Ceragon Networks Ltd. (CRNT) Q3 2014 Earnings Report, Transcript and Summary

(Call Starts Abruptly) joining us today. With me on the call is Aviram Steinhart, who has been our CFO for the past three years. This conference call will be his last with Ceragon. So, I’d like to take this opportunity to express mine, the Board and the team appreciation for the many contributions, Aviram have made at Ceragon and extend our best wishes for much success in the future. Also in the call with me today is Doron Arazi, our new CFO, who has been working closely with us over the past few weeks to effect a smooth transition. Doron will assume all the CFO responsibilities on November 1. He has been leading our planning and budgeting for next year. This will be your first opportunity to hear from Doron, he will discuss the outlook and some of the priorities after Aviram completes the Q3 discussion. As we've been anticipating for the past several quarters, Q3 represents a revenue inflection point due to overall improvement in global demand and the very strong reception for IP20 platform. After a year and a half of essentially flat revenues, we broke out the pattern with a 9.5 sequential increase in revenue. We expected a pickup in revenues beginning in Q3 due to our strong bookings during the first half of the year. Actual revenues in Q3 were at the high end of our own expectations driven by particularly strong demand from customers in India. We were roughly at the breakeven level, on an operating basis for Q3, despite strong pressure on gross margin from our revenue mix being skewed heavily towards India. Now that we see revenues growing again achieving sustainable profitability and positive cash flow is our primary focus that is the core objective of our various operating initiatives. Since we launched the IP20 platform, we’ve continued to be gratified by the positive response from around the world. The strong reception we’ve received validates our strategy of being first to market with full product line on a single platform providing the highest capacities close advance features for the entire array of products. Customer feedback confirms that we offer the best performance as well as the most flexibility for both current and future requirements. We continue to be involved in a growing list of 12 technical evaluations and qualification activities. Our bookings continue to accelerate with a book-to-bill ratio well over 121 again in Q3. Very large orders from our customers in India continue to drive the increase and we continue to grow our backlog as demand for IP20 challenges our ability to ramp manufacturing quickly. IP20 accounted for 46 of total bookings year-to-date and well over half of bookings in Q3. As we’ve discussed on our last call, we did not anticipate that the pace of the various projects would result in a huge pickup in bookings from India several quarters ahead of most of the large projects in other regions. We also didn't anticipate this much pressure to deliver such large volumes of IP20 products so early in the manufacturing ramp-up. Recently our biggest challenges have been a direct result of our success. On a geographic basis, except for India, bookings so far this year have been very much in line with our expectations. On the other hand, orders from India so far this year are triple our earlier expectations. Our ability to reach the high end of our guidance was directly related to a push to ramp-up manufacturing of IP20 to satisfy demand particularly in India. We’re able to ship close to 50% more IP20 links in Q3 than Q2, but the push to do so also affected our gross margin. We experienced higher cost associated with shipping this much IP20 business due to items such as extra hours, expediting fees and shipping costs. Looking ahead, based on bookings, we expect more of the same challenges, to affect us in Q4. Our revenue targets for Q4 remains the same, but the revenue mix is likely to be even more skewed towards India. So with the ongoing ramp of IP20 production, we expect our gross margin to be lower than Q3. The current far from optimal geographic mix of revenues will not prevail indefinitely. Projects end, then other come on stream. So to some extent the geographic mix of revenues will be self-correcting over time. However, we are not willing to tolerate low-margin growth in the meantime and we are evaluating initiatives and that will enable us to make good progress toward our long-term operating margin goal during 2015. We intend to carefully evaluate the extent to which we should continue to accept certain volume orders and we intend to become a more selective in the deals we pursue in general. We will be reevaluating and perhaps adjusting our criteria for deciding whether to accept various terms in a given deal. We will also take steps to ensure that we focus on the most profitable opportunities and avoid having our resources spread to same. In other words we’re carefully mapping our path towards our goal of exiting next year with an operating margin near the mid-single digit level and moving toward our longer-term target beyond 2015. Now, I’d like to turn the call over to Aviram to discuss the financial results of Q3. Aviram?

Thank you, Ira. I will go through some of the details of our Q3 results. Our third quarter revenues were $99 million at the high end of our guidance range. Our GAAP gross margin was 25.6%. Non-GAAP gross margin was 25.7%. The lower gross margin reflects a geographical mix skew more towards India than anticipated. The non-GAAP figure excludes $300,000 from amortization of intangibles, $200,000 of changes in pre-acquisition indirect tax position and $50,000 in stock-based compensation. Third quarter operating expenses were $26.1 medium. Non-GAAP operating expenses were $25.4 million, compared to $27 million in Q2. The non-GAAP operating expenses exclude $200,000 from amortization of intangibles and $500,000 of stock-based compensation. Operating expenses were temporarily lower than anticipated run rate due to seasonal factors. On a GAAP basis, we reported an operating loss of $800,000. On a non-GAAP basis, we reported an operating profit $100,000. Finance expenses in Q3 were $3.3 million. The increase related primarily to the discounting of letter of credit for one of our largest customer and to the lesser extent from the impact of foreign exchange currency evaluation. Tax expenses was about $1.5 million in the third quarter. Non-GAAP tax expenses were $300,000 excluding $1.2 million of non-cash tax adjustments. On a GAAP basis, we reported a net loss in Q3 of $5.6 million or $0.08 per share. On a non-GAAP basis, we reported a net loss in Q3 of $3.6 million or $0.05 per share. The geographic breakout is presented in the press release. The most significant change was another large sequential increase in India on top of the large increase from Q1 to Q2. We had two 10% customers in Q2, one in India and one in Africa. And our OEM sales accounted for about 7% of total revenue in Q3. Turning to the balance, trade receivables increased to $162 million from $146 million in Q2, putting DSO at 169 days. This reflects the sequential increase in revenue as well as the impact of the geographical mix. At the end of Q3, we had $48.5 million in cash. We use net proceeds from the following offering closed in August of approximately $45 million to pay down approximately $23 million in debt, as well as strengthening our cash position. Cash used in operation during Q3 was $7.9 million. Now, I’ll turn the call back to Ira.

Thank you, Aviram. Now I’ll ask Doron to elaborate on some of the other priorities we’ve been working on since he joined. Doron?

Thank you, Ira. Hello everyone. I am so ecstatic about my new role at Ceragon and look forward to having the opportunity to meet as many of you as possible in person very soon. One thing that has really made a big impression on me since joining Ceragon is the customer reaction to the IP20 platform. It is obvious not only for financial metrics like bookings, but also the level of good activity and the extensive pipeline of opportunities that IP20 is highly differentiated in the market. We expect to reach our targets revenue range for Q4 of $105 million to $115 million. For the reasons discussed, our gross margin will be more affected by an even larger volume of lower margin business in Q4 compared to Q3. Therefore, we expect Q4 gross margin to be lower than Q3. We also expect operating expenses to return to the $26 million to $27 million level over the near term. As we move into 2015, we’re likely to see a gradual trend towards a more optimal revenue mix based on shifts in geography and we also plan to be more selective and focused on deal terms as Ira described. Also given the large markets that constitute our future opportunities, we expect some lumpiness from quarter-to-quarter according to the timing of various project roll-outs. Given our assumptions about the pace of various large projects and our intention to be more selective, we are tampering our revenue assumptions for next year, but not our profitability goals. We continue to have a goal of making substantial progress toward our target operating margin. We intend to focus on finding ways to further improve our already best-in-class product cost position. We will target improvements within the supply chain and optimize our manufacturing efficiency even as we continue to ramp production. We will continually reevaluate our allocation of resources, explore opportunities to further reduce operating expenses and focus even more attention on improving our working capital management. Through a combination of these initiatives, we believe, we will be able to generate positive cash flow and achieve a gradual improvement in our operating margin until we reach our goal. Now, I'll turn the call back to Ira.

With market leading technology, the best cost position in the industry, the scale and global reach to participate in the global roll-out of the largest LTE networks, we strongly believe we have the ability to reach sustainable profitability by further improving our execution and this will be our focus over the coming quarters. Now, we will be pleased to take your questions. Operator?

Thank you. (Operator Instructions) We’ll first go to the line of Alex Henderson with Needham. Go ahead, please.

Lots of questions generated by the commentary here. The first one is, you’ve obviously got a heavy skew to the mix to India in September and December quarter. Can you give us some sense of based on the order rates you’ve seen from other geographies? When you expect the mix to shift back to a higher margin geography play (ph), so that we can get the mix backup over that 30% threshold. Is it reasonable to think that in the first half of the year that both quarters will in fact be over 30% gross margins? Can you give us a little bit better clarity on that kind of trajectory?

