Veraz Networks, Inc. Q2 2009 Earnings Call Transcript

Veraz Networks, Inc. (VRAZ)

Q2 2009 Earnings Call

August 6, 2009 4:30 pm ET

Executives

Ron Vidal - MD, MBS Value Partners

Doug Sabella - CEO

Al Wood - CFO

Analysts

Jim Kennedy - Marathon Capital

Presentation

Operator

Welcome to the Veraz Networks' Second Quarter 2009 Financial Results Conference Call. (Operator Instructions).

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

Ron Vidal

With me today 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 result of its second quarter ended June 30, 2009 on Business Wire. The text of this release is available on our website, at www.veraznetworks.com.

We would 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 results of operations. These forward-looking statements are not historical facts or rather are based on Veraz's current expectations and beliefs and are based on information currently available to us. Words such as may, will, expect, intends, plans, believes, targets and estimates and variations of 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 obligation 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 a more detailed discussion of these and other risk factors.

Any future product features or related specifications that may be referenced in today's call are for informational purposes only and are not commitments to deliver any technology or enhancement. Veraz reserves the right to modify future product plans at any time.

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

Doug Sabella

Thanks, Ron, and thank you for joining us on our second 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 over to Al for a detailed description of our financial results and outlook.

Although our revenue grew year-over-year, it was lower than we had forecasted. The shortfall was primarily due to approximately $3 million in forecasted switch acceptances and an equal amount of bandwidth optimization business being pushed into later quarters.

Revenue weakness occurred in both our switching and bandwidth optimization product lines, while services was in line with our expectations. As we have stated previously, portions of our revenue are from large deals, which can vary significantly from quarter-to-quarter and at timing of these deals can be difficult to predict.

We are pleased to have improved our cash and short-term investment balances again in the second quarter. We have now improved our balance sheet in two of the last four quarters and have been near cash flow neutral over the past 12 months, leaving us with approximately $0.83 a share of cash on our balance sheet and no debt.

As business conditions changed, we acted early to cut expenses and consistently drive our results to positive cash flow. By taking these actions, we have built a strong balance sheet which gives us the flexibility to manage our way to the global recession and position us for future growth and investment as new market opportunities arise.

From a partner perspective, we are happy to report that during the quarter we have strengthened our relationship with ECI Telecom, our largest shareholder and an important business partner. We were able to successfully resolve many of the outstanding issues with ECI and are optimistic that the partnership will continue to be mutually beneficial.

Now, I'd like to spend a few moments describing what we are doing to drive growth in our business. The strength of our switching and bandwidth optimization technology solutions has been demonstrated around the globe. In fact, it is a rare occasion that we are not the winners in the competitive technical evaluations that occur during the RFP process.

However, technological advantage does not always translate into winning business. This fact is accentuated during difficult economic times when some service providers may prefer to direct their capital budget to their long term large vendors.

On the product side, the extensibility of our I-Gate platform is allowing us to broaden our addressable market, while limiting the cost of development and reducing the unit product costs. Today, we are seeing growing interest in our SIP trunking capabilities and are in the early stages of several large deployments, including the already announced deployment as 013 NetVision.

In addition, we are currently completing several trials with Tier I operators for our Session Bandwidth Optimizer, or SBO, which enables network live bandwidth optimization of voice traffic in 3G and future LTE networks. By mid 2010, the I-Gate platform will be capable of transporting IP sessions, whether it be voice, data or video.

Finally, the same platform is being used for our Network-adaptive Border Controller, or NaBC, which is a next-generation session border controller. Our NaBC is gaining market momentum from operators as they seek the flexibility to operate SBCs as both standalone network elements or as integrated elements within their interconnect networks.

Now, I would like to turn to the performance of our regions and our overall visibility. We entered 2009 with the strongest IP backlog in our history, and in Q2 we continued to grow our backlogs. In Q2 we added two additional customers, raising our total to 118. Our Q2 bookings were again back-end loaded and we continue to see our customers taking a cautious approach to capital expenditures.

At the present time, Q3 is looking significantly stronger than Q2 on the booking front, and we anticipate many of these bookings to convert into revenue in the third quarter. We expect sequential growth and bookings in the third quarter and strong bookings in the second half of 2009.

Our EMEA region saw solid quarterly bookings in both our switching and bandwidth optimization businesses. Year-to-date performance is slightly down from 2008 due principally to a slowdown in orders in the oil and natural resource dependent regions of Africa. We currently expect good bookings in EMEA during the third and fourth quarters from several large search expansions and new search deployments in Europe and the Middle East.

