Gilat Satellite Networks Ltd (GILT) 2006 Q3 法說會逐字稿

Good morning. My name is Jessica and I will be your conference operator today. At this time, I would like to welcome everyone to the Gilat Satellite Networks third-quarter 2006 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Thank you. Ms. Priest, you may begin your conference.

Thank you. Good morning and good afternoon. Thank you for joining us today for Gilat's third-quarter 2006 results conference call. Before we get started, I would like to remind everyone that today's call contains forward-looking statements. Such forward-looking statements involve risks and uncertainties. The actual results may differ materially from such forward-looking statements. Gilat Satellite Networks, Limited does not undertake to publicly or privately update or revise its forward-looking statements even if experience or future changes make it clear that any projected results, expressed or implied, will not be realized. That said, on the call this morning is Gilat's Chairman of the Board and Chief Executive Officer, Amiram Levinberg, and Tal Payne, Chief Financial Officer. Amiram?

Thank you, Andrea. Good day, everyone. On the agenda for today's call, we will go over our main business highlights, our key financial indicators, and then I will discuss Gilat today and where we are headed. After this, Tal will take you through the detailed financial results, and I will summarize the quarter. We will open the floor for questions right after this.

Gilat has had another strong quarter in Q3 2006 with good results and improvement in all key financial areas indicators. This is our fourth consecutive quarter of improved financial results. This quarter, we sold more business in emerging markets, especially in Russia, Africa, and Latin America, and more rural projects worldwide.

We also saw more deals related to business [continuity]. These types of deals are mostly relevant to U.S. business market.

In addition, during the quarter, York converted its loan into equity, greatly strengthening our balance sheet. We will discuss this and how it affects us later in this call.

Looking at the financial indicator summary slight, you can see a trend of sequential improvements in our two main financial indicators, revenues and net income. Revenues increased from $49 million in the third quarter of 2005 to $63.8 million in this quarter. Net income changed from a net loss of $1.7 million in the third quarter of 2005 to $2.7 million in the present quarter on a GAAP basis or $3.5 million on a non-GAAP basis. Tal will go into more details on our financials a bit later.

As we have detailed each quarter for you, Gilat currently operates under three business units -- Gilat Network Systems, or GNS, an equipment provider (technical difficulty) operator worldwide; Spacenet, a service provider in North America; and Spacenet Rural, a service provider primarily in Latin America.

This quarter, we have seen growth in sales by our GNS units, particularly in rural communications and the enterprise applications. We see an increase in USO, or Universal Service Obligation projects, for which Gilat is providing equipment. Two regions of particular growth this quarter were Russia and Africa, and we have seen growth over a longer period of time in Latin America.

The opening of the Russian market, which was relatively closed to VSAT technology due to [cost]-prohibitive regulations until recently, presents a growth opportunity for the market. We're working hard to penetrate this market, and have already announced our initial successes there in projects such as the one we are doing for the Modern University of Humanities, where the main application is distance learning, videoconferencing and Internet access. We are also expanding the market we address, such as with our [satellite backhaul] solution that we discussed in the previous call.

In August, we announced a deal with Enitel Nicaragua's largest telecom operator. There, we are providing a [satellite] backhaul solution, in addition to enabling Internet excess and telephony services for rural communities.

Spacenet Rural Communications is our rural telecom service provider which operates in Latin America, mainly in Peru and Colombia.

I want to clarify that when I mention a rise in USO and Rural Communications projects, these do not necessarily translate into revenues for Spacenet Rural, since we often provide the products in USO projects via GNS to other operators. One example of this is a contract we just signed with Portugal Telecom. They chose our SkyEdge technology to fulfill their USO to bring telephony and Internet accessed to more communities in regions of southern Portugal.

Spacenet, Inc., our North American service provider has recently announced that H-E-B has extended its contract. H-E-B, for those not familiar, is a large food retail chain in Texas and Mexico. This contract extension was part of a technology research proposed that was offered to H-E-B and is based on our SkyEdge platform. We propose technology refresh to our customers that are using our legacy products, and whose contracts are coming to an end.

