Veraz Networks Q1 2009 Earnings Call Transcript

Veraz Networks, Inc. (VRAZ)

Q1 2009 Earnings Call

May 07, 2009 04:30 PM ET

Executives

Ron Vidal - Investor Relations

D. A. Sabella - Chief Executive Officer

A. J. Wood - Chief Financial Officer

Analysts

Edward Jackson - Cantor Fitzgerald

George Notter - Jefferies & Co.

Presentation

Operator

Hello, this is the conference call operator. Welcome to the Veraz Networks First Quarter 2009 Financial Results Conference Call. As a reminder all participants will be in listen-only mode. There will an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions). The conference is being recoded.

At this time I would like to turn the conference over to Ron Vidal. Mr. Vidal?

Ron Vidal

Thank you, operator. With me on today's call are Doug Sabella, Veraz's President and Chief Executive Officer, and Al Wood, Veraz's Chief Financial Officer.

At approximately 4:05 PM Eastern Time, Veraz issued a press release with the results of it's first quarter ended March 31, 2009 on Business Wire. The text of this release is available on our website at www.veraznetworks.com.

We'd like to remind you that during the course of this conference call, Veraz management may make forward-looking statements including financial projections, statements as to the plans and objectives of management for future operations, and statements as to the company's future economic performance, financial condition or result of operations.

These forward-looking statements are not historical facts but rather are based on Veraz's current expectations and beliefs and our based on information currently available to us. Words such as may, will, expect, intends, plans, beliefs, targets, and estimates and variation to these words are intended to identify forward-looking statements.

By discussing our current perception of the market and making these forward-looking statements, we are not undertaking obligations to provide updates in the future. Veraz's actual results may differ materially from those projected in these forward-looking statements. And no one should assume at a later date that these comments from today are still valid.

Please refer to Veraz's recent SEC filings for more detailed discussion of these and other risk factors. Any future product, feature, or related specification that may be referenced in today's call are for informational purposes only and are not commitments to deliver any technology or enhancements. And Veraz reserves the right to modify future product plans at any time.

I would now like to turn the call over to Veraz's President and CEO, Doug Sabella.

D. A. Sabella

Thanks Ron, and thank you for joining us on our first quarter 2009 earnings call. With me today on the call is our CFO, Al Wood.

I'll begin the call by providing an overview of our business, products and customers and then, I'll turn the call to Al for a detail description of our financial results and outlook.

As we look at our results for the first quarter, it's important to recognize that despite the difficult global economy, we achieved all of our previously issued financial guidance including revenue, net loss and cash flow.

We've now delivered on our financial guidance for three consecutive quarters, an important metric to our investors and employees, and reflecting our hard work and efforts to achieve our financial goals.

Although the global economic situation remain difficult and many of our competitors are struggling, we see positive indications that service providers will continue to grow and begin to replace 18 circuit switch platforms because it is the right economic choice for their businesses.

In the telecom industry, downturns in the economic cycle are generally followed by multi-year replacement cycles of all the generation platforms, and we believe that this economic cycle will be no different.

In fact, we have seen a substantial up tick in a number of RFPs related to replacement of legacy Class 4 infrastructure form both our traditional customer segment and also from larger tier one providers.

We have the right technology and platforms at the right time while we're also seeing a contraction of viable competitors, who have comparable products and service capabilities. We believe that we are entering a multi-year replacement cycle and that these factors encourage us about what the coming quarters and years will hold for Veraz.

On the revenue side, we achieved 21 million of total revenue in the first quarter inline with our previously provided guidance. Revenue from our IP business, which consisted switching Gateways was solid and our services revenue relating to both new IP installations and growth in our IP maintenance business increased to its highest level ever.

Our gross margins were strong in all categories and particularly, for services which achieved its highest level ever. We continue to carefully manage our inventory and forecasting process to make sure that we have the right mix of products and product availability to meet customer demands while also tightly managing our overall working capital requirements.

As we previously stated, it is our goal to maintain a cost structure that will create long-term value for our customers and shareholders and that it has significant leverage. During the quarter, we reduced our operating expenses by $1.3 million while maintaining our commitment to research and development, which increased slightly.

