Gilat Satellite Networks Ltd. (GILT) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Gilat's Second Quarter 2017 Results Conference Call. All participants are present in listen-only mode. Following management's formal presentation instructions will be given for the question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, August 8, 2017. I would now like to turn the call over to June Filingeri of Comp-Partners to read the safe harbor statement. June, please go ahead.

All right, thank you, Yuni. Good morning, and good afternoon, everyone. Thank you for joining us today for Gilat's Second Quarter 2017 Conference Call and Webcast. A recording of this call will be available beginning at approximately noon, Eastern Time today, August 8th, and will be available for telephone replay until August 11th at noon. The webcast will also be archived on the Gilat website for a period of 30 days. Also please note that investors are urged to read the forward-looking statements in Gilat's earnings releases with reminder that statements made on this earnings call that are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such 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 these forward-looking statements whether as a result of new information, future events or otherwise. The company expressly disclaims any obligation to do so. More detailed information about risk factors can be found in Gilat's reports filed with the Securities and Exchange Commission. With that said, let me turn to introductions. On the call today are Yona Ovadia, Gilat's CEO; and Adi Sfadia, Gilat's Chief Financial Officer. I would now like to turn the call over to Yona Ovadia. Yona, we are ready to begin.

Thank you, June and good morning, good afternoon, good evening, everyone. Thank you for joining us today. I'm pleased to report that Gilat achieved very good financial results for the second quarter of 2017. And I'm especially pleased in our achievement, which is reflected in the increase of our adjusted EBITDA objective for the year. This is due to the significant improvement in our profitability both GAAP and non-GAAP. This can be seen across all profitability measures including in the significant step up in our operating income and GAAP net income. In addition and equally importantly, we are optimistic that both our growth engines mobility and mobile backhaul will generate additional business in the second half of the year. Going into further details, the major driver of this profitability improvement was a substantial increase in revenues from mobility growth engine, mainly our solutions for In-Flight Connectivity including modems, antennas and transceivers, which represented a larger percentage of total revenues compared to previous quarters. Our strategy to focus on cellular backhaul for the mobile market, as our second growth engine is also contributing to our profitability. To reflect the new level of profitability attained thus far this year, we have increased our 2017 management objectives for adjusted EBITDA to a range of $ 22 million to $ 26 million from a range of $ 20 million to $ 24 million. We have also narrowed the range of our revenue objective given the headwind in our LATAM legacy business, which we have reported in previous quarters. Going into a business review. In addition to our continued focus on improved profitability in the second quarter, we continued to see materialization of our strategic direction and growth engine. As I noted last quarter, the industry is supporting our viewpoint that high throughput satellites are unlocking the mass market by delivering fiber-like benefits at fiber-like price. I would like to focus my comments on our mobile backhaul and over satellite and our mobility market, which -- sorry, with a focus on In-Flight Connectivity. In addition, I will discuss further development in our ongoing business. In regards to our mobile cellular backhaul business. We are seeing a declining capacity price and the ever growing need for quality, affordable broadband everywhere is driving growing acceptance of our LTE over satellite solution. We note, that more and more leased lines are being replaced , T1 connections are being upgraded to mobile 4 G service. Reliable broadband connectivity is now being considered everywhere, including in tourist centers, campuses along highways as long as for public safety. Our existing customers such as Softbank-Sprint, Optus and others are extending their networks and as such, we have received additional orders from cellular backhaul satellite equipment. To this end, we continue to develop our telco strategy of providing the industry-leading LTE over satellite cellular backhaul solution while making significant strides forward and are optimistic that opportunities in our pipeline in North America, Latin America and Asia will mature in the second half of this year. In mobility, the mobility industry and In-Flight Connectivity in particular is another strategic direction and growing engine for us. Our portfolio solution extends from modems which offer unparalleled speed and performance to our leading antenna and industry-leading transceivers. We see that IFC industry is seeking innovative technologies to enable excellent user experience, for example, enabling 400 megabit per second to each aircraft, while achieving drastic improvement in satellite bandwidth utilization. Such a grateful technology was introduced by our aero modem, now commercially deployed by Gogo with accelerated installations plan to reach over 1,800 aircrafts across more than 13 airlines worldwide. As Gogo just stated yesterday, in their earnings call, the modem delivers 16x more throughput than their previous solution, and I quote, the network features faster and more sophisticated processing that enabled much shorter hand-offs from 1 satellite to the next further improving our service availability. We also committed to delivering the best performing antennas . We have developed the unique dual mode Ku/Ka antenna and are committed to continued investment in next generation electronically-steered antennas, also known as ESA. And this innovative technology will enable our partners to provide higher throughputs per aircraft and much improved user experience. Turning now to our other business. I would like to discuss 3 additional points. First, Gilat is making progress in propelling the satellite TV market into broadband services. As mentioned earlier, HTS and declining prices of capacity have driven satellite- based broadband to a mainstream competitive solution that can now satisfy the ever growing demand for data at affordable, plentiful and high quality connectivity. We are seeing more and more interest from and MNOs and DTH providers to leverage satellite connectivity to retain and acquire customers. Specifically, this quarter, NTV-Plus, a major Russian DTH provider has joined this fast-growing broadband market by offering high quality Internet service to its subscribers enabled by Gilat 's proven technology . This follows the already successful broadband service offered by Tricolor, the largest DTH provider in Russia. Gilat satellite solution in Russia provides affordable broadband connectivity leveraging the Eutelsat, Ka, HTS satellite. Gilat is enabling lowering the barrier to entry via offering our Scorpio, which is a full outdoor, self-install and automatic service activation VSAT. In addition , we also -- it's worth mentioning that Gilat was awarded a major contract for $ 11 million from Telebras in Brazil to fulfill the public policy of the Brazilian governmental national broadband plan of providing fast and affordable broadband communication to commercial and government entities . We hope that this is the start of our turnaround in our business in Latin America and we're focused on accelerating this positive trend. Finally, regarding our project in Peru, second quarter revenues were as expected. Overall, we are on track to deliver complete regional solutions for certification during end of 2017 and first half of 2018 and then move to ongoing operation of these networks. Our long-term plan for these regions and others that we hope to win in Peru is that once the networks go live, we expect Peru to generate between [$ 40 million and $ 60 million] of recurring revenues each year starting 2019. Revenues will come from operating revenues from FITEL and additional services to be sold on the network, therefore nicely profitable. So in summary, the second quarter was another quarter of strong progress for Gilat in which we are focused on our strategic growth engines and made progress in both mobile and mobility. With this progress, we are pleased to increase our profitability objectives for 2017, including moving up the adjusted EBITDA range. We will continue to execute our strategic priorities. And as I have mentioned, we are optimistic about the rest of the year. Adi, now we're ready for your report.