We see this as an opportunity to upgrade their technology to Gilat's most advanced platform. These proposals provide excellent opportunities to increase value to our customers, such as higher bandwidth and managed network services. The H-E-B contract is one of a few technology refresh deals signed recently.

H-E-B is interesting, as it is an example of the news of our platform for buildings continuity. The main communication for H-E-B is performed by frame relay, while our VSAT network [perform part] redundancy.

Also, this quarter, York Capital exercised its option to convert all of its $70.4 million loans and $1 million interest into approximately $10.6 million ordinary shares of the Company. After the conversion, Gilat's outstanding shares increased from roughly 23.2 million shares to approximately 33.8 million shares.

York's decision to shift its position from a debtholder to a shareholder is a strong vote of confidence in our Company and we are pleased with the positive effect it has on our balance sheet. The York conversion marks the successful completion of our business turnaround with four sequential quarters of revenue growth and increased profitability.

We believe Gilat today is a solid company, well-positioned for continued growth. We have a wide global customer base, including some top tier operators such as Telefonica, Telkom South Africa and Optus. In the enterprise market, our blue chip customers include companies like [Dollar General], Valero, and Holiday Inn.

Also, we're not overly dependent on any single customer or project. We have a diversified revenue stream deriving from three main sources. First, the sale of equipment worldwide to operators and service providers; second, services in the North American market, mostly to enterprises; and last, services for Internet telephony and data communications for rural communities, primarily in Latin America.

The service revenues contribute stability and visibility to our business. While naturally, the potential slope for the organic growth is moderate, the equipment revenues enjoy potentially higher growth potential, which we have experienced this year, despite its lumpy nature between quarters. All in all, the diversification of the wide global customer base and revenue streams enables us to have stability and help us grow the business in a controlled fashion.

As for our product lines, SkyEdge is our the latest VSAT system and has very good market acceptance. We provide value-added solutions based on the SkyEdge platform for specific market segments, and continue to move up the value chain. This is for both equipment sales and for our service (indiscernible).

We hold a strong financial position. We have approximately $140 million in cash balances, while our total debt decreased to about $46 million, as will be discussed in further details by Tal.

Having successfully turned around our business, we're looking ahead at 2007 and beyond with plans for future growth. We plan to target certain segments that we believe will contribute to our long-term growth.

The first is business continuity. As previously mentioned, we believe that in the U.S. market, business continuity will become a growth driver as businesses increasingly demand backup solutions for the [main] communication week. The Cisco VSAT NM, which we discussed at length in our last call, is also intended to address this need.

The second driver that we foresee is USO -- Universal Service Obligation projects, which aim to improve the equality between the urban and rural populations. In these projects, public telecom operators are mandated by the government to provide universal services to all areas, and our technology offers a cost-effective solution for these needs. We see growth in these types of projects, and are focused on providing solutions and services to operators fulfilling their obligations all over the world.

The third driver is non-satellite wireless technologies. Wireless technologies in general, and specifically, WiMAX, can be viewed as both a complementary solution and a competing technology to satellite communication. The technologies complement each other when satellite is used for backhaul and WiMAX or other wireless technology is used for last mile access.

Some of our customers are already using wireless technologies. And looking ahead, we intend to leverage our customer base and expand our offering to include non-satellite wireless solutions as well.

The first driver is government markets. This market is characterized by significant government budgets allocated for either social equality projects or for national security projects. These are very different types are project, sharing a common denominator of unique communication requirements and a significant budget.

We already implement government projects worldwide such as projects serving the Ministry of Education in Mexico, the Russian Post, and large projects for the governments of Peru and Columbia. Given our experience in the field and the potential growth in the number of these projects worldwide, we see further growth for Gilat through penetration to new regions.

After evaluating the market segments and opportunities mentioned above, we set our 2007 management goals for double-digit revenue growth. Our goal is to see operating income and net income growing accordingly somewhat offset by expenses incurred due to entry into areas mentioned above.

Specifically, we intend to increase our net R&D budget to strengthen our core VSAT technology as well as to support our new growth drivers. In the core VSAT technology, our R&D will work to enhance space segment efficiency, business continuity platforms and improve Internet user experience. We will also integrate our VSAT technology with non-satellite wireless technology, and customized wireless solutions to our existing customers' need.

All in all, we plan to see our operating income grow while maintaining its ratio relative to revenues. We are excited about these new opportunities. They will enable us to leverage our core competencies and marketing presence towards other lucrative markets. We believe we will reap the fruit of this investment in 2008 and beyond.

Now, I would like to hand over the call to Tal Payne, our CFO, who will go into more financial details of this quarter. Tal, will you please?

Thank you, Amir. Good morning and good afternoon, everyone. I would like to take a few minutes to discuss the results we published this morning. We are pleased to conclude yet another successful quarter, the fourth consecutive quarter of improvement in our major financial indicators.

During this the third quarter, our topline increased by 30% year-over-year with a significant increase in our bottom-line results as well. As a reminder, our quarterly results for 2006 include the impact of FAS 123R, which is the inclusion of non-cash stock option expenses in the P&L. In our press release, we are presenting GAAP and non-GAAP results and reconciliation tables which highlight this data.

Now, I will go over our financial results in more details. Revenues for the third quarter were $63.8 million compared to $49 million in the third quarter of 2005, an increase of 30%. The increase is attributed mainly to strong sales for GNS, especially in emerging markets such as Africa, Eastern Europe, and Latin America.

GAAP net income for the third quarter of 2006 was $2.7 million or $0.11 per diluted share compared to a net loss of $1.7 million or $0.08 per diluted share from the third quarter of 2005. Non-cash stock option expenses accounted for $0.7 million in this quarter. Non-GAAP net income, excluding non-cash stock option expenses was $3.5 million in the quarter or $0.14 per diluted share.

Our gross margin is affected by our mix of products and services in the regions in which we sell and the size of the transaction. Gross margin for the third quarter was approximately 35.3%. In the third quarter, we performed an inventory write-off in the amount of approximately $500,000 mainly due to the closing of our previous Skystar Advantage 180 product line. As a reminder, this was our fourth-generation VSAT product, and tens of thousands of them are still operated in the field. Most of our customers today are already using our sixth-generation new SkyEdge platform. Excluding the inventory write-off, our gross margin for the quarter remains at 36%, in line with our expectations.

Selling, marketing, general, and administrative expenses for the quarter were $15.6 million, similar to the comparable quarter in 2005. On a non-GAAP basis, expenses decreased to $14.9 million.

Our operating income for the quarter on a GAAP basis increased to $3.7 million, and on a non-GAAP basis, to $4.4 million from an operating loss of $400,000 in the third quarter of 2005. Our EBITDA in the quarter reached $10 million, an increase from $4 million in the third quarter of 2005.

Now turning to the balance sheet, we finished the quarter with a total cash balances, including restricted cash, of $140.6 million. We generated cash flow from operating activity of $19.9 million compared to a negative of $5.4 million in the comparable quarter in 2005. Our payments for principal and interest on loans in the quarter amounted for $8.6 million.

I would also like to note that the third quarter, we benefited from some strong collection of advances from customers. However, this collection level can vary between quarters.

At the end of September, we announced that York Capital Management exercised its option to convert all of its $70.4 million loans plus accrued interest accrued interest of approximately $1 million into 10.6 million ordinary shares. Following the transaction, York's shareholding will represent approximately 33% of Gilat's outstanding and issued shares, with beneficial ownership of about 41.5%.

Our debt levels as of the end of the third quarter decreased from $117.5 million to $45.8 million. This conversion has also decreased our interest expenses going forward.

Our trade receivables at the end of the quarter were $35 million, representing DSO less than 60 days. Under our current liabilities, you can see that our other Accounts Payable increased by $14.4 million in the quarter. This increase is derived from strong collection of advances from our customers and growth in our deferred revenues.

Payment terms and revenue recognition differs between different types of customers and transactions. Hence, the increase is not an indication of a trend.

Shareholder equity increased by approximately $72.6 million, mainly as a result of the York conversion, reaching $166.7 million at the end of the third quarter.

That concludes my remarks. I will now turn the call back to Amiram.

