SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2005 |
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ___________ to __________ |
Commission File Number 0-27266
Westell Technologies, Inc.
(Exact name of registrant as specified in its charter)
| DELAWARE | 36-3154957 |
| |||
(State or other jurisdiction of | (I.R.S. Employer |
| ||||
incorporation or organization) | Identification Number) | |||||
| 750 N. Commons Drive, Aurora, IL | 60504 |
| |
(Address of principal executive offices) | (Zip Code) | |||
Registrant’s telephone number, including area code | (630) 898-2500 |
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check or mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant is an accelerated filer as defined be rule 12b-2 of the Act. | |||
Yes | X | No |
|
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of July 25, 2005:
Class A Common Stock, $0.01 Par Value – 55,392,575 shares
Class B Common Stock, $0.01 Par Value – 14,741,872 shares
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION: | Page No. |
Item 1. Financial Statements |
Consolidated Balance Sheets | 3 | ||
- | As of June 30, 2005(unaudited) and March 31, 2005 |
| |
Consolidated Statements of Operations (unaudited) | 4 | ||
- | Three months ended June 30, 2005 and 2004 |
| |
Consolidated Statements of Cash Flows (unaudited) | 5 | ||
- | Three months ended June 30, 2005 and 2004 |
| |
Notes to the Consolidated Financial Statements (unaudited) | 6 |
Item 2. Management’s Discussion and Analysis of Financial Condition |
| ||
| and Results of Operations | 11 | |
Item 3. Quantitative and Qualitative Disclosures About Market Risks | 15 |
Item 4. Controls and Procedures | 16 |
PART II OTHER INFORMATION
Item 1. Legal Proceedings | 16 |
Item 6. Exhibits | 16 |
Safe Harbor Statement
Certain statements contained in this Quarterly Report of Form 10-Q regarding matters that are not historical facts or that contain the words “believe”, “expect”, “intend”, “anticipate” or derivatives thereof and other words of similar meaning, are forward-looking statements. Such forward-looking statements include risks and uncertainties, and actual results may differ materially from those expressed in or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those discussed under “Risk Factors” set forth in Westell Technologies, Inc.’s Annual Report on Form 10-K for the fiscal year ended March 31, 2005. Our actual results may differ from these forward-looking statements. Westell Technologies, Inc. undertakes no obligation to publicly update these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events or otherwise.
2 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES | ||
| CONSOLIDATED BALANCE SHEETS |
|
ASSETS |
| June 30, 2005 |
| March 31, 2005 |
| |||
|
|
| |||||
| (unaudited) |
| |||||
| (in thousands) |
| |||||
Current assets: |
|
|
|
| |||
Cash and cash equivalents | $ 30,625 |
| $ 26,350 |
| |||
Investments | 1,283 |
| 610 |
| |||
Accounts receivable (net of allowance of $306,000 and $278,000 respectively) |
33,928 |
|
30,167 |
| |||
Inventories | 23,923 |
| 26,419 |
| |||
Prepaid expenses and other current assets | 2,545 |
| 2,806 |
| |||
Deferred income tax asset | 3,980 |
| 3,980 |
| |||
Total current assets | 96,284 |
| 90,332 |
| |||
|
|
| |||||
Property and equipment: |
|
|
|
| |||
Machinery and equipment | 43,534 |
| 44,505 |
| |||
Office, computer and research equipment | 25,505 |
| 25,270 |
| |||
Leasehold improvements | 8,779 |
| 8,810 |
| |||
|
|
| |||||
| 77,818 |
| 78,585 |
| |||
Less accumulated depreciation and amortization | 62,340 |
| 62,067 |
| |||
|
|
| |||||
Property and equipment, net | 15,478 |
| 16,518 |
| |||
|
|
| |||||
Goodwill | 6,990 |
| 6,990 |
| |||
Intangibles, net | 6,307 |
| 6,893 |
| |||
Deferred income tax asset and other assets | 57,955 |
| 59,357 |
| |||
|
|
| |||||
Total assets | $ 183,014 |
| $ 180,090 |
| |||
|
|
| |||||
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities: |
|
|
|
|
Accounts payable | $ 18,788 |
| $ 19,671 |
|
Accrued expenses | 8,684 |
| 7,962 |
|
Accrued compensation | 2,656 |
| 6,627 |
|
Deferred revenue | 1,076 |
| 1,234 |
|
Current portion of long-term debt | 174 |
| 318 |
|
|
|
| ||
Total current liabilities | 31,378 |
| 35,812 |
|
Other long-term liabilities | 2,089 |
| 2,080 |
|
|
|
| ||
Total liabilities | 33,467 |
| 37,892 |
|
|
|
|
|
|
Minority interest | 2,628 |
| 2,540 |
|
Stockholders' equity: |
|
|
|
|
Class A common stock, par $0.01 Authorized – 109,000,000 shares Issued and outstanding – 54,240,298 shares at March 31, 2005 and 54,943,798 shares at June 30, 2005 | 549 |
| 542 |
|
Class B common stock, par $0.01 Authorized – 25,000,000 shares Issued and outstanding – 14,741,872 shares at March 31, 2005 and June 30, 2005 | 147 |
| 147 |
|
Preferred stock, par $0.01 Authorized – 1,000,000 shares Issued and outstanding - none | -- |
| -- |
|
Deferred compensation | (2,270) |
| (2,476) |
|
Additional paid-in capital | 391,881 |
| 389,242 |
|
Treasury stock at cost – 93,100 shares | (247) |
| (247) |
|
Cumulative translation adjustment | (412) |
| (672) |
|
Accumulated deficit | (242,729) |
| (246,878) |
|
|
|
| ||
Total stockholders' equity | 146,919 |
| 139,658 |
|
|
|
| ||
Total liabilities and stockholders' equity | $ 183,014 |
| $ 180,090 |
|
|
|
|
The accompanying notes are an integral part of these Consolidated Financial Statements.
