Westell Technologies 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number: 0-27266
WESTELL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
750 N. Commons Drive, Aurora, Illinois 60504
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (630) 898-2500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, $.01 par value
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The registrant estimates that the aggregate market value of the registrant's Class A Common Stock held by non-affiliates (within the meaning of the term under the applicable regulations of the Securities and Exchange Commission) on September 30, 2006 (based upon an estimate that 95% of the shares are so owned by non-affiliates and upon the average of the high and low prices for the Class A Common Stock on the NASDAQ National Market on that date) was approximately $109 million. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and registrant is not bound by this determination for any other purpose.
As of June 1, 2007, 56,568,074 shares of the registrant's Class A Common Stock were outstanding and 14,741,872 shares of registrant's Class B Common Stock (which automatically converts on a one-for-one basis into shares of Class A Common Stock upon a transfer of such stock except transfers to certain permitted transferees) were outstanding.
The following documents are incorporated into this Part III Form 10-K (and any amendments thereto) by reference:
WESTELL TECHNOLOGIES, INC.
2007 ANNUAL REPORT ON FORM 10-K CONTENTS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained in this Annual Report of Form 10-K including, without limitation, statements containing the words "believe," goal, on track, "anticipate," committed "expectation," expect, "estimate", "await," "continue," "intend," may, will, should, and similar expressions are forward looking statements that involve risks and uncertainties. The Company can give no assurance that the expectations reflected in the forward-looking statements will prove to be correct. These risks include, but are not limited to, product demand and market acceptance risks, need for financing, any economic downturn in the U.S. economy and telecom market, the impact of competitive products or technologies, competitive pricing pressures, product development, excess and obsolete inventory, new product development, commercialization and technological delays or difficulties (including delays or difficulties in developing, producing, testing and selling new products and technologies), the effect of Westells accounting policies, the need for additional capital, the effect of economic conditions and trade, legal social and economic risks (such as import, licensing and trade restrictions) and other risks more fully described in this Form 10-K for the fiscal year ended March 31, 2007 under the section Risk Factors. These statements are not guaranties of future performance. Westell undertakes no obligation to release publicly the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. At any time when the Company makes forward-looking statements, it desires to take advantage of the safe harbor which is afforded such statements under the Private Securities Litigation Reform Act of 1995.
ITEM 1. BUSINESS
Westell Technologies, Inc., (the Company) was incorporated in Delaware in 1980 and its headquarters are located at 750 North Commons Drive, Aurora, Illinois. The Company is comprised of two segments: equipment sales and teleconference services. In the equipment segment, the Company designs, manufactures markets and services a broad range of digital and legacy analog products used by telephone companies and other telecommunications service providers to deliver broadband services over both existing copper telephone wires and the fiber network that connect end users to a telephone company's central office. The central office is a telephone company building where subscriber lines are joined to switching equipment that can connect subscribers to each other. The copper wires and fiber that connect users to these central offices are part of the telephone companies' networks and are commonly referred to as the local loop or the local access network.
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 or fiber infrastructure. The Companys NSA product line consists of manageable and non-manageable T1 transmission equipment, associated mountings and special service plugs for the legacy copper telephone network. On January 2, 2007, the Company acquired Noran Tel, Inc. a manufacturer of network service access products. Westell realizes the majority of its revenues from the North American market.
The Companys 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 multiple participants. Conference Plus sells its services directly to large customers, including Fortune 1000 companies, and serves other customers indirectly through its private reseller program.
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Revenues and total assets from Westell's two reportable segments and product groups for the fiscal years ended March 31 are as follows (for more information also see Managements Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in this Annual Report on Form 10-K):
Financial information for each of the Companys segments and operations by geographic area are located in Note 11 of the consolidated financial statements included in this Annual Report.
The Companys stock is divided into two classes. Class A common stock is entitled to one vote per share while Class B common stock is entitled to four votes per share. The Companys largest stockholder is a voting trust that owned 47.5% of the voting control of the Company as of June 1, 2007. The trust was formed for the benefit of Robert C. Penny III and Melvin J. Simon and their respective families. Certain Penny family members also own or are beneficiaries of trusts that own shares outside of the voting trust. As trustees of the Voting Trust and other trusts, Messrs. Penny and Simon control 52.3% of the voting stock and therefore effectively control the Company.
The Companys Products
The equipment segment of the Companys 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:
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 equipment manufacturers. Increasing competition, in terms of the number of entrants and their size, and the increasing size of the Companys customers because of past mergers, continues to exert downward pressure on prices for the Company's products. At some point the Company may elect to eliminate some products and exit some markets based on an analysis of current and future prospects.
Digital subscriber line (DSL) technology uses complex modulation methods to enable high-speed Broadband services over copper phone lines. Current DSL equipment allows the simultaneous transmission of data at speeds up to 8 megabits per second when receiving information on the Internet, or 140 times faster than standard 56k modem
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dial up service, and up to 1 megabits per second when sending information on the Internet, or 17 times faster than standard 56k modem dial up service, while also providing standard analog telephone service over a single pair of copper wires. Current DSL equipment operates at distances of up to 18,000 feet from the telephone companys central office. A new DSL standard termed ADSL2+ is now being deployed by service providers. ADSL2+ increases downstream speed to 24 megabits per second while extending the reach of the equipment to potentially from 18,000 to 22,000 feet in certain circumstances. To increase the data rate of ADSL2+ for IPTV video applications, carriers are bonding ADSL2+ pairs together to double the speed of standard ADSL2+. Additionally, a higher-speed standard, VDSL2, is now being introduced and some limited deployment has begun. VDSL2 is targeted at IPTV solutions with a maximum data rate of 100Mbps on loops shorter than 3,000 feet. Westell has evolved its product line and introduced new products that support these new ADSL2/2+, bonded and VDSL standards. These new standards improve delivery of new services like Voice over Internet Protocol (VoIP) and Video in addition to high-speed Internet.
With DSL technology, a user can talk on the telephone and simultaneously transmit high-speed data over the same copper phone line. DSL products enable telephone companies to provide interactive multimedia services over copper wire while simultaneously carrying traditional telephone services, thus mitigating the need for the consumers to install second lines to provide these services. DSL technology is also known as Asymmetric Digital Subscriber Line (ADSL and ADSL2+) when it refers to products that provide the ability to send and receive information at varying speeds.
The DSL connection or link is comprised of a DSL Access Multiplexer (DSLAM) and equipment at the users location referred to as customer premise equipment (CPE). The DSLAM is a piece of equipment that typically resides in telephone companies' central offices. It aggregates, or multiplexes, multiple DSL access lines into a telephone company's high-speed line back to its core or central network. As network service providers increase deployment of DSL based services, the need for DSL line concentration at the central offices increases. The CPE is typically a small device enabling DSL services that is found adjacent to a personal computer.
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The following table sets forth a list of the Company's principal CNE products and their applications:
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NSA Products. Westells NSA products provide telephone companies with products to transport, maintain and improve the reliability of services over copper and fiber lines in the local access network. The following table sets forth a list of the Company's principal NSA products and their applications:
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Research and Development Capabilities and Engineering Base
The Company believes that its future success depends, in part, on its ability to maintain its technological leadership through enhancements of its existing products and development of new products that meet customer needs. The Company is focusing on expanding its product offerings in the equipment segment from basic high speed broadband Internet access to more sophisticated applications such as home wireless networking, voice, video and information service delivery converged services and IPTV/Video. Westell works closely with its current and potential customers as part of the product development process.
In fiscal 2005, the Company received $900,000 from customers to fund engineering projects which was offset in part by a $300,000 expense for engineering performed by a third party. The $600,000 was offset against research and development expenses. The Company did not receive any funding from customers for engineering projects in fiscal 2006 or fiscal 2007. The Company capitalized $1.9 million in software development costs in fiscal 2005. The Company did not capitalize any software development costs in fiscal 2006 or fiscal 2007. In fiscal 2007, 2006 and 2005 the Company spent approximately $24.4 million, $20.3 million and $15.9 million on research and development activities, net of customer funding and software capitalization.
Westell's quality systems, including product development processes, are registered to TL9000, which is the Telecommunication Industry's sector-specific version of the ISO9001:2000 International Quality System Standard. These processes are also registered to ISO9001:2000. The Company's research and development personnel are organized into product development teams. Each product development team is generally responsible for sustaining technical support of existing products, decreasing manufacturing costs, conceiving new products in cooperation with other groups within the Company and adapting standard products or technology to meet new customer needs. In particular, each product development team is charged with implementing the Company's engineering strategy of reducing product costs for each succeeding generation of the Company's products in an effort to be a highly valued, superior quality provider, without compromising functionality or serviceability.
The Company believes that the key to this strategy is choosing an initial architecture for each product that enables engineering innovations to result in performance enhancements and future cost reductions. Westells products are designed in conjunction with input from procurement and an analysis of manufacturability to reduce costs. The Company believes it has a quality record that is grounded in a solid interface and transference of knowledge between design and manufacturing teams. Successful execution of this strategy also requires that the Company continue to attract and recruit highly qualified engineers.
The Companys products are subject to industry wide standardization organizations which include the Internet Engineering Task Force, the DSL Forum, the American National Standards Institute (ANSI) in the United States and the European Telecommunications Standards Institute (ETSI) which are responsible for specifying transmission standards for telecommunications technologies. The industry transmission standard for ADSL adopted by ANSI and ETSI is based upon Discrete Multitone Technology (DMT). DMT is technology that allows digital information to be sent at high-speeds over copper phone lines and prevents the digital information from interfering with other services provided on the same copper phone line. Westell incorporates DMT technology into its DSL products. The Company has not developed a DMT transceiver technology for its product offerings and is dependent on transceiver technologies sourced from third parties. The Company has established multiple strategic relationships with transceiver technology vendors for DSL chipsets to be used in ADSL systems by the Company. Absent the proper relationships with key silicon chipset vendors, the Companys products may not comply with standards set forth by ANSI and ETSI. Should customers require standards based products containing transceiver technology not available to the Company under reasonable terms and conditions, the Companys business and results of operations would be materially and adversely affected.
