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Gilat Satellite Networks (GILT) Q3 2018 Earnings Conference Call Transcript

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Gilat Satellite Networks (NASDAQ: GILT)
Q3 2018 Earnings Conference Call
Nov. 12, 2018 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Gilat's third-quarter 2018 results conference call. [Operator instructions] As a reminder, this conference is being recorded, November 12, 2018. I would now like to turn over the call to June Filingeri of Comm-Partners LLC to read the safe harbor statement. June, please go ahead.

June Filingeri -- Comm-Partners LLC

Thank you, Illana [ph]. Good morning and good afternoon everyone. Thank you for joining us today for Gilat's third-quarter 2018 conference call and webcast. A recording of this call will be available beginning at approximately noon Eastern Time today, November 12, and will be available for telephone replay until November 17 at noon.

The webcast will 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 release with the 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.

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And 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.

Yona Ovadia -- Chief Executive Officer

Thank you, June. Good morning, good afternoon and good evening to everybody. Thank you for joining us today. I am pleased to report that the third quarter of 2018 was another positive quarter for Gilat as we made additional progress in building our growth engines and increasing our profitability.

Allow me to summarize, our financial performance. Third-quarter revenues were $62.8 million, which is down 10% from the same quarter last year, mainly due to the delayed revenue from our terrestrial infrastructures in Peru. Meanwhile, revenues from our fixed networks segment, which includes cellular backhaul, increased 18% year over year, while our mobility solutions segment, including IFC, increased 16% from the third quarter of 2017. Looking at profitability, our continued focus on building quality, profitable revenues through our growth engines, coupled with our relentless efforts to drive cost out of the business, yielded GAAP operating income of $6 million, an increase of 80% year over year and 44% higher than Q2 2018.

Adjusted EBITDA increased to $9.1 million in the third quarter of 2018, versus $7.1 million in Q3 '17 and $8.1 million in Q2 '18, representing an increase of 28% and 12% over the respective periods. Our bottom line also remained strongly profitable on both GAAP and non-GAAP basis in the third quarter, with GAAP net income of $8.7 million, including a one-time tax benefit that Adi will discuss and non-GAAP net income of $5.1 million. Turning to our annual management objectives for 2019, we have revised our revenue range to $265 million to $275 million to take into account delays in revenues in Peru due to the continued slow pace of projects inspection by Fitel of our initial three projects, coupled with the extra caution we're exerting related to our two recently won projects, which I will, of course, elaborate shortly. At the same time, we have increased the range of GAAP operating income to $22 million to $24 million, from $17 million to $21 million, and EBITDA to $35 million to $77 million, from $30 million to $34 million, and we see the fruit of our disciplined emphasis on profitable deals.

Let me provide more details on our business. Firstly, HTS and broadband. We continue to make additional and significant progress in materialization of our focus on broadband connectivity particularly with new HTS business around the world. First is a major deal in Russia this quarter with Gazprom Space Systems, also known as GSS, for broadband connectivity across the Russian territories.

GSS plans to launch its new HTS Ka satellite called Yamal 601 in February '19, for which Gilat was selected to provide the ground segment. The current phase of the deal is for only a third of the satellite capacity and is valued at about $18 million. I'd like to emphasize that this project, together with previously reported projects in the region, makes Gilat a dominant player in Russian Ka-band satellite market. Secondly, in Japan, we were awarded a multimillion-dollar deal this quarter with SKY Perfect JSAT for mobility and fixed services.

JSAT is Asia's largest satellite operator, and it will be providing a broad range of new services including government, utilities, banks, and hospitals, as well as broadband connectivity for several mobility applications. Third, in China, Gilat will now provide its ground segment to China Satcom also for its new satellite, ChinaSat-18, to be launched mid next year. With this launch, a full Ka HTS coverage will be provided all over China by China Satcom, which will be solely supplied by Gilat's platform. This means, for example, that every plane that flies domestically or in and out of China and need HTS Ka will need a Gilat modem.

These successes are on top of several other HTS wins already deployed around the world, thus further demonstrating Gilat's leadership in providing the high-performance, highly efficient ground network that serves multiple applications. Moving on to IFC, we have reached a significant milestone this quarter in IFC growth engines. Gilat's dual-band antenna terminal called -- known as -- also as Ku/Ka, has passed the standard for environmental testing of avionics hardware and received the DO-160 certification. This means that this terminal, which is unique in its ability to switch instantaneously and with uninterrupted user experience between band, is now certified for installation on commercial aircraft providing opportunities to HTS operators, IFC service providers and airlines who want to leverage IFC opportunities with the flexibility to use both the Ku or Ka-band.