The CALA region once again saw good bookings in the second quarter and its year-to-date performance is up year-over-year. In Q2, we completed the rigorous evaluation and certification process for our Class 4 switch and bandwidth optimization gateways from two US-based Tier I service providers for their Latin American operations and have now begun to receive orders.

The Asia Pacific region delivered a solid quarter, and year-to-date performance is flat when compared to 2008. We are, however, seeing significant order intake from India and several other countries in the regions. In addition, this past week we turned up traffic on our previously discussed Tier I switching deployment in the region, which will allow us to begin expansion planning.

The revenue shortfall that we experienced in Q2 is primarily driven by weak demand in our North American and Russian markets. Both of these regions have experienced year-over-year sales volume declines in excess of 50%.

Although we expected the weakness to continue in Russia, we were expecting but did not see a strong Q2 recovery from North America. Part of the rebound we forecasted in Q2 was in anticipation of orders from the US Federal government, which we have begun to receive this quarter.

Historically, our business is seasonal and strongest in the second half of the year, and this year seems to be shaping up to follow the same pattern. We are seeing increased sales activity and positive buying signs from our customers, and we currently believe that these will convert into orders and revenue in the second half of 2009.

In addition to our continued work to sell into new carriers, we are actively working to broaden our distribution capability beyond our current direct sales and regional reseller model in order to drive growth.

To maximize the potential opportunities for product such as the SIP trunking gateway and the NaBC require that we established relationships with, both large network equipment providers and global resellers.

We believe that our product line distribution is constrained and that evolving our distribution model is an imperative to growth. In the coming quarters, we will be providing further updates in our efforts.

In summary, we are optimistic that, both Q3 and Q4 will show substantial improvement as a result of, both expansions of existing customers and new customer wins.

We have a strong cash position, no debt and an overall healthy balance sheet. This combined with a very competitive product line and our plan to expand our distribution capabilities, give us confidence that we will resume a solid growth trajectory.

Now I will turn the call over to Al.

Al Wood

We are pleased to be reporting second quarter 2009 results. I am going to start off with the financial highlights of the second quarter, and then I will provide an update on our outlook for the third quarter of 2009. For Q2 FY '09, total revenues were $16.8 million lower than the Q2 guidance range we had previously provided of $22 million to $24 million.

As we have stated in previous earnings calls, our product revenues are often lumpy and difficult to predict. In Q2, we had some deals for which we had expected to be able to recognize revenue, but we are not able to do so, primarily due to delays installation and completion of customer acceptance test plans.

Further, while we were able to avoid the full impact of the global economic slowdown in Q1, we did feel its full impact in Q2 as we saw some deals get delayed into Q3 or later. Finally the first half of the fiscal year is seasonally the weakest half of the year, and we felt this effect in Q2.

The cumulative effect of the lumpiness of the deals, delays in purchases and the seasonally slower first half of the fiscal year combined to cause the revenue shortfall in Q2. While we had a difficult quarter from a revenue perspective, we continue to steadily expand the already diverse customer base from which our revenues are generated.

One customer, Belgacom accounted for 10% or more of our Q2 revenues. Our top-ten customers accounted for 49% of our Q2 revenues, and only 2 customers each accounted for $1 million or more of Q2 '09 revenues.

We believe that 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 Q2, FY'09 revenues were 15% from North America and 85% international consistent with Q1 FY'09 revenues, which were 15% from North America and 85% in international. The geographic mix of revenues can very significantly on a quarterly basis depending on the timing of the completion of projects and other factors.

Our Q2 IP product revenues consisting of our media gateway and ControlSwitch family of products were $10 million, a decrease of 24% from the $13.1 million IP product revenues recognized in the preceding quarter, but an increase of 3% from Q2 FY'08.

Our legacy DCME product revenues were $700,000 for Q2 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 period where the DCME sales are different than our expectations.

Our services revenue of $6.2 million is an 8% decrease in the preceding quarter, but a 15% increase from the same quarter of last year. The strong services year-over-year revenue performance reflects, both the recognition of services revenue related to some large installations that were accomplished in Q2 and a growing customer base with increased maintenance revenue.

As expected, the mix of services revenue continues to steadily shift towards the IP business, which offsets the expected decline in the service revenue attributable to our DCME business.

Total gross margin was 54.1%, a decrease from 58.0% in Q1, but an increase from 43.7% realized in Q2 FY'08. IP product gross margins were 54.6%, which was also higher than Q2 FY'08 margin of 50.8%, but less than that realized in Q1 '09 of 58.4%.

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 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 are pleased to be able to continue to maintain relatively strong gross margins.

As we have 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 our total gross margins of 55% to 60% and this quarter's results are only slightly below those goals.

