Ceragon Networks Ltd (CRNT) 2012 Q3 法說會逐字稿

Good day, everyone. Welcome to the Ceragon Networks Ltd. third-quarter 2012 results conference call. Today's call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks, and Mr. Aviram Steinhart, CFO of Ceragon.

Today's call will include forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and projects that involve a number of risk 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 forecast and estimates.

Some of the factors could significantly impact the forward-looking statements and these include the risk of significant expenses in connections with potential (inaudible) tax liability associated with Nera's prior operations or facilities; the risk will combine Ceragon and Nera business may not perform as expected; risk associated with increased working capital needs; and other risks and uncertainties which are discussed in greater detail in Ceragon's annual report on Form 20-F and Ceragon's other filings with the Securities and Exchange Commission.

Forward-looking statements speak only as of the date on which they are made and Ceragon undertakes no commitment to revise or update any forward-looking statement in order to reflect events and circumstances after the date any such statement is made. Ceragon's public filings are available from the Securities and Exchange Commission's website at www.SEC.gov or may be obtained on Ceragon's website at www.Ceragon.com.

I will now like to turn the call over to Mr. Ira Palti, President and CEO of Ceragon. Please go ahead, sir.

Thank you for joining us today and double thanks for those on the East Coast which probably are at home today bracing for Sandy Hurricane and you who are joining us this morning. With me on the call is Aviram, our CFO.

Our revenues in Q3 were consistent with our guidance. More important, we increased our gross margin to nearly our target level and we reported sequential improvement in operating margins to 4%. As expected, our cash used in operation was less than $1 million and we are on track to generate significant cash flow in Q4 as we indicated on our last call.

We are pleased with this performance in light of the challenging macro environment. We remain optimistic about the business because we are well positioned in an attractive sector that is likely to enjoy numerous growth drivers for years to come. We are a strong company with an excellent technology and product cost position in our market space. We are taking share and we expect to continue to outperform the overall industry.

Exploiting this strength our primary financial focus is on reaching our goal of 10% operating margin and generating sustainable free cash flow. But, at the same time, we are not immune to the macroeconomic economy and to the factors that are causing the second half of the year to be slower than everyone originally expected. We see that same picture in the trend of our bookings.

As we now report, the communication equipment sector so far have mostly contained downward revisions to the outlook. We also expect revenues in Q4 to decline sequentially. With growing concern over the risk for serious global slowdown, operators are becoming more cautious, negotiations are taking longer, budgets for next year are receiving extra scrutiny, and spending will be deferred as long as possible.

Further consolidation among wireless operators will create disruption and delays in network deployments. At the same time, some regions have their own issues. Europe shows signs of further slowing and India continues to be subject to persistent regulatory uncertainty.

As you might have remembered from our last call, we were encouraged during Q2 by a strong pickup in bookings that began in April and continued throughout the second quarter. Unfortunately, this pattern did not continue during Q3, and as an example, we had three large orders that we expected to close during Q3 and the operators are taking their time.

We are not losing any business. We remain generally confident, but we also believe we have to be proactive in ensuring we stay on track with our profitability goals regardless of the near-term environment. Therefore, we are accelerating the implementation of some efficiency increasing organizational alignment to ensure that we continue to improve our profitability and grow our earnings, even under the assumption that the revenues for the next several quarters will be flat off a base of $104 million to $110 million in Q4.

Specifically, we are taking these three actions. We are streamlining India and APAC into a single regional management structure. This will improve efficiency with no effect on customer-facing positions.

We are also combining two solution groups into one. I am referring to the teams in Bergen and Tel Aviv comprised mainly of R&D people. In addition to improving efficiency, it reflects the fact that we are working toward our long-term goal of having both long-haul and short-haul run on a similar platform.

With excellent progress towards a state-of-the-art, companywide ERP system, we are accelerating the integration of the administrative or back office functions between former Nera and Ceragon.

