Ceragon Networks Ltd.

Good day, everyone. Welcome to the Saragon Network's limited second quarter 2020 results conference call. Today's call is being recorded and will be hosted by Mr. Ira Pulte, President and CEO of Saragon Networks. Before we start, I would like to note that this call includes information that constitutes forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934 as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that our expectations will be obtained or that any deviations therefrom will not be material. Such statements involve risks and uncertainties that may cause results to differ materially from those anticipated. These risks and uncertainties include but are not limited to the effects of general economic conditions, the effect of the COVID-19 crisis on the global markets and on the markets in which we operate, including the risk of a continued disruption to our and our customers' providers, business partners' and contractors' business as a result of the outbreak and the effects of the COVID-19 pandemic, and such other risks and uncertainties, and other factors that could affect our results as detailed in our press release that was published earlier today and as further detailed in Saragon's most recent annual report on Form 20F and in Saragon's other filings with the Securities and Exchange Commission. Such forward-looking statements, including as to the risks and uncertainties and other factors that could affect our results represent our views only as of the date they are made and should not be relied upon as representing our views as of any other subsequent date. Such forward-looking statements do not purport to be predictions of future events or results, and there can be no assurance that it will prove to be accurate. Saragon may elect to update these forward-looking statements at some point in the future, but the company specifically disclaims any obligation to do so. Saragon's public filings are available from the Securities and Exchange Commission's website at www.sec.gov and may also be obtained from Saragon's website at www.saragon.com. 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 Ira Pulte, President and CEO of Saragon. Please go ahead, sir.

Good morning and good afternoon to everyone joining us on the call today. With me on the call today are Ran Vered, our Chief Financial Officer, and Ossie Sessler, Head of Investor Relations. Before getting into the quarter, I hope that you, your loved ones, and coworkers are healthy and well. I want to assure you that our top priority is ensuring the health and safety of all our employees, wherever they are, even as we walk to serve our customers. It has been three months since we first discussed the impact that COVID-19 was making on our business. In some ways, we are smarter than we were then, and in other ways, there is still plenty of uncertainty. But taken as a whole, I believe we are in very good shape. As you can see from the results, Q2 was better than Q1 with improved revenues margins, and net results. All of these metrics came in better than market average projections. With a focus on execution, we have reduced our accounts receivable and inventory, enabling us to generate a healthy $4 million in cash flow while also allowing us to reduce our loans. Our ability to deliver continues to improve day to day.

