Ceragon Networks Ltd (CRNT) 2011 Q2 法說會逐字稿

Good day, everyone. Welcome to the Ceragon Networks Ltd. second-quarter 2011 results conference call. Today's call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks and Ms. Tsipi Kagan, CFO of Ceragon Networks.

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 projections 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 the forward-looking statements include the risk that Nera and Ceragon's businesses will not be integrated successfully; the risk that any synergies from the transaction may not be fully realized or may take longer to realize than expected; the [substance] of the Nera transaction making it more difficult to maintain relationships with customers, employees or suppliers; the risk that Nera or Ceragon's business may not perform as expected 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.

During the question-and-answer session, please limit yourself to one question. We will poll for follow-up questions if time permits. I would now like to turn the call over to Mr. Ira Palti, President and CEO of Ceragon. Please go ahead.

Thank you for joining us today. With me on the call is Tsipi Kagan, Ceragon's CFO, and I would like to thank you again because I know one eye is on the screens and you are taking the time for being with us this morning.

We are very pleased with our progress in Q2. Some highlights first. Q2 revenues were strong and exceeded the high end of our guidance. Business continued to be good, reflecting a book to bill that was again over 1 and we have about two quarters of backlog moving forward. And from a strategic perspective, our most important accomplishment was to quickly integrate the two companies to create a single global organization, a truly global company with a balance of business and full capabilities in each of six regions around the world.

This has enabled us to make very rapid progress in migrating former Evolution short-haul product customers to the FibeAir short-haul product. On the Q1 call, we indicated that four of Nera's 10 largest customers have already ordered FibeAir products. During Q2, we migrated two more large customers for a total of six.

To give some color on how we see this migration occurring, let's take an example of a major regional operator in Latin America. During Q2, we received large orders from this operator to expand and upgrade their network in four countries in Latin America and we were selected to provide all microwave transmission equipment and related services in some of the regions.

Our teams are installing Evolution long-haul together with FibeAir IP-10 short-haul products for new projects. We believe that our selection by such an important regional operator supports our confidence in our ability to successfully migrate key customers.

One more footnote on this very positive migration story, we have discovered that the pattern among ex-Nera customers is to continue to order Evolution short-haul products for complete existing projects and to order IP-10 for new projects as they come along. The migration is growing very well from the standpoint of customers' attitudes and willingness to specify IP-10.

Due to the project time of six to nine months between booking, installation and revenue recognition, it may take a little longer for the gross margin improvement to show on the P&L. This is strictly a project recognition timing issue for a quarter or two and we continue to be very pleased with how quickly customers are embracing the combined capabilities of the organization. We now have enough experience with the unified organization and enough customer feedback that we can conclude that our target financial model is valid and that we are on track to achieve our goal by the end of 2012.

In addition to expecting this to be a very accretive deal, we have successfully lowered Ceragon's risk profile for this acquisition. We now have a very balanced geographic exposure where no single region dominates over time. Prior to the acquisition, we had relatively low direct customer concentration, but OEM partners were frequently 10% customers. Today, we continue to enjoy strong OEM relationships, but a shift at any one of them is now less likely to have a major impact.

This geographic and customer diversification is also an extremely important factor in our ability to successfully manage the Company. To illustrate this point, we can look at our experience in India. It is well known that during 2010 a security-related ban on the import of equipment into India caused orders to halt for nine months. The impact on our financial results was mitigated by the fact that we had built substantial backlog and we continue to recognize revenue on the installations of equipment we achieved before the ban.

As we have noted, for most direct business, revenue recognition occurs about six to nine months after receiving the orders. Although the ban was lifted and order patterns returned to more normal levels in India, we all knew that there could be a quarter where backlog would be depleted before revenue could be recognized on the orders. You can see this timing effect by geographic mix this quarter. But there was a substantial decline in revenue from India, which was offset by a substantial increase in revenues recognized from Latin America. Neither the drop in India nor the increase in Latin America should be viewed as signaling any change in long-term trends of business.

This illustrates my point that with such broad geographic diversification, variances in one region tend to be offset by another. We now have a very balanced global company with exposure to unnecessary resources in every region of the world. We believe this will be a tremendous asset going forward.