We believe that this unique aero terminal provides opportunities worldwide. One of these immediate opportunities that we're optimistic about is in China where we are working with a strong local partner, Air Esurfing, a subsidiary of Air Media. As you may know, Air Esurfing announced recently that they won IFC projects with several Chinese airlines and that they have developed for them a comprehensive solution based on Gilat's dual-band antenna. Moving on to cellular backhaul, in our cellular backhaul growth engine, we have had several network extensions and expansions at our large customers worldwide.

In addition, we have a healthy pipeline of new deals and we expect to report them in the coming months. Moving on to Peru, I would like to elaborate on the situation in Peru. As previously reported in June 2018, we were awarded two additional regional telecommunication infrastructure projects from the government agency of Fitel in Peru, and those regions are called Ica and Amazonas. As stated in today's earnings release, the losing party recently appealed the award and obtained a preliminary injunction against it.

Gilat has been informed by Fitel that it believes that the injunction was improperly obtained and is opposing it. Gilat is not a party in either actions, and we firmly believe based on advice of counsel that the chances of success of the losing party are remote. Yet we decided to exercise caution and reduce our revenue targets for 2018. Our revised revenue targets also take into account the slow pace of inspections and approval by Fitel of our initial three projects for them as I mentioned earlier in my remarks.

Further, I would like to clarify that the delayed revenues are reported mainly under our construction segment, and I want to stress again that these are low-margin revenues that are not our main interest but rather are the operation high-margin reviews that will arrive in 2019 although delayed. Finally, I also want to emphasize that we strongly believe and expect that we will overcome these recent delays in the coming few months, and we remain optimistic and committed to make Peru a source of recurring profitable revenue for Gilat. Moving on to non-geostationary, also known as NGSO, as part of our ongoing HTS and VHTS business, we're also involved in the next wave of satellite constellations. As non-geostationary satellites are being developed and launched, Gilat is leading in the developing and demonstrating broadband connectivity solutions for multi-orbit constellations and is in discussion with most, if not all, of the LEO and MEO players.

One of the high points of our activity in this area of NGSO was last month when Gilat cooperated with Global Eagle in the first-ever live in-flight testing with a Telesat LEO satellite. The testing was carried out on Global Eagle's Albatross test aircraft and yielded a continuous uninterrupted broadband connectivity, plus a switch-over between a Telesat GEO satellite and its LEO satellite. The test included secure real-time video chatting using Skype and WhatsApp in parallel, as well as secure Internet browsing. With this milestone, Gilat solution has now proved its technical and technological advantage of supporting not only multiple application satellites band and beams, but also a world-first transition between satellite of multiple orbits.

In conclusion, we are confident in our strategy and remain focused on our growth engines of cellular backhaul, IFC and HTS/VHTS and continue to conduct a balancing act of significant investments in R&D to maintain our product leadership while continuously improving profitability. With that, Adi, we are now ready for your report. Please, go ahead.

Adi Sfadia -- Chief Financial Officer

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 effects of stock-based compensation, amortization of purchased intangibles, litigation expenses related to trade secret claims, expenses for tax contingencies to be paid under an amnesty program, and deferred-tax benefit that was recorded for the first time. 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 third quarter of 2018. Revenues for the third quarter of 2018 were $62.8 million, compared to $69.9 million in the third quarter of 2017, reflecting lower revenues from our terrestrial infrastructure segment, which include the construction phase of our projects in Peru partially offset by higher year-over-year revenues from our fixed networks and mobility solutions segments.

Revenues in the previous quarter were $66.5 million. Fixed networks segment revenues were $34.9 million, compared to $29.6 million in the same quarter last year, representing an 18% year-over-year increase mainly due to increased revenues from our cellular backhaul solutions and from our Latin America region, including our activity in Colombia for the government. Fixed networks revenues in the previous quarter were $36.2 million. mobility solutions segment revenues were $21.8 million, compared to $18.9 million in the same quarter last year and $25 million in the previous quarter.

The 16% increase in revenues year over year reflects higher IFC revenues. Terrestrial infrastructure projects segment revenues, which include the construction revenues for our projects for Fitel in Peru, were $6 million, compared to $21.4 million in the same quarter last year and $5.3 million in the previous quarter. As discussed previously during the construction phase, revenues of Fitel can vary quarter to quarter depending on the percentage of the project's completion. We are now in the final stages of the construction phase of the first three regions, and our current progress is slower than originally expected with start of the networks awaiting Fitel inspection and accept an approval of those networks.

Once received, those projects can move to the operational phase. Those inspections are currently progressing significantly more slowly than expected. We are now expected to conclude during the first half of 2019. At that point, operation will begin and with it, service revenues.

In addition, as previously reported, we were awarded two additional projects in Peru from Fitel totaling $153.5 million. We have recently informed the companies which were part of the consortium whose bid was rejected by the government have sought an overturn -- to overturn the award. Additionally, they have sought and obtained the preliminary injunction against the award. We were not officially served with the notice concerning the injunction request and we are not a party in either action.

We have been informed that Fitel and the government authority that issued the bid for them believed that the injunction was improperly obtained and they are opposing it. Based on the legal advice, we believe that the likelihood of success of the losing company is remote. Nonetheless, we decided to exert caution and update our revenue objective for the year. The overall impact of those delays in Peru on our revenues is about $25 million from our original expectation for the year.

Turning now to our third-quarter 2018 revenues as a percentage of total revenues. Fixed networks represented 56% of revenues, mobility solutions represented 35%, and terrestrial infrastructure projects represented 9% of revenues. In the third quarter of 2017, those percentages were 42% for fixed networks, 27% for mobility solutions and 31% for terrestrial infrastructure, demonstrating the shift of our revenue mix toward our area of strategic focus. Our GAAP gross margin in the third quarter of 2018 increased to 38.5% of revenues from 29.1% in the same quarter last year.

The increase in our gross margin is mainly attributable to a more favorable revenue mix and lower revenues from our project in Peru, which have lower margins during the construction phase. Our gross margin in the previous quarter was 33.7%. Total operating expenses on a GAAP basis for the third quarter were $18.2 million, compared to $17 million in the same quarter last year and $18.3 million in the previous quarter. GAAP operating profit was $6 million, representing a substantial increase from operating profit of $3.3 million in the same quarter last year and up from $4.1 million in the previous quarter.

GAAP net income in the third quarter was $8.7 million, or $0.16 per diluted share, compared with net income of $2.1 million, or $0.04 per diluted share, in the same quarter last year and $2.2 million, or $0.04 per diluted share, in the previous quarter. Net income in the third quarter of 2018 includes a deferred-tax benefit of $4.1 million that was recorded for the first time in our U.S. subsidiary, Wavestream, due to its continuous profitability and its ability to utilize NOLs in the near future. On a non-GAAP basis, operating income for the third quarter was $6.5 million, or 10.3% of revenues, compared to operating income of $4.9 million, or 7% of revenues, in the same quarter last year.

Non-GAAP operating income for the previous quarter was $5.7 million, or 8.5% of revenues. Non-GAAP net income in the third quarter was $5.1 million, or $0.09 per diluted share, compared to non-GAAP net income of $3.6 million, or $0.07 per diluted share, in the same quarter last year. Non-GAAP net income for the previous quarter was $3.7 million, or $0.07 per diluted share. Adjusted EBITDA for the third quarter of 2018 was $9.1 million, or 14.5% of revenues, compared to adjusted EBITDA of $7.1 million, or 10.2% of revenues, in the same quarter last year.

Adjusted EBITDA in the previous quarter was $8.1 million, or 12.2% of revenues. As of September 30, 2018, our total cash and equivalents, including restricted cash, were $103.3 million, an increase of $7.5 million from the previous quarter. During the quarter, we generated about $9.6 million from operating activities, out of which about $5.5 million was from our Peruvian activity and $4.1 million was from our satellite activity. The increase was offset by capex spending of about $2.9 million.

DSOs, which include our fixed networks and mobility solutions segments and exclude revenues of our terrestrial infrastructure projects segment, include -- increased to 73 days, compared to 64 days in the previous quarter, mainly due to some large customer payments that were slipped to early Q4. Our shareholders equity at the end of the quarter totaled about $233.5 million, compared to $223.1 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?

Questions and Answers:

Operator

Thank you. [Operator instructions] The first question is from Gunther Karger of Discovery Group. Please, go ahead.

Gunther Karger -- Discovery Group -- Analyst

Good morning and good afternoon, gentlemen, and to the operator also. One question. Is there any update on the Chinese railroad systems that you've got an agreement with?

