Ceragon Networks Ltd (CRNT) 2006 Q3 法說會逐字稿

Good day everyone and welcome to the Ceragon Networks Limited Third Quarter 2006 quarterly results conference call. Today's call is being recorded. And today's call is being 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 Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause Ceragon's actual results to be materially different from those expressed or implied by such results, or to be materially different from those expressed. For additional information regarding the risk associated with Ceragon's 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 would now turn the call over 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. This was a very strong quarter for us and we expect it to continue this way forward. We crossed the 30 million per quarter milestone and more importantly, we reported record net income of $1.9 million or $0.07 per share. A break away from the $0.03 to $0.04 we've been reporting for the past several quarters.

The increase in both revenue and profit came from the success of our go to market strategy. In Q3, our top line grew 62% compared to a year ago and it was up 29 sequentially. Even after this big sequential increase, our bookings are strong with a book-to-bill ratio a little bit greater than one. Each of our three OEM partners is contributing to this strength. Together, OEMs accounted for about 34% of total revenue this quarter which was higher than we expected as the relationships with all three partners has developed faster than we originally anticipated. Direct sales and business with distributors also grew in Q3 accounting for an 18% increase versus Q3 of last year.

Our go to market strategy involved both direct and OEM business. We expect that the OEM portion will carry on rapidly and will gradually account for a higher proportion of our total revenue over the next several quarters. As we continue to cultivate our existing OEM relationship and add new ones. Conventions and consolidation are the two primary themes for both operators and equipment providers. We believe that having strong OEM partners is important in order to achieve efficient overall scale. We believe that by working with OEMs we can maximize our potential and avoid being excluded from many opportunities in high capacity vehicles. By combining our OEM relationship with technology innovation and our continuous cost reduction strategy, we believe that we can grow faster than the overall market, continue to increase our market share, and add to our bottom line with incremental business that other vendors can't pursue because of their higher cost structure.

The Asia Pacific region continues to boom, accounting for 38% of total revenue. APAC showed another large sequential increase in Q3 on top of the large increase in Q2 versus Q1. Once again, India was particularly strong and we are supplying to all four of the largest providers in India directly and through our OEM channels. Adding to the strength was a repeat business from our other customers in the region such as Digitell in the Philippines and our distributor in Australia. EMEA broke out the 8 to 9 million per quarter range which has been for the past six quarters contributing over 11 million to Q3 revenue. The strength came from all over the region. North America was a bit lower than in the past few quarters owing to the fact that FiberTower wasn't a 10% customer in Q3 as it has been during the past four quarters. We believe that rapid revenue from FiberTower relates to integration activities with first revenue and expect that the combined company will continue to be an important customer going forward. The overall outlook for North America remains positive based on strong demand from distributors, continuing business with customers such as Cellular One, a return to more normal ordering preference of Fiber Tower and of course new customers.

Looking at the trends by market segment, we are seeing growth in all segments both sequentially and year-over-year. The strongest growth continues to be in the cellular segment which is where our OEMs are focused. Cellular is 55% of total revenue. As we have discussed before, demand in this segment is being driven by continued subscriber growth and need for additional capacity to handle higher bandwidth per subscriber. Revenue from fixed and alternative operators continues to grow as Metro, Wi-Fi, WiMAX and other broadband networks expand. The Private and Government Network segment also continues to grow nicely and continues to account for about a quarter of our total revenue, roughly the same as last year.

From a product point of view, we are also tracking according to plan. We continue to be pleased with the traction we are seeing in our newer product. We are seeing excellent demand for the Fiber 1500 P Family, PST and HP which now accounts for most of our revenue. We continue to lead the market in high capacity IP-based product with faster data rates in the market -- with the fastest data rates in the market and the most configurable solution using native IP in the air. We are offering data rates from 50 to 400 mega bits or 800 megabits using X6 technology. Our new IP-Max gigabit solution optimized for next innovation back haul networks and metro ethernet networks continues to gain traction and we shipped over 60 links this quarter.

