Gilat Satellite Networks Ltd. (GILT) Q2 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Gilat's Second Quarter 2019 Results Conference Call. All participants are in a listen only mode. Following the managements formal presentation instructions will be given for the question-and-answer session. [Operator instructions] As a reminder, this conference is being recorded, August 6, 2019. I would now like to turn the call over to June Filingeri of Comm-Partners LLC to read the safe harbor statement. June, please go ahead.

All right. Thank you. Good morning and good afternoon, everyone. Thank you for joining us today for Gilat's Second Quarter 2019 Conference Call and Webcast. A recording of this call will be available beginning at approximately noon Eastern Time, today, August 6, and will be available for telephone replay until August 9 at noon. The webcast will be archived on the Gilat Web site for a period of 30 days. Also, please note that investors are urged to read the forward-looking statements in Gilat's earnings release with a 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. As 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, and the company expressly disclaims any obligations 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. Good morning, good afternoon, good evening, everybody. Thank you for joining us today. I'm pleased to report that Gilat achieved continued improvement in profitability in the second quarter of 2019 as we continue to focus on building a mix of high-quality revenues through our growth engines of broadband, mobile cellular backhaul and mobility in-flight connectivity. I'm especially pleased to share with you two significant milestones that we have recently announced. First, in the area of in-flight connectivity, we have now entered into the business aviation antenna market segment, and this further strengthens Gilat as a major IFC player in this fast-growing satellite communication market. Secondly, we reached a critical milestone in Peru with approval to enter the operational phase of the three region telecom projects awarded to Gilat in 2015 by Fitel. And I will elaborate more on both of these accomplishments in a few moments. Summarizing our financial performance in the second quarter, GAAP operating income totaled $4.9 million, adjusted EBITDA was $8.9 million and revenues totaled $59.7 million, and we continue to deliver bottom line profitability with GAAP net income of $3.4 million or $0.06 per diluted share. Based on our performance year-to-date and our current outlook, we reiterate our management objectives for 2019, namely revenues ranging between $275 million to $295 million, GAAP operating income of between $23 million and $27 million and adjusted EBITDA between $38 million and $42 million. Moving to the business section and starting with Mobility. As I've discussed with you several times in the past, we view aero antennas, and in the long-term, particularly ESA antennas, to be a key component of our IFC growth engine. I'm pleased to share with you that we have entered the business aviation antenna market with an initial award of tens of millions of dollars from a Tier-1 business aviation service provider for our tail mount antenna with further potential of additional significant revenues from follow-on orders. The business aviation segment requires premium service and, therefore, calls for a high-end solution that must be based on innovative technology. We are proud to have met the rigorous requirements of our customer and confident in our ability to deliver on the high performance and reliability needs of this market. Further, while looking forward to the huge opportunity that this market offers, as per the NSR reports on 2018, by 2028, over 5,000 business jets are expected to use satellite broadband communication. I would also like to note that this milestone not only adds to Gilat a new IFC market segment but it also is increasing our portfolio with an airborne tail mount antenna in addition to our leading airborne modem as part of our long-term road map to ESA antennas. Going back to our traditional market of baseband to the aviation market, we continue to see great potential here too, as evidenced in our May 13 announcement of our business with Honeywell. However, more recently, the demand to provide free WiFi to passengers has been a hot topic with large U.S. airlines. Last May, Delta announced plans to offer free WiFi in early 2020, other airlines, such as Southwest and Alaska Airlines, already have free in-flight messaging. And most recently, United's CEO discussed their intent to make WiFi free for their customers. It is quite likely that