Our business is in structure to achieve profitability at a quarterly revenue point of approximately 25 million. We continued to both aggressively reduce operating expenses and lower our breakeven point, while ensuring that we adequately invest in sales, marketing and developments. The global nature of our business makes it a challenging task that requires continuous attention by management.

Our success in driving down our costs over the past several quarters was accomplished while making significant investments in our operations in Brazil and several other strategic markets that we are beginning to successfully penetrate.

We fundamentally believe that our model continues to have significant leverage that will be achieved as we grow through this $25 million breakeven point.

Now, I would like to spend a few moments describing the trends that we are seeing in the dynamic global marketplace.

The shift to IP network continues to advance because IP networks are the most cost effective methods to move network traffic. But it is a multi-year shift resulting in a continuing need for network equipment that can manage and transport hybrid sessions of both IP and TDM (Time-Division Multiplexing) traffic.

Our previous investment in TDM has given us a solid foundation, but today nearly all of our research and development is dedicated to the management and transport of IP session that includes both voice and data. This need to manage hybrid session is consistently seen in the RRPs from every region in the world.

Additionally, the proliferation of all types of applications beyond voice and mobile devices is a significant growth opportunity for mobile operators and the bandwidth constrains are of significant challenge to their growth objectives. This is an area in which our bandwidth optimization capabilities are being increasingly recognized and leveraged by mobile customers around the world.

Additionally, today we announced the availability of our ControlSwitch Release5.8, demonstrating the value of our investment and IP session management. With Release5.8, wholesale operators now have the ability to cost effectively transition mobile operator interconnections from TDM to IP while reducing OpEx and enabling new IP base services.

Since most of our customers are outside the United States and in some other fastest growing regions, we are at the forefront of observing and exploiting global trends that may not be evidenced if we simply sold our products and services in North America. For instance, mobile bandwidth constrains less severe in the U.S. and Europe than they are in every other part of the world.

The work we are doing to provide bandwidth optimization for both voice and data and our soon to be announced capabilities around mobile backhaul optimization are core requirements for mobile providers. And thus, important investment segments for Veraz.

We also believe that as intelligent devices increasingly propagate mobile networks in the U.S. and Europe, the need for improved bandwidth management will become increasingly important.

Now, I would like to turn to the performance of our regions and our overall visibility. We entered Q1 with the strongest IP backlog in our history. Although, for the first time since Q1 '08, we had a slightly negative book-to-bill. We exited Q1 '09 with the highest IP backlog of any Q1 period.

Our visibility has improved and we expect sequential growth in bookings and a strong back half of 2009. Our Q1 bookings were back end loaded to a greater extent than it's typical for a quarter, which is traditionally back end loaded. And as a result, our deferred revenue declined, but we did not -- because we did not begin several projects until the April timeframe.

In Q1, our switching business was seasonally quite strong, but our bandwidth optimization business, which is a churned business, was lighter than we expected. In Q1, we captured three new Class 4 switching customers and we have a very strong funnel of switching deals. We also have rebuilt our bandwidth optimization funnel and expect to see solid Q2 performance.

The EMEA region had a very solid quarter in both our switching and bandwidth optimization businesses. It is and remains our largest region and we captured two new switching customers in Q1.

The Calla region remains our fastest growing region. And after a record Q4, the region delivered a solid and balanced quarter between bandwidth optimization and Class 4. In Q1, we invested a lot a time and effort in the Brazilian deployments that were closed in Q4.

In Q1, we entered into a Class 4 switching trail with a tier one carrier and our Gateways were certified with one of the largest mobile operators in the region. The Asia-Pacific region delivered a solid quarter and continues to make great progress.

Our bandwidth optimization solutions continue to sell well throughout the region, but especially in India and we want a new Class 4 deal in the region. This is a region that twelve months ago faced significant challenges and is now emerging as a well managed and increasingly successful region.

The North American region had a challenging quarter and although we did not capture any new customers due to the very difficult economic environment, we were able to close business with our significant installed base of switching customers.

In summary, we delivered a quarter within the financial guidance that we had outlined last quarter including reducing operating expenses while increasing research and development.