Thank you, Yona, and good morning and good afternoon everyone. I would like to remind everyone that our financial results are presented both on a GAAP and non-GAAP basis. We regularly use supplemental non-GAAP financial measures internally to understand, manage and evaluate our business and to make operating decisions. We believe these non-GAAP financial measures provide consistent and comparable measures to help investors understand our current and future operating performance. Non-GAAP financial measures mainly exclude the effect of stock- based compensation, amortization of purchased intangibles, litigation expenses related to trade secret claims and expenses for tax contingency to be paid under an amnesty program. The reconciliation table in our press release highlight these data and our non-GAAP information presented exclude these items. I will now move to our financial highlights for the second quarter of 2017. Revenues for the second quarter of 2017 were $66.2 million, a 2% decrease compared to the $67.9 million in the second quarter of 2016 and 4% increase compared to the previous quarter. Our GAAP gross margin in the second quarter of 2017 was 30% of revenues compared to 27% in the previous quarter and 22% in the same quarter last year. The increase in our gross margin is mainly attributable to a favorable revenue mix in Q2. Total R&D expenses on a GAAP basis were $6.2 million, same as in Q2 2016 and $6.7 million in the previous quarter. Sales and marketing expenses were $5.6 million compared to $5.9 million in the same quarter last year and $5.8 million in the previous quarter. G&A expenses were $5.9 million compared to $ 5.7 million in the same quarter last year and $4.8 million in the previous quarter. G&A expenses include about $600,000 of tax related penalties due to the company's decision to participate in tax amnesty program in Brazil. An additional $300,000 of related expenses are included in the financial expenses. The tax amnesty program was announced during Q2 and offer an approximate 60% decrease in payments due to tax related litigation cases that the company has pending in the Brazilian court. Total operating expenses on a GAAP basis was $17.7 million, same as in the same quarter last year and $17.3 million in the previous quarter. GAAP operating profit in Q2 was $1.9 million compared to an operating loss of $2.5 million in the same quarter last year, and operating profit of $18,000 in the previous quarter. Net income on a GAAP basis were $2.1 million or income of $0.04 per diluted share compared to a loss of $3.7 million or a loss of $0.07 per diluted share in the same quarter last year, and the loss of $784,000 or a loss of $0.01 per diluted share in the previous quarter. On a non-GAAP basis, the operating profit for the second quarter was $4.1 million or 6% of revenues compared to an operating profit of $525,000 in the same quarter last year. Non-GAAP operating profit for the previous quarter was $2.5 million or 4% of revenues. Non-GAAP net income in the second quarter was $4.6 million or income of $0.08 per diluted share compared to a non-GAAP loss of $586,000 or a loss of $0.01 per diluted share in the same quarter last year. Non-GAAP net income for the previous quarter was $1.7 million or income of $0.03 per diluted share. Adjusted EBITDA for the second quarter of 2017 was $5.9 million or 9% of revenues compared to adjusted EBITDA of $2.4 million or 3% of revenues in the same quarter last year. Adjusted EBITDA in the previous quarter was $4.3 million or 7% of revenues. As of June 30, 2017, our total cash and equivalent, including restricted cash net of short-term bank loans and credits were $109.5 million, an increase of $16.3 million on the previous quarter. DSOs, which exclude receivable and revenue of our service segment decreased to 71 days compared to 90 days in the previous quarter. Our shareholder's equity at the end of the quarter totaled about $ 212.7 million compared to $ 210.3 million at the end of the previous quarter. That concludes our review. Thank you for your attention. I would like now to open the call for questions. Operator, please?

