets and liabilities. Net cash provided by (used in) operating activities was $14.0 million for the first three months of fiscal 2024, compared with $(6.3) million in the prior year. The $20.3 million increase is primarily attributable to improvements in working capital and increased net income prior to non-cash adjustments compared to the prior year. 23 Investing Activities Net cash used in investing activities was $0.7 million for the first three months of fiscal 2024, compared to $8.3 million in the prior year. The $7.6 million decrease is primarily due to non-recurring activity included in the prior year associated with the Redline acquisition partially offset by proceeds received on the sale of marketable securities. Financing Activities Financing cash flows consist primarily of borrowings and repayments under the Company’s Credit Facility and proceeds from the exercise of employee stock options. Net cash provided by (used in) financing activities was $0.2 million for the first three months of fiscal 2024, compared with $(0.3) million in the prior year. The $0.5 million change is primarily due to less payments for taxes related to the net settlement of equity awards, partially offset by lower proceeds on the exercise of employee stock options. As of September 29, 2023, the Company’s principal sources of liquidity consisted of $35.5 million in cash and cash equivalents, $38.8 million of available credit under its Credit Facility, and future collections of receivables from customers. The Company regularly requires 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 its credit and sovereign risk. Historically, the Company’s primary sources of liquidity have been cash flows from operations and credit facilities. Additionally, the Company has an effective shelf registration statement on Form S-3 allowing it to offer and sell, either individually or in combination, in one or more offerings, up to a total dollar amount of $200.0 million of any combination of the securities described in the shelf registration statement or a related prospectus supplement. The Company believes that its existing cash and cash equivalents, the available borrowings under its Credit Facility, the availability under its effective shelf registration statement and future cash collections from customers will be sufficient to provide for its anticipated requirements and plans for cash for at least the next 12 months. In addition, the Company believes these sources of liquidity will be sufficient to provide for its anticipated requirements and plans for cash beyond the next 12 months. The Company borrowed and repaid $25.2 million against the Credit Facility during the first three months of fiscal 2024. As of September 29, 2023, the Company had no borrowings outstanding and was in compliance with all financial covenants contained in the Credit Facility. As of September 29, 2023, the Company had commercial commitments outstanding of $60.5 million, that were not recorded on the unaudited condensed consolidated balance sheets. The Company does not believe, based on historical experience and information currently available, that it is probable that any significant amounts will be required to be paid on these performance guarantees in the future. Critical Accounting Estimates For information about the Company’s 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 its fiscal 2023 Annual Report on Form 10-K.