Ceragon Networks Ltd (CRNT) 2013 Q3 法說會逐字稿

Good day, everyone. Welcome to the Ceragon Networks Ltd. third-quarter 2013 results conference call. Today's call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks, and Mr. Aviram Steinhart, CFO of Ceragon.

Today's call will include statements concerning Ceragon's future prospects that are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and projections that involve a number of risks and uncertainties. There can be no assurance that the future results will be achieved, and actual results could differ materially from forecasts and estimates. These are important factors that could cause actual results to differ materially from forecasts and estimates.

Some of the factors that could significantly impact the forward-looking statements in this presentation include risks associated with the impact of restructuring activities; risks associated with continuing losses and possible liquidity issues; risks associated with the possibility that new products will not be accepted in the market; the risk of significant expenses in connection with the potential contingent tax liability associated with Nera's prior operations or facilities; and other risks and uncertainties which are discussed in greater detail in Ceragon's Annual Report on Form 20-F and Ceragon's other filings with the Securities and Exchange Commission.

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

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

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

Our Q3 results were in line with our guidance. Our book-to-bill ratio of about 1, and our accelerating trial activity all indicate that our business is starting to improve, even in a challenging CapEx environment.

There were no meaningful geographic changes during Q3, just the normal quarter to quarter fluctuations. In general, Latin America remains strong, and Africa is running considerably ahead of last year.

As you have seen by our recent announcements, we have achieved a major strategic milestone with the release of our integrated IP-20 platform and are moving ahead with initiatives to improve our financial performance. Therefore, on today's call, we would like to focus on three main topics. First, the significance of completing a major investment cycle resulting in the launch of a premium next generation platform, which in turn clears the way to rationalize our organization.

Second, the end of a crucial phase in implementing our strategic vision, a vision which began with the decision to acquire Nera three years ago. We will explain how all this works together to put us in the best possible position to leverage our technology and product cost leadership and fully participate in the upcoming CapEx cycle, gain additional market share, and deliver improving operating leverage.

Third, despite some of the recent developments with current and prospective customers, that suggests a rebound in the overall market that will begin soon.

Let's start. We are also nearly with the holding challenges of mobile operators, dramatic growth in data classic coming from cloud concept and applications which continue to provide requirements for much higher capacity. The operator revenue challenges, which drives them into new business models, including various degrees of network sharing and shifts in technology and network topology into LTE advanced small cell C-RAN networks which will eventually lead into heterogeneous networks.

So clearly, operators need a simple solution to a very complex set of issues. The list of critical requirements is easy to describe yet extremely difficult to deliver. Operators looking to deploy flexible, scalable, ultrahigh capacity hauling networks based on an SDN architecture that are open, service-centric and simple to manage; support any combination of transmission technology and network topologies in any configuration while being extremely power efficient with the smallest possible footprint and lowest possible operating costs.

Sound simple? Isn't it?

With this list in mind, it is certainly obvious why operators are hesitating while deferring spending as long as possible. Network planning has become a very complex process. New microwave holding products are coming into the market all the time. Most offer incremental improvements, but none address the full range of holding requirements with a future-proof approach until now.

We have completed an important phase of a multi-year investment initiative, and last week we introduced the full IP-20 portfolio. It is a game-changing, SDN-ready platform, which merges multiple long haul and short haul products into a single hardware architecture managed by a common operating system, the CeraOS.

The IP20 platform addresses the full scope of back haul and front haul leads across the entire network from small cells to large macro cells for aggregation to trans solutions all for ultrahigh capacity solutions.

The new IP-20 series complements existing fiber and evolution products. It does not replace them. The IP-20 platform is the premium ultrahigh capacity future-proof offering. It features the industry's highest radio density and all operators 4 times the capacity of our existing products with a form factor one-half the size. The common operating system simplifies network operation and, in many unique ways, the IP-20 platform reduces our customer's most painful point, the total cost of ownership.

Our website provides a wealth of details, but let me give you a short summary of the various products.

FibeAir IP-20C is a compact, all outdoor multi-core radio providing 1 to 2 gigabits of capacity in a single box all in a very limited channel bandwidth. It is already shipping and is live in customer networks.

