Ceragon Networks Ltd (CRNT) 2015 Q2 法說會逐字稿

Ladies and gentlemen, good morning. Welcome to the Ceragon Networks Ltd. second-quarter results conference call. Today's call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks. 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 forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially, including the risk that Ceragon will not achieve the benefits it expects from its expenses reduction and profit enhancement programs; the risk that Ceragon's expectations regarding future revenues and profitability will not materialize; the risk that Ceragon will not comply with the financial or other covenants in its agreements with its lenders; risks associated with doing business in Latin America, including currency export controls and recent economic concerns; risks relating to the concentration of our business in Asia-Pacific region and in developing nations; the risk of significant expenses in connection with potential contingent tax liabilities associated with NERA's prior operations or facilities; and other risks and uncertainties detailed from time to time in Ceragon's Annual Report on Form 20-F, and Ceragon's other filings with the Securities and Exchange Commission, and represents our views only as of the date they are made, and should not be relied upon as representing our views as of any subsequent date.

We do not assume any obligation to update any forward-looking statements. Ceragon's public filings are available from the Securities and Exchange Commission's website at www.SEC.gov or may be obtained at Ceragon's website at www.Ceragon.com.

I will now turn the call 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 Doron Arazi, our CFO.

By now, you have seen our press release indicating that we have made excellent progress during Q2. We have now achieved a very important milestone, restoring our financial stability with solid profitability and positive cash flow. More important, we are much more confident that we can continue the trend of profit improvement.

During this call, we would like to explain the source of this confidence. We will discuss how we have validated our strategy, what we have learned to do better, and what new profit goals we have set as a result.

Our strategy has three main pillars -- having the best technology and solutions, being well-positioned in all geographies, focusing on high-value opportunities. All three elements are required in order to sustain and increase profits. We believe we are the wireless backhaul vendor best positioned in all three aspects.

The IP-20 platform is a highly differentiated solution with many advantages that we discussed in detail on our last call. When the wireless backhaul market considers which company offers best-of-breed solution, Ceragon is the company that typically comes to mind. How do we know? Customers and potential customers tell us. Market research and even some of our competitors say it.

This is our reputation, one we have earned over many years by being first-to-market with the most advanced technology. Our IP-20 platform provides benefits that can only be achieved through the power of vertical integration from in-house chipset designs all the way through to a broad portfolio of solutions, fulfilling the entire scope of wireless backhaul needs.

As we have explained in the past, in some deals, operators are not interested in best-of-breed solutions. Some are only interested in getting the least expensive network that will meet a set of minimum standards to satisfy current requirements. In other cases, the operator may lack the internal capabilities or resources to evaluate the backhaul portion of the network separately.

After experiencing difficulties trying to differentiate a solution in bundled deals, we have placed our focus entirely on best-of-breed deals. These deals are where the customer places value, on a best-of-breed backhaul solution. And we have the opportunity to be judged in all respects, not just by price and payment terms.

We have spent some time analyzing and segmenting the overall wireless backhaul market, now finding support and validate our view of the market and our strategy of focusing on the best-of-breed segment. Using 2014 figures from industry analysts, we estimate that the best-of-breed portion of the market is approximately $2.5 billion or a little over half the total wireless backhaul market.

Like the overall market, the best-of-breed portion is fragmented. We estimate the six companies have a share ranging between 10% and 15%, 15% being the highest share. What is significant about our analysis is that we are one of the two vendors with the largest share, along with NEC, not Ericsson and not Huawei.

The next thing to recognize is there is crossover between the two segments in both directions. In some regions, an operator may want a bundled deal, and in another region, the same operator may choose the best-of-breed approach. This illustrates the importance of correctly analyzing and understanding each deal.

Our analysis verifies the demand for best-of-breed solutions is worldwide, including in all the price-sensitive regions. This highlights the importance of being well-positioned in all geographies, which is the second major pillar of our strategy. It's a nice theory to think a vendor can increase profits by avoiding price-sensitive regions. It doesn't work well in practice, because telecom network investment tend to occur in waves.

