Ceragon Networks Ltd (CRNT) 2006 Q2 法說會逐字稿

Good day everyone and welcome to the Ceragon Networks Limited second-quarter 2006 quarterly results conference call. Today's call is being recorded and will be hosted by Mr. Ira Palti, President and Chief Executive Officer of Ceragon Networks and Mr. Tali Idan, Chief Financial Officer of Ceragon Networks. Today's presentation will include forward-looking statements under the Private Securities [Legislation] Reform Act of 1995. These statements are subject to risks and uncertainties that could cause Ceragon's actual results to be materially different from these expressed or implied by such statements. For additional information regarding the risks associated with the Ceragon business, please refer to Ceragon's annual report on Form 20-F and Ceragon's report filed with the SEC. Web users can visit Ceragon at www.Ceragon.com to read the complete forward-looking statement language. I will would now like to turn the meeting to Mr. Ira Palti, President and Chief Executive Officer of Ceragon. Please go ahead, sir.

Thank you for joining us today. With me on the call is Tali Idan, our CFO.

I'm pleased to report that we continued to execute according to plan during Q2 and it was an excellent quarter. Revenue was up 32% from the second quarter of last year and gross margin was 36.7, as expected for the lower end of the indicated range. On a non-GAAP basis, we reported an increase in operating margin of 3.8% and EPS of 3.8% and EPS of $0.04. (indiscernible) strengthened again this quarter with book-to-bill ratio of much better than one.

Demand for additional back-haul capacity continued to grow, particularly in Asia. Our revenues from Asia-Pacific increased dramatically in Q2 (technical difficulty) due to a strong demand from India which we supplied through Nokia, an important OEM partner. To put the growth in Asia-Pacific in perspective, our sales for this region are 2.5 times greater in the first half of 2006 compared to the first half of last year. In addition to more demand from existing customer in India and the Philippines, we're adding new customers in the region. For example, we recently announced that we've been selected by Optus [Intel], the second-largest cellular operator in Australia to supply our 1500P solution for the fixed and 3G networks. As growth in cellular subscribers continued in Asia-Pacific, demand for additional backhaul capacity grows as well. We expect this region to continue to be a strong source of strength in the future and we believe we are gaining market share.

North America is also accounting for above-average growth so far this year. With first-half revenues up over 60% compared with first half of '05, this reflects strong demand from distributors for IP products and orders from [carriers] carriers segment. On past calls, we have discussed on of these customers [FiberTower] that is offering wireless backhaul as a cost-effective alternative to expensive leased lines. FiberTower was again a 10% customer in Q2. As most of you know, FiberTower is in the process of merging with First Avenue Network. We have good relationships with both companies which we expect to continue after the merger.

We also announced recently that Cellular One in the U.S. is expanding their backhaul network via a combination of server and solutions and we believe this is a good example of the success we are enjoying because of the breath of our product portfolio.

Looking at the trend by market segment, we're seeing very strong growth in the cellular segment driven by continued subscribe growth and the need for additional capacity to handle higher bandwidth per subscriber in the 3G EVDO world. Revenue from fixed operators was down at bit sequentially but still showed double-digit growth in the first half of '06 compared to the first six months of last year. We continue to expect this sector to be a strong growth driver as metro Wi-Fi, WiMAX and other broadband networks expand.

The Private and Government Network segment continued to grow nicely. They account for a little more than a quarter of our total revenue, about the same as last year.

From a product point of view, we are also tracking according to plans. We continue to be pleased with the traction we're seeing in our newer products. We are seeing continued growth in the 1500P series, which accounted for 60% of revenue in Q2. We're seeing excellent demand for both FibeAir 1500P and the FibeAir 1500HP, our solution that is optimized for long-haul applications. As we mentioned last quarter, we have been moving forward on an aggressive development effort with IT products. Our IP-MAX family of software (indiscernible) on the radio continues to do well. In May, we introduced as part of the IP-MAX family a gigabit radio offering the highest capacity and highest throughput on the market. This product is based on native IP (indiscernible). We're very pleased with the acceptance of this product. We already have orders for over 100 [links] from 15 customers. This solution is optimized for next-generation backhaul networks and metro Ethernet network applications, including WiMAX, Wi-Fi, triple-play with IP DSLAMs and IP backhaul and cellular networks.

In addition to the transition to new design to new [designed to cost] products, our other cost reduction measures are on track we're making progress and we're making progress on our outsourcing initiatives and we will be completing the move of all our production to contract manufacturing within the next few weeks.