As expected, we completed the utilization and outsourcing model and finished moving all our production to contract manufacturing during Q3. This gives us the ability to scale very quickly to meet the rapidly growing demand. By pursuing this strategy, we were able to nearly double production this quarter, even in the midst of a conflict in the north [Inaudible]. The benefit of our cost reduction measures is being met by the large increase in lower margin OEM business in Asia Pacific. Adjusting for this factor, our gross margin this quarter would have gone back up and have been about the same as Q3 of last year, 38% with a similar revenue mix.

Before Tali discusses the financials, I want to elaborate on our business strategy which is the basis for the financial outlook. Now, three primary market trends that will affect our business--Networks, all networks are becoming all IP from the core to the edge. All the market participants, the operators and equipment vendors are striving to move up the value chain, meaning that carriers are becoming marketing companies focused on selling new higher output services and the very large equipment vendors are focused on offering complete solution and even doing managed services deals. So they are virtually the owners of the network. This is resulting in consolidation and convergence at all levels. Third, our out segment of the market, the high capacity backhaul is growing very fast due to the requirements for more backhaul capacity and improving economics driven by technology driven improvement. In this environment, our primary challenges are to implement go to market strategy that's provide us with scale and reach to compete effectively in a consolidating environment and to execute well through continuous cost reduction and operational efficiency and the ability to ramp up quickly in the number of links we supply.

Our strategy going forward is the same to serve both Q1 and Q2 operators globally for a combination of direct sales, OEM partnerships and strong, local distributors. As I mentioned, the success of our OEM strategy is happening more quickly than we originally anticipated. We will continue to develop substantial effort to further developing OEM relations and adding new ones to the three we already have. OEM business over the long term could eventually reapproach 50% of total revenue. And at this point, I'd like to add one cautionary note. As one of our important OEM relationship Nokia is obviously a significant factor in this scenario. We acknowledge that both total revenue growth and OEM contribution would be lower if Nokia decided to move to Siemens product. So far, we have no indication of this and we are optimistic about the future of this relationship. Having said that, we've done a model with another set of assumptions and we believe that we can show double digit growth next year over 2006 without Nokia.

The second part of our strategy relates to expanding our early lead in IP. We will continue to invest in R&D in order to develop more comprehensive solutions and we've already begun work on our next generation radios. As a result, operating expenses will continue to grow but at a very modest rate. This will also result in additional operating leverage and enable us to report higher net income. To summarize, we expect Q4 to be similar to Q3 in terms of both revenue mix and net income. Therefore, we are using the second half of the year as a new baseline model from which to think about the future. Our preliminary view of 2007 assumes a gradual increase in revenue from the second half of 2006 reaching a 10 to 15% increase over the annualized run rate of this year's second half. In this scenario, we would expect non-GAAP net income to grow slightly faster than revenue depending somewhat on channel and geographic mix. Thus, we expect our net margin to improve in 2007 over where we are today. Now, I'd like to turn the call over to Tali to discuss the financials. Tali?

Thank you, Ira. We set a new record in both top and bottom line in Q3. Revenues reached 30.5 million representing an increase of 62% compared to $18.9 million in Q3 last year. And the sequential increase of 29%. We reported the record non-GAAP net income of 1.1 million or $0.07 per share compared with $887,000 or $0.03 per share in Q3 last year, and the $1.1 million or $0.04 per share in Q2. Revenues from cellular operators accounted for 45% of total revenue in Q3, about the same as in the previous quarter. Reflecting continued strength in the cellular market was a growing portion generated by our OEM partners. Fixed operators accounted for 21% of revenue compared with 17% in Q2. Private Networks accounted for the remaining 24% compared to 27% in Q2.