Adi Sfadia -- Chief Financial Officer

Hi, Gunther. Nice to have you with us again. No. There is no real update on the railroad opportunity.

It's still in the same situation of testing phase within the customer. No real progress. CRRC is the name of the company.

Gunther Karger -- Discovery Group -- Analyst

Thank you.

Operator

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

Mike Hebner -- IFS Securities -- Analyst

Yes. I see the world as we're looking at this 5G and infrastructure people are worried about China, and it seems to be your company is able to play both sides of the fence getting investment and contracts in -- Asian contracts. Any comments? Are you seeing anything out there?

Yona Ovadia -- Chief Executive Officer

I'm not sure if you have anything particularly specific in mind. But I think that the landscape, when you look at it in China, the most lucrative market by far but also the most confusing I would say is the IFC market. This market is yet to be unlocked. Most of the airlines in China offer connectivity only for international flights in and out of China, while domestic flights do not offer this service.

And just to remind you, there are, as we speak today, about 3,000 planes flying domestically. So there's massive opportunity there. But the market is still locked waiting for something to happen to open up. When will this happen, your guess is as good as mine, could be a week, could be a decade.

But definitely, this is the No. 1 opportunity. And we are, among many others, are looking at this opportunity because we have the basement for China Satcom, we have now the dual-band antenna that is certified -- that has been certified, and we have a partnership with Air Media. So this is definitely a lucrative opportunity that is being carefully watched by all of the service providers in the world, be that Gogo, Panasonic, Inmarsat, Honeywell, everybody else, but us ourselves.

Secondly, our second opportunity is the continuation of satellites being launched by the Chinese government with a China Satcom affiliate, which is more long-term but also a good opportunity for us because we think we have the presence in China, the relationship but more importantly, the technology that these new constellations and new satellites would need.

Mike Hebner -- IFS Securities -- Analyst

So what do you see this 5G stuff as it's rolling out? When do you start to see some revenue opportunities from this?

Yona Ovadia -- Chief Executive Officer

OK. I'm sorry, I did not realize you were referring mostly to 5G.

Mike Hebner -- IFS Securities -- Analyst

No. I mean, both of these things, but now you're talking about that. But now as Verizon and everybody is moving on this 5G front, new question, what do you see? Are people starting to spend money? Are we starting the cellular backhaul? And with the satellites, are we picking up revenue on this front yet?

Yona Ovadia -- Chief Executive Officer

I think not yet. I think that the satellite industry will take some time to follow the mobile operators that offer terrestrial 5G connectivity. The reason I think -- there are several reasons but one major one is the delay in communication that are caused by the geo -- by the fact that the GEO constellations are 34,000, 36,000 kilometers. That creates latency.

5G offers instantaneous response. So I think that it'll take a while until the GEO satellite operators will figure out a way to overcome this hurdle and to provide service that does not have latency. And it is likely in my opinion that 5G over satellite will be best served by the LEO constellations. But these are, as you surely know, a few years down the road.

In any case from our perspective, we are preparing a platform to support 5G, this is part of our R&D road map. Of course, this is central to our R&D road map going forward. But for that, we'll need a partner, which is the satellite. And as I mentioned, GEO will have a difficult time dealing with the latency challenge and more likely the NGSO constellations will deal with it better.

But these are -- any guess is a good here, could be three years, could be five years down the road.

Mike Hebner -- IFS Securities -- Analyst

Good. Thank you.

Operator

We have a follow-up question from Gunther Karger of Discovery Group. Please, go ahead.

Gunther Karger -- Discovery Group -- Analyst

Yes, thank you. What's the evolving situation with Gogo? Is there any update for your business with Gogo at this time?

Adi Sfadia -- Chief Financial Officer

Actually, no updates business with Gogo is business as usual. Recently they announced their financials. It seems that they are progressing. Everything is on track.

We see no delays, not in orders and not in payments.

Yona Ovadia -- Chief Executive Officer

We have good business with Gogo. We continue to have good business with Gogo. We are pleased.

Operator

[Operator instructions] The next question is from Tamil Kassab [ph] of Exane. Please, go ahead.

Sami Kassab -- Exane BNP Paribas -- Analyst

Good morning, gentlemen. it's Sami Kassab at Exane BNP Paribas. I have two questions. The first one, can you comment on the tests you've done with Global Eagle and Telesat and perhaps remind us of the main benefits of LEO versus GEO when it comes to IFC? And secondly, can you comment on satellite wholesale capacity pricing? Are you seeing pricing declining or are they flattening out?

