Procera Networks' (PKT) CEO James Brear on Q2 2014 Results - Earnings Call Transcript

| About: Procera Networks, (PKT)

Procera Networks (NYSEMKT:PKT)

Q2 2014 Earnings Call

August 06, 2014 4:30 pm ET

Executives

Nicole Noutsios -

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 & Company, Incorporated, Research Division

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Mark Kelleher - D.A. Davidson & Co., Research Division

Vijay Bhagavath - Deutsche Bank AG, Research Division

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

Operator

Greetings, and welcome to the Procera Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Nicole Noutsios. You may now begin.

Nicole Noutsios

Thank you, operator. Good afternoon, and welcome to Procera Networks' Second Quarter 2014 Financial Results Conference Call. On the call today from Procera are James Brear, Chief Executive Officer; and Charles Constanti, Chief Financial Officer.

Please note that the financial results reported today include both GAAP and non-GAAP financial measures. Procera's non-GAAP measures exclude the impact of stock-based compensation, the cost of outside professional services to negotiating, performing legal, accounting and tax due diligence for potential mergers and acquisitions, expenses connected with cost-reduction efforts and income tax effects from our non-GAAP gross profit, operating expenses and net income measures.

A reconciliation of GAAP to non-GAAP measures is part of the financial tables posted on -- with Procera's news release on the second quarter results, which is available at the IR section of the company's website.

Before we begin, let me also note that today's call contains forward-looking statements, including statements relating to the expected demand for Procera's products and the company's financial and other expectations for 2014. These forward-looking statements are subject to risks and uncertainties that can cause actual results to differ materially from those projected, including the risks set forth in Procera's most recent annual report on Form 10-K and quarterly report on Form 10-Q filed with the SEC, as well as specific risks and uncertainties noted in Procera's news release on second quarter 2014 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, whether as a result of new information or otherwise.

I'll now turn the call over to James.

James F. Brear

Thank you all for joining us. Our Q2 revenue was $20.6 million, up 16% from last year, and we delivered a gross margin of 59% on a non-GAAP basis. We effectively managed our operating expenses and net operating results were breakeven for the quarter on a non-GAAP basis. Our customers are increasingly using our solutions to enhance their subscribers' experience. Whether they use our analytics capabilities to optimize their infrastructure or create and differentiate new services or use our optimization capabilities to monetize or improve the quality of their networks, we've become a strategic partner to our customers, by enabling them to build better and smarter networks.

Over the last several quarters, we've talked about organic technology development that is intended to separate Procera from our competitors and open up new addressable markets within the service provider space. This week, we launched a new patent pending technology that we call RAN Perspectives for mobile operators. RAN Perspectives provides mobile operators with the subscribers' view of how the network is performing for them and provides a unique quality of information from the subscribers' point of view. For example, RAN Perspectives can alert the mobile operator when the subscribers experience a persistent coverage problem and allow the operator to proactively investigate, solve the problem, before the subscriber calls to complain, or even worse, turn to another operator that may have a better coverage in that area.

RAN Perspectives allows us to reach further into the radio network and offer a real-time view of the mobile network, down to the mobile device, and extends Procera's already rich view of the data network, further separating us as the leader and enhancing the subscribers' experience from the handset to the Internet. By adding RAN Perspectives capability, Procera is uniquely positioned to provide the viewpoint of the mobile subscriber. Procera is also unique in how we combine both subscriber and network views that includes quality of the experience metrics for applications and connectivity.

RAN Perspectives is a leap forward that enables mobile operators to deliver a higher quality of experience to their subscribers, and more importantly, measure, report and take action to improve the quality of the network as it's experienced by its subscribers.

We're excited that we have a number of Tier-1 mobile operators testing this technology, and we plan to announce further RAN Perspectives enhancements in the coming quarters.

In addition to announcing RAN Perspectives, we also launched an enhanced version of our PL20K, that supports leading throughput reaching up to 16 -- 600 gigabits. We are seeing an increased demand for both fixed and mobile operators for very high-bandwidth solutions, as their networks grow with the widespread consumer adoption of streaming media over broadband. This enhancement was designed to deliver line rate 100 gig connections that meet the scalability needs of the largest operators in the world.

