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Tekelec (NASDAQ:TKLC)

Q4 2008 Earnings Call

February 11, 2009 8:00 am ET

Executives

Mike Gallentine - Investor Relations

Frank Plastina - President and Chief Executive Officer

William Everett - Chief Financial Officer

Analysts

[Vijay Bagabat] - Deutsche Bank Securities

George C. Notter - Jefferies & Co.

Amir Rozwadowski - Barclays Capital

Kenneth Muth - Robert Baird

Scott Coleman - Morgan Stanley

Larry Harris - C.L. King

Catherine Trebnick – Avian Securities

Natarajan “Subu” Subrahmanyan - Sanders Morris

Operator

Good morning and welcome to Tekelec's fourth quarter and year end 2008 earnings release call. (Operator Instructions)

It's now my pleasure to turn the call over to Mike Gallentine. You may now begin.

Mike Gallentine

Thank you. Today I'm joined by Frank Plastina, President and Chief Executive Officer, and Bill Everett, Chief Financial Officer of Tekelec.

Hopefully by now you have access to a copy of the slides and supplemental material posted on our website at Tekelec.com. You can access the slides by hitting the link labeled Investors and then clicking on the Investor Relations homepage. In that location you can also access the press release issued earlier today.

As a reminder, there will be a telephone replay of this conference call available for seven days following the call. You may also listen to a rebroadcast on our website at anytime during the next 90 days. All of this replay and rebroadcast information can be found in the Investor Relations section of Tekelec's website.

I would also remind you that during the course of this conference call we will make projections or other forward-looking statements regarding future events or the future financial performance of the company. The actual events or results of the company may differ materially from these forward-looking statements as a result of important risk factors, including those discussed in our 2007 Form 10-K, the first, second and third quarter 2008 Form 10-Qs, the press release issued earlier today, and other documents the company periodically files with the Securities and Exchange Commission.

Also, unless explicitly noted, all financial results and metrics during our call today are non-GAAP results from continuing operations. Please see the slides and supplemental material posted to our website for information reconciling non-GAAP to GAAP measures. We will also post the actual transcripts of this call on the Investors section of our website.

With that said, I would like to turn the call over to Frank Plastina. Frank?

Frank Plastina

Thanks, Mike, and good morning to everyone on the call. We were very pleased with our strong operating performance for the fourth quarter and for the full year 2008, which includes record-setting milestones for our company.

We achieved record performance for full year revenue, non-GAAP EPS, and cash flow from operations. These include full year revenue of $460.6 million, which consisted of recording revenue from projects in 56 countries, full year non-GAAP EPS of $0.94, and full year cash flow from operations of $106 million, which equates to $1.52 of operating cash flow per diluted share.

In addition, order input for the fourth quarter of $160.6 million was at the high end of our targeted range, and order input performance was particularly strong in North America. As a result of our positive book-to-bill ratio during the fourth quarter of 2008, we finished the year with a strong backlog of $412.1 million.

Revenue, gross margin and operating margin were also strong for the quarter and the full year. Revenues at $119.9 million were up 4% year-over-year for the fourth quarter, and we generated operating margins from continuing operations of 21% for the quarter and 20% for the total year, which is in line with our stated long-term goal. Our gross margin performance of 68% for the fourth quarter and 67% for the total year each represent a 6 percentage point improvement over the same period in 2007.

Our continued strong financial position enhances our ability to address the potential impact of the current economic environment and to execute on our business strategy. We made two tuckin acquisitions in 2008 - mBalance and Estacado - to grow our solutions portfolio and our market opportunity by moving into adjacent spaces that build on our core competencies.

mBalance, a leading developer of messaging solutions, enables mobile operators to efficiently support their text messaging growth with a high performance networked messaging solution. The software was already an important element in Tekelec's mobile messaging solution, which provides a cost efficient and highly scalable means of handling text message growth and security. The mBalance SMS network solution is installed in 48 mobile networks in 38 countries. mBalance has generated a positive cash flow from operations since 2005 and we expect the transaction to be slightly accretive in 2009 on a non-GAAP basis.

In addition to our inorganic activities, we also continued to grow our solution portfolio organically through continued investment in R&D. In 2008 we filed a total of 112 patent applications and were issued a total of 36 patents, increasing our portfolio of issued, nonexpired patents to 185 as of December 31, 2008.

Our continued investment in our product portfolio has enabled us to expand our geographic footprint by adding three new customers in the fourth quarter. Two purchased our EAGLE product and one selected our IAS product. For the full year 2008, we won 17 new customers, bringing our total new customer wins over the past two years to 40. In addition to these new EAGLE and IAS customers, we have also added 38 new customers through the mBalance acquisition.

We continue to build on our market-leading position in number portability solutions. Our successful implementation of number portability for customers in Mexico and Brazil over the past year earned us three additional number portability customers in CALA during the fourth quarter. These three customers had previously decided to deploy a competing solution. In North America, we deployed our new number portability database, capable of supporting 384 million entries.