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The following table lists the principal products currently under development along with their description and expected application:
The Company anticipates that it will generate revenue from the products listed in the above table in fiscal year 2008 and fiscal year 2009. However, there can be no assurance that the Company will be able to introduce such products as planned.
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The Company's principal customers historically have been large Regional Bell Operating Companies (RBOCs) within the United States. In addition, Westell sells products to several other entities, including public telephone administrations located outside the U.S., independent domestic local exchange carriers, competitive local exchange carriers, inter-exchange carriers, Internet service providers, and business enterprises. Revenues from international customers represented approximately $7.3 million, $7.5 million and $8.4 million of the Company's revenues in fiscal 2007, 2006 and 2005, respectively, accounting for 2.8%, 2.7% and 3.1% of the Company's revenues in such periods.
The Company depends, and will continue to depend, on the Regional Bell Operating Companies (RBOCs) and other independent local exchange carriers for substantially all of its revenues. Sales to the RBOCs accounted for 67.8%, 78.1% and 77.5% of the Company's revenues in fiscal 2007, 2006 and 2005, respectively. Sales to the Companys largest two customers, Verizon and AT&T accounted for 37.0% and 28.9% of the Company's revenues in fiscal 2007, respectively. Consequently, the Company's future success will depend upon the timeliness and size of future purchase orders from the RBOCs, the product requirements of the RBOCs, the financial and operating success of the RBOCs and the success of the RBOCs' services that use the Company's products. Any attempt by an RBOC or other telephone company access providers to seek out additional or alternative suppliers or to undertake the internal production of products could have a material adverse effect on the Company's business and results of operations. In addition, the Company's sales to its largest customers have in the past fluctuated, and in the future could fluctuate significantly from quarter to quarter and year to year. The loss of such customers or the occurrence of such sales fluctuations would materially adversely affect the Company's business and results of operations.
The Companys contracts with its major customers are primarily pricing and product specification agreements that do not require a specific level of quantities to be purchased. Each customer provides the Company with purchase orders for units on an as-needed basis.
The RBOCs and the Company's other customers are significantly larger than, and are able to exert a high degree of influence over, the Company. As a result, our larger customers may be able to reschedule or cancel orders without significant penalty. Prior to selling its products to telephone companies, the Company must undergo lengthy approval and purchase processes, which are discussed in the section, captioned Marketing, Sales and Distribution.
Marketing, Sales and Distribution
The Company sells its products in the U.S. through its domestic field sales organization and selected distributors. The Company has had an established sales force and channel to domestic service providers since its founding in 1980.
The Company markets its products domestically within the United States, as well as in Canada and Europe. In North America, the Companys traditional NSA products are sold directly to the service providers or in some cases to distributors who service these carriers. The Companys CNE products are sold directly to telephone carriers, to distributors who service these carriers and to Internet service providers who provide DSL services. The Company believes that the DSL sales channels are very dynamic and continually looks to adapt and configure its sales force and processes to meet these changes.
Prior to selling its products to telephone companies, the Company must undergo lengthy approval and purchase processes. Evaluation can take as little as a few months for products that vary slightly from existing products in the local access network and often longer for products based on new technologies. Accordingly, the Company is continually submitting successive generations of its current products as well as new products to its customers for approval.
Although the telephone company approval processes may vary to some extent depending on the customer and the product being evaluated, they generally are conducted as follows:
Laboratory Evaluation. The product's function and performance are tested against all relevant industry standards.
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Technical Trial. Access lines are equipped with the product for simulated operation in a field trial. The field trial is used to evaluate performance, assess ease of installation and establish troubleshooting procedures.
Marketing Trial. Emerging products are tested for market acceptance of new applications and services. Marketing trials usually involve a greater number of systems than technical trials because systems are deployed at several locations in the telephone company's network. This stage gives telephone companies an opportunity to establish procedures, train employees to install and maintain the new product and to obtain more feedback on the product from a wider range of operations personnel.
Commercial Deployment. Commercial deployment usually involves substantially greater numbers of systems and locations than the marketing trial stage. In the first phase of commercial deployment, a telephone company initially installs the equipment in select locations for select applications. This phase is followed by general deployment involving greater numbers of systems and locations. Commercial deployment does not usually mean that one supplier's product is purchased for all of the telephone companies' needs throughout the system as telephone companies often rely upon multiple suppliers to ensure that their needs can be met. Subsequent orders, if any, are generally placed under single or multi-year supply agreements that are generally not subject to minimum volume commitments.
The relationships that the Company establishes in this extensive process are critical in almost every case. The Company has a history of working closely with the service providers in this fashion and the Company has won numerous quality awards from a variety of customers over the past twenty years.
The Company is exploring new channels, markets and partners for its newer products. The deployment of emerging fixed mobile convergence (FMC), IPTV/video and information services all represent opportunities for the Companys TriLink, UltraLine Series3 and Westell MediaStation products at customers beyond its traditional base of customers.
Westell maintains 24-hour, 7-day-a-week telephone support and provides on-site support. The Company also provides technical consulting, research assistance and training to some of its customers with respect to the installation, operation and maintenance of its products.
The Company has general purchase agreements with most of its major customers. These agreements may require the Company to accept returns of products within certain time limits, or indemnify such customers against certain liabilities arising out of the use of the Company's products. Although, to date, the Company has not experienced any significant product returns or indemnification claims under these contracts, any such claims or returns could have a material adverse effect on the Company's business and results of operations.
The Company's products are required to meet rigorous standards imposed by its customers. Most of the Company's products carry a limited warranty ranging from one to two years for CNE products and seven to ten years for NSA products, which generally covers defects in materials or workmanship and failure to meet published specifications, but excludes damages caused by improper use and all other warranties. In the event there are material deficiencies or defects in the design or manufacture of the Company's products, the affected products could be subject to recall.
On May 21, 2007 the Company announced a restructuring plan which included its intent to move substantially all of the manufacturing of CNE and NSA products from Aurora, Illinois to offshore suppliers. This decision represents a new operating strategy, adopted by the Companys Board of Directors, to better align the Company with the requirements of the marketplace. The aim of this new operating strategy is to reduce costs, while maintaining the Companys reputation for quality products and services. The transition affects approximately 300 Aurora employees. The Company will continue to be housed in the current Aurora facility. Alternative uses for the factory portion of the building made idle by this decision are being explored. The Company expects to complete the
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restructuring by March 31, 2008. Reliance on third-party offshore subcontractors involves several risks. (See Risk Factors)
The Company has purchase contracts with suppliers of material components. Most purchased items are standard commercial components available from multiple suppliers. There are also single-sourced components needed to produce products. One of the single-sourced items in broadband consists of the license to run an operating platform. There are a number of other suppliers in the market that could supply the Company with this same technology, however, it would take the Company at least nine months to reengineer the product and subsequently get product approval from customers. This delay would materially adversely affect the Companys business. Broadband product sales accounted for 59.2% of revenue in fiscal 2007. All purchase contracts are short term in nature with the exception of three long-term commitments to purchase memory chips.
A substantial portion of the Company's shipments in any fiscal period can relate to orders for products received in that period. Westell's processes are also registered to TL9000, as well as to ISO9001:2000. Further, a significant percentage of orders, such as Network Interface Units, or NIUs, may require delivery within 48 hours. To meet this demand, the Company maintains raw materials inventory and/or finished goods inventory at its facilities or outsource suppliers. In addition, the Company maintains some finished goods inventory at the customers sites pursuant to agreements that the customers will eventually purchase such inventory. Because of the rapid technological changes to our products, the Company faces a reoccurring risk that the inventory it holds may become obsolete.
The markets for the Company's products are intensely competitive and the Company has no reason to believe that this competitive environment will ease in the future, especially in the rapidly changing markets for broadband products. Westells primary competitors vary by market. The Companys principal competitors with respect to its NSA products are Adtran, ADC Telecommunications and Pulsecom. The Company's principal competitors with respect to its CNE broadband products are primarily Siemens Information and Communication Network Inc.,, Motorola (Netopia), 2Wire Inc., Cisco Systems Inc. (Linksys), D-Link Systems Inc., ActionTec Electronics Inc., Thomson and ZyXEL Communications Co. The Company believes that it is currently one of the leading sellers of DSL products in North America. However, many of the Companys competitors are significantly larger and have more financial resources than the Company. To compete against these competitors, the Company focuses on quality, time to market and the ability to react quickly to market changes resulting from U.S. based product development teams. The Company expects that continuing competitive pressure from Asian based manufacturers will continue downward pressure on pricing.
Additional competition is seen from products that increase the efficiency of digital transmission over copper wire such as wireless, cable and other products delivering broadband digital transmission. Telephone companies face competition from cable operators, new local access providers and wireless service providers that are capable of providing high speed digital transmission to end users. At the end of 2006, 29 million customers used cable broadband in the U.S. in contrast to 24 million DSL subscribers. By 2009, Infonetics, a service that provides industry trend data, is forecasting there to be 56 million cable broadband users in North America versus 48 million DSL users resulting in a 46% market share for DSL. In addition, the deployment of products and technologies for copper wire may also reduce the demand for NSA products currently manufactured by the Company. The deployment of HDSL2 and HDSL4 systems in the U.S. reduces telephone companies' need for T-1 repeaters, which results in a decrease in demand for Westell's T-1 products such as its Network Interface Units. The Company believes that the domestic market for some of its older, low speed NSA transmission products is decreasing, and will likely continue to decrease, as high capacity digital transmission becomes less expensive and more widely deployed. (See the Risk Factors)
Conference Plus, Inc., founded in 1988, is a full service conferencing company that manages and hosts specific software and applications relating to conferencing and meeting services. Conference Plus is a 91.5% owned subsidiary of Westell and manages its teleconferencing and meeting services through its main operations center in Schaumburg, Illinois and a facility in Dublin, Ireland. Conference Plus services generated $48.5 million, $45.1 million and $44.4 million in revenues in fiscal 2007, 2006 and 2005, respectively.