On the technology side, we have started shipping new innovative features to help our customers deal with a capacity shortage. Some of our unique features include asymmetric transport that increases downstream traffic capacity by as much as 50% for the same frequency usage and adaptive bandwidth recovery that can double the capacity of network rings. These capabilities are generating a lot of interest with operators in all regions as they are struggling to lift the capacity bottlenecks in their networks.

To summarize, business is good. We are getting the orders and growing in both long-haul and short-haul products and the integration is progressing well. We are operating a single unified organization with balanced global exposure and progress towards customer migration and excellence. We are on track to achieve our strategic goals. Now I would like to turn the call over to Tsipi to discuss the financials.

Thank you, Ira. I will go through the GAAP results first. Revenues in Q2 were $110 million, slightly above the top end of our guidance. Our GAAP gross margin was 21.4%. On a GAAP basis, we reported an operating loss of $16.2 million, which includes $3.8 million in expenses that represent the cost of employees let go during the reorganization, but whose salary continued to impact the quarter; $9.8 million in inventory step-ups; $700,000 of amortization of intangibles in connection with acquisition; and $1.4 million in stock-based compensation. Excluding these charges, we had a non-GAAP operating loss of $470,000.

On a GAAP basis, we reported a net loss of $17.4 million, or $0.48 per share. Our non-GAAP net loss in Q2 was $1.6 million, or $0.04 per share. Cash and cash investments totaled $64.4 million as of June 30, 2011. Now

I would like to discuss some of the factors that contributed to our non-GAAP results. The geographic breakout of revenues appears in the press release. Latin America -- more than doubling from Q1, reflecting a large amount of revenue recognized from Evolution products compared with Q1. Europe also continues to be a large contributor to revenues. The decline in India reflects the timing of resumptions of orders after the security-related ban on imports. As Ira explained, we don't see any implication for overall business trends in these figures.

On a combined basis, our OEMs together accounted for 6% of total revenue. We had only one 10% customer in Q2, which was the major regional operator in Latin America. During Q2, our revenue mix contained a higher portion of revenue recognized from prior shipments of the Evolution product, which caused the blended non-GAAP gross margin in Q2 to be a bit lower than Q1 at 31.9%. Non-GAAP operating expenses were $35.7 million, including a negative impact of about $600,000 from currency exchange rates. Our net loss included financial interest expense of $312,000 and tax expenses of $817,000.

Looking ahead at Q3, our revenue guidance is $110 million to $117 million. This continues to reflect good business conditions, excellent bookings and a strong backlog with which we can recognize revenues from. We continue to believe we are on track to reach our goal of mid-30%s gross margin and over 10% operating margin based on a quarterly run rate of around $150 million by the end of next year. Our goal of being close to halfway at the end of 2011 is a challenge, but still attainable. Now we are happy to take your questions.

(Operator Instructions). Peter Misek, Jefferies & Co.

Can you just -- one quick housekeeping question before I ask a more fundamental one, just a housekeeping question on the cash flow statements. Can you walk through some puts and takes in terms of the uses of cash here? The working capital usage seemed a little higher than we would have expected. When can we see that normalize and what level of cash are you comfortable with on the balance sheet? And then I have a follow-up, please.

Okay, so this quarter, I mean if you take the operating loss of $1.6 million, you have to add to that the fact that the $3.8 million, the ongoing restructuring is cash expenses, plus, from previous quarter, we made a provision for restructuring costs of $8 million and we paid some of it, roughly $2 million. We also had the cost of the deal itself, which we paid this quarter, roughly $1.5 million. So if you add up all the figures that I mentioned, you roughly get the use of cash from operations of $10 million.

We do expect to, also next quarter, to have substantial payments of such nature and we believe that around $55 million, which we feel comfortable with, we are going to stabilize in terms of cash balance.

Great. In terms of -- you discussed on the call about order patterns in Latin America and India. Any kind of thought process or does it still remain a 2013, late 2012 event for either Europe or North America? And that is my question. Thank you.