Looking ahead, extremely strong demand has caused us to increase our expectation for total company revenue growth in 2006. We are raising our revenue growth target to about 35% growth over 2005 instead of our previous target of 25%. Our strategy to increasing our business with OEMs is boosting our revenue faster than we expected, mainly in Asia. It is important to realize that this lowers the overall gross margin expectation. Just to remind you, our current long-term target model is based on the assumption that OEM business will account for about 10% of total revenues. We now believe OEM business could be as much as 20% of revenue for 2006, helping to accelerate [overall] and contributing to our bottom line. Now I would now like to turn the call over to Tali to discuss our Q2 results in more detail. Tali?

Thank you, Ira. Quarterly revenues again reached a new record of 23.6 million, representing an increase of 32% compared to 18 million in Q2 last year and a sequential increase of 11%. Revenues from cellular operators accounted for 56% of total revenues in Q2 compared with 41 in the previous quarter. The large jump resulted from a combination of larger orders and more OEM business. Six operators accounted for 17% of revenues, down from 33% in Q1. We don't think this decline represents any trend in demand. Private Networks accounted for the remaining 27%, similar to Q1.

Europe, Middle East and Africa accounted for 34% of revenues. Asia-Pacific accounted for 31% of revenues, a dramatic increase over Q1. North America was 29% of revenues in Q2 and Latin America accounted for the remaining 7%.

We had two 10% customers in Cellular Network segment in Q2, FiberTower and Nokia. As Ira mentioned, our quarterly bookings strengthened in Q2 with book to bill much higher than one. This quarter, gross margin declined to 36.7%, within the range we expected. Operating expenses were up moderately from Q1. As we indicated, we expect operating expenses to continue to increase sequentially for the balance of the year, but we expect them to decline as a percentage of revenue with an improvement in net income.

On a GAAP basis, we reported net income of 835,000, or $0.03 per share, which included stock option expense of 260,000, or $0.01 per share. Pro forma non-GAAP net income was 1.1 million, or $0.04 per share. This was about even with pro forma non-GAAP net income of 1 million, or $0.04 per share, in both Q2 of 2005 and in Q1 of 2006.

Moving onto the balance sheet, our cash balance at the end of the second quarter was 30.3 million and DSOs were 74 days. In Q2, we had positive cash flow of 300,000. We expect cash flow in Q3 to be negative due to the work negative working capital needed to support the additional revenue increase. For Q3, we expect revenues in the range of 25 to 27 million. We expect our gross margin in Q3 to be between 34 and 36%, depending on the mix of the revenue. Generally, more OEM deals reduce the gross margin. As I said, for the remainder of the year, we expect the operating expenses will grow in absolute terms, but decline as a percentage of revenue. This will result in improving operating margin and net income. Back to you, Ira.

Before we take your questions, I'm sure many of you are interested to know how the conflict in the north of Israel is affecting us. Two of our contract manufacturers have their factories in the northern part of the country. The larger one is operating normally and the smaller one is operating at less than full capacity. But so far, it hasn't caused us any major problems. It's a difficult situation for everyone, but we're operating fully on a business-as-usual basis. Now we will be happy to take your questions.

(OPERATOR INSTRUCTIONS). Rich Church, C.E. Unterberg Towbin.

Nice quarter guys, congratulations. Can you tell us what OEM is overall as a percent of revenue?

Overall in this quarter, OEM business was about 15% of the revenue.

Okay. And can you talk about the Nokia-Siemens partnership? And will this, while the business is good today after that closes, does that impact the Nokia relationship?

We don't know yet. And I think no one internally in Nokia knows yet what will happen after closing the deal. The way we work with them right now, we're working very, very tightly and continuing business as usual with the Nokia team and delivering more to the customers. And we expect this to continue forward, although I think on the last call I said as well, there might be internal political decisions which will change that.

Can you quantify how many RFPs or opportunities that you're currently pursuing jointly with Nokia?

We are pursuing with Nokia quite a few accounts together. And by the way, OEM business is not only Nokia for us.

Okay. And that was going to be my next question. Are you continuing to pursue other OEMs? And do you think we will see some announcements in the next couple of quarters?

First of all, we're pursuing other OEMs. We are working with other OEMs. Announcement is a different thing. It depends on the specifics of each one of the deals.

Okay. Alright, thanks a lot.

Thank you, Rich.

Matt Robison, Ferris Baker Watts.

Can you tell me where lead times have been and where they're going to go?

Lead time to provide products to customers -- is that what you mean?

Yes.

Okay, lead times are dependent on, first of all, on size of deals. It depends on different ways we work with different customers. For smaller deals, usually the lead times are relatively short. For the larger projects, we usually schedule them over a period of time which might be two quarters time before our scheduling until we complete the [whole business].

Have they been increasing or decreasing?

The lead times in general have been decreasing.

Decreasing?

Decreasing, yes.

You mentioned your CMs in northern Israel, are those for specialized assemblies? I think you've reported that you use Flextronics in the past, which obviously is located in a lot of places. What is your sensitivity to those contract manufacturers?