And perhaps most importantly,

are booking for the quarter where above one, driven by an improving business environment and a growing number of 5G opportunities and other projects in many regions. So, despite the uncertainty in the market, we have performed well and continue to move forward. Though it remains very difficult to make predictions, current indications are that we are on track for returning to our normal quarterly revenue run rate of 70 to 75 million in Q3. Ran will give the details. In fact, as we said in May, we believe that the net effect of COVID-19 will be positive for us over the long term, because the change in lifestyle that is created is bringing new urgency to the need for broadband for countries, consumers, and businesses across entire industries. This is leading operators to accelerate their 5G rollouts and to continue to invest in 4G network expansions. For the short term, however, the outlook is harder to predict. With the situation changing from day to day, it is difficult to forecast the timing of orders, to forecast supply chain dynamics, to forecast deployment schedules, and therefore our ability to execute at 100% efficiency. In response, we have been focusing on handling the challenges that came up in our day-to-day operations, and I believe we have been handling them well. First, we are doing everything in our power to keep our employees safe and healthy, including full compliance with all health directives. Our office workers have transitioned to dividing their time between home and the office, with meetings taking place mostly via collaborative video meetings. Despite the change in routine, all our departments continue to progress in line with our work plans. We are also managing our customer interactions closely using remote tools and this is working well. While we prefer face-to-face interactions, the new normal has had some surprising advantages. For example, the ability to take prospective customers on virtual demos through our labs, and to actually carry out more customer interactions each day. At the same time, the situation has created significant challenges for our supply chain. Many suppliers and shippers are not working at full capacity, making shipment harder to organize and more expensive. Once equipment is delivered, the installation process can take longer than planned, due to changing operator work schedules and local lockdowns. On top of this, the situation has impacted some of our customers' network-built-out plans. For example, much of Latin America, including our clients in Colombia, Peru, and Mexico, went into full lockdown during the quarter. In addition, some customers are delaying capital investments and are affected by currency fluctuations. For example, a customer in Peru froze a project for six months, while others in Latin America were affected by local reductions in revenue and currency fluctuations. This obviously led our revenue from Latin America to be lower than expected. At the same time, the situation is creating opportunities. Opportunities that we could not have predicted six months ago. We see signs of increased focus on 5G network development by operators in the US, Europe, and the Pacific Rim, together with 4G expansions with others. These are aimed at delivering broadband for all and enhancing connectivity, the need for which has been amplified by the current situation. The quickest effect came from wireless ISPs in Europe and the U.S. who saw the need and have moved swiftly to serve their customers. This has increased our overall bookings and backlog. The need for capacity, deployment speed, and flexibility has sharpened the case for open, unbundled networks, convincing more operators to adopt a best-of-breed approach that is based on all outdoor solutions for backhaul and fronthaul. As a premier of wireless backhaul all outdoor solutions and front haul, this plays to our strengths. Our technology is increasingly recognized as a key piece of 5G deployment strategies, leading to increased interest as 5G plans develop and opportunities as well as challenges unfold. For example, in Europe, we have been awarded several new contracts for 5G network rollouts. some with existing customers, and some with new operators in countries from the northwest through the central and eastern parts of the continent. Each of these operators takes a different approach to 5G network development, and our industry-leading 5G all-outdoor backhaul portfolio across the vast millimeter wave and microwave spectrum allows us, to cater for diverse operator 5G network development plans. Some of the operators selected our latest microwave technology, which can deliver four gigabits in a single all-outdoor device over recently regulated ultra-wide 224 megahertz channels to ensure 5G macrocell capacity over a distance. That's four times wider channels than commonly used in 4G. We have a new capability to do so thanks to our multi-core chipset technology. Other operators use our compact millimeter wave solutions over ultra-wide 2000 megahertz channels to modernize macro cells to 5G with a 10 gigabits per second backhaul and some select and combination of the two approaches. In the US, a new wireless service provider has invited us to participate in a field trial for the wireless backhaul portion of its new 5G network. We are also in discussions with a new wireless service provider in Japan for wireless frontal and backhaul solutions that will deliver speeds of 20 gigabits for its 5G and 4G network. We believe that this is just the beginning with COVID highlighting the need for more cost effective and flexible solutions. Operators in the US, Europe and APAC are continuing and in some instances accelerating the 5G projects and more and more operators are now looking at the open network concept. In addition, as lockdowns are released, many countries have moved towards initiating or accelerating rural 4G network expansion programs and ramping up their 4G network backbone capacity. As an example, in Sub-Saharan Africa, we were selected by Orange Niger, a new customer for us, to modernize and build an extensive wireless backbone for its newly built 4G network. We are pursuing similar projects with others in the region. Finally, in India, during the quarter, we returned to a good run rate of deliveries and installations for our Bharti projects. There are two more developments that are worth mentioning. In several countries, governments are providing stimulus packages to encourage telecom infrastructure investment. like the 10-year, 20 billion RDOF Rural Digital Opportunity Fund launched by the FCC in the U.S. This is a mark to close the digital divide, but facilitating the deployment of high-speed broadband networks in rural America. We expect that a portion of that will be relevant to our market, resulting in projects that will benefit Saragon. In addition, several countries, including the U.K. and India, so far have limited the use of telecom equipment and services from China. This may mean that local operators who have been using Chinese equipment will have to find alternatives. If so, this may walk to our advantage. From a product development point of view, we continue to make progress in the development of our next generation wireless hauling chipset, a big step forward that will support our products for the more advanced stages of the 5G network transformation in the years to come. We now expect to reach tape out by the end of Q1 2021. During the quarter, some of you participated comparing H1 2019 to H1 2020.