other airlines will follow as passenger demand for always-on connectivity surges. Free WiFi not only increases the take rate shifting from mainly business travelers to a mix of business and leisure travelers but also likely to change the usage models. Free WiFi expands the usage from primarily e-mail and messaging to running higher-bandwidth applications, such as streaming and social media, which promises to become the norm during travel. Now needless to say, this strength is potentially important implications for the satellite industry, including Gilat. Industry estimates call for a significant increase of the required IFC bandwidth and, therefore, also for additional equipment, and particularly equipment that can provide excellent satellite resource utilization, such as Gilat's high-performance simple and Taurus modem that easily meets the demand for hundreds of concurrent passengers, providing hundreds of megabits per second and high processing power. We, therefore, are optimistic about our pipeline of IFC projects both in the traditional business of baseband as well as in the new business of aero antennas. the new business of aero antennas. Moving on to the second big event of the quarter, and as I mentioned in my opening remarks, we have turned a corner in our projects in Peru. By way of overall background, Gilat has won six regions in Peru with the plan announced in February of this year to move to the operational phase in three regions, mainly Huancavelica, Ayacucho and Apurimac in 2019 and in the fourth region of Cusco in the first half of 2020, while continuing construction of the fifth and sixth region of Ica and Amazonas. In line with this plan, last month, we received approval to enter the operational phase in the first 3 regions of Huancavelica, Ayacucho and Apurimac and to start delivery of broadband internet services to over 0.5 million people in those regions. Entering this phase enables Gilat to unlock access to revenue of approximately $12 million per annual -- per annum of operation fees for a period of 10 years as well as to start selling services over the network. And in fact, we already have started efforts to sell network services over the infrastructure that we have built and recently started to operate, and we believe that we will report progress on these efforts in the coming weeks and months. As I've said multiple times in the past, our interest is -- in Peru project is not the construction dollars but mainly the operational fees and the ability to sell additional services over the network, all of which yield higher margins. With this significant milestone, we're realizing our objective to turn Peru into a source of secure, multiyear, profitable revenue and to deliver on our corporate values of contributing to bridging the digital divide in Peru and worldwide. Moving on and briefly covering Gilat's cellular backhaul business. We were awarded an expansion project further through our managed services cellular backhaul project with Globe Telecom, the leading telco in the Philippines. The new three year multimillion dollar contract is for delivery of broadband to essential community institutions, such as schools and hospitals, via satellite-based WiFi. This expansion demonstrates, yet again, our conviction that the declining price of satellite capacity along with strong ground segment equipment, such as that supplied by Gilat, provides telcos worldwide an additional and legitimate tool for delivering cost-effective, quality broadband to their customers. We continue to see potential in this market, and we believe we will be able to report additional progress soon. Finally, on non-geo satellite orbits, abbreviated known as NGSO. NGSO is becoming a reality as the list of NGSO constellation grows and new large players, such as SpaceX and Amazon enter the market and influence the market dynamics. Gilat sees growing opportunity in this market and is heavily engaged in it as we position ourselves as a significant player in the ground segments market that is opening up and requires high performance, better efficiency and reduced cost per bit. We, therefore, continue to invest significantly in R&D, taking our platform to the next level and offering the market a best-in-class baseband and VSAT platform as well as electronically steered array antennas for NGSO. And so in summary, we're encouraged with the two critical milestones achieved in first half of 2019 in the aero antenna win as well as the turning a corner in Peru, and we remain committed to our plan to continue and build high-quality revenues while continuing to improve bottom line results. And with that, Adi, we move to you.

