Ceragon Networks Ltd.
Q1 2016 Earnings Call Transcript

Published: 9 May 2016

[Operator:]

Good day, everyone. Welcome to the Ceragon Networks Limited First Quarter 2016 Results Conference Call. Today's call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks. Today's call will include statements concerning Ceragon's future prospects that are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on the current belief, expectations, and assumptions of Ceragon's management. For examples of forward-looking statements, please refer to the forward-looking statements paragraph in our press release that was published earlier today. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially, including risks associated with a further decline in revenues beyond Ceragon's expectations; the risks that Ceragon's expectations regarding future profitability will not materialize; the risks that Ceragon will not achieve the benefits that it expects from its expense reduction and profit enhancement programs; the risks that Ceragon will not continue to comply with the financial or other covenants in its agreements with its lenders; risks associated with doing business in Latin America in general, and in Brazil in particular, including currency export controls and recent economic concerns; risks relating to the concentration of our business in India, Africa, and in developing nations, including political, economic, and regulatory risks from doing business in those regions; the risks of significant expenses in connection with potential contingent tax liability and other risks and uncertainties detailed from time to time in Ceragon's Annual Report on Form 20-F and Ceragon's other filings with the Securities and Exchange Commission; and represents our views only as of the date they are made and should not be relied upon as representing our views as of any subsequent dates. We do not assume any obligation to update any forward-looking statements. Ceragon's public filings are available from the Securities and Exchange Commission's Web site at www.sec.gov or may be obtained from Ceragon's Web site at www.ceragon.com. I'll now turn the call over to Mr. Ira Palti, President and CEO of Ceragon. Please go ahead, sir.

[Ira Palti:]

Thank you for joining us today. With me on the call is Doron Arazi, our CFO. We are very pleased with Q1, considering it is typically affected by sequential factors. We had higher gross margins, we controlled our expenses, and we're breakeven on the non-GAAP basis even at the lower level of revenue. More important, we had very strong cash flow and our balance sheet is looking much healthier after we further reduced our debt and still increased our cash on hand. The most significant message I have today is we believe Q1 was our tough quarter, and expect our revenue trend to go back to an upward trend. Our Q1 bookings pipeline of business and feedback from the field cause us to expect higher revenue, sequentially each quarter for the balance of the year, and we continue to look for profit improvement in 2016 versus 2015. On the last call, I noted that we are taking some steps to fine-tune our execution in an effort to optimize the tradeoff between revenue and profit. We believe we are making progress, and we are pleased to see our gross margin improving across regions and customers, including some of the most challenging ones. To be clear, we are not encouraging you to think our Q1 non-GAAP gross margin of over 36% is sustainable for the rest of the year. Doron will give you a detailed explanation of gross margin. My point is optimizing the tradeoff between revenue and gross profit has been a continuous process over the past year; one, that we have fine-tuned and improved along the way and we will continue to improve. Meanwhile, we are satisfied that our organization is the right-size in relationship to the available opportunities with acceptable margins for the foreseeable future. We took the necessary steps to adapt more than a year ago, and we are getting better at executing while some of the competitors continue to struggle with the disruption of right-sizing and achieving profitability. Some of the factors walking in our favor include

[Doron Arazi:]