Thank you. Ladies and gentlemen, at this time we'll begin the question-and-answer session. [Operator Instructions] The first question is from Andrew Spinola of Wells Fargo. Please go ahead.

Yona, I wanted to ask specifically to the backhaul opportunity. You mentioned that you're hoping for some of the contracts in Asia-Pac and the U.S. to become more firm in the second half, but in general, when I look at sort of the -- some of the industry commentary on this opportunity, it seems like there could be a lot of growth. And I'm just wondering, when you look out across your sales force, are you seeing sort of like the number of RFPs increase the size of the RFPs. What's happening in that market in terms of the organic opportunity for backhaul?

First of all, thanks for the question, Andrew. I'm a little bit struggling with the question, because what we see in the marketplace is balance between on the one hand realization that this is a mainstream solution with more and more opportunities to be deployed. Some of them I have listed like campuses, in universities, like highway, like islands, touristic centers et cetera and the realization that this is the mainstream solution versus the traditional conservative nature that telcos demonstrate in order to protect the quality of their service to their customers. And so we are struggling as leaders. I think of this market niche with proving that this is indeed a mainstream solution and we are seeing change by the day, and we're seeing growing interest, as I've indicated by the day. We think that the potential is very significant. We always depend on pioneers such as SoftBank, such as Optus, such as others that we hope to conclude with -- in the coming weeks and months, but it's such a win, opens new opportunities. And we are going into proof-of-concept testing and we're going into trials in order to persuade others that are more skeptical and more concerned about protecting their core network that this is a reality. So we see a balance here which is -- is gradually shifting and we believe it's going to be like a snowball phenomena. But growing interest and growing belief that this is a reality, this is a mainstream solution provided we have done decent proof-of-concept -- decent testing of our equipment in their laboratories and in their field. As far as RFP, since we are pioneers, we see less of an standard RFP process to begin with, but probably towards the tail end of the process when they want to make sure that we're also competitive in price. So normally the start is initiated by us less by a formal RFP. Though sometimes or in most of the cases, not all, it's concluded with an RFP just to keep our -- keep us competitive and keep our hands to the fire. But in general, what we see, the landscape that we see is there is growing belief that this is a mainstream solution. There is growing number of -- types of opportunities for deployment and we keep fighting this balance between the desire to move in this direction versus the conservative nature of protecting their core network and their user experience. So I hope, I answered your question.

