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WSTL > SEC Filings for WSTL > Form 10-K on 23-May-2014All Recent SEC Filings

Show all filings for WESTELL TECHNOLOGIES INC

Form 10-K for WESTELL TECHNOLOGIES INC


23-May-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview
The following discussion should be read together with the Consolidated Financial Statements and the related Notes thereto and other financial information appearing elsewhere in this Form 10-K. All references herein to the term "fiscal year" shall mean a year ended March 31 of the year specified.
Westell Technologies, Inc., (the Company) is a global leader of intelligent site management, in-building wireless, cell site optimization, and outside plant solutions focused on innovation and differentiation at the edge of telecommunication networks, where end users connect. The comprehensive set of products and solutions the Company offers enable telecommunication service providers, cell tower operators, and other network operators to reduce operating costs and improve network performance. With millions of products successfully deployed worldwide, the Company is a trusted partner for transforming networks into high quality, reliable systems.
The Company designs, develops, assembles and markets a wide variety of products and solutions. Intelligent site management solutions include a suite of Remote monitoring and control devices which, when combined with the Company's Optima management system, provides comprehensive machine-to-machine (M2M) communications that enable operators to remotely monitor, manage, and control site infrastructure and support systems. In-building wireless solutions include distributed antenna systems (DAS) interface panels, high-performance digital repeaters and bi-directional amplifiers (BDAs), and system components and antennas, all used by wireless service providers and neutral-party hosts to fine tune radio frequency (RF) signals that helps extend coverage to areas not served well or at all by traditional cell sites. Cell site optimization solutions consist of tower mounted amplifiers (TMAs), small outdoor-hardened units mounted next to antennas on cell towers, enabling wireless service providers to improve the overall performance of a cell site, including increasing data throughput and reducing dropped connections. Outside plant solutions, which are sold to wireline and wireless service providers as well as industrial network operators, consist of a broad range of offerings, including cabinets, enclosures, and mountings; synchronous optical networks/time division multiplexing (SONET/TDM) network interface units; power distribution units; copper and fiber connectivity panels; hardened Ethernet switches; and systems integration services. In fiscal year 2014, the Company operated under three reportable segments:
Westell, Kentrox and CSI.
Westell Segment
The Westell segment consisted of all product offerings under our cell site optimization and outside plant network solutions, as well as our internally-developed passive DAS interface panels. For fiscal year 2014, Westell segment product offerings were developed at the Company's design centers in Aurora, Illinois; Goleta, California; and Regina, Canada; and operations were managed centrally at our Aurora facility where all products were assembled, tested, packaged, and shipped to customers. Kentrox Segment
The Kentrox segment consisted of our intelligent site management solutions, which were acquired with the Kentrox acquisition on April 1, 2013. For fiscal year 2014, Kentrox segment product and service offerings were developed primarily at the Company's design center in Dublin, Ohio, where Kentrox was previously headquartered, and operations were managed centrally at the Dublin facility where all products were assembled, tested, packaged, and shipped to customers.
CSI Segment
The CSI segment included our in-building wireless solutions acquired with the CSI acquisition on March 1, 2014. For fiscal year 2014, CSI segment products were developed at the Company's design center in Manchester, New Hampshire, where CSI is headquartered, and operations were managed centrally at the Manchester facility where all products were assembled, tested, packaged, and shipped to customers.
Customers
The Company's customer base for its products is highly concentrated and comprised primarily of major telecommunications service providers, cell tower operators, and other network operators. Due to the stringent customer quality specifications and the regulated environment in which its customers operate, the Company must undergo lengthy approval and procurement processes prior to selling most of its products. Accordingly, the Company must make significant up-front investments in product and market development prior to actual commencement of sales of new products. The prices for the Company's