Thank you, Ira. Since you all seen the press release, I will just highlight some of the significant items. Our first quarter revenues of $59.8 million represented a 21% sequential decrease from Q4 of 2015. I want to echo Ira's comment that we believe Q1 represents the bottom in terms of revenue, and we expect to see higher revenue in future quarters, beginning in Q2. The geographic breakdown of Q1 revenue appears in the press release. The most significant change from Q4 to Q1 was the lower revenue in India, which Ira has already spoken about. We had one above 10% customer in the quarter a large operator in India that is a longstanding customer. In Q1, our gross margin improved sequentially again to 36.3% on a non-GAAP basis. Gross margin was high this quarter, primarily because of significantly lower revenue from India and APAC, as well as exceptionally high margin revenue in North America and Europe. While we think these margins are not a new standard, that should be expected going forward. We continue to believe we can sustain gross margin level solidly above 30% in 2016. We saw fluctuations from quarter-to-quarter based on the exact mix of revenue as we recognized during a particular period. Non-GAAP results in Q1 excluded a net expense amount of $300,000. This amount included expenses of $1.2 million of usual items, non-cash tax adjustments, stock-based compensation and amortization of intangibles assets. These expenses were offset by non-recurring income of $0.9 million, our financial expenses that was excluded non-GAAP results as well. This income resulted from an adjustment to the provision taken for the re-measurement of certain dollar-related assets in Venezuela. Unexpectedly, we received payments from the Venezuelan government-owned oil and gas company. We do not think this signals an overall shift in the situation, and while we continue to explore different ways for collecting from our customers there, we're not expecting to collect any further payment at least in the immediate future. In Q1, we continue to maintain tight control of our operating expenses, which were $19.6 million. We expect to be able to keep operating expenses around $20 million per quarter. We reported a non-GAAP operating profit of $2.2 million. Our non-GAAP operating margin of 3.6% is below the level we would like to see, and is a function of the low level of revenue in Q1. We expect that our operating margin will improve as revenue increases. Non-GAAP financial expenses declined to $1.8 million, primarily due to low expenses from exchange rate differences. Subject to currency fluctuations, we expect our financial expenses to remain in the range of $1.5 million to $2 million during the near-term. Assuming currency exchange rate differences are fixed at the level we've seen in Q1, the range we suggest will be primarily driven by the level of utilization of our credit facility and factoring activity. We had a very small non-GAAP net loss of $447,000, which was breakeven on a per share basis. Turning to the balance sheet, receivables were $82.1 million with DSOs of 95 days; a major improvement from Q4, from early the result of very strong collection in Q1. Going forward, we target DSO to be in the range of 105 to 125, subject to the geographic mix of revenue. One of our goals is further optimizing cash balances and debt facility utilization to reduce interest expenses. At March 31, 2016, we had cash and cash equivalents of $41.8 million, a significant increase from the end of Q4. We generated cash of approximately $10.5 million, and we reduced our debt to $30 million at the end of Q1, from $35 million at the end of Q4. It is noteworthy that our cash net of bank debt now exceeds $10 million. This cash flow was higher than our plans for Q4, primarily due to better collection than expected, and before the impact of our cash flow in Q2. Overall, we continue to focus on better payment terms from our customers and collection on time. Our book-to-bill ratio was significantly above one during Q1, which is one reason for our conviction that we have the low point of revenue behind us, and can look forward to higher revenue of incoming quarters, particularly in the second half of the year. As we mentioned, based on the success of our sales strategy, we expect our gross margin to remain solidly above 30% throughout 2016, and we want to emphasize that we continue to believe we can achieve significantly higher profit on a constant currency basis in 2016 versus 2015, and sustain positive cash flow. The one caveat we need to mention is the global macroeconomic picture. Since last quarter we have not seen any increase in customer concerns over macro factors and our assumption is that this will remain the case. Now, we would like to open the call to questions. Operator?

[Operator:]

Thank you. [Operator Instructions] And we will go to the line of James Kisner with Jefferies. Please go ahead.

[James Kisner:]

Hi, Ira [ph], thanks very much for taking my questions. So I just wanted to drill down on the high margin, you said that it's mostly due to geographic mix, but -- and some exceptionally high margin in North America and Europe, why are these revenues so high margin, is that just the nature of the business in the region, or is that -- because the deals are based on technology, your mix of initial hardware versus capacity, or is there some other factor why those revenues are so high margin in America and Europe?

[Doron Arazi:]

Basically you mentioned a couple of reasons. I think that most of them are relevant, and I think most of them got together and brought us to this situation. So, first of all, obviously the geographical mix has a very significant impact on our gross margins. It's not a secret that the level of pricing between developing countries and developed countries is very significant in our industry, and that obviously drives the margins higher when the geographical mix is skewed [ph] more to developed countries. Regarding the relatively high gross margins in North America and in Europe, it's more of particular deals that, where I would say to some extent, unique. It's not something that we, as I said, believe is sustainable for the long-term, but obviously from time-to-time, we expect to enjoy such situations where we bring so much value to our customers.