Europe, Middle East, and Africa accounted for 37% of revenues while Asia Pacific accounted for 38% of revenue, a large increase over prior quarters. North America was 18% of revenues in Q3, a drop that reflects lower revenue from the carrier-carrier segment and Latin America accounted for the remaining 7%. We had two 10% customers in the cellular network segment in Q3, both OEMs. As Ira mentioned, our quarterly bookings continued strong in Q3 with a book-to-bill a bit over one. This quarter, gross margin declined to 31.5% below the range we originally expected due to the higher than anticipated proportion of OEM business, mainly in Asia Pacific.

As expected, operating expenses were up modestly from Q2 leading to improved operating leverage and an increase in operating profits to 1.6 million from 900,000 in the previous quarter. On a GAAP basis, we reported net income of 1.5 million or $0.06 per share which included equity based compensation of $335,000 or $0.01 per share. Pro forma non-GAAP net income was 1.1 million or $0.07 per share. Our non-GAAP net margin was 6.2% up from 4.7% a year ago and compared to 4.6% in Q2.

Moving on to the balance sheet, our cash balance at the end of this third quarter was $28.7 million and DSO's were 79 days. Looking ahead to net quarter as Ira mentioned, we expect Q4 revenue in the range of 30 to 32 million with a similar profile in terms of both mix of revenue and profitability. Now, we will be happy to take your questions.

Thank you. [OPERATOR INSTRUCTIONS] And we'll take our first question from Gina Chen with Unterberg, Towbin.

Thanks, this is Rich Church and thanks and congratulations on a great quarter, guys. With regards to the guidance comment, I calculated you're at 132 to 138 million for 2007.

Yes, this is within the range that we guided.

Okay, and can you make any comments about gross margin to go in '07? Do you think the mix OEM will cause further decline or do you think it's stabilized this year?

I think it's it stabilizes around the rate that we are currently having.

Okay, and can you talk about the, well first, on the guidance , that includes Nokia's 7 number, right?

Yes, it does.

Okay and can you talk about the strength that the OEMs are having? Is this in 3G and is it single carrier deployment or are they seeing multiple opportunities?

Okay, the OEMs have a mix of business similar to our direct business. It's multiple opportunities. It's not a single customer. We work with all of them on different customers around the globe, mainly this quarter in the Asia Pacific region, and again, it depends on the geography where and what type of an application it is. When you say usually Asia Pacific, it talks fiber growth to date which is 2G. If you look at deployments with them in Europe, then it's 3G- type of application.

And we'll take our next question from Matt Robinson with Ferris Baker Watts.

Hi. Great quarter. I'm interested to see how the OEM model is working on the expense line. Your expenses didn't increase as much as they have in the past. Would you expect to continue that kind of trend keeping those flat and levering them with those channels?

Yes, we think that our expenses will continue to grow at the lower rates than we've seen before.

So there was -- we don't need to expect to see a catch up in the fourth quarter?

Yes, there is going to be a certain increase dollar wise, but a modest one.

So the 26% of revenue kind of level is something you can sustain?

Yes, maybe even improvement.

What, can you remind us who your other two OEMs are? You mentioned Nokia.

We mentioned Nokia and I cannot remind you because I never told you, so it would be hard to remind but there are reasons for still not announcing the names of the other two.

I'm glad it wasn't a lapse in my memory then.

No, it's not.

How much inventory or do these OEMs generally carry inventory and if they do, can you give us some flavor of how much?

They carry inventory but usually very very small amounts. One of the reasons is the whole business environment that we work in. Both direct and via OEMs is that you get the specification from the end customer very late in the cycle and they require usually a relatively short delivery time, so everything needs to be from an execution operational target towards those very hard to carry inventories. So the frequency mix, sub frequency mixes, and other parameters which we almost build to order.

Yes, well, that's a traditional model in your business, so -- now as far as your work in process and your raw materials, is there any meaningful difference between OEMs?

Nope.

So if you did have the worst case scenario where you had to face a captive scenario with a Siemens merger with Nokia, then whatever inventory you have you can sell to others; correct?

