Ceragon Networks Ltd.
Q3 2013 Earnings Call Transcript

Published: 11 Nov 2013

[Operator:]

Good day, everyone. Welcome to the Ceragon Networks Ltd. Third Quarter 2013 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 statements concerning Ceragon's future prospects that are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and projections that involve a number of risks and uncertainties. There can be no assurance that the 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 the forward-looking statements in this presentation include risks associated with the impact of restructuring activities; risk associated with continuing losses and possible liquidity issues; risk associated with the possibility that new products will not be accepted in the market; the risk of significant expenses in connection with the potential contingent tax liability associated with NERA's prior operations or facilities; 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 or 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 will now like to turn the conference 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 Aviram Steinhart, our CFO. Our Q3 results were in line with our guidance. Our book-to-bill ratio of about 1 and our accelerating plant activity all indicate that our business is starting to improve, even in a challenging CapEx environment. There were no meaningful geographic changes during Q3, just the normal quarter-to-quarter fluctuations. In general, Latin America remains strong and Africa is running considerably ahead of last year. As you have seen by our recent announcements, we've achieved a major strategic milestone with the release of our integrated IP-20 platform and are moving ahead with initiatives to improve our financial performance. Therefore, on today's call, we would like to focus on 3 main topics. First, the significance of completing a major investment cycle resulting in a launch of the premium next generation platform, which in turn, clears the way to rationalize our organization; second, the end of a crucial phase in implementing our strategic vision, a vision which began with the decision to acquire Nera Networks [ph] 3 years ago. We'll explain how all this works together to put us in the best possible position to leverage our technology and products cost leadership and fully participate in the upcoming CapEx cycle, gain additional market share and deliver improving operating leverage; third, despite some of the recent developments with current and prospective customers that shows risk rebound in the overall market that will begin soon. Let's start. We're all familiar with the hauling challenges of mobile operators. Dramatic growth in data traffic coming from cloud concept and applications, which continue to drive requirement for much higher capacity. The operator revenue challenges, which drives them into new business models, including various degrees of network sharing, and shift in technology and network topology into LTE advanced small cells Cera networks, which will eventually lead into heterogenous networks. So clearly, operators need a simple solution to a very complex set of issues. The list of critical requirements is easy to describe, yet extremely difficult to deliver. Operators looking to deploy flexible, scalable auto high capacity hauling networks based on an SDN architecture that are open service centric [ph] and simple to manage, support any combination of transmission technology and network topologies in any configuration, while being extremely power efficient with the smallest possible footprint and lowest possible operating cost. Sound simple, isn't it? With this list in mind, it's fairly obvious why operators are hesitating or deferring spending as long as possible. Network planning has become a very complex process. New microwave hauling products are coming into the market all the time. Most offer incremental improvements. But none address the full range of hauling requirements with the future proofed approach until now. We have completed an important phase of a multi-year investment initiative. And last week, we introduced the full IP-20 portfolio. It is a game-changing SDN-ready platform, which merges multiple long-haul and short-haul products into a single hardware architecture managed by a common operating system that serve our office [ph]. The IP-20 platform addresses the full scope of backhaul and front haul needs across the entire network for small cells to large market cells for aggregation to transolutions, all for ultra-high capacity solutions. The new IP-20 series complements existing fiber and evolution products. It does not replace them. The IP-20 platform is a premium ultra-high capacity future proof offering. It reaches with the industry highest regular density and it's all the operators 4x the capacity of our existing products with a form factor 1/2 the size. The common operating system simplifies network operation and, in many unique ways, the IP-20 platform reduces our customers' most painful point the total cost of ownership. Our website provides a wealth of details. Now let me give you a short summary of the various products. FibeAir IP-20C is a compact all outdoor, multi-core radio providing 1 to 2 gigabits of capacity in a single box, all in a very limited channel bandwidth. It is already shipping and is live in customer networks. FibeAir IP-20S is its small cousin, a compact all outdoor, single carrier radio solution, targeting small cell deployment. It will begin shipping in Q1. The fiber IP-20G and fiber IP-20N are the most powerful microcell backhaul solutions in the market. IP-20G is optimized for exercise, while IP-20N is optimized for aggregation nodes. The IP-20N is already operating in a lot of customer networks, and the IP-20 G will be shipping in Q1. IP-20 LH is the long-haul portion of the portfolio and is actually 3 different products