is impacted mainly by the decline of our production services, negative 78 million euros, leading to sales decrease around 3 million episodic, and by DVD services reduction of 8 million, mainly due to lower volumes. This is partially mitigated by connected volume, increased 30 million euros of EBITDA, delivering a very strong year, marginally in relation to EMEA and lifetime activities. Again, Connected Home is in the past Slide 17. We have already commented that there is an EBT variance for partial services. So maybe a quick word on the adjusted EBT variance of 17 million euros. It is reflecting the variance at the EVD level of 78 million, and that's partially offset by lower DNA and seems to better manage and lower rendering costs. Slide 18, same slide and for production services. For this time, we are discussing EVD. Adjusted EVs are at negative 29 million euros. has improved since last year by 3 million euros. The negative minus 8 million of the EBITDA variance is more than offset by lower DNA. And these are driven by production capacity optimization on one hand, and also, as we have mentioned that in the past, the positive impact of the new contract structure that are kicking in. The EBITDA set aside and post-variance of €79 million versus last year. And this is mainly driven by the billion-euro payment chart I just talked about of €68 million. Following COVID-19 revised assumptions, that's not the main item. More importantly, higher work used for the calculations, higher work reflecting, these contracts reflecting basically on new costs of debt. Sign 19, connected home. So, EBITDA is this year, and again, I think it should be noticed, it's positive. That's 20 million euros. Strong results in a difficult year. It illustrates beyond the strength of its division the success The plus 38 million euro variance versus last year is related to EBITDA improvements and lower tangible depreciation and royalties reserves. The non-recurring EBIT of minus 10 million euro is mainly related to the impact of new restructuring plans. and EBITS. The various items to consider are here, the PPE amortization of a negative 22 million has improved by 6 million due to lower R&D PPE amortization on connected homes. We're talking here mainly about R&D amortizations. The impairments and write-off of a negative 72 million euros is related to HES impairment charges on Goodwill for 68 million negative or higher than last year, by 30 million euros, and they relate to additional restructuring charges to the panorama cost selling plan in all PDs. To be noted, the pace at which the panorama plans are being deployed have accelerated, as Richard has mentioned it, and are very much on track to deliver them quicker and faster than expected. The other non-current positive impact of 8 million is many In our standard quarterly run rate, reflecting the sharp reduction in travel, accommodation expenses and variable compensation.

G&A, which was $4.8 million, was actually about half a million higher than the first quarter of 2020. For Q3, we expect OPEX to increase to a level of $20.5 to $21.5 million, mainly due to the increased R&D investment in the final stages of the chip development that is planned for the quarter. Financial expenses and other expenses were back to the normal expected level. Tax expenses for the quarter were low at half a million dollars. On a non-GAAP basis, net loss improved from Q1 to $4.9 million compared to the first quarter, or 6 cents per diluted share. Our GAAP net loss was $5.5 million, or 7 cents per diluted share. Turning to the balance sheet, we work intensively throughout the quarter to improve our stability and working capital, and you can see our success in almost every parameter. We reduced our inventory by another $6 million during the quarter, and we are now at approximately $54 million, down $20 million from our peak a year ago. Our focus on collections has reduced our receivables to $97.5 million, down $21 million since the beginning of the year. Our DSOs now stand at 133.6 days. We have returned $13 million in loans, a step that reduced our financing expenses while increasing our stability. The net result of all of this is that we generated $4 million positive cash flow from operations and investing activities for the quarter. In parallel, we extended our credit line from a consortium of banks for another year while raising our credit line from $40 million to $50 million. This is a vote of confidence in our prospects and financial responsibility. we continue to invest in our major development programs to ensure that our future roadmap supports our design win efforts, sustaining our positioning as the strongest company in wireless hauling, and the key to generating future revenues. While the short term may be lumpy and hard to predict, We believe that long-term trends are working in our favor and that it will benefit when markets return to the new normal. Current indications lead us to believe that we are returning to our normal $70 to $75 million average quarterly run rate for the third quarter and expect that we will remain at that level for the fourth quarter. However, with COVID-19 still having a clear impact on our supply chain and installations and the situation far from resolved, there are many unknowns that could affect the timing of revenues, changing the indicators that we see today. Meanwhile, we continue with our work to improve our financial stability and to straighten our operations. So that's the second quarter. I would like now to open the call for your questions. Operator?

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1, 0 command. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press 1 then 0 at this time. And one moment, please, for your first question. Your first question comes from the line of Alex Henderson. Please go ahead.