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, amortization of lease incentive, litigation expenses or income related to trade secrets claims, reorganization costs, expenses for tax contingencies to be paid under an amnesty program and initial recognition of deferred tax assets with respect to carry forward losses. The consolidation table in our press release highlights this data, and our non-GAAP information presented exclude these items. I will now move to our financial highlights for the second quarter of 2019. Revenues for the second quarter of 2019 were $59.7 million compared to $66.5 million in the second quarter of 2018. Revenues in the previous quarter were $62.1 million. Fixed Networks segment revenues, which includes cellular backhaul revenues, were $30.4 million in the second quarter compared to $36.2 million in the same quarter last year and $36.4 million in the previous quarter. The decrease in revenue is mainly due to lower revenues from the Latin America region, especially due to finalizing our projects in Colombia as well as temporary delays in closing some expected deals. Mobility Solutions segment revenues in the second quarter were $22.6 million compared to $25 million in the same quarter last year and $20.9 million in the previous quarter. Second quarter 2019 revenues were impacted by some delays in shipments from our Wavestream subsidiary, which we expect to catch up within the next quarter or two. Terrestrial Infrastructure Projects Segment revenues were $6.7 million compared to $5.3 million in the same quarter last year and $4.8 million in the previous quarter. As discussed previously, revenues for Fitel can vary quarter-to-quarter depending on the percentage of the projects' completion. As previously announced and as Yona mentioned, we have received acceptance from Fitel for the transport networks of the first 3 regions we won in early 2015 in addition to an operational approval for the transport and the access networks in those regions. The acceptance triggered $38 million payment, out of which we already received about $23 million in July. In addition to the operational revenues from Fitel, we can start selling services over the network, especially cellular backhaul, which should carry high margins. Those future revenues will be recorded in the Fixed Networks segment. Construction revenues from our remaining projects for Fitel in Peru will continue to be recorded in the Terrestrial Infrastructure Projects segment. In total, in the second quarter of 2019, Fixed Networks represented 51% of revenues, Mobility Solutions represented 38% and Terrestrial Infrastructure Projects represented 11% of revenues. In the second quarter of 2018, those percentages were 54% for Fixed Networks, 38% for Mobility Solutions and 8% for Terrestrial Infrastructure. Our GAAP gross margin in the second quarter of 2019 was 36.8% of revenues compared to 33.7% in the same quarter last year. The increase in our gross margin is mainly attributable to a more favorable revenue mix compared with the year ago quarter. Our gross margin in the previous quarter was 37.9%. Our total operating expenses on a GAAP basis for the second quarter were $17.1 million compared to $18.3 million in the same quarter of last year and $19.1 million in the previous quarter. GAAP operating profit in Q2 was $4.9 million compared to operating profit of $4.1 million in the same quarter last year and $4.5 million in the previous quarter. GAAP net income in the second quarter was $3.4 million or $0.06 per diluted share compared with net income of $2.2 million or $0.04 per diluted share in the same quarter last year and net income of $2.8 million or $0.05 per diluted share in the previous quarter. On a non-GAAP basis, operating income for the second quarter was $6.3 million or 10.5% of revenues compared to an operating income of $5.7 million or 8.5% of revenues in the same quarter last year. Non-GAAP operating income for the previous quarter was $5.6 million or 9% of revenues. Non-GAAP net income in the second quarter was $4.8 million or $0.09 per diluted share compared to non-GAAP net income of $3.7 million or $0.07 per diluted share in the same quarter last year. Non-GAAP net income for the previous quarter was $4 million or $0.07 per diluted share. Adjusted EBITDA for the second quarter of 2019 was $8.9 million or 14.9% of revenues compared to adjusted EBITDA of $8.1 million or 12.2% of revenues in the same quarter last year. Adjusted EBITDA in the previous quarter was $8.2 million or 13.2% of revenues. As of June 30, 2019, our total cash and equivalent, including restricted cash, were $69.5 million, a decrease of $34.8 million from the previous quarter. The decrease is primarily attributable to a dividend payment of about $25 million and to a decrease in cash related to our project in Peru of about $11.5 million and CapEx spending of about $1.6 million, offset in part by cash generated from our operations, excluding our construction activity in Peru, of about $3.2 million. DSOs, which include our Fixed Networks and Mobility Solutions segments and exclude receivables and revenues of our Terrestrial Infrastructures Projects segment, increased to 83 days compared to 75 days in the previous quarter. Our shareholders' equity at the end of the quarter totaled about $223.2 million compared to $219.6 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.