We now have orders or deployments with 79 service providers in 28 countries around the world for our number portability solution. As more countries have introduced number portability and subscriber volumes have increased, there are now over 2.1 billion subscribers who have the capability to port their number. A recent report by industry analyst firm Analysys Mason notes that our EAGLE-based number portability solution is now deployed in carriers serving 750 million of these subscribers, giving us a market-leading share of approximately 35%.

As we have indicated in our past calls, we continue to diversify our customer base and are not overly dependent on any specific customer. In the fourth quarter of 2008 we had four customers that represented 10% or more of total revenue, with the [Carso] group, consisting of [America Mobiles] and Telmex at 13%, Telecom Italia Group at 12%, and both Verizon and the Orange Group at 10% for the quarter. On an annual basis, we had only one 10% customer, the Orange Group, which represented 10% of consolidated revenues for the year. During the last several years we have had nine different 10% quarterly customers.

I will now turn the call over to Bill, who will go into more details on the results for this past quarter. Bill?

William Everett

Thanks, Frank.

I will provide further insight into our fourth quarter and full year results and provide guidance for the next six months. Please refer to Slides 5 to 12, which provide both our GAAP and non-GAAP results for the three months and years ended December 31, 2008 and 2007, along with the associated reconciliations. As Mike mentioned earlier, unless otherwise stated, all the financial metrics presented herein are on a non-GAAP basis from continuing operations.

Revenue for the fourth quarter of 2008 was $119.9 million, up 4% compared to $115.2 million for the fourth quarter of 2007. In the fourth quarter of 2008 we generated consolidated gross margins of 68% compared to 62% for the fourth quarter of last year. I will discuss our improved gross margin performance for the quarter and full year in more detail later in my remarks.

Net income from continuing operations was $18.2 million or $0.27 per diluted share for the fourth quarter of 2008, with the earnings per share up 29% compared to $14.9 million or $0.21 per diluted share for the fourth quarter of 2007.

Operating margin from continuing operations for the fourth quarter of 2008 was 21%, up from 15% in the fourth quarter of last year.

Other income and expense net for the quarter was a loss of $100,000 compared to income of $2.9 million in the same quarter a year ago. This decrease of approximately $3 million was due primarily to lower interest income on our investment portfolio, offset in part by lower interest expense. We also incurred a net charge of $2 million related to our auction rate securities which I will discuss in more detail later in the call.

The increase in earnings per share from continuing operations compared to the fourth quarter a year ago also reflects in part the lower number of shares outstanding as a result of redeeming the convertible debentures in June 2008 and the stock repurchase programs the company has undertaken.

For the full year 2008, revenue was $460.6 million, up 7% compared to $431.8 million in 2007. For the year, we generated consolidated gross margins of 67%, up from 61% in 2007. Net income from continuing operations for the full year was $64.7 million or $0.94 per diluted share, with the earnings per share up 42% compared to $48.3 million or $0.66 per diluted share for 2007. Operating margin from continuing operations for the full year 2008 was 20%, up from 13% for 2007.

Total other income for 2008 was $1.6 million, down from $10 million in 2007. This decrease of approximately $8.4 million was due primarily to lower net interest income on our investment portfolio as a result of sharply lower interest rates and the net $2 million loss associated with our auction rate securities.

Orders for the fourth quarter of 2008 were $160.6 million. This was down 14% compared to the record $186.2 million for the fourth quarter of 2007, but up 84% from the third quarter of this year. In the fourth quarter, our orders were particularly strong in North America, but we saw weakness in CALA and some of the other emerging markets due in part to the factors we noted on our last call. Orders for the full year 2008 were $453.3 million, down 1% compared to $459.2 million for 2007.

As we anticipated on our last call, we believe that the uncertainties created by the financial crisis and rapid currency devaluations in the emerging markets negatively impacted our fourth quarter orders, although it is difficult to quantify the amount.

Please refer to Slides 21 and 22 for a breakdown of our revenue by product and service categories for the three months and years ended December 31, 2008 and 2007.

For the fourth quarter of 2008, total product revenue was $83 million, essentially unchanged from the fourth quarter last year. Compared to the same quarter last year, number portability products represented a larger share of total product revenue, while Eagle and other signaling products were a smaller percentage. The increase in number portability revenue is due primarily to achieving revenue recognition on several large number portability projects in Brazil and, to a lesser extent, on expansion projects in North America.

Total services revenue in the fourth quarter of 2008 was $36.5 million, up 14% from $31.9 million in the fourth quarter last year. The increase in total services was due primarily to increased professional services revenue associated with signaling and number portability projects internationally.

For the full year 2008, overall product revenue was $320.4 million, up 6% from $303.7 million for 2007, driven by our continued success with our signaling product line along with our increase in number portability revenue. Partially offsetting the increase in these product revenues was a significant decline in our performance management and monitoring product revenue.

I would like to comment on the prospects for our performance management product line. In 2008, performance management product revenue declined 40% from 2007 to $21.9 million.