I’ll start with an, the order and the project focus that we see across the world to answer your question, and I’ll let Doron handle the margins question with you. What we see right now is that we see all other projects progressing a bit slower than our original expectation from the point of view of the mix. We do expect projects in the U.S. to start ramping up towards the end of from a booking perspective towards the end of Q1 and to see initial effects in Q2 and the second half of next year. Based on very good progress we’re making in those, but also based on timelines of those projects and the processes both of testing, integration and others, we’re going in those projects, both in the North American market and in some of the other markets.

So just to be…

Regarding gross margin plans.

Go ahead.

Regarding gross margin plans, so as we said we expect Q4 to be lower than Q3, but based on what we see now in terms of the funnel and the opportunities coming from regions that are with lower cost. We believe that starting Q1 of 2005, we will start seeing gradual improvement in our gross margin. In terms of whether we’re going to reach 30%, I think that the jury is still out there, I think it will take more time than anticipated, but obviously we tend to plan for a much better gross margin towards the end of 2015.

So, it seems like a lot of the pressure here is a function of geographic mix, but it also seems like some of it has do it with the timing of the ramp, obviously to the extent that you have ramped volumes, shouldn't there be an improvement in the efficiency of delivering those products establish as a result of that volume increase no longer needing, expediting and air-freighting and things of that sort?

I think you’re 100% right. That’s ramping up and ramping up the production reduces costs in the way that we deliver and the production cost go down, but as the, skew towards low margin regions will still be higher in Q4 than was in this quarter. We expect gross margin to come down and then start coming back up again because all of the things that you mentioned.

So, can you breakout between the - can you give us some sense of the magnitude of the expediting costs relative to the gross margin pressure and so we can at least get a sense of how much of this is mix and how much of this is temporary one-time costs?

The first maturity of the impact product is coming from the geographical mix and when you’re shipping a substantial amount of - as we did for India, this is the first maturity. I think you can contribute between 1% to 2% on everything that’s associated to the note fully optimizing yet due to the ramp-up of the production efficiency, so 1% to 2% (indiscernible)...

Great, that’s helpful. Thank you. Just one other question and then I’ll cede the floor. There are two variables here obviously what you report on revenues and what you’ve been seeing in orders. Can you give us some quantitative indication of where the book-to-bill was in the quarter, I assume its well above one at this point?

It’s well above one and it’s - as I said on the call significantly well above one, which has been significantly building our backlog and continuing to put huge pressure on our delivery because one of the things that when you have that ramp-up, significant ramp-up in the bookings, it's also the significant pressure on delivery because customers easily place in orders than one time yesterday.

So, just to finish that thought, outside of India, it also looks your book-to-bill was way above 1, with orders out of U.S., Canada, Colombia and alike. Can you just talk about your non-India order rate?

Non-India, it’s probably book-to-bill was around one, a little bit above one, but closer to one.

Thank you.

Thank you.

We’ll go next to the line of (indiscernible). Please go ahead.

Hi, just, thank you for taking my questions. Going back to the gross margin pressure, can you dig into the manufacturing ramp, what has surprised you, what can you do to make it go more efficiently and are there any specific surprises that has hold you back from getting to that 30% level as quickly as you’d originally expected?

I think that we’re putting an emphasis or the question of putting an emphasis on just on the cost of the ramp-up. I think Aviram mentioned between the expediting and everything and everything out there somewhere like 1% to 2% but not more than that. If you look at the ramp-up we had over time three major challenges which are classical by the way in any significant ramp-up that you do. One is yields of products which when you start out the yields are lower and then the increase and on most of the line right now the yields are where we want them to be or close to where we want them to be already. And then you have also challenges around the supply chain because you need really to get enough components in place and some of the components that we’re using are such that it takes time to manufacture them, it takes to bring them into the fact to raise and do the assembly. And when you do a ramp-up we usually plan almost five to six months ahead on quantities. And if you need to shrink the time it has its costs.

So, by the middle of next year do you expect that the supply chain pressure will be normalized?

Now my expectation as of by the middle of this quarter already the supply chain pressures will be normalized around those, because once we started ramping up sometime in Q2. We already looked at the different quantities and we started moving a lot of stuff I believe it’s maybe the middle of this quarter or beginning of next quarter, that pressure will have to be stabilized?

Okay. Does that mean you…

That’s really important for our - really important for our customers to - for us the ability to deliver on time.

So, does that view give you some confidence that gross margin will start to improve in the first quarter maybe one quarter delay to what you’re originally expecting timeline wise?