3 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
| Three Months Ended June 30, |
| ||
|
| |||
| 2005 |
| 2004 |
|
|
|
| ||
| (unaudited) (in thousands, except per share data) |
| ||
|
| |||
|
|
|
|
|
Equipment revenue | $ 63,736 |
| $ 44,920 |
|
Service revenue | 11,905 |
| 11,252 |
|
|
|
| ||
Total revenues | 75,641 |
| 56,172 |
|
|
|
|
|
|
Cost of equipment sales | 47,134 |
| 31,638 |
|
Cost of services | 5,864 |
| 5,988 |
|
|
|
| ||
Cost of goods sold | 52,998 |
| 37,626 |
|
|
|
| ||
|
|
|
|
|
Gross margin | 22,643 |
| 18,546 |
|
Operating expenses: |
|
|
|
|
Sales and marketing | 6,170 |
| 5,352 |
|
Research and development | 4,657 |
| 3,574 |
|
General and administrative | 4,354 |
| 4,014 |
|
Intangible amortization | 324 |
| 364 |
|
|
|
| ||
Total operating expenses | 15,505 |
| 13,304 |
|
|
|
| ||
Operating income | 7,138 |
| 5,242 |
|
|
|
|
|
|
Other (expense) income, net | (178) |
| 361 |
|
Interest expense | (4) |
| (36) |
|
|
|
| ||
Income before minority interest and income taxes |
6,956 |
|
5,567 |
|
Income taxes | 2,713 |
| 2,183 |
|
Minority interest | 94 |
| 97 |
|
|
|
| ||
Net income | $ 4,149 |
| $ 3,287 |
|
|
|
| ||
|
|
|
|
|
Net income per common share: |
|
|
|
|
Basic | $ 0.06 |
| $ 0.05 |
|
|
|
| ||
Diluted | $ 0.06 |
| $ 0.05 |
|
|
|
| ||
Weighted average number of |
|
|
|
|
Basic | 69,124 |
| 68,294 |
|
|
|
| ||
Diluted | 71,566 |
| 70,975 |
|
|
|
| ||
The accompanying notes are an integral part of these Consolidated Financial Statements
4 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Three Months Ended June 30, | ||
| |||
| 2005 |
| 2004 |
|
| ||
|
|
|
|
| (unaudited) (in thousands) | ||
|
|
|
|
Cash flows from operating activities: |
|
|
|
Net income | $ 4,149 |
| $ 3,287 |
Reconciliation of net income to net cash provided by (used in) operating activities: |
|
|
|
Capitalization of software development costs | -- |
| (358) |
Depreciation and amortization | 2,558 |
| 2,275 |
Gain on sale of fixed assets | (130) |
| -- |
Restructuring | (98) |
| (163) |
Deferred Taxes | 1,417 |
| 2,006 |
Minority interest | 94 |
| 97 |
Tax benefit received on stock option exercises | 1,103 |
| 178 |
Changes in assets and liabilities: |
|
|
|
Accounts receivable | (3,507) |
| 859 |
Inventory | 2,496 |
| (2,136) |
Prepaid expenses and other current assets | 261 |
| 43 |
Other assets | (15) |
| 97 |
Accounts payable and accrued expenses | (240) |
| (2,101) |
Accrued compensation | (3,971) |
| (4,288) |
|
| ||
Net cash provided by (used in) operating activities | 4,117 |
| (204) |
|
| ||
|
|
|
|
Cash flows from investing activities: |
|
|
|
Purchases of property and equipment | (727) |
| (294) |
Proceeds from the sale of equipment | 130 |
| -- |
Purchase of investments | (673) |
|
|
|
| ||
Net cash used in investing activities | (1,270) |
| (294) |
|
| ||
|
|
|
|
Cash flows from financing activities: |
|
|
|
Net repayment of long-term debt and leases payable | (144) |
| (2,872) |
Proceeds from the issuance of common stock | 1,544 |
| 1,917 |
|
| ||
Net cash provided by (used in) financing activities | 1,400 |
| (955) |
|
| ||
|
|
|
|
Effect of exchange rate changes on cash | 28 |
| 3 |
Net increase (decrease) in cash | 4,275 |
| (1,450) |
Cash and cash equivalents, beginning of period | 26,350 |
| 11,241 |
|
| ||
Cash and cash equivalents, end of period | $ 30,625 |
| $ 9,791 |
|
| ||
The accompanying notes are an integral part of these Consolidated Financial Statements
5 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Uaudited)
Note 1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2005.