Hey, guys. So, nice quarter. Thanks for the detail on the guide. I was hoping you could give us a little bit more granularity around the gross margin commentary. Clearly, returning to normal levels somewhere in the 30 to 35 range is a nice improvement, but can you give us some sense of how much of the pressure was a function of geographic mix and how much of the pressure at 26.5 was a function of COVID-related cost expediting and related expenses. And to what extent do you think that that latter COVID-related stuff falls out as we go through the third quarter and fourth quarter? I mean, is it reasonable to think that the mix shifts back and the combination of those two can get you up towards the middle of that pack, or is it more towards the lower end of the gross margin range? How should we be thinking about it?

Thanks. Hi, Alex. It's Ran. Thanks for the question. So as you say, it's really a mixture of of all of that. So it's a mixture of more India in our revenue, which is really the geographical mix. It's also a matter of the low revenue of the product taken into effect or into account that we have some fixed costs built in our cost of revenues. And as I also mentioned, the impact of COVID-19. At this point, when we're looking at Q3 and Q4, and assuming the quarterly average run rate, we do forecast it to be in the range that we used to have between 30 to 35, but probably at the low range of the growth margin. we do not see, we do still have a COVID impact on supply chain, on shipments, on the cost to install that still has a toll on our operations. But at this level of revenue, we do expect it to get back to the 30 to 35%, again, probably at the low end of the range.

You broke up a little bit when you were talking about the OPEX number. I think I heard you say the third quarter OPEX was expected to be in the 20.5 to 21.5. Is that right?

That is correct, Alex, and mainly because of ramping up R&D, mainly for the new chip development.

Right. And then you said that you expect financial expenses to return to normal. Can you define what normal looks like?

So actually, I think that Q2 was normal. If you're looking on 2019, our average was $1.5 million. I would say that it's also very dependent on the exchange rate impact, but taking into account the fact that we reduced our loans because we had a strong positive cash flow in the first half of the year, so our interest is probably going to be down, but I cannot expect the FX rate. I would still forecast and have a normal rate of $1.4 million, $1.5 million. What happened in Q1 was really a one-timer.

I see. So it's compared to the Q1 that you were referring to. That's helpful. And then we had a comment about a U.S. field trial. Was that the same as the Tier 1 win that you had earlier, or is that something different?

No, that's something different. We're still in that tier one we referred to earlier, which is a current tier one. We're still in their labs. And this is a new account, a new 5G operator in the U.S., which we are invited to participate in the field files.

Great. I'll see you at the floor. Thanks. Thank you, Alex.

Your next question comes from the line of George Iwanek. Please go ahead. George Iwanek, your line is open. Please go ahead.

Can you hear me? Yes. Good morning, George. All right. Good morning, everyone. Yes, George. Good morning. Can you give us a sense of what linearity was like during the quarter? Did it improve and is it continuing to improve at this point from month to month? And then, you know, if we are back in the normal kind of 70 to 75 range, how do you feel seasonality kind of kicks in from here?

Quarter was not linear and very hard to focus linearity moving forward. We had various degrees across the quarter, depending on the regions. I would, if I would tend to characterize the quarter, it was back and loaded on some of the activities. Moving forward, I believe we're returning, at least in Q3, to a more normal linear. Well, linearity quarters were never linear, but more linear than in Q2. but very hard to predict, and especially that, and I think I said it a few times on the comments, situations locally in different places around the world changes on a daily basis based on authorities, regulation. We might move in and out of lockdowns on deployments, on ability to deliver supplies, Sometimes it's also on the supply chain. And this is very, very hard to predict at this point because we are dependent on a whole list of many suppliers. Some of them, we do carry inventories of parts. Some of them is more just in time. So it's very hard to predict the linearity at this point. Longer in general, on the other hand, I see a significant improvement in the sense that the number of surprises that we see was much, much lower than in Q1. And as the quarter progressed towards June, less and less surprises, and I think that in... Moving into this quarter, which is Q3, July was even less surprising from that perspective.

Thank you. And then following up on the North America trends, so you do have the new customers that you're working with there. Can you give us a sense of what's happening with your existing customers with T-Mobile and Sprint and how everything is starting to unfold there?

At this point, the only thing I can say is that Timo and Sprint are continuing to be customers. We do see orders, but it's lower levels. I think they're very much focused to this point on integrating their two organizations. Let's remember they did the merge and then started integration right into COVID-19, which didn't make it quicker from that perspective. But I think they're very much focused there and making a lot of progress. We do expect to see them as significant customers back, sometimes probably towards the end of this year at this point.