Our PL20K series platform has been widely deployed at major service providers since 2012. And this upgrade allows our customers to benefit from the highest-performing solutions in the industry. With this enhancement, we now offer both high-performance hardware-based solutions, as well as software-based virtualized solutions, targeted to meet the needs of a broader addressable market.

Virtualization is a high-priority and rapidly evolving strategic initiative for our customers. We believe we are uniquely equipped to deliver on the promise of network virtualization, and we expect to see wins later in 2014.

We continue to be selected by large service providers around the world. We added 12 new service provider customers in Q2, including 3 new Tier-1 providers.

Looking at the second quarter, our product revenue mix was: 30%, mobile; 46%, fixed; 10%, cable; and 14%, embedded enterprise or higher education. Per our last earnings call, we continue be cautious about the U.S. cable market. However, we have executed a master supply agreement with a major Tier-1 MSO in Western Europe and expect to announce a sizable first-time order in the near future. We continue to gain market acceptance by the way of new opportunities, with 48% of our second quarter product revenue coming from new customers and 52% from follow on.

Trial activity is strong. We have 14 direct trials with Tier-1 global service providers. These trials are underway or plan to begin in the next 60 days. It should be noted that we continue to see increased interest from U.S. mobile operators and are in or plan to begin trials with 3 U.S. mobile carriers.

Based on our bookings, current funnel and expected orders, we are maintaining our full year revenue guidance of 15% growth compared to 2013.

Looking at the second half of the year, we will continue to execute on our strategy to deliver long-term shareholder value. To achieve long-term growth, we're focused on expanding our product portfolio and partnerships, with an emphasis on improving the subscribers' experience.

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

Charles Constanti

Thank you, James. Total revenue for the second quarter was $20.6 million, up 16% from last year. Bookings in the second quarter were $23.9 million. About the bookings metric: Going forward, we will report bookings as a factor of quarterly revenue, expressed as greater or less than 1. This is to be more consistent with industry norms.

During the quarter, 2 customers contributed 10% or more of revenue and together totaled 21% of revenue. Support revenue in the second quarter was $5.5 million, up 30% from the prior year. Our support revenue grew with increases in ongoing support arrangements, reflecting growth in our installed base, as well as increased revenue from professional services.

Total deferred revenue was $15.6 million and is primarily maintenance and support arrangements and term licenses for our embedded NAVL product.

Looking at second quarterly revenue by geography. EMEA was 45% of revenue, Americas was 30% and APAC was 25% of revenue. The non-GAAP gross margin rate for the quarter was 59%. This compares with 62% sequentially from Q1 and from Q2 of last year. The decrease in the gross margin rate for this quarter reflects the mix of chassis-based product sales, including another sizable order from a Tier-1 Western service provider, which tend to produce a lower gross margin than our appliance-based products.

Non-GAAP operating expenses in the second quarter were $11.9 million, down $900,000 sequentially from Q1 and up $300,000 from last year, a less than 3% increase on a year-over-year basis. The sequential reduction reflects the seasonality of certain costs, such as the impact of the annual audit cycle, as well as the impact of cost reduction efforts implemented in Q1 of this year.

The GAAP net loss for the second quarter was $1.4 million, compared to a GAAP net loss of $3.3 million in Q2 of last year. On a non-GAAP basis, our net results for the quarter were approximately breakeven compared to a non-GAAP net loss of 33 -- $333,000 in Q2 of last year. We ended the quarter with $107 million of cash and short-term investments, up slightly from Q1, with over $1 million of cash generated from operations. DSOs were 81 days and within our normal range.

Reviewing guidance for 2014, we continue to expect revenue growth of 15% for the full year. We are currently targeting a number of large Tier-1 customers and feel that we have a strong base heading into Q3. However, there is a possibility that revenue from these opportunities may further skew into Q4, depending on the timing of expected orders and the timing of revenue recognition.

Our gross margin rate is expected to be in the low- to mid-60s. Gross margin rates fluctuate based on the mix of software and hardware in a given quarter. We expect to be profitable in the second half of 2014 on a non-GAAP basis and to be narrowly profitable on a non-GAAP basis for the full year.

Thank you, I'll turn the call back to James.

James F. Brear

We at Procera are excited about our future. With the recent wins, product launches and alignment with strategic initiatives, like analytics and virtualization, we feel we're moving closer to the Procera of the future.