We use, as we said, out of our operation, and in general, our change in the way we do manufacturing is that we do all our manufacturing via contract manufacturers. Most of that is done in Israel by those two contrast manufacturers. Some of it is done outside of Israel. They do build specialized (indiscernible) specialized assembly. We are sensitive to both, although I expect that under contingency plans, we can move manufacturing from those sites to other places as well. We had mentioned one of the reasons we're using (indiscernible) is exactly that, that their ability to move their manufacturing capability to other places around the world is relatively easy. Nothing is easy in [those terms], but relatively easy.

What was your headcount exiting the quarter?

It was about 275 employees.

So it was flat from -- you didn't add any from the prior quarter?

Very few.

Ira, your percentage growth as compared to Tali's commentary implies some -- if you the arithmetic there -- implies some pretty good acceleration in the fourth quarter. What would be the backdrop for that?

Backdrop for that is exactly what I said, is that we see very strong demand and increasing some of the OEM deals, and that we had a very good excellent booking for this quarter. Some of those are larger projects to be, as you said, (indiscernible) lead times which will be delivered in between this and the fourth quarter.

Given that, should we assume that the OEM factor might be even bigger in the fourth quarter, so margins could show some sequential decline in the fourth quarter I guess within your range?

Not necessarily.

Back when you took the charge towards the end of last year, there was -- it sounded at that time like at that time you were going to have a significant cost improvement in the second half of '06. Are you starting to see that?

We are starting to see that in two ways, by the way. One is, we're starting to see that in our cost reduction and design to [close] product and the way we're shipping here, and the other, it allows us to work with the OEMs on a much easier basis.

Okay. How does that second factor relate to it?

Can you repeat the question?

How does what you did in December, or rather the fourth quarter, enable you to work better with the OEMs?

[At the OEM], deals with OEM have to a lot around structuring the deal correctly with them and the value chain pricing across for the whole chain. When you structure -- when you do cost reduction, design to cost and reduction measures, you come up with products which are benefiting into that value chain, which leaves margin both for us and the OEMs [to] the deals with the customers.

So you can accommodate margin stacking?

Yes, we can accommodate margin stacking.

In that 60% 1500P family, did that include your HP?

Yes it does.

Okay. Congratulations on getting the operating margin going back in the right direction again in the second quarter.

Thank you.

(OPERATOR INSTRUCTIONS). Kevin Dede, Merriman.

Let me offer my congrats too on the quarter. Nice job, guys.

Thank you Kevin.

Have you completely migrated all of your manufacturing out of your internal capacity?

As I said on the call, we're in the process and we expect that to be totally completed within the next few weeks.

Okay. Can you give us some insight as to what the product mix is going into some of your OEM customers in India, and how you might see that change, and maybe give us a read on where you think gross margin goes in the fourth quarter?

Product mix going into the OEM channel, and not just India, is very similar to what we see as the product mix overall. I would say the only -- I was trying to say up-front that the only change we see is that it has a higher percent of [SDH] versus IP products, but I might be wrong on that. On the second part, it's almost the same. So it's very similar to the product mix we see overall. It's not any different I think than what we see in our direct channel and other channels.

Would it be different by geography?

It would be different by deal. Certainly some of those deals go into the cellular network, then (indiscernible) products, some of those go into other networks (indiscernible) IP products. So some of it [would] go into different types of projects for those OEMs and will have the HP product coming in (indiscernible).

Okay. Any indication on the trend in gross margin beyond 3Q, just given the bookings that you have seen?

It will highly depend on the mix that we recognized in the fourth quarter and how that is being delivered. It's a little bit too early to say.

Okay. And do you have insight into how far along FiberTower and First Avenue are and what their CapEx outlook might be?

I have some insight, but that's a question that you probably have to ask them directly.

Okay. Any issue with source components?

Not anything which is new. It's like -- and I think we had one of the issues that is coming up once in a while is that a lot of the markets are shifting to lead-free RSH type of components toward the end of the year, and this will cause not now but probably towards the end of the year some lead time increase in components which we -- you can take into account already buying, pre-ordering some of those.

Okay, great. Thanks for taking the questions.

Rich Valera, Needham & Company.

I believe you had had a prior gross margin target of 36 to 40% and it sounds like you will be below that range possibly in the next quarter. Could you sort of frame where your new gross margin target, long-term gross margin target, might be, and how much of that impact is from OEMs, the OEM mix increasing, and are there any other factors in that? Thank you.

I think we're trending as we exhibited originally in our cost reduction and product mix trends that we originally forecasted, [which says] that, without the OEM business increasing, we would have seen the same type of early indication we gave. I think the reduction that we see moving forward has to do a lot with the mix of the OEM business coming in. But too, as I said in one of the prior questions, [is two] intersecting type of directions in there. One is cost reduction, product cost reduction (indiscernible) of the new products lower costs, which increase the margins, then the other OEM mix going up, which decreased some of that margin.

