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Executives

Rob Fink - KCSA

Amiram Levinberg - Chairman of the Board and Chief Executive Officer

Ari Krashin - Chief Financial Officer

Erez Antebi - CEO Elect

Analysts

James Breen - William Blair & Company

Gilat Satellite Networks Ltd. (GILT) Q3 2011 Earnings Call November 15, 2011 9:30 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Gilat’s Third Quarter 2011 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.

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

Rob Fink

Thank you, Rachael. Good morning and good afternoon, everyone. Thank you for joining us today for Gilat’s third quarter 2011 results conference call. A recording of the call be available beginning at approximately noon Eastern Time today, November 15 until November 17 at noon. Our earnings press release and website provide details on accessing the archived call.

Investors are urged to read the forward-looking statements and our earnings release which states 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 the risk factors can be found in our reports filed with the Securities and Exchange Commission.

With that said, on the call today is Amiram Levinberg, Gilat’s Chairman of the Board and Chief Executive Officer; Erez Antebi, Gilat’s new CEO elect; and Ari Krashin, Chief Financial Officer. Amiram, the call is yours, please go ahead.

Amiram Levinberg

Thank you, Rob. Good day, everyone. Thank you for joining us. During today's call we will review key business highlights discussing more details of our financial result and provide an update on recent corporate development. Before addressing these topics, I would first like to highlight an announcement that was made yesterday regarding the signing of a strategic alliance for Ka-band development with Rostelecom's RTComm, and with Russian Institute of Technology NIIR.

The agreements are part of government initiative to broadband connectivity throughout the Russian Federation. We are excited about this project and I would go into further details later in my comments. The third quarter was highlighted by strong financial performance in our core business. Quarterly revenues increased to $83.9 million, compared to $58 million in the third quarter of 2010. Gross margin in the third quarter were 35% compared to 34% in the same period last year. And EBITDA was $8.1 million compared to $4.4 million in the third quarter of 2010.

On a non-GAAP basis, our operating income for the quarter was $4.3 million, up from a non-GAAP operating income of $1 million in the comparable quarter of 2010. I will provide you with further details on our quarterly results later in the call. Our North American business was strong in the third quarter, led by Spacenet's commercial activity. We received new managed network services contracts from Goodyear, Boston market and Cumberland Farms. These new managed networks are based on our award winning Prysm Pro and other services provided by our newly acquired broadband provider, CICAT.

Spacenet also received a multi-year contract extension from Dollar General, its largest customers, as well as its customers in the gaming sector. Spacenet’s civilian, government and industrial division received a significant new SkyEdge II system order from a prime federal government contractor, as well as new order from and CenterPoint Energy. The third quarter also saw Spacenet finalize its roll-out of SkyEdge networks for Texas and Illinois lottery.

Spacenet’s integrated government solutions received U.S. Government eligibility to offer its products and services to government organizations and government contractors. These include sales of subscription services as well as sale of satellite transponder and bandwidth. The latest award is a federal supply schedule under the future commercial satellite communication services acquisition, FCSA program. This contract follow recent awards for a Blanket Purchase Agreement by the naval air warfare center aircraft division and a basic ordering agreement by the NATO consultation, command and control agency.

While these are all IDIQ, that is indefinite delivery, indefinite quantity eligibility awards, they do further qualify us and we are hopeful that they will translate to contracts in the future. Moving to our international VSAT business, this quarter we announced a major milestone, winning a contract with SES Astra2Connect for the supply of Ka-band VSATs and hubs for the consumer network in Europe.

The use of our Ka-band platform will allow SES to deliver significantly faster internet and Voice over IP services to private households and small businesses across Europe. This was our first significant award in the Ka-band arena and we see strategic importance in our relationship with SES. As a reminder, Astra2Connect currently serves over 80,000 end-users and is the largest based broadband network in Europe. SES is the second largest satellite operator in the world.