In the opinion of management, the unaudited interim financial statements included herein reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s consolidated financial position and the results of operations and cash flows at June 30, 2005 and for all periods presented. The results of operations for the three month period ended June 30, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2006 ("fiscal year 2006").
Note 2. Computation of Income Per Share
The computation of basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share includes the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The following table sets forth the computation of basic and diluted earnings per share:
|
| Three Months Ended June 30, | ||
|
| |||
Dollars in thousands, except per share amounts |
| 2005 |
| 2004 |
|
|
| ||
Basic Earnings per Share: |
|
|
|
|
Net income |
| $ 4,149 |
| $ 3,287 |
Average basic shares outstanding |
| 69,124 |
| 68,294 |
Basic net income per share |
| $ 0.06 |
| $ 0.05 |
|
|
|
|
|
Diluted Earnings per Share: |
|
|
|
|
Net income |
| $ 4,149 |
| $ 3,287 |
Average basic shares outstanding |
| 69,124 |
| 68,294 |
Effect of dilutive securities: stock options and warrants |
| 2,442 |
| 2,681 |
|
|
| ||
Average diluted shares outstanding |
| 71,566 |
| 70,975 |
|
|
| ||
Diluted net income per share |
| $ 0.06 |
| $ 0.05 |
Options to purchase 3,489,051and 2,632,108 shares of common stock for the three months ended June 30, 2005 and June 30, 2004, respectively, were not included in the computation of diluted shares because the options’ exercise prices were greater than the average market price of the common shares.
Note 3. Restructuring Charge
The Company recognized a restructuring expense of $2.6 million in fiscal year 2003. This charge included personnel and facility costs related primarily to the closing of a Conference Plus, Inc. facility and personnel and facility charges at Westell Limited. Approximately 25 employees were impacted by these reorganizations. In fiscal year 2005, the Company terminated a lease that was partially reserved for in the 2003 restructuring. This termination resulted in the reversal of $545,000 of restructuring for facility costs. As of June 30, 2005, the Company paid approximately $2.0 million of these accrued restructuring costs leaving a balance of $90,000.
6 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Uaudited)
The Company's restructuring accrual balances, all of which are legal, facility and other costs are presented in the following table:
(in thousands) | Balance March 31, 2005 | Paid through June 30, 2005 | Balance June 30, 2005 | |
| ||||
Legal, facility and other costs | $188 | (98) | 90 | |
Note 4. Interim Segment Information
Westell’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and market strategies. They consist of:
1) | A telecommunications equipment manufacturer of broadband products, and |
2) | A multi-point telecommunications service bureau specializing in audio teleconferencing, multi-point video conferencing, broadcast fax and multimedia teleconference services. |
Performance of these segments is evaluated utilizing revenue, operating income and total asset measurements. The accounting policies of the segments are the same as those for Westell Technologies, Inc. Segment information for the three-month periods ended June 30, 2004 and 2005, are as follows:
(in thousands) | Telcom Equipment |
| Telcom Service |
| Consolidated Total |
|
|
| |||
Three months ended June 30, 2004 |
|
|
|
|
|
Revenues | $ 44,920 |
| $ 11,252 |
| $ 56,172 |
Operating income | 3,639 |
| 1,603 |
| 5,242 |
Depreciation and amortization | 1,316 |
| 959 |
| 2,275 |
Total assets | 108,292 |
| 17,593 |
| 125,885 |
|
|
|
|
|
|
Three months ended June 30, 2005 |
|
|
|
|
|
Revenues | $ 63,736 |
| $ 11,905 |
| $ 75,641 |
Operating income | 5,468 |
| 1,670 |
| 7,138 |
Depreciation and amortization | 1,751 |
| 807 |
| 2,558 |
Total assets | 164,128 |
| 18,886 |
| 183,014 |
Reconciliation of Operating income for the reportable segments to income before income taxes and minority interest:
| Three Months Ended June 30, | ||
| |||
(in thousands) | 2005 |
| 2004 |
|
| ||
Operating income | $ 7,138 |
| $ 5,242 |
Other income (expense), net | (178) |
| 361 |
Interest expense | (4) |
| (36) |
|
| ||
Income before income taxes and minority interest |
$ 6,956 |
|
$ 5,567 |
|
| ||
7 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Uaudited)
Note 5. Comprehensive Income
The disclosure of comprehensive income, which encompasses net income and foreign currency translation adjustments, is as follows:
| Three Months Ended June 30, | ||
| |||
(in thousands) | 2005 |
| 2004 |
|
| ||
Net income | $ 4,149 |
