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Gilat Satellite Networks Ltd. (NASDAQ:GILT)

Q1 2014 Earnings Conference Call

May 21, 2014, 9:30 AM ET

Executives

Philip Carlson - IR, KCSA

Erez Antebi - CEO

Yaniv Reinhold - CFO

Analysts

Gunther Karger - Discovery Group

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Gilat’s First Quarter 2014 Results Conference Call. All participants are at present in listen-only mode. Following the management’s formal presentation, instructions will be given for the question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded, May 21, 2014.

I would now like to turn the call over to Philip Carlson of KCSA to read the Safe Harbor statement. Philip, please go ahead.

Philip Carlson

Thank you. Good morning and good afternoon, everyone. Thank you for joining us today for Gilat’s first quarter results conference call. A recording of this call will be available beginning at approximately noon Eastern Time today, May 21 until May 23 at noon.

Our earnings press release and website provide details on accessing the archived call. Investors are urged to read the forward-looking statements in our earnings releases, which state 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. 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.

With that said, on the call today is Erez Antebi, Gilat’s Chief Executive Officer; and Yaniv Reinhold, Chief Financial Officer. Erez, please go ahead.

Erez Antebi

Thank you, Phil, and good day, everyone. I would like to begin by providing a high level overview of the first quarter results, and then discuss the business. Following my comments, Yaniv will discuss our financial results. I will then summarize and open the call for questions.

Our revenues for the first quarter of 2014 were $50.9 million, compared to $55.7 million in the fourth quarter of 2013. The revenue decline is attributed to two projects that were completed, our previous project in Colombia which ended in Q4 2013, and completion of installing all 48,000 VSATs in NBN FRSS project.

I will point out that in Colombia we were awarded a new project at the end of 2013 where we will begin to provide Internet services to schools. This project will start generating revenues in the second half of 2014. In Australia, we are now continuing the operations phase of the project. NBN has yet to make a decision whether or not to expand services under the FRSS, and if so, by what means and to what extent.

In this quarter, we see the Commercial and Defense divisions improve their profitability when compared to the fourth quarter of 2013. We are also starting to see the results of the cost cutting efforts implemented last year. As a result, we see an increase of our non-GAAP gross margin to 42%, up from 39% in the fourth quarter of 2013, and a non-GAAP operating income of $0.5 million, compared to an operating loss of $100,000 in the fourth quarter 2013.

On a GAAP basis, our gross margin was 39%, up from 36% in the fourth quarter. Our GAAP operating loss for the first quarter was $1.5 million as compared to an operating loss of $2.7 million in the fourth quarter of 2013.

I will now discuss some of our business highlights for the quarter. Let’s start with the Commercial division and the strategic focus for the division delivering broadband Internet access for consumers and enterprises based on Ka-band and High Throughput Satellites. During the quarter, we had an important announcement of our partnership with Inmarsat to provide new ground services on their Global Xpress, or GX Satellites.

For those less familiar with Inmarsat’s Global Xpress fleet, it is comprised of four High Throughput Satellites, the first of which has already been launched, providing global Ka-band capacity. Gilat will be providing a suite of fixed Global Xpress land terminals and network management services. These will be made available to Inmarsat’s value-added resellers, enabling them to address their prospects and opportunities. We expect Global Xpress service to start at the beginning of 2015.

In Europe, we continue to expand with SES Broadband Service using their new ASTRA 2E satellite. The satellite entered into commercial service in the middle of the first quarter. It enables the delivery of broadcast and broadband services in Europe, the Middle East and Africa, and we have signed up new ISPs in Germany and Italy, both countries are new markets for Gilat with SBBS. The ISPs are using the Ka-band capacity to offer services of up to 20-megabit per second download speeds and are targeting private households and small businesses.

In the first quarter, we also announced a partnership with Thaicom to launch a service that will provide customers across the Asia-Pacific region with an integrated satellite connectivity solution. This comprises of Gilat’s SkyEdge II-c VSAT satellite ground equipment and Thaicom’s four IPSTAR High Throughput Satellites. We have just begun our joint marketing efforts together with Thaicom and we see a strong pipeline of potential business. We hope to be able to announce deals in the coming quarters as a result of this partnership.

We believe our ability to win these business partnerships is a strong testament to our leadership and ability in the Ka-band and High Throughput Satellite market. In the first quarter, we announced the launch of Capricorn, our new high-performance VSAT and the newest expansion of our SkyEdge II-c family of products. This terminal will support download speeds of 200-megabit per second and upload speeds of 20-megabit per second integrated with advanced features such as acceleration, compression and encryption. It offers a more efficient, cost effective solution for the service provider.

We see the Capricorn as the fastest TDMA VSAT in the market. The unprecedented data rates made possible with the Capricorn open up new opportunities for satellite communications. Last mile connectivity is continuously growing at a fast pace. While our 10-megabit per second or 20-megabit per second may seem high-speed connectivity today, we see customer demands for even higher speeds.