We are proceeding with the implementation for Optus for NBN Co First Release Satellite Services, FRSS. As you may recall, the National Broadband Network, NBN, is an Australian Government initiative to deliver a nationwide broadband network to all Australians with planned investments of upto 43 billion Australian dollars over eight years. NBN initiated the FRSS an interim solution to provide high-speed broadband connectivity to remote Australian residents, small businesses and indigenous communities. We were chosen to provide VSAT hub installation, hub operations and services as part of the service. We have already deployed our equipment in to three gateways, and though the service is not yet officially launched, private customers are already connected and their systems operational. Feedback we received so far is positive.

This quarter we also saw the demand for government, enterprise in USO applications continuing, including several cellular backhaul deals both for our SkyAbis solution and SCPC modem. We announced a couple of deals in Russia with Synterra in the far-east and to Yakutia Ministry of Finance. And interesting award we announced, though we could not disclose the name of the customer, was for a network that provides video surveillance as well as commence and control applications in order to secure various national assets in remote and difficult to reach locations.

Sensors backhauled by the VSAT include, fixed, quick deploy and mobile sources such as unmanned aerial vehicle, UAV. The network will operate in a multi-star configuration based on a hub in a central location and NetEdge gateways in various geographically distributed sites. As I discussed on our previous call, we were also selected to deliver Satellite-on-the-Move communication solution as part of a security initiative aimed at combating internal and border threats.

The project is valued at over $10 million and Raysat Antenna Systems will provide equipment and services, including over 100 StealthRay Satellite-on-the-Move antennas. We have begun delivery of the equipment and the implementation is proceeding well.

Finally, yesterday we announced a strategic alliance with Rostelecom’s RTComm and the Russian Government’s institute NIIR for Ka-band VSAT network in Russia. The Russian Government has decided to make a significant investment in a constellation of three Ka-band multi-spot beam satellites. The constellation is designed to support two million subscribers and will provide internet access throughout the Russian Federation. Most of these subscribers are expected to be residential customers but the network will also serve SMEs, enterprise and government users.

The arrangement with NIIR and RTComm calls for the supply of gateways and terminals to RTComm and the sharing of manufacturing knowhow which will also enable local customization. Implementation of the agreement will begin this year. For those less familiar Rostelecom, according to published reports, the company has the largest backbone network and the most last mile connections in the country and is a leading long distance carrier in Russia. It announced consolidated revenues of 275 billion rubles in 2010, which is about US$9 billion.

RTComm is the satellite arm of the group and operates one of the largest VSAT network in Russia. This award is another important achievement for using the Ka-band arena. It is our second major VSAT award for Ka-band and the win strengthened our position as one of the leading Ka-band players in the industry today. Given the size of Russia and the capacity of Ka-band satellite, this project carries a potential even bigger than the two other recent consumer awards we announced, namely Optus NBN, and SES Astra2Connect.

We see Ka-band multi-spot beam satellite as more than a new frequency. Ka-band satellite offer large amount of capacity at lower price than current technology satellite. We therefore see this next generation satellite technology as driving significant future growth in the VSAT industry.

That concludes our business overview. Now before I turn the call over to Ari Krashin, our CFO, a few words on the corporate changes we recently announced. Specifically the nomination of Erez Antebi as Chief Executive Officer of the company effective January 1, 2012. As indicated, I intend to continue to serve as Chairman of the Board of Gilat and work closely with Erez and the executive team.

Erez currently holds the position of executive advisor for Ka-band solutions and he was instrumental in our being awarded Astra2Connect in Europe, Optus NBN in Australia, and now for this latest Ka-band initiative in Russia. Previously, Erez held for five years the position of Chief Executive Officer of our equipment business unit, Gilat Network Systems, or GNS, including two years in which he also headed Spacenet Rural Communications.

I have been working with Erez for many years since he joined Gilat in ’91. I know him well. He has more than proven his leadership and operational skill, and I am confident he will lead the company towards continuous growth and strong accomplishment. Erez, now your turn. Would you like to say a few words to our listeners on the call?