So a lot of that improving bookings trends that you're seeing in North America have been normalizing is from the WISP activity?

It came mainly from the WISP activity, yes. Smaller WISP activities, some smaller operators, and a lot of it is WISP. And as I said in my comments, we see a lot of WISP activities both in Europe and the U.S.

All right. And then just one more regional question and then one modeling question. From an India perspective, how sustainable do you feel the demand environment is there? And kind of like what are you budgeting for? maybe for the rest of the year?

I think at this point, stable demand, mainly for our main customer for this year, which is Bharti. For the rest of the year, we know the deployment plans they have are mainly for 4G across India, and I believe they'll stay at those levels probably well into second half of next year. with a caveat that India, on the revenue perspective, is highly dependent on deployments. And India is 700 plus different districts, and each district has its own lockdown policy. And I know the team's map with red, greens, and yellows, and what's lockdown and what's not, where we can deploy and not deploy across the region. So there are fluctuations in there. But from an event perspective, it's there. Longer term, I believe we will see, and probably not the beginning of next year, also 5G coming on board and making sure that it's there. The two things that are happening in India is also Chinese telecom equipment is banned at this point. Although to our effect, we've been able to push the Chinese out from some of our accounts by using a better technology a long time ago. And I do expect that India at some point during next year will also do the 5G auctions and delivery outbound.

Okay, and then just a modeling question. When you look at OpEx in that 20.5 to 21.5 range, when you get to the tape out in the beginning of next year, does OpEx start to pull back on the R&D side, or do you anticipate it kind of just staying flat at that point?

We do expect that R&D will pull back significantly at that point, because most of the increase is all sorts of subcontractors and outside the company and not internal headcount, which support the table.

Thank you very much.

Next we'll go back to the line of Alex Henderson. Please go ahead.

Thanks. I was hoping you could talk a little bit about the progress you're making on the partnering with other people relative to your chipsets and what you're seeing in terms of competition in the chipset market and whether there's any change that you're seeing from MaxLinear in particular.

So first, we are working on our technologies and the chipset is part of that with NEC and we're continuing to work very closely with them on different technologies, and part of it is the chipset in there. We are in discussions with others with ups and downs, like any discussions that we are having, and details, if something will come out, we'll probably announce. Up until that point, I don't want to refer to different discussions. And at this point, we still believe that we are way ahead from anything from anyone else at this point, especially on millimeter and microwave chipsets moving forward.

I see. And is there... Any sense of what the timeline for this new chipset to actually get into a finished product? When do you expect the chip design that you're talking about taping down to actually be in the next-gen product?

Usually from tape out of a chipset to next-gen product is sometimes usually around 12 months.

So it would be roughly when?

So it's the beginning of 2022. I see. Beginning of mid-2022.

All right. And then going back to the U.S. market, you've got a lot of potential there. Margins are higher. You're seeing strength in Europe. Europe margins tend to be higher. You're talking about 5G. 5G tends to have more features and be at higher end speeds. Africa has historically actually been a higher margin area. I get it that you've got some weakness in some other geographies, but it sounds like the mix should be shifting back to a better mix in 2021 than what you're looking at now. Is that a reasonable assessment?

I think it's a reasonable assessment. It is a reasonable assessment, and that's what we are targeting.

Great. I'll see you before. Thanks.

Thank you, Alex. Your next question comes from the line of Gunther Carter. Please go ahead.

Yes, good morning. I don't have a question. I have a comment. I want to commend Osi for, since she has come aboard, there's been a significant improvement in communications. telling the world what you're doing. So, Osi, thank you very much.

Thank you, Gunther. In the name of Osi, she's here in the room with me. There's a big smile on her face.

If there are any additional questions, please press 1 and 0. And at this time, there are no further questions.

Thank you. So there you have it. We're operating well in an uncertain reality, working to position the company to benefit both from short-term opportunities and long-term market growth. Second quarter was an improvement over the first, and we expect even better for Q3 and beyond. Thanks for joining us here, and we would be happy to see you on our next virtual R&D tour. as at least for the short term, we probably won't meet face-to-face. Virtually, would love to see all of you. Thank you, and a good day.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect.