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Gilat Satellite Networks Ltd. (NASDAQ:GILT)

Q2 2009 Earnings Call Transcript

August 11, 2009 9:30 am ET

Executives

Tom Watts – IR, Watts Capital Partners

Amiram Levinberg – Chairman and CEO

Ari Krashin – CFO

Analysts

Jonathan Ho – William Blair

Larry Harris – CL King

Howard Sterling – Hudson Securities

Rich Valera – Needham & Co.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Gilat's second quarter 2009 results conference call. All participants are present in a listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. (Operator instructions). As a reminder, this conference is being recorded August 11, 2009.

I would now like to turn the call over to Mr. Tom Watts from Watts Capital Partners to read the Safe Harbor statement. Tom, please go ahead.

Tom Watts

Good morning and good afternoon. Thank you for joining us today for Gilat's second quarter 2009 results conference call. A recording of the call will be available beginning at approximately 12:00 PM Eastern Time today, August 11, 2009, until August 13, 2009 at 12:00 PM. Our earnings press release and website provides details on accessing the archived call.

Investors are urged to read the forward-looking statements in our earnings release, which say that statements made on this earnings call, which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All forward-looking statements, including statements regarding future financial operating results involve risks, uncertainties, and contingencies, many of which are beyond the control of Gilat and which may cause actual results to differ materially from anticipated results.

Gilat is under no obligation to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise, and we expressly disclaim any obligation to do so. More detailed information about risk factors can be found in our reports filed with the Securities and Exchange Commission.

That said, on the call this morning is Amiram Levinberg, Gilat's Chairman of the Board and Chief Executive Officer, and Ari Krashin, Chief Financial Officer. Amiram, please go ahead.

Amiram Levinberg

Thank you Tom. Good day everyone. I would like to begin today's call with a highlight of our second quarter results followed by more detailed review of our business during the quarter. After this, I will take you through the detailed financial results, and then we will open the floor for questions right afterwards.

Our second quarter ended lower than the comparable quarter in 2008. Taking into account the continued challenging economic environment, this is not unexpected. On a positive note, we continued to release less money from the restricted cash held by trustees in Colombia and recognized more revenues from our Colombian operations. Indications from Columbia are good and we are meeting our obligations according to the new agreement with the Colombian government.

We're also beginning to see the first signs of optimism in the market, which has been sluggish for quite some time. So while we cannot say anything concrete on this, we think that the market will improve in the second half of 2009 compared to the first half. Also we have just recently announced two new products, one for the US and the other focused on developing markets, which I will talk about more later in the call.

Looking at the developed markets, business results were somewhat lower than in the comparable quarter in 2008. If you remember in the previous quarter, I mentioned that the recession in the US is having an effect on Spacenet's business, so this is not unforeseen. Despite these, Spacenet signed several extensions of existing contracts as well as expansions for additional services during the quarter, a large portion of which came from the gaming sector.

In the developing regions, we announced several new contracts, Servicio Satelital in Argentina, Telikom PNG in Papua New Guinea and Taiwan's CSD Telecom. Latin America remained strong in the quarter compared to the comparable quarter in 2008 while in other regions, we see the market conditions still challenging, and this has had a negative effect on our results.

We also continue to see US LTE [ph] projects and government funded initiatives (inaudible) communications around the world, usually in the developing countries. Both Telecom PNG and CSD Telecom in Taiwan, which as I just mentioned earlier are good examples of such projects.

Moving to the financial indicators summary slide, revenues for the second quarter of 2009 were $56 million, a decrease compared to the – compared with quarterly 2008. Having said that, we are seeing more positive signs in the market and while it is too early to say, we believe we have passed the lowest point in this trend. Nevertheless, this quarter, we took further cost-cutting measures, which included certain compensation and benefit modification. We will see the effect of these measures starting in Q3.

Ari will discuss the Q2 2009 results in more detail later in the call. Getting into a little more details in our business during the second quarter, I will begin with the developed market. In the past year, Spacenet has been fairly unaffected by the recession in the US though this quarter we have begun to feel the slowdown in the economy. In the second quarter, Spacenet continued to receive orders from customers in the gaming sector.

It is interesting to note that while many of our customers are effected by the economic environment and longer sales cycle, the gaming sector behaves a bit differently. When a sales lottery is opened to a tender, this is irrespective of the financial climate. These tenders are usually much new operational deals and most often require new terminals to be installed. As such, opportunity for the gaming sector are really driven by the schedules of the states that have lotteries and not other sectors.