Okay, if you look at order preference, first of all, you can see that we are getting order patterns right now in Europe with some of the operators. You are mostly referring to an uptake in building networks for LTE. If I look at the US market, I would guess it is a 2013 type of a story because initially they will be deploying inside major cities because they have a lot of fiber and they will take time until they reach the microwave areas for major deployments in the US.

We see similar patterns in Europe. Although, in Europe, I believe that some of it is already happening as they are upgrading networks at this point also in -- not only in the major cities. Most of it today is for HSDPA+, but with a very strong view towards DLT expansions and upgrading the networks.

Ittai Kidron, Oppenheimer.

Thanks. Can you give us a little bit of a breakdown in the revenue between Nera and Ceragon?

No, we do not break the revenue between Nera and Ceragon. I think we discussed that on the last call. We now operate as one large company. I do not even have the numbers internally in that fashion. We look at the regions, and I think we gave the revenue breakdown in the regions and the regions operating and in some of the regions, I am getting a total mix between FibeAir and Evolution products and it is hard to break at this point.

Okay, so maybe you can help me then think about the comment that you made in your speech where you said it is going to take longer to get gross margin improvement. And you have been in this business for a long, long time, Ira and you know how long it takes to convert customers and how long it takes to get revenue recognition. So what is it that you have learned this quarter that you didn't know last?

No, I don't think we said longer. I think we are reaching our targets and moving forward. The comment that we said is that it usually takes two quarters to convert and book it into a project and the comment is basically referring -- we got orders from Latin America for FibeAir products this quarter and we started shipping this quarter. By the time this shows up on our revenues will be Q4 because it takes that long for us to install, get it out there, recognized. So it will start showing the effect in any significant way only in Q4 and that was the original plan as we indicated from the beginning of the year.

So how do we think about gross margin in the September quarter and also can you give us some color about now that you have kind of downsized to where you think you need to be, how do I think about the OpEx here incrementally going forward?

So I think that in terms of the gross margin, you will see a slight improvement in the next quarter, we believe and again, more of that in Q4 and as I mentioned in my script that, in Q4 of next year, we plan to reach our target. So that means we are going to be in the high 30%s for the gross margin. And what was your second question? Sorry.

Operating expenses.

And in terms of the operating expenses, we do like to take it down from where we are now. In fact, we were on target in terms of our downsizing, which we wanted to get to $35 million. As I mentioned, we were slightly higher than that because of the exchange rate and we are still working and seeing in the different regions what can be done to reduce it further. But in terms of the headcount, we do feel that all the changes and the [stuff] we had to make was done.

So is flat the right way to model you into September?

Yes.

Okay, good luck.

Thank you.

Daniel Meron, RBC Capital.

Hello. Good morning. Good job on the numbers. Can you give us a little bit more color on -- when it comes to the bookings, can you give us a percentage of how much of your business right now is booked from your own -- or the legacy Ceragon productlines versus that of Nera? And out of the orders that you have attained, is there a percentage of just how far advanced are you with the overall conversion and out of the 10 customers that you also mentioned?

You asked I think three or four questions and I will have to break them out one by one. If we look at orders right now, and you asked about Evolution versus FibeAir, and if we can count that on a link basis, I think more than 65% of the links are FibeAir and below 40% are the links, including short-haul and long-haul, from the Evolution productline. And this is changing quite rapidly at this point. Although moving forward, we will have Evolution long-haul links and we will have FibeAir short-haul links in the mix as we move forward. One by one. That was the first question. The second one, Daniel, remind me.

Yes, is there a way to think about quantifying the number of customers or where you are compared to your original plans of the customer conversion? It sounds like (multiple speakers).

We indicated that we moved 6 out of the 10 customers at this point. I believe that this quarter in Q3 we will see two or three out of the top 10. I think it is a long target. It is where we wanted to be. We wanted to be, by Q4, by migrating all the customers. (multiple speakers)

I will jump back into the queue. I have got more questions. Thank you.

Alex Henderson, Miller Tabak.

Hey, guys. First, what was the final headcount and what do you expect the headcount to do in the back half of the year? And then can you give us the book-to-bill as well? And I have got a conceptual question.

We have 1300 employees.

I'm sorry, Tsipi, I can't hear you.