Going into 2008, we had anticipated recording additional revenue during the year; however, as the year progressed, additional software releases were required in some cases to satisfy customer acceptance criteria for revenue recognition. Much of this additional work is expected to be completed during the first half of 2009. We also expect the availability of new features in these releases will help generate additional new orders for performance management and monitoring products in 2009. Although 2008 orders were weaker than anticipated for this product line, we did secure 10 new customers during the year, including three Tier 1s.

Next I would like to comment on the geographic breakdown of revenue and our continued strong international performance. Slides 18 through 20 provide a breakdown of revenue by region.

During the fourth quarter of 2008, revenue outside North America represented 64% of our total revenues compared with 62% in the same period last year. For the full year 2008, revenue outside North America represented 61% of our total revenue, up from 57% in 2007. We expect that international orders and revenue will continue to represent more than 50% of our consolidated total on an ongoing basis as we continue to expand our global footprint.

We believe that this continued expansion of our international business, particularly in the emerging markets, in today's economic environment may require additional investments in accounts receivable and working capital as we await payments on milestone billings and customer acceptances on newly installed systems.

Now let me turn to consolidated gross margins. Our consolidated gross margins were 68% for the fourth quarter of 2008 compared to 62% in the fourth quarter of 2007. Full year gross margins were 67% compared to 61% for 2007. Our fourth quarter 2008 gross margins benefited from a favorable product mix, including the number portability revenue discussed earlier, better than expected performance related to certain contract and warranty provisions, and lower manufacturing and inventory costs.

Total operating expenses for the fourth quarter of 2008 were $56.6 million, up 5% compared to $54.1 million in the fourth quarter of 2007. This increase is primarily due to higher R&D spending related to investments in developing SIP-based products to help our customers migrate to IP networks. In addition, our success in continuing to win new signaling and number portability orders outside North America has required continued investment in ITU and local feature development to respond to customer requirements.

Our non-GAAP effective tax rate for the fourth quarter was 28% compared to 26% in the fourth quarter of last year, due primarily to higher pre-tax income and lower tax-exempt interest income compared to the fourth quarter a year ago.

Our GAAP financial statements for the quarter include the impact of share-based compensation. Pre-tax share-based compensation for the fourth quarter of 2008 was $3.5 million, essentially unchanged from $3.6 million in the fourth quarter of 2007. Pre-tax share-based compensation for the full year decreased 15% to $13.3 million compared to $15.7 million for the full year 2007. Please refer to Slides 23 and 24 for a summary of the impact of share-based compensation by line item.

We exited the fourth quarter with a very strong balance sheet. We had cash and cash equivalents of $209.4 million as of December 31, 2008 compared to $228.6 million as of September 30, 2008. The decrease during the quarter is attributable primarily to the net cash investment of $35.8 million for the purchase of mBalance in December, partially offset by $18.1 million of cash flow from operations generated during the fourth quarter. Our working capital balance at December 31, 2008 was $210.4 million, down from $227.7 million at the end of September, 2008 due to the purchase of mBalance. Please refer to Slide 25 for certain key balance sheet metrics.

As Frank mentioned earlier, for the full year 2008 we generated positive cash flows from continuing operations of $106 million compared to $52.5 million for the full year 2007. These strong cash flows for the full year 2008 compared to 2007 are due primarily to the increase in earnings from continuing operations, working capital management, and to the receipt of two tax refunds during the year totaling $23.3 million. The largest of these was $18.9 million, which was reported in the third quarter of 2008 and was attributable to the carryback of net operating losses and capital losses generated from the sale of SSG in 2007. We expect to be in a tax-paying position in 2009 and do not expect a benefit from similar tax refunds.

At December 31, 2008 the company continued to hold $87.2 million of student loan auction rate securities valued at fair value in accordance with FAS 115 and 157. This valuation reflects a cumulative decline in value of $20.7 million recorded in 2008. As a result of entering into the previously announced auction rate securities rights agreement with UBS, these auction rate securities are now considered trading securities. Accordingly, as required by FAS 115, the $20.7 million writedown was reported as a non-operating expense in the income statement during the fourth quarter of 2008.

Under the terms of the UBS rights agreement, Tekelec has the right to require UBS to purchase these securities at par plus accrued interest at any time between June 30, 2010 and July 2, 2012. This agreement was valued at fair value at December 31, 2008 in accordance with FAS 157 and 159. The fair value of the agreement was $18.7 million and the fair value of this agreement was recorded as a non-operating gain in the fourth quarter of 2008.

The net impact of recording both of these investments at fair value at December 31, 2008 was to reduce GAAP and non-GAAP income before taxes by $2 million for the quarter and year ended December 31, 2008. Any future changes in fair value of either of these investments will be recorded in non-operating income. We will continue to classify our auction rate securities and the UBS rights agreement as long-term assets carried at an estimated fair value until we believe that we are within 12 months of a liquidity event. Since year end, approximately $3.9 million of our auction rate securities have been called by one of the issuers, which reduces our total balance to $104 million at par value.