FibeAir IP-20S is its small cousin, a compact, all-outdoor single carrier radio solution targeting small cell deployment. It will begin shipping in Q1.

The FibeAir IP-20G and FibeAir IP-20N are the most powerful macro cell backup solutions in the market. IP-20G is optimized for exercise, while IP-20N is optimized for aggregation nodes. The IP-20N is already operating in a lot of customer networks, and the IP-20G will be shipping in Q1.

The IP-20LH is the long haul portion of the portfolio and is actually three different products -- the Evolution, the FibeAir, and the compact long haul products -- each optimized for specific needs depending on factors such as distance and capacity requirements.

Finally, the CeraOS SDN-ready and is coming to all hardware configurations and provides a complete set of features and capabilities across all products.

We have enjoyed a long-standing reputation within the industry for our leading edge technology and our long history of design to cost achievements. Because we control our own technology, we have been able to be first to market with many unique features while maintaining the best product cope position in the industry. The new platform will enable us to make a significant improvement in product costs, furthering our own best-in-industry position.

As orders for IP-20 products convert to revenues and become a greater proportion of the overall product mix, we expect to gradually move in the direction of our target gross margin level of 35% plus.

After completing this major investment cycle, we announced an organizational restructuring that will reduce our operating expenses by 15%, significantly lower our revenue breakeven point, and position us to achieve substantial additional operating leverage as growth resumes. Nearly 70% of the cost reduction is associated with our ability to rationalize our R&D and support functions around the new IP-20 platform. We chose to implement all of the cost reduction measures at the same time in order to minimize the disruption to the organization.

The new platform launch represents the combination of a strategic vision that began with our decision to acquire Nera Networks three years ago. In multiple phases, we have accomplished the difficult challenge of fully leveraging the inherent geographic reach and further strengths of both companies, positioning us to take the combined company to the next level.

For those listening who may not be familiar with our strategic initiatives, we acquired Nera Networks based in Bergen, Norway in January 2011 and completed the initial integration milestone during the first quarter of the closing. We were able to quickly integrate nearly all former Nera short haul customers to a high performance, low cost short haul product and began the process of planning a design to cost expertise to former Nera long haul product line.

After (technical difficulty) to implement a state-of-the-art Company-wide ERP system, we were able to integrate administrative or back office functions in the middle of 2013. At the same time, we combined our two solution groups, long haul and short haul, into one as we continued to work toward a vision of a single platform.

At this point a year ago, we were concerned about the relatively weak booking pattern and believed an expense reduction was important to accomplish quickly because we could do it without harming the business, and we couldn't see a pickup in the market for several more quarters.

As revenue dropped from Q4 2012 to Q1 this year, before stabilizing at around the $90 million level, we made a conscious decision to maintain our development effort and complete the investment cycle so we could be in a position to capitalize on the upturn in the market by having our IP-20 platform tested and certified far ahead of our competitors. As we shared our network with customers and began trials with some of our new products, we received extremely positive feedback, which reinforced the importance of this decision.

Now we have reached the product development milestone we had set for ourselves three years ago, which enables us to take immediate action to reduce our internal cost structure by an additional 15%, resulting in an annual cost saving of about $25 million without affecting customer-facing activities.

This means we will be able to get past the internal disruption of the restructuring and be ready to capitalize on the market upturn when it begins, which we assume and feel will occur around the middle of next year.

As we noted on our last call, we're continuing to see signs that customer spending on hauling solutions is on the verge of an upswing. The indication consists of trials and evaluation, as well as planning and budgeting activities. We are currently in ongoing trials with two global Tier 1 operators. These trials require a major commitment of resources by the customer, and it is not something they would do unless they plan to move ahead if the outcome is positive.

To give you a few examples, we are beginning to supply our IP-20N to a Tier 1 operator that is in the process of merging two networks that resulted from an acquisition in a particular European country, all in preparation for moving the combined network to LTE.

We are also involved in trials with another Tier 1 operator in Europe, gearing up for deploying LTE across the entire continents.

Another global Tier 1 operating in Brazil has already made the decision to migrate to LTE using our products, and their plans are clearly influenced by the World Soccer Cup coming in 2014 and Summer Olympics in 2016.