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Conference Plus allows multiple individuals, organizations and/or businesses to conduct conference calls using a combination of voice, video or web such as graphs or spreadsheets. Conference Plus offers conference call services that can include a blend of audio, graphics, spreadsheets or other documents that can be carried over and archived on the Internet to enhance the traditional voice conference call. By enabling the sharing of this blend of information, Conference Plus can help organizations increase productivity and save money by reducing travel time, bringing down travel costs, and making it easier for people in remote locations to work together. Teleconference and meeting service technologies also allow organizations and individuals to collect and disseminate information faster, more accurately and without the associated costs of face-to-face meetings.
Diverse Distribution Channels
Conference Plus has historically acted as a provider of conferencing and meeting services on a wholesale basis, managing and hosting applications for major carriers and telecommunications resellers. About half of Conference Plus revenues come from indirect commercial teleconferencing services to customers who market or use Conference Plus services under their own brand name. Such companies choose to outsource and private label audio, web and video teleconferencing services to maintain continuity, save costs and focus on their core competencies. By selling into indirect or resale customers, Conference Plus effectively increases the size of their sales organization without incurring the expense necessary with a direct sales force.
Conference Plus also sells its services directly to companies through its National Accounts Sales force. This area continues to be a strong part of Conference Pluss business and the Company expects to continue to invest resources in this area in order to maintain a diverse mix of revenue distribution. The deployment of this strategy is designed to improve the recognition of the Conference Plus brand, which has strategic long term benefits to the Company.
A critical part of Conference Plus approach is its state of the art network and integrated systems. Conference Plus has a state of the art network infrastructure that enables it to take advantage of the relationships it has with major telecommunications providers to provide quality service. Conference Plus has deployed equipment in carrier Points-of-Presence to take advantage of the higher capacity and the lower cost structure available with such deployments.
Conference Plus has built an integrated reservations, scheduling and billing system called Conferencing and Reservation Billing System (CRBS) that is a significant differentiator in the conferencing market. CRBS allows Conference Plus to leverage its operations on a global basis. This reliable and scalable system is seamlessly integrated in the operational environment from the point of reservation through the billing process. This integration allows Conference Plus to enjoy scale advantages and to be able to provide transparent branded services to its customers. This system is built and maintained by an in-house team of engineers, developers and technicians who continually work to improve and enhance the system based on industry trends, customer requests and strategic direction.
Conference Plus has extended certain capabilities of CRBS to a publicly available web portal where customers can sign up for service, manage their accounts and control their conferences. Conference Plus has also tightly integrated with third party suppliers of web conferencing services to enhance our audio and video services. In addition to making these services available to customers, Conference Plus has the ability to privately brand the entire web experience to match any other brand visualization that may be required. This capability is beneficial for both indirect customers where this helps support the indirect brand as well as for large enterprise customers where branding can help drive corporate adoption.
Conference Plus has also begun leveraging the capabilities of CRBS for certain large scale conferencing deployments where the technology can simplify and streamline the usage, billing and cost accounting services for select customers.
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As customers globalize their telecommunications services, Conference Plus has expanded its operational presence internationally to meet these needs. In addition to its main operational centers in Schaumburg, Illinois and Dublin, Ireland, Conference Plus has teleconferencing bridges located in Chicago, Illinois, Broadview, Illinois and London, England. Conference Plus is able to serve the teleconferencing needs of customers headquartered anywhere in the world through these facilities. The Conference Plus facility in Dublin, Ireland was established in 1998 to help meet the growing demand for global conferencing service. The international market for teleconferencing is expected to grow as a result of deregulation and improved networks with associated reductions in end user costs.
Conference Plus indirect or private label customers and many of its other customers are significantly larger than, and are thus able to exert a high degree of influence over, Conference Plus. Conference Plus depends on large customers to provide a significant percent of its revenues. A loss of one of these customers would have a material adverse effect on Conference Pluss business. The Company has a strategy in place to mitigate the loss of a major customer. Prior to selling its services, Conference Plus must undergo lengthy approval and purchase processes. Evaluation can take a few months for services that vary slightly from existing services used by the prospective customer to a year or more for services based on technologies such as video or data teleconferencing or which represent a new strategic direction for the customer, as in the case with private labeling teleconference services for a large reseller.
Competition in the teleconferencing business is intense and Conference Plus expects that competition will increase due to low barriers of entry and recent entrants into the audio teleconferencing service market. Many of Conference Plus' competitors, including InterCall, AT&T, Verizon, Premiere and British Telecom, have much greater name recognition, more extensive customer service and marketing capabilities and substantially greater financial, technological and personnel resources than Conference Plus. There can be no assurance that Conference Plus will be able to successfully compete in this market in the future or that competitive pressures will not result in price reductions that would materially adversely affect its business and results of operations.
The telecommunications industry, including most of the Company's customers, is subject to regulation from federal and state agencies, including the FCC and various state public utility and service commissions. While such regulation does not affect the Company directly, the effects of such regulations on the Company's customers may, in turn, adversely impact the Company's business and results of operations. For example, FCC regulatory policies affecting the availability of telephone and communications services and other terms on which service providers conduct their business may impede the Company's penetration of certain markets. The Telecommunications Act of 1996 lifted certain restrictions on the carriers ability to provide interactive multimedia services including video on demand. Under the Telecommunications Act of 1996, new regulations have been established whereby carriers may provide various types of services beyond traditional voice offerings.
In addition, the Telecommunications Act of 1996 permits the carriers to engage in manufacturing activities after the FCC authorizes a carrier to provide long distance services within its service territory. A carrier must first meet specific statutory and regulatory tests demonstrating that its monopoly market for local exchange services is open to competition before it will be permitted to enter the long distance market. When these tests are met, a carrier will be permitted to engage in manufacturing activities, and the carriers, which are the Company's largest customers, may become the Company's competitors as well. See Risk Factors.
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Proprietary Rights and Intellectual Property
The Company's success and future revenue growth will depend, in part, on its ability to protect trade secrets, obtain or license patents and operate without infringing on the rights of others. The Company relies on a combination of technical leadership, copyrights, patents, trademarks, trade secrets and other intellectual property laws, nondisclosure agreements and other protective measures to protect our unpatented proprietary know-how. The Company regards some of its technology as proprietary and the Company has been granted 26 patents and has an additional 17 U.S. patents pending relating to its NSA and CNE products. The expiration of any of the patents held by the Company would not have a material impact on the Company. The Company expects to seek additional patents from time to time related to its research and development activities.
Many of the Company's products incorporate technology developed and owned by third parties. Consequently, the Company must rely upon third parties to develop and to introduce technologies which enhance the Company's current products and enable the Company, in turn, to develop its own products on a timely and cost-effective basis to meet changing customer needs and technological trends in the telecommunications industry. Without third party transceiver technologies, such as DMT technology, the Company would not be able to produce any of its DSL systems. Consequently, if the Companys third party transceiver suppliers fail to deliver transceivers that meet the Companys requirements or fail to deliver transceivers that meet industry standards and other alternative sources of DSL transceiver technology are not available to the Company at commercially acceptable terms, then the Companys business and results of operations would be materially and adversely affected. The Companys reliance on certain third party technology is also discussed above in Research and Development Capabilities and Engineering Base.
Rapid technological evolution has resulted in the need to implement strategic alliances with technology suppliers in order to accelerate the time to market for new products. Without such relationships, due to the lengthy carrier product approval and purchase cycles, the technology may be obsolete by the time the Company completes the product approval and purchase cycles.
As of March 31, 2007, the Company had 898 full-time employees. Westells domestic equipment manufacturing business had a total of 536 full-time employees, consisting of 131 in sales, marketing, distribution and service, 112 in research and development, 264 in manufacturing and 29 in administration. Conference Plus had a total of 291 full-time employees. Noran Tel had a total of 57 full-time employees. Westell Limited had a total of 14 full-time employees. The Company's employees are not represented by a collective bargaining agreement nor has the Company ever experienced any work stoppage. The Company believes its relationship with its employees is good.
The SEC maintains an internet site, www.sec.gov, through which you may access the companys annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and other information statements, as well as amendments to these reports. In addition, the company makes these reports available free of charge on the Companys internet website, www.westell.com. Westell maintains a corporate governance page on the Companys website. This website includes, among other items, the Code of Conduct, Audit Committee Charter and Nominating Committee Charter. The corporate governance information can be found at www.westell.com under Investor Relations.
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ITEM 1A. RISK FACTORS
You should carefully consider the risks described below in addition to the other information contained and incorporated by reference in this Form 10-K. If any of the following risks occurs, our business, operating results or financial condition would likely suffer, and the market price for our securities could decline.
We have incurred losses in the past and may incur losses in the future.
Although we have had 20 consecutive profitable quarters, in the past, due to our significant ongoing investment in DSL and other new technology, we incurred losses through fiscal 2002. Through fiscal 2002, we incurred operating losses, net losses and negative cash flow on both an annual and quarterly basis. The Company had an accumulated deficit of $226.5 million as of March 31, 2007.
In addition, we expect to continue to evaluate new product opportunities. As a result, we will continue to invest heavily in research and development and sales and marketing, which could adversely affect our short-term operating results. We can offer no assurances that we will remain profitable in the future.
Our stock price is volatile and could drop unexpectedly.
Like many technology stocks, our stock has demonstrated and likely will continue to demonstrate extreme volatility as valuations, trading volume and prices move significantly. This volatility may result in a material decline in the market price of our securities, and may have little relationship to our financial results or prospects.
Our class A common stock price has experienced substantial volatility in the past and is likely to remain volatile in the future due to factors such as:
Many of the factors listed above are not within our control. In the past, companies that have experienced volatility in the market price of their stock have been the subject of securities class litigation.
We have and could face securities class litigation, which could significantly harm our business.
In fiscal 2000, Westell Technologies, Inc. and certain of its officers and directors were named in consolidated class actions. Although these class actions were settled, we could face securities litigation in the future that could result in the payment of substantial damages or settlement costs in excess of our insurance coverage. Any adverse outcome could harm our business. Even if we were to prevail in any such litigation, we could incur substantial legal costs and management's attention and resources could be diverted from our business that could cause our business to suffer.
