Ceragon Networks Ltd (CRNT) 2015 Q4 法說會逐字稿

Good day, everyone. Welcome to the Ceragon Networks Limited Fourth Quarter and Full Year 2015 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 as defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on the current beliefs, expectations and assumptions of Ceragon's management. For examples of forward-looking statements please refer to the forward-looking statements paragraph in the press release that was published earlier today. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially, including risks associated with a further decline in revenues beyond Ceragon's expectations; the risk that Ceragon's expectations regarding future profitability will not materialize; the risk that Ceragon will not achieve the benefits it expects from its expense reduction and profit enhancement programs; the risk that Ceragon will not continue to comply with the financial or other covenants in its agreements with its lenders; risks associated with doing business in Latin America in general and in Brazil in particular, including currency export controls and recent economic concerns; risks relating to the concentration of our business in India, Africa, and in developing nations, including political, economic and regulatory risks from doing business in those regions; the risk of significant expenses in connection with potential contingent tax liability; 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 from Ceragon's website at www.ceragon.com.

I'll 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. Both our Q4 and full year results validate the effectiveness of our value-based sales strategy. Before discussing the details of Q4, I'd like talk about the full year, which illustrates the progress we have made since we began implementing this strategy more than a year ago.

In 2015, we returned to profitability and exceeded our goal of $7 million non-GAAP net income. This was achieved through a combination of continued improvement in product cost, very stringent control of operating expenses and most important, through implementing our value-based selling strategy. This strategy focuses on pursuing the highest value deals, meaning the ones that meet our profitability and working capital criteria. This usually means deals where the operator is willing to invest their own time and resources to assess backhaul vendors individually and award the largest share of the business to the vendor they believe offers the best overall value for their particular requirements.

During the course of 2015, we have been able to increase our non-GAAP gross margin by close to 700 basis points from 26.3% in Q1 to 33.2% in Q4. That is while we did not have an optimal geographic mix to help us. We are pleased that North America was up 15% in 2015, however, revenues from India was also up by the same percentage in 2015, and other regions that tend to have gross margin above the corporate average declined year-over-year in 2015.

Perhaps, in the future, we'll be fortunate enough to see the geographic mix shift towards all the highest margin regions at the same time, but any such shift is likely to be temporary. Therefore, we pursue a strategy on a deal-by-deal basis, globally, despite the regional ups and downs.

For the full year, we generated about $10 million in free cash flow which we used to reduce our debt and optimize our finance structure. In addition to our near-term goal of sustaining and improving profitability and positive cash flow, our longer-term goal is to maintain our technology leadership, increase our share of high-value deals, and eventually return to a pattern of revenue growth, as requirements for ultra-high capacity solutions increase and vendor consolidation continues.

Our analysis of our available data indicates that we have the highest share of the best-of-breed portion of the market and only one other vendor, which is NEC, has a share as high as ours. This segment of the market remains fragmented and likely to consolidate.

As we begin 2016, we are taking some steps to fine-tune our execution in an effort to optimize the trade-off between revenue and profit, and we believe sustaining profitability remains job number one, particularly with macroeconomic headwinds developing.

Turning to Q4 results, we achieved our profit goal, reporting sequentially higher gross margin, but lower revenue compared with Q3, and we were pleased to record our third consecutive profitable quarter. Like other telecom equipment providers, we are seeing macroeconomic uncertainty developing, particularly in emerging markets, primarily as a result of lower oil prices and the strong US dollar.

In general, business in North America appears to be pretty steady. Although North America declined sequentially in Q4, this was partially due to the timing of revenue recognition. Europe also seems stable, at a low level by historical standards, due to weakness in Eastern Europe, as well as the Euro. The current business for us in Europe is coming mainly from Tier II operators.

Business also looks steady in Latin America, aside from regions like Brazil where we consciously reduced our exposure. We have gained new customers in Mexico, and they are becoming significant as a result of the competitive mobile network expansion going on in Mexico.