We are fortunate to have built a base of customers that are well diversified by geography, size, type of network operated and type of services provided. We operate around the world and we have gained an enormous amount of experience successfully selling, installing, operating and servicing customers that have a wide variety of needs.

At a time when many others in the industry are experiencing difficulties, we have cash, no debt; have good cost structure and a set of products and services that are aligned with the needs of one of the fastest growing communication segments in the world.

And now, I'll turn the call over to Al.

A. J. Wood

Thanks, Doug and good afternoon everyone. We are pleased to be reporting first quarter 2009 results. I'm going to start with the financial highlights of the first quarter and then I will provide an update on our outlook for the second quarter 2009.

For Q1 FY '09, total revenues were $21.0 million within the Q1 guidance range we previously provided of 21 to $23 million. Historically, we have seen the first quarter to be generally our weakest quarter of the year and this Q1 appears to be following the same pattern.

We continue to steadily expand the already diverse customer base from which our revenues are generated. We had one customer Bezek that accounted for 10% or more of our Q1 revenue. Our top ten customers accounted for 52% of Q1 revenue and four customers each accounted for $1 million or more of Q1 '09 revenue.

We believe this lack of customer concentration has been and continues to be a significant advantage as we are not overly reliant on any particular customer, capital budget, geography or type of network operator.

On a geographic basis, our Q1 FY '09 revenues were 15% from North America and 85% international as compared to Q4 FY '08 revenues, which were 13% from North America and 87% international.

The geographic mix of revenues can vary significantly on a quarterly basis depending on the timing of the completion of projects and other factors.

Our Q1 IP product revenues consisting of our Media Gateway and ControlSwitch family of products were $13.1 million, a decrease of 22% from the $16.9 million IP product revenues recognized in the preceding quarter and a 37% decrease from Q1 FY '08.

Our legacy DCME product revenues were $1.2 million for Q1 FY '09. As we have said previously, at this late stage of the product lifecycle of this legacy product, the rate of decline of the DCME product revenues will vary from quarter-to-quarter. We still expect our DCME product sales to continue to decline overtime while there will be some periods, where the DCME sales are different than our expectation.

Our services revenue of $6.7 million is a 14% increase from the preceding quarter and a 20% increase from the same quarter of last year. This strong services revenue performance reflects both the recognition of services revenues related to some large installations that were accomplished in Q1 and our growing customer base with increased maintenance revenue.

As expected, the mix of services revenues continues to steadily shift towards the IP business, which offsets the expected decline in the service revenues attributable to our DCME business. Total gross margin was 58.0%, an increase from 53.6% in Q1 FY '08, but a decrease from 60.1% for Q4 FY '08.

IP product gross margin was 58.4% and is the third quarter in a row, where IP product margins were at such high level. As we have stated previously, the percentage of total gross margin as well as the IP product margin will vary due to the mix of revenues as well as the characteristics of the specific deals recognized within the period.

We continue to try to strive to achieve the right balance between maintaining relatively high gross margins for our products and growing our market share. Despite a challenging economic environment, we're pleased to be able to continue to maintain relatively strong gross margin.

As we've stated in the past, while we are often not the low price leader in competitive situations, our customers recognize the quality of our products, services and our overall commitment to their success. While there will be some variability in any given quarter, for our long-term business model, we expect to have total gross margins of 55 to 60% and this quarter's results are consistent with those goals.

For Q1, operating expenses were $14.5 million including 900,000 of stock compensation expense as compared $18.6 million including 900,000 of stock compensation expense for Q1 FY '08, and $16.1 million including a million dollars of stock compensation expense and 200,000 in expense related to the SEC investigation for Q4 FY '08.

On a non-GAAP basis, our Q1 operating expenses were $13.7 million as compared to $17.7 million for Q1 FY '08 and $14.8 million for Q4 FY '08.

Immediately following our Q2 FY '08 performance and in anticipation of the developing global economic crisis, we stated that we would take immediate measures to streamline our operations and reduce our operating expenses. At that time, we said that going forward we believe that such streamlining measures would reduce our quarterly non-GAAP operating expenses to 14 million to $15 million per quarter starting in Q4.