Thank you, Tal. And now, for a brief summary. Our third-quarter results were strong. We see a sequential improvement in all our financial indicators for the fourth quarter in a row. Our financial position has improved, and York's strong conversion was also a strong message of confidence. We successfully completed the turnaround of our business, and we are looking ahead at 2007 and beyond with plans for future growth as we discussed in detail. With proven solutions, a wide, growing customer base, and strong financial position, we are ready to face the opportunities and challenges ahead.

Now, if there are any questions, we would be happy to answer them. Operator, could you help us with that?

(OPERATOR INSTRUCTIONS). Jim McIlree.

Thank you. Could you talk a little bit about growth in 2007? You're saying that you expect double-digit topline growth. Is that expected to be concentrated in one particular area? Or is that double-digit for all of your business units?

It's probably going to be kind of a mix, Jim. I would say that generally speaking, the area which we can grow faster than the others is the equipment sales, generally speaking, just because the service part is kind of more stabilized than the equipment by nature, as is described in my presentation. So as a general trend, I would say it will come more from equipment than from services.

Okay. And on the margin comment that you made, I just want to make sure I got it correct. You are saying that operating margins in 2007 are likely to be similar to what they were for all of 2006? Is that correct?

No, what I said -- what I said is that the operating income will grow -- means the number itself will grow, but it will maintain its ratio relative to the revenues. That's what I meant, roughly.

Okay, so I think we're saying the same thing on that. Great. And lastly, are there any particular geographies that you are planning to be more aggressive in in terms of equipment sales? Are you seeing growth coming from any special regions of the world that is greater than the rest, or is it broad-based?

It's mostly kind of international, if we would define domestic as the U.S. But other than that, we see -- since we have said that a major growth potential for us is USO and rural communication networks, we see that practically all around the globe -- and as you can see, even in this quarter, even in Europe, like the Portugal Telecom example -- so I would say internationally, but across the globe.

And the other growth which I've mentioned which is related to business continuity will affect more kind of bookings, less so with regard to the revenues, for the reason I have given before.

Okay. And I lied; I do have one more question. When you are looking at 2007, is there a lot of -- how much of that would be already in the backlog? And how much do you need to get in new orders in order to post double-digit topline growth?

Well, I'm not going to give you a specific, if you like, number. But again, naturally, when you look at the three business units, Spacenet Rural, being a service organization, is driven from large governmental project, where the projects are very big in size, but then you sign them only once in a while. So Spacenet Rural we predict fairly nicely. Then, Spacenet -- most of the revenues are kind of booked ahead, but we still [hunt] during the year to extend contracts and to have new contracts.

With regards to GNS, which is the equipment side of the business, there on one hand, we hunt from quarter to quarter. On the other hand, a phenomenon that we have actually -- starting like in the last year or year and a half, we have some fairly substantial backlog for GNS as well, just due to the fact that since we have increased our position in the value chain and went to multiple element deals for GNS as well, we have some nice backlog for GNS.

So I know I didn't give you an exact number to your question, but I tried to sketch kind of the flavor to the situation.

[Ittai Kidron].

Good numbers. Could you give us a little bit more inside as to where do you think your headcount is going to go next year -- with all the opportunities that you're going to pursue, what kind of hiring you need to do and in what areas?

Don't see a very significant change in terms of headcount during the year -- probably some increase in R&D; not very significant, but then don't see very significant. Obviously, when we grow revenues and sales will increase to some extent -- but all in all, not a very big change in headcount.

Okay. And can you comment on the current price environment on the equipment side? How competitive are your competitors right now? Are you seeing anything unusual on that front?

Well, it's always competitive, but let me put it this way. The more the project or the bid is kind of standard, it means if people are looking for [research] for connectivity only, be it for the Spacenet services or for equipment that GNS is selling, then the price can be very competitive. And if the product is kind of plain vanilla, it means the only protocol they are [interested is] TCP/IP, and no specialty whatsoever, then the product is very competitive, and specifically when it comes in kind of big [VSAT] numbers.

The more unique the project is, the more customization we have, then obviously the pressure is lower because we can do some tailored solution. We can provide other services and we may sell value-added solutions to our customers, and there the pressure is kind of lower.

In nature, I would say that the larger the orders, the lower the gross margin as a rule of thumb, if you like.