The answer to why now is because we can do it now without hurting the business and because the change in our order pattern tells us the time is now. Because we have almost completed the development of our next-generation radio platform, which means that we are not risking the timing of any specific product launches by making those changes now, allowing us also to actively continue our constant innovation mode.

Because the back office and solution group consolidation would have happened anyway, even in the rapid growth environment but over a longer period of time. The decision to reduce headcount is always an extremely difficult one and we would certainly have preferred to use a combination of attrition and reassignment to accomplish the same objective.

Quite frankly, one of my concerns is that the motivation for those initiatives will be misunderstood and the potential benefits overlooked. By implementing these already considered actions now we will reduce our OpEx by about 11%, but I want to make it clear that we are not doing an across-the-board cut in response to deteriorating business prospects. We are not reacting to problems, we are improving the organization.

However, in order to meet our earlier profit goals and justify the current level of OpEx we would have to be able to see ourselves quickly growing into an organization of $140 million per quarter run rate. In the current environment we can't make that assumption. In fact, at the moment we don't have any justification for assuming better-than-flat sequential revenues for several quarters using Q4 as the base.

So we are accelerating those actions of aligning the organization without impacting current business in any way. After these initiatives we will be positioned to support a $120 million quarterly run rate without additional operating expenses. Once top-line growth resumes about above $120 million per quarter we would need to increase OpEx, but not at the same rate as revenue. Therefore, we are creating a foundation for substantial operating leverage after we get past the near-term headwinds.

Is there an upside to our revised assumption of several flattish quarters from Q4 levels? Yes, there is. If LTE deployments and modernization accelerate faster than we expect, this could provide upside. We are assuming it will be difficult to gain additional market share in this environment. If we can, it will be an upside.

We have the potential to exceed 35% gross margin if pricing and mix is more favorable than our assumptions. If order patterns improve after operators finish reviewing the budgets next year that could also produce upside. If demand for our next-generation radio platform ramps faster than we expect toward the end of next year, this could provide some upside late in the year.

We think the industry dynamics favor our business and our company over time. We already have an outstanding product cost position and excellent technology. We are making realistic assumptions and taking prudent action to keep ourselves on the path to increasing profits and sustainable free cash flow regardless of the macro picture.

We are not giving guidance for 2013, but you can be assured we are committed to substantially higher year-over-year net profits. Now I would like to turn the call over to Aviram to discuss these matters in more detail from the financial perspective. Aviram?

Thank you, Ira. I will go through the Q3 results and then elaborate on the financial aspect of the organizational changes we announced today.

Our third-quarter revenue was $118 million, within the range of our guidance. Our GAAP gross margin of 31% includes $300,000 of amortization of intangible assets, $2.9 million inventory step up, $100,000 of stock-based compensation expenses, and $800,000 of changes in pre-acquisition indirect tax positions. Excluding those items, non-GAAP gross margin improved to 34.5% from 33.8% in Q2. The improvement results from reducing product cost of our long-haul product and a more favorable customer mix.

Third-quarter GAAP operating expenses were $37.8 million. Excluding $600,000 in amortization of intangibles and $1.3 million of stock-based compensation, our non-GAAP operating expenses were $35.9 million, slightly less than Q2.

On a GAAP basis we reported an operating loss of $1.3 million. Our non-GAAP operating profit for the third quarter was $4.7 million, or 4% operating profit margins.

Finance expenses in Q3 was about $1.1 million and tax expenses was about $300,000. On a GAAP basis we reported a net loss of $2.7 million, or $0.07 per share. On a non-GAAP basis we reported a net profit in Q3 of $3.3 million, or $0.09 per share.

The geographical breakout of revenues appears in the press release. The biggest change from Q2 was Africa, which showed a significant decline reflecting the longer negotiations that Ira referred to. We had no 10% customer in Q3. Overall, total OEM sales accounted for 12% of total revenue.