Yes. Correct. 100% correct on that.

Okay, I'll get out of the queue.

Thank you, Matt.

And next we'll hear from [Al Tobia with Siden].

Yes, hi. Just regarding FiberTower, when would you expect them to come back and I noticed that they just got a big financing done today and obviously they were probably focused internally on the acquisition but when would you expect them to come back into your numbers.

We expect them to come back into our numbers beginning in this quarter. Which is Q4.

Right. So but the fact that guidance is kind of flattish sequentially on the top line, is there seasonality in the other element of your business or FiberTower comes back, is that upside possibility to the number that's out there?

Currently the way we forecast the guidance is we expect a similar quarter. It's been a very strong quarter and expect to execute again a very strong quarter with about the same numbers.

Okay and then just one other question, just so I clarify this. You were saying that next year, if Nokia, if you have to remove Nokia from the numbers because of the change over there with Ericsson, that they would -- or I'm sorry, Siemens, that you would -- that you would still be able to grow the top line in double digit; is that right?

That's correct.

Would you be able to grow the bottom line or would you take a bottom line hit?

It would be a little bit harder to grow the bottom line, but I think we'll still be able to grow the bottom line although at a slower rate.

Okay. So you'd be rolling it at something in the single digits and that's sort of the worst case look for next year? And when you say that, are you saying from this level that we're at now or year on year.

Year on year.

Okay. Thanks.

Next we'll take a question from Ehud Eisenstein with Oscar Gruss.

Ira, I'm not sure that I understood your comment about the gross margin in the third quarter of last year, the 38%. Can you repeat it, please?

Yes, gross margin in the third quarter of last year was 38%. One of the things we have been guiding through assuming much slower growth in our OEM business and much more gradual growth was that we'll start seeing an improvement in the growth margin in Q3 and Q4 of this year and we have those, we've been guiding that on some of the calls. We saw a dramatic increase in our OEM business which drove down the margin, what we wanted to go back and compare is see if we are executing according to our original plan, so if we take a similar mix that we forecasted, similar to Q3 of last year, our gross margin would have gone up back to 38%.

In other words if you exclude the OEMs, your non-OEM business is back to the 38 level? Is that what you're saying?

Even a little bit above that because even in Q3 of last year, we had some OEM business.

I see. So the cost reduction strategy, the 1500 P, they're all in place?

They are all in place and that's what I said on the call. They are all in place moving very nicely out towards the market and we are continuing our cost reduction effort. It's not a one-time strategy. This is a strategy which continues forward to be able to expand both market share and continue growing in the market and it has both cost reduction and as I mentioned, we are also investing R&D dollars in moving this forward.

Okay, so the double digit non-Nokia scenario should assume higher than 35% on the growth I would say?

It would assume a higher growth margin than we are forecasting with full OEM business for next year.

Okay, and just a follow-up on the OEMs, you mentioned different opportunities and different countries. Are you guys bidding for large opportunities here in the U.S?

Yes, we are.

Is it for server for data?

Both.

And can you give us some magnitude of when you say large? Is it six, seven, eight digit?

No. I won't give the magnitude. There are large opportunities right now in the U.S. market, both cellular and data, and we are involved in all.

With your OEMs?

And it's both direct and OEM and it's as I would say, okay it's in the bidding process. I do not attach probabilities of success rate either way.

I see. Thanks so much.

Thank you.

And now we'll take a question from Quinten Slattery with Symmetry Peak Management.

Hi, guys, great quarter. Question just on your cash reserves. Do you expect at some point to maybe raise some more cash and a follow-up question, just what's the range that we should be looking at for your ideal DSO range? Thank you.

We don't have currently plans to raise cash, we certainly do not wish to raise cash at the level where the stock price is currently is. As far as DSO, our target range for DSO is between 70 to 90 days.

Thank you.

This is what we are expecting to have.

And our next question will come from Matt Robinson with Ferris Baker Watts.