That will probably start improving towards the second quarter but it’s not because of that, it’s because of geographical mix. Geographical mix is a much higher pressure than those 1% or 2% in moving around the numbers. And I think that’s the major effect that we see, it’s not the manufacturing ramp-up costs within the picture. They added to it, but they added to it in there. What you’re really seeing is a ramp-up of the manufacturing and the capabilities from 90 last quarter Q2 to 99 this quarter to a range of 105 and 115 in Q4, which really means increased quantities out there. By the way the ramp-up in because of the geographical mix the ramp-up in proportion on the number of links that we sent is much, much higher than those proportions, which is reflected backwards in the margin.

When you are looking at vetting the new deals that you signed, when you look at a region like India, are there deals that you are in right now that you would have been more cautious to enter in under the new statistics in a way that you’re going to be looking at ramping customers?

One of few deals, yes, not all of, most of them, no, one of the few deals, yes.

Okay. And then how much of IP20 contribution do you have in the other regions right now, when you look at Europe, North America and the rest of the world?

Let’s do it this way. Overall what we see is we had over 50% this quarter is the number. APAC and India were higher in the proportion, U.S. is leading I think in U.S. we are close to 100% by now of the IP20 family in what we ship. And then we have Africa which is lower than the average mainly because we ship a lot of long-haul which just came up online as IP20 product in last quarter. We announced Latin America is below the averages still takes time to transfer the customers and Europe is close to or a little bit below, number, I don’t have the numbers in front of me, so I am in some way in my head looking at customer and customer list I am trying to get the numbers out there.

Just one last question, North America saw some aggression in the third quarter. How comfortable are you with the ramp expectations you have for next year? Are orders already signed and it’s just the timing of deployment or is there some work to be done still?

There’s still work to be done. The process in taking up large projects in the North American market is a long process. We always assume it’s long and then it’s even longer from that process, but we’re making very, very nice progress on all of those. We don’t see any stop points out there, but things are taking longer because of the processes and the way that we do. You’re probably referring to one of the large project that we see orders from them no, not yet.

Right. Thank you very much.

Thank you very much.

(Operator Instructions) We’ll next go to the line of (David Allen) with MetLife. Go ahead please.

Good morning gentlemen. I have two basic questions. The first one is if you could give us more information about Europe, whether the European economy has been rather slow and I was wondering on a per country basis, can you give us more information about sales into both Western and Eastern Europe?

Sure. We're seeing Europe as indeed as slow. We will not give a breakdown by country, but we can say that we're seeing more business at this point from Eastern Europe more than Western Europe. And definitely we do not plan at this point for significant increase in this volume in Europe and we expect it to stay slow over the next several quarters.

You can't provide more colon than that?

At this point no, this is the color we can give.

What color are you looking at?

I am trying to get a sense of trends whether the economic slowdown in Europe has affected the sales cycle, the adoption rates of your technology?

Usually and I'll get back to that. Usually economic slowdown we see it very, very late. I don't think it’s the economic slowdown. I think in the overall, most of our business in Western Europe up to now has been in vertical market less to operators. We did mention in previous calls, we're involved with one of the largest operators in Europe as part of their projects. We're making progress there, but slow progress at this point. So, I don't see a ramp-up with them in the next one or two quarters on the bookings. In Eastern Europe and Russia, we are involved with more operators in both. There, yes, we see hesitation, I am not sure it’s relevant to the economic slowdown. It has to do with local market condition and competitive conditions in each one of those markets.

Got it. Thank you. Second question is about headcount. What was your headcount on 930 versus last year 930?

I don't think we published the outcomes and I don’t have it in the top of my head and I'm looking at Aviram of course he doesn't have the exact numbers but I will give the rough numbers.

Okay.

If I look at 930 last year from now I would guess around between 1,400 and 1500 where we are down to 1,100 at this point.

And is that primarily in the production side, sales side or research side?

I think all across, we've taken significant steps last November in reduction of headcount, which had to do, first we reduce one R&D site which was in Bergen, and then we'll reduce it across the board in all sorts of other functions both in - we have a lot of our employees involved in projects and project installation, we reduce there and we also reduce G&A functions.

Great. Good luck.

I think the easiest way to look at it almost is if you look at the proportions on sales and marketing, R&D and G&A costs coming down, it's about the proportions that came on headcounts.

Got it. Thanks for your commentary and I appreciate it and good luck.

Thank you very much.

We have no further questions in queue at this time.