When one operator moves, the other follows. Operator consolidation in one region freezes the market temporarily but later spurs upgrades. If a vendor is not present in every region with a full array of backhaul capabilities, they are probably missing the market a significant portion of the time.

Even if your product is purchased through OEMs, it is important that the mobile carrier operator specifies your solution directly because they value it. This is where our smaller competitors have fallen behind. Recently, we were selected by a tier 2 supplier of LTE base stations to supply the microwave backhaul. They recognize our position as best-of-breed in wireless backhaul, and believe they can capitalize on it to win certain deals.

We are continuing to gradually increase our business with other OEMs, as more carriers specify our solution. There are good reasons to think that, over time, the best-of-breed segment of the market will grow relative to the bundled segment. However, for the near-term, our working assumption is that the best-of-breed market in dollar terms is likely to be fairly flat. Therefore, within the best-of-breed category, we must focus our resources on lending and retaining the highest value opportunities.

This third pillar of our strategy focusing on the highest value opportunities sounds simple, but in principle is quite difficult. Because of shifting dynamics in the market, it requires the entire organization to work together to evaluate and balance a wide array of variables. When we are successful in all three aspects of our strategy, we can operate from a position of strength and act opportunistically to enhance our market position.

For instance, in Q2, we increased our share of particular deals with a long-time customer when another supplier ran into technical problems. Some examples of ways we have improved our financial discipline and ability to execute include much deeper and more thorough analysis of every opportunity; improving decision-support system to provide better information more quickly; changing the mindset of the organization regarding the criteria used to evaluate good opportunities; changing compensation schemes to better motivate the salesforce in the right direction; adhering to strict expense control measures; implement more stringent criteria for extending payment terms; and considering the impact on working capital and financial stability when setting criteria for accepting deals.

We are continuing to work on some areas to make even more improvements. One example would be improving our on-time delivery performance. Doing a better job in all three aspects of our strategy will enable us to capture a larger share of the most profitable business available, and further improve profits and financial stability. It is not likely that this will occur on flat or even slightly lower revenue.

The trade-off is reflected in our Q2 bookings. Our book-to-bill was slightly below 1; but much more significant, the estimated gross margin for these bookings is substantially higher than our Q2 gross margin, providing us with additional confidence in our ability to improve the bottom line.

To summarize, we have returned to solid profitability with a realistic plan to further increase profits going forward. Our market is going through a transition, and is also subject to seasonal factors, so we can't promise sequential profit improvement every single quarter, but we expect the overall trend to continue.

It's too early to offer a specific profit target for 2016, but depending on where we end up this year, we think it's not unrealistic to have a goal for next year of doubling our 2015 non-GAAP net profit on a constant currency basis. As our strategy becomes better understood and we continue to show progress towards our goal, we expect our valuation to reflect our improving prospects.

With that, I'll turn the call over to Doron to share more of the financial details and key business metrics with you. Doron?

Thank you, Ira. I will provide additional details on our financial performance and discuss the near-term outlook. Since you have all seen the press release, I'll just highlight some of the significant items.

Our second-quarter revenues of $94.8 million represented a 1% sequential increase from Q1, in line with our expectations. The geographic breakdown of Q2 revenue appears in the press release. Revenue from Latin America returned to a more typical level after a large project in Colombia skewed Q1. Lower revenue from Europe was more than offset by significantly higher revenue from North America. We had one above-10% customer in the quarter, a large operator in India we have served for many years.

In Q4 of 2014, we outlined our plan to reach and sustain profitability. We set a target of reaching a non-GAAP gross margin of at least 27% by Q4 of 2015. We exceeded that level in Q2 with non-GAAP gross margin of 28.6%. This was a little higher than expected due to a more favorable revenue mix than anticipated.

We continue to note that we expect some fluctuations from quarter to quarter, based on the exact mix of revenue we recognized during the period. Nevertheless, we were encouraged with the gross margin improvement across all regions as compared with Q1, which gives us higher level of confidence in our ability to continue the general trend of improving gross margin.