Africa remains weak by historical standards, mainly due to macroeconomic caution; as well as one large customer of ours that is slowing down its deployment due to some pending strategic decisions. APAC tends to be lumpy, but so far we don't see any shift in the overall tone of business. Finally, India continues to be relatively strong, but is one of the regions we are keeping a close eye on for signs of macroeconomic effects.

As we indicated before, we continue to target a further improvement in profitability in 2016, as a result of higher gross margin on lower revenue compared to 2015. We believe we can sustain our gross margin above 30% and continue to maintain tight control of our operating expenses. The extent of our year-over-year profit improvement in 2016 will depend on whether macroeconomic headwinds intensify, causing operators to reduce or delay their spending regardless of capacity needs.

Looking beyond this year, we are pleased to see market demand continuing to evolve toward our strengths, as the global 4G build-out must continue. The only question is, at what pace? Our ability to sustain positive cash flow will enable us to continue to invest in order to exploit our vertical integration advantages in terms of both product costs and time-to-market as we begin to prepare for the next major technology cycle a few years out.

You have probably noticed that the industry is beginning to talk about 5G. We also made an announcement last week in advance of Mobile World Congress that describes our particular strengths as the market evolves toward 5G. However, it's important to separate vision-sharing and thought leadership from any near-term impact on our business.

You won't see 5G deployed to any significant extent for the next several years. More than anything else, operators are eager to avoid a forklift upgrade requiring them to rip out the equipment and replace it. Therefore, it's important for us to begin now to show them how we have anticipated the major requirements of 5G networks when designing the IP-20 platform. This foresight will enable a simple, cost-effective evolution from 4G to 5G that preserves as much as possible the investment being made now in Ceragon's wireless backhaul solutions.

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. Since you have all seen the press release, I'll just highlight some of the significant items. Our fourth quarter revenues of $75.6 million represented an 11% sequential decrease from Q3. The geographic breakdown of Q4 and full-year revenue appears in the press release.

There were no major shifts in geography from Q3 to Q4. APAC tends to be lumpy; this quarter it was partially due to revenue recognition timing from one of our bigger customers as was the case in North America as well. We had one above-10% customer in the quarter, a large operator in India that is a long-standing customer. Once again, we significantly exceeded the gross margin target we set to ourselves a year ago.

In Q4 our gross margin improved sequentially to 33.2% on a non-GAAP basis. We believe we can sustain gross margin levels above 30% in 2016, with some fluctuations from quarter-to-quarter based on the exact mix of revenues we'll recognize during a particular period. Non-GAAP results in Q4 excluded a net income of $3.2 million of the usual items, non-cash tax adjustments partially offset by stock-based compensation and amortization of intangible assets.

In Q4, we continued to maintain tight control of our operating expenses, which were $20.2 million. We expect to keep this level during the current year. We reported a non-GAAP operating profit of $5 million. Our non-GAAP operating margin of 6.6% 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 down from Q3 to $2.3 million. Our non-GAAP net income was $2.1 million, or $0.03 per diluted share.

Turning to the balance sheet, receivables were $120 million, with DSOs of 126 days, in line with our expectations at the beginning of the year. One of our goals is further optimizing cash balances and debt facility utilization to reduce interest expenses. At December 31, 2015, we had cash and cash equivalents of $36.3 million, lower by approximately $3 million from the cash levels at the end of Q3. We generated positive cash of $6.1 million and we reduced our debt to $35 million at the end of Q4 from $44 million at the end of Q3, leaving us at year-end with roughly the same amount of cash balances as loan balances.

Our book-to-bill ratio was slightly below 1 in Q4, which we attribute at least partially to macroeconomic factors. This, together with typical seasonality, suggests sequentially lower revenue in Q1. This is something we already expected and mentioned on the last conference call, but the decline may be a bit greater than we expected earlier in light of the developing macroeconomic headwinds. On top of this, we have a timing issue with one customer which may impact revenue recognition in Q1 as well.

As we mentioned, based on the success of our sales strategy, we expect our gross margin to remain solidly above 30% throughout 2016 and we want to emphasize that we believe we can achieve significantly higher profits in 2016 versus 2015 and sustain positive cash flow, unless macroeconomic concerns spread and intensify beyond what we are seeing now.