And last question, Tal, on your income statement, you have the grants over there that are offsetting your R&D expenses. Can you give us a little bit more color whether this is something that is going to be a recurring going forward, one time, and how much visibility you have into that so we can kind of model it appropriately?

I would say we don't expect to see this number change significantly next year -- the same level that we saw this year -- not on a quarterly basis because sometimes you have fluctuation between quarters. But in an annual level, we expect it to stay approximately in the same amount.

Tom Watts.

Congratulations on the quarter; it was very good. (multiple speakers) A couple of questions. One, (multiple speakers) in terms -- you mentioned that next year, you talked about headcount increase, and an additional investment in R&D. You've made great progress on the EBITDA margins sequentially every quarter. Do you have a target that you're shooting for on EBITDA margins? And with the increased investments, do we see improvements next year? Or could we be below the level that came in this quarter?

There was kind of lots of noise, Tom, on the line when you asked the question, so I would apologize and ask you to repeat it kind of shortly.

You've made lots of improvements on your EBITDA margins. You mentioned that you're going to be investing next year in R&D. With that incremental investment, could we see EBITDA margins go below where we saw this quarter? And how should we think about EBITDA margins for '07?

Generally speaking, I would say that if we look at the parameters and will see that, obviously, the gross margin as a number will go up, and then operating will go up and net income will definitely go up, with that caveat in the operating as I have said before.

But, as a trend, we intend this year to make a shift between options and salary. It means next year we will see less options and more remuneration in cash. It means bonuses. And for that reason, the effect you will see on EBITDA is going to the smaller than on any of the other parameters I have mentioned before.

This year, we have I think roughly 3.8 or $4 million worth of options. Next year, you will see a lot lower number. This number is going to be translated into bonuses. And this is a policy that we have decided to adopt after we have seen what other companies are doing, and what will attract our employees more.

So to summarize, we will see improvements in all of these parameters; less so in the EBITDA.

Okay. And then also, Andreas Georghiou has been on line a couple of months at Spacenet. You talked about your business continuity focus in the U.S. Has there been any shift in strategy at all? And is there any progress we could mark? And how have the leads on the Cisco VSAT NMs been going in the U.S. market so far?

As we have said last quarter when we talked about the Cisco NM, this is a process that is going to take quite sometimes. And to answer the question, I've been asked whether there will be a result to that deal this year, and I said no. We will be able to see results only in 2007.

The reason to that is that this is a really -- Cisco NM is a Cisco product, and sales are driven by Cisco. And therefore, it's really up to them, combined with the long cycle of doing VSAT [sale] in any event. So I would expect to see outcome to that in the year 2007, as I've said in the previous quarter.

The fact that Andreas is with us for two months is great. We're very pleased, and we think there is a big change in Spacenet. But results with regard to Cisco to be seen practically in 2007.

As a minor [effect], I should also say that it helps us in other sales. For example, you might have noticed that the Portugal Telecom deal I've just mentioned before is a deal where Portugal Telecom said they wish to be a Cisco-certified [hub] operator. It means they see opportunities for them to leverage in them. And I'm quite confident that this was a consideration for them to prefer us as the vendor for the [hard and the] system. But as I've said, will see a real effect in 2007.

Okay. And final question for Tal, could you just give us a little bit more detail on that increase and payables of 14 million? And is that something that is likely to be sustained or is that temporary?

I will say the following. It's pretty similar to what we saw last quarter. Last quarter was the same effect as the line item increase in approximately $20 million in this quarter and $14.4 million, and it's the same explanations. We have very strong collections of advanced system customers. We're doing a good job in collections and taking the appropriate levels of risk with our customers. So we are collecting in advance a lot of our sales. You can see it in the cash side, and you can see it in the liability side. I would not say it is an indication of a trend.

Jim McIlree.

Cash generation has been terrific in the past two quarters, but some of it has come from working capital. I was wondering if you'll be able to continue to generate cash from working capital going forward or if there is something that's changing about your business that will cause you to require cash for working capital?