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products vary based upon volume, customer specifications, and other criteria, and they are subject to change for a variety of reasons, including cost and competitive factors.
To remain competitive, the Company must continue to invest in new product development and in targeted sales and marketing efforts to launch new product lines. Failure to increase revenues from new products, whether due to lack of market acceptance, competition, technological change meeting technical specifications or otherwise, could 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 invest in product research and development activities.
In view of the Company's reliance on the telecommunications market for revenues, the project nature of the business 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. The Company has experienced quarterly fluctuations in customer ordering and purchasing activity due primarily to the project-based nature of the business and to budgeting and procurement patterns toward the end of the calendar year or the beginning of a new year. While these factors can result in the greatest fluctuations in the Company's third and fourth fiscal quarters this is not always consistent and may not always correlate to financial results. The Kentrox segment business is driven by specific customer projects. The Company believes that two of those customer projects ramped down toward completion in the third quarter of fiscal year 2014. Critical Accounting Policies
The preparation of financial statements in accordance with GAAP requires management to make use of certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and that affect the reported amounts of revenue and expenses during the reported periods. The Company bases estimates on historical experience and on various other assumptions that management believes are reasonable under the circumstances. These estimates and assumptions form the basis for judgments about carrying values of assets and liabilities that may not be readily apparent from other sources. Actual results could differ from the amounts reported. In Note 3 to the consolidated financial statements, the Company includes a discussion of its significant accounting policies. The Company believes the following are the most critical accounting policies and estimates used in the preparation of the financial statements. The Company considers an accounting policy or estimate to be critical if it requires assumptions to be made concerning uncertainties, and if changes in these assumptions could have a material impact on financial condition or results of operations. Business Combinations
The Company applies the guidance of ASC topic 805, Business Combinations. The Company recognizes the fair value of assets acquired and liabilities assumed in transactions; establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; expenses transaction and restructuring costs; and discloses the information needed to evaluate and understand the nature and financial effect of the business combination. Inventories and Inventory Valuation
Inventories are stated at the lower of first-in, first-out (FIFO) cost or market value. Market value is based upon an estimated average selling price reduced by estimated costs of disposal. Should actual market conditions differ from the Company's estimates, the Company's future results of operations could be materially affected. Reductions in inventory valuation are included in cost of goods sold in the accompanying Consolidated Statements of Operations. The Company reviews inventory for excess quantities and obsolescence based on its best estimates of future demand, product lifecycle status and product development plans. The Company uses historical information along with these future estimates to reduce the inventory cost basis. Subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Prices anticipated for future inventory demand are compared to current and committed inventory values. Inventory Purchase Commitments
In the normal course of business, the Company enters into non-cancellable commitments for the purchase of inventory. The commitments are negotiated to be at market rates. Should there be a significant decline in revenues the Company may absorb excess inventory and subsequent losses as a result of these commitments. The Company establishes reserves for potential losses on at-risk commitments.
Income Taxes
The Company accounts for income taxes under the provisions of ASC topic 740, Income Taxes (ASC 740). ASC 740 requires an asset and liability based approach in accounting for income taxes. Deferred income tax assets, including net operating loss (NOL) and certain tax credit carryovers and liabilities, are recorded based on the differences between the financial statement