| $ 3,287 |
Other comprehensive income |
|
|
|
Foreign currency translation adjustment | 260 |
| 49 |
|
| ||
Comprehensive income | $ 4,409 |
| $ 3,336 |
|
| ||
Note 6. Inventories
The components of inventories are as follows:
| |||
| June 30, |
| March 31, |
|
| ||
(in thousands) | 2005 |
| 2005 |
|
| ||
Raw material | $ 12,922 |
| $ 16,827 |
Work in process | 96 |
| 217 |
Finished goods | 15,795 |
| 14,507 |
Reserve for excess and obsolete inventory and net realizable value |
(4,890) |
|
(5,132) |
|
| ||
| $ 23,923 |
| $ 26,419 |
|
| ||
Note 7. Stock Options
The Company has elected to follow Accounting Principle Board Opinion No. 25 “Accounting for Stock Issued to Employees” (APB No. 25) and related interpretations in accounting for its employee stock options and awards. Under APB No. 25, employee stock options are valued using the intrinsic method, and no compensation expense is recognized since the exercise price of the options equals or is greater than the fair market value of the underlying stock as of the date of the grant. The following table shows the effect on net income and income per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock Based Compensation.”
| Three months ended June 30, | ||
| |||
(in thousands, except per-share amounts) | 2005 |
| 2004 |
|
| ||
Net income, as reported | $ 4,149 |
| $ 3,287 |
Stock-based employee compensation expense included in reported net earnings, net of related tax effects |
-- |
|
-- |
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects |
(1,130) |
|
(967) |
|
| ||
Pro forma net income | $ 3,019 |
| $ 2,320 |
Earnings per common share: |
|
|
|
As reported | $ 0.06 |
| $ 0.05 |
Pro forma | $ 0.04 |
| $ 0.03 |
Earnings per common share, assuming dilution: |
|
|
|
As reported | $ 0.06 |
| $ 0.05 |
Pro forma | $ 0.04 |
| $ 0.03 |
8 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Uaudited)
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for grants in fiscal 2005 and 2006:
| 2005 |
| 2006 |
|
| ||
Expected volatility | 95% |
| 89% |
Risk-free interest rate | 3.65% |
| 3.75% |
Expected life | 5 years |
| 5 years |
Expected dividend yield | 0.0% |
| 0.0% |
Note 8. Warranty Reserve
Most of the Company’s products carry a limited warranty ranging from one to seven years. The specific terms and conditions of those warranties vary depending upon the product sold. Factors that enter into the estimate of the Company’s warranty reserve include the number of units shipped historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the reserve as necessary. The Company reports warranty reserve as both current and long term liabilities. The following table presents the changes in the Company’s product warranty reserve:
|
| Three months ended June 30, | ||
|
| |||
(in thousands) |
| 2005 |
| 2004 |
|
|
| ||
Total product warranty reserve at the beginning of the period |
|
$1,806 |
|
$1,853 |
Warranty expense |
| 548 |
| 539 |
Charged to other accounts |
| -- |
| -- |
Deductions |
| (509) |
| (554) |
|
|
| ||
Total product warranty reserve at the end of the period |
|
$1,845 |
|
$1,838 |
|
|
| ||
Note 9. Deferred Compensation
The Company has a deferred compensation program with the Chief Executive Officer that is funded through a rabbi trust. The rabbi trust qualifies as a Variable Interest Entity under FASB Interpretation No. 46, Consolidation of Variable Interest Entities and as such is consolidated in the Company's financial statements. Approximately $1.3 of cash has been funded into the rabbi trust as of June 30, 2005 and the Company has recorded a $1.3 million long term liability to accrue for the deferred compensation liability. The rabbi trust is subject to the creditors of the Company. All amounts deferred under this compensation program vest on the earlier of March 31, 2006, the executive's death, permanent disability or a change in control of the Company.
Note 10. Guarantee
In conjunction with a sale of product lines and specified fixed assets in fiscal year 2005, the Company provided an unconditional guarantee in the amount of $1.62 million relating to a 10 year term note payable to the lender that financed the transaction. This guarantee will stay in place until the note is paid in full. The Company must pay all amounts due under the note payable upon demand from the lender. In fiscal year 2005, the Company assessed its obligation under this guarantee pursuant to the provisions of FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" and recorded a $300,000 liability for the value of the guarantee. The Company will evaluate the liability periodically and adjust the value as required. No adjustments in the liability have been made to date.