This is a follow-up. Tali, do you expect to see a better cash generation in the December quarter?

No. Still not in the December quarter. This quarter was a quarter of very rapid growth and we have to finance this growth and we will still have to pay for it during the fourth quarter and of course it depends also what kind of additional growth we are going to have in the fourth quarter, but no, currently, I think we will still burn some cash in Q4.

If I backed into the number right, if 66% of your business is at 38% gross margin then the other 34% is a high teens kind of gross margins that OEM business. Where do you think that OEM business can go? Gross margin wise?

OEM business really has quite a wide range, so it depends on the deal, it depends on the geography, so it will range between the teens and the mid 20s and even higher.

And is it pretty much the same for all your OEMs?

No, it does differ.

If it differs mainly on where the OEM does business. The pull-down on the margins come from working both with OEMs in some of the Asia Pacific region but where the pool is is towards the lower numbers so it depends on the geography we're working with the OEMs.

How much do you have to -- how much of your sales and marketing or other operating expense resources do you have to apply to that kind of revenue?

Some, but not much. Most of the sales and marketing goes towards the direct business.

Can you give us a sense as to where the operating margin -- how you look at the operating margin from the OE versus the direct?

No, not at this point.

Fair enough. Okay, thanks a lot.

Thanks.

And we'll now hear from Kevin Dede with Merriman.

Tali, and Ira, congrats on a nice quarter. Would you mind just elaborating a little bit on the mix of capacity radios you're selling both direct and on the OEM side.

Meaning what?

Are you seeing more on the lower capacity going to your OEMs and maybe that's put some pressure on beyond what you would have expected?

No. We only do high capacity radios. All the OEMs we work with right now, all three, have their own low capacity PDH radios. As you know, Nokia has a very successful PDH line, so we only sell high capacity radios with those OEMs.

Okay, can you comment on what gross margins might look like if you were not to see Nokia next year? I guess what I'm wondering is how much pressure and gross margins Nokia specifically is putting.

First of all, the gross margin will go up, I think someone on the call mentioned 35%.

Yes, I know, I mean--.

And, it's the deals. It's not just the pressure from Nokia. As we mentioned this quarter, we had both, two of the OEMs were 10% customers.

We also gave the indication, we said that if this quarter we had the amount of OEM that we had a year ago, which was around 10% of revenues, we would have 38%, but if we didn't have any OEM at all, I would have higher than 38% gross margin.

Right, very good. You mentioned, Ira, the next generation radio. Can you give us some parameters in what sort of features might be included in that and what your looking at?

We're looking at the very advanced radio moving forward which will continue our drive, mainly towards executing on the strategy and both legs of the strategy. One is expending our market and working via OEMs and other places which means we need to put fourth a very high focus on cost reduction activities in those radios and the other is supporting where we believe the market is going over the long range into more of an IP-focused backhaul so those radios have to be more focused on that market segment specifically.

Okay, last question for me, obviously very familiar with some of the consolidation going on in the industry and the drive towards scale and I'm just sort of wondering how you think that might change the competitive landscape.

First of all, the consolidation that is happening right now and that's what we've been talking about. Consolidation is being driven -- and let's start from the top. On the top, on the consolidation it's being driven first of all by the customers themselves which consolidate and want to provide triple or quadruple-play type of solutions so we see a lot of consolidation with the customers. The very large equipment vendors are responding to that by merging themselves and forming much larger groups, but there is groups that are focusing themselves on service and managed services again going up the value chain, so we see the play with them then is exactly part of the OEM strategy of both going direct and doing OEM with some of the larger players to build our scale within the new, I would say, economies of how the market is behaving.

Very good. Thank you for taking my questions, Ira.

Thank you.

And our next question will come from Rich Valera with Needham & Company.

Thank you. Good morning. Just wondering--.

Good morning, Rich.

Good morning. For your internal planning purposes if you assigned a probability to the possibility that Nokia goes with Siemens radios, would you be willing to share that with us?