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

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

So, just want to understand your comments on seasonality a little more, for Q1. I look at the last couple of years, it was down 60% sequentially in March of 2015 and 21% in March of 2014, I'm wondering if that's what you consider normal seasonality down 15%, 20% and maybe help us to understand like how much more exaggerated that could be in Q1?

I don't think it could be more exaggerated than what you have indicated. However, this is pending some revenue recognition issues that we have with one of our projects. But generally speaking at this point, we do not expect something that is more, I would say, deeper than what you have just mentioned.

Okay. And so relatedly on the revenue recognition issues, so I think you mentioned that North America and APAC, so I think North America issue was bigger, but you had rev rec issues for both regions. Is your guidance for Q1 assuming that some of that revenue is scored or are the revenue recognition issues that you're citing that are affecting Q1 are those the same that are affecting Q4? And I guess, I'm wondering when you expect to recognize that revenue that you're missing in Q4 and perhaps even how big that is?

So, first of all, referring to North America, the issue there is much smaller. And yes, we do expect this to rebound in Q1, and we're working on that, but it's still work-in-process. Regarding the other business, it's much bigger, it could be up to $5 million, even $6 million impact on a specific quarter. In both cases, North America and APAC, we do believe that we will be able to recognize these revenues for the rest of the year.

So, just to be clear that the rev rec issue that's -- potentially affecting Q1, that's the same issue that was affecting Q4 or are those are separate in terms of APAC or are those separate issues?

In APAC, it's basically the same issue, it's a big project where the acceptance process that is defined in the contract is not exactly what's going on in the field, and the customer may have other priorities, and eventually all of us know that the customer is the customer, and we are working closely with the customer to satisfy his need, as well as figuring out what can be done.

Okay. So, I guess just relatedly here on the revenue level. So, Q1 is going to be down. I mean, this is -- Q4 is the, I guess, fourth quarter down in a row that's down. Just wondering like the absolute revenue level is -- is this Q4 level kind of roughly what we should expect this year? Should we expect the average of the year is lower than that. And I know there's a lot of uncertainty out there, which from a modeling perspective just looking at the trajectory, any kind of help you could offer on revenues, even if it's vague would be helpful. Thanks.

Yes, with the caveat of the headwinds in the macroeconomic that we have started seeing, I think that you need to think as, on 2016, as the average level of the last quarter meaning Q4 of 2015. This should be the annual average number for each and every quarter in 2016.

Okay and last one, what's the status of the credit facilities? My notes here have it due in June, is that still the case? And I assume you'd be extending if it's due in June.

We're on the last milestone of extending it. Basically everything is a grid upon and it's just a matter of just signing the papers. We believe that this will be behind us within two weeks or three weeks max.

Alex Henderson, Needham.

Yes, so it was a good line of questioning, I thought I'd just make sure that I'd punctuate what we heard. It sounds like your revenues for the March quarter were down around the $60 million revenue level. But for the full year, you're suggesting a number that's close to $300 million, which would suggest you've growth starting to rebound in the back half of the year, is that the right way to think about what you've said?

Yes. We do believe that if what we see in the macro is relatively short-term, that's going to be the behavior of our revenue in our business throughout 2016.

You also said in the comments that you expected to be profitable across the year, but it doesn't sound like the first quarter achieves that goal given that $60 million level, even at 32%, 33% gross margin, it looks like that would be a loss, is that also accurate?

Basically, as you said, if you assume a very low top line, all the way to $60 million, we could be in a situation in which we'll have a relatively small non-GAAP loss. But we believe that the rest of the year is going to be profitable and hopeful if we can recognize the revenue that we cannot recognize in Q1, and throughout the rest of the year, we will compensate for that.

At the same token, if we are able to come to a higher revenue as part of accelerated acceptances or negotiation with the customer, the numbers can still be, in terms of bottom-line for Q1, still be positive.

So, it's right around the area. Okay. So, the other question is around the interest expense line. You've obviously done a great job of bringing down that debt position to now a net cash position. I assume that as you're renegotiating, your rates are coming down as well.