As indicated by this example, the main driver of microwave hauling growth over the next several years is likely to be the implementation of next generation LTE-based networks beginning in Europe and Latin America by mid-2014.

We have also identified specific large projects in other regions for which our platform is extremely well-suited. As a result of the initiative we have been discussing, we believe we are in the best position in our history to participate in market growth, increase our share, and improve profitability after the restructuring.

Now I would like to turn the call over to Aviram to discuss the financial details. Aviram?

Thank you, Ira. I will go through the Q3 results and elaborate on the restructuring we announced today.

Our third-quarter revenue was $92.1 million, within the range of our guidance and similar to the prior quarter. Our GAAP gross margin was 30.9%. Non-GAAP gross margin was 31.9%, a slight decline from Q2. The non-GAAP figures exclude $300,000 of amortization of intangible assets; $600,000 of charges in pre-acquisition and direct acquisitions; and $40,000 in stock-based compensation.

Third-quarter GAAP operating expenses were $32.6 million. Non-GAAP operating expenses was $31.6 million compared to $31.9 million in Q2, reflecting our continued focus on expense control. The non-GAAP operating expenses exclude $300,000 in amortization of intangibles and $700,000 of stock-based compensation.

On a GAAP basis, we reported an operating loss of $4.1 million. Our non-GAAP operating loss for the third quarter was $2.2 million. Finance expenses in Q3 was $2 million. Tax expenses was about $4.4 million in the third quarter, which included $4 million of nonrecurring adjustments of the valuation allowance on our tax assets. On a GAAP basis, we reported a net loss of $10.4 million, or $0.28 per share. On a non-GAAP basis, we reported a net loss in Q3 of $4.5 million, or $0.12 per share.

The geographic breakout of the revenue appears in the press release. Latin America continued to be very strong, and Africa was down a little from an extremely strong Q2, but still showing good results while the remaining regions continue to be sluggish. We had one 10% customer from Africa this quarter, and our OEM sales accounted for 3% of our total revenue in Q3.

Turning to the balance sheet, trade receivables increased to $129 million, putting DSOs at 120 days, an increase from Q2. Cash from operations was negative by $7.4 million, and after purchasing of property and equipment, our negative cash flow in Q3 was about $11.5 million.

We drew down on our credit facility during Q3, so that total cash and cash equivalents were $44.8 million at the end of the quarter. As of September 13, we had unused borrowing capacity of $12 million, in addition to approximately $45 million in cash on our balance sheets.

As Ira explained, we're implementing a major cost reduction program. The long haul-related R&D and support function located in Bergen, Norway operation will now be handled by Tel Aviv and Romania teams. There will be no changes in sales, sales support and offshore and defense teams located in Bergen.

In addition, we will be realigning field offices in Europe, Africa, and APAC, moving them to smaller, low-cost locations and opening a global professional services center for customer support, resell and order intake in low-cost location in Slovakia. We will reduce headcount in operations, finance, IT, and HR, as well as search and other actions.

The cost of the restructuring is expected to range between $18 million to $21 million. About 70% will be cash spread over the next three quarters.

As Ira indicated, we expect annual savings of approximately $25 million broken down as follows -- approximately $4 million in cost of goods sold; $11 million in R&D; $4 million in sales and marketing; and $6 million in G&A. This will bring our non-GAAP revenue breakeven level at around $90 million, thus eliminating operating losses at the current revenue levels.

We expect revenue in the fourth quarter to range between $85 million to $95 million. We expect continued revenue stability in the first half of 2014 with gradual improvement from mid-2014 onward as the ongoing trial activity translates to orders.

Lower COGS and higher margins on new premium products will have a positive impact on gross margins in 2014. Combined with our cost reduction measure, this could enable us to reach a 5% operating margin exiting 2014. We assume we will reach a $100 million revenue level by the end of next year. In turn, this would position us to deliver substantial operating leverage in 2015 as market conditions improve and our new products continue to ramp.

Now I will turn the call back to Ira.

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

Thank you and now I will turn to your questions.

(Operator Instructions). George Iwanyc, Oppenheimer.