9 |
WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Uaudited)
Note 11. New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”). Under this new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic value method in accordance with APB 25. Instead, companies will be required to account for such transactions using a fair-value method and recognize the expense over the service period. SFAS 123R allows for several alternative transition methods, but the Company has not yet determined the transition method it will use. On April 14, 2005, the Securities and Exchange Commission announced the adoption of a rule that defers the required effective date of SFAS 123R for registrants to the beginning of the first fiscal year beginning after June 15, 2005. The Company expects to adopt this statement in the first quarter of its 2007 fiscal year. The adoption of SFAS 123R will have an impact on the Company’s results of operations, although it will have no incremental impact on the Company’s overall financial position.
In January 2005, the Financial Accounting Standards Board (FASB) issued revised Statement of Financial Accounting Standards (SFAS) No. 151, Inventory Costs, an amendment of ARB No. 43. The amendments made by SFAS 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. SFAS 151 will be effective for the Company beginning in fiscal year 2007. The impact of SFAS 151 is not expected to have a significant impact to the consolidated financial statements.
Note 12. Subsequent Event
In July 2005 all 512,820 outstanding warrants were exercised on a cashless basis resulting in the issuance by the Company of 369,036 shares of Class A Common stock.
10 |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview
The Company is comprised of two segments: telecommunications equipment manufacturer and teleconference services bureau. The equipment manufacturing segment consists of two product lines: Customer Networking Equipment (CNE) products and Network Service Access (NSA) products. The CNE product line includes broadband and digital subscriber line (DSL) technology products that allow the transport of high-speed data over the local loop and enable telecommunications companies to provide broadband services over existing copper infrastructure. The Company’s NSA product line consists of manageable and non-manageable T1 transmission equipment, associated mountings and special service plugs for the legacy copper telephone network. Westell realizes the majority of its revenues from the North American market.
The Company’s teleconference service segment is comprised of a 91.5% owned subsidiary, Conference Plus, Inc. Conference Plus provides audio, video, and web conferencing services. Businesses and individuals use these services to hold voice, video or web conferences with many people at the same time. Conference Plus sells its services directly to large customers, including Fortune 1000 companies, and serves other customers indirectly through its private label reseller program.
The equipment manufacturing segment of the Company’s business consists of two product lines, offering a broad range of products that facilitate the broadband transmission of high-speed digital and analog data between a telephone company's central office and end-user customers. These two product lines are:
• | Customer Networking Equipment (CNE): Westell’s family of broadband products enable the transport of high-speed data over existing local telephone lines and allow telecommunications companies to provide broadband services using their current copper infrastructure. The Company’s broadband products also enable residential, small business and Small Office Home Office (SOHO) users to network multiple computers, telephones and other devices to access the Internet. Digital Subscriber Lines (DSL) products make up the majority of the revenue in this product group. |
• | Network Service Access (NSA): Westell’s NSA product family consists of manageable and non-manageable T1 transmission equipment for telephone services, and an array of mounting products used for connecting telephone wires and cables, and special service plugs. The T1 transmission equipment termed Network Interface Units (NIU) and the associated NIU mounting products make up the majority of revenue from this product group. |
Below is a table that compares equipment and service revenues for the quarter ended June 30, 2005 with the quarter ended June 30, 2004 by product line.
| Three months ended June 30, | ||||
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(in thousands) | 2005 | % |
| 2004 | % |
|
| ||||
CNE | $ 53,044 | 70.1% |
| $ 31,803 | 56.6% |
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NSA | 10,692 | 14.2% |
| 13,117 | 23.4% |
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|
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Total equipment | 63,736 | 84.3% |
| 44,920 | 80.0% |
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|
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Services | 11,905 | 15.7% |
| 11,252 | 20.0% |
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|
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|
|
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Total revenues | $ 75,641 |
|
| $ 56,172 |
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The prices for the products within each market group vary based upon volume, customer specifications and other criteria and are subject to change due to competition among telecommunications manufacturers and service providers. Increasing competition, in terms of the number of entrants and their size, and increasing size of the Company’s customers because of past mergers, continues to exert downward pressure on prices for the Company's products.
The Company's customer base is comprised primarily of the Regional Bell Operating Companies (RBOCs), independent domestic local exchange carriers and public telephone administrations located outside the U.S. Due to the stringent quality specifications of its customers and the regulated environment in which its customers
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operate, the Company must undergo lengthy approval and procurement processes prior to selling its products. Accordingly, the Company must make significant upfront investments in product and market development prior to actual commencement of sales of new products.
