Ceragon Networks Ltd.
Q3 2012 Earnings Call Transcript

Published: 29 Oct 2012

[Operator:]

Good day everyone. Welcome to the Ceragon Networks Limited Third Quarter 2012 Results conference call. Today’s call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks, and Mr. Aviram Steinhart, CFO of Ceragon. Today’s call will include forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and projects that involve a number of risks and uncertainties. There can be no assurance that future results will be achieved and actual results could differ materially from forecasts and estimates. These are important factors that could cause actual results to differ materially from forecasts and estimates. Some of the factors that could significantly impact forward-looking statements include the risk of significant expenses in connection with potential contingent tax liability associated with Nera’s prior operations or facilities, the risk the combined Ceragon and Nera business may not perform as expected, risks associated with increased working capital needs, and other risks and uncertainties which are discussed in greater detail in Ceragon’s annual report on Form 20-F and Ceragon’s other filings with the Securities and Exchange Commission. Forward-looking statements speak only as of the date on which they are made, and Ceragon undertakes no commitment to revise or update any forward-looking statement in order to reflect events and circumstances after the date any such statement is made. Ceragon’s public filings are available from the Securities and Exchange Commission’s website at www.sec.gov or may be obtained on Ceragon’s website at www.ceragon.com. I would now like to 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 and double thanks for those on the east coast which probably are at home today bracing for Hurricane Sandy, and for you who are joining us this morning. With me on the call is Aviram, our CFO. Our revenues in Q3 were consistent with our guidance. More important, we increased our gross margin to nearly our target level and we reported sequential improvement in operating margins to 4%. As expected, our cash used in operations was less than 1 million and we are on track to generate significant cash flow in Q4 as we indicated on our last call. We are pleased with this performance in light of the challenging macro environment. We remain optimistic about the business because we are well positioned in an attractive sector that is likely to enjoy numerous growth drivers for years to come. We’re a strong company with an excellent technology and product cost position in our market space. We are taking share and expect to continue to outperform the overall industry. Exploiting this strength, our primary financial focus is on reaching our goal of 10% operating margin and generating sustainable free cash flow. But at the same time, we are not immune to the macro economy and to the factors that are causing the second half of the year to be slower than everyone originally expected. We see that same picture in the trend of our bookings. As you know, reports from the communication equipment sector so far have mostly contained downward revisions to the outlook. We also expect revenues in Q4 to decline sequentially. With growing concern over the risk for serious global slowdown, operators are becoming more cautious, negotiations are taking longer, budgets for next year are receiving extra scrutiny, and spending will be deferred as long as possible. Further consolidation among wireless operators will create disruption and delays in network deployments. At the same time, some regions have their own issues. Europe shows signs of further slowing and India continues to be subject to persistent regulatory uncertainty. As you might remember from our last call, we were encouraged during Q2 by a strong pick-up in bookings that began in April and continued throughout the second quarter. Unfortunately, this pattern did not continue during Q3 and as an example, we had three large orders that we expected to close during Q3 and the operators are taking their time. We are not losing any business. We remain generally confident, but we also believe we have to be proactive in ensuring we stay on track with our profitability goals regardless of the near-term environment. Therefore, we are accelerating the implementation of some efficiency increasing organizational alignment to ensure that we continue to improve our profitability and grow our earnings, even under the assumption that the revenues for the next several quarters will be flat off a base of 104 to 110 million in Q4. Specifically, we are taking these three actions

[Aviram Steinhart:]

