Good day, everyone. Welcome to the Ceragon Networks Limited Third Quarter 2017 Results conference call.

Transcription

1 Operator Good day, everyone. Welcome to the Ceragon Networks Limited Third Quarter 2017 Results conference call. Today s call is being recorded and will be hosted by Mr. Ira Palti, President and CEO of Ceragon Networks. Today s call will include statements concerning Ceragon's future prospects that are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of Such forward-looking statements are based on the current beliefs, expectations and assumptions of Ceragon's management. For examples of 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 associated with a decline in revenues; the risks relating to the concentration of Ceragon's business in India, Latin America and in developing nations and the political, economic and regulatory risks from doing business in those regions, including potential currency restrictions; the risk associated with a change in Ceragon s gross margin as a result of changes in the geographic mix of revenues; the risk associated with the loss of a single customer or customer group, which represents a significant portion of Ceragon s revenues; the risk associated with Ceragon s failure to effectively compete with other wireless equipment providers; 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. Ceragon s public filings are available from the Securities and Exchange Commission s website at or may be obtained from Ceragon s website at Also today s call will include certain Non-GAAP numbers. For a reconciliation between GAAP and Non-GAAP results please see the table attached to the press release that was issued earlier today. I will now turn the call over to Mr. Ira Palti, President and CEO of Ceragon. Please go ahead, sir. 1

2 2 Ira Palti President and CEO Thank you for joining us today. With me on the call is Doron Arazi, our CFO. We are pleased to report another solid quarter, consistent with the parameters we gave for the second half of the year. Revenue was toward the lower end of our run-rate assumption of $75-$80 million, but we had very good gross margin over 35%. There were several contributing factors to the high level this quarter and we haven t changed our view on what level of gross margin is sustainable going forward. We also had strong bookings in Q3 with a book-to-bill ratio over one. So, the main take-away from this quarter is that our profit-focused strategy continues to serve us well and the business is moving along nicely. Timing issues, such as order lumpiness and revenue recognition, sometimes make it difficult to figure out how things are trending and we will try to help with our views on that during our remarks. Looking at the different regions, India continues to be a

3 very strong driver of our revenue. As we know from the pattern earlier in this year, orders from this region can be quite lumpy... and the timing of revenue recognition depends on the different elements of each deal, which can make it quite difficult to discern the trend. In general, we think that the aggressive buildout resulting from the competition between Bharti Airtel and Reliance Jio will continue for another 1-2 years. The consolidation between Vodafone and Idea will create a stronger third competitor at some point as well, which is a positive for us. We are expecting additional orders from this region during the near term, but we don t know the exact timing. So it s difficult to talk about trends when these orders could count toward this year, or could be part of What we can say is that we expect the spending to continue in India next year, but at a slower pace than the very aggressive spending of this year. So, the message on India is: demand is strong, and we continue be very successful in this region, but trying to discuss quarter-to-quarter trends is problematic due to the 3

4 lumpiness. As you know, Africa has been weak... and it shows signs of becoming a little weaker as one of the major operators in the region, with business in other regions as well, is allocating resources to other places. But it s still an important region for us long-term and demand should improve once the operators have access to hard currency and can pay in dollars. The need for wireless backhaul in Africa is growing whether the spending is or not. Latin America remains a mix bag with some regions like Brazil and Argentina continuing to show improvement, while others like Mexico have slowed a bit. We don t expect any dramatic changes going forward from what we see now. Asia Pacific is always lumpy, so we measure our progress except over a long period. What we can say now is that we are making some good in-roads there. As we announced during the quarter, we have two new customers in the region. 4

5 We were selected based on the advantages of our IP-20 platform in terms of providing more coverage with better operational efficiency. Our professional services teams ability to assist with network design, planning, and coordination of spectrum was also a contributing factor in our being selected. Meanwhile, demand in Europe seems kind of flat... and we think it is likely to remain flat at the current level for a while. Long-term, it remains an important region for us and it is one of the regions where we are engaged in 5G trials or demos, which once starts to deploy will increase demand in this region. Turning to North America, you will recall that during the first half of the year, deployment issues in the field caused a North American customer s orders to be lower than originally planned. This customer has been working through the deployment issues and continues to deploy Investors are understandably concerned about how the on-and-off merger discussions between T-Mobile and Sprint might affect Ceragon. As you all are probably aware 5

6 they announced that the merger talks are off. It could be some time before these operators can come to new resolution how they proceed internally, It would work out in our favor in the long term either way since, together or apart, they will need to catch up and compete as effectively as possible with the #1 and #2 operators. Since we are a preferred vendor to both, we are well-positioned to benefit when they have their revised plans in place. We have had a low level of business with these customers recently for different reasons, so we see the impact of this issue as more of a delay in when the business will pick up. We continue to make progress with our strategy of penetrating the vertical markets, and our pipeline of potential business in public safety in North America continues to expand. Therefore, we don t expect to see declining revenue from North America because we continue to gradually gain share in the vertical markets in North America via our channel partners. Speaking of channel partners, we had a very successful three-day event in Tel Aviv recently. To remind you, we 6