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and tax bases of assets and liabilities, applying enacted statutory tax rates in effect for the year in which the tax differences are expected to reverse. Valuation allowances are provided against deferred tax assets which are assessed as not likely to be realized. On a quarterly basis, management evaluates the recoverability of deferred tax assets and the need for a valuation allowance. This evaluation requires the use of estimates and assumptions and considers all positive and negative evidence and factors, such as the scheduled reversal of temporary differences, the mix of earnings in the jurisdictions in which the Company operates, and prudent and feasible tax planning strategies. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the dates of enactment. The Company accounts for unrecognized tax benefits based upon its assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. The Company reports a liability for unrecognized tax benefits resulting from unrecognized tax benefits taken or expected to be taken in a tax return and recognizes interest and penalties, if any, related to its unrecognized tax benefits in income tax expense. See Note 4 for further discussion of the Company's income taxes. Goodwill and Other Intangibles
Goodwill is the excess of the total purchase consideration transferred over the amounts allocated to identifiable assets acquired and liabilities assumed at the acquisition date. Goodwill is not amortized, but it is tested for impairment at the reporting unit level by first performing a qualitative approach to test goodwill for impairment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the two-step, quantitative, goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required.
Goodwill is reviewed for impairment at least annually in accordance with ASC 350, Intangibles-Goodwill and Other, or when an event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying value. The Company performs its annual impairment test in the fourth quarter of each fiscal year and begins with a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value.
If the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, it is necessary to perform a two-step goodwill impairment test. The first step tests for impairment by applying fair value-based tests at the reporting unit level. Fair value of a reporting unit is determined by using both an income approach and a market approach, because this combination is considered to produce the most reasonable indication of fair value in an orderly transaction between market participants. Under the income approach, the Company determines fair value based on estimated future cash flows of a reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the level of risk inherent in a reporting unit and its associated estimates of future cash flows as well as the rate of return an experienced investor might expect to earn. Discount rate assumptions are considered Level 3 inputs in the fair value hierarchy defined in ASC 820, Fair Value Measurements and Discounts. Under the market approach, the Company utilizes valuation multiples derived from publicly available information for comparable companies to provide an indication of how much a knowledgeable investor in the marketplace might be willing to pay for a company. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to individual assets and liabilities within each reporting unit.
If the Company concludes that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value, a quantitative fair value assessment is performed and compared to the carrying value. If the fair value is less than the carrying value, impairment is recorded.
Intangible assets with determinable lives are amortized on a straight-line basis over their respective estimated useful lives. If the Company were to determine that a change to the remaining estimated useful life of an intangible asset was necessary, then the remaining carrying amount of the intangible asset would be amortized prospectively over that revised remaining useful life. On an ongoing basis, the Company reviews intangible assets with a definite life and other long-lived assets other than goodwill for impairment whenever events and circumstances indicate that carrying values may not be recoverable. If such events or changes in circumstances occur, the Company will recognize an impairment loss if the undiscounted future cash flow expected to be generated by the asset is less than the carrying value of the related asset. Any impairment loss would adjust the asset to its implied fair value. Revenue Recognition and Deferred Revenue The Company's revenue is derived from the sale of products, software, and services. The Company records revenue from product sales transactions when title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed or determinable, and collectability is reasonably assured.
Revenue recognition on equipment where software is incidental to the product as a whole, or where software is essential to the equipment's functionality and falls under software accounting scope exceptions, generally occurs when products are shipped,