I will say the following. It really depends on the type of sales you had and in which region they had. The last two quarters, we actually generated cash from operating -- from working capital. I don't think it's the right trend to assume going forward. We would like to increase our sales in the next year. And in order to do that, we will probably have to have some investment in working capital. Nothing dramatic, but just ordinary course of business. The last two quarters -- I will not take them as an indication for the future.

Okay. Terrific. Thank you.

[Jonathan Lamenthor].

A couple of quick questions. You guys had cash of $140 million, which is $106 million in cash equivalent, $11 million in restricted cash, and $22 million in cash payments held by trustees. Can you just explain exactly what's restricted cash and the cash held by trustees are, both short-term and long-term?

Sure. I will take that one. I will start with the larger amount which relates to cash restricted in the trustee. It's relating to Compartel II project, a project that we have in Colombia. The government paid all the amount into the trustee. This is the cash that you see in those amounts. In previous years, it was up to 65 million. We released this cash based on specific milestones. We met most of the milestones -- up till today, all of the milestones that we needed to. So 60% was released in the first year. The remainder of the amount is released over the remaining period of the service, which is around four years. So the split between the short-term and the long-term representing our expectations for release from the trust of these amounts. The amount used in the short term is the amount we expect to release in the next 12 months. And the amount you see in the long term is over the remainder of the life. So that's regarding the restricted cash interest [fee].

Regarding the other restricted cash, it's regular cash that related to performance bonus that we provide in part of our transactions. And 5 million out of it is relating to our lease contract in the U.S. for [special] building.

And how large are your NOLs now?

I don't recall the number exactly. I think it's around $160 million. (multiple speakers) all in all, yes -- in the U.S. and in Israel.

Okay. And lastly, why is your growth so different than what Hughes Communications is seeing?

Perhaps you should refer this question to Pradman. (laughter) But (indiscernible) -- no, we wouldn't like to refer so much to Hughes, but to say that we are very much focused on enterprise and rural telecom. Hughes is more focused on consumers these days. And I guess this explains some of the differences between our results and their results.

Thanks; congratulations.

[Jennifer Adams].

My question was asked earlier by Tom. I was just calling in on his behalf. But thank you.

[Christian Reimans].

The question was regarding Cisco, and it has already been asked. Thank you very much.

(OPERATOR INSTRUCTIONS) [Larry Harris].

Congratulations. This is actually David Friedman for Larry Harris. I was wondering if perhaps I could ask you a question about your taxes and what can we look at going forward?

Sure. I will say the following. It's a continuation of the question of the NOL, I would say we don't expect to see taxes in Israel, since we have tax losses enough for a few years. The same situation in the U.S. at the moment, where the tax losses for enough years as well there.

The only place we actually pay taxes at the moment is Latin America, since in many of these countries, we are profitable, and these are the taxes you actually see in the P&L in the last few years.

I will say you should expect the same level of taxes for next year. One thing I will say is obviously, when you continue to be profitable, at a certain point, you will have to write or accumulate your deferred taxes assets, and then it affects the taxes in the P&L. Obviously, it doesn't affects the tax payments, or the cash payments, but you have to take that into account in the long run.

Thank you so much and congratulations again.

[Dore Konna].

My question is about the increase in outstanding shares. Is that going to be offset by the savings and the interest when the earnings per share are computed going forward?

I will say the following. At the moment, in the diluted shares before the transaction and after, it was not diluted, and therefore was not included in the calculation, meaning that the interest divided by the number of shares of York was higher than the diluted EPS. So we shouldn't see effect until the point that actually there the EPS would increase. And therefore, it will be pulling the EPS lower (indiscernible). Was it clear or should I repeat it?

I'm sorry; could you repeat that?

Sure. I will say the EPS in this quarter was $0.11. If you take the interest payment to York divided by the number of shares of York, it will be approximately $0.13. As a result of that, it was not dilutive up to this point, because the EPS was lower then the amount relating to York. Once the EPS will be higher, then it will be dilutive.

(OPERATOR INSTRUCTIONS). At this time, there are no further questions in queue.

Okay. I would like to thank you very much for joining us this quarter's call, and I expect to communicate again next quarter. Thank you very much, and bye.

This concludes today's conference call. You may now disconnect.