[Operator Instructions] The first question is from Gunther Karger of Discovery Group. Please go ahead.

Yes. The question has to do with tariffs, trade wars and unpredictable trade policies of the United States potentially with the Trump administration regarding China. Does this, in any way, positively or negatively, impact Gilat's business worldwide?

No. Actually, we don't feel any pressure from -- or expect any influence of the trade war between China and the U.S., at least not in the near future. Actually, we hope to a bit benefit in it because we are not American company and it will not affect our ability to sell in China. Other than that, we don't see any influence.

The next question is from Kevin Dede of H.C. Wainwright.

I was curious about the commercial versus private mix in your aircraft antenna business. I know you talked about great opportunities on both sides, I was just wondering if you could talk to exactly where you're putting your priorities given the interest in the commercial airline fleets in the U.S. and -- versus the large private fleets?

Yes. We believe that the business aviation market is more of a blue ocean than the commercial aviation market, and therefore, it's a path to create and win business in that segment would be easier than in the commercial aviation. So we think that we have, right now, more opportunities than the one that we announced in the business aviation. And through that, we want to create a presence in the market. We want to create acknowledgment that Gilat has a leading product, and with that, expand to commercial aviation. Commercial aviation was and remains on our agenda. However, we think that the path to that part of the market is through business aviation where there is, as I said, more of a blue ocean. There is opportunity that we can capture. There is revenue that we can realize, and from there, expand. Both of these markets are part of our long-term plan, but the easier path we thought was through business aviation where we see huge potential and less of offerings, definitely not the best-in-class product that we bring to the table. But I want to start this is on the antenna side. We keep pushing hard on both fronts from the modem perspective. As I mentioned, we have Gogo, we have announced Honeywell, and we believe we'd achieve more wins in the coming months.

You started to touch on technological differences. I was wondering if you could just kind of convert that to sort of the bandwidths that you have to deal and, right, I mean, obviously, you're not going to need the same throughput on the business side.

No, of course not. The business aviation market is, of course, typically private jets, corporate jets, things of that nature. They don't come close to what a commercial flight would use, but they need high quality, no interruptions and a varying degree of connectivity depending on their needs. So the solution we bring to market that we announced earlier this week addresses that part of the business. However, the technology remains the same both on the antenna side as well as on the modem side. The technology that we have can fit business aviation and commercial aviation. It's just a question of the size of the antenna that you put on the airplane and the strength of the modem that you have inside the airplane. From our perspective, the technology we developed and the innovation we bring to the table addresses both markets. We have no issue and no challenges in meeting the demands of both markets, but as I said, the easier path into the market was through business aviation. And we have a significant player that is working with us, so that's the first achievement that we have. I believe more will follow.

And just from a profitability perspective, are both segments pretty much the same from a margin perspective?

In terms of margin, yes, more or less, the margin are the same. I would stress that the antennas margin is a bit lower than margins on baseband because the product significantly more expensive than modems.

Last question for me, Yona and Adi. The -- congratulations on the work in Peru. I was wondering, if you could offer some insight on how that progress has translated to business development opportunities given that you've been able to help an important partner build a considerable network and prove it. How does that open doors for you?

It's opened lot of doors in Peru. There is a lot of demand for bandwidth in the rural areas. This is why the government is investing about $2 billion in putting fiber all across Peru. Now the fact that we managed to get the ATP after about a year delay, the acceptance, and we've recently started the operation, it's going to affect, first of all, our revenue because it's unlocked about $12 million in recurring revenue on a yearly run rate. In addition, the pipeline of services that we can sell over the network is increasing. We could not sell anything because the networks were idle. Now that's working and we see a lot of interest from the local MNOs and other service providers. And I guess, in few months, we'll be able to start selling those services as well.

The next question is from Michael Hebner of IFS Securities. Please go ahead.

I was wondering about the cash situation in the balance sheet. And so, I see you used last year, for the 6 months, you had $18 million provided. And this time, you had a negative $2.4 million; and trades payable wrong way $3 million; inventory is wrong way $6 million; advances from customers, wrong way by $8 million. I'd assume the cash is going to be replenished by the $23 million we received in the quarter?

Yes. I think you did the math right. Last quarter, since we had to progress in the acceptance in Peru, we had to pay a lot of vendors in order to run and close everything, it's why you see about $12 million decrease in our cash in Peru. But we already got $23 million out of it in July and another $15 million we should get in the coming few weeks. So I think it's decreased, but I guess until the end of the year, we'll continue to see increase in cash generation from operating activity. As for inventory, in my notes, I said that we had some delays in shipments in our Wavestream subsidiary. This caused a bit of inventory increase. Nothing that has worried us. We already see how, we're already seeing these days how they catch up, and I believe they will do all the catch-up until the end of the year. Trade receivables and payables, it's ongoing business, depends on payment terms with each vendor or customer.

So you got the antenna business, why not the modem business? We have -- who is the competitor there that's getting the modem business?

Actually, we are selling full terminal, which includes antenna, box, amplifiers and modem.

So it's just a package deal?

Yes.

Yes. It's a full terminal. We sell full terminal, everything included.

Now like the big picture going forward here, so where do you see, I mean you talked about those things, and so you've got the $200 million or $300 million in revenue $275 million to $295 million, so where do you see the business coming in new markets, new things 5G, whatever? I mean where do you see the growth in the business here?