[James Kisner:]

All right, that's very helpful. I heard you made [ph] comments about the revenues improving through the year. Last quarter, I think, you talked about average revenue run rate of $75 million this year, should we assume that that is probably not on the table any more, perhaps there'll always be higher margin, but should we not assume that that average revenue run rate is $75 million?

[Doron Arazi:]

I'd say that generally speaking, seeing the models that were developed by the analysts covering us, after the call in Q -- the end of Q4, these models have very good proximity to what we believe the year can look like. And in other words, it's probably still something around 75. It might be slightly lower, but it's not a big difference at this point as opposed to what I see from the analysts covering us.

[James Kisner:]

Okay, thank you very much. I'll pass.

[Operator:]

And our next question will come from Alex Henderson with Needham.

[Alex Henderson:]

Hi. Just a follow-up from that last question, so when you say, it's not meaningfully different from what was in the models prior, are you implying that it's not meaningfully different on the June, September, December, or are you saying for the full year, because obviously it came in a little light on the revenues relative to where the Street was for the March quarter. Should we adjust out that March number from the full year and just leave the three quarters the same, or are you saying you are going to make it up?

[Doron Arazi:]

Hi, Alex. Thanks for the question. As you know, I'm not giving guidance, but I would say that when I look at the numbers that are expected from us at this point, before this call, for Q2 and also for the rest of the year, most of them. Q2 and full year are in a very close proximity to what we believe we can still achieve for 2016 and the relevant quarters.

[Alex Henderson:]

So what I'm hearing you say is the numbers that were out there for the June, September and December quarter are reasonably useful metrics down, but not necessarily the full year from the -- because of the mix in the March quarter?

[Doron Arazi:]

I think that the difference between March quarter, that was anticipated, and what we achieved is not that big. And from my perspective, looking at the full year it's less than 1%. So I'm not sure this is the level of accuracy we're talking about now when we are not giving -- given any guidance.

[Alex Henderson:]

Okay. So going back to the gross margin questions, obviously 36.3% in your seasonally softest quarter of the year is an exceptional number, and clearly the Indian mix had a lot to do with that. It sounds like you've got some pretty good orders coming in from India. So would you say that the gross margin assumptions that were out there in kind of 32%, 33%, 34% range are still in the right ballpark, or is there more variability than that?

[Doron Arazi:]

I think that as you said, India has obviously a lot of impact on the gross margins, but as we've said in a couple of calls before, we were able to improve our gross margins in India. So generally speaking, the impact that we've seen, for example, in 2015 and beginning of 2015 is not expected to reiterate itself in 2016. I think that we can conservatively say that we'll probably be at the between, solidly above 30%. So, if you mentioned 32%, it makes a lot of sense. If the mix is more favorable to developed countries, it can give even growth slightly higher.

[Alex Henderson:]

Okay. Then one last question, do you have any 10% customers in the quarter?

[Doron Arazi:]

Yes, I mentioned one Indian customer that is a longstanding customer of ours is over 10%.

[Alex Henderson:]

Okay, thanks.

[Operator:]

And we will go to line of George Iwanyc with Oppenheimer. Please go ahead.

[George Iwanyc:]

Thank you for taking my questions. So following up on the India questions, can you give us an idea of the type of seasonality you expect in India going forward, given the bookings strength that you are talking about?

[Ira Palti:]

I think that's what we mentioned on the call is that we believe India will continue to rollout significantly over the next year-and-a-half. I think, all over the operators in India and most of them are customers of ours are giving up a very strong competition, and for market share around 4G and high data services within India in between existing operators, densifying their network and shifting to 4G, and the need to redo the network for very high capacities to new operators like Reliance Jio, which are building large network to capture significant market there. At the same time -- but remember that the whole structure will be used for 4G, and also data services, because the fixed line alternative is [indiscernible] at this point. So they're giving up for very high capacity across the networks.

