Veraz Networks, Inc. Q3 2009 Earnings Call Transcript

Veraz Networks, Inc. (VRAZ)

Q3 2009 Earnings Call

November 5, 2009 16:30 pm ET

Executives

Doug Sabella - President and CEO

Al Wood - Chief Financial Officer

Ron Vidal - MBS Value Partner, Investor Relations

Analysts

Ted Jackson - Cantor Fitzgerald

Presentation

Operator

Hello this is the chorus call operator. Welcome to the Veraz Networks third quarter 2009 financial results conference call. As a reminder all participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator Instructions). For your information, today's conference call is being recorded.

At this time, I would like to turn the conference to Ron Vidal. Mr. Vidal, you may begin.

Ron Vidal

Thank you operator. 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 today Veraz issued a press release with the result of its third quarter ended September 30th, 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 but 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 projections 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 as to 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 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 enhancement. Veraz reserves the right to modify future product plans at any time.

Now I’d 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 the third 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.

We are pleased to report that sequential revenue growth combined with the strong gross margins and our continued focus on cost controlled enable us to deliver a non-GAAP operating profit. Our results continue to validate that we have build the scalable business that would generate substantial profit as the overall industry and our business resuming normalize growth trajectory.

Although our revenue was lighter than expected, our business is sound and we are seeing the beginnings of recovery that will drive revenue growth in 2010. Like many in our industry, we continue to feel the effects of global economy and where service providers are tightly managing capital expenditures.

Our book-to-bill ratio for Q3 was greater than one and included the additional of eight new customers, including the four switching and four bandwidth optimization customers. The value of these deals range from [$700,000] bandwidth optimization deal to a $5 million switching deal that is the first phase of a larger series of deployments.

The new customer additions increased our total customer account to 127, roughly half of which are switching and half bandwidth optimization customers. Of the 127 a third are mobile network providers, with the remaining being landline service providers.

Service providers continue to select our switching solution to gain an advantage over the competition by leveraging the core capabilities of our platforms. Call control, routing, signaling, multi-protocol support and bandwidth optimization are the key competitive advantages that are embedded in our solution.

This functionality was critical to traditional TDM networks, remains critical to the hybrid IP TDM networks of today, and will remain critical to the emerging pure IP networks, whether it’ll be 4G wireless or (inaudible).

Most networks around the globe handle both TDM and IP sessions, and require switching technology that can seamlessly support both IP and TDM traffic. The trend towards pure IP networks is accelerating, and we are increasingly seeing service providers purchase our platform with an expectation that the majority of traffic will be IP-based.

We believe that the ability of our platform to efficiently peer, route, control, and optimize sessions with other IP networks provide us with a unique advantage as the absolute number and complexity of IP sessions grow.

This accelerating shift from TDM to IP is driving our investment program, as we continue to extend our core competitive advantages and add incremental functionality, such a Security and Deep Packet Inspection into our platforms.

In 2010, the results of these investments will become visible in the introduction of our IP backhaul and bandwidth optimization solution, and in new releases of our standalone Session Border Controller, SBC.

The current version of our SBC, the Network-adaptive Border Controller is gaining market acceptance, as network operators seek the flexibility to operate SBCs as both standalone network elements or as integrated elements within their Class 4 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 Q3 we continue to grow our backlog and experience sequential bookings growth.

Our switching business delivered solid bookings, but our bandwidth optimization business continued to experience soft demand. At the present time, Q4 appears to be consistent with a natural uplift in orders that typically occurs at the end of the year and thus we expect to build additional backlog in Q4.

Although our EMEA region performance is down year-over-year, we did close one of the largest switch deals in our history. The award is initially worth over $5 million and we expect the total value of the deal to grow substantially in 2010.

Our traditionally strong African market for bandwidth optimization remained constrained in Q3, but Q4 is shaping up to be a strong quarter for this solution in Africa. Additionally, in EMEA we expect to close several multi-million dollar switch expansions in Q4.

The CALA region experienced strong bookings in the third quarter and the region is growing in excess of 20% year-to-date. We continue to experience strong demand in our bandwidth optimization solution, with several Tier 1 mobile providers throughout the region.

We also successfully completed the live trial of our IP backhaul bandwidth optimization solution with a global Tier 1 mobile provider, which bodes well for market acceptance when this product becomes available for the second half of 2010.

Our business in India remained strong in the quarter and we expect to see several new switch deals close in Asia in Q4. We continue to invest in market penetration activities throughout the Asia Pacific region and expect to see the market increasingly contribute to our overall results.

The North American and Russian markets remain challenging. Both of these regions have experienced year-over-year sales volume declines in excess of 50%. Although we are expecting the weakness to continue in Russia, we were expecting, but did not see a strong Q3 recovery for 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.

As we look to 2010, we believe our customer base and customer win rates provide a strong platform for growth. Although, our revenue base is not contemplated, we do have a stable number of customers that continue to expand their networks albeit at a slower pace, than we experienced during the good economic times.