For Q1, we again tightly controlled our non-GAAP operating expenses at $13.7 million, which is below our target of $14.5 million. We are focused on restraining our expenses while growing revenues to return to profitability and positive cash flow.

For Q1, our non-GAAP operating loss was $1.2 million, which was better than our previous guidance of 2 to $3 million loss. The Q1 cash used by operations was $2 million, which was also better than our previous guidance of 3 to $4 million operations cash used.

In light of the global recession, which was felt in Q1, the solid Q1 financial performance as a result of the effort to quickly right size the business to reflect the difficult economic environment combined with continued acceptance by our customers of the brand solutions and services.

Going forward, while the results will vary on a quarter-to-quarter basis, we intend to continue with our efforts to carefully manage Veraz to ensure that we deliver a non-GAAP operating profit and positive cash flow on a long-term basis.

Other income expense and income tax netted to $600,000 negative for Q1, which was driven primarily by foreign exchange losses on balance sheet items that are denominated in foreign currency from our foreign subsidiaries. Net loss for the period was $3 million or $0.07 loss per share, which was a smaller loss in our previous management guidance of 4 million to $3 million or $0.10 to $0.07 loss per share.

On a non-GAAP basis, net loss was $1.9 million or $0.04 loss per share, which was better than the previous management guidance of non-GAAP net loss of 3 million to $2 million or 7 to $0.05 loss per share.

Turning to the balance sheet, our cash in short-term investments were $36.4 million as compared to $38.6 million as of Q4 FY '08. For Q1, FY '09, we had negative cash flow from operations of $2 million, which was better than guidance previously provided of 4 to $3 million negative operations cash flow.

After taking into account the cash flows from investing and financing activities in Q1. Our total cash flow was negative $2.2 million. In Q1, we did not factor any of our accounts receivable. As compared to Q4 FY '08, our deferred revenue was down to $12.9 million from $17.2 million.

As we've said in previous communications, our deferred revenue balance is nearly a subset of our total backlog. And thus fluctuations in the deferred revenue balance may not always be a good leading indicator.

In Q1, our book-to-bill ratio was slightly below one and as expected, we consumed the small portion of our total backlog. However, our total backlog remains at the second highest level we have had in eight quarters. In Q1, we reduced our accounts receivable by $3.5 million to $28.2 million and our DSO decreased from 108 to 121 days.

Let me close with a few forward-looking comments concerning an update to the Q1 outlook for Q2 FY '09.

And I remind you that comments that I'm about to make are based on the current indications for our business, which may change at anytime. We undertake no obligation to update these comments.

As outlined in our press release issued earlier today, we expect Q2 revenues to be in the range of 22 to $24 million and a net loss of 3 million to $1 million or $0.05 to $0.03 loss per share on a GAAP basis. And on a non-GAAP basis, a net loss of $2 million to breakeven or $0.04 loss per share to breakeven per share, after exclusion of approximately $1.2 million in non-GAAP expenses, primarily related to stock compensation.

We expect net cash use from operations to be approximately 1 to $3 million.

In summary, while we still have many challenges in front of us, we are encouraged by the fact that we were able to swiftly trim expenses and take other measures to adjust to the difficult economic times that are now unfolding. And at the same time continue to grow our business.

We believe that although we are in a challenging environment, we are committed to making steps necessary to meet those challenges and deliver value to our customers and to our shareholders.

We look forward to updating you with reports on our progress in future calls. We will now take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Ted Jackson at Cantor Fitzgerald.

Edward Jackson - Cantor Fitzgerald

Hey guys, congrats on making the guidance.

A.J. Wood

Thanks, Ed.

Edward Jackson - Cantor Fitzgerald

A few model questions and then some larger ones. The first one is given the balance sheet FX issues, would you expect that line item on you're income statement -- other income line item on your income statement to ever flip positive?

A.J. Wood

Yes, we would Ted. And historically, there have been a few cases wherein fact it has been positive. And just to give a little bit more color even though you weren't asking that question, we do have accounts receivable in ruble in Russia and in Brazil and those currencies both declined against the U.S dollar in Q1, and that's where the primary source of the FX movement happened.

Edward Jackson - Cantor Fitzgerald

Do you have any suggestions to how we should look at that for the second quarter?

A.J. Wood

Yeah we actually, one, we don't plan on it having happened -- having such as precipitous decline in the ruble in particular in Q2, of course we didn't plan on in Q1 either. These things will happen from time to time and we do look at hedging when necessary. But this was quite a drop in Q1 as you might recollect.

Edward Jackson - Cantor Fitzgerald

Okay. Then could you tell me what CapEx was in the quarter and the outlook for the remainder of the year?

A.J. Wood

Yeah, so for the quarter, we spent a little over $400,000 in CapEx and that's a little higher than our normal run rate. We will ordinarily run about 200 to $300,000 per quarter. So I would expect that to be the remainder for each of the remaining quarters.

Edward Jackson - Cantor Fitzgerald

Okay. And then same question with depreciation. Could you tell me what depreciation was in the quarter?

A.J. Wood

Sure. Depreciation was a little over $700,000 for the quarter and we will expect that to be roughly consistent for every quarter for the remaining quarters.

Edward Jackson - Cantor Fitzgerald

And then moving over to the balance sheet. You've had your receivables come down, you've had your inventory come down some in this quarter, what's the outlook for that in the next quarter? Or both those line of that-- do you see continued improvements there or do you see --

A.J. Wood

So let's do the last one first which is with respect to inventory, we think that inventory will roughly hold at this level and with respect to the accounts receivable, as we expect more bookings in Q2 than we had in Q1, we will expect AR to grow in Q2.

Edward Jackson - Cantor Fitzgerald

And then just a clarification, when you were talking about bandwidth optimization and -- that you've had solid bookings relative to the second quarter, you're not talking about DCME are you --

D.A. Sabella

No, no. It's our IP bandwidth optimization, which is primarily sold to wireless providers so they can optimize communications between MNCs.

Edward Jackson - Cantor Fitzgerald

Actually I though it was, just wanted to make sure I had that right.

D.A. Sabella

Okay.

Edward Jackson - Cantor Fitzgerald

And then my last question has to do with your ECI relationship. If you went through their last Q, there is a fair amount of discussion about your relationship as it relates to the DCME product as well as the Russian operation. And it sounds like you all have a fair amount of conflict on both those --in both those areas. And I wanted to hear from you kind of what's going on there? Where you are in terms of resolving those conflicts, this conflict, this issue? And it's really kind of an open-ended question, but I think it's important.

D.A. Sabella

Well -- Both the shareholder and a commercial partner. And it's always a challenge working both fronts and sometimes they get overlapped et cetera. And so we continue to work. We expect them to remain a good partner. And there is -- point of challenge and we are ahead a couple of points of challenge very specifically in Russia for us as we've kind of embarked on a more independent path. So, but we expect to work through all those issues, and then we don't expect any surprises.

Edward Jackson - Cantor Fitzgerald

And so with regards to Russia is it your goal to continue to work with them in terms of supporting the customer base that's already in there, or are you looking to...

D.A. Sabella

We have -- we've always had by the way, our own sales team in addition to our own technical team that work side-by-side with them. And we continue to work with them on projects, and we would expect to continue to work with them on projects. In addition, we are taking a more directly active role in the marketplace also.

Edward Jackson - Cantor Fitzgerald

And does this situation involve you coming to terms with a new partnership agreement with them, and are you in the process ...

D.A. Sabella

I don't want to comment on that except, obviously, partnerships always evolve and how you do arrangements evolve in terms of resellers, agencies et cetera.

Edward Jackson - Cantor Fitzgerald

And then somewhere on the DCME front, I know it's falling in ...

D.A. Sabella

On the DCME front, look, we've had better long standing relationship with them and we do -- we're doing less and less business with them. So it's just a set up of questions we've got going back and forth that relate to I would just say these three inch documents that are very thick and lawyers have a good time with.

Edward Jackson - Cantor Fitzgerald

Okay. And then just one last thing, I mean, you've been talking Brazil for over a year, about the strength in that. And clearly, the rest of the markets called on because most conference calls I listened to this quarter, many people are talking about how those things strengthen Brazil and making investments there.

Could you just give us a sense in terms of what the, like the number of customers you have or the number of systems you have installed there, some kind of metrics to let us know sort of what your penetration is in the Brazilian market?

D.A. Sabella

Sure.

Edward Jackson - Cantor Fitzgerald

Because I think my sense is, it's pretty decent.

D.A. Sabella

Sure. First of all I think its great that -- a lot of peers have discovered the global business as opposed to just the domestic business and going after markets that are emerging like Brazil, and if they're listening to us.

But it would be -- we currently have three switch deployments in Brazil. And we've got on the mobile side, the largest mobile providers are using are our bandwidth optimization platforms. And its -- these are not one-off projects, these are ongoing projects where that are actually multi-year and involve also in the future they are helping us even directionally kind of evolve our product because they are obviously related to some very large global service providers.

Edward Jackson - Cantor Fitzgerald

All right. I'll step back at line. Thanks.

D. Sabella

Okay.

Operator

Our next question comes from George Notter at Jefferies.

George Notter - Jefferies & Co.

Hi. Thanks a lot. I guess I was trying to figure out who you guys are seeing competitively in the marketplace. Also through the string season, we're hearing lots about obviously softer economy, fewer deals are around for proven vendors in many cases and as a result, you are seeing increased price pressure in some places. Are you guys seeing any of that and maybe you can just comment on the competitive environment in general? Thanks.

D. Sabella

Sure. Hi, George. Absolutely, we're not immune to it. I would tell you that on the international front, we're seeing Huawei everywhere, but especially in Latin America and Asia more than any other player is competing of right now, we are head-to-head with. The others we see kind of on deal-by-deal, but they are basically -- we're going to head-to-head with them everywhere.

I'd actually tell you that there is definitely pricing pressure going on, but I think that our cost structure of our offerings have given us a competitive advantage and we've been able to kind of protect and maintain our margins thus far. But we're also not going to walk away from business. So, we're trying to be aggressive to grow our share and grow our position especially as it relates to the Class 4 side of the equation because once you're in, the expansions that really become high value revenue for us.

But the deal flow itself in terms of RFPs, we actually saw a substantial number of switching RFPs in Q1 from both like I said in my prepared statements, both from our what I'll call a traditional tier two kind of players et cetera, but also from larger tier ones that are looking to begin to replace their old circuit switch infrastructure. And they are actually to our pleasant surprise, inviting us and actively listening to what we have to say in the RFP process because I think there is a growing recognition from them that actually although we're one of the smaller players, we actually have the most innovative platform in the world.

George Notter - Jefferies & Co.

Got it. And then if you look that set of deals in RFPs that are out there, how do you post it out, I mean are many of these deals done individually, point product selections or are you seeing them give more or less go as part of larger equipment deals with the existing integration functions and bigger projects?

D. Sabella

It's a great question and I would tell you it's actually a combination and let me just give you an example. We have something in the midst of competing for now, it's a very large switch deal and I've got to be very careful not to speak about who it's with, but we are competing with Huawei.

And obviously our focus is just in the Class 4 and they've got a whole broader set of relationships with this customer around other mobile networks and GSM equipment and what they're doing with 3G deployments et cetera and they are almost exclusively Huawei.

So, the leverage points that we find ourselves competing with is obviously very challenging, but its not with the systems integrator, its actually going head-to-head with Huawei. In another instance, though and we talked about this win last quarter with a pretty large, one of the major wireless providers in Asia Pacific, outside of India, we actually competed head-to-head, we are final at against Alcatel-Lucent. And although we won the business, it's actually a managed services agreement with Alcatel-Lucent. So, they will actually be operating our switch. So, they were unable to actually leverage their management -- managed services deal into their product victory.

George Notter - Jefferies & Co.

Got it. Okay. Thanks very much.

D. Sabella

Okay.

Operator

(Operator Instructions). There are no more questions at this time. Would you like to make any remarks, sir?

Ron Vidal

No. So, thank you everyone for joining us and we look forward to you joining us on our next call. Thank you.

Operator

Thank you all very much for participating in the Veraz Networks' Conference Call. This concludes today's event. Thank you.

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