7 currently have about 80% of our business related to service providers mostly Tier 1 and Tier 2 mobile operators, of which there are just over 400 world-wide. We work directly and very closely with the decision-makers at each of these operators. On the other hand, for the 20% of our business that consists of vertical markets, our approach is to sell mainly through channels. At our event we had representatives of more than 20 different value-added resellers from around the world, each representing dozens of end customers. We know these channel partners found this event valuable, not only from their direct feedback, but from the fact that several of them sent more than one person to attend at their own expense. We have done several of these events and they offer a great return on investment because they afford us an opportunity to give our channel partners an in-depth understanding of our technology. We also learn from them as they discuss their problems, pain-points and future needs. These partners left Tel Aviv with a strong sense of 7

8 our multi-core strategy and our commitment to solving customer problems. This level of involvement creates a much larger impression that no amount of advertising or webinars could be expected to achieve... and it helps us keep our marketing budget highly-focused. One of the things did was share our vision for the vital role wireless backhaul will play as we continue to evolve from 4G to 5G networks. The theme at the event was The Future is Closer Than We Think. For investors who are interested in when they might see the revenue impact, we continue to believe that commercial deployments of 5G will begin only in 2020 and only in a few regions initially. However, from the perspective of planning a major technology evolution, the year 2020 is just around the corner closer than we think. These 5G networks will eventually enable business models and services that are completely different from what we have today. I am referring to the Internet of Things... or more accurately, the Internet of Everything. 8

9 Machine-to-machine, vehicle-to-anything, smart cities, smart public transportation, next generation public safety... and for consumers, online gaming, virtual reality... augmented reality, very data driven reality! From the network perspective, this means a whole new reality in the form of much higher capacities, lower latency, more sites, denser sites. All this will put huge pressure on the backhaul network. That will mean more fiber, of course... but it will be neither practical nor cost effective to use fiber everywhere. More wireless backhaul, that is one thing that won t change. But it will require major advances in wireless backhaul technology and it will be even more important to solve these capacity and densification issues in the smartest way possible using the least amount of scarce spectrum and real estate, not to mention expensive power and labor. As you know, we are leading the market with Multicore Everywhere. As our competitors stretch to offer some version of multicore technology on certain products, 9

10 we will be shipping Multicore products for every deployment scenario across our entire platform. There are many different multi-core use cases and specific technologies to address them. For example, in dense urban environments a feature of multi-core technology called Advanced Frequency Reuse, allows operators to overcome constraints on densification by mitigating interference to allow more links that use the same frequency to co-exist close to each other and the example is 4X4 MIMO technology is particularly useful in suburban areas where there is a shortage of spectrum by using only a fraction of the spectrum for a given capacity. Advanced Space Diversity is a feature of Multicore Everywhere that increases capacity with reduced expense for long-haul applications by extending the network reach without tower space limitations by using 25% less realestate, equipment, and power. Multicore has already been a huge success with hundreds of thousands of nodes installed globally. Even though we are already using our vertically-integrated 10

11 technology to innovate ahead of the industry, we are pushing ahead aggressively toward the next milestone. Two years ago, we began deploying some of our R&D resources to focus on the next leap forward. Today we offer dual-core, and by the time 5G will require exponentially higher throughput, we will be offering 8-core solutions. We are already involved in testing and trials for 5G or planning to begin them very soon with various operators around the world and we will be ready with wireless solutions that will help realize the promise of 5G. One thing to bear in mind is that we don t expect the demand for 5G to be completely incremental. In other words, there will be a shift toward the need for these higher capacity solutions. We have seen this shift begin already. We continue to believe that we will benefit from the implementation of 5G because we are determined to remain the strongest specialist and we are pursuing strategies to become even stronger over the next couple of years so that we will be positioned to further increase 11

12 our market share at the expense of the weaker players. But part of a comprehensive strategy for growth connected with 5G will be seeking opportunities to move into adjacent spaces as we have mentioned in the past... and this is something we are continuing to work on. It also is worth noting that, by being the strongest wireless backhaul specialist with the most advanced technology we also position ourselves to be attractive on the radar for a large generalist that has fallen behind the technology curve. As things stand today, we see this scenario as challenging because of the internal cultures of the generalists. Our mission is to create the value and use it to capture more of the market one way or another. Fortunately, we see more than one viable path to long-term profit growth and we are in a strong position to go in whatever direction offers the best risk-adjusted potential. Now I ll turn the call over to Doron for some detailed remarks on our financials. Doron? 12

13 Doron Arazi Chief Financial Officer Thank you, Ira. Since you have all seen the press release, I ll just highlight some of the significant items. Our third quarter revenue of $76.0 million represented an 18.6% sequential decrease from Q2, in which we recognized over $20 million in extra revenue from additional orders from India received in Q1 that were not part of our plan. As shown in today s press release, after a big spike in India during Q2, the geographic breakdown of revenue shifted in Q3 to a lower percentage from India, as expected. It s worth adding that it s difficult to define what is a normal level of business from India because of the tendency to be lumpy from quarter to quarter. Revenues from Latin America, Europe and North America all increased sequentially in both absolute dollars and as a percentage of revenue. Asia Pacific and Africa remained 13