I can't share a number which hasn't been assigned to, but I'll say it this way. It's usually a 0-1 event or sometimes not a 0-1 event. If it's a gradual one, we are optimistic, as I said on the call that we'll continue the relationship and we are working very closely with them, but as I said, I think in prior questions, one of the decisions -- one of the decisions might be political so it's something I cannot assign a probability. On the other hand, if you look at our focus for '07, we find we are guiding right now for '07 with Nokia in there.

Right. And maybe just a little different way of looking at that, I'm assuming you know Siemens products pretty well. Can you just give us your own sort of competitive analysis of how you stack up against the comparable products that Siemens would be offering to Nokia if they were to choose to go with them?

Okay, first of all, I think Siemens is a formidable competitor. They have a very good product set, comparable in some areas. In some areas, the product line is missing like they do not have any radios for the FCC North American standards, and they have very little IP capability. In other places they are comparable to others, so it will be a tough competition.

Okay, thank you.

[OPERATOR INSTRUCTIONS] And we'll now take a question from Joanna Makris with Canaccord.

I'm wondering if you could quantify the percentage of sales that came from IP-Max in the quarter and I'm wondering if you could talk about just the general pipeline and activity surrounding trials and RFPs on the IP and ethernet side.

We do not break out how much came from the IP-Max product line, but to give you a flavor of it, most of our Private and Government Network business is IP-based which means at least 25%, reason being is that the private customers and the government have moved to IP a long time ago. Cellular is totally SDH and then the fixed and alternative operators are split somewhat in between IP and non-IP applications. If you look at that moving forward, we see a strong pool for the IP-Max product line where we see most of the growth coming from our alternative operators which are planning and deploying Wi-Fi and WiMAX networks where we are the backhaul link to those networks the same as in cellular networks. Does that help?

That does, thank you.

And next we'll have a follow-up question with Ehud Eisenstein with Oscar Gruss.

Yes, if you just can give us more color on the microwave relocation at the 2.1 G?

Say again?

We recently saw that some of the incumbent carriers will have to relocate their link from their 2.1 gigahertz to different frequencies, I believe it's called microwave relocation?

Okay. The relocation, this is mainly I think a relocation within the axis of frequency.

Yes.

They still use the same towers and the same locations. Once they do that, from a backhaul perspective, it almost does not have an effect. We do expect that while doing that, they will probably increase the capacities per tower while changing the technology and moving to additional capabilities and this will have some effect on use of backhaul radios.

And you expect this in the next 12 months or it's longer term ?

I don't know.

Fair enough. Thanks.

We haven't seen it a s a very direct push towards microwave backhaul addition.

I understand. Thanks so much.

[OPERATOR INSTRUCTIONS] And we'll now take a question from [Tony Chestani with Astral Capital].

Hi, good morning. Just one question. What revenue level would you expect to, I mean, you've talked before on prior calls about hitting a 10% operating margin level I guess, non-GAAP. What total revenue level I guess assuming Nokia stays in place, what total revenue level would you hit 10% operating margin, please?

Okay. When we guided for the 10% operating margin, we were talking about 30 million with a very modest OEM mix into the numbers. We do, right now, based on the guidance, we do expect our net margin to grow from the level we are at which is 6.2% over next year, but very gradually over the year. 10% is still further into the future.

Would it be like 180 million to 200 million in revenue like maybe an '08 time frame?

Maybe. But we don't know yet.

Okay, thank you.

And it does appear we have no further questions at this time. I'd like to turn the call back over to Mr. Ira Palti. Please go ahead.

I'd like to thank all of you for participating with our calls and I would like also of you to also invite you to the AEA conference in Monterey on the 6th, the 7th, of November. Both myself and Tali will be presenting at the conference, so we can meet there face to face. Thank you again for joining us.

And that does conclude today's conference. We thank you for your participation and have a great day.