Procera Networks Management Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 4.13 | About: Procera Networks, (PKT)

Procera Networks (NASDAQ:PKT)

Q3 2013 Earnings Call

November 04, 2013 4:30 pm ET

Executives

James F. Brear - Chief Executive Officer, President and Director

Charles Constanti - Chief Financial Officer, Principal Accounting Officer, Vice President, Secretary and Treasurer

Analysts

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

Victor Chiu

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Alexander B. Henderson - Needham & Company, LLC, Research Division

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Procera Networks Third Quarter 2013 Financial Results Conference Call. [Operator Instructions]

I would now like to turn the conference over to Mr. Eric Bailen [ph]. Please go ahead, sir.

Unknown Executive

Thank you. Good afternoon, and welcome to Procera Networks' third quarter 2013 financial results conference call. On the call today, from Procera, are Jim Brear, Chief Executive Officer; and Charles Constanti, Chief Financial Officer.

On today's call, Jim will start with an update on Procera's performance and growth strategy; Charles will review the third quarter results; and Jim will then provide outlook for 2013, before opening the call for questions.

Please note that the financial results reported today include both GAAP and non-GAAP financial measures. Procera's non-GAAP financial measures exclude the impact of stock-based compensation, business development expenses, as well as acquisition-related amortization and deferred compensation, amortization of intangible assets and tax benefits. A reconciliation of GAAP to non-GAAP measures is part of the financial tables posted on Procera's news release on third quarter results, which is available at the Investor Relations section of the company's website at proceranetworks.com.

Before we begin, let me note that this call contains forward-looking statements, including statements related to the expected demand for Procera's products and the company's financial and other expectations for 2013. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected, including the risks set forth in Procera's annual report on Form 10-K and quarterly reports on Form 10-Q filed with the Securities and Exchange Commission, as well as the specific risks and uncertainties noted in Procera's news release on third quarter 2013 financial results. These forward-looking statements represent the company's judgment as of today, and the company disclaims any intent or obligation to update these forward-looking statements.

Now I'll turn the call over to Jim.

James F. Brear

Thanks, and welcome, everyone. I'm very pleased to report that Q3 was another strong quarter for Procera.

Our third quarter revenue was $21.3 million, up 33% year-over-year, and was a company record and an important milestone for the company. This reflects strong momentum in winning new customers and increased demand for our products across all customer segments.

Our strong results demonstrate Procera's gaining market share and recognition as the global leader in the fast-growing and involving Internet intelligence market. I'm also very proud of our Procera team and the achievements for which we recently have been recognized. At the end of the quarter, we received a distinguished award from BTR, the cable and technology industry's premier source for product and technology news, for our Dynamic LiveView product.

Dynamic LiveView is an example of how Procera is ahead of our competition in providing Internet intelligence to our customers.

Dynamic LiveView provides unparalleled, real-time visibility for network operators that could be used for network forensics, big data collection and customer experience management. Dynamic LiveView is an original Procera innovation and is a complement to our innovative Report Studio, which has been in use for several years by network operators to create custom big data reports using Procera's industry-leading fine-grained statistics.

I'm very proud of our team for achieving the 4.5 stars out of 5 for this award from BTR.

This quarter, we made a number of product announcements. Virtualization is a priority for the company and we've led the way with our virtualization capabilities and announcements in August. In October, we demonstrated our leadership by being the only vendor in the market to participate in the Network Function Virtualization testing at SDN World Congress in Germany. Procera is the leading virtualization company and has demonstrated these capabilities across multiple platforms and we expect to enter customer trials in the very near future.

In October, we announced the launching of the PacketLogic 8960, the fastest IP appliance in the industry. The PL 8960 is also ideally suited to LTE network deployments, meeting the needs of mobile operators for dispersed small footprint configurations that quickly and economically scale the millions of users, as LTE coverage expands to address subscriber expansion.