We have 1300 employees currently, but, in fact, that is the level where we expect to stay and the additional cuts are going to come from other places and not necessarily headcount.

Okay. And then did you have a book-to-bill in the quarter?

We said it was higher than 1.

Above 1. Great. So listening to your commentary, you made the comment that the Indian business obviously is reflecting the fact that six months ago or nine months ago you had weakness in orders out of India primarily as a result of the blockage there. Presumably, now that that block has been lifted, six months ago, you should have been seeing orders over the last six months that should be rolling out into the back half. Is it reasonable to expect that that portion of the business that is coming from India should rebound pretty sharply in the back half as those customers that have -- were in hiatus now are back to normal?

And then conversely, I think you made the comment that Latin America is up sharply as a percentage of sales, but we shouldn't draw a conclusion from that. Yet it seems to me that the Latin American business ought to have the visibility that those customers are additive and continuing to convert, so they should also be improving into the back half. Am I wrong in the thinking on those geographies?

I think you are not wrong in thinking of those two geographies, but I think that you are pushing it a little bit. I don't expect India to bounce back significantly. Yes, we will see much higher revenues than we see at this point. Although we had peaks in 2010 based on 2009 high peaks. We will see an increased revenue level from India and we will see continued revenue levels from Latin America.

So just to be clear, the back half is an improvement. It is not next year that we are waiting for an improvement?

No, no, no. It is a back-half improvement.

Great, thanks.

Matt Thornton, Avian Securities.

Hey, good morning, Ira. Good morning, Tsipi. Ira, maybe you can just walk us through I guess the regions where book-to-bill was greater than 1 or I guess the drivers of book-to-bill being above 1 first off and then can you just kind of talk about the macro demand that you have seen incrementally? Since we all spoke three months ago, maybe just talk and give us some regional flavor as to how demand is tracking just from a macro standpoint.

I think demand is tracking period. That means that we see continued execution in all the regions and we have not seen any significant, I would say, changes in the demand in any of the regions. I think I alluded -- I'll start with things I alluded a little bit earlier. I think one of you asked me about US, where we see demand, but it is not -- it is stable, but it's not yet for significantly for the mobile networks; although we do have mobile networks in the North America regions. We do see strong Latin America. We do see a pickup in Africa for us where based on the integration I think we are making inroads to places where we have not been before. We see India coming back and we see Europe being stable while going after a lot of operators in Europe where some of them are now upgrading their networks towards LTE deployment.

I think that one of the things that coming back in a lot of the discussions is I do not see on the one hand a hockey stick, neither things being flat, but gradual increase because worldwide what we see is a huge mixture of a lot of operators with a lot of local decision-making, which, at the end, averages out very nicely into a gradual increase we are writing on.

Got you. Ira, just in terms of the regions that drove the bookings, I think we saw the revenue mix, but I guess when you talk about book-to-bill being 1, can you just give us some flavor of what regions you saw the stronger bookings? I mean I guess what you just went through there, is that characterizing your bookings momentum as well?

Yes, I think it is.

Okay, fair enough. And then just one follow-up if I could, some housekeeping stuff. Tsipi, I just wanted to make sure I heard this correctly. Gross margin, you are expecting that to be up sequentially into 3Q; OpEx flat sequentially into 3Q?

That's true.

Okay. And then just one final one. How can we think about tax, tax rate on a go-forward basis? Any color you can provide?

Yes, in fact, again, we don't pay taxes in Israel. We are in no way in the tax expenses that you see and the financials are basically in the different subsidiaries that we have local taxes. So that is the level that we can expect going forward. In the long run, it is going to be between 15% to 20%, but, at the moment, the level is $700,000 a quarter that comes from the regions, from the subsidiaries.

Perfect. That's helpful. Thanks, guys.

Larry Harris, CL King.

Yes, thank you. I just wanted to clarify something and that is in terms of the customers migrating to the FibeAir platform. I think you have indicated 6 of the 10 largest Nera customers have done so. Is that on both short-haul and long-haul or is that just on short-haul?