No, no, that's exactly what I was sort of getting at. And sorry to stay on high-level question, but I'm kind of curious on the same -- at the same time, that was great color on backhaul. Is the broadband opportunities that you're looking at, clearly Russia is moving ahead, Africa is on the horizon. Is it similar to the backhaul situation where you're still having to do a lot of the initial going to the clients and getting them to be interested? Or is there -- is that market a little bit further along in terms of the development as a demand?

I think, it's difficult to compare, because the basic -- our basics are different. There is no doubt that the market is there. There is no doubt that DTH providers and the MNOs believe that the opportunity is there once the barrier to entry is met. So unlike cellular backhaul, they are believers. But at the same time, it's always this question of -- it's not a question of technology, it's not a question of credibility, it 's not a question of connecting satellite network to a core network. They know it works. They just want to make sure that the economics works. And it's all about barrier to entry, which we're fighting very hard. So it's a different battle. They do want to believe in it. They just want the numbers to work, which is very difficult in a market where people are not -- cannot afford to pay the $50, $60, you would see in the U.S. We are talking about Russia, we are talking about Latin America. As you mentioned, talking about Africa. The ARPU there is a lot lower. And therefore, the barrier to entry is a very difficult barrier. So the nature of the business is different. The DTH providers and the other telcos we're working with, they are believers in concept, in the credibility of the technology, in our equipment. They just the numbers to work, which is a challenge, which is different, it's just a different beast. But as I said earlier, we see there also progress. In Russia, once we entered Tricolor, we see others rallying also to join the race. We hope to have some business in that market outside of Russia as well. But we'll have to be patient a little bit with that.

You referenced the Ka/Ku antenna. I think, you had an unannounced customer on that. Have you been able to add additional customers and what's the ramp like right now? Are you shipping those antennas? Or is that still to come?

We're not shipping those yet, because we are going now into a certification process, which will take a few months. But in parallel, we are already marketing those -- this antenna, and we believe in it. So at this point, this is all I can say.

The next question is from Kevin Dede of Rodman & Renshaw. Please go ahead.

Could you offer little more insight on the Telebras deal? How did you restructure, how did you reorient, why did you become competitive there, and why are you so -- why you so optimistic about that deal signaling a change in your Latin American [business]?

I'm optimistic about -- I'm cautiously optimistic about our business in Latin America, because we believe in making progress and grow the business via large opportunities. There were few of them in the region and in some parts; there are opportunities we skipped because of unstable economy such as Venezuela. So this is the first significant deal that we have won in the region for a while. This is a very big satellite, very central to the satellite industry in general in the region. And we hope that following that win , we have opened the door to additional cooperation with Telebras as well as other players in the region once we have demonstrated our capability to deliver such significant project and once we have repositioned ourselves to win significant deals which are needle movers for our business in the region.

Can you offer a little more detail. I mean, is this something specific to, say, 1 city? Or is it a national coverage, Telebras operating their own satellite, just give us a little more insight on exactly what you're doing there.

Well, the satellite itself covers all of Brazil, including well into the ocean, I think, like 200 miles into the ocean. So it's covering -- it gives coverage for all of Brazil plus some of the ocean around the country to cover aero and maritime opportunities. Now the -- some of the satellite is being deployed for military services, most of it for commercial services and [we're happy] -- illuminate the beams all over the country. We believe that once we are -- our technology there is deployed, then the users of that -- capacity of that satellite will be also oriented towards using our technology. And therefore, it's not only that $ 11 million and change dollar service we're giving them, but also it opens the door for our ability to deliver our services and technology for the consumers of that capacity, which would be MNOs, DTH providers and possibly other service providers in Brazil. So it's not only the size of the opportunity, but also opening the door. Let me say, almost will be the default for those buyers of capacity from Telebras. Now you may or may not know, but Telebras is going on a bid for this capacity, I believe at the end of this month, maybe next month, not exactly sure about the date. And to sell their capacity and where we believe they will be in a good position to provide our services to the buyers of this capacity. That's why I think, this is not only big by itself, but indicative to a trend that we hope to develop to grow our business not only in Brazil but all over the region.

Then, is there anything specific on your end that changed in your marketing or your sales effort?