Turning to the balance sheet, trade receivable increased to $193 million putting DSO at 149 days. Turning to our cash position, we had cash and cash equivalents totaling $48.6 million at September 30. Our operating cash flow was negative by only $900,000 and we are on track to generate substantial positive cash flow in Q4 as we indicated on our last call.

At the end of the quarter we had about $54 million in debt. We had long-term debt of $29 million, including current maturities to be paid over four quarters. We have short-term debt of $25 million, which we drew down from our $40 million short-term credit facilities. During Q3 we increased our total short-term credit facilities by $10 million to reach the $40 million in total.

As explained last quarter, the reduction in our cash reserves is largely a timing issue. We are profitable and expect continued improvement, which means we expect to return to positive cash flow in Q4 and beyond into 2013.

Looking ahead to Q4, we are expecting revenues to range between $104 million to $110 million, reflecting a book-to-bill below 1 in Q3 and a challenging macro environment. We will also have total restructuring charges in the range of $6 million to $7 million, nearly all of which will have a cash impact, about $3 million in Q4 and the rest over the next two quarters.

We will not see the full effect of the initiatives announced today until Q2. Beginning in Q2 we are targeting quarterly operating expenses of $32 million to $33 million. Third quarter splits roughly as follows -- R&D of $10 million to $11 million, sales and marketing of $16 million to $17 million, G&A of $5 million to $6 million.

As Ira said, we believe more cautious assumptions about the overall business environment are now required and we are assuming relatively flat revenues using Q4 guidance as the base for several quarters. This is an assumption, not a forecast, because we don't have the backlog or the trends or macro environment to make a forecast with high confidence.

We are focused on profitability and we are setting a goal of 5% operating margins for 2013. This is our goal because it is realistic under current business conditions. We don't think it is wise to set a profit goal that requires a level of resources that may not be supported by the trend in revenues. We do believe it is realistic to assume gross margin in the mid-30%s for the next several quarters.

Assuming we hold our OpEx at $32 million to $33 million per quarter, we are positioned to deliver substantial improvements in net profit in 2013 compared to 2012, even if revenues does not improve from the level of our guidance for Q4. We are confident that the macro uncertainty will clear and will resume top-line growth because of the fundamental growth drivers in our business. We just don't know when this improvement will begin.

Once revenue growth begins to ramp up again we will have substantial operation leverage and incremental revenue will drop straight to the bottom line up to around $120 million third quarter, at which point we will have to add some OpEx to get to the next level.

Now I would like to turn the call back to Ira.

Thank you, Aviram. What we hope you will take away from this call is the sense that we do not see fundamental changes in our business. None of the actions announced today will affect any products or customers in any way.

You see our position within the [micro and backhaul] space is stronger than ever, and we think we are better positioned to cope with a temporary period of slow or no growth than some of our competitors. Lastly, we hope you have a better idea of how we plan to make progress to our profitability goals and to generating sustainable free cash flow if we are not fortunate enough to return to growth mode for a few quarters. Now we will be pleased to take your questions.

(Operator Instructions) Joseph Wolf, Barclays.

Thanks. First question on the revenue side. There was a shift in the geographic mix between second quarter and third quarter with some macro commentary that you guys provided. Could you just go through, if you think about the guidance for the fourth quarter on that flat level, what you are thinking about geographically and whether there are any pockets of hope, of expectations of improvement or whether the background that you are describing is kind of a geographical universal?

Then, on the balance sheet, if you look at the financial expense and the tapping of the credit facility or the bank facility for another $10 million and the expectation for fourth-quarter return to cash flow, are we looking at that kind of $1.1 million, $1.2 million in debt expense going forward or is there other plans to accelerate some sort of repayment?

Joseph, thank you for the questions. I will take the first half; I will let Aviram answer the second part of it.