Thank you, Ira. I will go through the Q3 results and then elaborate on the financial aspect of the organization and changes we announced today. Our third quarter revenue was $118 million, within the range of our guidance. Our GAAP gross margin of 31% includes $300,000 of amortization of intangible assets, $2.9 million inventory step-up, $100,000 stock-based compensation expenses, and $800,000 of changes in pre-acquisition indirect tax positions. Excluding those items, non-GAAP gross margin improved to 34.5% from 33.8% in Q2. The improvement results from reducing product costs of our long-haul product and a more favorable customer mix. Third quarter GAAP operating expenses were $37.8 million. Excluding $600,000 in amortization of intangibles and $1.3 million stock-based compensation, our non-GAAP operating expenses were $35.9 million, slightly less than Q2. On a GAAP basis, we reported an operating loss of $1.3 million. Our non-GAAP operating profit for the third quarter was $4.7 million or 4% operating profit margin. Finance expenses in Q3 was about $1.1 million and tax expenses was about 300,000. On a GAAP basis, we reported a net loss of $2.7 million or $0.07 per share. On a non-GAAP basis, we reported a net profit in Q3 of $3.3 million or $0.09 per share. The geographical break-out of revenues appears in the press release. The biggest change from Q2 was Africa which showed significant decline reflecting the longer negotiations that Ira referred to. We had no 10% customer in Q3. Overall, total OEM sales accounted for 12% of total revenue. Turning to the balance sheet, trade receivables increased to $193 million, putting DSO at 149 days. Turning to our cash position, we had cash and cash equivalents totaling $48.6 million at September 30. Our operating cash flow was negative by only 900,000 and we are on track to generate substantial positive cash flow in Q4, as we indicated on our last call. At the end of the quarter, we had about $54 million in debt. We had long-term debt of $29 million including current maturities to be paid over four quarters. We had short-term debt of $25 million which we drew down from our $40 million short-term credit facilities. During Q3, we increased our total short-term credit facilities by $10 million to reach the $40 million in total. As explained last quarter, the reduction in our cash reserve is largely a timing issue. We are profitable and expect to continue the improvements, which means we expect to return to positive cash flow in Q4 and beyond into 2013. Looking ahead to Q4, we are expecting revenues to range between 104 to $110 million, reflecting a book-to-bill below 1 in Q3 and a challenging macro environment. We will also have total restructuring charges in the range of 6 to $7 million, nearly all of which will have a cash impact, about 3 million in Q4 and the rest over the next two quarters. We will not see the full effect of the initiatives announced today until Q2. Beginning in Q2, we are targeting quarterly operating expenses of 32 to $33 million. Third quarter splits roughly as follows

[Ira Palti:]

Thank you, Aviram. What we hope you will take away from this call is the sense that we do not see fundamental changes in our business. None of the actions announced today will affect any products or customers in any way. We see our position within the microwave backhaul space is stronger than ever, and we think we are better positioned to cope with a temporary period of slow or no growth than some of our competitors. Lastly, we hope you have a better idea of how we plan to make progress to our profitability goals and to generating sustainable free cash flow if we are not fortunate enough to return to growth mode for a few quarters. Now we will be pleased to take your questions.

[Operator:]

[Operator instructions] Our first question is from Joseph Wolf from Barclays. Please go ahead.

[Joseph Wolf:]

Thanks. First a question on the revenue side. There was a shift in the geographic mix between second quarter and third quarter, with some macro commentary that you guys provided. Could you just go through as you think about the guidance for the fourth quarter on that flat level, what you’re thinking about geographically and whether there are any pockets of hope, of expectations of improvement or whether the background that you are describing is kind of a geographical universal? And then on the balance sheet, if you look at the financial expense and the tapping of the credit facility or the bank facility for another $10 million, and the expectation for fourth quarter return to cash flow, are we looking at that kind of 1.1, 1.2 million in debt expense going forward, or are there plans to accelerate some sort of repayment?

[Ira Palti:]

Joseph, thank you for the questions. I’ll take the first half and let Aviram answer the second part of it. If you look at the geographical mix, overall there were changes in Q3 over Q2 mainly by seeing a little bit of a stronger Europe in the revenue mix and in Latin America keeping its place, where Africa was a little bit down. When I look at those changes from a macro position, I would average out the two quarters. I would not say, okay, this a trend that we’re seeing geographically. I don’t think we are seeing any significant fundamental changes within any one of the regions between Q2 and Q3. Yes, we had for example India being slow for a long while on a regulatory issue. Europe is a little bit slowing down further than we saw, but I think the commentary I gave is relevant for all the business we do worldwide. People are cautious, re-evaluating, taking their time, looking at the macro economy, looking at technologies, thinking do they deploy now or a little bit later; and all of those are slowing down the market at this point without, I would say, specific geographies as one. Although we see, for example, a little bit better in Latin America, a little better in certain areas in Africa, but in general it’s all over the place. Aviram, to the balance sheet issues?

[Aviram Steinhart:]

Yeah, Joseph, if I understand the question, it was around the financing expenses. Yes, we intend and the plan and the focus as we see it for now is to generate significant positive cash flow next quarter. We will use this cash to pay debt and reduce our short-term credit facilities. Having said that, I think looking forward for the next two quarters from the level that we have, I think that the next two quarters you should plan around financing expenses of around 1 to $1.2 million a quarter. In the second half of next year, we’ll see the financing expenses slightly go down.

[Joseph Wolf:]

Okay, great. Just a quick follow-up for Ira – you made a comment on customers being cautious. I wonder if you could give us a little bit of insight into the technology decisions being made, and you mentioned having a new product as potentially being—a new radio potentially providing some upside at the end of next year. What are customers deploying? Are you seeing them just do very incremental, are they looking at older technology, and where could they go if things get a little bit more optimistic?

[Ira Palti:]

I think that independent of the technology, I think all the operators look on their P&Ls and really ask the overall question, how do they make money from data, and how do they expense very large data networks as they move forward? We have different solutions with people who are—we see people who are moving, have made the decision and are deploying LTE, and we see people who are sitting on the sidelines or deciding to still deploy 3G. We do provide the technologies both for today modernization and we will be providing for the next level of modernization within the operators to support both what I would call high speed 3G HSPA+ type of networks, and LTE networks as they move into the future. And on the backside, we’re in discussions with other operators both on current and future technologies, road maps and products as we move, and this is a process which is ongoing. But the decision making at the end is lower at this point.

[Joseph Wolf:]

Okay, great. Thank you.

[Operator:]

Next question is from Mike Walkley from Canaccord Genuity. Please go ahead.

[Mike Walkley:]

Great, thank you. Good morning guys. Just on the significant cash flow for Q4, can you talk about just the accounts receivable? Is this just taking down the DSOs and how you see maybe the accounts receivable and DSOs in 2013, how they might progress? Than you.

[Aviram Steinhart:]

As we said, I believe, on the last two calls, we had several large orders or tenders that we won with a Tier 1 customer that had payment terms which were beyond our standard DSO. We knew that Q2 and Q3 would be tough in cash. At the end of the day, it’s a timing issue and this timing to pay now those projects that we implemented are becoming due October, November, December. This is why we see now expecting the DSO to go down and to collect more than we planned over the last two quarters. Looking ahead for next year, I think if the same customer weeks will stay the same, the DSO will continue to go down. But on the horizon, there are more deals that are coming, more potential Tier 1’s, and it’s too early for me to say how those will be closed and what will be the final payment terms on them. In general, of course, we are targeting to reduce from the level of DSO today over the next six to nine months; but again, it depends on transactions that are on the table over the next few quarters and how they materialize in terms of the payment terms.

[Mike Walkley:]

Okay, that’s helpful. And then Ira, you mentioned some large contracts, just timing of orders continuing to be pushed out. Is there any competitive dynamic, risk of losing share, or do you think you’re in with those customers and it’s just more they’re slowing down their spending, given the macro environment?

[Ira Palti:]

I think on those, it’s really we are in with the customer, they’re slowing down the spending of their decision-making processes.

[Mike Walkley:]

Okay, great.

[Ira Palti:]

And I think just to remind you on the call (inaudible), we do not think we are losing market share or we are losing any deals. It sometimes takes longer, and when people are not urgently and have the pressure to do everything yesterday, it takes a little bit more time.

[Mike Walkley:]

Okay, great. Thanks. And just on your own ASICs and radio chipsets, could you just update us on the progress? I know it’s second half of the year, but with some of the R&D changes, do you feel that you’re still on track despite some disruptions that might go on now with the planned reductions? Thank you.

[Ira Palti:]

Yes, we are 100% on track even with some of the disruptions we are doing. We have taken the measures to do the disruptions in such a way that we are not hitting any of the product schedules and release schedules we have for next year as we roll out new products.

[Mike Walkley:]

Great. Any feedback from your customers on the road map?

[Ira Palti:]

When we announce the products, we’ll talk about the feedback from the customers.

[Mike Walkley:]

Okay, that’s fair. Thank you very much for taking my questions.

[Operator:]

Next question is from Ittai Kidron from Oppenheimer. Please go ahead.

[Ittai Kidron:]

Thanks. Hey guys. I just want to follow up on Mike’s question on market share. I believe that in your prepared remarks, you also mentioned that you don’t anticipate gaining share, and I want to understand why in this environment you don’t have market share gain opportunities ahead of you.

[Ira Palti:]

We have opportunities, okay? We know where we think we’ll gain market share, and that’s why I commented on this also as being one of the potential for the upside.

[Ittai Kidron:]

You seem less confident, though, in your ability to do that. I mean, I understand the economy—

[Ira Palti:]

But then I’ll put the buts on the table.

[Ittai Kidron:]

Okay.

[Ira Palti:]

But in an environment where people are being cautious, also the operators’ decisions sometimes tend to be much more conservative, and let’s remember that gaining market share means I need to displace someone, throw them out. If the decision cycle is slower or people say, okay, we are doing something on a lesser scale, the tendency to make the significant move from an operator and say, okay, I’m going with someone new or changing the practice at this point is a little bit lower. That dynamic plays also in that type of an environment, saying that okay, we are a little bit more cautious at this point on really ramping up and gaining market share.

[Ittai Kidron:]

Okay, that makes sense. Regarding your planned OPEX reduction, why does it take three quarters to see that flow in expenses? Maybe you can give us a little bit more detail. Outside of headcount, is there anything else that takes longer to do, because that’s something that could be done fairly quickly and could be reflected in results fairly quickly.

[Ira Palti:]

Okay. I think that I mentioned on the call that we are taking organizational alignment and efficiency measures. There are two ways to do that, and one of the ways is do it very, very quickly, but then we might hurt the business. It will take because a geographical agreement practices in different places, it takes time for the restructuring to take down, and we believe we can do some of those moves with the people, together with the teams where we need to transfer responsibilities on others to lessen the effect within the company, and that takes a little bit of time. That’s why we think it will come most of the expense in Q4, and then will probably be a little bit more of it in Q1 with very little in Q2 of next year.

[Ittai Kidron:]

Okay, and a couple questions for Aviram. Aviram, regarding the operating margin comments you made about 2013, that 5%, was that an annual rate or is that a run rate you hope to get to exiting the year?

[Aviram Steinhart:]

This is an annual rate.

[Ittai Kidron:]

I’m finding it hard to get to that number if you assume kind of flattish revenues from your fourth quarter level for the next two, three quarters. Even at the OPEX level that you model, you assume you’re getting—

[Aviram Steinhart:]

The question is what to model. If you’re modeling that you are running at the rate that we said on the revenue, the average of this, and you assume the gross margin that we are targeting and running the OPEX around the 32 level, or close to the 32 level, you will get to the numbers that I gave you. It also depends how fast you are taking the revenue on Q1—on the OPEX on Q1, so how much you are putting on Q1. Play with the numbers – you should get to the 5%. In my Excel, it’s working.

[Ittai Kidron:]

Okay, maybe we should exchange versions later. But the OPEX cuts, I think you mentioned will be fully reflected only in the June quarter. Did I get that right?

[Aviram Steinhart:]

I said the full effect will be starting Q2. It means there will be already significant reduction in Q4, more significant – almost all of it – in Q1, and complete the process starting from April 1. We will see the new level of OPEX that we mentioned in the discussion.

[Ittai Kidron:]

Okay. And in the fourth quarter, if all goes to your guidance, are you going to be profitable on the bottom line or about break-even? Am I about right?

[Aviram Steinhart:]

If everything goes as we said, we will be profitable.

[Ittai Kidron:]

Profitable, okay. And lastly, regarding the collections, again following on Mike’s question, you’ve talked about in this fourth quarter collecting a lot on the accounts receivable. Can you confirm that already in the month of October, since we’re a month into the quarter, that you’ve already collected a lot of this? I’m just trying to make sure that this is on track.

[Aviram Steinhart:]

You know, collection is one of the tricky things because you have customers that always in the last two weeks of the quarter that can slip, so this is why we are always cautious. But when we are looking in October, yes – when I’m looking at October, the graphs and the trends that we have, October collection is much stronger than the same months July that we were previous quarter. So we’re seeing the trend already in effect, and it’s also coming—other than the trend of relatively small business, there are chunks of the big projects that completed, and that could be one payment of $50 million, for example, okay? So those are coming—some of them are coming in November, some of them are coming in December, and those are really the ones that we talked about that are coming in one chunk that we expect to come this quarter.

[Ittai Kidron:]

Very good. Good luck, guys.

[Operator:]

Next question from Daniel Meron from RBC Capital Markets. Please go ahead.

[Daniel Meron:]

Thank you. Just wanted to understand a little bit more on what carriers are doing right now. It is clear, just like you said, that data is growing, so what are the means that they are addressing data growth and the capacity expansions that they need to address that right now? And is this the new norm going forward which may reduce the long-term usage of your solutions, or you think this is just temporary usage and there is no way around deploying the capacity, either wireless, backhaul, fiber or any other means to support that? Thank you.

[Ira Palti:]

First, let’s remember that the market does not disappear, okay? We’re still doing excellent business and a significant business on a quarterly basis. I think that the range of plus-minus 10% versus a running level having to do less with a technological decision on what the operators are doing but having to do with the process of how quickly you make decisions, are you slowing down the budget for a while, are you making the decision – okay, I’m modernizing a city. Do I modernize all of it, or modernize the core of the city this year and the second half of the city or the outside and the suburbs next year? We see all sorts of those decisions being taken across the board. It’s the questions that people are saying, okay, we are doing data, we are deploying. In some areas, yes, we want to provide high capacity 3G data not now, next year, and it’s not a technology decision. People still use and require both a lot of fiber and a lot of microwave links to support the solutions, and we are very confident we have the right solutions to support their total need range and capacities that are required with the right technologies.

[Daniel Meron:]

Okay, that’s fair. So this is just tactical timing issue rather than anything else. So is there a time frame or trigger for carriers to switch and accelerate their deployments? Is there something aside from your product launch that could change the course of things?

[Ira Palti:]

I think the whole message around the call is we do not know, or we are cautious about exactly that question. I think if I had a good answer, then the outlook we would have given out there and the way we move forward would have been different. I would have said okay, two flattish quarters, the third one is up; or one flattish quarter, et cetera. We don’t know at this point, and as a working model, what we are conveying on the call at this point, we have taken more cautionary working model out there while making sure we are increasing our profitability, even in this kind of an environment which we believe is a little bit slower. By the way, it’s the same message I hear from competitors and operators and people that we talk to within the industry. Is there something that I can put the finger on? I think I’d put a finger on some things. It’s my belief at some point we’ll start seeing the LTE competitive landscape become such that people will start deploying because of their competitive pressure within certain geographies. We do expect at some point local issues like India regulatory to be resolved. I think all of us expect at some point, and we don’t know when, macro economic issues in Europe will sort themselves out and we’ll see increased deployments. So there’s a lot of ifs which really point to upside, but all those ifs have also a question mark next to them, which is when. And that’s why looking at our booking patterns and what we have on the table, we have decided that we are accelerating the organizational efficiency moves we had on the table to be able to really go very strong into next year, both from a profitability perspective and from a free cash flow perspective, allowing us to be a very stable company that we can work with the customers and meet our profitability goals at a much lower level of revenues than we originally planned for.

[Daniel Meron:]

Okay. And just last question from me before I yield the floor, as we look into this restructuring plan, those accelerated, what kind of measures are you taking to make sure that you’re not missing opportunities along the way? I understand that it’s going to be a very gradual process, but is there any (inaudible) to make along the way that may impact some business?

[Ira Palti:]

We have taken a very deep look at what we are doing and where we are doing it and how we are doing it, and we assume at this point that it will have a negligible effect on the business.

[Daniel Meron:]

Okay, very well. Thank you. Good luck.

[Operator:]

Next question is from Peter Misek with Jefferies. Please go ahead.

[Peter Misek:]

Thank you. In terms of carriers by geography and trying to figure out order patterns or potential orders, has M&A or potential M&A had any impact on your order activity book, and do you see any significant changes – and I know you’ve talked about a lot – but trying to get more percentage cut here of fiber versus microwave backhaul. Thank you.

[Ira Palti:]

The first question, I don’t understand fully because at this point we are running as strongly as possible as an independent organization, and I don’t understand the M&A question and it’s association we drive the business with our customers, both direct and via the channels very strongly as we move forward. And if you ask about fiber versus microwave, I don’t think we see significant change in the trends. What we really see is that the early LTE deployments which are mostly in the city are all being done on fiber. We didn’t expect otherwise, by the way, because in the city you’ll see very little microwave at this point. And I don’t see a significant change in the mix. I think what we’re seeing is that everyone is deploying high capacity microwave driving the capacities and really building the network modernization process where they can, if they want to at some point down the road, support LTE deployments.

[Peter Misek:]

So the question on the M&A, just follow up giving you an example, would a T-Mobile-PCS, Softbank-Sprint merger or potential mergers have any impact on order activity in the marketplace, or other mergers that are happening around the world?

[Ira Palti:]

Now I can answer, yes. Now I understand the question – yes, consolidation within operators, and I think I referred to it in my prepared remarks, is one of the things that we saw which is slowing down order patterns. When you have a consolidation between operators, the first thing they do, they stop all CAPEX spending or most of the CAPEX spending for a while until they rationalize their internal operation, how do they structure internally, how do they rationalize the assets that they have, whether they have base stations or not, how do they cross over and other patterns, and only then they resume business. Yes, this is one of the places where we see part of the slowdown, and you’re 100% correct on that.

[Peter Misek:]

Thank you.

[Operator:]

There are no more questions in queue.

[Ira Palti:]

Okay, I would like to thank all of you for joining us for the call, especially thanks for those on the east coast, people hunkering down for Sandy. Please, we will do follow-up calls with most of—with all of you and probably face-to-face during the quarter, and we’ll be happy to answer further follow-on questions. Thank you very much and have a nice day. Thank you.

[Operator:]

Ladies and gentlemen, this conference will be made available for replay after—[end]