To remain competitive, the Company must continue to invest in new product development and invest in targeted sales and marketing efforts to cover new product lines. Failure to increase revenues from new products, whether due to lack of market acceptance, competition, technological change or otherwise, would have a material adverse effect on the Company's business and results of operations. The Company expects to continue to evaluate new product opportunities and engage in extensive research and development activities.
The Company is focusing on expanding its product offerings in the equipment segment from basic high speed broadband to more sophisticated applications such as networking, VoIP, wireless systems, video, multimedia distribution and control and user interfaces. This will require the Company to continue to invest in research and development and sales and marketing, which could adversely affect short-term results of operations. In view of the Company’s reliance on the DSL market for revenues and the unpredictability of orders and pricing pressures, the Company believes that period-to-period comparisons of its financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. Revenues from NSA products such as NIUs have declined in recent years due primarily to reduced demand resulting from the migration by telephone companies to high-speed digital transmission products and the sale of Data Station Termination product lines that occurred in the first quarter of fiscal 2005.
In the equipment manufacturing segment, the Company is focusing on new product opportunities such as the DSL wireless gateway, voice/media-over-IP, and vertical applications. The Company has introduced new products including UltralineTM, ProLineTM, VersaLinkTM, TriLinkTM and TR-069 compliant software which are targeted at the home networking, small office/home office (SOHO) and small business markets. The Company continues to support the Verizon One product, a multimedia gateway. The Company has multiple evaluations and is entering trials for TriLinkTM, UltraLineTM and the Westell Media Gateway, a variation of the VerizonOne product marketed outside of the United States. The Company continues to focus on expanding existing and new products into the international markets such as Europe, Canada, Mexico and the Pacific Rim.
The Company expects revenue and earnings per share in the quarter ended September 30, 2005 to be lower than revenue and earnings per share in the June 30, 2005 quarter as a result of seasonal weakness, a change in customers promotional strategies, deferred product transitions and additional pricing pressures. The Company expects to sell a higher mix of its ProlineTM product and fewer VersaLinkTM units in the quarter ended September 30, 2005 compared to June 30, 2005. As the selling price of VersaLinkTM is higher than that of the ProlineTM product, lower revenue is expected. The Company believes that its customers continue to expect growth in the broadband market that the Company’s CNE products serve. More users are subscribing to DSL services and some subscribers currently using DSL technology desire new DSL technology as the older modems cannot deliver newer applications that require higher broadband speed.
The NSA market continues to decline as the transition to high-speed digital service continues. The Company expects NSA revenue to continue to decline 10% to 15% per year. The Company’s goal is to increase market share in mountings and NIUs in the NSA market to offset in part reduced prices for NIUs and mountings. The Company is investing in new products in the NSA product line that complement the broadband market products such as PowerSpan that may support the deployment of VoIP in residential markets and partnership derived products such as VirtualEdgeTM and INTELePORTTM.
Results of Operations
Revenues | Three months ended June 30, | ||||
| |||||
| 2005 |
| 2004 |
| Change |
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|
| |||
Consolidated revenue | $75,641 |
| $56,172 |
| $19,469 |
Equipment revenue: |
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|
|
|
CNE | 53,044 |
| 31,803 |
| 21,241 |
NSA | 10,692 |
| 13,117 |
| (2,425) |
Total equipment revenue | 63,736 |
| 44,920 |
| 18,816 |
Services revenue | 11,905 |
| 11,252 |
| 653 |
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CNE revenue increased due to a 45% increase in unit sales and an overall increase in selling price per unit of 12% due to the sale of VersaLinkTM product in fiscal 2005 which has a higher selling price per unit than traditional modems. Traditional modem units sales decreased 10% and had price reduction of 13% in the first quarter of fiscal 2005 compared to the same period in fiscal 2004. NSA revenues decreased due to lower unit sales and lower selling prices per unit. In addition, NSA product revenue in the June 30, 2004 quarter includes an $883,000 contractual settlement from a customer, $900,000 of non-recurring revenue and approximately $500,000 of revenue from a product line subsequently sold. The overall decrease in NSA product revenue is due to reduced demand resulting from the migration by telephone companies to high-speed digital transmission products. Revenue in the services segment increased due to an increase in minutes billed in the fiscal year 2005 quarter offset in part by lower revenue per minute at the Company’s Conference Plus, Inc. subsidiary.
Gross Margin | Three months ended June 30, | ||||
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| 2005 |
| 2004 |
| Change |
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|
| |||
Consolidated Margin | 29.9% |
| 33.0% |
| (3.1)% |
Equipment Margin | 26.0% |
| 29.6% |
| (3.6)% |
Service Margin | 50.7% |
| 46.8% |
| 3.9% |
Gross margin as a percent of sales in the equipment segment declined due primarily to a higher mix of CNE sales and lower NSA sales in the three months ended June 30, 2005 compared to June 30, 2004. In addition, the June 30, 2004 margin includes the $833,000 contractual settlement mentioned above. The Company believes continued pricing pressures and continued reduction of NSA sales affecting its equipment segment could continue to adversely impact margins in the future. The service margins increase is due to a reduction in long distance rates and a decrease in depreciation expense. It is the Company’s strategy to offset the effects of these anticipated price reductions with continued cost reductions and introducing new products that have higher sales prices and margins.