I think we indicated a few times that, moving forward, we will have two product lines and two solution groups supporting long-haul product. All of them will come based on the Evolution product, which I think is one of the leading long-haul products with a very rich feature set and that is what we are delivering to customers worldwide. And by the way, we have migrated just the opposite. One or two customers we have migrated from Ceragon FibeAir long-haul to the Evolution long-haul products and on the short-haul product, it will be the FibeAir short-haul where we are migrating all customers into that platform.

And you think you can get the improvements obviously in gross margin because of this move on the short-haul side?

Yes.

All right, thank you.

Ilya Grozovsky, Morgan Joseph.

Thanks. I just wanted to kind of get back to the gross margins. Ira, you had said I guess when you acquired Nera that the way to measure the success, one of the ways to measure the success of the acquisition was that there would be an incremental improvement in the gross margins, obviously with the difference in the two sides of the business. So this quarter, the gross margins were essentially flat, down slightly. How should we think about what that is saying about the acquisition and how it is going?

I think that it is too early to tell. Really we didn't expect it in the second quarter to really start taking an effect because, as I said, if we migrate customers and we started migrating in Q1 and Q2, it will take two -- well, two quarters until those things show up. It will show up in Q3 and in Q4. This quarter, I think, as Tsipi indicated, because the mix was a little bit larger -- was a little bit larger on Evolution because we recognized revenues on Evolution a little bit more, it affected the margin a little bit down.

And then also my other question was about, in the third quarter, do you expect a non-GAAP profit?

We expect to be close to breakeven on a non-GAAP basis for Q3.

I'm sorry, I didn't hear you. There was an echo.

We expect to be breakeven on a non-GAAP basis for Q3.

Okay, thank you.

Scott Searle, Merriman Capital.

Thanks, good morning. Just quickly if I could. Ira, have you talked about what percentage the top 10 customers at Nera represented as a portion of their mix and could you give us an idea of what long-haul was as a percentage of the mix in the process and maybe an update -- I know the long-haul product a little bit different in terms of what you were doing there, but in terms of updating that product, how is that tracking according to your prior schedule?

I don't think we indicated the top 10 customer (inaudible) on the mix and I don't have the top -- from the top of my head to tell you if it is -- usually top 10 customers is about 70% to 80%. But I can tell you from the top of my head, I don't have the number. So it is really my guess at this point and this is from -- that is usually typical of our customers.

If you look in the long-haul/short-haul mix, at this point, the long-haul from a link perspective is about 15% of our business from the number of shipments that we have.

(multiple speakers).

And you asked about cost reduction on the long-haul. I think we indicated that it will be in two steps. One, the first step, it will be cost-reducing. The product as is -- touching both the product, less of it design and this is moving good on track where we will start seeing results probably from that product somewhere in the beginning of next year. And then we are doing a complete redesign based on Ceragon technologies for the product, together with some of the Nera strong technologies and mixing the two into our new products. That is further down the road.

Okay. And if I could, just a follow-up on India. It sounds like it will certainly be coming back, but is there a timeline of when you would start to expect India to become a more meaningful contributor like it has been in the past in the $10 million to $20 million on a quarterly basis? Is that later this year or is that something we have to look out to 2012? Thank you.

Later this year. At the range of $10 million to $20 million, later this year.

Great, thank you.

[Brad Erickson], Pacific Crest Securities.

Good morning, thanks for taking my question. Just curious on the Africa business. I think you guys have said in past quarters that that business is likely to fluctuate to a certain degree quarter-to-quarter and obviously did this quarter. Can you kind of talk about what you see for the second half in the Africa business and the associated margin headwinds I would assume from that?

First, I think that we talked about that business operating but a much smaller business before the beginning of this year on a standalone basis where we had one or two customers and it was fluctuating because when you have a very low number of customers, it was fluctuating. I think that what -- on the basis of moving forward and since the beginning of this year, where, on a merged basis, we see Africa as one of the regions continuing to contribute on a regular basis with the fluctuations that are typical of any one of the regions, but not anything different from the other six regions moving forward. Africa is not the strongest headwind in margins. And I think it is part of the regions that some were in between.

Okay, that's helpful. And then I mean just in terms of second half versus first half, I mean would you expect things to be roughly in line or growing a little bit? What do you see for that in the second half?

