Ceragon Networks Ltd (CRNT) 2015 Q3 法說會逐字稿

Good day, everyone. Welcome to the Ceragon Networks Limited third-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 expense 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 wonders, 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 the Asia-Pacific region and in developing nations, the risk of significant expenses in connection with potential contingent tax liability 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 represent 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 on 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. We continue to make progress toward our key business and financial objectives. In Q3, we achieved significantly higher gross margin compared with Q2. We increased net profits. We generated significant positive cash flow and we reduced our debt even though revenue declined almost 10% sequentially.

Lower revenue is a result of our strategy to be very selective and focused on maximizing profitability with each and every deal. In general, we are retaining the profit goals we mentioned on the last call and we believe they are realistic. However, we also think we will see a bigger trade-off between revenue and gross margin than we thought previously. This shift in both our revenue and gross margin expectations illustrates the importance of the approach we are taking deal by deal.

Our revenue trend isn't directly correlated to macro factors. We continue to believe the overall wireless backhaul market is likely to remain fairly flat up or down slightly and depending on whether you measure it according to units or dollars. As we discussed on our last call, we are focusing on the best-of-breed segment, which represents about half of the total wireless backhaul market. We are in a better position to take advantage of our strengths when service providers are willing to invest their own time and resources to assess backhaul vendors' offerings individually and selected by who brings the best value to the required solution.

By contrast, in bundled deals, there is no separate vendor decision for backhaul and the primary factors are price -- price and payment terms. As we noted on our last call, even within the best-of-breed portion of the market, there are wide variations between customers. Not every customer that is looking for ultra-high capacity and advanced features is willing or able to pay an appropriate premium. Furthermore, some customers fully evaluate each, but still use price and payment terms to determine which vendor will be awarded the largest (technical difficulty) awarded. We won't be able to get every trade or decision exactly right, but if we are going to make a choice, we would rather make it in the direction of lower revenue with higher margins.

In that context, we are very pleased with the strength in booking in North America. As you saw in our recent announcement, the strength is broad-based and doesn't include any business from anticipated projects from one large operator. We continue to believe those orders will be forthcoming, but the timing is being affected by the carrier focus on internal restructuring issues. For now, we are being cautious in our assumptions until we have better visibility on this project.

Business in Europe and APAC is soft by historical standards. There is no obvious reason for this beyond a variety of customer-specific reasons that cause projects to move slowly. We don't see this changing for the next several quarters and we will concentrate on improving our approach to this market to ensure that we are getting as much of the business as possible.

After very strong business in Africa during 2014, we are seeing relative weakness due to a spending freeze at one large customer with [everything] the continent and heightened competition in the market. The current pace of orders in Latin America seems likely to continue, but our future assumptions are a bit cautious due to the ongoing political and currency issues, particularly in Brazil. The trend in our business in India is very strong, but difficult to anticipate. While there is ample evidence that the relatively high level of business could be sustained through next year, we are somewhat reluctant to make this assumption because of the tendency for a pause after a period of rapid deployment.

More good news is that our IP-20 platform continues to be viewed as leading the industry and competitors have been slow to catch up. We believe our strategy of focusing on bringing unique value to our customers who will appreciate it will continue to be successful in increasing profits, which is our primary goal.

I'd like to note that we are able to achieve the higher margins because we have invested consistently over the years to have the best-of-breed solutions with the lowest product cost in the industry. Without this product functionality, quality and cost position, stringent control of OpEx alone would not be nearly enough to sustain ability. Our IP-20 platform provides benefits and value that can only be achieved through the power of vertical integration with in-house chipset design and a broad portfolio of solution for filling the entire scope of wireless backhaul needs.

We continue to invest more in R&D than most of our competitors and a significant proportion of our budget is devoted to design-to-cost investments. This is what makes our strategy viable. That leaves us with a question -- what has to happen for Ceragon to return to growth mode? We see two primary factors -- one, on the operator side and one on the vendor side. First, operators must continue to roll out more advanced 4G and eventually 5G networks with more capacity, better efficiency to accommodate the ongoing explosion of data traffic from connected smartphones and all types of IoT devices.

On the global basis, 4G LTE still has a long way to go before being fully deployed.

Second, there needs to be a rationalization of the number of vendors in the best-of-breed portion of the wireless backhaul, which will bring the market to a more rational pricing environment in those areas of the market where value is appreciated and scale with global reach are important. In the meantime, we will continually to refine our strategy and work on further improving our execution. We see opportunities to gradually increase the amount of revenue coming from certain vertical markets with best-of-breed characteristics. Over time, we expect to increase our marketshare as weaker players withdraw. Our immediate plan is to continue focusing on profitability and cash flow, pay down debt and be in the strongest possible position to take advantage of new opportunities as we identify them.