Our technological innovation in the Capricorn VSATs enables services not feasible today. We expect it to be used in high-performance networks such as for next-generation residential customers, high-end enterprises, education projects and LTE backhaul.

I would like to say a few words about LTE and cellular backhaul. LTE, which is a fourth-generation cellular technology, provides a single handset over a 100-megabit per second. The technology is still not widely deployed outside urban regions. However, we are gradually seeing the expansion of LTE to more remote regions, and as a result, we see requests for satellite-based backhaul of fourth-generation base stations.

To support these regions, VSAT performance needs to be extremely high, a 100-megabit per second or even 200- megabit per second. Also, the variability or bursts of the traffic is also a critical factor. We believe this is a distinct advantage for our TDMA-based solution, which can allocate capacity between base stations where needed, while at the same time support very high download rates. Given our significant technological advantage over the competition in this area, we are optimistic regarding the potential for the Capricorn.

Now, let’s discuss our Enterprise business. We continue to secure new customers and expand existing relationships for other commercial projects during the quarter. In Southeast Asia, we signed several expansion deals with service providers. We also signed a contract for a new network in New Zealand replacing a competitor’s VSAT solution. This network is targeting residential and business customers.

One interesting deal is with an Asian operator providing cellular backhaul services in Peru. Another new customer is TV Azteca which is providing satellite connectivity to schools in Colombia. TV Azteca will provide services similar to what we are providing in Colombia but in other regions of the country. We also had expansions by Telefonica Peru, a long time customer of ours, who is using our VSATs for cellular backhaul.

In Brazil, we have received additional orders for the turnkey rural telephony solutions I mentioned last quarter. We expect to see more orders from this project as the implementation continues during 2014.

In the first quarter, we announced CellEdge, our solution for small cells and I would like to explain the difference between CellEdge and cellular backhaul we are providing for some time now. A cellular network is typically built of base stations provided by telecom vendors like Huawei, Siemens, Ericsson and others. When these base stations are located in remote areas, connecting them to the core network may be done by satellite, and Gilat provides the VSAT and ground equipment to do that.

In the case of CellEdge, Gilat provides the base station together with the satellite connectivity, tower, energy and other related services. So this offering is more comprehensive and complete for the mobile network operator. We have designed CellEdge for coverage of more rural areas where the needs are different than urban. Capacity requirement is smaller, energy and logistics can be challenging.

Since we have the capability to execute projects in remote areas, our value proposition to the operators is essentially, tell us where you want coverage and we will make it happen cost effectively. I am happy to announce that we received our first order for CellEdge by a leading mobile operator in Brazil. This order is very significant in that it validates our view that mobile network operators see value in an integrated offering of a small cell with VSAT connectivity. It also validates that Gilat can offer such cellular solutions to a leading mobile network operator.

We see cellular service to underserved areas as a growing market where we believe there is an increasing opportunity for Gilat. Our small cell solutions over satellite are designed specifically for rural areas with populations as low as several thousand people.

We now turn our attention to the Defense division. We see the situation in the defense sector improving compared to 2013. There seems to be more visibility for programs in the U.S. compared to 2013. We have received a good flow of new orders in the first quarter and we see an improved sales funnel into the future.

Outside of the U.S., we are seeing increased interest by countries in zones of heightened tensions such as Central and Eastern Europe and Southeast Asia. As such, in the first quarter we were awarded a deal by the Ministry of Defense of a Southeast Asian country for a SkyEdge II hub and a range of terminals.

To support the growing market potential, we are continuing to work on new and innovative products in the Defense division. During the first quarter, we announced the availability of our new 50-watt Ka Block Upconverter, or BUC. It performs more efficiently and at higher level than our previous product in a package that is half the size.

For example, this BUC draws less power and emits less heat. As a result, it improves system reliability and lowers lifecycle costs for the integrator. We also launched the StealthRay 300X-M Low-Profile X-Band Antenna. X-Band is used by defense agencies for various applications. The product’s compact size enables its deployment in small platforms in the air, land and sea. It is the latest addition to the StealthRay 300 family and our growing portfolio of low-profile on-the-move solutions, which we believe are the most comprehensive in the industry.

About two weeks ago, we announced a suite of solutions specifically targeted for unmanned platforms called BlackRay. These solutions are based on our existing on-the-move modems, high-performance BUCs and either our low-profile antennas or our new parabolic antennas. Gilat BlackRay terminals are one of the smallest and most compact terminals available on the market.

The small size and light weight of BlackRay terminals increases the operational range of these UAVs. We are proud to announce that another leading integrator has recently chosen our BlackRay terminal for their UAV. This is a testament to the value of the integrated terminal for such applications. We are participating in two UAV tenders that are for programs of records in the U.S. DoD encompassing hundreds of UAVs.

