August 11, 2000
WESTELL TECHNOLOGIES INC (WSTL)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
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OVERVIEW
Westell Technologies, Inc. ("Westell" or the "Company") derives most of its equipment revenue from the sale of telecommunications equipment that enables telecommunications services over copper telephone wires. The Company offers a broad range of products that facilitate the transmission of high-speed digital and analog data between a telephone company's central office and its end-user customers. These products can be categorized into three business units presented below.
o TELCO ACCESS PRODUCTS ("TAP"): Products that maintain, repair and monitor special service circuits used over copper telephone wires in the portion of the telephone companies' network connecting the central office with the customers' locations (the "Local Loop"). Products include all of Westell's analog products and products that support digital T-1 transmission such as its Network Interface Units ("NIU") products. o TRANSPORT SYSTEMS: DSL products that contain components that are located in the telephone companies' central offices. Products include Westell's Supervision, a system comprised of central office shelves and electronics that enable high-speed transmission over copper telephone lines. o CUSTOMER PREMISE EQUIPMENT ("CPE"): High-speed DSL modems and routers that are located at the customers' premises. These products include Westell's WireSpeed(TM) modems that are designed to provide high-speed access through personal computers.
The Company's service revenues are derived from audio, multi port video and multi media teleconferencing services from the Company's Conference Plus, Inc. subsidiary.
Below is a table that compares equipment and service revenues for the quarter ended June 30, 1999 with the quarter ended June 30, 2000 by business unit.
June 30, June 30,
(in thousands) 1999 2000
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TAP.......................... $ 13,824 $ 30,221
Transport Systems............ 2,189 6,017
CPE.......................... 1,175 61,880
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Total equipment.............. 17,188 98,118
Services..................... 6,971 9,758
Total revenues............... $24,159 $ 107,876
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Westell's net revenues increased 346.5% in the three months ended June 30, 2000 when compared to the same period last year due to a 470.9% increase in equipment revenue combined with a 40.0% increase in service revenue. The increase in equipment revenue is due primarily to the increased sales of the Company's CPE products along with the impact of the Teltrend acquisition. The increase in service revenue is a result of increased teleconference call minutes.
The Company expects to continue to evaluate new product opportunities and engage in extensive research and development activities. This will require the Company to continue to invest heavily in research and development and sales and marketing, which could adversely affect short-term results of operations. The Company believes that its future revenue growth and profitability will principally depend on its success in increasing sales of DSL products and developing new and enhanced TAP and other DSL products. In view of the Company's reliance on the emerging DSL market for growth and the unpredictability of orders and subsequent revenues, 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 TAP products such as NIU's have declined in recent years as telcos continue to move to networks that deliver higher speed digital transmission services. 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.
RESULTS OF OPERATIONS - Period ended June 30, 2000 compared to period ended June 30, 1999.
Revenues. The Company's revenues increased 346.5% from $24.2 million in the three months ended June 30, 1999 to $107.9 million in the three months ended June 30, 2000. This revenue increase was due to increased equipment revenue of $80.9 million and teleconference service revenue of $2.8 million. The increased equipment revenue was due primarily to increased sales of the Company's products. Revenue from the CPE products climbed 5,166.4%, to $61.9 million for the three months ended June 30, 2000 compared to $1.2 million for the quarter ending June 30, 1999 due to higher unit volume offset in part by lower unit selling price. Revenues from the Company's TAP and Transport Systems business units, in the quarter ended June 30, 2000, increased to $30.2 million and $6.0 million, respectively, compared to $13.8 million and $2.2 million in the same quarter one year ago. The increase in revenues from the TAP business unit is primarily reflective of the acquisition of Teltrend Inc. which occurred in March, 2000. The increase in revenues from the Transport System's products is primarily due to higher unit sales volume. The Company's teleconference service revenue of $9.8 million for the quarter ended June 30, 2000 increased $2.8 million from $7.0 million in the same quarter one year ago. This increase in revenue is attributable to continued growth in call minutes at the Company's subsidiary Conference Plus, Inc.
Gross Margin. Gross margin as a percentage of revenue decreased from 31.1% in the three months ended June 30, 1999 to 21.5% in the three months ended June 30, 2000. This decrease in gross margin was primarily due to higher material costs, resulting from increased demand in the overall market for semi-conductor components used in our DSL products and increased freight costs. Margins were also affected by the additional costs related to the inventory step-up resulting from the Teltrend Inc. acquisition. This decrease in gross margin was somewhat offset by product mix changes and product cost integration in the TAP and Transport Systems business units and increased service revenues in the three months ended June 30, 2000.
Sales and Marketing. Sales and marketing expenses increased 99.6%, from $3.7 million in the three months ended June 30, 1999 to $7.4 million in the three months ended June 30, 2000. Sales and marketing expenses decreased as a percentage of revenues from 15.3% in the three months ended June 30, 1999 to 6.8% in the three months ended June 30, 2000. The increase in sales and marketing expenses was primarily due to the acquisition of Teltrend Inc., increased marketing of the DSL products and increased shipping charges to customers associated with the increase in sales. The Company believes that continued investment in sales and marketing will be required to expand its product lines, bring new products to market and service customers.
Research and Development. Research and development expenses increased 106.8%, from $3.6 million in the three months ended June 30, 1999 to $7.4 million in the three months ended June 30, 2000. Research and development expenses decreased as a percentage of revenues from 14.9% in the three months ended June 30, 1999 to 6.9% in the three months ended June 30, 2000. The increase in research and development expense is reflective of the Company's acquisition of Teltrend Inc. which occurred in March, 2000. Additionally, the Company received $700,000 from customers to fund on-going engineering projects during the three months ended June 30, 1999, which was offset against research and development expenses. The Company believes that a continued commitment to research and development will be required for the Company to remain competitive.
General and Administrative. General and administrative expenses increased 74.8%, from $3.2 million in the three months ended June 30, 1999 to $5.7 million in the three months ended June 30, 2000. General and administrative expenses decreased as a percentage of revenues from 13.4% in the three months ended June 30, 1999 to 5.3% in the three months ended June 30, 2000. The increase in general and administrative expenses is a result of the Company's acquisition of Teltrend Inc. which occurred in March, 2000.
Goodwill Amortization. Intangible assets include goodwill, synergistic goodwill and product technology related to the Teltrend acquisition. The purchase price of approximately $238,241,873 exceeded the fair market value of net assets acquired, resulting in goodwill of $64,207,801 and synergistic goodwill of $57,000,000 which will be amortized on a straight-line basis over an average of approximately ten years.
Other (income) expense, net. Other (income) expense, net increased from an expense of $24,000 in the three months ended June 30, 1999 to income of $169,000 in the three months ended June 30, 2000. The income for
RESULTS OF OPERATIONS - continued
the period was primarily due to interest income earned on temporary cash investments along with the recognition of foreign currency gains/loss.
Interest expense. Interest expense decreased from $379,000 in the three months ended June 30, 1999 to $119,000 in the three months ended June 30, 2000. The interest expense during the current period is a result of interest incurred on net obligations outstanding during the period under promissory notes and equipment borrowings. The decrease is due to convertible debt being fully converted during the three months ended June 30, 2000.
Benefit for income taxes. There was no benefit for income taxes recorded for both three month periods ended June 30, 1999 and 2000. The Company decreased the valuation reserve for the entire provision generated during the current quarter of $1.1 million. The Company will evaluate on a quarterly basis it's ability to record a benefit for income taxes in relation to the value of tax planning strategies available in relation to the resulting gross deferred asset.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2000, the Company had $13.0 million in cash. As of June 30, 2000, the Company had $8.0 million outstanding under its secured revolving promissory note facility and $6.4 million outstanding under its equipment borrowing facility. As of June 30, 2000, the Company had approximately $8.0 million available under its secured revolving credit facility. The secured revolving credit facility and the equipment borrowing facility required the maintenance of a minimum cash to current maturity ratio, a current ratio, a maximum debt to net worth ratio and target EBITDA. The Company is currently in compliance with all such covenants with exception of the targeted EBITDA, which has been waived by the bank.
The Company's operating activities used cash of approximately $22.8 million in the three months ended June 30, 2000. This primarily resulted from a net loss from operations along with increases in accounts receivable, inventory, accounts payable and accrued expenses.
Capital expenditures for the three month period ended June 30, 2000 were approximately $6.7 million, of which $4.1 million was funded by an equipment promissory note. The Company expects to spend approximately $23.3 million for the remainder of fiscal year 2001 related to capital equipment expenditures.
At June 30, 2000, the Company's principle sources of liquidity were $13.0 million of cash and the secured revolving credit facility under which the Company may borrow up to $8.0 million based upon receivables and inventory levels. In July, 2000, the Company received a commitment from the bank to increase the available line of credit to $30.0 million. Cash and cash equivalents, anticipated funds from operations, along with available credit lines and other resources, are expected to be sufficient to meet cash requirements for the next twelve months. Cash in excess of operating requirements will be invested on a short term basis in federal government agency instruments and the highest rated grade commercial paper.
The Company had a deferred tax asset of approximately $43.3 million at June 30, 2000. This deferred tax asset relates to (i) tax credit carryforwards of approximately $4.7 million, (ii) a net operating loss carryforward tax benefit of approximately $29.4 million and (iii) temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts measured by tax laws. Of such tax credit carryforwards, the first $243,000 of credits expire in 2008 and $722,000 of credits may be carried forward indefinitely. The net operating loss carryforward begins 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.
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. Although realization of the deferred tax asset is not assured as the Company has incurred operating losses for the 1998, 1999 and 2000 fiscal years, management believes that it is more likely than not that it will generate taxable income sufficient to realize the majority of the tax benefit. A majority of these deferred tax assets are expected to be utilized, prior to their expiration, through a tax planning strategy available to the Company The
Company generated taxable income for the three month period ending June 30, 2000. The tax provision of approximately $1.1 million was recorded and offset by a reduction of the valuation allowance. Management will continue to periodically assess whether it remains more likely than not that the deferred tax asset will be realized. If the tax planning strategy is not sufficient to generate taxable income to recover the deferred tax benefit recorded, an increase in the valuation allowance will be required through a charge to the income tax provision. However, if the Company achieves sufficient profitability or has available additional tax planning strategies to utilize a greater portion of the deferred tax asset, an income tax benefit would be recorded to decrease the valuation allowance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
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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 fluctuation affecting net investments and earnings denominated in foreign currencies. The Company's future primary exposure is to changes in exchange rates for the U.S. dollar versus the Great British pound and the Irish pound. The Company also has a sales order and accounts receivable denominated in Great British pounds. The Company at times uses foreign currency hedging to manage the exposure to changes in the exchange rate on accounts receivable.
As of June 30, 2000, the net change in the cumulative foreign currency translation adjustment account, which is a component of stockholders' equity, was an unrealized gain of $386,000.
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. As further described in Note 1 of the Company's 10-K for the period ended March 31, 2000, the Company's debt consists primarily of a floating-rate bank line-of credit. 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 9.5% to approximately 19.5%) average interest rate on the Company's debt. If such an increase occurred, the Company would incur approximately $380,000 per annum in additional interest expense based on the average debt borrowed during the twelve months ended March 31, 2000. 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 interest rates. |