So just maybe try to ask it another -- would you say that OEM -- I guess trying to put some range on it -- OEM goes from 10 to 20%, which is it sounds like nominally what's happening at least near-term. Is that, what, something like 200 basis points of pressure on that range? Is that a good way to look at it, or is there any other way to frame it?

I think that's about right, a way to frame it. It might be a little bit higher pressure.

Okay, that's very helpful. Thank you.

Matt Robison, Ferris Baker Watts.

A follow-up. (indiscernible), can you comment on taxes, when you expect to be paying taxes?

Still way in the future. We're still carrying a very large amount of loss carryforward.

So a couple of years away?

Oh yes, more than a couple of (MULTIPLE SPEAKERS) the amount is about $76 million in losses.

Okay.

So we do wish to make $76 million in profits in the next couple of years, but we still only have [the budget map].

Okay, thanks.

[Louis Toma], [Long Trail Investments].

Nice quarter guys. Just had a couple of questions. I missed the beginning of the call where you were breaking out the different segments in terms of the private network backhaul. Could you just go over that again please?

I will try to do it quickly. Cellular segment was 66% of revenues, fixed operator 17%, private networks 27%, and as far as the geography --.

I have that, that's all. Thank you. And can you just, for the -- can you just talk a little bit about the size of the market? When you look at the emerging markets for cellular, how do you look at that just in terms of the growth of the market and the size of the market that you guys are seeing?

If we look at the size of the market, we assume the markets for this year for split-mount SDH radios, which is then main market we play in, to be somewhere at around the -- below billion mark, somewhere probably around 900 to 1 billion mark, which puts us, where is our market share within that market space. And it's growing all over the place. It's not in just emerging markets. We should have very strong demand for backhaul need in the North American market, we see it in the Asia-Pacific and we see it in Africa as well.

So the 900 million is total market worldwide?

Total market, worldwide, yes. For the segment we play in, if you ask other people what's the total market for point-to-point radios, low-capacity, high-capacity, and other applications point-to-point radio, it's a much larger market.

How much -- when you look at that whole (MULTIPLE SPEAKERS)

That hole is about 3.5 billion.

Okay, and who do you compete with mostly? Who do you see when you're competing for deals?

In this segment, there are a few players, some of the larger ones and some dedicated once. Larger ones are companies like NEC, Siemens, Alcatel in the -- are the larger players. And by the way, not all of them are larger than us. [And the safe] and then you have dedicated players like [Nera] like [Stratix] and a few other very small players.

I know Stratix recently introduced some updates to their [Eclipse] product. How does your product compare to their Eclipse in terms of functionality and comprehensive solution?

Stratix made a very nice move and introduced a product which we introduced about three years ago.

Okay, so you're already there?

We're already there, yes, we're already on the next cycle.

One last follow-up -- what is the net cycle (MULTIPLE SPEAKERS)?

Just to give you a feeling on that, just a little bit of color to what I said, Stratix has introduced [at least] mainly for the low-capacity PDH market, which is their main play and are [playing] very nicely in markets we do not play in, and [they're] -- they might have an advantage in the PDH (indiscernible).

Okay, thank you.

[Jane Levy], [Field] Capital.

Hi, guys. I just wanted to get a feel for what you think operating expenses might trend towards maybe a year after -- roughly at the $8 million mark, you're delivering nice operating margins. Do you think it stays roughly in this range going forward increases, decreases?

You mean for 2007, for example?

Yes.

We believe it will increase. Mostly the expenses that are more related to sales than others. R&D, we see more moderate increase. We will put (indiscernible) [on sale]. It depends of course on how much OEM revenues we may have. The more OEM revenues, the less increases in sales. And G&A -- general and administrative -- should (indiscernible) grow percentage-wise.

Okay, so sales and marketing should decrease as a percentage of revenues?

All of the expenses should decrease as a percentage of revenues, even within Q3 and Q4 of this --.

Okay. So it is possible that your operating margins this year will exceed those of last year, for the full year?

It is possible, yes.

Okay, thanks.

[Amir Ackerman], CIBC World Markets.

Good afternoon. Can you anticipate where [you're focused for] the third quarter?

Yes, the forecast that we gave for the third quarter was revenues in the range of 25 to 27% -- I'm sorry, [$25 to $27] million. And as far as gross margin percentage, we gave the range of 34 to 36.

Okay, thank you.

And we have no further questions at this time. I would like to turn the conference back over to Mr. Palti for any additional or closing remarks.

Thank you very much for joining us for the conference and I'd like to see you again and like to talk with you again next quarter. Thank you.

Thank you, that does conclude our conference for today; if you would please disconnect at this time.