These customers are still providing revenue predictability as evidenced by our increasing services business. The 3P business is complimented by a steady increase in the number of new customers and gives us confidence that we will resume growth in 2010.

In summary, we are optimistic that the sequential growth we have experienced will continue into Q4 and in subsequent quarters, as a result of both expansion from existing customers and new wins.

We have a strong cash position, no debt and overall healthy balance sheet. Our financial position combined with a very competitive product line and a scalable cost structure gives us confidence that 2010 will be a positive year for Veraz.

Now, I’ll turn it over to Al.

Al Wood

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

For Q3 FY '09, total revenue was $18.7 million, lower than Q3 guidance range we’ve previously provided of 20 to $22 million. As we stated in previous earnings call our product revenues are often lumpy and difficult to predict.

In Q3 we had some deals for which we had expected to yield recognized revenue but were not able to do so, primarily due to delays in installation and completion of the customer acceptance test plan.

While we are able to avoid the full impact of the global economic slowdown in Q1, we have felt its full impact in Q2 and Q3 as we saw some deals get delayed into Q4 or later. The cumulative effect of the lumpiness of the deals, delays in purchases, and the overall slower economy in the fiscal year, combined to cause the revenue shortfall for Q3.

While we had a less than satisfactory quarter from our revenue perspective, we continue to steadily expand the already diverse customer base from which our revenues are generated. One customer, Ross Telecom, accounted for 10% or more of our Q3 revenues. Our top ten customers accounted for 47% of our Q3 revenues and only three customers, each accounted for $1 million or more of Q3 '09 revenues.

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 Q3 FY '09 revenues were 17% from North America, and 83% international, which is consistent with Q2 FY '09 revenues which were 15% from North America and 85% 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 Q3 IP product revenues, consisting of our media gateway and ControlSwitch family of products were $10.6 million, an increase of 7% from the $10 million of IP product revenues recognized in the preceding quarter, but a decrease of 30% from Q3 FY'08.

Our legacy DCME product revenues were $0.5 million for Q3 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 $7.5 million is a 23% increase from the proceeding quarter and a 33% increase from the same quarter of last year. The strong services year-over-year revenue performance reflects both the recognition of services revenues related to some large installations that were accomplished in Q3 and our growing customer base with increased maintenance revenue.

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

Gross margin was 63.9%, an increase from 54.1% in Q2 and an increase from 59.2% realized in Q3 FY'08. IP product gross margins were 66%, which was also higher than Q3 FY'08 margin of 64.6% and the Q2'09 gross margins of 54.6%. These gross margin percentages for both our IP product revenues and our services revenues are the highest recorded by the company on a quarterly basis.

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 specific deals recognized within the period.

We have continued 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 stated in the past, while we are not often a low price leader in competitive situations.

Our customers recognize the quality of our product services and 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 exceed those goals.

For Q3, operating expenses were $11.9 million, including $600,000 of stock compensation expense, as compared to $18.0 million, including $2 million for stock compensation, restructuring and SEC investigation expenses for Q3 FY'08 and $12.9 million including $800,000 of stock compensation expense for Q2 '09.

On a non-GAAP basis, our Q3 operating expenses were $11.3 million as compared to $16.2 million for Q3 FY'08 and $12.1 million for Q2 FY'09. We have aggressively managed our operating expenses as seen by the Q3 operating expenses being at the lowest level of quarterly operating expenses in over four 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 constraining our expenses, while growing revenues to return to profitability and positive cash flow.

As a result of this aggressive cost control and record level gross margins, despite revenues being softer than expected, we were able to deliver breakeven operating income and on a non-GAAP basis a profit of $800,000.

Other income and expenses and income tax netted to $1.7 million negative for Q3, which was driven primarily by the reversal of a deferred tax asset in our Israeli subsidiary. Net loss for the period was $1.6 million or $0.04 loss per share, which was within our previous management guidance of $2 million to $1 million loss or $0.05 to $0.02 loss per share.

On a non-GAAP basis, net loss was $800,000 or $0.02 loss per share, which was also within previous management guidance of non-GAAP net loss of $1 million to breakeven, or $0.02 loss per share to breakeven per share.

Turning to the balance sheet, our cash and short-term and long-term investments were $32.3 million, a decrease as compared to $36.5 million as of Q2 FY'09. For Q3 FY'09, we had negative cash flow from operations of $4.2 million, which is lower than the guidance previously provided of $4 to $2 million negative operations cash flow.

In Q3, our deferred revenue decreased to $13.9 million, as compared to $16.4 million in Q2. As we’ve 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 Q3, our book-to-bill ratio was above one. In Q3, our accounts receivables increased from Q2 by $200,000 to $30.7 million and our DSO decreased from 163 to 148 days.