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Due to the rapid technological changes in our industry, our products may become obsolete before we can realize significant revenues from our products, which could cause us to incur charges for excess and obsolete inventory and materially harm our business.
The telecommunications industry is subject to rapid technological change and volatile customer demands, which results in a short product commercial life before a product becomes obsolete. As a result, we have in the past and may in the future devote disproportionate resources to a product that has an unexpected short commercial life and/or have to write off excess and obsolete inventory, each of which would harm our operating results and financial condition and harm our business. From time to time, we may need to write off inventory as excess or obsolete. In the past, we have experienced such write-offs. If we incur substantial inventory expenses that we are not able to recover because of changing market conditions, it could have a material adverse effect on our business, financial condition and results of operations.
Pricing pressures on our products may affect our ability to be profitable in the future.
We have and may in the future offer products and services based upon forward pricing, which is the pricing of products below production costs to take into account the expectation of large future volumes and corresponding reduction of manufacturing costs. Forward pricing would cause us to incur lower margins on product or service sales unless we can reduce the associated costs. We believe that costs may decrease if:
There is no guarantee that we will be able to secure significant additional business and reduce per unit costs that we have factored into our forward priced products. As a result, we could incur low or negative margins in connection with sales of forward priced products even if our unit volume increases. Low margins from our sales of products and services could result in fluctuations in our quarterly operating results and would materially and adversely affect our profitability and ability to implement our business goals.
Our products face competition from other existing products, products under development and changing technology, and if we do not remain competitive, our business will suffer and we will not remain profitable.
The markets for our products are characterized by:
New products introductions or changes in services offered by telephone companies or over the Internet could render our existing products and products under development obsolete and unmarketable. Specifically, the drive by telephone companies to offer new VoIP, IPTV, Video and FMC services will cause the current products to be replaced with newer, more compatible technology. Further, we believe that the domestic market for many of our traditional NSA products is decreasing, and will likely continue to decrease, as high capacity digital transmission becomes less expensive and more widely deployed. For example, our Network Interface Unit (NIU) product revenue decreased 24.6% in fiscal 2005 and an additional 0.7% in fiscal 2006. Our fiscal 2007 NIU revenue increased by 70.4% due to the acquisition of HyperEdge. Our future success will largely depend upon our ability to successfully develop and market new products.
In addition, our current product offerings primarily enable telephone companies to deliver communications over copper telephone wires in the local access network. Telephone companies also face competition in the delivery of digital communications from cable operators and wireless service providers. If end users obtain their high-speed
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data transmission services from these alternative providers, then the overall demand for our DSL and other broadband products will be impaired.
To remain competitive, we must develop new products to meet the demands of these emerging transmission media and new local access network providers. Our business would be severely harmed if our products become obsolete or fail to gain widespread commercial acceptance due to competing products and technologies.
Evolving industry standards may adversely affect our ability to sell our products and consequently harm our business.
Industry wide standardization organizations such as the International Telecommunications Union, American National Standards Institute and the European Telecommunications Standards Institute are responsible for setting transceiver technology standards for DSL and other products. We are dependent on transceiver technologies from third parties to manufacture our products. If transceiver technologies needed for standards-based products are not available to us in a timely manner and under reasonable terms, then our revenues would significantly decrease and our business and operating results would suffer significantly.
In addition, the introduction of competing standards or implementation specifications could result in confusion in the market and delay decisions regarding deployment of our products. Delay in the announcement of standards would materially and adversely impact our product sales and would severely harm our business.
We are dependent on third party technology, the loss of which would harm our business.
We rely on third parties to gain access to technologies that are used in our current products and in products under development. For example, our ability to produce DSL products is dependent upon third party transceiver technologies. Our licenses for DSL transceiver technology are nonexclusive and the transceiver technologies have been licensed to numerous other manufacturers. If our DSL transceiver licensors fail to deliver commercially ready or standards compliant transceiver solutions to us and other alternative sources of DSL transceiver technologies are not available to us at commercially acceptable terms, then our business and operating results would be significantly harmed.
Any impairment in our relationships with the licensors of technologies used in our products would force us to find other developers on a timely basis or develop our own technology. For example, it would take us approximately nine months to reengineer the product and subsequently get product approval from customers if the Company lost its existing licenses to the DSL technology and operating platform used in its DSL products. There is no guarantee that we will be able to obtain the third-party technology necessary to continue to develop and introduce new and enhanced products, that we will obtain third-party technology on commercially reasonable terms or that we will be able to replace third-party technology in the event such technology becomes unavailable, obsolete or incompatible with future versions of our products. We would have severe difficulty competing if we cannot obtain or replace much of the third-party technology used in our products. Any absence or delay would materially adversely affect our business and operating results.
We are dependent on sole or limited source suppliers, the loss of which would harm our business.
Integrated circuits and other electronic components used in our products may only be currently available from only one source or a limited number of suppliers. Our inability to obtain sufficient key components or to develop alternative sources for key components as required, could result in delays or reductions in product deliveries, and consequently severely harm our customer relationships and our business. Furthermore, additional sole-source components may be incorporated into our future products, thereby increasing our supplier risks. If any of our sole-source suppliers delay or halt production of any of their components, or fail to supply their components on commercially reasonable terms, then our business and operating results would be harmed. For example, it would take the Company approximately nine months to reengineer the product and subsequently get product approval from customers if the Company lost its existing licenses to the DSL technology and operating platform used in its DSL products.
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We may experience delays in the receipt of key components that could result in delays in related product deliveries. There is no guarantee that we will be able to continue to obtain sufficient quantities of key components as required, or that such components, if obtained, will be available to us on commercially reasonable terms.
We have few long term contracts or arrangement with suppliers which could adversely affect our ability to purchase components and technologies used in our products.
We have few long-term contracts or arrangements with our suppliers. We may not be able to obtain components at competitive prices, in sufficient quantities or under other commercially reasonable terms. If we enter into a high-volume or long-term supply arrangement and subsequently decide that we cannot use the products or services provided for in the supply arrangement, then our business would also be harmed. We enter into short term contracts with our suppliers in the form of purchase orders. Purchase orders are often non-cancelable within contractual time periods. These purchase orders are issued to vendors based on forecasted demand. If the forecasted demand is materially incorrect, we may find that we cannot use the products ordered, then our business would also be harmed.
We will become dependent on our third party offshore outsource manufacturing partners to produce and deliver our products timely which could adversely impact our ability to meet the delivery requirements of our customers.
On May 21, 2007 the Company announced its intent to move substantially all of the manufacturing of CNE and NSA products from Aurora, Illinois to offshore suppliers. Reliance on third-party offshore outsource manufacturing partners involves a number of risks, including:
We may be adversely impacted by the rising cost of product material components such as copper, petroleum, gold, platinum and silver.
The costs of commodities such as copper and petroleum, and to a lesser extent; gold, platinum and silver, all components of the Companys products, could increase the cost of the Companys products thereby adversely impacting our business and operating results.
We will not be able to successfully compete, develop and sell new products if we fail to retain key personnel and hire additional key personnel.
Because of our need to continually evolve our business with new product developments and strategies, our success is dependent on our ability to attract and retain qualified technical, marketing, sales and management personnel. To remain competitive, we must maintain top management talent, employees who are involved in product development and testing and employees who have developed strong customer relationships. Because of the high demand to these types of employees, it may be difficult to retain existing key employees and attract new key employees. In addition we do not have non-compete contracts with most of our employees. Our inability to attract and retain additional key employees could harm our ability to successfully sell existing products and develop new products and implement our business goals.
Our quarterly operating results are likely to fluctuate significantly and should not be relied upon as indications of future performance.
We may experience significant fluctuations in quarterly operating results. Due to the risks identified below and elsewhere in "Risk Factors," sales to our largest customers have fluctuated and could fluctuate significantly between quarters. Sales to our customers typically involve large purchase commitments, and customers purchasing our
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products may generally reschedule without penalty. As a result, our quarterly operating results have fluctuated significantly in the past. Other factors that have influenced and may continue to influence our quarterly operating results include:
Due to fluctuations in quarterly results, we believe that period-to-period comparisons of our quarterly operating results are not necessarily meaningful. Our quarterly fluctuations make it more difficult to forecast our manufacturing and purchasing needs and revenues. It is possible that in some future quarters our operating results will be below the expectations of securities analysts and investors, which may adversely affect our stock price. As long as we continue to depend on DSL products and new products, there is substantial risk of widely varying quarterly results, including the so-called missed quarter relative to investor expectations.
We may experience delays in the deployment of new products.
Our past sales have resulted from our ability to anticipate changes in technology, industry standards and telephone company service offerings, and to develop and introduce new and enhanced products and services. Our continued ability to adapt to such changes will be a significant factor in maintaining or improving our competitive position and our prospects for growth. Factors resulting in delays in product development include:
There can be no assurance that we will successfully introduce new products on a timely basis or achieve sales of new products in the future. In addition, there can be no assurance that we will have the financial and manufacturing resources necessary to continue to successfully develop new products or to otherwise successfully respond to changing technology standards and telephone company service offerings. If we fail to deploy new products on a timely basis, then our product sales will decrease, our quarterly operating results could fluctuate, and our competitive position and financial condition would be materially and adversely affected.
The telecommunications industry is a highly competitive market and this competition may result in operating losses, a decrease in our market share and fluctuations in our revenue.
We expect continuing competition as the DSL and broadband market in general continues to evolve. Because we are significantly smaller than many of our competitors, we may lack the financial resources needed to increase our market share. Many of our competitors are much larger than us and can offer a wider array of different products and services required for a telephone companys business than we do.
We expect continued aggressive tactics from many of our competitors such as:
Our lack of backlog may affect our ability to adjust to an unexpected shortfall in orders.
Because of customer ordering demands we generally ship products within a short period after receipt of an order. We typically do not have a material backlog (or known quantity) of unfilled orders, and our revenues in any quarter are substantially dependent on orders booked in that quarter. Our expense levels are based on anticipated future
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revenues and are relatively fixed in the short-term. Therefore, we may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall of orders. Accordingly, any significant shortfall of demand in relation to our expectations or any material delay of customer orders would have an immediate adverse impact on our business and operating results.