If you look at the geographical mix, overall there were changes in Q3 over Q2. Mainly by seeing a little bit of a stronger Europe in the revenue mix and in Latin America keeping its place where Africa was a little bit down. When I look at those changes from a macro position I would average out the two quarters. I would not say, okay, this is a trend that we are seeing geographically.

I don't think we are seeing any significant fundamental changes within any one of the regions between Q2 and Q3. Yes, we had, for example, India being slow for a long while on the regulatory issues; Europe is a little bit slowing down further than we saw. But I think the commentary I gave is relevant for all the business we do worldwide.

People are cautious, are reevaluating, taking their time, looking at the macro economy, looking at technologies, thinking do they deploy now or a little bit later, and all of those are slowing down the market at this point without, I would say, specific geography as one. Although we see, for example, a little bit better in Latin America, a little better in certain areas in Africa, but in general it is all over the place.

Aviram, to the balance sheet issues?

Joseph, I understand the question was around the financing expenses. Yes, we intend and the plan and the focus as we see it for now is to generate significant positive cash flow next quarter. We will use this cash to pay that and reduce our short-term credit facilities.

Having said that, I think looking forward for the next two quarters from the level that we have I think that the next two quarters you should plan around financing expenses of around $1 million to $1.2 million a quarter. In the second half of next year we will see the financing expenses slightly go down.

Okay, great. Just a quick follow-up for Ira. If you look at that -- you made a comment on customers being cautious. I wonder if you could give us a little bit of insight into the technology decisions being made. You mentioned having a new product as potentially being -- a new radio potentially providing some upside at the end of next year.

What are customers deploying? Are you seeing them just do very incremental, are they looking at older technology, and where could they go if things get a little bit more optimistic?

I think independent of the technology I think all the operators look on their P&Ls and really ask the overall question is how do they make money from data and how do they expense very large data networks as they move forward? Whereas different solutions with people who are -- we see who are moving and have made the decision and deploying LTE and we see people who are sitting on the sidelines or deciding to still deploy 3G.

We do provide the technologies both for today modernization and we will be providing for the next level of modernization within the operators to support both what I would call high-speed 3G [HSDPA+++] type of network and LTE networks as they move into the future. On the backside, we are in discussions with the other operators, both on current and future technologies, roadmaps, and products as we move. This is a process which is ongoing, but the decision-making at the end is lower at this point.

Okay, great. Thank you.

Mike Walkley, Canaccord Genuity.

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

As we said, I believe on the last two calls we had several large orders or tenders that we won with Tier 1 customer that had payment terms which were beyond our standard DSO. We knew that Q2 and Q3 would be tough in cash.

End of the day it is a timing issue. This timing to pay now those projects that we are implementing or implemented are becoming to become due October, November, December. This is why we see now expecting the DSO to go down and to collect more than we planned over the last two quarters.

Looking ahead for next year, I think if the same customer weeks will stay the same the DSO will continue to go down. But on the horizon there are more deals that are coming, more potential Tier 1s. It is too early for me to say how those will be closed and what will be the final payment terms on them.

In general, of course, we are targeting to reduce from the level of DSO today over the next six to nine months. But, again, it depends on transactions that are on the table over the next few quarters and how they are materializing in terms of the payment terms.

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

I think that on those it is really we are in with the customers that are slowing down the spending of their decision-making processes.

Okay, great. Just one question for me and I will pass it on --

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

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

Yes, we are 100% on track without -- even with some of the disruptions we are doing. We have taken the measures to do the disruptions in such a way that we are not hitting any of the product schedules and release schedules we have for next year as we roll out new products.

Great. Any feedback from your customers on the roadmap?

When we announce the products we will talk about the feedback from the customers.

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

Thank you very much, Mike.

Ittai Kidron, Oppenheimer.

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

We have opportunities. We know where we think we will gain market share, and that is why I commented on this also as being one of the potentials for the upside.