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

Thank you, Ira. Since you have all seen the press release, I will just highlight some of the significant items. Our third-quarter revenues of $85.4 million represented a 10% sequential decrease from Q2. The geographical breakdown of Q3 revenue occurs in the press release. There were no major shifts in geography in Q3. We had one above 10% customer in the quarter, a large operator in India that is a long-standing customer. A year ago, we set a target of reaching 27% margin by Q4 of 2015. We not only exceeded that target level in Q2, but we substantially improved gross margin again in Q3, reporting 32.4%. As Ira said, we believe we can sustain this level and even improve a little more from this level in 2016.

Also we should continue to note that we expect some fluctuations from quarter to quarter based on the exact mix of revenues we recognized during the period. Non-GAAP results in Q3 excluded $2.3 million of the usual items -- stock-based compensation, amortization of intangible assets and non-cash tax adjustments. In Q3, we continued to maintain tight control of our operating expenses, which were $20.2 million. Given the booking level and outlook, we are going to focus on keeping operating expenses in the $20 million to $21 million range.

With the improvement in gross margin coupled with lower OpEx, we continue improve our operating results reporting a non-GAAP operating profit of $7.5 million. Our non-GAAP operating margin of 8.8% again exceeds our original goal of reaching a mid-single digit non-GAAP operating margin by the end of the year. Non-GAAP financial expenses were again down slightly from Q2 to $3 million. The decrease was mainly due to lower exchange rate-related expenses than in Q2 partially offset by an increase in fees for discounting receivables of a large customer in India to compensate for loan payment terms.

Our non-GAAP net income was $3.7 million or $0.05 per diluted share. As you'll recall, we set a new profit goal for 2015 at the end of Q2. We were looking to achieve $7 million or more in net income for the year on a constant currency basis. On that basis, our analysis indicates that our Q3 non-GAAP net income would have been approximately $1 million higher, putting us near our annual target this quarter.

Turning to the balance sheet, receivables were $122 million with DSOs of 116 days, down from 126 days at the end of Q2. At September 30, 2015, we had cash and cash equivalents of $39.2 million, the same level as the end of Q2. We generated positive cash of $7.2 million, which we used mainly to reduce our debt to $44 million at the end of Q3 from $51 million at the end of Q2. This level of debt utilization is already below the lowest debt level we negotiated with our bank consortium to be available by the end of February 2016. We believe that we will be in a position to make further reductions in debt as we continue to generate positive cash flow and expect to be in an excellent position to obtain favorable borrowing terms when it is time to renew our loan agreement in the middle of next year.

Turning to the outlook, as Ira noted, we are retaining our goal of $7 million in non-GAAP net income for 2015, which implies a sequential decline in net income in Q4 compared to Q3. Our book-to-bill in Q3 was below 1. As we have noted before, our focus on selecting and winning the most profitable deals in each region is bound to result in some fluctuations from quarter to quarter.

As we have seen a very clear trade-off between bookings and gross margin during the past two quarters, we are not guiding for a specific revenue range for Q4. In general, based on our booking trends, we should be prepared to see a trend toward lower revenue extend into 2016. On the other hand, we expect our gross margin to remain solidly above 30% and we emphasize that we believe we can achieve significantly higher profits in 2016 versus our $7 million non-GAAP net income target for 2015.

Another quarter of experience with implementing our strategy and making the trade-off between revenue and gross margin increases our confidence that we should continue with this strategy in order to continue generating more profits and positive cash flow. Now we would like to open the call to questions. Operator.

Thank you. (Operator Instructions). James Kisner, Jefferies LLC.

I guess I just want to clarify the gross margin results in Q3. Nice gross margin, by the way. Can you just give us a little more color on how much of that is a result from perhaps renegotiated pricing versus purely just low margin business just going away? I just want to understand that nuance a little bit. And then also for 2016, I think you said that you would have gross margin -- you could be at least as good as this for the year, but it sounds like there's variability and perhaps it would fall below this level potentially in an individual quarter. I just want to clarify that you weren't trying to say that this level in Q3 was an absolute floor. Thanks.

I will start with the deal. We are selecting on a deal by deal basis and we are doing all the things that you have said in different proportion, different regions and different customers. We walked away from some deals with very low margins, which you can see a little of that in the reduction of the revenue level. We also renegotiated some deals in some geographies and changed the terms and conditions to better gross margin. And being a little bit more careful in new deals that we are selecting on the table also contributes to the same mix.

Together, by the way, with activities at the back end of continual product cost reduction, operational efficiency and other measures, which also contribute to the gross margin [mode].