Industry consolidation could make competing more difficult.
Consolidation of companies offering high-speed telecommunications products is occurring through acquisitions, joint ventures and licensing arrangements involving our competitors, our customers and our customers competitors. We cannot provide any assurances that we will be able to compete successfully in an increasingly consolidated telecommunications industry. Any heightened competitive pressures that we may face may have a material adverse effect on our business, prospects, financial condition and result of operations.
We depend on a limited number of customers who are able to exert a high degree of influence over us and loss of a major customer could adversely impact our business.
We have and will continue to depend on the large Regional Bell Operating Companies as well as other telephone carriers including smaller local telephone carriers and new alternative telephone carriers, for substantially all of our revenues. Sales to the Regional Bell Operating Companies accounted for approximately 67.8%, 78.1% and 77.5% of our revenues in fiscal 2007, 2006 and 2005, respectively. Consequently, our future success will depend upon:
The Regional Bell Operating Companies and our other customers are significantly larger than we are and are able to exert a high degree of influence over us. These customers may generally reschedule orders without penalty to the customer. Even if demand for our products is high, the Regional Bell Operating Companies have sufficient bargaining power to demand low prices and other terms and conditions that may materially adversely affect our business and operating results.
Any attempt by a Regional Bell Operating Company or our other customers to seek out additional or alternative suppliers or to undertake the internal production of products would have a material adverse effect on our business and operating results. The loss of any of our customers could result in an immediate decrease in product sales and materially and adversely affect our business.
Conference Pluss customer base is very concentrated as its top ten customers represent a large portion of total revenue. Customers of Conference Plus have expanded their requirements for our services, but there can be no assurance that such expansion will increase in the future. Additionally, Conference Pluss customers continually undergo review and evaluation of their conferencing and meeting services to evaluate the merits of bringing those services in-house rather than outsourcing those services. There can be no assurance in the future that Conference Pluss customers will not bring some portion or all of their conferencing and meeting services in-house. Conference Plus must continually provide higher quality, lower cost services to maintain and grow its customer base. Any loss of a major account, would have a material adverse effect on Conference Plus. In addition, any merger or acquisition of a major customer could have a material adverse effect on Conference Plus.
Our customers have lengthy purchase cycles that affect our ability to sell our products.
Prior to selling products to telephone companies, we must undergo lengthy approval and purchase processes. Evaluation can take as little as a few months for products that vary slightly from existing products or up to a year or more for products based on new technologies such as DSL products. Accordingly, we are continually submitting successive generations of our current products as well as new products to our customers for approval. The length of the approval process can vary and is affected by a number of factors, including:
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The requirement that telephone companies obtain FCC or state regulatory approval for most new telephone company services prior to their implementation has in the past delayed the approval process. Such delays in the future could have a material adverse affect on our business and operating results. While we have been successful in the past in obtaining product approvals from our customers, there is no guarantee that such approvals or that ensuing sales of such products will continue to occur.
Our services are affected by uncertain government regulation and changes in current or future laws or regulations could restrict the way we operate our business.
Many of our customers are subject to regulation from federal and state agencies, including the FCC and various state public utility and service commissions. While these regulations do not affect us directly, the effects of regulations on our customers may adversely impact our business and operating results. For example, FCC regulatory policies affecting the availability of telephone company services and other terms on which telephone companies conduct their business may impede our penetration of local access markets.
In addition, our business and operating results may also be adversely affected by the imposition of tariffs, duties and other import restrictions on components that we obtain from non-domestic suppliers or by the imposition of export restrictions on products that we sell internationally. Internationally, some governments actively promote and create competition in the telecommunications industry. Changes in current or future laws or regulations, in the U.S. or elsewhere, could materially and adversely affect our business and operating results.
Potential product recalls and warranty expenses could adversely affect our ability to remain profitable.
Our products are required to meet rigorous standards imposed by our customers. Most of our products carry a limited warranty ranging from one to two years for CNE products and seven to ten years for NSA products. In addition, our supply contracts with our major customers typically require us to accept returns of products within certain time frames or indemnify such customers against certain liabilities arising out of the use of our products. Complex products such as those offered by us may contain undetected errors or failures when first introduced or as new versions are released. Despite our testing of products and our comprehensive quality control program, there is no guarantee that our products will not suffer from defects or other deficiencies. Historically we have not experienced material problems with product defects, recalls, returns or indemnification claims, however, if such claims exceed our reserves for such claims, our business could be harmed. Such recalls, returns or claims and the associated negative publicity could result in the loss of or delay in market acceptance of our products, affect our product sales, our customer relationships, and our ability to generate a profit.
Investors could be adversely affected by future issuances and sales of our securities.
Sales of substantial amounts of our common stock in the public market could adversely affect the market price of our securities. Westell had 56,568,074 shares of common stock outstanding as of June 1, 2007. Options to purchase 8,872,739 shares of class A common stock, 7,116,525 of which were exercisable, are also outstanding on June 1, 2007. These obligations could result in substantial future dilution with respect to our common stock.
We rely on our intellectual property that we may be unable to protect, or we may be found to infringe the rights of others.
Our success will depend, in part, on our ability to protect trade secrets, obtain or license patents and operate without infringing on the rights of others. We rely on a combination of technical leadership, trade secrets, copyright and trademark law and nondisclosure agreements to protect our non-patented proprietary expertise. These measures, however, may not provide meaningful protection for our trade secrets or other proprietary information. Moreover, our business and operating results may be materially adversely affected by competitors who independently develop substantially equivalent technology.
In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as U.S. law. The telecommunications industry is also characterized by the existence of an increasing number of patents and
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frequent litigation based on allegations of patent and other intellectual property infringement. From time to time we receive communications from third parties alleging infringement of exclusive patent, copyright and other intellectual property rights to technologies that are important to us.
There is no guarantee:
Further, such litigation, regardless of its outcome, could result in substantial costs to and diversion of our efforts. Any infringement claim or other litigation against or by us could have a material adverse effect on our business and operating results.
Business interruption could prevent our ability to deliver product and services to our customers and could adversely affect our business.
Our operations could be impacted by business interruptions such as fire, flood, power loss and other events beyond our control. We have a detailed disaster recovery plan and business interruption insurance but these may not be sufficient to fully cover losses that may occur.
We may engage in future acquisitions or fund raising activity that could dilute our current stockholders.
We expect to continue to review potential acquisitions and we may acquire businesses, products or technologies in the future. In addition, the Company may decide to raise additional capital to fund its operations. In order to accomplish these activities, acquisitions and fund raising, we could:
These events could harm our business and/or the price of our common stock. Acquisitions also entail numerous integration risks that could adversely affect our business.
Conference Pluss large competitors could adversely affect Conference Pluss ability to maintain or increase its market share.
Conference Plus participates in the highly competitive industry of voice, video, and multimedia conferencing and meeting services. Competitors include stand-alone conferencing companies and major telecommunications providers. Conference Pluss ability to sustain growth and performance is dependent on its:
Any increase in competition could reduce our gross margin, require increased spending on sales and marketing, and otherwise materially adversely affect our business and operating results.
Our principal stockholders can exercise significant influence that could discourage transactions involving a change of control and may affect your ability to receive a premium for class A common stock that you purchase.
As of June 1, 2007, as trustees of a voting trust containing common stock held for the benefit of the Penny family and the Simon family, Robert C. Penny III and Melvin J. Simon have the exclusive power to vote over 47.5% of the votes
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entitled to be cast by the holders of our common stock. In addition, members of the Penny family who are beneficiaries under this voting trust are parties to a stock transfer restriction agreement which prohibits the beneficiaries from transferring any class B common stock or their beneficial interests in the voting trust without first offering such class B common stock to the other Penny family members. Certain Penny family members also own or are beneficiaries of trusts that own shares outside of the voting trust. As trustees of the Voting Trust and other trusts, Messrs. Penny and Simon control 52.3% of the voting stock. Consequently, we are effectively under the control of Messrs. Penny and Simon, as trustees, who can effectively control the election of all of the directors and determine the outcome of most corporate transactions or other matters submitted to the stockholders for approval. Such control may have the effect of discouraging transactions involving an actual or potential change of control, including transactions in which the holders of class A common stock might otherwise receive a premium for their shares over the then-current market price.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
The Company leases the following real property:
The Basingstoke lease has an early termination clause that allows the Company to exit the lease at June 2008 with a 6 month lease penalty. The Company has announced its intent to move substantially all of the manufacturing of CNE and NSA products to offshore suppliers. Alternative uses are currently being explored for the portion of the Aurora facility that will be impacted. Among those possible uses is a product distribution operation.
The Company does not own any real property.
The Company is involved in various legal proceedings incidental to the Companys business. In the ordinary course of our business, we are routinely audited and subject to inquiries by governmental and regulatory agencies.
Management believes that the outcome of such proceedings will not have a material adverse effect on our consolidated operations or financial condition.
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The Company's Class A Common Stock is quoted on the NASDAQ National Market under the symbol "WSTL." The following table sets forth for the periods indicated the high and low sale prices for the Class A Common Stock as reported on the NASDAQ National Market.
As of June 1, 2007, there were approximately 868 holders of record of the outstanding shares of Class A Common Stock and 6 holders of record of Class B Common Stock.
The Company has never declared or paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain any future earnings to finance the growth and development of its business. In addition, the Companys credit facility restricts the Companys ability to pay dividends.
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The following selected consolidated financial data as of March 31, 2007, 2006, 2005, 2004 and 2003 and for each of the five fiscal years in the period ended fiscal year 2007 have been derived from the Company's consolidated financial statements, which have been audited by Ernst & Young LLP. The data set forth below is qualified by reference to, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements and the related Notes thereto and other financial information appearing elsewhere in this Annual Report on Form 10-K.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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.