It seems like (multiple speakers) though in Europe (inaudible) I mean I understand (multiple speakers)

But then I will put the buts on the table. But in an environment where people are being cautious, also the operators' decisions sometimes tend to be much more conservative. And let's remember that gaining market share means I need to displace someone and throw them out.

If the decision cycle is slower or people say, okay, we are doing something on the lesser scale, the tendency to make the significant move from an operator and say, okay, I am going with someone new or changing the practice at this point is a little bit lower. That dynamic plays also in that type of an environment saying that, okay, we are a little bit more cautious at this point on really ramping up and gaining market share.

Okay, that makes sense. Regarding your planned OpEx reduction, why does it take three quarters to see that full in expenses? Why isn't -- maybe you can give us a little bit more detail, outside of your headcount is there anything else that takes longer to do? It seems that is something that could be done fairly quickly and could be reflected in the results fairly quickly.

Okay. I think that I mentioned on the call that we are taking organizational alignment and efficiency measures. There are two ways to do that and one of the ways is do it very, very quickly, but then we might hurt the business.

We will take -- because a geographical agreement practices in different places, it takes time for the restructuring to take down and we believe we can do some of those moves with the people, together with their teams, where we need to transfer responsibilities and others to lessen the effect within the Company. And that takes a little bit of time.

That is why we think it will come -- most of the expense in Q4 and then it will probably be a little bit more of it in Q1 with very little in Q2 of next year.

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

This is an annual rate.

I'm finding it hard to get to that number if you assume flattish revenues from your fourth quarter level for the next two, three quarters. Even at the OpEx level that you model, you assume you are getting to (multiple speakers)

The question is (inaudible). If you are modeling again, if you are modeling that you are running at the rate that we said on the revenue, the average of this, and you assume the gross margin that we are targeting and running the OpEx around the $32 million level or close to the $32 million level you will get to the numbers that I gave you.

And also depends how fast you are taking the revenue on Q1, on the OpEx from Q1. So how much you are putting on Q1. Play with the numbers you should get to the 5%; Mike says it is working.

Okay. Maybe we should exchange [versions] later on, but the OpEx cuts I think you mentioned will be reflected only in the June quarter. Did I get that right?

I said the full effect will be starting Q2. It means that it will be already a significant reduction in Q4; most significant, almost all of it, in Q1; and complete process starting from April 1 till we see the new level of OpEx that we mentioned in the discussion.

In the fourth quarter, if all goes to your guidance, are you going to be profitable on the bottom line or about breakeven? Am I about right?

We -- if everything go as we said, we will be profitable.

Okay. Lastly, regarding the collections. Again, falling on Mike's question. You have talked about in this fourth quarter collecting a lot on the accounts receivable.

Can you confirm that already in the month of October, since we are a month into the quarter that you have already collected a lot of this? I am just trying to make sure that this is on track.

Collection is one of the tricky things because you have customers that always in the last two weeks of the quarter that can slip, so this is why we are always cautious. But when we are looking on October, yes. When I am looking at October the graphs and the trends that we have October collection is much stronger than the same month, July, that was our previous quarter.

So we think the trend is already in effect. It is also coming -- other than the trend of a relatively small there are chunks of the big project that completed, and that could be one payment of $[63] million for example. So those are coming, some of them are coming in November, some of them are coming in December. And those are really -- the one that we talked about that are coming in one chunk that we expect them to come this quarter.

Very good. Good luck, guys.

Daniel Meron, RBC Capital Markets.

Thank you. Just wanted to understand a little bit more on what tiers you are doing right now. It is clear, just like you said, that data is growing. So what are the means that they are addressing data growth and the capacity expansion that they need to address that right now?

And is this the new norm going forward which may reduce the long-term usage of your solutions, or do you think this is just temporary usage and there is no way around deploying the capacity using wireless backhaul, fiber, or any other means to support that? Thank you.

First, let's remember that the market did not disappear. We are still doing excellent business and a significant business at quarterly basis. I think that the range of plus/minus 10% versus the running level having to do less with the technological decision on what the operators are doing, but having to do with the process of how quickly you make decisions?