Visibility to order inflow continues to be difficult in the current environment. In addition, many service providers have estimated that they will reduce CapEx spending in 2009 compared to 2008. However, it is unclear how these CapEx reductions will impact ongoing investments in the signaling layer, particularly with expected growth in signaling traffic. We continue to expect that, among other factors, the uncertainties in the financial markets, the lack of credit in the developing world, and the appreciation of the U.S. dollar versus many currencies may negatively impact orders in 2009.

Given this environment and the associated lack of visibility, we are only providing P&L and orders guidance for the first six months of the year. We believe that revenue for the first half of 2009 will range between $225 and $240 million and non-GAAP gross margins will range between 64% and 67%. We anticipate a higher tax rate of 31% for the period, due primarily to certain one-time tax benefits received in 2008 and lower levels of tax-exempt interest income in 2009.

We expect our GAAP EPS for the first six months will range between $0.25 and $0.35 per diluted share and non-GAAP EPS will range between $0.36 and $0.46 per diluted share. In addition, we anticipate that our orders for the first six months of the year will range between $160 and $180 million, with the second quarter orders expected to be significantly higher than those in the first quarter. Please refer to Slide 26 for a summary of our guidance and a reconciliation of non-GAAP to GAAP measures.

Frank?

Frank Plastina

Thanks, Bill.

With the mBalance acquisition, Tekelec now has solutions deployed in 103 countries around the world. We continue to see network evolution trends because of where we reside in the network and as a result of our diverse customer base around the world.

We are seeing our customers evolve to new IP services and architectures. The pace of network evolution depends on the subscriber usage patterns, local and regional market dynamics, and their current network architectures. They want flexible migration paths to IP services and they need to ensure that existing revenue-generating services such as voice and SMS are compatible with new IP services. Service providers are also demanding a relatively rapid payback on their network investments and we have developed solutions that enable them to prove in this business case.

Later this week and at Mobile World Congress in Barcelona, we will be announcing our EAGLE XG product family, which introduces new applications and reflects a rebranding of our portfolio. EAGLE XG provides a path forward from our EAGLE signaling platform to enable operators to transition to new SIP-based capabilities and also the option to upgrade to a full-scale IP network in the future.

We are renaming the solutions in our portfolio that currently carry the tech monitor. This will simplify and focus our brands and better represent the functionality enabled by the particular solution.

In closing, Tekelec's portfolio of signaling and session management, mobile messaging and performance management solutions is focused on our customers' essential CapEx spending. Understandably, our customers are being cautious and so are we. We are financially strong and we have an experienced and disciplined management team who will continue to adapt as required.

I thank you for your time today and will now open up the call for any questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [Vijay Bagabat] - Deutsche Bank Securities.

Vijay Bagabat - Deutsche Bank Securities

Are there any pockets, any specific geographic regions where you're seeing the most opportunities, the most scope for growth this year and next?

Frank Plastina

I think from a geographic perspective we still continue to see growth in the emerging markets, but that's somewhat offset by some of the issues that we talked about in our prepared remarks. So the subscriber growth continues in those markets. For example, India during the month of January added 11 million subs.

We have worked through some of the issues with our customers; we expect to continue to work through them. But we have to be a little bit muted with our expectations because of that currency risk and the ongoing credit risks, especially bank to bank lines of credit, things like that that we alluded both in the prepared remarks this morning and in our last call.

We also see some pretty good opportunities in some of the developed markets, even in the U.S., for our newer parts of our portfolio. We think the mobile messaging market and the performance management market offer some pretty good opportunities for us to leverage our installed base of EAGLEs and move that market forward with some of our new portfolio.

Vijay Bagabat - Deutsche Bank Securities

And then to follow up, do you see competitive trends and pricing pressures intensifying this year in any way? Any meaningful change in the competition or in pricing this year?

Frank Plastina

It's an interesting question. I would say no, in general. What we're seeing more from a visibility perspective is that jobs and orders are moving to the right. It's not due to competitive losses, it's more due to internal pressures on CapEx budgets. I'll give you an example. If there was a $5 million opportunity, customers are now piecing that apart and making it two $2.5 million opportunities or 221. They're really dribbling the orders out and that is really what's making some of the visibility difficult.

We're not seeing any additional competitive pressures that we haven't already seen in the past on the signaling side. In fact, we think the EAGLE XG announcements will actually not only leverage the strength of EAGLE but put us that much further ahead as far as being the number one player on the signaling layer.

On mobile messaging and performance management, we are still the number three or four players in those markets. We think there's upside because we fundamentally are offering a very different way to solve those problems.

And from a competitive perspective, I think we're well positioned because we're going against competitors in each of those markets that do not sell a broad portfolio of software or equipment to service providers, companies like Agilent or Acision or Tektronix. We think as service providers start consolidating some of the suppliers they work with, we think we're very well positioned to add things like mobile messaging and performance management and other adjacent space software solutions to our core signaling expertise.

Vijay Bagabat - Deutsche Bank Securities

Any color on the pricing trends?

William Everett

I was going to comment on that. I think that the pressure for pricing is more driven by, particularly in the emerging markets, is driven by changes in currency rather than necessarily changes in the underlying pricing. If you look at the Brazilian real, the Indian rupee, the Mexican peso, several other currencies that are important currencies to us, those local currencies have devalued significantly in the last 13 months relative to the dollar. So that then translates at a local currency level a more-expensive product.

So we work through those issues with our customers, and I think that's been the biggest pressure translating into pricing rather than the underlying unit price in the local currency.

Operator

Your next question comes from George C. Notter - Jefferies & Co.

George C. Notter - Jefferies & Co.

I had a question about the order trends and the volatility of the order trends. Obviously, a great order number here in Q4. You're guiding for it to come down a fair amount over the next couple of quarters - $160 to $180 million. I guess I'm trying to understand if there's any intuitive explanation for the volatility in orders. Is it seasonality? Is it orders that maybe were pulled in from the first part of 2009? Any color there would be great.

Frank Plastina

It's not pull in and it's really not seasonality. It really is a much more conservative approach to CapEx. We've seen some announcements which I'm sure you're familiar with - AT&T, Verizon, Vodafone, all the others - saying they're looking at being very careful, at least in the first part of the year, seeing how the macroeconomic environment plays out and potentially loosening that up in the second half of the year if the macroeconomic factors dictate that they do that.

So what we're seeing is essentially a reflection - our call, that $160 to $180 million - literally conversations with each of our major customers that say we're going to be more careful in the first half of the year, and we're not quite sure what the second half is going to look like because we have to see whether or not the macroeconomic environment impacts our business. That's really the bottom line to what we're seeing.

The interesting thing to note is our pipeline in absolute dollar terms is actually higher this year than it was last year at the same time. What we're seeing fundamentally is a move to the right on spending. So we feel pretty good that our product portfolio is in excellent shape. We feel pretty good that we're very well positioned competitively. But we really just have to be patient as all of these CapEx budgets get worked out.

George C. Notter - Jefferies & Co.

How about the strength of the orders, then, this quarter? I heard you say that CALA was softer, emerging markets is softer, North America was strong, but was that a surprise, the strength in North America kind of offsetting the weakness in international?

Frank Plastina

I think it was a bit of a surprise. What that showed us in North America was I think it lent credibility to our point that we tend to be on the non-discretionary part of the CapEx budget. Very clearly our North American customers started scaling back in the fourth quarter, but we seemed to obviously be above the line when it came to cutting back and we got a pretty good order input for the quarter. All of our major North American customers gave us some pretty good orders in the fourth quarter.

So that gives credibility to both the fact that we're non-discretionary or at least a nondiscretionary element of a CapEx budget, and then secondly it tells us that the underlying traffic growth in signaling is still continuing.

Operator

Your next question comes from the line Amir Rozwadowski - Barclays Capital.

Amir Rozwadowski - Barclays Capital

I just wanted to touch base quickly on the number portability side of the business. Certainly, if we look at it on an overall basis for 2008, some very healthy growth there. I was wondering if you could give us a little bit of color in terms of potential opportunities in the coming year and whether we should expect a continuation of those robust growth rates? And then sort of as an aside to that how whatever those trends that you're seeing on number portability would impact your gross margin structure.

William Everett

Amir, I think, as we've said in past calls, focusing on a $25 to $30 million range as a steady state in number portability is probably a good number. We don't really see explosive growth in that number for a couple of reasons. First, it's lumpy based on whether or not a particular market adopts number portability in that particular year. And then secondly, the addons, such as the addon to 384 million entries in North America, those are really step functions, so it can go up or down significantly in any given quarter.

Having said that, we now have 35% of global share, as we indicated in the prepared remarks, and we are very well positioned with some of the markets that we expect will mandate number portability in the coming year, in particular, India. We have built a very nice installed base of EAGLEs in many customers in India, and we think as number portability gets mandated there we're well positioned, obviously, to add on that number portability software into our Indian customers.

Amir Rozwadowski - Barclays Capital

And then, Frank, if I may, obviously a lot of chatter around CapEx and sort of where carriers are allocating their investment dollars at this point. It seems as though some of the carriers are taking more of quarter-to-quarter approach to CapEx this year as opposed to committing to a full year spending outlook. I was wondering, is that sort of the sense that you folks are getting and, if so, do you ultimately expect them to give improved visibility at some point during 2009?

Frank Plastina

The answer is yes to both. We are seeing a very near-term approach to CapEx spending, 90day increments in most cases, which is why we're only providing six months' view on orders. We frankly don't have any information for us to give a 12-month view.

Having said that, we do have a view into traffic demand and traffic growth, so we still feel pretty good about our positioning from a competitive perspective to get that traffic or that CapEx growth when that traffic materials. So they are taking a very careful approach. They make take a longer-term view at some point during the year, but we're not sure that they will.

One thing I do want to emphasize is our request for quote and request for pricing activity hasn't slowed down. The long-term planning is continuing; the question is what are the short-term implications of the current macroeconomic slowdown and how will that necessarily impact the timing of some of these longer-range projects. These longer-range projects remain on the table; they are just simply being pushed out to the right, and we feel we're still very well positioned to get a piece of that longer-range evolution.

So we're going to take it slow. We're going to take it 90 days at a time, as our customers are doing. But in the meantime we're going to continue to position, obviously, some of the newer things that we're doing, continue positioning some of the newer elements of our portfolio such as mobile messaging and performance management.

Operator

Your next question comes from the line Kenneth Muth - Robert Baird.

Kenneth Muth - Robert Baird

Just a follow up on the first half '09 thoughts here. Do you expect the EAGLE portion - you had a very robust order and revenue in Q1 '08, so I'm trying to get a sense for the first half of '09, how we expect that to kind of compare. I would assume it'd probably be down just because of that hard comparable that you have on a six-month basis?

William Everett

Yes, that's right, Ken. And that obviously is also leading to the 64% to 67% gross margin guidance for the first six months. We had a very strong book-and-ship business in the first six months of last year. We don't expect that to repeat. And we do expect IAS to be a bigger component of our revenue in the first six months of this year versus what it was last year.

Offsetting that a little bit to the positive is our mobile messaging products, which included OEM elements last year and didn't really have a lot of revenue in the first half of last year from mobile messaging. We expect that to be pretty good margins in the first half of this year because of the mBalance acquisition eliminating that OEM markup and now we have a much healthier margin for that product.

Kenneth Muth - Robert Baird

And then on the first half '09, again, on number portability - I'm sorry, I missed what you may have just said there on the previous answer - but is that going to be dropping off as well just because you had such a huge Q4?

William Everett

Yes, Ken, I think that Q4 was very strong. And if you at it for the full year of 2008, we had about $40 million of LNP revenue, and that's very, very high for us. We say the steady state view is $25 million or so - $26 million - that's kind of the average. So that's been better and that obviously helped drive our margins up somewhat. But going back to the first half comparison, we recorded revenue on a fair amount of LNP business in Brazil and in Mexico and in the U.S. during the second half of this year. We won't necessarily have that same level in the first half of 2009. So that's one of the differences.

The other thing that we mentioned in the script - in the prepared remarks, really - is the delta associated with having less interest income and a higher tax rate in the first half than we had in the first half of last year.

Kenneth Muth - Robert Baird

Okay, so now going forward here, the monitoring business, now that you finally have all your software modules up and ready to go so you can recognize some of this revenue, how many customers will you be shipping to in the first half '09 for that?

William Everett

I'd have to get you the specific number on that, but in total, just to give you some flavor of that product line, we have 150 customers in total on our performance management software and we have only upgraded 30 or so - 30 or 40 - to the Linux carrier grade newer version of performance management. So we've got quite a ways to go to evolve the rest of the base to that carrier grade Linux from the old Windows-based product. That's one aspect of it. And then obviously we've got the new customers that we signed on. We booked 10 new customers last year, including three Tier 1s.

Kenneth Muth - Robert Baird

India and China you mentioned briefly, but would you expect revenue opportunity to be in 2009?

Frank Plastina

Did you say China or India?

Kenneth Muth - Robert Baird

Both.

Frank Plastina

China, no. We don't have a specific variant for the Chinese market. If there's any opportunities in China it'll either be in performance management or mobile messaging more so than EAGLE.

And in India, yes, tremendous opportunities in India, both from just a plain extension perspective to our current customers of EAGLE and then the add-on business potential for all three of mobile messaging, number portability and performance management.

Kenneth Muth - Robert Baird

In 2009?

Frank Plastina

In 2009, yes.

Operator

Your next question comes from Scott Coleman - Morgan Stanley.

Scott Coleman - Morgan Stanley

First, compared to when you reported third quarter results, have you seen any easing of credit conditions in your emerging markets business yet?

William Everett

Scott, I think that the answer is in part yes, but there's some new variables as well. When we reported in November for Q3, we saw quite a credit freeze occurring on an interbank basis, particularly in November and December, where in Europe, for example, banks wouldn't take letters of credit from each other. That piece of the credit problem has eased somewhat from our perspective, so we're starting to see more liquidity as between the different players in the market.

But in terms of the credit side of customers looking for financing, their desire to extend their payment terms or to look at their vendors for financing and so on, that continues to be something that is occurring from the customer side back to the vendors rather than from an institutional credit perspective.

So I'd say on the institutional side it's better. The carriers themselves are obviously struggling with their own finances and they're obviously looking for people to help them with that.

Scott Coleman - Morgan Stanley

And then maybe on a related note, in the third quarter you took, if I remember correctly, about a $2 million loss related to hedging activities. It didn't repeat again in the fourth quarter, although we did see some pretty significant swings in FX. Have you changed significantly either your hedging positions, your approach to it? What is happening that's different and maybe what should we expect in terms of the impact in your 2009 guidance?

William Everett

I think that for the year our total FX, which is the combination of realized exchange losses and remeasurement gains and losses and then also the translation impact on our financial statements, when you put all those factors together, they didn't have a material impact on Tekelec's overall operating results and we're hopeful that they won't have a material impact in 2009 either.

Between some of the quarters, particularly in Q3, when there was a really rapid devaluation that occurred right at the end of Q3, we did have some losses that were in other income. We had some gains in Q4. Our objective is to neutralize that, so we try not to either have gains or losses.

And there really is no change in our hedging strategy. I think we end up with issues that are difficult to control in some of our subsidiaries, where there isn't a hedgeable transaction, but we have to re-measure their financial statements into U.S. dollars and take that adjustment through the P&L. It's not a hedgeable position generally, and that was mostly in Brazil. So as the rates have stabilized, we didn't have a recurrence of those losses in Q4.

So our objective, I think, looking forward is even in periods of volatility over the long term, over 12 months, we would hope to neutralize that to essentially zero.

Scott Coleman - Morgan Stanley

And maybe a question on mBalance. In your slides you indicate that it added a couple of million dollars to backlog. Can you give us an idea of what it added to orders for the first half of the year so we can get a year-on-year comparison? And then do you expect that owning this business  what are your expectations that it can pull through incremental business of Tekelec's core products?

Frank Plastina

To answer your first quarter, it's not a material impact. Single digits millions would be the range in terms of the first half orders.

The pipeline's healthy. We hope to obviously convert more orders. The mobile messaging opportunities in the U.S. and other developing markets that I mentioned on an earlier question really are second half opportunities that we hope to convert. So we do hope to have a pretty healthy order book on mobile messaging before the year is out.

In terms of the second part of the question, sorry, Scott, what was the second part of the question?

Scott Coleman - Morgan Stanley

Does owning mBalance pull through incremental demand for your core products?

Frank Plastina

Yes, I think one thing that's interesting about the mBalance acquisition was that we actually acquired an additional 38 customers, so we do now have an opportunity to go into each of those customers and really sell the EAGLE vision in terms of signaling layer and control layer evolution. So there is an opportunity there that would pull in the rest of our portfolio into a customer where they already are strong.

So the opportunity is there, but I really expect the bulk of our order input to come from our ability to add mobile messaging capabilities to our current base of EAGLE customers.

Scott Coleman - Morgan Stanley

And Bill, I missed your comment on tax rate guidance for '09. What did you say?

William Everett

31%.

Operator

Your next question comes from Larry Harris - C.L. King.

Larry Harris - C.L. King

You indicated that we probably would not see a very strong book-and-ship order activity in North America in, say, the first quarter or the first half. What about in the fourth quarter of '08, with the strong North American orders. Was there a strong contribution in terms of the bookandship upgrade in extension orders?

William Everett

It was similar to what we saw in Q3, Larry. It was actually significantly lower than it was in Q1 and Q2 of last year. So the area where we had really strong book-and-ship business was particularly in the second quarter of last year, and Q4 was below that by a significant amount. Our business and our revenues and our orders in Q4 were not driven by bookandship business.

Larry Harris - C.L. King

So there were other contributors in North America than helped to generate the strong orders?

William Everett

Yes. Yes, I mean, the strong orders in North America are more reflective of potential bookandship going forward and there's a lot of extension business and things like that on the orders. So a lot of those didn't convert in the fourth quarter. That's something that's going to convert to revenue in '09. All of that is factored into our six-month guidance.

Larry Harris - C.L. King

I assume you'll be talking more about this relative to the EAGLE XG, but with the carriers looking at their capital expenditures on a quarter to quarter basis, do you think that's affected the timing, the transitions, say, from SS7 and Sigtran to IMS? Do you think that pushes IMS further to the right or is there any impact?

Frank Plastina

I think it does. And, in fact, that actually strengths the EAGLE XG story. Our entire view over the last couple of years has been that there's not going to be an on-off move to IMS and there's not going to be a lot of appetite for a whole bunch of new platforms that get deployed into the wireless core without a very profound business case to justify it. The fact that there's downward pressure on CapEx budgets now makes that view even stronger.

So we think that transitional view that we've built - which is essentially what EAGLE XG is; it's using everything that EAGLE gives you today and then use case by use case or functionality by functionality, evolving to that next step and evolving to platforms that can upgrade to IMS even with just a software upgrade in some cases whenever they're ready - so the ability for a service provider to handle the islands if SIP traffic and the islands of next gen traffic that they've built up based on certain deployments and handling that with just an addon to the current EAGLE as opposed to a whole new platform is very attractive, and it's a pretty good business case for us to prove in.

So we think the downward pressure on CapEx budget actually helps the entire EAGLE XG story and makes it more attractive.

Operator

Your next question comes from Catherine Trebnick – Avian Securities.

