Ceragon Networks Ltd. (NASDAQ:CRNT) Q2 2016 Earnings Conference Call August 8, 2016 9:00 AM ET
Ira Palti – President, Chief Executive Officer
Doron Arazi – Executive Vice President, Chief Financial Officer
George Iwanyc – Oppenheimer
Alex Henderson – Needham
Timur Ivannikov – Jefferies
Good day everyone. Welcome to the Ceragon Network Limited Second Quarter 2016 Results conference call. Today’s call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of the Ceragon Network.
Today’s call will include statements concerning Ceragon’s future prospects that are forward-looking statements and defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current beliefs, expectations, and the assumptions of Ceragon’s management. For examples of the forward-looking statements, please refer to the Forward Looking Statements paragraph in our press release that was published earlier today.
These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially, including the risks that Ceragon’s expectations regarding future revenues and profitability will not materialize; risks relating to the concentration of our business in India, Latin America and Africa, and in developing nations in other regions, including political, economic and regulatory risks from doing business in these regions, including but not limited to currency export controls and recent economic concerns; the risks that the amount of business coming from our most significant customers will go down or cease; the risk that Ceragon will not achieve the benefits it expects from the expense reduction plan and profit enhancement programs, as may be undertaken from time to time; the risk that Ceragon will not continue to comply with the financial or other covenants in its agreements with its lenders; the risk of significant expenses in connection with potential contingent tax liability; and other risks and uncertainties detailed from time to time in Ceragon’s annual report on Form 20-F and Ceragon’s other filings with the Securities and Exchange Commission, and represent our views only as of the date they are made and should not be relied upon as representing our views as of any subsequent date. We do not assume any obligation to update any forward-looking statements.
I will now turn the call over to Mr. Ira Palti, President and CEO of Ceragon. Please go ahead.
Thank you for joining us today. With me on the call is Doron Arazi, our CFO. We are pleased to report sequentially higher revenues with continued strong growth margins and a return to breakeven results on a GAAP basis with a non-GAAP profit. We continue to generate positive cash flow and we used a portion of our healthy cash position to further reduce our debt; however, the headline of today’s call is the improvement in our bookings during Q2.
Our book to bill ratio was well above 1 to 1, while having that with $10 million higher revenue sequentially. We continue to keep our primary focus on profitability, and our ability to grow orders in numbers and in volume that meet our growth margin criteria increases our confidence in our ability to improve net income in the second half of the year compared to the first half.
As you are aware from some of our recent announcements, higher bookings are being driven mainly by customers in India and Latin America, mainly Mexico. While the 4G LTE network build-out has peaked in most of the developed markets, it is still in early stages in the emerging markets. We continue to see the same phenomenon that we have described to you in the past. In such a competitive environment among carriers, once one carrier in the region moves, the others are forced to move ahead with expansion and modernization plans as well. We are well positioned to take advantage of this in two ways.
First, our global presence and strong carrier relationships enable us to respond quickly to this type of transition in the roll-out plans for one region to another. This is the tricky part of keeping tight control on operating expenses, making sure we do so without hampering our ability to respond [indiscernible] from one region to another. This is where we have an advantage over most other specialists. Second, our IP-20 platform is a major advantage because in this highly competitive situation between carriers, they are seeking best of [indiscernible] solution for them to compete. Also, in some of these emerging markets, the lack of a wired infrastructure requires that the wireless LTE network will provide the broadband connectivity and use higher capacities.
Aside from India and Latin America, we don’t see any clear trends among the other regions. Europe, Africa, APAC and North America remain stable but at a lower level than we would like to see. The reasons vary from one place to another. Since we get a lot of questions about potential new projects in North America, I’ll repeat that we continue to believe we are well positioned to benefit from the diversification optimization plans for large U.S. carriers. We’re engaged in some preliminary network planning discussions with this operator, but we have not received orders.
Meanwhile, we continue to look for opportunities to expand our addressable market through new high-value solutions where we can create strong competitive differentiation. The new product we announced this morning is one example. In recognition of the growing requirements for enhanced security for networks of all types, and particularly for networks serving public safety, homeland security and utilities, we have added a strong set of enhanced security features to our IP-20 platform to create a state-of-the-art premium solution called IP-20 Assured.
This high-value solution offers the enhanced security requirements combined with the well-known performance advantages of the IP-20 platform. We estimate the global market for such solution totals around $220 million a year, including products and services. We intend to focus on the U.S. initially, which represents about 45% of the total market, using this new product to enhance our position and enable us to gain share from competitors. Sales cycles can be quite long in this market, so it will take some time for revenue from the IP-20 Assured to ramp, but we believe this is a good example of ways we can build on our success and extend our reach into additional high-value opportunities to improve our long-term performance.
Looking towards next year, we do not see any major changes in overall market demand. We expect to continue to see demand follow 4G deployments as they rotate from one region to another. Taking an even longer view, we believe a lot of the current hype around 5G is probably justified, but it will be an evolution of the network and any significant impact is still several years out. Nevertheless, we are well positioned to benefit as the increased requirements for broadband access will require ultra-high capacity backhaul.
We plan to continue our current strategy for focusing on product cost and business profitability as the roll-out of 4G in emerging markets continues and we prepare for the evolution of 5G over the next several years.
With that, I’ll turn the call over to Doron to share more of the financial details and key business metrics with you. Doron?
Thank you, Ira. Since you have all seen the press release, I’ll just highlight some of the significant items. Our second quarter revenues of $70 million represented a 17% sequential increase from Q1, and with the strong bookings Ira referred to, our confidence in growing that Q1 was indeed the [indiscernible] quarter and we will continue to see gradual improvement in revenue during the second half of the year. The geographic breakdown of Q2 revenue appears in the press release. The most significant change from Q1 to Q2 was a resurgence in revenue from India and an increase from Latin America, which Ira has already spoken about. We had one above-10% customer in the quarter, one of our large customers in India.
In addition to our strategy of focusing on high-value business, we were able to complete the move of the manufacturing of our IP-20 product to contract manufacturers in lower cost regions. This helped sustain our gross margin at a high level. Although there can be quarter to quarter fluctuations, we believe we can expect gross margin levels above 32% during the second half of the year.
Non-GAAP results in Q2 excluded expenses of $1.6 million of the usual items: tax-related adjustments, stock-based compensation, and amortization of intangible assets. In Q2, we continued to maintain tight control of our non-GAAP operating expenses, which were $20 million, up slightly from Q1. We expect to be able to keep non-GAAP operating expenses around $20 million to $21 million per quarter.
We reported a non-GAAP operating profit of $4.9 million. Our non-GAAP operating margin improved to 7%. Non-GAAP financial expenses increased to $2.4 million primarily due to higher expenses from exchange rate differences, mainly in Africa and Latin America where it is difficult to hedge the majority of the currencies. Subject to currency fluctuations, we expect our financial expenses to remain in the range of $1.5 million to $2 million during the medium term.
We had non-GAAP net income of $1.6 million, which was $0.02 per share.
Turning to the balance sheet, receivables were $89.5 million with DSOs of 112 days. We continue to target DSO to be in the range of 105 to 125 days, subject to geographic mix of revenue. One of our goals is further optimizing cash balances and debt facility utilization to reduce interest expenses. At June 30, 2016, we had cash and cash equivalents of $34.4 million. On top of very strong collections and strong positive cash flow in Q1, we generated cash of approximately $1 million in Q2 and we used some of our cash to reduce our debt by $8.4 million to $21.5 million at the end of Q2. Overall, we continue to focus on better payment terms from our customers and collection on time.
As Ira mentioned, our book to bill ratio was well above 1 during Q2, based on a significantly higher revenue level. Based on the continued success of our sales strategy and our product cost reduction initiatives, we expect our gross margin to remain above 32% throughout 2016, and we want to emphasize that we continue to believe we can achieve significantly higher profits on a constant currency basis in 2016 versus 2015 and sustain positive cash flow, assuming no major changes in the macroeconomic picture.
Now we would like to open the call to questions. Operator?
Our first question comes from the line of George Iwanyc from Oppenheimer. Please go ahead.
Thank you for taking my questions. So it’s good to see the positive financial traction. Can you talk about the gross margin puts and takes as far as the second half comments that you have for 32%? Is this primarily the India strength or are there other pressure points that are pushing it down?
This is Doron. I think that the main pressure point is obviously the increase in the portion of revenue in India relative to the other regions. That would probably be the main factor that is kind of pushing down slightly the gross margins.
Okay. Ira, when you look at the regional mix, what are the positives that you’re seeing in Latin America, especially Mexico, and how sustainable is that into the second half and 2017?
I think what we are seeing, and it’s not only Mexico, we see it in other places in Latin America, we see by the way similar trends in other regions of the world, is as I said, 4G rollouts are continuing. They slowed down or reached a peak in the North America and the European regions with the big operators and are starting to roll out into the other geographies.
What happens in the other geographies is that we see what I call competitive situations. In one region or in one country, usually in a territory, one operator jumps and then we see all the others jump after him because they can’t lose the battle. It’s a battle for market share, new services, higher value services within those markets. That’s what we see in India, that’s what we see in Mexico, and that we see in places like South Africa and some other places. At that point, we see massive rollouts that usually stretch over a period of two to three years, and we are just in the beginning of the cycle. It’s not something that we expect to end at the second half of the year, because for an operator to really roll out and extensive 4G network is something around the two-year type of cycle.
The interesting part in this cycle where we have the advantages is the fact that in those places, the user network, a, for mobile but, b, just as well for broadband access to the home, let’s remember high capacity wire line doesn’t get to the home and a lot of the people will use the mobile network with all sorts of interesting plans on capacity also from the home for the internet access. So it drives the backhaul capacity very much high and it gives us an advantage with our very high capacity and ultra-high capacity solutions.
And are you seeing a sustainable demand in the mature markets – you know, Europe and the existing business space that you have in the U.S.?
In the U.S. because of the operator mix that we’re having, we see sustainable demand. In Europe, we have sustainable demand mainly because most of our business in Europe is non-operator related or with second and third tier operators which are still rolling out.
All right, and is pricing steady or are you seeing pressure?
You’re hearing my noises. I think I’ve been in the business long enough to stay prices steady is not a good remark. There is always pressures, although if we look at outside market research from the last few quarters, the decline in ASP is a little bit slower than we saw before and stabilizing in a lot of the places.
Okay. My last question, you had talked about previously a $75 million quarterly average for 2016. Is that something you’re still relatively comfortable with?
Yes, we are comfortable with the number of approximately 75 as an average.
All right, thank you.
Our next question comes from the line of Alex Henderson with Needham. Please go ahead.
Thanks. So it looks like your strategy of holding the line on pricing is finally convincing these customers that you’re serious and you’re going to be able to hold the line going forward. Congratulations – that was a ballsy move.
When we look out in the back half of the year, you’ve got a chance to produce sequential up fourth quarter, or third quarter. Is it reasonable to think that that’s attainable?
Alex, I’ll put two comments on that. First, it’s not holding the line on the price. I think one of the things that we were able to do over the last year is work with the customers and convince them on the value and the advantages that we have, and yes, turn that value with the customers also into a pricing with them and being able to get reasonable margins from them.
I think on the second question that you asked, I think if we need to reach $75 million on average for the year, which is around $300 million, yes, we’ll need a sequential increase both in Q3 and in Q4 to reach that number for the year.
Yes, the question wasn’t sequential, though. It was year-over-year.
Year-over-year? Alex, this is Doron. I assume you refer to the relatively longer term, which is 2017. I don’t think we see any changes in the market, and I think Ira has commented on that. We do believe that our position now is obviously slightly better, especially when our strategy, and you actually testified for that, is working and we gain more traction with our customers that are willing to pay some slight premiums for better products. So all in all, if you ask me whether there could be a sequential growth, generally speaking I would say positively, although it will be probably on the lower end of single digit growth.
So just to be clear, what I thought I heard you say, you’re saying you’re expecting low end of single-digit growth sequentially off of a $70 million base. That doesn’t strike me as capable of making up the gap between the average of $75 million a quarter, and does raise the question – can you get to an up year-over-year number in the fourth quarter, given the $75 million base in the December quarter? Can you do that sustaining the margins up in the 32 to 35 range?
So let’s start all over again. My understanding was you were talking about 2017.
Q – Alex Henderson
I’m talking about the fourth quarter of 2016. I’m not talking about ’17.
So I think we already said that the fact that we plan for an average of $75 million is an indication that we can continue growing sequentially from Q2 to Q3, and from Q3 to Q4.
It does suggest an up year-over-year number in the December quarter on the revenues, if that’s the case.
Yes, yes. If you compare to Q4 ’15, that’s correct.
Great, that’s what I was looking for. Thank you.
Our next question comes from the line of James Kisner with Jefferies LLC. Please go ahead.
Hi, this is actually Timur Ivannikov for James Kisner today. Thanks for taking our question. So we had a question regarding your Mexican and Latin American and Indian markets. So Ira, what fraction of 4G rollouts do you think still remain in those regions? Thank you.
I think I indicated before, if we look at the duration of typical 4G rollouts over time, it’s usually somewhere around the two to three-year period, very intensive in the first two years and slowing down a little bit in the third. If I look at India, I think we are somewhere after the first year by this time, and probably India will be longer than a three-year cycle because it’s a very large continent. In Latin America, the different geographies there are really starting out or started out this year.
All right, thanks. So in North America, you were talking about how the networks undergo densification – you know, they wanted to increase capacity after the existing installations are done, so are you expecting the same type of trend in India and Latin America, talking about densification and increasing capacity, additional business for you?
Yes, but this is further down the road. I think what we see right now is the first iteration of really inserting 4G into the network and increasing capacity. Densification will come further down the road, although in some places we’ve started seeing some of the things happening in parallel because of the demands for very high capacities, because there is a lot less wire line infrastructure that can provide the capacity.
All right. Last question is about the new platform that I think you said has additional security features. So from your point of view, it is always preferable for customers to install this upgraded platform, upgraded IP-20, and I don’t know if you could share how much more expensive it is compared to the regular IP-20, so any comments on that would be appreciated. Thank you.
From what we see from the structure of the mobile networks, they do not use the Assure platform at this point, neither from us nor from competitors, not from others. We might see a change in that direction further down the road, but at this point it’s not something that we expect. The platform is targeted mainly towards public safety, homeland security [indiscernible] that are more sensitive to all the security issues, and that’s where the platform is targeted at.
All right, thanks. That all we had.
We do have another question from—oh, never mind, Mr. Henderson left. As a reminder, folks, if you do wish to ask a question, please press star then one on your phone.
There are currently no questions in the queue at this time.
Okay, I would like to thank all of you for joining us for the conference call. If anyone has further questions and wants to contact us, you can do that either directly myself, Doron, Claudia are available if needed for one-on-one calls and further clarification. I am hoping to see you during this quarter both in some places face-to-face and conferences and in conversation with all of you. Thank you very much.
Ladies and gentlemen, this does conclude our conference call. Thank you for your participation in using AT&T Executive Teleconferencing. You may now disconnect.
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