Last year, for example, there were several such tenders and we were fortunate in a few of them with our gaming customers prevailed such as in Ohio and Pennsylvania. In other sectors, Spacenet also continued to receive extensions and expansions in existing networks in the first quarter. In addition to the commercial customers, Spacenet also continued to focus on government customers at the municipal, state and government level, mostly providing communication for emergency requests.

Also this quarter, Spacenet announced a new product offering. Based on the present forecast, many of our US enterprise customers require hybrid network solutions that are committed to both terrestrial networks and the satellite network. Spacenet now provides a communication package that includes both of these components as well as managing other aspects within the site, such as connectivity management and router configuration.

In the past, we would often do this with Prysm which would have two boxes at the customer site, a VSAT terminal and a Prysm appliance. We have now embedded this Prysm into a single unit together with the VSAT. In addition to the reduction in cost from the integration, we also this unified solution is better in terms of manageability, reliability and functionality. For example, the PrysmPro enables adding an integrated Wi-Fi access point and voice over IP gateways as well as firewall functionality and a local cache. Spacenet as a service provider in the (inaudible) security standards.

Now turning to the emerging markets, as I mentioned before, in the past quarter, we continued to release funds from our restricted cash held by trustees relating to the Compartel project in Colombia and recognized revenues from these operations. We have completed the upgrade of Internet services (inaudible) and the installation of new (inaudible). For most aspects, we have entered what is called the operational phase of the project. What is important to note is that we are meeting the operational indicators or benchmarks as set out in the amended contract.

(inaudible) site was a complex and difficult logistic project, in some cases requiring travel by foot or horse or donkey for those of you who are looking into the picture in the presentation (inaudible) the installation completed on schedule. We are proud that our newly installed sites enabled so many people in rural Colombia access to broadband Internet and telephony services.

The feedback we have received from the government entities in Colombia (inaudible). Having said that, our past experience teaches us that projects like the one in Colombia can take unexpected turns and so we continue to be conservative and recognize revenue only after payments are released.

In the emerging markets, we continue to see (inaudible) service obligation in government projects, mostly in Asia and Latin America. As we announced in the past quarters, our long time customer Telikom PNG was chosen both of SkyEdge and SkyEdge II VSAT platform. Telikom is replacing the (inaudible) network thus benefiting from the improved efficiency of (inaudible). These efficiencies can be translated through cost savings from less space capacity enabling more sites to be served using same base capacity or a mix between the two. The SkyEdge II network will enable Telikom to expand to additional market segments with a high performance platform such as growth demanded by the financial sector.

In another area of the world, we recently implemented a system providing internal Internet connectivity to a passenger train in Kazakhstan. Together with the Astel and Transtelecom, we're providing a complete connectivity package to the long haul train ride, which lasts up to 12 hours. The solution includes a tracking antenna designed for this specific requirement of communication on the moving train, as well as a full system to provide wireless access within the compartments.

One of the requirements for this project was that the solution for the station wireless connectivity between the compartments be Wi-Fi so that the compartment can be added or removed from the train without needing an installation. This is done with the wireless mesh product that we started the project we delivered. While we do not view this as a very large potential market, it is interesting to see how the demand for broadband connectivity (inaudible) for Internet demand.

In the second quarter, we also announced a new offering based on Gilat's new platform called NetEdge for the corporate and cellular backhaul market, mostly in the developing market. This solution is comprised of a multi-star network topology which is a bit different from the standard hub and spoke topology or the mesh topology which we already have in our SkyEdge II platform. Multi star networks are composed of several smaller star like networks where most of the traffic is between the remote site and the regional headquarters site.

One example for this is a bank with branches in several countries and headquarters in each country. Most of the traffic is between these branches and the regional headquarters. That has enabled such a one hop topology but also enables remote branches to connect directly in one hop to the main hub for Internet or Internet connectivity such as connecting to the global data center. All this is provided in a centrally management network sharing a common pool of satellite capacity among the sites.

NetEdge is especially designed for these type of applications and is better than mesh in terms of capacity and cost of a remote terminal, mostly because of the (inaudible). I mentioned in my example a corporate network scenario but this offering is also applicable to cellular backhaul scenario where the network is comprised of several smaller star networks, each with a small number of remote cell sites, connected to their base station through satellite.

NetEdge has several variance of gateways with the smallest called 2100, a very compact rack, that can easily fit into any regional bank data center, the larger variants, being additional capacity and support more [ph]. We are seeing interest in this solution from customers that needs to have small networks deployed in several countries or across large countries with fiber connectivity.

This concludes our business overview. Now I would like to turn the call over to Ari Krashin, our CFO, who will review the financials. Ari, please?