Non-GAAP results in Q2 excluded $1.7 million of the usual items -- stock-based compensation, amortization of intangible assets, and non-cash tax adjustments. In Q2, we reached and exceeded our target for operating expenses. This quarter, at $20.4 million level of OpEx, was actually a bit lower than the level we consider sustainable. Going forward, we continue to expect operating expenses to range between $21 million and $22 million per quarter.

With improvement in gross margin coupled with lower OpEx, we continue to improve our operating results, reporting a non-GAAP operating profit of $6.7 million. Our non-GAAP operating margin of 7.1% exceeds our goal of reaching a mid-single-digit non-GAAP operating margin by the end of the year.

Non-GAAP financial expenses were down slightly from Q1 to $3.2 million. The decrease was mainly due to reduced Accounts Receivable discounting activity, offset by an increase in currency exchange rate expenses. Our non-GAAP net profit was $3 million or $0.04 per diluted share, another major sequential improvement and well above our original expectations for what could be achieved by this point.

Turning to the balance sheet, receivables were $138 million with DSO of 126 days, down from 131 days at the end of Q1. At June 30, 2015, we had cash and cash equivalents of $39.5 million, indicating positive cash generation of $2.2 million in Q2.

Generating positive cash flow was our most important milestone. We are very proud to say we have achieved it, and expect to sustain positive cash flow going forward. We did not have a change in our borrowing during Q2, which remains at $51 million. We believe we have a comfortable level of cash for the level of business we have. As we continue to generate positive cash flow, we will have the option to use excess cash to pay down debt.

For the full year of 2015, we have set a goal of reaching at least $7 million of non-GAAP net income. With non-GAAP net income of $1.7 million for the first half of 2015, and especially with the improvement during Q2, we believe that under a constant currency assumption for the rest of the year, this target is achievable. However, it is too soon to provide firm guidance for full-year profit.

As we have seen a very clear trade-off between revenue and gross margin during the past two quarters, we are not guiding for a specific revenue range for Q3. And, in general, we expect revenue in the second half to be moderately lower than the first half.

We do want to emphasize that we believe our new higher profit goal for the year can be achieved with lower second-half revenue due to the trade-off we have described. For all the reasons mentioned during this call, our focus is maximizing our gross profit, given the current OpEx level, and improving our cash flow by taking deals that can support this strategy.

Now, we would like to open the call to questions. Operator?

(Operator Instructions) James Kisner, Jefferies.

This is Jason North for James. Congrats on the high GM for the quarter. I was curious for North America, it looks like that's at a four-year high in terms of revenues. What drove that? And how sustainable do you think it is as a percent of mix?

I think that we have been focusing a lot of our efforts as part of this strategy on high-value deals. And North America tends to have a higher proportion of high-value deals than the rest of the mix. And that's why we put an extra effort there.

I think you are noticing correctly -- this is a high mark in the last four years. I'm not sure that over the next two quarters we'll stay at that high mark, but if we average things out over a few quarters, we see that we are slowly increasing our position in the US, mainly from additional effort both into the operator's market where we see deployment with two large customers at this point, which we have been deploying with them already last year. And we are seeing a continual increase this year and additional effort that we see from other vertical markets within the North America region.

And without that, I'm just trying to segregate the helpful impact for gross margins based in North America, if that's going to regress a little bit to the mean. Can you give any source of like what gross margins might have been without that spike in North America?

I don't think that I can give you a specific answer. But I would say that while North America is definitely on the high-end side of the gross margin, we were able to generate much higher gross margin in other regions. And I do believe that even with the lower mix of revenue coming from North America, we can sustain this level of gross margins.

Okay. Are you -- any type of goals or qualitative guidance for gross margins in the back half of the year besides up?

So I think that the trajectory is to continue in the pace -- or not in the pace, in the vector that we have seen in the last two quarters. Obviously, there is a limit to how much we can improve the gross margin but we still believe that we can take it further. And I want to caveat that by the issue of the regional mix.

So the general trajectory is, yes, we can do better than 28.6%. That is what we believe. But on a quarterly basis, it will be a little bit more difficult because of regional mix.