On these tenders, we were chosen by major well-known integrator for each opportunity. We see the growing UAV market as a potential for Gilat. This is especially true as the demand for smaller UAVs with satellite communications grows. This is another segment where we believe we have a strong competitive advantage with our fully integrated terminal because of its small size and weight.

Historically, satellite communications has been mostly used by airborne platforms. However, lately there has been an increased demand for unmanned naval vessels as well. We are already working with a system integrator on our BlackRay Marine 250 to be integrated into one such unmanned vessel. The environmental requirements for such terminals are very demanding and we have designed a solution to meet the harsh conditions that they will face at sea.

Our low-profile terminals have recently been deployed in missile boats and [fastest] (ph) aircraft providing patrol capabilities to the Naval Command. I am proud to say that our terminals have been used in combat operations successfully.

The commercial aviation market also continues to be in our focus. We believe that passengers will require access to the Internet on almost every flight and that cabin connectivity is therefore a growth market. We have been active in this market for a while providing BUCs to current KU Aviation Services through TCom and AeroSat. They, in turn, have been providing their solutions to planes served by Row44 and Gogo. We expect this market and our part in it to expand further when Inmarsat’s Global Xpress service will start in 2015.

I’ll remind everyone that we are the exclusive provider of BUCs to Honeywell for the Global Xpress network and that Honeywell is the exclusive provider of airborne terminals to the Global Xpress network. Our project with Honeywell is proceeding well and we are meeting our milestones.

I would like to conclude with our Services division, which is comprised of Colombia and Peru. I will begin with Peru. As a reminder, we were awarded a $30 million project with IAL at the end of 2013. The project includes deployment and operation of microwave infrastructure and wireless service to 70 communities along the most remote section of the Amazon River in Peru. We expect to see a significant portion of the implementation of the network as well as initial revenues in the second half of 2014.

Moving to Colombia, Kioscos Vive Digital, the project we were awarded by MINTIC, the Colombian Ministry of Information Technology and Communication, is valued at $99 million. The project is for the expansion of Internet services in rural areas of the country. The project requires a period of deployment followed by three years of connectivity and educational training services for over 1,900 digital kiosks in two regions. We are proceeding on track with the project implementation and expect to start generating revenues from this project in the second half of the year.

To summarize the Services division, we believe that 2014 holds a lot of potential and we expect to see revenues from these two deals which I just discussed in the second half of 2014.

That concludes our business overview. I would now like to turn the call over to Yaniv Reinhold, our CFO who will review the financials. Yaniv, please?

Yaniv Reinhold

Thanks, Erez, and hello, everyone. I would like to remind everyone that our financial results are presented both on a GAAP and non-GAAP basis. The GAAP financial results include the effects of non-cash stock option expenses as per ASC 718, amortization of intangible assets resulting from the purchase price allocation, restructuring costs and net income or loss from discontinued operations.

The reconciliation table in our press release highlights this data, and our non-GAAP information is presented excluding these items.

Now, moving to our financial highlights for the first quarter of 2014. Revenues for the first quarter of 2014 were $50.9 million, compared to $65.4 million for the same period in 2013. The difference is mostly attributed to the completion of our project in Colombia and from NBN Co. We have finished the Compartel project in Colombia and have not yet started to generate revenues from the new MINTIC project. This is expected at the second half of 2014.

In addition, we had lower revenue from the NBN Co project in Commercial division. We have finished the installations at NBN Co and have not yet received a notification as to whether the project will be extended beyond 48,000 sites. We continue to generate revenues from the service portion of the project.

On a GAAP basis, our gross margin this quarter reached approximately 39.3%, compared to approximately 34.8% in the comparable period last year. As we have mentioned over the past few quarters, our gross margin is affected by the regions in which we operate and the types of deals we recognize. The increase in our gross margin this quarter was primarily due to two reasons. The first is due to the mix of deals with higher margin and the second is due to our cost reduction in COGS.

Gross R&D expenses on a GAAP basis were $7.2 million this quarter compared to $7.6 million in the same quarter of 2013. The decrease in R&D expenses reflects our reduction in fixed expenses resulting from the integration efforts and growing synergies within the division. We’re continuing to invest substantial funds in R&D to support our strategy in Ka-band and on-the-move applications.

Moving to selling, marketing, general, and administrative, on a GAAP basis, expenses for the quarter remained relatively constant at $14.6 million, compared to $14.4 million for the same quarter last year. We experienced high variable expenses and they were offset by a reduction in fixed expenses.

Operating loss on a GAAP basis was $1.5 million in the first quarter of 2014 compared to operating income of $1.1 million in the comparable quarter of 2013. We regularly use supplemental non-GAAP financial measures internally to understand, manage and evaluate our business and make operating decisions. We believe these non-GAAP financial measures provide consistent and comparable measures to help investors understand our current and future operating cash flow performance.