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risk of loss has transferred to the customer, objective evidence exists that customer acceptance provisions have been met, no significant obligations remain, collection is reasonably assured and warranty can be estimated.
Revenue recognition where software that is more than incidental to the product as a whole or where software is sold on a standalone basis is recognized when the software is delivered and ownership and risk of loss are transferred. The Company also recognizes revenue from deployment services, maintenance agreements, training and professional services. Deployment services revenue results from installation of products at customer sites. Deployment services, which generally occur over a short time period, are not services required for the functionality of products, because customers do not have to purchase installation services from the Company, and may install products themselves, or hire third parties to perform the installation services. Revenue for deployment services, training and professional services are recognized upon completion. Revenue from maintenance agreements is recognized ratably over the service period.
When a multiple element arrangement exists, the fee from the arrangement is allocated to the various deliverables so that the proper amount can be recognized as revenue as each element is delivered. Based on the composition of the arrangement, the Company analyzes the provisions of the accounting guidance to determine the appropriate model that is applied towards accounting for the multiple element arrangement. If the arrangement includes a combination of elements that fall within different applicable guidance, the Company follows the provisions of the hierarchal literature to separate those elements from each other and apply the relevant guidance to each.
If deliverables do not fall within the software revenue recognition guidance, the fair value of each element is established using the relative selling price method, which requires the Company to use vendor-specific objective evidence (VSOE), reliable third-party objective evidence or management's best estimate of selling price, in that order.
If deliverables fall within the software revenue recognition guidance, the fee is allocated to the various elements based on VSOE of fair value. If sufficient VSOE of fair value does not exist for the allocation of revenue to all the various elements in a multiple element arrangement, all revenue from the arrangement is deferred until the earlier of the point at which such sufficient VSOE of fair value is established or all elements within the arrangement are delivered. If VSOE of fair value exists for all undelivered elements, but does not exist for one or more delivered elements, the arrangement consideration is allocated to the various elements of the arrangement using the residual method of accounting. Under the residual method, the amount of the arrangement consideration allocated to the delivered elements is equal to the total arrangement consideration less the aggregate fair value of the undelivered elements. Using this method, any potential discount on the arrangement is allocated entirely to the delivered elements, which ensures that the amount of revenue recognized at any point in time is not overstated. Under the residual method, if VSOE of fair value exists for the undelivered element, generally maintenance, the fair value of the undelivered element is deferred and recognized ratably over the term of the maintenance contract, and the remaining portion of the arrangement is recognized as revenue upon delivery, which generally occurs upon delivery of the product.
The Company has established VSOE based on its historical pricing practices. The application of VSOE methodologies requires judgment, including the identification of individual elements in multiple element arrangements and whether there is VSOE of fair value for some or all elements.
The Company's product return policy allows customers to return unused equipment for partial credit if the equipment is non-custom product, returned within specified time limits, and currently being manufactured and sold. Credit is not offered on returned products that are no longer manufactured and sold. The Company's reserve for returns is not significant.
The Company records revenue net of taxes in accordance with ASC topic 605, Revenue Recognition (ASC 605).
Stock-Based Compensation
The Company recognizes stock-based compensation expense for all employee stock-based payments based upon the fair value on the award's grant date over the requisite service period. If the awards are performance based, the Company must estimate future performance attainment to determine the number of awards expected to vest. Determining the fair value of equity-based options requires the Company to estimate the expected volatility of its stock, the risk-free interest rate, expected option term, expected dividend yield and expected forfeitures.
Product Warranties
Most of the Company's products carry a limited warranty of up to seven years. The Company accrues for estimated warranty costs as products are shipped based on historical sales and cost of repair or replacement trends relative to sales.

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Results of Operations
Fiscal Years Ended March 31, 2014, 2013 and 2012

Revenue                    Fiscal Year Ended March 31,            Increase (Decrease)
                                                                 2014 vs.      2013 vs.
(in thousands)            2014           2013        2012          2013          2012
Westell              $    52,223       $ 38,808    $ 43,629    $    13,415    $ (4,821 )
Kentrox                   46,174          N/A         N/A           46,174       N/A
CSI                        3,676          N/A         N/A            3,676       N/A
Consolidated revenue $   102,073       $ 38,808    $ 43,629    $    63,265    $ (4,821 )

In fiscal year 2014, consolidated revenue increased $63.3 million compared to fiscal year 2013 due primarily to the acquisition of Kentrox which accounted for $46.2 million of the increase. Kentrox revenue was subject to purchase accounting adjustments which effectively reduced revenue by $2.1 million to fair value the performance obligation related to deferred revenue. The CSI acquisition added $3.7 million of revenue in fiscal year 2014.
The Westell segment revenue increased 35% due primarily to sales of new products for wireless networks, including distributed antenna systems (DAS) products, and tower-mounted amplifiers. These new products accounted for 43% of the Westell segment revenue in fiscal year 2014 compared to 6% in fiscal year 2013. TDM/SONET, the segment's legacy products, decreased 23% in fiscal year 2014 compared to fiscal year 2013. This decrease is a result of a shift from T1 to Ethernet technology for the backhaul of cellular traffic and customer programs to constrain spending through the management of inventory levels and reuse of decommissioned products.
In fiscal year 2013, Westell segment revenue decreased 11% compared to fiscal year 2012 resulting primarily from lower demand for legacy products, noted above.