We also continue to make progress with our partners. We continue to ex-co [ph] on large joint deployments of Openet. We believe that we have a compelling joint solution and we're winning new business with our Revenue Express solution with operators that want to avoid challenges of PCRF and PCEF integration by going to a prepackaged solution.

Last week, we formally announced our partnership with Skyfire, a best-in-breed provider for optimization solutions to service providers. This partnership allow network operators to deploy Skyfire's mobile optimization solution by leveraging Procera's advanced traffic steering capabilities.

We are pleased to report that our partnership with Tata is progressing well. Tata's unique cloud-based approach to policy-based service providers in new emerging markets has been very successful. This cloud service is a leading example of how virtualization is already taking hold in the policy enforcement space for revenue-generating services. We hope to announce a new Tier 1 joint win shortly.

We continue to expand our customer base. We added 18 new service provider customers in Q3, 5 of which were Tier 1 wins. Our revenue mix for Q3 was 47% fixed, 27% mobile, 15% cable and 10% higher education enterprise. 71% of our third quarter revenue was from new customers with 29% follow-on.

Trial activity is strong and balanced across customer types and regions. We have 16 direct trials with Tier 1 global service providers. These trials are underway or planned to begin over the next 60 days.

I'd like to now talk about how we continue to execute on our strategy and scale our business. During the year, we aggressively pursued opportunities for new business in international markets. We have seen strength in new markets such as the Middle East, Japan and Latin America. Wins in these markets during the third quarter included a new multimillion-dollar order from a new large mobile operator in the Asia-Pacific region.

In August, we received an initial multimillion-dollar order from a Tier 1 mobile operator in Latin America, and in September, we received another multimillion-dollar hardware-expansion order from a Tier 1 service provider in Western Europe. Contributing to our growth, Vineyard's revenue increased 31% sequentially and the integration continues to go smoothly. We are pleased to report that we've won 4 new embedded wins with Vineyard technology and I expect to announce more exciting wins in Q4 as well.

With that, I will turn the call over to Charles for a more detailed look at our financials.

Charles Constanti

Thank you, Jim. Total revenue for the third quarter was $21.3 million, up 33% from last year, this is a record quarterly revenue for Procera.

Bookings for the third quarter were a record $22.6 million. Product revenue in the third quarter was $16.3 million, up 26% from the prior year and up 20% sequentially from the second quarter of 2013. Our global sales team and partnership expansion provided the foundation for this growth.

Support revenue continued to grow and is an important source of recurring revenue. Support revenue in the third quarter was $5 million, up 62% from the third quarter of 2012 and up 19% sequentially from Q2. Our support revenue reflects continued expansion of the installed base of our products, ongoing support arrangements and growth in professional services.

Deferred revenue was $12.9 million, combining short and long term, and is comprised of maintenance and support, together with term licenses for our NAVL product. The NAVL product was acquired with the Vineyard acquisition in January of 2013 and our Q3 revenue for this product was approximately $800,000, up 31% sequentially from Q2. We expect NAVL revenue to continue to grow with new wins.

Looking at third quarter revenue by geography: EMEA, 45% of revenue; Americas was 31%; and APAC was 25% of revenue. With the expansion of our global sales force, we expect the contribution of offshore sales to be an important part of our revenue mix and growth.

The non-GAAP gross margin rate for the quarter was 50%. Sequentially, this compares to 62% in Q2. The margin rate in Q3 is consistent with our discussion on the Q2 earnings call about a large mega-carrier deal with a heavy concentration of hardware that reduced the margin rate for Q3, with an expectation of future software license revenue opportunities.

Non-GAAP operating expenses in the third quarter were $11.2 million, down slightly sequentially from Q2 and up $3.1 million from last year.

About half of the year-over-year increase in operating expenses is from organic increases in our business from expanding our global reach and infrastructure and the other half was from the assumption of the Vineyard operations, which was part of the acquisition. The GAAP net loss for the third quarter was $2.9 million, compared to GAAP net income of $2.8 million in the third quarter of 2012.