On a non-GAAP basis, operating income was $0.5 million in the first quarter of 2014, compared to operating income of $3 million in the comparable quarter of 2013. On a GAAP basis, net loss for the quarter was $2.7 million or a loss of $0.06 per diluted share, compared to net loss of $2.4 million, or a loss of $0.05 per diluted share in the same quarter of 2013.

As of March 31, 2014, our total cash balances, including restricted cash, net of short-term bank credit, decreased to $76.4 million. This was mainly due to our investments in the IAL project in Peru and the MINTIC project in Colombia as we anticipated. Our shareholders’ equity at the end of the quarter totaled $224.2 million.

That concludes our financial review for the quarter, and now I would like to turn the call back to Erez. Erez?

Erez Antebi

Thank you, Yaniv. Before I begin my summary, I would like to remind you of some corporate updates from this quarter. Amiram Levinberg, one of the founders of the company and Chairman of the Board, has decided to step down from his position. I would like to thank Amiram for the long period we worked together and for his contributions to the company over many years.

Dov Baharav was elected as the new Chairman of the Board of Gilat. Mr. Baharav served as the CEO of Amdocs and Chairman of the Board of Israel Aerospace Industries in addition to numerous other senior executive positions. I speak for the entire management team when I say we are happy to have him as part of our team and wish Dov success in his new position.

Additionally, in the first quarter of 2014, FIMI acquired approximately 2.1 million shares from York. FIMI is now the largest stakeholder of Gilat at 23.2%.

And to my summary, this quarter we announced two important partnerships in the Ka-band and HTS market. One was Inmarsat Global Xpress and the second was Thaicom IP start. We saw a steady flow of deals in the Commercial division and are optimistic regarding our new products. Two promising products are the Capricorn VSAT and CellEdge small cell solution. We also had our first significant sale of CellEdge to a leading mobile operator.

In the Defense division, we announced new products targeting unmanned platforms. Our products have been chosen by another UAV system integrator and our maritime terminals were deployed in combat operations. There is more visibility of the U.S. DoD budget and growth of demand in international defense markets. Our service operations in Peru and Colombia are on track with our plans for the year.

Looking at the year in general, when planning to budget for 2014 we estimated a stronger half for the year. The growth in the second half is expected to come from two main factors, first, growth in revenues from the projects in Peru and Colombia, which we expect to see in the second half of 2014, and second, growing commercial and defense activity.

We are starting to see an improvement in the profitability of our Commercial and Defense divisions and the effects of the cost cutting steps we took last year. These are reflected in our gross margins as well as in our operating expenses.

We are confident we are on track to meet our management objectives for the year, which we previously stated, achieving revenues in the range of $240 million to $245 million and EBITDA margin levels of approximately 9%.

That concludes our review. We would now like to open the floor for questions. Operator, please?

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Gunther Karger of Discovery Group. Please go ahead.

Gunther Karger - Discovery Group

I have two questions. Question number one concerns the Eastern European area with regards to its current political instability; will this help or hurt the Gilat’s prospects and its market sectors? And number two question is that India’s political climate changing to a new leadership, how will that impact, if at all, Gilat’s business in that region?

Erez Antebi

Regarding Eastern Europe, I think that -- first of all, to answer both your questions, it’s a bit early to tell what the exact impact will be. But we are seeing in Eastern Europe, we’re seeing a more, I would say, interest in our defense products as they are looking -- because they are seeing higher tensions and they are looking at what they are going to do with their defense budgets and they are looking towards probably increasing them, therefore we are seeing more interest from that area. So, potentially it could help our business there.

Regarding India, there was a new government elected, but I think it’s very recent and it’s too early to tell. We hope it will be positive but we have no way of knowing.

Gunther Karger - Discovery Group

Regarding India, the reason I asked the question about India because the new leadership is said to be more friendly towards business, more friendly towards business from other countries, and that’s the reason I was asking that question.

Erez Antebi

I understand. We read the same newspapers. We also see that’s what they are said to be. But the new government just stepped in and we don’t know yet what will actually happen on the ground. So we’re hopeful but that’s all we can be.

Operator

(Operator Instructions) There are no further questions at this time. Before I ask Mr. Erez Antebi to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin two hours after the conference. In the U.S., please call 1-888-326-9310. In Israel, please call 03-925-5900. Internationally, please call 972-3-925-5900.

Mr. Antebi, would you like to make your concluding statement?

Erez Antebi

I just like to thank everyone for participating. We appreciate the time and we appreciate the attendance. Thank you very much and hope to see you soon on the next call.

Operator

Thank you. This concludes Gilat’s first quarter 2014 results conference call. Thank you for your participation, you may go ahead and disconnect.

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