I think that the growth will come from several different vectors. First of all, cellular backhaul is very important growth engine for us both in terms of top line and bottom line. In-flight connectivity with or without the new antenna is a growth engine, and we expect it to continue to grow in the coming few years. In addition, we are aiming to enter into the NGSO. And winning a deal in NGSO means a lot of revenues to Gilat, but it's not something that will happen tomorrow morning. Even if we win tomorrow morning, there is a development time, and it will take time until we see the revenues. In addition, the bread and butter, the broadband services and the product that we are selling, we believe it will continue to grow, not in high double digits but definitely continue to grow.

Where do you see you're having a distinct advantage where your product is better than the marketplace? Do you have any vision in that front?

I think, first of all, from an IFC perspective, our modem is, in our humble opinion, the best in the market. And I think that as we talk today, the number of airplanes flying, as we speak, with a Gilat modem is significantly higher than any other competitor in the marketplace. So we are very proud of our IFC technology. We think it's the best in the market. And the proof is in the fact that Honeywell has selected our product, and we believe we'll get more traction in the market. Now we want to grow and accelerate our growth with IFC, and therefore, we've penetrated the antenna market, and we believe that our antenna for the BA market is the best in the market and significantly, if I may say so. And we are quite proud of the product we have, we developed and the innovation we brought to our customer. We intend to take this product further and to expand later on into the commercial aviation market. This is on the IFC side. On the NGSO side, these are long cycles that will take a long time to win and further time to materialize into revenues. However, we are currently planning a platform that will be, in our opinion, the best in the market for NGSO. NGSO is a huge market. If you look at the number of players in the market, we are starting with mPOWER for FCS and then we have Telesat, we have Amazon, we have OneWeb, we have LEO sat and many others. So the market is very, very significant from our perspective, and we're investing a lot in R&D in order to build the platform that will take a significant portion in that market. This platform, by the way, is also the catalyst for our entry into the next generation of product, which will be 5G-enabled, and we think that there will be short distance between our NGSO platform and 5G. So we are preparing ourselves for that as well. So I think from a technology perspective, I would just summarize it saying that we continue to invest in R&D in significant percentage of our revenues. Currently, we are exceeding, I think, 13% or 14% of our revenue, and we intend to keep it, if not to grow it. And therefore, I don't think that -- I'm not aware of any other players that invests so much in R&D in order to keep our edge and our advantage in the growth engines that we are focused on. So I believe that we will continue to maintain technological advantage compared to other alternatives in the marketplace, which will pave our way into continued growth in the growth vectors that we identified.

Did I see on your balance sheet -- I mean on the statement that your R&D spending was actually down over...

Yes. It's not down. In some cases, we need to categorize R&D cost as cost of goods sold in case we are providing some development services uniquely to a specific customer and he pays for that. So this quarter, we had some revenue that required R&D to invest and it's part of COGS. I believe that even starting from next quarter, we'll see R&D in the same ratio you saw in the previous quarter.

[Operator Instructions]. We have a follow-up question from Gunther Karger of Discovery Group.

The question deals with the recent military order from the U.S. Army. It's been some time since Gilat has gotten business in this sector, and I'm just wondering if this order was a one-shot thing. Or is it the beginning of a reentry or a resurgence in that particular military market?

Yes, Gunther, actually, it's a good question. First of all, it's a very important order for us. Indeed, the U.S. military and defense, in general, wasn't a growth engine in the last few years, but we are still serving this market. We haven't announced a lot of deals, but we're still serving this market. This is important deal, and it looks like a new beginning. I can't say it's going to be the next growth engine, but no doubt there is a lot of budget spending in the U.S., and we have plans to take different parts of it.

A follow-up on that, if I may. The U.S. is one market, and what the policy has been evolving under the Trump administration is trying to get other countries that participate and then in programs to pick up an increased share of their expenses and commitments. So what I'm asking here is, does this increase worldwide in defense spending at the expense of possibly a reduction in foreign military aid by the U.S. have any positive impact on your business?

No. Currently, we don't see any impact on our business.

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 my participants that a replay of this call is scheduled to begin 2 hours after the conference. In the U.S., please call 1 (888) 326-9310. In Israel, please call 03-925-5900. Internationally, please call 972-3-925-5900. Mr. Sfadia, would you like to make your concluding statement?

I want to thank you all for joining us on this call and 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 great day.

Thank you. This concludes Gilat's Second Quarter 2019 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.