[Aviram Steinhart:]

Thank you, Ira. I will go through the Q3 results and elaborate on the restructuring we announced today. Our third quarter revenue was $92.1 million, within the range of our guidance and similar to the prior quarter. Our GAAP gross margin were 30.9%. Non-GAAP gross margin were 31.9%, a slight decline from Q2. The non-GAAP figures excludes $300,000 from amortization of intangible assets, $600,000 of charges in pre-acquisition indirect tax position and $40,000 in stock-based compensation. Third quarter GAAP operating expenses were $32.6 million. Non-GAAP operating expenses were $31.6 million compared to $31.9 million in Q2, reflecting our continued focus on expense control. The non-GAAP operating expense excludes $300,000 in amortization of intangible and $700,000 of stock-based compensation. On a GAAP basis, we reported an operating loss of $4.1 million. Our non-GAAP operating loss for the third quarter was $2.2 million. Finance expenses in Q3 was $2 million. Tax and expenses was about $4.4 million in the third quarter, which included $4 million non-recurring adjustments of the valuation and allowance on our tax assets. On a GAAP basis, we reported a net loss of $10.4 million or $0.28 per share. On a non-GAAP basis, we reported a net loss in Q3 of $4.5 million or $0.12 per share. The geographic breakout of the revenue appears in the press release. Latin America continued to be very strong and Africa was down a little from an extremely strong Q2, but still showing good results, while the remaining regions continued to be sluggish. We have one 10% customer from Africa this quarter, and our OEM sales accounted for 3% of our total revenue in Q3. Turning to the balance sheet. Trade receivable increased to $129 million, putting DSO at 120 day, an increase from Q2. Cash flow from operations was negative by $7.4 million. And after purchasing of property and equipment, or negative cash flow in Q3 was about $11.5 million. We drew down on our credit facility during Q3, so that total cash and cash equivalents were $44.8 million at the end of the quarter. As of September '13, we had unused borrowing capacity of $12 million in addition to approximately $45 million in cash on our balance sheets. As Ira explained, we are implementing a major cost-reduction program. The long-haul related R&D and support function located in Bergen, Norway operation will now be handled by Tel Aviv and Romania teams. There will no change in sales, sales self-support and offshore and defense teams located in Bergen. In addition, we will be realigning field of cases in Europe, Africa and APAC, moving them to smaller, low-cost location and opening global professional service center for customer support, presell and order intake in low-cost location in Slovakia. We will reduce headcount in operations, finance, IT and HR, as well as several other actions. The cost of the restructuring is expected to range between $18 million to $21 million, about 70% will be cash spread over the next 3 quarters. As Ira indicated, we expect annual saving of approximately $25 million broken down as follows

[Ira Palti:]

We have reached an important strategic milestone by introducing our new platform with unmatched capabilities. As a result, we're able to make changes to our cost structure that will position us to return to profitability and to deliver significant operating leverage once top-line growth resumes. This sustainable cost structure that will support a revenue increase of up to 25% from current levels is only modest increased in variable expenses. Therefore, we believe we are in the best position to capitalize on a new wave of operator CapEx, not only growing with the market, but also gaining share and improving profitability. Thank you. And now, I'll turn to your questions.

[Operator:]

[Operator Instructions] For the first question, we'll go to the line of George Iwanyc with Oppenheimer.

[George M. Iwanyc:]

I think you said that the restructuring will take place over the next 3 quarters. Can you give us a sense of how much the pace of that? Are most of the cuts going to be in the current quarter?

[Aviram Steinhart:]

Most of the cuts is going to be in this quarter, with some portion which is much lower next quarter and a very marginal in remaining part at Q2 next year.