[George Iwanyc:]

Okay. So, do you…

[Ira Palti:]

I believe this will -- then we believe this will continue well into 2017.

[George Iwanyc:]

Okay. From a percentage contribution, is the March quarter contribution a potential low for the year and that India grows as a percentage of mix in the rest of the year?

[Doron Arazi:]

Yes, the answer is positive. We think that the contribution of India in Q1 of 2016 is probably at the lower end. But we'll see much higher contribution in the upcoming quarters.

[George Iwanyc:]

Okay. And then the potential stabilization you're seeing in Latin America, can you give us a bit more color on the dynamics there?

[Ira Palti:]

I will give you the dynamics there. I think that we look at the politics, the macroeconomics, I think, we see both in the business, but we read the papers where Argentina stabilized, where we had during some parts of last year a lot of currency, and currency issues are now in Argentina since the last election there, I think we're in a good shape and we see a lot of the operators reinvesting to the mobile operators. Brazil has stabilized. You can see from the currency exchange rate, which was very unfavorable for a while, then retreated, and we think that we are in a good position there, although at the lower revenue level, mainly because we chose the projects we want to do, and do not want to do in Brazil. And we see strength over in other places in Latin America; in Mexico and Colombia and other places, where people are investing. Let's remember that if I look at the world-wide trends of the 4G rollouts, which drove North America and European business over the last three years, in most places have come to -- with some of the operators into, I'd say, maturity below in what we see in Latin America and in APAC and India, this is where 4G was starting to rollout, or has started to rollout and is driving our business in those regions.

[George Iwanyc:]

Okay. And From our overall pricing standpoint, do you see that vendor rationalization playing out as you mentioned last quarter? Has there been any more attention paid to the best of breed segment by either the larger vendors or some of the more niche vendors?

[Ira Palti:]

I can't quantify at this point is that there is significant changes there. I think we see still the tough competition, and -- in both segments, in the non-best of breed and in the best of breed segments, I think because we have a technological and value advantage in those markets, able to get our share and probably expand our share within the best of breed market.

[George Iwanyc:]

Okay. And is it fair to say pricing is stable in the best of breed segment?

[Ira Palti:]

Yes, it's relatively stable. I think we see like in any technology, a continual slow decline, but I think it's slower than we've seen in prior years.

[George Iwanyc:]

Okay, thank you.

[Operator:]

And our next question will come from the line of Gunther Karger with Discovery Group. Please go ahead.

[Gunther Karger:]

Yes, good morning. Have you seen any shift from terrestrial backhaul to a satellite-based backhaul?

[Ira Palti:]

Good morning, Gunther. We do not monitor the satellite backhaul, but what we see in most places, and this is a trend over the many years that we have seen is that the higher the capacity, the most terrestrial that we see versus satellite. And satellites is moving and it's really a front where -- in the very dense areas, you'll see fiber, and then the next, what we call, suburban to rural areas, we see a lot of microwaves. And then when you go deep into the rural areas, you'll see -- start seeing satellite, all depends on the capacities. By the way, all technologies link up with the capacities as well, but I don't see a significant change in that area.

[Gunther Karger:]

Thank you.

[Ira Palti:]

Thank you.

[Operator:]

[Operator Instructions] And currently, there are no questions in queue.

[Ira Palti:]

Okay. I would like to thank everyone for joining us this morning on the call. Please feel free to contact us if you need a one-to-one basis, both myself and Doron for further up questions and looking -- talking about our outlook and products, and as we move forward, and I do expect to see some of you on the one-to-one, face-to-face basis during our U.S. visits, both on conferences and Mobile World shows we do on a regular basis. Thank you, and have a good day.

[Operator:]

And that does conclude our conference for today. Thanks for your participation, and for using AT&T Executive Teleconference. You may now disconnect.