I would say that more than anything else, it is heightened management attention and willingness to take deals that is longer -- they are in state of the country that gross or modern ensures that we will get pay down like Venezuela and other places in that region . We have been doing that for a while, but it takes time for results to show. So personally I have devoted lot of time. We have changed some personnel in the field. But in general, management has put extra focus in building relationship with the Telebras of the world and in chasing those larger opportunities. This has been going for a while, but wins are -- it takes time to mature. So it took us a while to win this opportunity and to create what we believe is further opportunities. But this has not happened yesterday. We've been doing that for quite some time, except that it takes time for this to come to fruition. So I think the main thing is managerial focus, people on the ground and ability to take a little bit more risk provided that return is guaranteed.

Do you think there is sufficient capacity there over time to deliver reasonable services at the consumer level?

To my best knowledge, if anything, there will be overcapacity over Brazil because Telebras is not the only one launching a satellite. I think that there are couple of number of satellites about to be launched about, Brazil. And when you look at road map going forward in the coming two to three years, there will be lot of capacity above this country and mainly Brazil, maybe also Mexico, but I think Brazil. And therefore, there will be opportunity for us in two ways. One, provide services and equipment to those satellite operators and secondly as we go into consumer broadband to cellular backhaul, there will be a lot of capacity meaning reduction in price, which is always a catalyst to our business.

On the Scorpio, you mentioned that self-install, I apologize, I'm not that familiar with it. Can you just talk a little about, whether or not you need a straight line of sight for southern exposure or how easy it really is?

Okay, the thing that is special about Scorpio, which is unique in the marketplace, it's a 1 unit. It's no IDU or ODU which is indoor unit, outdoor unit. It's all one outdoor unit that is installed in the -- on top of the -- on the roof. And therefore it eases the installation, it reduces the cost because there are less parts for the work and it is enabling self-install with at best support in remote. In terms of statistics, we have already started shipping out this unit, not in great volumes. We're ramping up our production capabilities. To- date, the experience in the field is that 50% of the installations were indeed self- installed, meaning there was no necessary neither by phone or asking for a technician to come. But given the fact that this is a new product, we believe that the -- this is the beginning. This is done in the first steps and this number will go up significantly.

Can you just give us a little detail on the level of Internet service that you're getting out of that Ka, with NTV and Tricolor in Russia? Just kind of curious about what sort of uplink and downlink speeds they're seeing?

We don't control that, Kevin, the operator decides. They have different packages with different uplink and downlink. I really don't want to go into that. Our technology, not looking at them. This is their business. We provide the technology, they decide how much to sell, at what price to sell, what KPIs to sell. That's not my business.

I understand. Do you think, the service packages that they're offering could be competitive in a more developed installation or a more developed environment where wireline connections are say anywhere between 20 megabits and 50 megabits?

I am struggling answering this question because I don't know the internals of their business model.

No, that's fair Yona, I just was curious. I just kind of wanted to see what the endgame competitive package might look like just for comparison purposes, but I appreciate your insight. I really do and apologize for catching you off guard on that, but thank you very much for trying. I really appreciate it.

The next question is from Gunther Karger of Discovery Group. Please go ahead.

The question, in the Chinese market particularly in the area of rail that you have mentioned in the past, is there any update in that aspect?

Hi, Gunther. Nice to speak with you again. In general, there is no specific update on that. We have a lot of sales focus in China. This country, it go slow there. Their sale cycle is longer than the rest of the world. As for the trains, we are still in testing and certification progress -- process and at the end the demand for this is depend on the ability of CRRC, the train manufacturer to offer our solution as one of their option to their customers. This is basically what we can update and what happened in the last quarter.

Follow up on the plane area. Does your technology apply to medium to short haul like intercity 200 mile range distance operations versus strictly only long hauls?

No, I think, it's applied to short haul. Thank you, Gunther.

[Operator Instructions] There are no further questions at this time. Before I ask Mr. Adi Sfadia to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin 2 hours after the conference . In the U.S., please call 1-888-782-4291. In Israel, please call 03-925-5918. Internationally, please call 972-3925-5918. Mr. Sfadia, would you like to make your concluding statement?

I want to thank everyone for joining us for the call today and thank you for your time and attention. We hope to see you soon or speak to you in our next call. Thank you very much and have a good day.

Thank you. This concludes Gilat's Second Quarter 2017 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.