With that, I'll now open the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Sanjiv Wadhwani from Stifel, Nicolaus & Company.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

Jim, couple of questions. Last quarter, you talked about a Tier-1 mobile operator trial in the U.S. I was wondering if you could kind of give us a perspective of what's going on there and how that's progressing? And then second question I had was, as it relates to your full year guidance, which you've kept at 15%, obviously, implying a big ramp in the second half of this year. Can you walk us through whether there are multiple sort of ways to get there? Or is it dependent on sort of 1 or 2 large orders coming in? For example, you spoke about the large MSA you signed with a Western European cable operator. Is it dependent on sort of 1 or 2 of those types of deals? Or are there multiple sort of ways to get there?

James F. Brear

Sure. On the first question, yes, we have expanded our trials as I stated. We're now in a couple more U.S. mobile operators. And they are progressing, but that's probably as much I'd like to talk about those at this point. And regarding -- what was the second question?

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

Just in terms of...

James F. Brear

Right, the [indiscernible].

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

Ways to get to, yes, full year guidance.

James F. Brear

So yes, to get the full year guidance is going to require good execution across all the theaters. It will require a handful of large transactions that we have visibility to. Obviously, we did note that there is one that we're hoping will close in the very near future that will, I would say, reduce the risk for the full year. But there are a couple of more that we're going to need to close and rev rec to meet guidance or exceed.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

Got it. Okay. Just one quick follow-on, on the expanded trials in the U.S. mobile operators. Is the new RAN Perspectives part of that equation? Or is that sort of not yet in trial activities with sort of these U.S. mobile operators?

James F. Brear

That has not been presented to them yet.

Operator

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

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Just a couple of quick housekeeping verifications first. The market verticals, I think, I wrote them down incorrectly, the mobile, telco, cable, enterprise split. If you could just run through that again real quick?

James F. Brear

Sure. Bear with me for a minute. It was 30%, mobile; 46%, fixed; 10%, cable; 14%, embedded enterprise or higher ed.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Okay, great. And then in the guidance, you talked about being, I think the word was narrowly profitable for the year, and you did give us pretty much the indication on revenue, as well as gross margin. And it seems to imply somewhat growth in your operating expenses, based on that commentary, just doing the algebra. Your operating expenses were a little bit lower this quarter than we expected and down from the March quarter. So how much of that is lumpiness? How much of it is tracking with revenue? How should we think about the cadence of operating expenses?

Charles Constanti

I think it will be a little bit of, call it the -- I think looking at Q3, probably flattish with Q1, and then up into Q4, as we experience more variable compensation in particular. But there is some seasonality with Q2 being a typically lower OpEx quarter for us.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Okay. And in terms of the new product, the RAM -- RAN Perspectives product, could you help us understand how to think about that as the market opportunity, and even just from a technological perspective, where does it get deployed? Is this a software solution that lives in the mobile packet core? Just a little bit more texture around how to think about it architecturally and then how to think about the revenue opportunity or business opportunity?

James F. Brear

Yes, what this does, Simon, is really extend our reach into the RAN, but even specifically onto the device. We are going to have our technology embedded in the SIM that allows us to get location awareness. And for the service provider, that's very valuable, when you can combine RAN intelligence with packet intelligence. And when we can do that, we can then very elegantly triangulate around the subscriber, to really help them, and the carrier, see what's happening, improve the experience on a -- in real time.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

So this is a -- essentially it will be a piece of software that will be downloaded to the mobile phone and sit on the SIM card on the device?

James F. Brear

Correct.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

And how should we think about that market opportunity? Is there any kind of metric or market sizing to help us put it in perspective relative to the business?

James F. Brear

Yes, but we're probably not ready to really describe it at this point, from a competitive standpoint. But we do believe there's really no one that does it this way. And so it's kind of gives us a leg up and an opportunity to combine a number of different capabilities to address challenges that the customer had previously, had to go to multiple providers to solve.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Okay. And then just one last one for me then is, you talked about virtualization wins are expected later in 2014. I assume that would be very minimal revenue contributions, but if you can give us any kind of quantification of how to think about the trajectory for 2015 of the virtualization contribution?