On a non-GAAP basis, our net loss for the third quarter was $189,000, compared to non-GAAP net income of $3.6 million in the third quarter of 2012. We ended the quarter with $109 million of cash and short-term investments, this is down approximately $2 million from Q2, primarily an increase in accounts receivable and reflects the increase in revenue in Q3.

DSOs were 88 days, about flat with last quarter.

For guidance, we expect our gross margin in Q4 to be in the high-50s to low-60s, anticipating that there will be additional hardware revenue from the mega-carrier that impacted our gross margins in Q3.

As we have described, a portion of the software revenue to be recognized for this mega-carrier will follow the hardware revenue. We have factored in very little of this software revenue into our Q4 expectations. We expect gross margin rates in early 2014 to more closely reflect our near-term model of the low- to mid-50s.

In Q4, we expect non-GAAP operating expense to be in the range of $12.5 million to $12.7 million. The sequential increase in operating costs will come from a combination of higher R&D costs, including nonrecurring engineering and higher variable compensation on revenue growth.

We are modeling a return to profitability in Q4 on a non-GAAP basis. We are reiterating our guidance for annual revenue growth of at least 30% for 2013. Our guidance is based on a bottoms-up analysis of our pipeline with the deals we have won, deals we expect to win and the related revenue we expect to recognize during the fourth quarter, including the revenue contribution from Vineyard and ongoing support revenue.

I'll turn the call back to Jim.

James F. Brear

Looking forward, we enter the fourth quarter with a very strong pipeline and competitive momentum. I continue to feel very optimistic about the business, and we will stay focused on executing our long-term strategy.

Our Q3 results reinforce our confidence that Procera's well-positioned to address a strong long-term growth market, and I'm proud that our investments in global sales expansion have resulted in a record top line. I expect these investments to be key drivers for our results in Q4.

The Procera team has scaled nicely, and I'm confident in our team's ability to deliver.

Thank you for participating in the call, and I will now turn the call over for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Sanjiv Wadhwani from TIFEL (sic) [Stifel].

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

That's from Stifel. Jim, just a broad-level question on your guidance. Obviously, great that you've been able to maintain full-year guidance at 30%, given that your closest competitor will see a 10% decline this year. I was wondering if you could talk about the pipeline a little bit more, maybe give us more geographic color. How much is going to come from existing customers versus follow-on orders? And are there a lot of sort of larger deals? Or are there a lot of sort of smaller, less than $1 million-type deals in the pipeline? And I have a couple of follow-on questions.

James F. Brear

Sure. So in terms of the geographical expectation, it's going to be pretty balanced. I can see it coming from quite a bit from Europe. I would expect that the lion share of the business will be new. We have a number of pretty large transactions that are in the queue or that we hope to win, as well as some existing. But for the most part, it will be based on new revenue, new customer acquisition.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

Got it, that's helpful. And then on the large Western European customer, which, obviously, impacted your Q3 margins and slight impact on Q4. Where are they in terms of the hardware uptake? I mean are you thinking that they're largely done post-Q4? Or there is sort of a lot of follow-on hardware activity in 2014?

James F. Brear

I would expect that we'll see, maybe, some in Q1, not too much, and then will probably go into somewhat of a quiet period, and it could accelerate in the second half, potentially, in 2014.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

All right. But there is some software that they are taking in Q4, if I'm not mistaken?

James F. Brear

Yes.

Charles Constanti

Very little in Q4 that we're putting in our numbers.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

Got it. Okay. And one last question. It's actually more of a high-level question. I think, last year, at this time, I think we were talking about a lot more Tier 1 activity, perhaps, maybe some in the U.S. I don't think we've seen a lot of that. And obviously, you guys have done a great job growing 30%. I don't want to take away from that, but I wanted to see if you could walk us through what's happening in the industry broadly. And what do you think is the Tier 1 dynamic now versus 1 year ago?