I would just add one comment. Actually looking out to 2016 and obviously before doing the thorough work of an annual operational plan, I think that the booking of the last couple of quarters is giving us confidence that the 32.4% that you have seen, it's not just the one-time occasion and it looks like it becomes a trend. Obviously, trying to be cautious, we said on the script that we have quite high confidence that we can sustain our gross margins above 30%, but we also commented that we believe that, on average, for next year, we can be at the level of the gross margins of Q3 and maybe even slightly above. And all of that, as I said, is based on the trends that we have seen in the last two or three quarters.

Okay, that's helpful. So let's just turn to the revenues for a second if you don't mind. So you said that your book-to-bill was below 1. I don't know if you can give us any more detail there. Was it 0.5? Was it 0.7? How bad was it and I'm just kind of wondering was there any kind of -- were there some deals that hit in Q3 that you did not expect to land in Q3 that perhaps you might have expected to land in Q4? I'm just trying to understand the dynamics around the sequential decline. And I guess sort of relatedly, are you seeing any slowing in a particular region -- any regions -- specifically other than just where you backed away on deals, is there any kind of softening in the environment reflected in that book-to-bill also? Thanks.

Okay. So we see the book-to-bill below 1. It's not, as you called it, 0.5 bad. It's mainly because of selecting deals, so it's causing a little bit of a slowdown. I think I mentioned also on the call a little bit, we see a relatively strong environment in the North America region and flat mainly in APAC and in Europe. We see Latin America continuing -- well, within Latin America, we see Brazil weakening because of the local currency. We see Africa weakening at this point mainly because a competitive environment and one of our larger customers in that area, which is a multicountry operator, is exiting the continent at this point. So while the transition is there, it will take time to pick up sales again to the local operators within the region.

And we see, by the way, India keep on going strong with a caution that we have seen India sometimes after a very rapid deployment at some point drop off drastically for a digestion period of deployments. We do not see a softness, I would say, globally. It's all local sometimes country by country, operator by operator, mixed with decision-making processes on our side, what we walk into and what we don't walk into so we can maintain healthy -- both a healthy profit and the margin and which really walks on both hand-in-hand with better payment terms and less need for working capital, which also has an effect on our cash flow.

All right. Thank you very much. I will pass it.

Alex Henderson, Needham.

So when I look at the numbers on the top line, I actually was not all that surprised that revenue was weak considering the macro conditions. If you were to parse between the pricing issues that you are addressing and the discipline that you are bringing to the gross margin and the broad macro conditions in emerging markets where raw material pricing has been under such pressure causing a lot of currency pressure, how would you parse between those two factors in the weakness in the revenues?

Without better, I would say, detailed analysis, about half and half and that's without doing it better. That's more of a gut feeling in between. I know differences in different geographies, but if I need to mix them up, it's about those numbers.

So when we are looking at the first quarter of 2016, I know you don't give guidance that far out, but historically that's been a sequential decline quarter, fairly steeply from the fourth quarter. Based on the change in the way you are addressing business, does that happen going forward, or alternatively is the price dynamic the dominant factor and therefore less seasonality in that quarter than normal?

I don't think that the seasonality will have a major impact. I think the way we pick and choose the deals, even if it's on account of keeping statistically the booking trend in the nice trajectory, this is the thing that is probably going to count more.

Adding to Ira's comment about your original question, we know that we had an impact just for the fact that some of the business is in local currency and that was quantified and I would say that it was definitely higher than $1 million this quarter. Obviously, some of the delays we see in projects that were either canceled or delayed is coming from the macro economy and on that, we definitely not have any control and this is why it's hard to quantify this piece and say, okay, we probably lost $5 million or $3 million or $6 million.

Given your comments last quarter that you expected essentially flat revenues in 2016 based on the change in the pricing structure and you are now down considerably first half to second half, should we still be anticipating flat for the year, or should we be putting a decrement down for 2016 based on the fact that your current run rate looks more like it's more in the $82 million to $85 million range quarterly and use that as sort of the baseline?

At this point, our expectation is that there will continue to be a trade-off between gross margins and top line and basically that drives to a conclusion that we expect lower revenue levels than what is out in the market up until now, but I want to emphasize that this is a trade-off and to the previous question's answer, the tradeoff is going to be in the gross margin that we see much better gross margins.

Right, so just to answer the question though, the question was first half versus second half. So I assume that the $80 million to $85 million run rate we are talking about here in the back half of the year is the reasonable level of run rate in the first half and second half of next year? We shouldn't be expecting any meaningful change in that, correct? We are not going to see another downdraft of 10%, 15% in 2016, I assume, on the revenues?

Obviously, things may fluctuate between quarter to quarter and as we said, we are not guiding for a specific top line. So I will just say that we need to continue following cautiously on the trends. Definitely the numbers that we have seen in the first half of 2015 are not the numbers we are planning for next year.

One last question. Actually two. One data point I forgot to ask. Headcount at the end of the quarter and then one last question. So you made the comment about rationalization of vendors in the space. It doesn't really seem like anything is changing on that front. Is there some reason why you think that that might occur, or is there any perception that there's going to be a change in the structure of the market because, otherwise, looking for 5G and rationalization of vendors is a long period.

We talked about long period of, yes, both trends are longer-term type of activities. I think the market is getting into a position where things will start to happen. I think also you'll see it from the top. You will see the Alcatel/Nokia merger will start taking place in the beginning of the year. So we believe that both rationalization and we started seeing also some of the 4G, 5G stuff starting to roll out. We have a lot of 5G discussions with people. People are pushing in that direction. It's not a [tumor] type of thing, but I think it will drive our growth a little bit further down the road.

Okay. I will cede the floor. Thanks.

George Iwanyc, Oppenheimer.

Ira, can you give us a sense -- just following on the same line of questions -- the type of visibility you have into 2015? When you look out on a regional-by-regional basis, you talked about how India might change quickly. Do you have deal flow that supports a one-quarter view, a 6 to 9-month view? How far out does it go?

I think there is two. We work in really, I would say, 3 or 2.5 (inaudible) out there. Nothing has changed from our visibility perspective or the way we work. We have immediate deal flow, which is usually for the next three months, which we see on the table, which is really things that we negotiate already both terms and probably also terms and exactly the content and stuff.

Further out, probably for another four to five months, it's deals we are involved in and further down than that, almost a year out, we have customer relations and contacts that we have with the customers, we know what their plans are. But remember, at this point in time, from our perspective, we are planning the budget for next year and using the rolling there. I don't see at this point any change in that type of visibility. Sometimes the visibility changes because of macroeconomics and stuff, which is happening sometimes quite rapidly. At this point, I think that most of what we see around the macro economy we are starting to factor in into what we see further down the road.

Okay. And then when you look within each of the regions, is the gross margin that you saw in this past quarter reflective of what you think is sustainable in those regions? Is India contributing at the level that you expect it to hold at or do you still see room for improvement within any particular region?

As I think Doron indicated, we will probably stay around the number we achieved in this quarter, which means under the current mix that we have, we believe that the gross margin profiles in the different regions will stay about the same as where we are. At this point, I don't see at this point significant changes neither by the way to the high upside and the downside within those profiles within the different regions. We do overtime expect, by the way, a little bit of shift in geographies, which would probably further improve the gross margin, but slowly. And we said that I think on the call in addition, we are going after some -- we see promising niche markets within the vertical spaces, which we go after, which might also have a little bit of an effect.

Okay. And then last regional question. When you look at North America, you seem fairly positive about the order opportunities there, but that's not including any new business from the one large carrier. So what's giving you the confidence with your existing business there?

What's giving us confidence is talks with those customers who are in a very good position and are continuing to deploy based on their plans and their plans into next year.

Okay. Doron, when you look at FX, are there any factors that we should be aware of?

No, I think the good very tight control over OpEx and there is -- we are a bit behind in terms of some of the recruitment in some areas. But, as I said, it looks like we can keep our OpEx at the level of $20 million to $21 million without affecting the business and the different initiatives that we have within the organization. So I feel that this level of OpEx is something that we can retain.

Okay. So when we look at R&D, sales and marketing, the levels that we are looking at right now are kind of the ones that we should look to see them settle in at?

Yes, more or less. There could be some shift between G&A to R&D or G&A to sales and marketing as we move along, but generally speaking, if we look at the bottom line of the total OpEx, it's going to be in the range of $20 million to $21 million.

And just my last question, on the currency side, are you seeing any unusual headwinds in any of the regions?

Obviously, we have a big challenge, especially in Latin America, in particular Brazil. And basically, after a huge decline in the last quarter, we hope for some rebound. But this is something that we don't have too much control except for trying to be more sophisticated in the future in the way we handle our exposures.

All right. Thank you.

(Operator Instructions). Mr. Palti, we have no questions in queue.

Okay. I'd like to thank everyone for joining us this morning. If you have further questions, or you want clarifications, both myself and Doron are available for direct questions. And we would like -- we would be glad to elaborate a little bit more on the details on one-on-one calls both on the phone and face-to-face over the next few weeks. Thank you very much for joining us this morning and have a good day.

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