Ari Krashin

Thanks Amiram. Good morning and good afternoon to everyone joining us on the call today. Our revenue for the second quarter of 2009 was $56 million compared to $65.6 million in the second quarter of 2008. During this quarter, the global economic conditions and conservative spending in the telecom sector and the recession in the US continued to affect our revenues both the GNS and in Spacenet.

The decrease in our revenues as partially offset by the revenue from our Colombian operations as we continue to release money from the receipted cash held by trustees and recognized more revenues in the amount of approximately $8 million.

As mentioned by Amiram, the indication from Columbia are good, where we are meeting our obligations, hence we expect to continue to release more money during the second half of 2009 which will turn into revenues. Our gross margin for the second quarter was approximately 30% compared to 32% in the second quarter of 2008 and up slightly from 29.5% in Q1 of 2009. The year-over-year decrease in our gross margin is attributed mainly to the decrease in revenues mostly in GNS and Spacenet offset by the increase in revenues and profitability from Colombia.

Net R&D expenses decreased from $3.9 million in Q2 2008 to $3.1 million this quarter. The decrease is a result of the decline in our gross R&D expenses, reflecting the effect of the cost-cutting measures we made at the beginning of the year as a positive effect of the devaluation of the shekel versus the dollar compared to 2008. During the second quarter of 2009, we had an operating loss of approximately $492,000 compared to an operating income of approximately $742,000 in the second quarter of 2008. The minimal loss this quarter was strictly the effect of the cost-cutting measures we made at the beginning of the year and a positive impact from our Colombian operations offset by the decrease in our revenues.

We expect that the additional cost-cutting measures taken in Q2 which will start to take effect during Q3 will help us maintain the appropriate level of expenses going forward. Net financial expenses for this quarter was $0.6 million compared to financial income of $0.9 million in the same quarter in 2008. The reduction is attributed mainly to the low level of interest rates and negative impact of the fluctuation in the US dollar versus other currencies in a difficult location in which we operate.

Our GAAP net loss for the second quarter of 2009 was $1.2 million or $0.03 per diluted share compared to a net income of $1.3 million or $0.03 per diluted share for the second quarter of 2008. Our financial position continues to be strong as we continue with our effort to control over level of expenses and manage our working capital, together with the good indication of Colombia, enabling us to increase our free cash balances by approximately $7.6 million during this quarter. Our cash and cash equivalents and marketable securities amounted to $141.1 million at the end of the quarter. Our shareholders equity at the end of the quarter remained steady and totals $228.7 million.

Now I would like to turn the call back to Amiram. Amiram?

Amiram Levinberg

Thank you, Ari. Before we conclude, I would also like to update regarding the request for class-action lawsuit that was filed against us in November 2008. You may recall that the request of the classic law suit against Gilat and its directors was related to the merger agreement which is not closed.

Last month, this case was dismissed. After the judge reviewed the defense, he strongly recommended to the plaintiff that they reconsider the lawsuit, and the plaintiff late determined not to pursue the matter further. We are pleased that this matter will not take any further time and resources of the company. Of course, this (inaudible) from our lawsuit for $47 million against the investors who were to have closed under the merger agreement. That law suit will stand.

To summarize our call, while we had a decline in revenues this quarter, we were able to significantly balance it by maintaining cost control. We further adjusted our budget in the second quarter although we are seeing signs of better business prospect in the next two quarters. We continue to release money from the restricted (inaudible) Colombia and increase our free cash to approximately $7.6 million. We also announced two new products this quarter, which will enhance our market position and expand our vertical market.

That concludes our review. We've will now like to open the floor for questions. Operator please?

Question-and-Answer Session

Operator

Thank you. (Operator instructions). The first question is from Jonathan Ho of William Blair. Please go ahead.

Jonathan Ho – William Blair

Good morning.

Amiram Levinberg

Hi, there. Good morning, Jonathan.

Jonathan Ho – William Blair

Good to hear from you guys. My first question is on your comments about the positive signs in the market and an improvement in the second half of 2009, can you maybe give us a little bit more color on what you're seeing in terms of customer order patterns and just roughly what your expectations are in terms of maybe on the top line or even with last year for the back half of the year, or are we looking for incremental improvement, just maybe some magnitude type viewpoint in terms of the second half?

Amiram Levinberg

You know, to give you some color, I would say that in the first half of the year, not only we saw a decline in revenues, but we saw that what we used to call long cycles for bookings take too long to the extent that booking averages go down. As we see it now, we think that booking level are catching up again, and this is the first indication of improvement. So we think that the bookings will catch up in the next two quarters. How fast we will be able to translate that into revenues, this is a bit too soon to say. But I hope that we can improve on revenues as well but it is a bit too soon to say.