James F. Brear

I'd say, overall, we're ahead of schedule. We fry at more Tier 1 wins globally. It's probably a company record, 5 this quarter alone, so we're very proud of that. You're right in the sense that the U.S. market, predominantly driven, if you think, by the mobile operators, we really have not seen that traction to date. But as I've stated before, there's many large operators around the globe, predominantly in the mobile side, that are very exciting, that we're pursuing.

Operator

And our next question comes from the line of Simon Leopold with Raymond James.

Victor Chiu

This is Victor Chiu in for Simon Leopold. I wanted to follow-up a little bit on the mega-carrier. If we consider the opportunity from this customer, kind of in aggregate, I guess, kind of discounting the fact that they're taking on more hardware in the initial stages. How would the -- I guess, how would the gross margins kind of look if we look at it in aggregate? And maybe if the deal had been recognized in a more traditional method, how would the gross margins kind of compare to what we've been seeing over the past, maybe, 2, 3 quarters?

James F. Brear

I would think that over the course of the several years, we would exit with the margins in the mid- to high-60s is my expectation.

Victor Chiu

Okay. Any related to this particular deal? Is that...

James F. Brear

That's what I'm referring to. Yes.

Victor Chiu

Got you, got you. Okay, and let me see. I guess, just from a macro point of view, I kind of wanted to see the preliminary guidance for carriers that have reported so far. It seems like CapEx environment could shake out the [indiscernible] with American in this upcoming year. I just wanted to get your guys' impression on your visibility for next year and how you envision the spending environment for carriers and where PPI lies kind of a net priority?

James F. Brear

We probably don't get much view to the macros. I would say, for us, not much has changed, good or bad. We continue to have a very strong pipeline. We don't see a real slowdown, in any way, for our technology in any geography. So we're pretty insulated from that.

Operator

And our next question comes from the line of Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

So, Jim, I think the big question everyone has on their mind is going through this fourth quarter and this guide, along with the good bookings and the good deferred, what's the hedge that you have on the quarter? I mean, how many deals do you really need to close to get to the quarter for December? Is there a couple different ways that you can attack the number? Or is it really just -- comes down to 3, 4 deals that have to close by maybe the second week of December? Any more color there will be helpful.

James F. Brear

I would say this quarter feels a whole lot like last quarter. We have a lot of new opportunities, a lot of new wins. For us to execute, we're going to have to continue winning new deals, and there's a handful of those that we need to close. We also need to focus on rev-wrecking [ph] those as well and making sure that anything was in deferred gets recognized. But we do have multiple paths to executing on the number.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

And when you say execute on the number, there's multiple ways that you guys can exceed the guidance at this point, right? This is not those handful of deals come in and you're just sort of slightly above 30%. Is that...

James F. Brear

No, that's right. We've got a pretty broad set of opportunities. As I said earlier, our funnel is the largest it's ever been. So we have a lot of different ways to get there. Obviously, it's going to require winning those deals and then getting them recognized, so there's still a lot of work to be done, but a number of paths.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Yes. That's helpful, Jim. And, Charles, could you just talk about the fourth -- I know you guided to the blended gross margin for the fourth quarter, but could you talk about the product margin and sort of that relative to the service margin? Where you'd expect that the come in? Now that the other customers are coming in with more normalized product margins, how we should try to model that?

Charles Constanti

I would expect the service margin to be relatively flat sequentially and that the product margin would go up sequentially from Q3.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Would you expect product margins in the sort of mid- to high-50s? Is that a good target?

Charles Constanti

I think it is, yes.

Operator

[Operator Instructions] And our next question comes from the line of Catharine Trebnick with Northland Securities.

Unknown Analyst

This is Josh [ph] in for Catharine. So I'm wondering, what percent of your current revenue comes from your analytics business? And then can you talk a little bit about the addressable market for the analytics business and how you have your sales force focused in that area?