Okay, that makes sense. A quick follow-up here on the cash flow. You are saying that's going to be positive. Are you talking free cash flow or operating cash flow?

I'm looking at the cash flow that we can generate after taking into account everything, including paying interest. So, it's all the way down before we decide whether we want to pay -- we want to reserve this cash in our bank account or we want to pay back part of the loans.

Okay, that makes sense. I'll go back in the queue. Thank you.

Thank you, Jason.

Alex Henderson, Needham.

I just want to make sure I heard what I heard correctly -- or what I thought I heard correctly. So, you are saying that you think you can do $7 million or so in net income for FY -- or calendar 2015. But the comment I thought I heard you say was that you expected that in 2015 to 2016, that you would be able to double your operating income? Is that -- was that operating income? Or what was the metric there?

Hi, Alex, this is Doron. It's the same metric. We were talking about net income non-GAAP for 2015, and Ira commented that we can probably double this number for next year.

I guess I'm a little confused at what causes that improvement. Is that going to be a function of gross margin? Is that going to be a function of flat OpEx? Because it doesn't sound like you are really forecasting any growth on a full-year basis. So, I mean, are you assuming that you return to decent topline growth in 2016? What's the driver of that improvement?

The main driver is the combination of better gross margin and keeping our OpEx very tight. And I would say similar level to what you've seen and what we guided for in this call.

Alex, I want to take it not from the numbers perspective but from a strategy perspective. From a strategy perspective, I think we put out very high -- we are going after the high-value deals. And I think that we indicated more over in the last call and this call again, it's more important for us to grow the bottom line and be efficient in the operation, and go after high-value deals than go after -- a lot of the deals increase the top line.

And I think both when we indicated for the next two quarters going forward, we probably will maintain similar revenue -- might be a little bit even down -- than we are at this point on a quarterly basis, of fluctuating around where we are, while focusing on the high-value deals and our advantages both in geography and in the products to increase the gross margins, while maintaining a constant OpEx, which will flow down into the bottom line.

Right, so just to be clear, if you just basically hold the numbers relatively steady, you would need a fairly significant improvement in gross margins. Are you talking about getting back to an average for the 2016 of gross margins at 30% or plus? Or are we talking about some composite of a little bit of growth and a little bit of gross margin expansion in that 2016 number?

I'm a little confused to how you get a doubling of profit off of essentially what sounds like flat revenues when it was flat OpEx. I mean, the flat OpEx doesn't provide any leverage if there is no revenue growth, and there's not enough movement in the gross margin to double operating profits.

Yes. So, as we said, I think most of the ones during the formal announcement, we have seen in the last two quarters, a booking with very, very nice gross margins. And we believe that even if we stay flat on the revenue, the level of gross margin we can achieve, based on what we have seen so far, together with the continuous reduction of our product costs and some other measures, we can have a 30% level of gross margin next year.

And basically we put that as a target. So, obviously we don't guide for that at this point. But based on what we have seen, this is definitely an achievable target in our eyes.

Okay. Could you talk a little bit about -- I mean, there's been some pretty precipitous changes in emerging markets over the last couple of months, really, certainly even post your close of your quarter. For instance, Cisco reported last night that they were down 48% in India, just as an example. I mean, not India, in Brazil as an example.

Are we -- should we be concerned about the damage that's being done to emerging markets because of the commodity price route causing contractions and spending in those geographies? I know that's a big macro question for a company that shouldn't be that tied to macro, but it's kind of unavoidable.

I think it's a very valid question. No, we do not see it this way in such large numbers. Although we see issues with some operators in some of the markets, I think we indicated, for example, in Latin America returned to lower-level with a peak we had in Q1. We see some of the other emerging markets still being very active.

I think Brazil has its own situation where we are working closely with the customers. I do not expect significant changes there at this point from what we see within the market.

Okay. And then just going back to the competitor that's having difficulty with their -- the quality control. Do you see a change in the relationships they are having with their customers that's opening up an opportunity that you might be able to take advantage of? And is that actually a relevant determinant? Or is it more important how your relationship in competition is between the majors that are obviously the larger portion of the marketplace?