Sales and Marketing | Three months ended June 30, | ||||
| |||||
| 2005 |
| 2004 |
| Change |
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|
| |||
Consolidated sales and marketing expense | $6,170 |
| $5,352 |
| $818 |
Equipment sales and marketing expense | 4,017 |
| 3,808 |
| 209 |
Services sales and marketing expense | 2,153 |
| 1,544 |
| 609 |
The equipment segment sales and marketing expenses increase was primarily due to salary increases. Sales and marketing expense increase in the Company’s services segment was due primarily to more employees at Conference Plus. The Company believes that sales and marketing expense in the future will continue to be a significant percent of revenue and will be required to expand its product lines, bring new products to market and service customers.
Research and Development | Three months ended June 30, | ||||
| |||||
| 2005 |
| 2004 |
| Change |
|
|
| |||
Consolidated research and development expense | 4,657 |
| 3,574 |
| 1,083 |
Equipment research and development expense | 4,200 |
| 3,172 |
| 1,028 |
Services research and development expense | 457 |
| 402 |
| 55 |
The increase in research and development expense is primarily a result of more employees in the period ended June 30, 2005. In addition, the Company capitalized $358,000 of engineering expenses as an intangible asset for TR-069 compliant software in the three months ended June 30, 2004. No costs were capitalized in the period ended June 30, 2005. The Company believes that research and development expenses will increase in fiscal year 2006 as the Company continues to expand its product offerings. Areas of focus include VoIP, video, multimedia distribution and control, wireless systems, user interfaces and other broadband applications.
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General and Administrative | Three months ended June 30, | ||||
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| 2005 |
| 2004 |
| Change |
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|
| |||
Consolidated general and administrative expense | $4,354 |
| $4,014 |
| $340 |
Equipment general and administrative expense | 2,579 |
| 2,281 |
| 298 |
Services general and administrative expense | 1,775 |
| 1,733 |
| 42 |
The increase in general and administrative expense in the equipment segment was due primarily to increased fees relating to Sarbanes-Oxley 404 compliance.
Intangible amortization Intangible assets include product technology related to the March 17, 2000 acquisition of Teltrend Inc. Intangible amortization expense, which is attributed to the equipment segment, was $324,000 and $364,000 for the three months ended June 30, 2005 and 2004, respectively.
Other income (expense), net Other income (expense), net was $178,000 of expense in the three months ended June 30, 2005 and $361,000 of income for the three-month period ended June 30, 2005. The June 30, 2004 quarter contained income from a $400,000 legal settlement in the equipment segment. The remainder of other income (expense), net for the three-month period ended June 30, 2004 and all of the three month period ended June 30, 2005 was comprised of interest income earned on temporary cash investments and unrealized gains or losses on intercompany balances denominated in foreign currency.
Interest expense Interest expense decreased to $4,000 in the three months ended June 30, 2005 from $36,000 in the three months ended June 30, 2004. The decrease in interest expense during the current period is a result of lower net obligations outstanding during the period.
Income taxes The Company recorded $2.7 and $2.2 million of income tax expense in the three-month periods ended June 30, 2005 and 2004, respectively, based on an estimated tax rate for the year of approximately 39%.
Liquidity and Capital Resources
At June 30, 2005, the Company had $30.6 million in cash and cash equivalents consisting primarily of federal government agency instruments and the highest rated grade corporate commercial paper. At June 30, 2005, the Company had no amounts outstanding and $28.4 million available under its secured revolving credit facility.
On June 30, 2005, the Company had a revolving credit facility that provided for maximum borrowings of up to $30 million. The term on the credit facility expires on June 30, 2006. This asset based revolving credit facility provides for total borrowings based upon 85% of eligible accounts receivable and 30% of eligible inventory not to exceed $4.0 million as of June 30, 2005. The $4.0 million inventory limitation is reduced by $0.1 million on the first day of each month. Borrowings under this facility provide for the interest to be paid by the Company at the prime rate or Libor rate plus 2.5%. This credit facility contains covenants regarding EBITDA, tangible net worth and maximum capital expenditures. The Company was in compliance with these covenants on June 30, 2005 and expects to comply with these covenants for the term of the credit facility. The Company expects to replace the existing credit facility with a new facility with similar borrowing capacity prior to June 30, 2006.