Catherine Trebnick – Avian Securities

My question, again, CapEx. Are you seeing within this really tight domain of CapEx any particular spending that is targeted towards near-term revenue generation on our services? I'm trying to get more of a flavor for is perhaps messaging might be more important right now in some carriers than perhaps doing maintenance for signaling. Is there any of your ancillary products that seem to be being pulled forward because they're looking at near-term revenue generation services because they're on such a tight CapEx tightrope?

Frank Plastina

Yes, I think so. I think that's really driving some of the potential pipeline that we've got on both mobile messaging and performance management. I mean, actually getting some insight as to what's driving the problems in the network and driving the revenue is adding some opportunities for us for IAS and performance management.

Mobile messaging, definitely that is a big revenue driver in the near term, and it's a big traffic problem and traffic issue that needs to be solved, so a lot of the CapEx now is being focused towards that and a lot of thinking is going back to having that efficient signaling layer handle all that messaging traffic. And then obviously to the extent that we can add on some additional features with our mobile messaging product, whether it's firewall, ad insertion, whatever the case is, those are very attractive elements to the service providers, particularly in an environment where dollars are scarce.

William Everett

Catherine, the other thing I would add to that is that's really one of the reasons why we're focused on the EAGLE XG as well, because applications like Service Broker enable customers to create revenue-generating applications by doing things like enabling prepaid functions that they couldn't otherwise address and creating more incremental revenue. So that's another side of the search for additional revenue on the carrier side.

Catherine Trebnick - Avian Securities

Are you seeing any difference geographically in the demand for the products, like maybe more number portability in Mexico than messaging in Europe? I don't know, I'm just trying to get some color.

Frank Plastina

Yes, I think number portability is really market by market, depending on whether or not there's a mandate. So we do expect number portability to be somewhat steady, with potentially a binary opportunity in India should they move forward aggressively with number portability this year. I think that would be the biggest difference and that would really move our numbers one way or the other.

In terms of mobile messaging, we see that opportunity everywhere. Texting has become mainstream in every single market we play in, and we literally are seeing mobile messaging opportunities in all of our EAGLE base of customers around the world. And what makes that particular product interesting is it's essentially a software solution; architecturally it leverages our current EAGLE and very clearly proves in a business case versus a legacy SMSC. So it's a very disruptive piece of technology and not a huge incremental investment to deploy.

Operator

Your last question comes from Natarajan “Subu” Subrahmanyan - Sanders Morris.

Natarajan “Subu” Subrahmanyan - Sanders Morris

First, can you just talk to us about the turns nature of the overall business? I know you mentioned there's not going to be much in North America for the first half. I'm trying to correlate that to the orders versus revenues. Your midpoint of revenues for the first half is flat year-over-year, but orders are down almost 17%. I'm just trying to understand for the full year would you expect book-to-bill to go more towards 1.0? I know you're not providing second half guidance, but just in general the correlation between orders and revenues for the year?

William Everett

We're not giving the 12-month guidance. In the past, that's largely where we've targeted. So, you know, you look at last year, we ended up roughly at about 0.99 to 1 for the year, and we're always going to look to equate the orders and the revenue.

Right now what makes it difficult really is our CapEx or our service provider input on their CapEx budgets is that they haven't even solidified their second half, so we're not quite sure what that order input is going to look like. But we are quite confident that signaling traffic and the actual fundamental demand factors are still growing. So we believe that that will eventually translate into orders, but right now we're not quite sure when. And really, six months is about all the visibility we have.

Natarajan “Subu” Subrahmanyan - Sanders Morris

Sure. I was just trying to understand in terms of - year-over-year comps for orders are obviously a little bit weaker than revenue year-over-year comps for the first half, and I'm wondering if it kind of equates out to if orders are leading indicator of revenues for the full year, do you think?

William Everett

Well, I think, Subu, that we have a substantial amount of backlog coming into the year, so if we have orders weakness in the first half, it will impact at the end of Q3 and in our Q4 revenue, but most of the revenue we're going to record in the first half of the year is coming out of backlog. So we have pretty good visibility to that.

Where the issue is is that, as we said in our prepared remarks, we expect the order input in Q1 to be quite a bit softer than it's going to be for the Q2 component of it. So you're looking at two quarters where we know that, due to a lot of factors, Q1 will be lower than probably - a good chance lower than last year. So we look at it and say, we know that part with pretty good certainty, but our visibility drops off pretty dramatically so we don't know what to say with respect to the second half of the year. And we hope the seasonality that's occurred in the past will occur this year as well, but it's very difficult to say because the service providers are really not giving us that visibility.

Natarajan “Subu” Subrahmanyan - Sanders Morris

And traditionally, second and fourth quarter would be the seasonally strong quarters for orders, is that right?

William Everett

That's correct. The fourth quarter traditionally is the strongest by far. Last year was a good indication. Fourth quarter was $160 million; the second quarter was $122 million. And the same phenomenon occurred in 2007 as well.

Operator

Ladies and gentlemen, this concludes today's Tekelec fourth quarter and year end 2008 earnings release conference call. Thank you for your participation. You may now disconnect.

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