I think we indicated and I think Tsipi gave the guidance for next quarter where we believe that Q3 will grow over Q2 and where we expect top line to be somewhere between 110 and 117 (multiple speakers).

Right, sorry, I was asking about Africa specifically. Sorry.

Oh, Africa specifically?

Yes, sorry about that.

No, I don't have the exact numbers, but we are growing in all regions and that again depends on revenue recognition locally where the mix usually in between all the regions, that is what is being reflected in the top line.

All right. Thank you very much. I appreciate it.

Kevin Dede, Brigantine Advisors.

Hi, Ira. Nice job on the top line.

Thank you.

Again, can you just give me a little more insight on what you see happening with that large customer in Latin America? I think what I understand is that they are buying more of the Ceragon FibeAir IP-10, is that correct? So you are seeing that large Latin American customer shift from the Evolution product. Is that a fair assessment?

Let's talk of it in two different ways, okay? When you ask what I see with that customer -- a lot of hard work. We have large orders from that customer, a lot of migration. We need to install all of it, push it into the field, make sure the networks are up and running. There is a huge team all over Latin America deploying it, making sure that everything is in there and we expect to see further down additional orders.

The mix there is with that customer were places where they need long-haul complex systems. They will continue ordering Evolution where we think this is one of the best-of-class products out there and on the short-haul side, they will continue on buying FibeAir products for the excess pieces of the network where the two products are integrated one and the other on a total network. At the end, we deliver a total network with both products.

Fair enough, thanks. And can you just characterize the RFP activity that you are seeing in Western Europe versus North America? Granted you had mentioned HSPA+ migrations in Europe with the preparation for LTA. I am just wondering if you are seeing bid activity increase and how you might relate that activity into both markets.

If I look at the activity, it is hard for me to tell from the top of my head the exact numbers. I think there is differences a little bit in between the two regions. In North America, you have, I would say, a single digit number of mobile operators. Three, four very large ones, a few more small ones. In Europe, you have a lot more operators because each country has their own, the global networks of Vodafone, Telefonica and others, but also the regional operators. So we see a lot more if you look at the number of RFPs, a much larger number of RFPs and we see activity all over the place and doing the similar upgrades to the things that we see happening in the US market.

From a technology perspective, we see very similar patterns. Some adopters of LTE, some adopters of HSPA+, which I think some of the US operators now lately have been already pushing it out as a 4G network as well.

Would you say the level of activity has increased in Europe through the course of the year?

Slightly, but not in any significant way.

Great, okay. Thank you.

Blaine Carroll, Rodman & Renshaw.

Yes, thank you, good morning, everybody. Tsipi, can you quickly talk about the accounts receivable and if there is any change in the payment pattern of your customers, where you see receivables going over time and DSOs and is there a difference between the Nera payment cycle versus the Ceragon payment cycle? Thank you.

In fact, the nature of the customers is the same, so I don't see a difference between the payment pattern from the ex-Nera customers and the Ceragon customers. What we saw this quarter, in fact, we had a decrease in trade receivables and DSOs went down, but I think that, again, we had a strong collection this quarter, but the pattern itself didn't change -- for this specific quarter, the receivables went down to 114 and therefore DSOs were 93, but we definitely can see that, in many places, there is a lot of pressure on payment terms and increasing payment terms.

What would the target DSO be, Tsipi and what is the quality of the receivables? Are they backed by letters of credit and so forth?

It really depends on the customers. Where we feel that we need a letter of credit, we do ask that from the customers. When we do a deal with the big operators that have reputable histories, so we don't have a lot of issues with collections and that is not the major issue. It is more in terms of the business itself and it depends on the regions, the different kinds of payment terms. But it is not an issue of collection. We do not see a problem with that. So we do see that the customers pay on time and therefore, if I had to give target DSOs, it would be probably around 110 days, something like that, slightly higher than what we are now, but that is roughly where we see that payment term.

Beautiful. Thank you.

Mr. Palti, there are no further questions in queue. Please continue.

Okay, I would like to thank everyone again for joining us this morning. And if you have any follow-on questions and want discussion from the one-on-one, we will be glad to accompany you and answer questions. Thank you again. See you soon.

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