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AVNW > SEC Filings for AVNW > Form 10-K on 23-Sep-2013All Recent SEC Filings

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Form 10-K for AVIAT NETWORKS, INC.


23-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview of Business; Operating Environment and Key Factors Impacting Fiscal 2013 and 2014 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 consolidated financial statements and the accompanying notes. In the discussion below, our fiscal year ending June 27, 2014 is referred to as "fiscal 2014" or "2014"; our fiscal year ended June 28, 2013 is referred to as "fiscal 2013" or "2013"; our fiscal year ended June 29, 2012 is referred to as "fiscal 2012" or "2012"; and our fiscal year ended July 1, 2011 is referred to as "fiscal 2011" or "2011."
We generate revenue by designing, developing, manufacturing and supporting a range of wireless networking products, solutions and services for mobile and fixed communications service providers, private network operators, government agencies, transportation and utility companies, public safety agencies and broadcast system operators across the globe. Our products include point-to-point (PTP) digital microwave transmission systems designed for first/last mile access, middle mile/backhaul, and long distance trunking applications. We also provide network management software solutions to enable operators to deploy, monitor and manage our systems, third party equipment such as antennas, routers, and multiplexers, necessary to build and deploy a wireless transmission network, and a full suite of turnkey support services.
We work continuously to improve our established brands and to create new products that meet our customers' evolving needs and preferences. Our fundamental business goal is to generate superior returns for our stockholders over the long term. We believe that increases in revenue, operating profits and earnings per share are the key measures of financial performance for our business.
Our strategic focus in fiscal 2014 will be to continue to accelerate innovation and optimize our product portfolio, improve costs and operational efficiencies, grow our revenue and create a sustainable, profitable business model. To do this, we have examined our products, markets, facilities, development programs, and operational flows to ensure we are focused on what we do well and what will differentiate us in the future. We will continue working to streamline management processes to attain the efficiency levels required by the markets in which we do business.
Although the general trend of increasing demand for bandwidth to support mobile networks applies in all markets, we expect to see quarter-to-quarter fluctuations within markets and with individual customers based on customers' past purchasing patterns. Seasonality is also a factor that impacts our business. Our fiscal third quarter revenue and orders have historically been lower than the revenue and orders in our second fiscal quarter because many of our customers utilize a significant portion of their capital budgets at the end of their fiscal years, which is typically the calendar year end and coincides with our second fiscal quarter. The majority of our customers begin a new fiscal year on January 1, and capital expenditures tend to be lower in an organization's first quarter than in its fourth quarter. We anticipate that this seasonality will continue. The seasonality between the second quarter and third quarter may be affected by a variety of additional factors, including changes in the global economy and other factors.
During fiscal 2014, we expect to provide increased managed services to certain customers in certain geographies. Our operating results may be impacted by the provision of these services to the extent that we incur upfront and ongoing expenses associated with the provision of these services that are not offset with additional revenue from product sales associated with these services until a future period.
Please refer to the section entitled "Risk Factors" in Item 1A in this Annual Report on Form 10-K.

Operations Review
During fiscal 2013, we secured orders and continued to expand our footprint with our customers in the mobile operator market using our current technology and service capabilities. The market for mobile backhaul continues to be our primary addressable market segment and the demand for increasing the backhaul capacity in our customers' networks continues to grow in line with our expectations. In fiscal 2013 we saw sustained demand in North America as we supported the long-term evolution ("LTE") deployments of our mobile operator customers. Internationally, our business continued to rely on a combination of customers increasing their capacity to handle subscriber growth, the ongoing build-out of some large 3G deployments, and the emergence of early stage LTE deployments. Our objective continues to be to position Aviat Networks to support our customers for LTE readiness and to 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 in serving new business and enabling us to expand our business with existing customers across all markets. During fiscal 2013, our growth in revenue over fiscal 2012 was predominantly attributable to an increase in service orders in North America and


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Africa. However, as disclosed above and in the "Risk Factors" section in Item 1A of this Annual Report on Form 10-K, 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 service.
During fiscal 2013, we incurred restructuring expenses that were taken to reduce our operational costs. We intend to complete a majority of the remaining restructuring activities under the Fiscal 2013-2014 Plan during fiscal 2014. See "Restructuring Charges" below.
Revenue
We manage our sales activities primarily on a geographic basis in North America and three international geographic regions: (1) Africa and Middle East, (2) Europe and Russia and (3) Latin America and Asia Pacific. Revenue by region for fiscal 2013, 2012 and 2011 and the related changes are shown in the table below:

                                Fiscal Year                         $ Change                     % Change
(In millions,
except percentages)    2013         2012         2011       2013 /2012     2012 /2011    2013 /2012    2012 /2011
North America       $  180.5     $  164.9     $  160.4     $     15.6     $      4.5          9.5  %        2.8  %
Africa and Middle
East                   182.2        147.7        143.6           34.5            4.1         23.4  %        2.9  %
Europe and Russia       48.0         53.6         73.4           (5.6 )        (19.8 )      (10.4 )%      (27.0 )%
Latin America and
Asia Pacific            60.6         77.8         74.7          (17.2 )          3.1        (22.1 )%        4.1  %
Total Revenue       $  471.3     $  444.0     $  452.1     $     27.3     $     (8.1 )        6.1  %       (1.8 )%

Our revenue in North America increased $15.6 million, or 9.5%, in fiscal 2013 compared with fiscal 2012. In fiscal 2013, we saw improved sales to North American mobile operators which were attributable to their ongoing buildout of LTE networks in the region. At the same time, North America sales to non-mobile customers, such as power utilities and state and local government private networks, were flat in fiscal 2013 compared with fiscal 2012.
Our revenue in North America increased $4.5 million, or 2.8%, in fiscal 2012 compared with fiscal 2011. We have seen substantial changes in product mix of our sales in this region from year to year. The bulk of our product revenue in North America came from our Eclipse product platform, whereas in the first half of fiscal 2011, our legacy products made up a significant portion of the region's sales. The revenue growth and product mix changes reflect continued success in transitioning our customer base to the new product platform as well as an increase in our services business from major customers in fiscal 2012. Our revenue in Africa and Middle East increased $34.5 million, or 23.4%, in fiscal 2013 compared with fiscal 2012. The majority of the increase came in the first half of fiscal 2013 and was attributable to demand from mobile operator customers in Africa investing in network transmission capacity in order to accommodate growth in network data traffic and to increase their service competitiveness. Revenue from mobile operators in Europe and Russia declined $5.6 million, or 10.4%, in fiscal 2013 compared with fiscal 2012. We believe the decrease was related to economic difficulties experienced generally throughout Europe. Revenue in Latin America and Asia Pacific declined $17.2 million, or 22.1%, in fiscal 2013 compared with fiscal 2012. The decrease was primarily due to a decline in customer purchases in Asia as some of our larger customers, who are beginning to roll out LTE service, continue to deploy large orders that we delivered in the past year.
Our international revenue declined $12.6 million, or 4.3%, in fiscal 2012 compared with fiscal 2011. Our business in Asia and Latin America showed improvement in fiscal 2012 from increased orders from network operators. However, our sales in Europe and Russia were down from fiscal 2011 primarily due to the reduction of business with a major customer in Russia who took substantial deliveries in fiscal 2011, partially offset by increased orders and sales to wireless network operators in other European countries. In fiscal 2012, we experienced substantially increased sales with our long-term customers in Africa, offsetting the reduced volume in the Middle East. Africa continued to be our strongest international sector, where we continued to compete successfully for wireless infrastructure business of large network operators, particularly in West Africa.
Our revenue from product sales increased $1.2 million, or 0.4%, in fiscal 2013 compared with fiscal 2012. The increase came primarily from strong sales in Africa, offset in part by reductions in Asia Pacific, Europe and a small year-to-year decrease in North America. Our services revenue increased $26.1 million, or 24.1%, in fiscal 2013 compared with fiscal 2012. The increase in fiscal 2013 came from additional services delivered in North America, Africa and a small increase in Europe, offset in part by a decrease in Asia Pacific.


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Our revenue from product sales decreased $22.0 million, or 6.2%, in fiscal 2012 compared with fiscal 2011. Product sales were lower in Europe and Russia and North America, offset in part by gains in Asia Pacific and Middle East Africa. Our services revenue increased $13.9 million, or 14.7%, in fiscal 2012 compared with fiscal 2011. The increase in fiscal 2012 came from additional services delivered in North America, due to a growth in demand for our network services and support in the region, Africa and Middle East, offset in part by a decrease in Asia Pacific and Latin America.
During fiscal 2013, the MTN Group in Africa accounted for 25% of our total revenue compared with 17% in fiscal 2012 and 14% in fiscal 2011. We have entered into separate and distinct contracts with MTN Group as well as separate arrangements with MTN Group subsidiaries. For fiscal 2013, revenue from Verizon Wireless accounted for 11% of our total revenue. The loss of all or a substantial portion of MTN Group's business or of Verizon Wireless' business could adversely affect our results of operations, cash flows and financial position.

Gross Margin

                                Fiscal Year                          $ Change                      % Change
(In millions,
except percentages)    2013         2012         2011       2013 /2012      2012 /2011     2013 /2012     2012 /2011
Revenue             $  471.3     $  444.0     $  452.1     $      27.3     $     (8.1 )        6.1 %        (1.8 )%
Cost of revenue        331.2        312.3        324.0            18.9          (11.7 )        6.1 %        (3.6 )%
Gross margin        $  140.1     $  131.7     $  128.1             8.4            3.6          6.4 %         2.8  %
% of revenue            29.7 %       29.7 %       28.3 %
Product margin %        28.8 %       30.4 %       29.2 %
Service margin %        31.9 %       27.4 %       24.9 %

Gross margin for fiscal 2013 increased $8.4 million, or 6.4%, compared with fiscal 2012, primarily due to higher sales volume. Gross margin as a percentage of revenue remained approximately the same in fiscal 2013 compared with fiscal 2012. Product margin as a percentage of product revenue for fiscal 2013 decreased 1.6% compared with fiscal 2012. The slight reduction resulted from competitive pricing pressures in the international markets, offset in part by a small increase in margin on product sales in North America. Service margin as a percentage of service revenue for fiscal 2013 increased 4.5% compared with fiscal 2012. Service revenue volume increased substantially in fiscal 2013, which enabled us to spread our fixed costs over a larger base of service business in North America as well as in international markets, resulting in improved service margin rate.
Gross margin for fiscal 2012 increased $3.6 million, or 2.8%, compared with fiscal 2011. Gross margin as a percentage of revenue increased 1.4% compared with fiscal 2011. The year-over-year gross margin improvement was primarily due to the absence in fiscal 2012 of a $6.0 million one-time charge related to manufacturing overhead that we recorded in the first quarter of fiscal 2011 and to the absence of large inventory write-downs, which we incurred in fiscal 2011 as we transitioned out of the legacy products.
Prior to fiscal 2011, we capitalized most of the costs associated with our internal manufacturing operations as a component of the overall cost of product inventory. Beginning in the first quarter of fiscal 2011, we shifted the manufacturing of our products primarily to contract manufacturers and completed the transfer by the end of fiscal 2011. Accordingly, the costs associated with our internal operations organization are now expensed as incurred. Gross margin in fiscal 2011 was negatively affected by the immediate expensing of $6.0 million of such previously capitalized costs in the first quarter of fiscal 2011.
Exclusive of the net impact from these charges, the gross margin and gross margin as a percentage of revenue in fiscal 2012 were lower than fiscal 2011 due to competitive pricing pressures and a small shift in the mix of our business toward services, which caused a small decline in the fiscal 2012 gross margin rate.
The general business trends of strong price competition for new business in all regions and major customer consolidations continue to put pressure on our gross margin. We expect our gross margin as a percentage of revenue to decline in the first quarter of fiscal 2014 due to anticipated geographic mix changes in the quarter and timing of long-term project completions. In the second quarter of fiscal 2014, we expect gross margin as a percentage of revenue to be in line with levels we generally experienced in fiscal 2013. In the second half of fiscal 2014 and beyond, we anticipate a directional improvement in gross margin rates as a result of the transition to our next generation products. Research and Development Expenses


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                                Fiscal Year                          $ Change                       % Change
(In millions,
except percentages)    2013         2012         2011        2013 /2012      2012 /2011     2013 /2012    2012 /2011
Research and
development
expenses            $   39.4     $   36.0     $   40.5     $        3.4     $     (4.5 )        9.4 %        (11.1 )%
% of revenue             8.4 %        8.1 %        9.0 %

Our R&D expenses increased $3.4 million, or 9.4%, in fiscal 2013 compared with fiscal 2012. As a percentage of revenue, R&D expenses also increased to 8.4% in fiscal 2013 from 8.1% in fiscal 2012. The increase in R&D expenses of $3.4 million consisted primarily of a $2.0 million increase of personnel expenses and a $0.6 million increase in material supplies due to our investment in new product development. In addition, depreciation expenses increased by $0.4 million due to additions of new lab equipment. We continue to invest in new product features, new functionality and lower cost platforms that we believe will enable our product lines to retain their technology leads in a cost effective manner.
Our R&D expenses declined $4.5 million, or 11.1%, in fiscal 2012 compared with fiscal 2011. As a percentage of revenue, R&D expenses also decreased to 8.1% in fiscal 2012 from 9.0% in fiscal 2011. The decrease in R&D expenses of $4.5 million, consisting mostly of personnel expenses, was primarily due to restructuring of our research and development workforce in prior years. In addition, share-based compensation expense in fiscal 2011 was higher by $1.0 million due to vesting of performance shares upon the achievement of new product development milestones in fiscal 2011.
Selling and Administrative Expenses

                                Fiscal Year                         $ Change                      % Change
(In millions,
except percentages)    2013         2012         2011       2013 /2012     2012 /2011     2013 /2012     2012 /2011
Selling and
administrative
  expenses          $   95.5     $   99.5     $  107.6     $     (4.0 )   $     (8.1 )      (4.0 )%        (7.5 )%
% of revenue            20.3 %       22.4 %       23.8 %

Our selling and administrative expenses declined $4.0 million, or 4.0%, in fiscal 2013 compared with fiscal 2012. The decrease was due primarily to a $2.1 million reduction in professional services, a $1.2 million reduction in personnel expenses, a $1.4 million reduction in telecommunications expense and a $0.7 million reduction in bad debt expenses, partially offset by a $1.3 million increase in share-based compensation expenses and a $0.8 million increase in transactional taxes assessments related to certain international entities. We will continue to seek ways to improve our operating efficiency in fiscal 2014. Our selling and administrative expenses declined $8.1 million, or 7.5%, in fiscal 2012 compared with fiscal 2011. The decrease was due primarily to a $2.6 million reduction in sales and administrative compensation expenses and a $0.4 million decrease in facility expenses as a result of the restructuring programs we implemented, a $2.0 million decrease in agent commission expenses driven by lower fee-based revenues, and a decrease of $1.1 million in expenses for information technology projects, partially offset by an increase of $1.3 million in share-based compensation.
Restructuring Charges
During the fourth quarter of fiscal 2013, we initiated a restructuring plan (the "Fiscal 2013-2014 Plan") that was intended to bring our cost structure in line with the changing business environment of the worldwide microwave radio and telecommunication markets, primarily in North America, Europe and Asia. Activities under the Fiscal 2013-2014 Plan included the downsizing of our Santa Clara, California headquarters and certain international field offices, and reductions in force to reduce our operating expenses.
During the first quarter of fiscal 2011, we initiated the Fiscal 2011 Plan to reduce our operational costs primarily in North America, Europe and Asia. Activities under the Fiscal 2011 Plan included the reductions in force to reduce our operating expenses and downsizing or closures of our Morrisville, North Carolina, Santa Clara, California, Montreal, Canada offices and certain international field offices. The Fiscal 2011 Plan has been completed as of the end of fiscal 2013.
Earlier in fiscal 2009, we commenced a restructuring plan (the "Fiscal 2009 Plan") to reduce our workforce in the U.S., France, Canada and other locations throughout the world and outsource our San Antonio manufacturing operations to a third party in Austin, Texas. The Fiscal 2009 Plan was completed as of the end of fiscal 2011.
Our restructuring charges by plan for fiscal 2013, 2012 and 2011 are summarized in the table below:


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                                Fiscal Year                          $ Change                     % Change
(In millions,
except percentages)    2013         2012         2011       2013 /2012     2012 /2011     2013 /2012    2012 /2011
Restructuring
charges:            $    3.1     $    2.3     $   15.4     $     0.8      $     (13.1 )       34.8  %      (85.1 )%
By Plan:
  Fiscal 2013-2014
Plan                     1.8            -            -           1.8                -          N/A           N/A
  Fiscal 2011 Plan       1.3          2.3         12.7          (1.0 )          (10.4 )      (43.5 )%      (81.9 )%
  Fiscal 2009 Plan         -            -          2.7             -             (2.7 )        N/A        (100.0 )%

Our restructuring expenses consisted primarily of severance and related benefit charges and, to a lesser extent, facilities costs related to obligations under non-cancelable leases for facilities that we ceased to use. Restructuring charges increased by $0.8 million in fiscal 2013 compared with fiscal 2012 primarily due to employee termination benefits related to the initiation of the Fiscal 2013-2014 Plan, partially offset by the absence of a $1.3 million facilities charge in fiscal 2012 associated with the sublease and relocation of our Morrisville, North Carolina facility. We intend to complete a majority of the remaining restructuring activities under the Fiscal 2013-2014 Plan in fiscal 2014.
Restructuring charges declined significantly by $13.1 million in fiscal 2012 compared with fiscal 2011. The changes were due to the completion of Fiscal 2009 Plan in fiscal 2011 and the fact that major restructuring activities under the Fiscal 2011 Plan, such as the downsizing of our Morrisville, North Carolina office, occurred in fiscal 2011.
Other Income (Loss), Interest Income and Interest Expense