Are you slowing down the budgets for a while? Are you making decision, okay, I am modernizing a city; do I modernize all of it or modernize the core of the city this year and the second half of the city or the outside on the suburbs next year?

We see all sorts of those decisions being taken across the board. It is the questions that people say, okay, we are doing data, we are deploying. In some areas, yes, we want to provide high-capacity 3G data; not now, next year.

And it is not a technology decision. People still use and require both a lot of fiber and a lot of microwave links to support the solutions. We are very confident we have the right solutions to support their total mid-range and capacities that are required with the right technologies.

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

I think the whole message around the call is we do not know or we are cautious about exactly that question. I think if I had a good answer then the outlook we would have given out there and the way we move forward would have been different. I would have said, okay, two flattish quarters, the third one is up or one flattish quarter, etc. We don't know at this point.

As the working model, what we are conveying on the call at this point, we have taken more cautionary working model out there while making sure we are increasing our profitability, even in this kind of an environment which we believe is a little bit slower. By the way, it is the same message I hear from competitors and operators and people that we talk to within the industry.

Is there something that I can put the finger on? I think I put a finger on some of the things. It is my belief at some point we will start seeing the LTE competitive landscape become such that people will start deploying because of their competitive pressure within certain geographies. We do expect at some point local issues, like India regulatory, to be resolve.

I think all of us expect at some point, and we don't know when, macroeconomic issues in Europe will sort themselves out and we will see an increase in deployments. So there is a lot of ifs which really point to upside, but all those ifs have also a question mark next to them which is when.

And that is why, looking at our booking patterns and what we have on the table, we have decided that we are accelerating the organizational efficiency moves we had on the table to be able to really go very strong into next year, both from profitability perspective and from a free cash flow perspective. Allowing us to be a very stable company that we can work with the customers and meet our profitability goals at a much lower level of revenues than we originally planned for.

Okay. And just last question from me before I yield the floor. So as you look into this restructuring plan that was an accelerated what kind of measures are you taking to make sure that you are not messing up [trainees] along the way. I understand that it's going to be a very gradual process, but is there any concessions that you need to make along the way for that that may impact some business?

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

Okay, very well. Thank you, good luck.

Peter Misek, Jefferies.

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

The first question I don't understand fully because at this point we are running strongly as possible as an independent organization and I don't understand the M&A question and its association. We drive the business with our customers, both direct and via the channels, very strongly as we move forward.

If you ask about fiber versus microwave, I don't think we see significant change in the trends. What we really say is that a lot -- the early LTE deployments, which are mostly inner-city, are all being done on fiber. We didn't expect otherwise, by the way, because in the city you will see very little microwave at this point.

And I don't see a significant change in the mix. I think what we are seeing is that everyone is deploying high-capacity microwave, driving the capacities, really building the network from a modernization process where they can, if they want to at some point down the road, support LTE deployments.

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

Now I can answer yes. Now I understand the question, yes. Consolidation within operators and I think (inaudible) in my prepared remarks is one of the things that we saw that which is slowing down order patterns.

When you have a consolidation between operators the first thing they do they stop all CapEx spending or most of the CapEx spending for a while until they rationalize their internal operation. How do they structure internally, how do they rationalize the assets that they have; do they have base stations or not, how do they cross over and other patterns. And only then they resume business.

Yes, this is one of the places where we see part of the slowdown and you are 100% correct on that.

Thank you.

There are no more questions in queue.

Okay. I would like to thank all of you for joining us for the call, especially thanks for those on the East Coast people hunkering down for Sandy. Please we will do follow-up calls with all of you and probably face-to-face during the quarter. We will be happy to answer further on the follow-on questions.

Thank you very much and have a nice day. Thank you.

Ladies and gentlemen, this conference will be made available for replay (audio stops in progress).