[Ira Palti:]

Another comment, and that's from Aviram answered you from the financial and the way we accounting it on the table. From our experience and from the way we operate the company, effectively, the change is, the personnel changes, the organizational changes will appear, I would say, 95% of them over the next 2 weeks. And -- but the accounting will take 2 quarters, a little bit to take into account. The execution will be much, much quicker than that.

[George M. Iwanyc:]

Okay. And Ira, when you look at improvement you expect in the middle of 2014, can you give us a sense of how the current bookings level is giving you visibility into that and what you see IP-20 -- into how that's driving the next 2 quarters and the change to get to the middle of next year?

[Ira Palti:]

The booking levels, at this point, do not -- we don't go that far out into 2014. But we do have visibility because, as I said, we are involved in quite a few trials with the new equipment. And we are involved in the planning and the budgeting cycles that some of the operators are doing and their plans. And our expectations, this will turn into bookings somewhere and additional incremental bookings and other processes somewhere towards Q2, which will start affecting revenues in Q3 and Q4 of next year. Let's remember, most of the things that we do when we get the bookings is very short-term. It's get the booking, send or deliver within the next 30 days, and then over the next 60 to 90 days, install everything. So it's more right now, of the level of trials and involvement in planning than in actual bookings for that type of a period and a scant [ph]. But that level of trials and planning has increased significantly over the last quarter.

[George M. Iwanyc:]

Okay. And then, do you anticipate most of the left to come from better spending? Or do you feel that there's an opportunity to gain share with the new products, given the kind of visibility you see in the trials right now?

[Ira Palti:]

Both. It'll come a little bit from better spending and a little bit from gaining share.

[George M. Iwanyc:]

Okay. And just one last question. Is there any shift in the regional dynamic that you expect next year? Or do you expect Asia Pacific to get stronger, more of a contribution from North America or is this mostly driven by Latin America and some gains in Europe?

[Ira Palti:]

The later, most of the shift will begin in the, say in Latin America, a little bit also from Africa and gains in Europe.

[Operator:]

All right, and next we'll go to the line of Joseph Wolf with Barclays.

[Joseph Wolf:]

Two questions. One is, I guess, going back to the bookings, which I guess, there's some muted enthusiasm about the momentum. Are the types of trials that you're doing and the bookings that you're getting right now longer lived? Meaning, you put it in the booking, but it takes more quarters to actually receive revenues for them than it would have been 1 year or 2 ago in terms of how we think about the business and the impact or the length of time you'll be at this $90 million breakeven level or so?

[Ira Palti:]

I don't think that the patterns of the deployment inside the customers is any different from booking to revenue than we have seen in the past. As I said, we are seeing a booking pattern, which supports the 90 plus for the, or around the 90 for the next 2 to 3 quarters. What we are optimistic about is things which have not turned into bookings, which is a lot of trials and activities with the customers, both existing and new.

[Joseph Wolf:]

I know these trials, just a quick follow-on, are these trials competitive? Or are you guys the only ones there, these are kind of exclusive engagements that turn into revenue?

[Ira Palti:]

I'll say the opposite. If we're exclusive, the probability of winning the deal is low. As most of the operators we work with usually would prefer to have more than a single vendor on the network. Yes, we are exclusive in the sense of, I think, we have the leading technology and pushing the envelope, but there's always 1 or 2 more which are put into the bundle.

[Joseph Wolf:]

Okay. And then a question on the cash flow. If I heard you right the cash component of the restructuring is somewhere around $12 million to $13 million. And if I look at the borrowings that you have and the cash that you have on hand, I'm just wondering how you feel about the cash and if you could give us what you expect the interest payments to be over the coming, couple of quarters. Are we steady at $2 million or does that shift based on the mix of the loans that you have?

[Aviram Steinhart:]

Yes, we have, as you mentioned, we have at the end of the quarter, $45 million in cash and additional $12 million in borrowing that we can still utilize from existing credit lines. So this, we financed most of the restructuring. On top of that, we are looking on strategic activities that we're actively looking on optimizing our cash through our existing resources. I'll give one example. We have still not optimized some of the cash resources that are sitting in some of the jurisdictions that the expatriation [ph] of the cash requires certain processes that we're looking at them. So we're optimizing existing resources. We are utilizing the cash that we have and we're also looking on probably on some other alternatives.

[Joseph Wolf:]

So that would imply that your interest payments will go up over the next couple of quarters and the borrowing will be -- or your lines will be drawn down a little bit?

[Aviram Steinhart:]

Yes, it's going to go slightly because if you take additional $12 million at the maximum at 4% so roughly, you can edit how much it's going up on a quarterly basis. It's not very significant that it will go slightly up.

[Operator:]

All right. And next, we'll go to the line of Peter Misek with Jefferies.

[Jason North:]

This is Jason North for Peter. With the new product ramping, could you just talk a little bit in terms of the timing of the boost it will give to gross margins? And how quickly should we expect that?

[Ira Palti:]

We expect the product to start ramping up in Q1 of next year, but it's a gradual ramp. We don't expect 90% of the revenues in the first quarter to be from the new products because as customers adopt them, put them into the networks. We do expect that by Q4 of next year, we will have above 50% of our bookings already on the new products, with a significant part of that already showing up in our numbers. And we do expect at that point to reach somewhere close to our target goal, but below way to that point still.

[Operator:]

[Operator Instructions] And next, we go to the line of Matt Ramsay with Canaccord Genuity.

[Matthew D. Ramsay:]

Ira, I just wanted to kind of balance some numbers off of you. Aviram, in your prepared remarks, you kind of referenced to Q4 revenue level of around $100 million and a 5% operating margin. Is that kind of the revenue trajectory and the plan that you guys are executing against? And I guess, what has to happen for you guys to get from where you are now that they are given the market dynamics?

[Aviram Steinhart:]

First, let's make sure we are talking about the first the same Q4. We are guiding, first of all, for Q4 this quarter between $85 million to $95 million, which is the average of what we've done over the last several quarters. What we said is that we expect, over the next first quarters of next year, stabilize revenue and start to ramp up -- starting from Q3 in revenue and in Q4, exiting the year with a target that we put now on projection of $100 million, Q4 next year.

[Matthew D. Ramsay:]

I think I had that right, I just wanted to kind of make sure. And if you look forward, Ira, to how your new products are ramping -- you mentioned starting in Q1 ramping to next -- that, say, $100 million in revenue next December quarter, you have any feel for what percentage you expect to be of the new product line by that point?

[Aviram Steinhart:]

Sorry, somewhere below 50%.

[Matthew D. Ramsay:]

Got you. Got you. And then, if we just step back and look at the industry. Obviously, some tough spending environment, but it sounds like your outlook for wireless backhaul, both short- and long-haul is better than it was at least the last time that we spoke. I guess, what do you look at for sort of TAM growth for on specialty backhaul vendors over the next 1 year or 2 versus some of the larger vendors continuing to sort of use their own products. So, I guess, if you look at the mix of product from the larger vendors versus the backhaul specialist, how do you think that mix plays out over the next couple of years?

[Ira Palti:]

The interesting part there is that the mixture between what we call captive market or system deals out there, which is mainly today, Ericsson and Huawei in the market. But over the last years, that mix between specialist and that type has been slowly, slowly pending towards the specialist. Okay, and there is the growth in the specialist portion within that type of a package, not significantly, it's staying somewhere around the 48, 52, one way or another over the last 5 or 6 years. I do not expect a significant change in that type of a mix. My belief, as we ramp up with a new product and gain market share, most of that market share will come from other specialist or from the edges of the big equipment vendors.

[Operator:]

There are no additional in queue at this time. Please continue.

[Ira Palti:]

I would like to thank everyone for joining us for the call today and looking forward to your one-on-one and questions and for your follow-on on our ramping up our strategy and vision as the market continues to change in our favor. Thank you very much, and have a nice day.

[Operator:]

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.