For Q2, operating expenses were $12.9 million, including $800,000 of stock compensation expense. As compared to $19.9 million, including $3 million for stock compensation and SEC investigation expenses for Q2 FY'08 and $14.5 million including $900,000 in stock compensation expense for Q1 FY'09.

On a non-GAAP basis, our Q2 operating expenses were $12.1 million as compared to $16.9 million for Q2 FY'08 and $13.7 million for Q1 FY'09. We have aggressively managed our operating expenses as seen by the Q2 operating expenses being at the lowest level of quarterly operating expenses in over two years.

We continue to drive the organization towards a highly effective and efficient operating model, while still delivering quality products and services to our customers and we are pushing hard to return to profitability as soon as possible. In short, we are focused on and remain committed to restraining our expenses while growing our revenues to return to profitability and positive cash flow.

Other income and expenses and income tax netted to $900,000 positive for Q2, which was driven primarily by foreign exchange gains on the balance sheet items and a tax benefit provision. Net loss for the period was $2.9 million or $0.07 loss per share, which was below our previous management guidance of $2 million to $1 million loss or $0.05 to $0.03 loss per share.

On a non-GAAP basis, net loss was $1.9 million or $0.04 loss per share, which was also below pervious management guidance of non-GAAP net loss of $1 million to breakeven or $0.03 loss to breakeven per share.

Turning to the balance sheet, our cash and short-term investments were $36.5 million, an increase as compared to $36.4 million as of Q1 FY'09. For Q2 FY'09, we had negative cash flow operations of $700,000, which was better than guidance previously provided of $3 million to $1 million negative operations cash flow.

In Q2, our deferred revenue increased to $16.4 million as compared to $12.9 million in Q1. As we have said in previous communications, our deferred revenue balance is merely a subset of our total backlog, and thus fluctuations in the deferred revenue balance may not always be a good leading indicator.

In Q2, our book-to-bill ratio was above 1. In Q2, our accounts receivables increased from Q1 by $2.3 million to $30.5 million and our DSO increased from 121 to 163 days.

Let me close with a few forward-looking comments concerning an update to the outlook for Q3 FY'09. I will remind you the comments I'm about to make are based on the current indications for our business, which may change at any time. We undertake no obligation to update these comments.

As outlined in our press release issued earlier today, we expect Q3 revenues to be in the range of $20 million to $22 million and a net loss of $2 million to $1 million or $0.05 to $0.02 loss per share on a GAAP basis, and on a non-GAAP basis a net loss of $1 million to breakeven or $0.02 loss per share to zero cents per share after exclusion of approximately $1.1 million of non-GAAP expenses primarily related to stock compensation. We expect Q3 net cash used from operations to be approximately to $2 million to $4 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 taking the steps necessary to meet those challenges and deliver value to our customers and 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 Jim Kennedy from Marathon Capital. Please go ahead.

Jim Kennedy - Marathon Capital

A question for you. Could you share with us to the extent you can in situations or either in your pipeline currently, what your success rate has been in terms of competitive bidding. You mentioned early on that you've seen some vendors prefer to stay with some larger vendors etcetera. In those deals that you have won, can you tell us a little bit what the competitive situation was?

Doug Sabella

Sure. Let me give you color on two different examples. First of all, in general we have a very good win rate. As I said earlier from a technology standpoint, we will generally win the technology take off, all right? And you get down to then, relationships etcetera.

Let me give you two different colors. In one, I refer to a Tier I carrier in Asia, where we have actually just gone live. We actually competed against Alcatel-Lucent for that deal, and they actually operate the network as a managed services contract, and we actually won the deal and deployed the switch etcetera.

You can win to become seeded, and tough. A recent launch that we had though was at a Tier 1 player in Latin America, where fundamentally we won the technology they got, but the Chinese government had the $2 billion of development funds to the customer and they chose Huawei, so that is kind of the two sides of the coin.

I would say in general though, our win rate is actually fairly good, it's well above 50%. The challenge is just deal flow and getting people moving from RFP process actually signing the contract etcetera.

Jim Kennedy - Marathon Capital

Okay, very good, appreciate it.

Ron Vidal

Thanks, Jim.

Operator

(Operator Instructions). We are showing no questions at this time. I'd like to turn the call back over to Mr. Ron Vidal for any closing remarks.

Ron Vidal

Yes. First of all, I want to thank everyone for their interest in our quarter and look forward to reporting our future results. Thank you.

Operator

Thank you, all very much for participating in the Veraz Networks' conference call. This concludes today's event. You may disconnect your lines at this time. Thank you.

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