I think the second part of your question is the right one. I think usually taking market share has to do mainly with the larger players. Although we believe we're one of the top two within the best-of-breed markets, and we are selected on most of those deals or being considered in most of those deals, I think it's part of the relationship and understanding of where we are in the position within the market, that we can use -- and I use that as an example also -- as taking advantage of our geographical spread and connections with the customers, not necessarily as a competitive overall assessment versus that specific vendor.

All right. One last question and I'll cede the floor. So you made the comment that half the market is best-of-breed, half the market is not. But the best-of-breed market is essentially flat.

At some point, however, you also implied that the best-of-breed buyers, who also tend to buy for more commodity purchases, would see a shift in the architecture of their networks towards higher data rate environments where they might be forced to move towards a best-of-breed product, implying some future inflection point to a period where there might actually be higher growth for the best-of-breed portion that you are targeting. When might that be?

We think it will occur, but we don't know. Probably it's further down the road. It's not in the quarter's range. It's probably well beyond 2016 on the pressure. And it's a gradual move. I don't expect an inflection point there.

I'll cede the floor. Thank you.

Thanks, Alex.

George Iwanyc, Oppenheimer.

Thank you for taking my questions. So, going back to margins and the best-of-breed mix, are the best-of-breed orders and contracts that you are going after, low-30% gross margins? Are they mid-30% gross margins, more in line with what your historical targets have been?

Basically, we manage this thing by region. This is why we indicated that there could be fluctuations in the gross margin because of the mix. So, the way we handle that is on a regional basis. But as I said, we see a positive trend in the gross margin across all regions. And we believe that for the long-term, we can maintain a mix that can bring us to this 30% or something close to that on average.

Okay. And then when you look at that regional contribution, India was still a fairly large contributor this quarter -- I think it was 30%. Did you see margin improvement there? And what type of contribution should we expect from India, let's say, two or three quarters from now?

Yes. So, first of all, India is a great example for a situation where we were able to improve the profitability and the payment terms. And actually in this quarter, you see the fruits of this effort, yes.

The gross margin in India is improving significantly, relative to 2014. And I think I said that in the previous call, obviously our decisions are based on an analysis for per-customer, not an analysis per region. We don't walk away from India, and we don't walk away from any country in the world where we think that the level of margins are, I would say, applicable to our strategy based on the regional analysis.

This is how we execute our strategy. And we do believe that we will see more contribution coming from India, definitely in the short-term.

Okay, now it's been a couple quarters since you focused on the better quality opportunities. And there's typically a quarter or two lag between booking an order and actually starting to see those revenues flow in. When should we start to see the best-of-breed mix kind of being at a normalized level? Is this a year out? Or is it a little bit longer than that?

Probably a year out, I think is the right approach, although it might be even a little bit sooner. I'm not sure if Q1 -- well, Q2 next year. Somewhere between Q1 and Q2 next year, where some of the older deals will be out of the mix.

Okay. And one final question. Can you give us a sense of how you've tweaked your sales compensation and how your messaging to the salesforce, these are the type of deals we want to go after, and making sure they are focused in the right areas?

Very simply, you talk about the high-value, you measure the high-value within the deals, you want to go after best-of-breed high-value deals. You compensate for high-value deals much better than you compensate for low-value, and we won on price only. So, we tweaked some of the parameters within the compensation scheme.

All right. Thank you very much.

Thanks.

(Operator Instructions) Gunther Karger, Discovery Group.

Yes, I just have a comment to congratulate you on achieving your goals. Thank you.

Thank you very much.

And at this time, there are no other questions in queue. Please continue.

Okay. So I'd like to thank all of you for participating in our call this morning. And we'll be open to any one-on-one questions and discussion over the upcoming days. We also want to advise you that for your convenience after the conclusion of this call, we'll be posting a copy of our formal remarks in PDF format or Investor Relations page of our website. And looking forward to speaking with all of you for more details. Thank you again.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.