Erez Antebi

Thank you, Amiram. Having been part of the company for over 17 years I am really honored now to be appointed to head Gilat. And I want to thank you Amiram, and the Board for their confidence. Looking at the satellite market, I see Ka-band technology and the expansion of satellite communications to defense application as two major market trends that open up exciting new prospects.

Gilat is focusing on these two segments and they are part of our growth strategy. With a strong management team and a clear and defined growth strategy, I look forward to leading the company to further success and profitability. Thank you for your time today.

Amiram Levinberg

Thank you, Erez. Congratulations once again.

Erez Antebi

Thank you.

Amiram Levinberg

And now, Ari, will review the financials. Ari?

Ari Krashin

Thanks, Amiram. I would like to remind everyone that the financial results are presented both in GAAP and non-GAAP basis. The GAAP financial results include the impact of FAS 123(R); the inclusion of stock-based compensation expenses in the P&L; expenses related to our M&A activities during 2010 and 2011; amortization of tangible and intangible assets resulting from the purchase price allocation; and other one-time income. 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 second quarter of 2011. Our revenues for the third quarter of 2011 grew by 45% to $83.9 million, from $58.0 million in the third quarter of 2010, with approximately $60 million attributed to Wavestream. Excluding the revenues for Wavestream, our revenues increased by 17% year-over-year, from $58 million in the third quarter of 2010 to $67.9 million. The increase in our revenues is mainly attributed to our strong performance in the international market and the increase in Raysat Antenna Systems revenues.

Our gross margin this quarter was approximately 35%, compared to approximately 34% in the third quarter of 2010. On a non-GAAP basis our gross margin reached 37% compared to 35% last year. As we mention from time-to-time, our gross margin is affected quarter-to-quarter by the regions in which we operate and the type of deals we consummate. The improvement in our gross margin is mainly attributed to the higher portion of equipment sales which typically carry higher margins, and these margins are in line with our expectations.

Gross R&D expenses were $8.4 million this quarter compared to $5.4 million in the same quarter of 2010. The increase in R&D expenses is primarily attributable to the cost associated with the consolidation of Wavestream. The increase in the R&D expenses is inline with our budgeting and efforts to developing new products for new markets, especially for the defense market. As we continued to position ourselves as one of the leading ground segment equipment provider in the Ka market. We are shifting some of our R&D efforts towards our Ka band product with intention of not increasing our current level of expenses.

Selling, marketing, general and administrative expenses for the quarter were $20.2 million compared to $15.4 million for the same quarter last year. The increase is primarily due to the consolidation of Wavestream as well as higher level of variable expenses related to the growth in revenue.

Operating income for the third quarter of 2011 was $1.9 million compared to an operating loss of $0.7 million in the third quarter of 2010. On a non-GAAP basis, operating income reached approximately $4.3 million in the third quarter of 2011 compared to an operating loss of $1 million in the comparable quarter of 2010.

Our GAAP net income for the quarter included approximately $4.4 million of other income, representing additional portion of the settlement from last year received -- of the settlement from last year received this quarter, and the last portion of gain from the sale of Axolotl. Net income for the quarter on a non-GAAP basis was $2.3 million or $0.05 per diluted share compared to $0.6 million or $0.01 per diluted share in the same quarter of 2010.

Our total cash balances, including restricted cash, net of short-term bank credit amounted to $50.6 million at the end of the second quarter. Our trade receivables at the end of the period were $55.3 million, representing DSO of 59 days. And our shareholders’ equity at the end of the quarter totaled $270.9 million.

Now, turning back the call to Amiram. Amiram?

Amiram Levinberg

Thank you, Ari. To summarize our call, in the third quarter we saw a year-over-year improvement across all financial parameters as we increased our revenues, gross margin, EBITDA, and operating income. The quarter was highlighted by our strong financial performance, as well as our first major Ka-band awards from Astra2Connect, new orders for Spacenet and significant new customer wins. We made progress in our strategy with another major award for our Ka-band VSAT technology in Russia.

We now have three major customers in the consumer segment, Optus NBN, SES Astra2Connect, and this recent strategic alliance in Russia. We have also significantly expanded our sales of Satellite-on-the-Move antennas to the defense market. We set, at the beginning of this year, management objective to increase our revenues from $233 million in 2010 to $330 million in 2011, and our EBITDA margin from approximately 6% to 10%. We feel we are on track and believe we will be able to meet these objectives.

Before I conclude the call, I would just like to say that this will be the last Gilat investor conference call that I will be heading. I hand over the reign, confident that Erez Antebi will succeed and grow the company to new heights. And with that note we would now like to open the floor for questions. Operator, please.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from James Breen of William Blair. Please go ahead.

James Breen - William Blair & Company

Thank you, very much. So just a couple of questions. One with respect to some of the new business that you are adding. Do you think that, number one, does it change your margin profile at all of the company, and then also we start to see more revenue coming from government entities in the future? And then secondly, just in overall competitive environment, how does it look out there right now and have you seen any uptick in competition? Thanks.

Amiram Levinberg

Well, I don’t think that we stop working with governmental entities, I think that we have done lots of business with governmental entities in the past as well, and we have actually participated in major rollouts, usually governmental initiatives that brought telephony and internet access in rural sides of country. The difference with this specific one is that the project in -- both projects in Russia and in Australia are this time kind of bringing broadband rather than telephony. So the emphasis in on broadband and specifically with the contract in Russia, the government has decided to dedicate a very significant budget for launching satellites in Ka-band. And they are talking, at this point of time, on three satellites. Two of which will be very heavy multi-spot beam satellites.

So it’s a very important and big initiative towards bringing satellite capacity and accessibility via satellite to many citizens. The goal that the government has published is that they would be able to do that to 2 million citizens. So we have been working with governments in the past. This is kind of a unique agreement just because it’s a major initiative. Indirectly, now that we are in defense, we also work with government but through -- selling equipment through integrators predominantly, I would say.

James Breen - William Blair & Company

And I think you mentioned that -- as these new contracts it seems to be more broadband then voice. Are there no (inaudible) in terms of the financials associated with those products. Are they more profitable than voice products are?

Amiram Levinberg

Even voice products now are all kind of IP base, which means Voice over IP. Generally speaking, I think that the profitability in these kind of projects is not so much different other than the fact that in different kind of points of time it’s always dependent on the mix of products and we always say that, hub components for example will carry a little bit higher margins than the VSAT, and issues like that.

James Breen - William Blair & Company

Okay. And then secondly, or I guess third on competition. Are the other guys bidding for some of the service that you are providing or is it really your opportunity to go out there and provide the service without a lot of the competition in your way?

Amiram Levinberg

Well, in this case it’s a completion non on services as such, but on selling our technology definitely there is strong competition in that regard. Ka technology exists within our major competitors, predominantly Hughes and ViaSat. And in this case there was even a small competitor that participated in this competition. So, yes, it’s always a tough competition.

James Breen - William Blair & Company

So I guess lastly, as there as more competition on the Ka side, do you think there is room for consolidation within this industry further?

Amiram Levinberg

Okay. It’s a question always being asked again. As you know there are only four kind of fairly big technology providers. Namely, Hughes, ViaSat, iDirect and us. There is always a potential for a consolidation in this market but as far as I know there is nothing in specific at this point.

Operator

The next question is from [Gunter Carger of Calvery Group]. Please go ahead.

Unidentified Analyst

Yes, good morning. I just wanted to congratulate you on a exemplary performance on a difficult world market and best of luck to you, Amir.

Amiram Levinberg

Thank you very much.

Operator

The next question is from [Leron Rockman of Oscar Group]. Please go ahead.

Unidentified Analyst

Hey, guys, congratulations for the quarter. Can you give us some updates regarding the Wavestream business, the C&E improvement in the military markets, in the DoD spending? And also regarding the commercial business (inaudible)?

Amiram Levinberg

Okay. Thank you. Leron. I would say the following. First, because we have been asked many times, we have said that this quarter Wavestream contributed to our revenue $60 million. Generally speaking, I would say the following. As you know there is some pressure on DoD budgets in the U.S., but when you dive into the detail, the Wavestream potential revenues and revenues more kind of effected by the -- I would say the micro-topographic of the situation. Major programs that Wavestream participate is (WINT). (WINT) is going -- phasing into increment two. In increment two, the situation is that it’s more initial purchasers at his point of time which is called LREP, if you are familiar with this acronym. So it will take definitely some time until it will pick up.

At the same time Wavestream, just announced a few days ago, that they have introduced a new line of products that goes into aeronautics vehicles. And I see very high potential there because the many initiatives now, both on defense and on commercial take satellite communications over airplanes, and over UAVs. And over airplanes predominantly for the application of internet access and over UAVs naturally for transmitting video. And Wavestream is just announced two products in this line. We have a first customer, which I cannot disclose at this point, to these products. And we see some revenues by now and lots of potential going forward from this direction.

Unidentified Analyst

Okay. That’s very helpful. Thanks. And regarding the Ka-band, can you give some color regarding this market. The expected growth for the future, what's the size of that market have you projected right now?

Amiram Levinberg

Okay. Let me tell you what's currently, generally speaking, exist in this market. First, the Ka-band is not just launching satellites in a new frequency band. In the past there were C-band and then KU-band. C-band is like 6 gigahertz, KU-band like 14 gigahertz, and in Ka-band transmission to the satellite at 30 gig and then receiving from the satellite at 20 gig. But it’s not just a change in the frequency as such. Actually, the new generation which is multi-spot beam satellite, all you can achieve with this frequency band, they are much narrower beam that is going to and from the satellites. And this generation of new satellites actually is quite optimal for unicast type of communication rather than multi-cast or broadcast. So it will be good -- on the video world it will be good only for local to local television. But then for VSAT it’s actually way more optimal then the regular “wide-beam satellite”.

Currently there are a few satellites of that nature in the globe. In the U.S., Hughes is using such capacity and also ViaSat, the other Wild Blue. In Europe there is a satellite called KA-SAT, it’s Eutelsat launched, but there is a list of operators that are about to launch such a capacity going forward and smaller capacity still narrow beam and small amount of capacity still narrow beam. And in Ka in regular “ satellites kind of piggyback on other satellite”. So there will be lot of this capacity. This capacity is optimized for VSAT, generally speaking because it is optimized for unicast. And just to give you sense, a heavy multi-spot beam satellite is going to cost somewhere between $400 million and $500 million as compared to a regular satellite which cost like $200 million to $250 million. Which means lots of investment in capacity which should be translated into ground segment as well. So, generally speaking, I think that the ground segment is a market for VSAT in ground segment. From a macro-economic standpoint, have to grow once you have this kind of -- once people have invested in this kind of capacity.

Unidentified Analyst

Thank you, very much. That’s very helpful. And then last question, Ari, regarding the OpEx and what can you tell us there, may be for next year how do you see that?

Ari Krashin

Well, obviously, we have not decided yet or finalized our budget for next year. So there is not much I can share with you at this point. But I can safely say that obviously we have put a lot of effort and we are -- there is three important part, obviously to maintain profitability and probably even improve profitability as we grow better along the way. So we are monitoring the OpEx and obviously we will beat the budget for next year accordingly.

Operator

There are no further questions at this time. Before I ask Mr. Levinberg to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin in two hours after the conference. In the U.S., please call, 1-888-782-4291 In Israel, please call, 03-925-5921. Internationally, please call, 972-392-55921. Additionally, a replay of this call will also be available on the company’s website, www.gilat.com. Mr. Levinberg, would you like to make a concluding statement?

Amiram Levinberg

Yes, thank you everyone for joining us today. Good day and good-bye.

Operator

Thank you. This concludes Gilat’s third quarter 2011 results conference call. Thank you for your participation. You may go ahead and disconnect.

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