So, can you give us some direction on what the trajectory of that interest expense net other line is going to do? Is it going to still be in the [1.6, 1.8, or 1.9] range in the first half and does it go below that in the back half? When is the inflection point when they actually -- your rates change?

So, first of all, you need to bear in mind that our financial expenses are not including just the interest. The big piece that we have suffered from in both 2015 and also in 2014 is the foreign exchange rate, especially in the developing markets. You probably know that during 2015, the dollar went very strong, oil prices went down and this had a lot of adverse impact on this line.

So, I think that we need to think in terms of what we can influence and what we can't. And I would say, generally speaking, that if we are at the run rate of $2.3 million, approximately half of it, maybe slightly less than that is foreign exchange rate. If currency rebounds, we'll probably see much better results in this line. The rest of the piece, which is interest, I think you should talk about between $50,000 to $100,000 decline from quarter to quarter.

Okay. So, if I assume the dollar is flat versus the shekel, then that would be [1.6-ish] kind of number.

Yes, and I can tell you that the shekel is the least of our problems. We have a very good hedging methodology and hedge -- shekel is not our problem.

Our problem is exotic currencies such as the Indian rupee, such as the Nigerian currency, to some extent the Brazilian, and the Argentinean currency, that either you cannot hedge them or the cost of hedging is so huge that you have no choice, but just take the risk and try to do some, what I would call, a natural hedge. But generally speaking, 1.6 could be a very, very good target for us assuming the currency effect is much lower than what it was last year.

I see, okay, I get it. And then just going back to this revenue recognition issue that you're highlighting for 1Q, does that -- is it likely that that's going to cause a lump in quarter as the March quarter is a lump out quarter where you get a spike in, say the June or September quarter, or is it likely to be spread over the course of the remaining three quarters of the year?

Yes. At this point, I think that what we will see is that this up to $5 million or $6 million are going to spread over the year. And only if we can either do some significant change in the engagement, this would actually be something that is happening in one quarter and we see some lumpiness there. I think that the assumption should be that this will probably spread over the year.

Okay. I'll cede the floor. Thanks.

George Iwanyc, Oppenheimer.

Thank you for taking my questions. Going back to the quarterly trends for 2016, what gives you the confidence that you can get revenue back above $75 million at some point? Which regions do you have a good visibility into, from either a deal flow standpoint or individual customers that already have given you discussions on order flow?

I think that's -- I think you mentioned exactly where we are. A, we'll look at our backlog at this point and see what's the inflow of deals that we had over the last two or three quarters coming in and what rate they will sustain. And then looking at the rest of the year across the regions, we still see strong demand in India. We see demand in the US market, in some of the Latin American markets. I think I mentioned over the call, both Latin America excluding Brazil and Mexico coming in. We see stable demand in Europe and that's why we think we can sustain those rates.

From -- and that's assuming the uncertain poor macro environment that we have right now. So, it would have to get worse to not provide some growth in later quarters.

Yes.

Okay. Shifting a little bit, the IP-20 platform has given you a lot of flexibility in incorporating new technologies. But with the small decreases you've seen on the R&D front from quarter to quarter, how long do you feel that you can sustain the flexibility in the leadership with that platform without having to start ramping up spending on R&D again?

You have to remember that at this point we're spending both on the platform and its flexibility and continuing driving the platform forward, and already spending on the future pieces, which will come out later. We believe that the current rate of R&D is something that we can maintain and do not need at this point in the foreseeable future to ramp it up.

Just look at the announcement, and yes, it's a vision and some of it is technologies that we have already, but not productized yet and some with the stuff that we're walking that we announced before Mobile World Congress as the 5G discussion starts now for three to four years or five years down the road from now. So we believe we are well-positioned within the technology cycle, both now and moving into the future.

Okay. And just a final question on the competitive side. You mentioned that NEC seems to be doing fairly well on the higher value segment. Do you see the vendors continuing to stay in the market, but at different segments or do you see actual consolidation at some point?