                                       Fiscal Year
(In millions)                   2013      2012       2011
Loss on sale of NetBoss assets $   -     $   -     $ (4.6 )
Other income, net                0.7         -          -
Interest income                  0.8       0.6        0.3
Interest expense                (0.8 )    (1.3 )     (2.2 )

Other income of $0.7 million for fiscal 2013 reflected a nonrecurring benefit related to a customer contract.
Interest income reflected interest earned on our cash equivalents which were comprised of money market funds and certificates of deposit.
Interest expense was primarily related to interest associated with borrowings, term loan and letters of credit under our credit facility and, in fiscal 2012 and fiscal 2011, also included preference dividends on our $8.25 million redeemable preference shares. The $8.25 million preference shares were redeemed at their carrying value on January 30, 2012, funded by a two-year term loan of $8.25 million under our credit facility at a fixed interest rate of 5% per annum.

Income Taxes
                                                     Fiscal Year                          $ Change
(In millions, except percentages)           2013         2012         2011       2013 /2012      2012 /2011
Income (loss) from continuing operations
before income taxes                      $    2.4     $ (14.0 )    $ (44.7 )    $      16.4     $     30.7
Provision for income taxes                   13.3         1.5         14.1             11.8          (12.6 )
As % of income (loss) from continuing
operations
  before income taxes                       561.1 %     (10.8 )%     (31.5 )%

The income tax expense from continuing operations for fiscal 2013 was $13.3 million. The variation between our income tax expense from continuing operations and income tax expense at the statutory rate of 35% on our pre-tax income of $2.4 million was primarily attributable to a $11.7 million increase in our reserves for uncertain tax positions, losses in tax jurisdictions in which we cannot recognize a tax benefit and increase in foreign withholding taxes. The increase in our unrecognized tax benefits was the result of additional information obtained during recent tax examinations in certain countries. The income tax expense from continuing operations for fiscal 2012 was $1.5 million. The variation between our income tax expense from continuing operations and income tax benefit at the statutory rate of 35% on our pre-tax loss of $14.0 million


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was primarily attributable to losses in tax jurisdictions in which we cannot recognize a tax benefit. The tax expense for fiscal 2012 of $1.5 million was primarily attributable to profitable foreign entities for which we have accrued income taxes.
The income tax expense from continuing operations for fiscal 2011 was $14.1 million. The variation between our income tax expense from continuing operations and income tax benefit at the statutory rate of 35% on our pre-tax loss of $44.7 million was primarily due to an $11.3 million increase in valuation allowance for Singapore deferred tax assets as of the beginning of fiscal 2011 and a $1.4 million foreign branch withholding tax accrual. The expense was partially offset by a valuation allowance release of $1.6 million on Mexico deferred tax assets as of the beginning of fiscal 2011.

Loss from Discontinued Operations

                                                 Fiscal Year                           $ Change
(In millions)                           2013         2012         2011        2013 /2012      2012 /2011
Loss from discontinued operations,
net of tax                           $   (4.1 )   $   (8.6 )   $  (31.7 )   $        4.5     $      23.1

Our discontinued operations consist of our WiMAX business, which was sold to EION Networks, Inc. ("EION") on September 2, 2011. We completed the business transition with EION in fiscal 2012. The loss from discontinued operations decreased $4.5 million in fiscal 2013 compared with fiscal 2012. The loss incurred in fiscal 2013 was primarily due to $4.2 million write-downs of certain WiMAX deferred cost of sales that were not transferred to EION and certain expenses we incurred to support a remaining customer obligation. The loss was partially offset by a $0.3 million write down of our payable to EION related to customer receivables and $0.1 million contingent payments we received from EION. The loss in fiscal 2012 included operating expenses we incurred to transition the business and a $1.9 million loss on disposition of the WiMAX business. The loss from discontinued operations decreased $23.1 million in fiscal 2012 compared with fiscal 2011. The decrease resulted primarily from the absence of large charges for provisions for excess and obsolete inventories and noncancellable purchase commitments which we incurred in fiscal 2011 when we decided to exit the WiMAX business, partially offset by higher WiMAX revenue in . . .

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