The Company commenced operations in 1980 as a provider of telecommunications network transmission products that enable advanced telecommunications services over copper telephone wires. Until fiscal 1994, the Company derived substantially all of its revenues from its Network Service Access (NSA) product lines, particularly the sale of Network Interface Unit (NIU) products and related products. NIU products accounted for approximately 17.5%, 10% and 10% of revenues in fiscal years 2007, 2006 and 2005, respectively. The Company introduced its first DSL products in fiscal 1993 and these products accounted for approximately 59%, 69% and 68% of revenues in fiscal 2007, 2006 and 2005, respectively. NIU products and DSL products are the two major products within the Companys telecom equipment business. Telecom equipment constituted approximately 81%, 84% and 84% of revenues in fiscal 2007, 2006 and 2005, respectively. The Company has also provided audio teleconferencing services since fiscal 1989, which constituted approximately 19%, 16% and 16% of revenues in fiscal 2007, 2006 and 2005, respectively. Westell realizes the majority of its revenues from the North American market.
The Company is comprised of two segments: telecommunications equipment manufacturer and teleconference services bureau.
The equipment manufacturing segment of the Companys 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:
The Companys 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 multiple participants. 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 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 Companys customers because of past mergers, continues to exert downward pressure on prices for the Company's products.
On November 18, 2005, SBC (now AT&T Inc.) acquired AT&T Corp. On December 29, 2006 AT&T, Inc. completed its acquisition of BellSouth. In the fiscal year ended March 31, 2007, sales to AT&T Inc. generated approximately 28.9% of the Company's total revenues, 21.3% in the equipment segment (primarily NSA products excluding sales made to AT&T Inc. through minority business enterprises) and 7.6% for the services segment. The
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largest customer of Conference Plus is AT&T Inc. AT&T offers services similar to Conference Plus. The Company is unable to predict at this time how the merger will impact the Company's results of operations in the future.
The Company's customer base is highly concentrated and 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 operate, the Company must undergo lengthy approval and procurement processes prior to selling 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.
To remain competitive, the Company must continue to invest in new product development and invest 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 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 VoIP, in-premise networking; wireless/wireline convergence, IMS (IP Multimedia Subsystem) and FMC (Fixed Mobile Convergence); video / IPTV and multifunctional broadband appliances. 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. The Company expects to increase spending in research and development and sales and marketing by approximately 8% in fiscal year 2008 compared to fiscal year 2007 in an attempt to take advantage of these market opportunities. In view of the Companys current 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.
In the CNE equipment manufacturing segment, the Company is focusing on the evolving broadband demand, which includes increased bandwidth, richer application sets and converged capabilities. The Company has introduced products for both the existing local telephone and fiber network including the Westell MediaStationsTM, UltraLine , ProLineTM, VersaLinkTM, and TriLinkTM, which are targeted at the home networking, small office/home office (SOHO) and small business markets. The Company has multiple evaluations and is entering trials for TriLinkTM, TriLinkTM IMS, UltraLine Series 3 and the Westell MediaStationTM. The Company continues to focus on expanding existing and new products into the international market.
The Company expects the overall NSA market to decline annually by approximately 10% as the transition to high-speed digital service continues. This decline could impact the Companys future revenue. The Company acquired 100% of the common stock of HyperEdge Corporation, on December 29, 2005 with the goal of strengthening its position in the NSA market. With the addition of HyperEdge the Company hopes to increase its market share in mountings and NIUs. The Company acquired 100% of the common stock of Noran Tel, Inc on January 2, 2007. With the addition of Noran Tel, the Company has obtained a Canadian market channel for some of its existing products, has added additional transmission products and has gained new products in the areas of power distribution and remote monitoring. The Company also plans to invest in new product areas to compliment wireless and fiber applications.
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Critical Accounting Policies
The Company uses estimates and judgments in applying its accounting policies that have a significant impact on the results reported in the consolidated financial statements. The following are the Companys most critical accounting policies.
The Company sells products primarily to various telecommunications providers and distributors. Sales to these customers have varying degrees of collection risk associated with them. Judgment is required in assessing the realization of these receivables based on aging, historical experience and customers financial condition. Historically, we have not had significant losses due to the inability for the Company to collect delinquent accounts. However, bankruptcy by a significant customer would have a material impact on our results 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 reserve for obsolete and potential obsolete inventory. The Company also evaluates inventory valuation for lower of cost or market concerns. Prices related to future inventory demand are compared to current and committed inventory values.
Inventory purchase commitments
In the normal course of business, the Company enters into commitments for the purchase of inventory. The commitments are at market rates and normally do not extend beyond one year. Should there be a dramatic decline in revenues the Company may incur excess inventory and subsequent losses as a result of these commitments. The Company has established reserves for potential losses on such commitments.
Valuation Allowance for Deferred Tax Assets
The Company has significant deferred tax assets that resulted primarily from historically generated net operating losses. A valuation allowance has been provided for a portion of these deferred tax assets that management believes it is more likely than not that will not be utilized. The Company assesses the realizability of deferred tax assets through an analysis of projected future taxable income in the jurisdictions where the deferred tax assets reside.
Goodwill and Intangibles
Accounting rules require that the Company evaluate goodwill for impairment annually. The Company determined that it operates in two reporting units for the purpose of completing the impairment test of goodwill. These reporting units are telecom equipment and telecom services. The Company utilizes third party appraisals of its telecom equipment and services reporting units fair values compared to book value to determine if there is a potential impairment. The Company performed its annual impairment test in the fourth quarter of fiscal 2007. These tests showed no impairment of goodwill. On an ongoing basis, the Company reviews intangible assets and other long-lived assets other than goodwill for impairment whenever events and circumstances indicate that carrying amounts may not be recoverable. If such events or changes in circumstances occur, the Company will recognize an impairment loss if the undiscounted future cash flows expected to be generated by the asset are less than the carrying value of the related asset. The impairment loss would adjust the asset to its fair value.
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 no longer account for share-based compensation transactions using the intrinsic value method in accordance with APB 25. Instead, companies are required to account for such transactions using a fair-value method and recognize the expense over the service period. 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 adopted this statement in the first quarter of its fiscal year 2007 using the modified prospective method. The adoption of SFAS 123R resulted in an additional pre-tax expense of $1.2 million in fiscal year.
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Results of Operations
The following table sets forth the percentage of revenues represented by certain items in the Company's statements of operations for the periods indicated:
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Fiscal Years Ended March 31, 2007, 2006 and 2005
In fiscal year 2007 consolidated revenues decreased 8.2%. Revenue in the equipment segment decreased 11.1% consisting of a 21.0% decrease in CNE product revenue and 33.2% increase in NSA product revenues. The decrease in CNE product revenue was due primarily to a 22.0% decrease in unit volume. The increase in NSA was due to the inclusion of revenue resulting from the acquisition of HyperEdge and Noran Tel. Revenue in the services segment increased by 7.7% in fiscal year 2007. This increase was due to an increase in minutes billed. In fiscal year 2006 consolidated revenues increased 4.8%. Revenue in the equipment segment increased 5.4% consisting of a 6.2% increase in CNE product revenue and by a 2.0% increase in NSA product revenues. The increase in CNE revenue was due to a 24.1% increase in units sold and offset in part by a 17.4% decrease in average sell price per unit. The increase in NSA revenue was due to the inclusion of approximately $4.6 million of revenue resulting from the acquisition of HyperEdge. Revenue in the services segment increased 2.0% due an increase in minutes billed offset in part by lower revenue per minute at the Companys Conference Plus, Inc. subsidiary.
The improved gross margin in the equipment segment in fiscal year 2007 was due primarily to the sales mix of less low-margin broadband products and the increased mix of sales of NSA products. Fiscal year 2006 gross margins were positively impacted by improvements in material costs. The gross margin in the services segment decrease in fiscal year 2006 was due primarily to increased overhead costs related to credit card fees, maintenance and web outsourcing costs. 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. It is the Companys strategy to offset the effects of these anticipated price reductions with continued cost reductions, such as moving manufacturing offshore, and introducing new products that have higher sales prices and margins.
Sales and marketing expenses were 11.5%, 8.8% and 8.2% of revenues, in fiscal year 2007, 2006 and 2005 respectively. Sales and marketing expense in the equipment segment increased in fiscal year 2007 due primarily to the acquisition of HyperEdge as well as $1.0 million of additional warranty expense. The services segment sales and marketing expense increase in fiscal year 2007 was due primarily to 16% more employees hired to increase sales made directly to end users. The equipment segment sales and marketing expense increase in fiscal year 2006 was due primarily to the acquisition of HyperEdge. The services segment sales and marketing expense increase in fiscal
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year 2006 was due to an increase in the number of sales and marketing employees. Sales and marketing expense is expected to increase in fiscal year 2008, primarily in the equipment segment. 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 expenses in fiscal 2007, 2006 and 2005 were 9.4%, 7.2% and 5.9% of revenues, respectively. Research and development expenses are incurred primarily in the equipment segment of the business. The fiscal year 2007 increase was due primarily to an increase in engineering headcount from the HyperEdge acquisition. In addition, the Company spent an additional $1.5 million on outside engineering services and there were approximately 15% more engineering employees in fiscal 2007 compared to 2006 that resulted in a $2.6 million increase in salary expense for the year. The increase in engineering service and employees was primarily to support the development of the video transport products as well as fixed mobile convergence products. The fiscal year 2006 increase was due primarily to software capitalization of $1.9 million that occurred in fiscal year 2005 when the Company was developing a managed software application. No software development was capitalized in fiscal 2006 or fiscal 2007 as the organization focused on hardware designs. No such offset occurred in fiscal 2006. In addition, the company spent an additional $1.3 million on outside engineering services and there were approximately 11% more engineering employees in fiscal 2006 compared to 2005 that resulted in $725,000 more salary expense for the fiscal 2006 year. The Company believes that research and development expenses will increase in fiscal year 2008 as the Company continues to focus on VoIP, in-premise wireless networking, wireless/wireline convergence including IMS (IP Multimedia Subsystem) and FMC (Fixed Mobile Convergence), video / IPTV and multifunctional broadband appliances, user interfaces and other broadband applications.