Gross profit and margin        Fiscal Year Ended March 31,           Increase (Decrease)
                                                                   2014 vs.      2013 vs.
(in thousands)               2014          2013         2012         2013          2012
Westell                   $  17,077     $ 13,325     $ 17,172     $  3,752      $ (3,847 )
                               32.7 %       34.3 %       39.4 %       (1.6 )%       (5.1 )%
Kentrox                      23,517        N/A          N/A         23,517          N/A
                               50.9 %      N/A          N/A           50.9  %       N/A
CSI                           1,364        N/A          N/A          1,364          N/A
                               37.1 %      N/A          N/A           37.1  %       N/A
Consolidated gross profit $  41,958     $ 13,325     $ 17,172     $ 28,633      $ (3,847 )
Consolidated gross margin      41.1 %       34.3 %       39.4 %        6.8  %       (5.1 )%

In fiscal year 2014, consolidated margin increased 6.8% compared to fiscal year 2013 due primarily to the Kentrox acquisition.
Westell segment gross margin decreased 1.6% year-over-year. The decrease was primarily because of higher excess and obsolete inventory charges offset by better absorption of overhead costs due to higher revenue. Fiscal year 2014 included a $2.5 million charge for excess and obsolete inventory compared to a $1.0 million charge in fiscal year 2013. The inventory charges resulted primarily from the technology shift to Ethernet that decreased demand for T1-related products, which had a more significant decline than the Company expected.
Gross margins in the Kentrox and CSI segments, were negatively impacted by the purchase accounting adjustments for the fair value. Kentrox revenue was effectively reduced by $2.1 million to fair value the performance obligation related to deferred revenue. The Kentrox and CSI segment inventory valuation step-up included in cost of sales was $1.6 million and $0.5 million, respectively.
In fiscal year 2013, Westell gross margin decreased 5.1% compared to fiscal year 2012. The decrease was primarily because of higher excess and obsolete inventory charges and lower absorption of overhead costs due to lower revenue. Fiscal year 2013 included a $1.0 million charge for excess and obsolete inventory compared to a $0.6 million charge in fiscal year 2012. The inventory charges resulted primarily from the technology shift to Ethernet that decreased demand for T1-related products.

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Sales and marketing (S&M)      Fiscal Year Ended March 31,              Increase (Decrease)
                                                                       2014 vs.         2013 vs.
(in thousands)                2014          2013        2012             2013             2012
Consolidated S&M expense  $   14,663      $ 7,492     $ 5,843     $     7,171          $    1,649
Percentage of Revenue             14 %         19 %        13 %

In fiscal year 2014, sales and marketing expenses increased by $7.2 million compared to fiscal year 2013 due primarily to the acquisition of Kentrox, which added $6.4 million of expense. The CSI acquisition added $0.3 million of expense. The remaining increase resulted primarily from increased commission expense of $0.4 million.

Sales and marketing expenses in fiscal years 2013 and 2012 consisted of the Westell segment only and increased 28% primarily due to higher compensation and related expenses which resulted from the addition of employees hired with the ANTONE acquisition, the addition of a Senior Vice President of Sales and Marketing and increased commission expense.

Research and development (R&D)         Fiscal Year Ended March 31,                 Increase (Decrease)
                                                                                 2014 vs.        2013 vs.
(in thousands)                      2014            2013           2012            2013            2012
Westell                        $     6,936      $    5,928     $    5,460     $      1,008     $       468
Kentrox                              3,778          N/A            N/A               3,778          N/A
CSI                                    625          N/A            N/A                 625          N/A
Consolidated R&D expense       $    11,339      $    5,928     $    5,460     $      5,411     $       468
Percentage of Revenue                   11 %            15 %           13 %

In fiscal year 2014, consolidated research and development expenses increased . . .

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