In connection with the Company’s management changes implemented at its subsidiary Conference Plus, Inc., in fiscal year 2003, the Company purchased 3.2% of the outstanding shares of common stock of Conference Plus, Inc. from former officers of Conference Plus, Inc. for approximately $1.6 million payable in cash and promissory notes. The purchase price was based upon the minority interest value set forth in an appraisal of Conference Plus, Inc. As of June 30, 2005, there was $126,000 outstanding under these notes.
The Company’s operating activities generated cash of $4.1 million in the three month period ended June 30, 2005. Cash generated by operations resulted primarily from net income, non-cash depreciation and amortization in both segments and reductions in inventory offset in part by increases in accounts receivable and reductions in accrued compensation in the equipment segment
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Capital expenditures for the three month period ended June 30, 2005 were $727,000. The capital expenditures in the equipment segment were $400,000 and were primarily for machinery and research and development equipment purchases. The services segment capital expenditures were $327,000. These expenditures were primarily for computer and telecom bridge equipment.
At June 30, 2005 the Company’s principle sources of liquidity were $30.6 million of cash and the secured revolving credit facility under which the Company was eligible to borrow up to an additional $28.4 million based upon receivables and inventory levels. Cash in excess of operating requirements, if any, will be invested on a short-term basis in federal government agency instruments and the highest rated grade commercial paper. The Company believes its future cash requirements for the next twelve months will be satisfied by cash generated from operations and its current credit facility.
The Company had deferred tax assets of approximately $68.5 million at June 30, 2005, consisting primarily of net operating loss carryforwards. The Company has recorded a valuation allowance reserve of $7.3 million to reduce the recorded net deferred tax asset to $61.2 million.
The net operating loss carryforwards begin to expire in 2012. Realization of deferred tax assets associated with the Company’s future deductible temporary differences, net operating loss carryforwards and tax credit carryforwards is dependent upon generating sufficient taxable income prior to their expiration. The Company uses estimates of future taxable income and a tax planning strategy that involves the potential sale of the Company’s 91.5% subsidiary Conference Plus, Inc. to access the valuation allowance required against deferred tax assets. Management periodically evaluates the recoverability of the deferred tax assets and will adjust the valuation allowance against deferred tax assets accordingly.
Critical Accounting Policies
There were no changes in critical accounting policies during the quarter.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Westell is subject to certain market risks, including foreign currency and interest rates. The Company has foreign subsidiaries in the United Kingdom and Ireland that develop and sell products and services in those respective countries. The Company is exposed to potential gains and losses from foreign currency fluctuations affecting net investments and earnings denominated in foreign currencies. Market risk is estimated as the potential decrease in pretax earnings resulting from a hypothetical decrease in the ending exchange rate of 10%. If such a decrease occurred, the Company would incur approximately $695,000 in additional other expense based on the ending intercompany balance outstanding at June 30, 2005. The Company’s future primary exposure is to changes in exchange rates for the U.S. dollar versus the British pound and the Euro.
As of June 30, 2005, the balance in the cumulative foreign currency translation adjustment account, which is a component of stockholders’ equity, was an unrealized loss of $412,000.
The Company does not have significant exposure to interest rate risk related to its debt obligations, which are primarily U.S. Dollar denominated. The Company’s market risk is the potential loss arising from adverse changes in interest rates. In the past 12 months the Company’s debt consisted primarily of subordinated term notes. Market risk is estimated as the potential decrease in pretax earnings resulting from a hypothetical increase in interest rates of 10% (i.e. from approximately 6.3% to approximately 6.9%) average interest rate on the Company’s debt. If such an increase occurred, the Company would incur approximately $5,000 per annum in additional interest expense based on the average debt borrowed during the twelve months ended June 30, 2005. The Company does not feel such additional expense is significant.
The Company does not currently use any derivative financial instruments relating to the risk associated with changes in foreign currency or interest rates.
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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
Under the supervision and with the participation of our senior management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based on this evaluation, our chief executive officer and chief financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting.
There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2005 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is involved in various other legal proceedings incidental to the Company’s business. Management believes that the outcome of such proceedings will not have a material adverse effect on our consolidated operations or financial condition.
ITEM 6. EXHIBITS
Exhibit 3.1 | Amended and Restated Certificate of Incorporation, as amended. |
Exhibit 3.2 | Amended and Restated By-laws, as amended. |
Exhibit 31.1 Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by the Chief Financial Officer Pursuant to Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002
Exhibit 32.1 | Certification by the Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of |
the Sarbanes-Oxley Act of 2002
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
WESTELL TECHNOLOGIES, INC. | ||
| (Registrant) |
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DATE: August 9, 2005 | By: /s/ E. VAN CULLENS |
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| E. VAN CULLENS |
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| Chief Executive Officer | |||
By: /s/ NICHOLAS C. HINDMAN, Sr. | ||||
| NICHOLAS C. HINDMAN, Sr. |
| ||
| Chief Financial Officer |
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