On the top in the market which is the non-value based, more commodity based, the big players are mainly the big vendors, which is the Huawei-Ericsson and some light of the ALU-Nokia business at this point, which is mainly bundle the deal. There I think -- that's my personal opinion, we are probably seeing the consolidation happening with three big players.

In the value based where we play and where we are the largest together with NEC, yes, there are different shifts and moves in there, mainly from the smaller vendors. We do expect this market to have shifts, consolidations in other place within it over the next couple of quarters.

All right, thank you.

Gunther Karger, Discovery Group.

Yes. Two questions, number one, what percentage of your total revenue is represented by vertical markets and would you care to make any comment on the vertical market?

Doron Arazi: The percentage of revenue from vertical market is not high, it's probably the level of 30%, 40% and even lower than that. It depends how you quantify the vertical markets. If I sell to a distributor, to a Tier II operator, and I have a negotiation with this to Tier II operator directly, is it vertical or is it our main market? So, it's hard to really quantify it, but it's probably around the numbers or even slightly lower than that. I think that we have seen this market as being relatively steady. So, no way specific color on that unless, Ira, you want to add on top.

I will add on top of that, that yes, we do put a focus on some of the vertical markets. They still stay a small percentage of our overall market, probably a bit of a larger share of our business comes from that from the overall market in there. They do compromise a nice segment within the best-of-breed, because those are markets where they really buy on value.

We did put an offer and we are pushing very hard into the public safety market in the US. We introduced new products into that market end of last year, early this year. We are focusing also on a big advantage that we have in, what we call, moving platforms, mainly around oil and gas drilling, which we see both trends in there because of oil and gas sometimes slowing down, sometimes accelerating to save expenses using a lot of more -- a lot more data in the market, and we do see that as a very significant part of our sale-on-value strategy.

Thank you, Ira.

(Operator Instructions) Alex Henderson, Needham.

Yes, I just wanted to make sure that I've clarified some of the comments you had made. It sounded like you expect the full-year profitability to actually improve in 2016. And I think you've even used the word significantly improving in 2016.

Yet, when I run the model out here with possibly a breakeven to slight loss in the first quarter and returning to $75 million plus type numbers in the remaining three quarters and using around a 33% gross margin, and again using about the same level of OpEx. I'm not actually coming up with an increase, I'm coming up with a slight decline in earnings for the year. Could you disabuse me of some of those assumptions that are allowing me to come out with the result that's consistent with your positive comments about the trajectory?

First of all, let's make it clear. We were talking in the formal announcement about two aspects; one is profit and the other one is profitability. We said loud and clear that we believe that we can maintain the level of the gross margins, which is basically profitability at the level of the gross profit, strongly above 30%. So, I don't know what you put in your model, but generally speaking --

Using 33%.

-- it could get even to 33%. Although as we said, we are very cautious and there could be some lumpiness there as well. This is one thing.

The other thing is -- and we stated that a couple of times back, we're talking in terms of constant currency. We're taking very small impact of exchange rates in our model, because this is something that we cannot control and probably the other difference is in the numbers of the finance expense.

Okay, I'm using the interest at $1.5 million per quarter, which is I think consistent with your interest expense line, excluding currency and gross margins of 33%, which sounds a little large, and I don't get an increase in profitability for the year. If I did that math out. Am I missing something here? I mean, it doesn't sound like you're forecasting an improvement in EPS for the year, am I correct in that assumption?

This is not the model we have in front of us under constant currency, and we do expect to have a significant improvement in the bottom line. So if we did $7 million or $7.4 million in 2015, we do expect to exceed that on a constant currency basis significantly.

Okay. I'll cede the floor. Thanks.

And Mr. Palti, we have no further questions in queue.

I'd like to thank you all for joining us for today. Like always, you're welcome for follow-on discussions on an one-to-one basis. We are glad to entertain further on questions.

I'm also inviting all of you, we'll be next week in Barcelona, to join us and come and meet us face-to-face in our booth at the Mobile World Congress. We'll be having and exhibiting some of our products and some of our vision and technology towards the 5G world. Thank you very much everyone.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.