Jonathan Ho – William Blair

Is there a particular region or a set of customers that seem to be willing to spend again on the carrier side or with other enterprise applications, just maybe talk about mix by customer segment what you are seeing?

Amiram Levinberg

I think as a general statement kind of almost across the board in the sense that we saw many delays and think that we didn't close for a long time stock closing now, and that applies for I would say may regions results mentioning any specific one I think. Ari, do you want to say a… okay, now is I think it is I think it is quite a (inaudible).

Jonathan Ho – William Blair

Okay. An in terms of Colombia, can you maybe just remind us about how much revenue per quarter you are expecting for the balance of the year and can they actually release any funds yet. We saw the press release a couple of days ago in terms of the completion on the project but have they actually paid you guys and any concerns there?

Amiram Levinberg

Let me remind you what this project is on, what is the money that we started to release. Generally speaking in Colombia we are kind of three major contracts, if you like, and doing Internet access and telephony. Two of the three are what we call paying contracts, which means we are to collect money from the trustee for these contracts, and the money that was held in the trustee at the beginning of the year was $24 million.

Actually the older – or the oldest contract, if you like, is telephony and some Internet sites which we are to give services till until the year – end of the year 2010, while the other two, which are the paying, if you like, also the contract that are expected to release money from the trustees, these should give us revenues roughly until the end of the year.

In the past, we said that if we are successful, we will be able to retrieve most of the money from the trust till this year. And what has happened in practicality is that we have – I think we have announced we could retrieve $8 million from the trust. In the previous quarter, in Q1, we retrieved slightly more than a couple of millions dollars and recognized, and the majority of the rest of the money will be released and recognized, knock on wood, until the end of the year.

So in the meantime, the other contracts should end roughly in Q4. Having said that, obviously, if we can, we will expand them to start with until the end of the year, and then we will try to expand them for next year, but this is definitely too premature to say, and we don't know whether these expansion will happen, or extension, if you like, will happen or will not happen.

Jonathan Ho – William Blair

Great. Just a question for Ari, how should we think about the impact of the cost-cutting measures that you talked about in the back half of the year and what is pretty reasonable for a level of OpEx based on some of those cost-cutting measures?

Ari Krashin

Well, the significant measures we have taken was at the end of June, so basically you don't see that effect in Q2 as we mentioned. Going forward, you know, rough numbers, I would expect an improvement of approximately a million dollars per quarter (inaudible) in cost savings coming from the headcount reductions, the salary reductions that we made, and other measures we have taken. So rough numbers we would say about a million (inaudible).

Jonathan Ho – William Blair

Great. And just a final housekeeping question, any update on sort of the law suit for I guess settlement that you have with the Galactic Group, any sense of the timing of that at this point, or are you still a little ways off?

Amiram Levinberg

There won't be a last date. I think it is very, very premature to say that there will be a settlement. So there might be a settlement, but it might be settled in court. To be settled in court is a fairly long process. So it is too premature to say.

Jonathan Ho – William Blair

Thank you.

Amiram Levinberg

Thank you, Jonathan.

Jonathan Ho – William Blair

Thanks.

Operator

The next question is from Larry Harris of CL King. Please go ahead.

Larry Harris – CL King

Yes, thank you. It is good to hear that you're looking forward to improvements in the second half of the year. In terms of I guess looking back for a second or two, you know with the foreign exchange issues, the relationship, the dollar, the euro, other currencies, does that affect your business say in the first half of this year?

Ari Krashin

Well, most of our revenues are generated in dollars, so we are mostly (inaudible) the revenue side. I mean there is a small portion from local currency but again a big portion is in dollars, so it didn't really affect the top line. We do have you know as we based – we have obviously based in Israel, so we do have most of the expenses in Shekels, but as we mentioned at the beginning of the year, we hedged the currencies, Shekels versus the dollar at a level of 3.9, which is basically this is the level that it is currently trading at. So it didn't really affect us significantly this year. It even proved a bit compared to last year which dollar hedged about 3.6 and now it is a bit better. But it is not a significant effect on any one of our numbers. Obviously, we would prefer to see the dollar at a much higher level, but currently we are hedged at 3.9.

Larry Harris – CL King

Good to hear. And just in terms of geographies here in the second quarter, you mentioned of course that Colombia did and Latin America did very well. The US was somewhat down. Were there any other geographic that stood out in the second quarter either particularly strong or soft?