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

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

Okay.

One other comment. Aviram answered you from the financial and the way we are counting it on the table. From our experience and from the way we operate the Company, effectively the changes, the personnel changes, the organizational changes, will appear, I would say, 95% of them over the next two weeks. But the accounting will take two quarters a little bit to take into account. The execution will be much, much quicker than that.

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

The booking levels at this point do not -- we don't go that far out into 2014, but we do have visibility because, as I said, we are involved in quite a few trials with the new equipment, and we are involved in the planning and the budgeting cycles that some of the operators are doing in their plans. And our expectation, this will turn into bookings somewhere in additional incremental bookings and other processes somewhere toward Q2, which will start affecting revenues in Q3 and Q4 of next year.

You have to remember, most of the things that we do when we get the bookings is very short term. It is, get the booking, send the delivery within the next 30 days, and then over the next 60 to 90 days, install everything. So it is more right now off the level of trials and involvement in planning than in actual bookings for that type of a period understand. But that level of trials and planning has increased significantly over the last quarter.

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

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

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

The latter -- most of the shift will be from gains in Latin America, a little bit also from Africa and the gains in Europe.

Thank you very much.

Joseph Wolf, Barclays.

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

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

And are these trials -- just a quick follow-on -- are these trials competitive, or are you guys the only ones there? These are kind of exclusive engagements that turned into revenue?

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

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

Yes, we have -- as you mentioned, we have at the end of the quarter, $45 million of cash and an additional $12 million in borrowing that we can still utilize from our existing credit lines. So this will finance most of the restructuring. And on top of that, we are looking strategic activities that we are actively looking on optimizing our cash through our existing resources.

To give you one example, we have still not optimized some of the cash we saw sort of fitting some of the jurisdictions that the expatriation of the cash requires certain processes that we're looking at. So we are optimizing existing resources. We are utilizing the cash that we have and also looking on parallel on some other alternatives.

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

Yes, it will go slightly. Because if you take an additional $12 million or the maximum at 4%, roughly, you can add in how much it is going up on a quarterly basis. It is not very significant, but it will go slightly up.

Okay. Thank you.

Peter Misek, Jefferies.

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

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

Okay. Thank you.

(Operator Instructions). Matt Ramsey, Canaccord Genuity.

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

First, let's make sure that we are talking about the same Q4. We are guiding, first of all, Q4 this quarter between $85 million to $95 million, which is the average of what we have done over the last several quarters.

What we said, we expect over the next first quarters of next year stabilized revenues start to ramp up starting from Q3 in revenue and in Q4, exiting the year with a target that we put now in projection of $100 million, Q4, next year.

Okay. Great. Thank you for clearing that up. I think I had that right. I just wanted to make sure.

And if you look forward, Ira, to how your new products are ramping, you mentioned starting in Q1 ramping through next year on that; say $100 million in revenue next December quarter, do you have any feel for what percentage you expect to be at the new product line by that point?

Somewhere below 50%.

And then if we just stepped back and look at the industry, obviously, it's some tough spending environments. But it sounds like your outlook for wireless backhaul both short and long haul is better than it was, at least the last time that we spoke. What do you look at for, first, TAM growth for specialty backhaul vendors over the next year or two versus some of the larger vendors continuing to use their own products? If you look at the mix of products and the larger vendors versus the backhaul specialists, how do you think that mix plays out over the next couple of years?

I think the interesting part there is that the mixture between what we call a captive market or system deal is out there, which is mainly today Ericsson and Huawei in the market. But over the last three years, that mix between specialists and that type have been slowly, slowly tending toward the specialists. And there is a growth in the specialist portion within that type of a package -- not significantly, staying somewhere around the [48%], [52%], one way or another over the last five or six years. I do not expect a significant change in that type of mix. My belief, as we ramp up with a new product and gain market share, most of that market share will come from other specialists or from the edges of the big equipment vendors.

Thanks for taking my questions. Best of luck with the new products and the restructuring.

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

I would like to thank everyone for joining us for the call today and looking forward to your one on one and questions and for your follow-on on our ramping up our strategy and vision as the market continues to change in our favor.

Thank you very much, and have a nice day.

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