James F. Brear

I don't really break it out that way. I'd say that we sell a handful of products where the analytics and reporting's integrated into the solution, so I'd say almost all the customers leverage the technology. It's pretty rare that we have any customer that just uses the enforcement technology. Say, literally 90% -- maybe 95% leverage our intelligence center and all the reporting and analytics.

Unknown Analyst

Okay. And then can you talk about the RFP activity for NFV and FDN area of products?

James F. Brear

Right now, it's still pretty early. I'm pretty bullish on the technology, particularly NFV. We're seeing a lot of interest, we're participating in a lot of leadership in the segment. I would expect that we'll start to see our trialing of our technology later this year.

Operator

And our next question comes from the line of Alex Henderson with Needham & Company.

Alexander B. Henderson - Needham & Company, LLC, Research Division

I just wanted to clarify a couple of numbers which you gave earlier. Did you say 47% was wireline and 27% wireless? Or did I get those reversed?

James F. Brear

It was -- wireline is the preponderant number.

Alexander B. Henderson - Needham & Company, LLC, Research Division

And then did you say 29% follow-on?

James F. Brear

Yes, I did.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Okay, good. And in terms of ongoing question, can you talk a little bit about the Vineyard number going sequentially into the fourth quarter? I think the quarter-to-quarter growth rate was somewhat less than I was expecting, so you did it more with your conventional business. But I was expecting that to ramp a little faster than that. So should I be tailing down the sequential growth rate in the 4Q to a similar-type growth rate that we just posted? Or would that accelerate into the fourth quarter as it starts to become more mature in-house?

James F. Brear

I guess what you're seeing is we're winning as we expected, so there really is no change there, it's just timing. So a lot of the orders, as you know, they're kind of annuity based, so they don't start until we sign and seal the deals, and they're taking longer than we had originally planned, so the revenue kind of just shifted later into the year. Charles, do you want to add anything?

Charles Constanti

Yes, that's right. So we are -- as we noted, we're seeing deal activity pick up in terms of closings.

Alexander B. Henderson - Needham & Company, LLC, Research Division

Okay. So it might ramp a little bit faster in the first half of next year but, sequentially, you were probably still off the original plan for 4Q then?

James F. Brear

We don't know.

Charles Constanti

I'm not exactly sure what numbers you're going off of, but I would expect it to grow from Q3 to Q4.

Alexander B. Henderson - Needham & Company, LLC, Research Division

The second question is have you seen any change in deal size within your pipeline? Can you talk about the closure timing, how long it takes to close them? And what kind of resources you feel you need for your international accounts, as your business is shifting more internationally?

James F. Brear

I would say we've got the infrastructure to support this -- the expansion, we really have done that starting this -- early this part of this year. So we don't see a lot of investment going forward. So we've got the team. The size of the opportunities, I'd say, if I look at our funnel, there's quite a few large transactions that we're excited about and we're able and ready to support them.

Operator

[Operator Instructions] And we have a follow-up question from the line of Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

So, Charles and Jim, I know this is a little bit preliminary here, but looking into Q1, so no one's shocked here, you're going to have a very strong December quarter, that's what's been outlined today. How should we think about the March quarter, as far as sequential decline? Because we don't want to have anyone have any surprises when you move into that period. Is there a template that we should look at versus last year for a sequential decline? Or because the very strong bookings going into the December quarter, we should expect a very significant sequential decline? We're currently at down 30%.

James F. Brear

I'd like to answer that question, Alex. I think it's still a little early for us to be able to kind of give you a readout at this point.

Operator

And I'm showing no further questions in the queue at this time. I'd like to turn the call back over to James Brear for closing remarks.

James F. Brear

Great, and thank you again for joining the call, and look forward to speaking with you on our next quarterly call.

Operator

Ladies and gentlemen, this concludes the Procera Networks third quarter 2013 financial results conference call. you may now disconnect.

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