Amiram Levinberg

I wouldn't say that. I think that with the exception of Latin America, Q2 suffered from lower revenues, and I think across the board, Latin America is a bit higher (inaudible).

Larry Harris – CL King

Okay, I understand. We're looking forward to improvements in the second half, of course?

Amiram Levinberg

Correct. And as I said, you know, the first month we will bookings and then don't know how fast revenues will attract these.

Larry Harris – CL King

Understood, understood. All right, thank you very much.

Amiram Levinberg

Thank you.

Operator

Your next question is from Howard Sterling of Hudson Securities. Please go ahead.

Howard Sterling – Hudson Securities

It is two parts to the same question, there are many newer high speed protocols coming in, LTE, WiMAX, and a host of others. Do you find that the competition in your areas for backhaul and other uses and what if anything is happening in the satellite area, in the VSAT area, to also increase bandwidth and utilization of bandwidth?

Amiram Levinberg

Okay. It is a refreshing question in the sense that most of the audience in this call are not into technology, but fine with me. LTE and WiMAX were for the previous time somewhat competing technologies, now I think LTE will grow most probably to become kind of fourth generation of cellular, would be more for fixed location connectivity. Both require backhaul as you rightfully said, and a fairly highly bandwidth for backhaul. By the way, even 3G requires a fairly large bandwidth for the backhaul.

I will state most of the satellite solutions which are used for these backhaul are SMPC [ph] or to say a few words more about that, if the operated has terrestrial connectivity to connect the equivalent of base stationed to base station controller, in the case of WiMAX and LTE, the base station back to the main network using simplified routes, if you have terrestrial connectivity, we will do that. You don't have to restore the connectivity via wires, they will try to install microwave link

But microwave links are not applicable because of line of sight, they will be using satellite. And their first choice in satellite would be to use usually what is called SMPC which is a practical a fixed wire in the sky. And then if the traffic is low and you want to have some statistics among the sites, they will be using TDMA networks like ours. And currently, most of the satellite applications [ph] which by the way we actually implement for our customers from time to time as much as the SMPC model is not our technology.

When it comes to TDMA, we are fairly strong in this application and we do require a lot but most of the second generation of cellular GSM traffic applications was done a few UMTS connectivity as well. Going forward, you have asked me whether people are looking for specific technologies to do it more efficiently in the sky, I would say the following. A, I guess we will see more TDMA networks just because they are more efficient in terms of using the base segment.

And B, you will see either multiple satellites, which are currently not really – I mean a kind of very rare, you don't see them a lot. B, when you see them, it is mostly, currently at least, in the US and the Central Europe, where you have (inaudible) with one venture that is trying to address this backhaul connectivity, which is called (inaudible) and this is a venture at a fairly primitive stage. They are trying to raise money and that is a very interesting concept called MEO, medium earth orbit satellites.

Howard Sterling – Hudson Securities

Got it, thank you.

Amiram Levinberg

Okay.

Operator

The next question is from Rich Valera from Needham & Co. Please go ahead.

Rich Valera – Needham & Co

Thank you, good morning. Was just looking for more clarification with respect to your comments about bookings picking up, were you suggesting that, maybe that in the recent quarters, you had book to bills below one-to-one, and that you actually saw positive book to bills either in the most recent quarter, or you expect to have sort of a positive book to bill to start building back up backlog in the September quarter?

Ari Krashin

Rich, we don't usually establish backlogs through the year, but I think the results kind of shows this, and we had kind of a lower booking levels in the first half of the year and we think it will change in the second half.

Rich Valera – Needham & Co

So, you hope to build some backlog in the second half, but you're not sure how quickly that will translate into increased revenue because of the timing of the recognition of that, is that fair?

Ari Krashin

Yes, that is correct.

Rich Valera – Needham & Co

Okay. Thanks very much for that clarification.

Ari Krashin

Okay, good.

Operator

(Operator instructions) There are no further questions at this time.

Before I Mr. Levinberg to go ahead with his closing statements, I would like to remind participants that a replay of the call is scheduled to begin in two hours after the conference. In the US, please call 188-782-4291. In Israel, please call 039255921. Internationally, please call 9-723-925-5921. Additionally a replay of this call will also be available on the company's website www.gilat.com. Mr. Levinberg, would like to make concluding statements?

Amiram Levinberg

Sure. Thank you for your clarification. I would like to thank you all for joining us for this quarter's call. Good afternoon and goodbye.

Operator

Thank you. This concludes Gilat's second quarter 2009 results conference call. Thank you for your participation. You may go ahead and disconnect.

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