Yona Ovadia -- Chief Executive Officer

OK. I'll answer the second question first. In general, the trend of price -- capacity price going down, we think that the trend continues. There are some periods of time where it's faster or slower.

It also depends in -- on geography. But in general, there is more capacity up there and, therefore, price has been and in our opinion will continue to go down and that is part of the reality that everybody is learning to live with. As far as Telesat, first, as I said, this is the world's first demonstration of connectivity between an airplane and a LEO satellite. The difficulty, of course, is the fact that the satellite is moving, not only the airplane, and still you have to track it and stay connected.

We managed to do that in cooperation with Global Eagle, and we have proven that connectivity with LEO constellations is feasible and not only feasible but we managed to demonstrate applications that are demanding high volumes of data like WhatsApp, like Skype and, of course, other social media applications. Now the benefits of LEO, as we see it, is in several dimensions. First of all, latency. LEO constellations are between 800 to 1,200 kilometers, compared to 36,000 kilometers of the GEO constellations.

That means a drastic reduction at latency and, therefore applications who require very low latency can find a solution in LEO, not necessarily in GEO. Secondly, they offer massive amounts of capacity, which means further reduction of capacity price, and this is something that many around the world are looking for and certain applications are not affordable to their own GEO, hopefully will be affordable on LEO. What will the price go to? I cannot speak of that, I have my own assumptions, but better ask the operators of the LEO constellation. The third one is the ability to provide the inter-satellite connectivity.

I think this will create, at least in some of the LEO constellations sort of a Internet in the sky which offers also very rapid speed times. So all that is a lot of big promise and therefore many people are expecting market disruption once these constellations are operational. Of course, the big question is, which of these constellations will be operational and when, as they are multibillion-dollar investments. But just to summarize, in our belief, we don't know that all constellations or planned constellations will be successful.

We think that not all of them will fail. So we try to work with those who will be successful.

Sami Kassab -- Exane BNP Paribas -- Analyst

Thank you very much.

Operator

We have a follow-up question from Michael Hebner of IFS Securities. Please, go ahead.

Mike Hebner -- IFS Securities -- Analyst

I didn't see the backlog information. Did you just not put that out? Or did I miss that in the report?

Adi Sfadia -- Chief Financial Officer

No. We are not disclosing our backlog information.

Mike Hebner -- IFS Securities -- Analyst

OK. I mean, the future orders, everything looks fine. Do you like where you're going?

Adi Sfadia -- Chief Financial Officer

Generally speaking, yes. The business looks good. You see the results in our financials. We gave updated EBITDA.

We raised our EBITDA targets for the year. Yes, business looks good.

Mike Hebner -- IFS Securities -- Analyst

What did you say the revenue for the quarter? Because of the Peru situation, what did we -- what would that would have added to it if it would have been there?

Adi Sfadia -- Chief Financial Officer

Well, this specific quarter, a few million dollars. For the year, it's -- as I said in my official notes, it can sum to about $25 million.

Mike Hebner -- IFS Securities -- Analyst

What's your best guess when this is going to be resolved? What is your counsel telling you down there?

Adi Sfadia -- Chief Financial Officer

I think that it's -- we're talking about several regions over there. We believe that part of it we'll be able -- we would be able to solve during Q1; and the rest, close to the end of the first half of the year. We are working closely with the government trying to support them with their inspection needs. We are progressing in everything that is up to us.

And I believe that in the first half of the year, we'll be able to overcome the hiccups that we have over there.

Mike Hebner -- IFS Securities -- Analyst

OK. Thank you.

Operator

[Operator instructions] There are no further questions at this time. Before I ask Mr. Adi Sfadia to go ahead with this closing statement, I would like to remind participants that a replay of this call is scheduled to begin two hours after the conference. In the U.S., please call 1 (888) 782-4291.

In Israel, please call 03-925-5904. Internationally, please call 972-3-925-5904. Mr. Sfadia, would you like to make your concluding statement?

Adi Sfadia -- Chief Financial Officer

I want to thank you all for joining us for the 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.

Operator

[Operator signoff]

Duration: 37 minutes

Call Participants:

June Filingeri -- Comm-Partners LLC

Yona Ovadia -- Chief Executive Officer

Adi Sfadia -- Chief Financial Officer

Gunther Karger -- Discovery Group -- Analyst

Mike Hebner -- IFS Securities -- Analyst

Sami Kassab -- Exane BNP Paribas -- Analyst

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