14 about the same. In any case, this one-quarter change is not necessarily an indication of longer term trends, which are as Ira described them. We had 2 above 10% customer in the quarter, a large customer in India and one in Latin America. Non-GAAP gross margin was 35.2% in Q3, which improved sequentially, primarily, due to the shift in geographic mix of revenue, and to a lesser extent due to lower shipping costs. While we are encouraged by the trend down of the shipping costs we do not expect them to be lower in the same magnitude, so we want to be clear that the 35% gross margin we reported for Q3 is not the new normal. However, based on the geographic mix of our orders and the pipeline of potential business, we continue to believe we can sustain gross margins above 32% in Q4. Turning to expenses, in Q3, we continued to keep tight control, with operating expenses remaining within our target range of $20-$21 million on a non-gaap basis. 14

15 We believe operating expenses may trend up slightly toward the high end of our range in the coming quarter. On a GAAP basis, we reported $5.7 million in operating income in Q3 and, after financial and tax expense, we had $3.5 million of GAAP net income, or $0.04 per diluted share. On a non-gaap basis, we reported operating income of $6.2 million and $4.4 million in non-gaap net income, or $0.05 per diluted share. We generally don t go into details about year-to-date figures since we have discussed each quarter individually and you can see the cumulative numbers in our press release. But one figure that we want to highlight is our non-gaap net income for the first 9 months of this year. It was $11.2 million. This is very close to our non-gaap net income for all of 2016; therefore, we expect to report a significant improvement for all of 2017 versus last year. Given our current visibility on the timing of orders, shipments, and revenue recognition during Q4, it would be a stretch to make our goal of 50% increase in net income over How close we finally come to this goal will 15

16 depend a lot on the timing of some of the orders from India that Ira referred to. But, we want to point out that the exact percentage increase in 2017 over 2016 is an arbitrary figure and is not nearly as important as the fact that our strategy continues to achieve the desired results. If these orders are not finalized in time to recognize the revenue in Q4, we expect them in Q1 of 2018 instead, which means there is no real significance to the timing from the business perspective it s only a matter of which accounting period they are counted in as bookings and revenue. Turning to the balance sheet at September 30, 2017, receivables were $127 million, with DSOs of 141 days. We had an unusual situation during the quarter which caused some of the balance sheet and cash flow optics at the end of the quarter to look strange. It was due to a timing issue that has been largely resolved already. In brief, India made some major changes to its indirect tax system that took effect in July. One of our customers had some technical issues with the implementation which 16

17 delayed its internal processes and caused our collection from this customer to be lower than expected. Meanwhile, this caused us to have negative cash flow in the quarter of about $13.4 million. With ample borrowing capacity, we funded this by temporarily increasing our borrowing by $15.8 million to $23.8 million at September 30. We have already received close to 90% of the delayed amounts and expect to receive the balance within Q4. Therefore, we expect the borrowing under our revolving credit agreement to decline significantly by the end of Q4. At the end of Q3, we had cash and cash equivalents of $36.5 million, giving us net cash of $12.7 million, with significant unused borrowing capacity. Looking ahead into next year, we don t expect dramatic changes in overall demand, so we don t see any reason at this point to change our quarterly run-rate assumptions. Since we don t yet have enough visibility to give more than order-of-magnitude assumptions about 2018 as a whole, a quarterly run rate of $75 to $80 million would put us somewhere in the $300 million to $320 million revenue 17

18 range for the full year. We think it s realistic to target some additional improvement in our cost structure in 2018, which gives us the confidence to say that we expect gross margin to remain above 32% in 2018, assuming no major negative impact from the geographic mix of revenue. On the OPEX side, taking into account current exchange rates of the main currencies we use for our operations against the USD, primarily the Shekel, we re likely to experience more pressure on our operating expense levels. To be more specific, in the beginning of 2017, we were able to hedge the Shekel against the US dollar at higher rates than the current ones, which mitigated some of the currency impact in 2017, but we will benefit less from our hedging starting in However, we are working on a plan that would enable us to stay within the same $20-21 million per quarter range we have targeted during recent quarters, or just slightly above while continuing our investment in technology as planned. We also expect lower financial expense next year. 18

19 Obviously, at this time of the year we are still involved in the internal bottom up planning process for next year, focused on controlling the things that can be controlled, but the primary point that is directing our planning is: We believe our ability to remain solidly profitable and invest in future technology will position us to capture a higher market share as 5G starts to ramp... and as competitors without a global presence and/or the benefits of vertical integration continue to weaken. As you know, we are exploring various strategic options that would enable us to increase our market share, as well as better capitalize on the opportunities created by the evolution to 5G. Meanwhile, our most important priority is to remain operationally and financially strong between now and when 5G begins to ramp. We are not afraid to make a bold move when we find the right one, but we intend to compete in the world of 5G requirements from a position of strength. We are optimistic, but we also recognize that the process may require some patience while staying with our profit-focused strategy. 19

20 Now, we would like to open the call to questions. Operator? 20