Let me close with a few forward-looking comments concerning an update to the outlook for Q4 FY'09. I remind you that 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 earlier today, we expect Q4 revenues to increase sequentially and our net loss to decrease sequentially. We expect Q4 net cash from operations to be in the range of $1 million positive to $1 million negative.

In summary, while we still have many challenges in front 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 continuing 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 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 from Cantor Fitzgerald.

Ted Jackson - Cantor Fitzgerald

Too bad on the top line, but real nice expense control, nice price to the bottom end?

Doug Sabella

Thank you.

Al Wood

Thanks.

Ted Jackson - Cantor Fitzgerald

A few questions, just quickly, first of all, if you're profitable on a pro forma basis, what would be the pro forma share count for the quarter?

Al Wood

The pro forma share count for the quarter would have decreased by about 1.2 million shares Ted or 1.3 million shares. I'm sorry, I beg your pardon, I was misstating that. It’s the same. I beg your pardon.

Ted Jackson - Cantor Fitzgerald

It’ll be the same, right. So you wouldn’t have anything come into the money and take the share account?

Al Wood

No.

Ted Jackson - Cantor Fitzgerald

What was depreciation and CapEx for the quarter?

Al Wood

Yes. And consistent with usual question, because Ted, I was prepared for this, so depreciation is $605,000 and capital expenditures where we purchased on $196,000.

Ted Jackson - Cantor Fitzgerald

Would those levels be constant, would you expect that to be relative consistent in the fourth quarter?

Al Wood

With respect to the depreciation and its entirely consistent, with respect to historical purchase of equipment its actually a little bit light, but that is reflective of our lower spending rate. So, I expect that going forward to be around 2 to $300,000 purchases of property and equipment.

Ted Jackson - Cantor Fitzgerald

Then, you had a great gross margin during the third quarter I know it’s a tough question to ask, given the lumpiness of your business. But would you be able to sustain these margin levels or?

Al Wood

So, we have had in prior quarter, for example, in Q1 we had a very strong gross margin and in Q4 of last year. So, we seeing the consistent -- often delivery above our targeted margin of 55% to 60%, this time it’s again a record level for us. We don’t think that on a long-term basis that’s sustainable. So we are still targeting 55% to 60%.

Ted Jackson - Cantor Fitzgerald

So, it would be prudent for us to, in the fourth quarter to expect you to be within your pro forma range?

Al Wood

That is correct. That’s our expectation.

Ted Jackson - Cantor Fitzgerald

With the 10% customer just because to make sure, I didn’t -- I don’t -- I have terribly hearing. But did you say Rom or Ros?

Doug Sabella

It’s Rostelecom in Russia, one of the largest carriers in Russia.

Ted Jackson - Cantor Fitzgerald

I think get there sometime.

Doug Sabella

Right.

Ted Jackson - Cantor Fitzgerald

Then I know you’re not giving an actual revenue estimate for the fourth quarter other than to say you expect to see some growth in it. Do you have a sense relative to mix? I mean, you had a pretty good jump up in terms of services revenue. Would we expect to see growth in services in the fourth quarter relative to the third? Would we see the mix maybe change over to some of the IP stuff, I mean just?

Al Wood

Great question, Ted. Services revenues in Q3 were at an all-time high, again a record for the company, and we think that Q4 we will return more to the normal level. Reason it was high in Q3 was because of deferred revenue that’s related to installations that we had recognized in Q3. So we expect it to come down to the normal level. However, we think that this coming down there will be a commensurate increasing in the other types of revenues that we have, IP product revenues and DCME product revenues.

Ted Jackson - Cantor Fitzgerald

Obviously, do you think DCME will actually pick up a little bit in the fourth quarter?

Al Wood

I really misspoke with respect to DCME. I really should have just couched it as IP product revenues.

Ted Jackson - Cantor Fitzgerald

Then, you are continually honing in and bringing the expense levels for the company down. Would you expect to see, given it's fourth quarter, any growth in your Opex on a pro forma basis, or would you expect to be able to hold it or may be trim it down a little bit more?

Al Wood

So I'm pleasantly surprised that we’re actually continued to trim it down in Q3 lower than what we had actually planned for. So that was great news. To be able to repeat that in Q4, we believe that that is not likely at best. All expenses except for sales will probably remain flat, and then sales will uptick reflective of accelerated kick in.

Ted Jackson - Cantor Fitzgerald

Then can you just th4e Israeli, the reversal of the tax asset in Israeli, exactly how much was that?

Al Wood

Approximately $1.7 million that was reversed, so it was a $1.7 million expense to o us in the quarter.

Ted Jackson - Cantor Fitzgerald

It was a non-cash?

Al Wood

Yes. That’s correct.

Operator

(Operator Instructions). At this time I'm showing no additional questions. I would like to thank everyone very much for participating in the Vraz Networks conference call. This concludes today's event.

Doug Sabella

Thank you.

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