General and administrative expenses in fiscal 2007, 2006 and 2005, respectively, were 6.9%, 5.8% and 6.4% of revenues, respectively. The fiscal year 2007 increase in general and administrative expenses in the equipment segment was due primarily to higher salary related expense. The fiscal year 2007 increase in general and administrative expenses in the services segment was due primarily to increase in salary related expenses, increased bad debt expense, increased franchise and other taxes and professional services expenses. The equipment segments slight decrease in expense in fiscal year 2006 was primarily due to lower franchise and sales and use tax expense. The fiscal year 2006 services segment of the business was virtually flat when compared to fiscal 2005.
Intangible amortization. Intangible amortization was $1.7 million, $1.4 million and $1.3 million in fiscal 2007, 2006 and 2005, respectively. The intangibles consist of product technology related to the March 17, 2000 acquisition of Teltrend Inc., product technology and customer relationships related to the December 29, 2005 HyperEdge Inc. acquisition and product technology and customer relationships related to the January 2, 2007 Noran Tel acquisition.
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Restructuring charge. The Company recognized a restructuring expense of $343,000 in the fourth quarter of fiscal year 2007. This charge included personnel costs relating to the termination of 18 employees at Westell Inc. As of March 31, 2007, $213,000 of these costs have been paid leaving an unpaid balance of $130,000.
On December 29, 2005, the Company acquired 100% of the stock of HyperEdge Corporation (see Note 1 to the Consolidated Financial Statements of the Company and is incorporated herein by reference). The Company implemented a restructuring plan to combine and streamline the operations of the companies to achieve synergies related to the manufacture and distribution of common NSA product lines. The Company estimated the costs of employee terminations, which were recorded as liabilities assumed in the acquisition, to be $550,000. Fifteen employees were impacted by this plan. All terminations were completed by the second quarter of fiscal year 2007. As of March 31, 2007, $434,000 of these costs have been paid leaving an unpaid balance of $116,000.
The Company recognized a restructuring expense of $443,000 in the third quarter of fiscal year 2006. This charge included personnel costs relating to the termination of 17 employees at Westell Inc. As of March 31, 2007, no amounts remain unpaid.
In fiscal 2005, the company recorded $793,000 of income related to restructuring activities due to two reversals of previously recorded charges. First, the Company recognized a restructuring expense of $698,000 in fiscal year 2004. This restructuring resulted from realigning the product focus due to product performance issues at Westell Limited that caused a workforce reduction of approximately 5 employees. In the quarter ended March 31, 2005, $248,000 of these charges were reversed as the Company was able to resolve these performance issues. As of March 31, 2007 no amounts remain unpaid. Second, the Company recognized 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 March 31, 2007 no amounts remain unpaid.
A table that summarizes the restructuring charges and their utilization can be found in Note 13 to the Consolidated Financial Statements of the Company and is incorporated herein by reference.
Other income, net. Other income, net was $3.2 million, $974,000 and $896,000 for fiscal years 2007, 2006, and 2005, respectively. Other income, net was primarily comprised of interest income earned on temporary cash investments and unrealized gains or losses on intercompany balances denominated in foreign currency. The increases in fiscal year 2007 over 2006 was due to higher levels of cash invested at better interest rates offset in part by an unrealized loss recorded on intercompany balances denominated in British Pounds.
Interest Expense. Interest expense was $7,000, $12,000 and $60,000 for fiscal 2007, 2006 and 2005, respectively. The decrease in interest expense during each year is a result of lower obligations outstanding during the period under promissory notes, capital leases and vendor debt.
Income Taxes. Income tax expense was $5.9 million in fiscal year 2007, a 39.8% effective tax rate compared to tax expense of $10.1 million, a 43.5% effective tax rate in fiscal 2006. The decrease in expense in fiscal 2007 is due to lower pre-tax earnings as well as the reduction of a portion of the Companys valuation allowance related to state net operating loss carryforwards (NOLs). In fiscal 2005, the Company recorded a net tax benefit of $12.8 million due to the reduction of all the remaining valuation allowance against federal NOLs as the Company had determined it was now more likely than not able to utilize these NOLs.
Minority Interest. Minority interest expense was $236,000, $304,000 and $520,000 in fiscal years 2007, 2006 and 2005, respectively. Minority interest expense is the minority shareholders share of income at 91.5% owned subsidiary, Conference Plus Inc.
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Quarterly Results of Operations
The following tables present certain financial information for each of the last eight fiscal quarters The Company believes that the unaudited information regarding each of these quarters is prepared on the same basis as the audited Consolidated Financial Statements of the Company appearing elsewhere in this Form 10-K. In the opinion of management, all necessary adjustments (consisting only of normal recurring adjustments) have been included to present fairly the unaudited quarterly results when read in conjunction with the audited Consolidated Financial Statements of the Company and the Notes thereto appearing elsewhere in this Form 10-K. These quarterly results of operations are not necessarily indicative of the results for any future period.
The Company expects to continue to experience significant fluctuations in quarterly results of operations. The Company believes that fluctuations in quarterly results may cause the market price of the Class A Common Stock to fluctuate, perhaps substantially. Factors which have had an influence on and may continue to influence the Companys results of operations in a particular quarter include the size and timing of customer orders and subsequent shipments, customer order deferrals in anticipation of new products, timing of product introductions or enhancements by the Company or its competitors, market acceptance of new products, technological changes in the telecommunications industry, competitive pricing pressures, accuracy of customer forecasts of end-user demand, write-offs for obsolete inventory, changes in the Companys operating expenses, personnel changes, foreign currency fluctuations, changes in the mix of products sold, quality control of products sold, disruption in sources of supply, regulatory changes, capital spending, delays of payments by customers, working capital deficits and general economic conditions. Sales to the Companys customers typically involve long approval and procurement cycles and can involve large purchase commitments. Accordingly, cancellation or deferral of one or a small number of orders could cause significant fluctuations in the Companys quarterly results of operations. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance.
Because the Company generally ships products within a short period after receipt of an order, the Company typically does not have a material backlog of unfilled orders, and revenues in any quarter are substantially dependent on orders booked in that quarter. The Companys expense levels are based in large part on anticipated future revenues and are relatively fixed in the short-term. Therefore, the Company may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall of orders. Accordingly, any significant shortfall of demand in relation to the Companys expectations or any material delay of customer orders would have an almost immediate adverse impact on the Companys business and results of operations and profitability.
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Liquidity and Capital Resources
At March 31, 2007, the Company had $70.2 million in cash and cash equivalents consisting primarily of the highest rated grade corporate commercial paper. At March 31, 2007, the Company had no amounts outstanding and $40.0 million available under its secured revolving credit facility.
The Company entered into a Second Amended and Restated Credit Agreement dated as of June 30, 2006 (the Credit Agreement). The Credit Agreement, which has improved terms over the prior agreement, is a three-year revolving credit facility in an amount up to $40 million. The obligations of the Company under the Credit Agreement are secured by a guaranty from certain direct and indirect domestic subsidiaries of the Company, and substantially all of the assets of the Company. Any proceeds from the revolving loans would be used for working capital purposes, acquisitions and for other general corporate purposes. The interest rate spread in the case of LIBOR and Base Rate loans and the payment of the non-use fees is dependent on the Companys leverage ratio. Currently the revolving loans under the Credit Agreement bear interest, at the Companys option, at the London Interbank Offered Rate (LIBOR) plus 1.5% or an alternative base rate. The alternative base rate is the greater of the LaSalle Bank National Association prime rate or the Federal Funds rate plus 0.50%. The Company is also required to pay a non-use fee of 0.2% per annum on the unused portion of the revolving loans.
The Credit Agreement contains financial covenants that include a minimum Fixed Charge Coverage Ratio, a minimum tangible net worth test, a total leverage ratio test (consolidated total debt to EBITDA), and a limitation on capital expenditures for any fiscal year. Other covenants include limitations on lines of business, additional indebtedness, liens and negative pledge agreements, incorporation of other debt covenants, guarantees, investments and advances, cancellation of indebtedness, restricted payments, modification of certain agreements and instruments, inconsistent agreements, leases, consolidations, mergers and acquisitions, sale of assets, subsidiary dividends, and transactions with affiliates. The Company was in compliance with these covenants on March 31, 2007 and expects to comply with these covenants for the term of the debt.
The Companys operating activities generated cash of $39.3 million, $31.7 million and $21.3 million in fiscal 2007, 2006, and 2005 respectively. Cash generated by operations in fiscal 2007 and 2006 resulted primarily from net income, non-cash depreciation and amortization, decreases in deferred tax assets, accounts receivable and inventory and was offset in 2006, in part by the decrease in accounts payable. Cash generated by operations in fiscal 2005 resulted primarily from net income, non-cash depreciation and amortization, increase in accounts payable and tax benefit received from the exercise of employee stock options and was offset in part by the increase in deferred tax assets, accounts receivables and inventories.
The Companys investing activities used $10.6 million, $19.0 million and $5.2 million in fiscal 2007, 2006 and 2005 respectively. In fiscal 2007, the Company used cash of $5.9 million to acquire Noran Tel, Inc. In fiscal 2006, the Company used cash of $14.0 million to acquire HyperEdge Corporation. Capital expenditures in fiscal 2007, 2006 and 2005 were $4.0 million, $4.5 million and $6.7 million, respectively. The equipment segment capital expenditures in fiscal 2007, 2006, and 2005 were $3.1 million, $3.1 million and $5.8 million, respectively. The capital expenditures in the equipment segment were primarily for machinery and research and development equipment purchases. The services segment capital expenditures in fiscal 2007, 2006 and 2005 were $0.9 million, $1.4 million and $0.9 million, respectively. These expenditures were primarily for teleconference bridge equipment.
At March 31, 2007 the Companys principle sources of liquidity were $70.2 million of cash and the secured revolving credit facility under which the Company was eligible to borrow up to an additional $40.0 million based upon receivables and inventory levels. Cash in excess of operating requirements, if any, will be invested on a short-term basis primarily in the highest rated grade commercial paper. The Company believes cash on hand and generated from operations will satisfy its future cash requirements for the next twelve months.
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Future obligations and commitments as of March 31, 2007 consisted of the following:
Purchase obligations consist of raw materials in the equipment segment and local and long distance telephone service commitments in the service segment that arise in the normal course of business operations.
The Company had deferred tax assets of approximately $62.4 million at March 31, 2007. The Company has recorded a valuation allowance reserve of $8.5 million to reduce the recorded net deferred tax asset to $53.9 million.
The net operating loss carryforwards begin to expire in 2012. Realization of deferred tax assets associated with the Companys 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 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.
Westell is subject to certain market risks, including foreign currency and interest rates. The Company has foreign subsidiaries in the United Kingdom, Ireland and Canada that develop and sell products and services in those respective countries and in other 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 $786,000 in additional other expense based on the ending intercompany balance outstanding at March 31, 2007. The Companys future primary exposure is to changes in exchange rates for the U.S. dollar versus the British Pound Sterling, Euro and Canadian dollar.
As of March 31, 2007, the balance in the cumulative foreign currency translation adjustment account, which is a component of stockholders equity, was an unrealized gain of $86,000.
The Company does not have significant exposure to interest rate risk related to its debt obligations, which are primarily U.S. Dollar denominated. The Companys risk is the potential increase in interest expense arising from adverse changes in interest rates. The Companys debt consisted primarily of capital leases. 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 3.5% to approximately 3.9%) average interest rate on the Companys debt. If such an increase occurred, the Company would incur approximately $716 per annum in additional interest expense based on the average debt borrowed during the twelve months ended March 31, 2007. The Company does not believe 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements required by Item 8, together with the reports thereon of the independent auditors set forth on pages 43 - 68 of this report. The Consolidated Financial Statement schedule
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listed under Item 15(a)2, is set forth on page 69 of this report and should be read in conjunction with the financial statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of March 31, 2007, the Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported as and when required.
Managements Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Management assessed the effectiveness of the Companys internal control over financial reporting as of March 31, 2007 using criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and concluded that the Company maintained effective internal controls over financial reporting as of March 31, 2007.
Because of its inherent limitations, although designed and operated to provide reasonable assurance that the objectives of the control system are met, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies may deteriorate.
The Companys assessment of the effectiveness of our internal control over financial reporting as of March 31, 2007 has been audited by Ernst and Young, LLP, an independent registered public accounting firm, as stated in its report which is included on page 44.
ITEM 9B. OTHER INFORMATION
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is set forth in registrants Proxy Statement for the Annual Meeting of Stockholders to be held in September 2007 under the caption Election of Directors and Section 16(a). Beneficial Ownership Reporting Compliance which information is incorporated herein by reference.
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The information required by this Item is set forth in registrants Proxy Statement for the Annual Meeting of Stockholders to be held in September 2007 under the caption Executive Officers, which information is incorporated herein by reference.
CODE OF BUSINESS CONDUCT
We have adopted a Code of Business Conduct within the meaning of Item 406(b) of Regulation S-K. This Code of Business Conduct applies to our principal executive officer, principal financial officer and principal accounting officer. The Company has filed a copy of this Code of Business Conduct at Exhibit 14.1 to this Form 10-K. This Code of Business Conduct is also publicly available on our website at www.westell.com. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K by posting on its website any amendments to, or waivers from its Code of Business Conduct applicable to these senior executives. Copies of the Code of Business Conduct will be provided free of charge upon written request directed to the Secretary of the Company.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in registrants Proxy Statement for the Annual Meeting of Stockholders to be held in September 2007 under the caption Compensation of Directors and Executive Officers, and Report of the Compensation Committee of the Board of Directors, which information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is set forth in registrants Proxy Statement for the Annual Meeting of Stockholders to be held in September 2007 under the caption Ownership of the Capital Stock of the Company, and Equity Compensation Plan Information which information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is set forth in registrants Proxy Statement for the Annual Meeting of Stockholders to be held in September 2007 under the caption Certain Relationships and Related Transactions, which information is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference to the section entitled Fees to the Companys Auditors in our Proxy Statement for the annual meeting to be held in September 2007.
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The consolidated financial statements of Westell Technologies, Inc. at March 31, 2007 and 2006 and for each of the three fiscal years in the period ended March 31, 2007, together with the Report of Independent Auditors, are set forth on pages 43 through 68 of this Report.
The supplemental financial information listed and appearing hereafter should be read in conjunction with the consolidated financial statements included in the report.
The following are included in Part IV of this Report for each of the years ended March 31, 2007, 2006 and 2005 as applicable:
Financial statement schedules not included in this report have been omitted either because they are not applicable or because the required information is shown in the consolidated financial statements or notes thereto, included in this report.
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The exhibits filed as part of this Annual Report on Form 10-K are as specified in Item 15(a)(3) herein.
The financial statement schedules filed as part of this Annual Report on Form 10-K are as specified in Item 15(a)(2) herein.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on June 14, 2007.
By /s/ Thomas E. Mader
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on June 14, 2007.
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Consolidated Financial Statements:
Financial Statement Schedule:
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and the Stockholders
Westell Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Westell Technologies, Inc. and subsidiaries (the Company) as of March 31, 2007 and 2006, and the related consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended March 31, 2007. Our audit also included the financial statement schedule listed in the Index at Item 15a(2). These financial statements and schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Westell Technologies, Inc. and subsidiaries at March 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1, in Stock Based Compensation, to the consolidated financial statements, effective April 1, 2006, the Company changed its method of accounting for stock based compensation. Also discussed in Note 1, in New Accounting Pronouncements, effective April 1, 2006, the Company adopted Securities and Exchange Commission Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Westell Technologies, Inc.s internal control over financial reporting as of March 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 12, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
June 12, 2007
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Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
To the Board of Directors and the Stockholders
Westell Technologies, Inc.
We have audited managements assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting, that Westell Technologies, Inc. and subsidiaries (the Company) maintained effective internal control over financial reporting as of March 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that the Company maintained effective internal control over financial reporting as of March 31, 2007, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Westell Technologies, Inc. and subsidiaries as of March 31, 2007 and 2006, and the related consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended March 31, 2007 and our report dated June 12, 2007 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
June 12, 2007
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WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
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WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
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WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except share amounts)
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WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
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WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
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WESTELL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies:
Westell Technologies, Inc. (the "Company") is a holding company. Its wholly owned subsidiaries, Westell, Inc., HyperEdge Corporation and Teltrend LLC design, manufacture and distribute telecommunications equipment which is sold primarily to major telephone companies. Conference Plus, Inc., a 91.5%-owned subsidiary, provides teleconferencing, multipoint video conferencing, broadcast fax and web teleconferencing services to various customers. Noran Tel, Inc. is a wholly owned subsidiary of Westell,Inc.
On December 29, 2005, the Company acquired 100% of the common stock of HyperEdge Corporation, a manufacturer of network service access products, for $14.0 million in cash. The Company has accrued $649,000 in transaction costs, including costs for employee severance. The Company paid $335,000 of transaction costs principally consisting of legal fees for the year ended March 31, 2007. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141 Business Combinations (SFAS No. 141) and accordingly the operating results of HyperEdge have been included in the consolidated financial statements from the acquisition date.
In accordance with SFAS No. 141, the total purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date with excess purchase price allocated to goodwill. During the quarter ended December 31, 2006, the Company adjusted the purchase price in the amount of $0.6 million (net of deferred tax) to accrue for the estimated cost to exit a purchase agreement that was outstanding as of the acquisition date, but was not recorded or disclosed to the Company upon acquisition.
On January 2, 2007, the Company acquired 100% of the capital stock of Noran Tel, Inc located in Regina, Saskatchewan. Noran Tel is a manufacturer of transmission, power distribution and remote monitoring products. Noran Tel employs approximately 57 people and will remain in Canada as part of the Companys Network Service Access product group. The purchase price for Noran Tel was $6.5 million CND ($5.6 million USD), with a potential earn-out of an additional $4.0 million CND ($3.4 million USD) if certain financial performance goals are met. Any earn-out would be considered additional purchase consideration. The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141 Business Combinations (SFAS No. 141) and accordingly the operating results of Noran Tel are included in the Companys consolidated financial results from the acquisition date.
In accordance with SFAS No. 141, the total purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date with excess purchase price allocated to goodwill. The total purchase price was $5.6 million USD. The allocation of the purchase price to the net assets acquired is as follows:
Intangible assets consist of amortizable intangible assets of $39,000 of product technology, $629,000 of customer relationships for Power products and $978,000 of customer relationships for Transmission products. Product technology is amortized over 5 years, customer relationships for Power products are amortized over 10 years and customer relationships for Transmission products are amortized over 12 years. Intangible assets also includes $375,000 for the trade name which is not amortizable. Noran Tels products are reported in the revenue category called Network Service Access (NSA) for segment reporting. The audited and pro forma results of operations based on historical results of operations including adjustments for interest and amortization, as though Noran Tel were acquired at on April 1, 2006:
The pro forma results of operations is presented for illustrative proposes only and is not intended to represent what the Companys results of operations would have been if the acquisition had occurred on those dates or to project the Companys results of operations for any future period.
On March 31, 2007 Conference Plus, Inc entered into a settlement agreement with a former executive to buy back shares of its operation located in Dublin, Ireland for $347,000. The shares had been issued to the employee when the Dublin company was acquired in 1998. In accordance with FASB Statement No. 141, the purchase of the minority shareholders interest was accounted for using purchase accounting and resulted in an addition to goodwill of $322,000.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Cash and cash equivalents generally consist of cash and commercial paper. The Company invests its excess cash in deposits with major financial institutions and the highest grade commercial paper of companies from a variety of industries. These securities have maturity dates not exceeding three months and can be liquidated at any time without penalty. Such investments are stated at cost, which approximates fair value, and are considered cash equivalents for purposes of reporting cash flows.
Investments consist primarily of fixed income mutual funds. These investments are accounted for at market prices and are considered available for sale marketable securities. There have been no significant gains or losses on these investments.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents and trade receivables. The Company currently invests its excess cash in commercial paper. The Company has cash and cash equivalents in one U.S. bank in excess of federally insured amounts.
Inventories are stated at the lower of first-in, first-out (FIFO) cost or market. The components of inventories are as follows:
The components of inventories are as follows: