AVIAT NETWORKS, INC. annual report, FY2018

Aviat Networks, Inc. — Fiscal 2018 Form 10-K Summary

Reporting period: The provided filing is the annual report for the fiscal year ended June 29, 2018, not fiscal 2017 Q4. Each fiscal year presented comprised 52 weeks. Aviat designs, sells and supports microwave and millimeter-wave wireless networking products, software and professional services for telecommunications, government, utility, transportation, public safety and other network operators.

Financial results and key metrics

Metric	Fiscal 2018	Fiscal 2017	Change
Revenue	$242.5 million	$241.9 million	Up 0.3%
Product revenue	$151.7 million	$153.5 million	Down 1.2%
Services revenue	$90.8 million	$88.4 million	Up 2.8%
Gross margin	$80.5 million	$75.5 million	Up 6.7%
Gross margin percentage	33.2%	31.2%	Up 2.0 percentage points
Operating income (loss)	$1.3 million	$(1.0) million	Improved
Net income (loss)	$2.3 million	$(0.6) million	Improved
Net income attributable to Aviat	$1.8 million	$(0.8) million	Improved
Diluted EPS	$0.33	$(0.16)	Improved
Cash flow from operations	$8.2 million	$9.4 million	Down $1.2 million
Capital expenditures	$6.6 million	$4.0 million	Up $2.5 million

Fiscal 2018 revenue was broadly flat year over year, but profitability improved materially due to better product and service margins, lower supply-chain costs and reduced inventory write-downs. Research and development expense increased to $19.8 million, or 8.1% of revenue, while selling and administrative expense increased modestly to $58.2 million. Restructuring charges were $1.3 million versus $0.6 million in fiscal 2017.

The fiscal 2018 tax benefit was $1.0 million, including a $3.3 million valuation allowance release related to refundable alternative minimum tax credits and a $1.3 million Singapore tax refund. These items contributed to reported net income and should be distinguished from recurring operating performance.

Liquidity, debt and balance sheet

Cash and cash equivalents were $37.4 million at June 29, 2018, compared with $35.7 million at June 30, 2017. Including restricted cash, cash totaled $37.8 million.
Accounts receivable, net, declined to $43.1 million from $45.9 million; inventories declined to $21.3 million from $21.8 million.
Total assets were $156.1 million and total liabilities were $98.5 million. Stockholders’ equity attributable to Aviat was $57.5 million.
Debt under the Silicon Valley Bank credit facility was $9.0 million at year-end. The facility had $8.5 million of available credit, was subject to borrowing-base limitations and financial covenants, and expired June 29, 2019. The $9.0 million borrowing was repaid in July 2018.
The company stated that existing cash, available credit and expected customer collections were sufficient for anticipated working capital and capital expenditures for at least the next 12 months, while noting that renewal of the credit facility and continued covenant compliance were not assured.
Contractual cash obligations totaled $44.5 million, including $25.1 million of supplier purchase obligations, $6.3 million of operating lease commitments and $2.9 million of uncertain tax positions.
Off-balance-sheet commercial commitments totaled $51.5 million, principally performance surety bonds and standby letters of credit. Management stated that significant future payouts were not considered probable based on historical experience.

Material changes versus the prior comparable period

Revenue was essentially unchanged, reflecting declines in North America, Africa and the Middle East, and Latin America and Asia Pacific, largely offset by stronger Europe and Russia revenue.
North America represented approximately 54% of revenue, compared with 55% in fiscal 2017; international revenue represented 47% of total revenue.
Europe and Russia revenue increased 28.9% to $18.2 million, primarily from a new mobile-network-operator customer.
Africa and Middle East revenue declined 2.8% to $58.5 million, continuing a multi-year decline associated with constrained customer capital spending, currency devaluation and reduced purchasing power.
Gross margin improved to 33.2% from 31.2%, with both product and service margins improving. Inventory and customer-service inventory charges fell to $0.4 million from $1.1 million and were substantially below the $9.9 million recorded in fiscal 2016.
Operating results returned to profitability, with operating income of $1.3 million versus an operating loss of $1.0 million in fiscal 2017.
Operating cash flow remained positive but declined to $8.2 million from $9.4 million, while capital expenditures increased to $6.6 million.
Backlog increased modestly to $162.4 million from $159.7 million, or to $178.8 million from $176.2 million including deferred revenue. Management expected to substantially fill the June 2018 backlog during fiscal 2019, but noted that orders could be delayed or canceled.
MTN Group accounted for 13% of fiscal 2018 revenue, down from 14% in fiscal 2017. The customer represented approximately 13% of year-end accounts receivable.

Guidance, outlook, risks and unusual items

Management anticipated top-line growth in fiscal 2019, supported by an expanded solutions portfolio, new customer wins, broader addressable markets and potential demand related to 5G deployments. The strategy emphasizes higher-capacity wireless products, integrated routing, software and cloud-based network management, professional services and lower total cost of ownership.

Key risks include intense competition, price and margin erosion, customer consolidation, long and unpredictable sales cycles, order delays or cancellations, and reliance on a limited number of major customers.
International operations expose Aviat to currency devaluation, political instability, economic weakness, regulatory requirements, anti-corruption compliance and customer payment risk. The company recorded a net foreign-exchange gain of $0.2 million in fiscal 2018, but cumulative foreign-currency translation losses reduced equity by $12.6 million.
The company outsourced manufacturing and relied on two independent contract manufacturers, as well as sole or limited sources for certain specialized components. Supply shortages, quality issues or supplier failures could delay shipments and reduce margins.
A new fiscal 2018–2019 restructuring plan was approved in the fourth quarter to consolidate back-office functions and align resources geographically. The plan generated approximately $1.5 million of fiscal 2018 severance charges, with remaining payments expected in fiscal 2019 and fiscal 2020.
Austrian customer litigation sought $1.0 million for alleged product defects. Aviat had not accrued a loss because the amount of any reasonably possible loss could not be estimated; management intended to defend the claim.
Adoption of the new revenue standard, ASC 606, beginning fiscal 2019 was expected to reduce opening accumulated deficit by approximately $5.3 million to $6.4 million, subject to final assessment. The filing identified potential timing changes for bill-and-hold sales, installation services, variable consideration, software revenue and sales commissions.
The company had substantial tax attributes, including U.S. federal tax loss carryforwards of approximately $332.5 million and foreign tax loss carryforwards of approximately $214.9 million, but maintained significant valuation allowances because future realization was uncertain.
A tax-benefit preservation plan and stock-transfer restrictions were intended to protect net operating losses from an ownership change, but may complicate an acquisition or substantial stock purchase.

Most important facts for investors to verify

Confirm that fiscal 2018 profitability is sustainable excluding the Singapore tax refund, AMT valuation allowance release and other discrete tax items.
Monitor whether revenue growth materializes in fiscal 2019, particularly in Europe, Africa and the Middle East, and whether pricing pressure limits margin expansion.
Review the renewal, borrowing-base availability and covenant compliance of the SVB credit facility after its June 2019 expiration.
Assess customer concentration, especially MTN Group and other large telecommunications customers, and the collection of international receivables.
Evaluate execution of the restructuring plan, expected cost savings and remaining restructuring cash payments.
Confirm the final ASC 606 adoption adjustment and its effect on revenue timing, deferred revenue, accumulated deficit and future comparability.
Track the Austrian product-defect claim, $51.5 million of commercial commitments and other guarantees for potential cash exposure.
Assess whether the company can convert its backlog into revenue, given stated cancellation, delivery-schedule and customer-financing risks.