James F. Brear

That'd be tough. So yes, you are right. We're hopeful that we can begin to not only articulate a compelling message, but then via wins, demonstrate that we are leaders when it comes to virtualization. And we have a lot of activity going on in all the industry groups, with our customers and prospects. Obviously, we're dependent on how quickly the industry moves, and there's dependencies with other technologies. But we're quite bullish on virtualization. And to size '15 is probably difficult right now. What we're focused in on is use cases that have impact, that carriers care about, that will be meaningful, and then aligning the right partnerships to give us that trajectory. And so that's kind of where we're focused. And then if we do that at -- do that well, we will, we'd hope to see some contribution in '15.

Operator

Our next question comes from the line of Mark Kelleher with D.A. Davidson.

Mark Kelleher - D.A. Davidson & Co., Research Division

If I go back to the buckets, the fixed wireline, the mobile, the cable and the enterprise, kind of some moving around there between the fixed and the mobile in the quarter, and cable continues kind of sluggish and enterprise seems kind of steady. If I look at those buckets going forward and look at the trials that you're in, what should we expect in terms of the mix? Which buckets are growing faster?

James F. Brear

Well, it's kind of 2 questions. We've seen it ebb and sway. We -- over the last 24 months, we definitely seen an increase in our mobile, and I would expect that to continue. But we're always pleasantly surprised with the fixed operators and cable. So as we look forward, I would still see mobile continuing to take more share from -- as a percentage. But that does not mean that fixed and cable won't as well. And if I look at our trials, it's pretty balanced.

Mark Kelleher - D.A. Davidson & Co., Research Division

And what about the enterprise? Is that...

James F. Brear

Enterprise is probably going to stay kind of right where it's been.

Mark Kelleher - D.A. Davidson & Co., Research Division

Okay. And any change in the competitive environment in any of those buckets?

James F. Brear

No.

Operator

Our next question will come from the line of Vijay Bhagavath from Deutsche Bank.

Vijay Bhagavath - Deutsche Bank AG, Research Division

Two questions, if I may. You didn't explicitly guide for Q3, and you have consensus sitting at around 22%, 23% sequential revenue growth heading into the print. So I'd like to better understand, you have a fairly steep hurdle for the September quarter. You have not explicitly guided. And if I recollect, you did mention in the prepared comments on, you're rev rec skewing towards Q4, so maybe it could be a back-end loaded year. So help us understand all of these dynamics heading into the back half.

Charles Constanti

Yes. No, I think, we've been positioning a back-end loaded quarter throughout. So really kind of no change there. We are executing, I think, increasingly well in our international markets. There is a two-edged sword to that: One is that, it's good business; the other is that, it is a little more predict -- difficult to predict exactly when we are going to see rev rec. So we're trying to be cautiously, give us as much sort of flexibility in terms of not boxing in, say, Q3, as we settle out the quarter. As we talked about, we do have an important win that we're looking at and we just talked about. And that's going to help with it. But even that win, exactly when it's going to revenue rec -- when we're going to see the revenue recognition. So I think, there's, obviously, for Q3, there is a bit of a range, that would probably -- it could be where the Street's at. It could be lower than where the Street's at, but there is a range that, of where that Q3 could land.

Vijay Bhagavath - Deutsche Bank AG, Research Division

And then a quick follow-up, if I may. For the full year guide of 15%, what gives you the conviction on that number? Is it anything on the mobile side? Is it a combination of mobile and fixed? Help us understand the conviction behind reiterating the full year outlook.

James F. Brear

I think the conviction is we haven't seen any of our opportunities go away, either because they decided to not go forward with the project or they were lost to competition, that's not the case. So nothing has changed. We did, as we mentioned, we are moving in on a very large opportunity that we don't know exactly how that will impact when. We do know that it will be second half, but not sure when. So that's kind of the view.

Operator

Our next question comes from the line of Alex Henderson with Needham.

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

If I remember correctly, I think you had indicated you were expecting OpEx to be essentially flat for the full year '14. Is that still the case?

Charles Constanti

What we said, it would be effectively flat with the Q1 level.

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

On average?

Charles Constanti

On average, yes.

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

All right. Okay. And then the gross margins, if you could talk a little bit about the product gross margins, it would be helpful. You've had times when you've launched your higher scale products, which tend to be chassis-oriented, that you've seen considerable pressure on the product gross margins. You just launched a new high-end chassis. To the extent that, that's the case, should we anticipate that, that might pressure your gross margins if that product ramps over the back half of the year?

Charles Constanti

It really creates more volatility, than, per se changing our overall business model. So it really -- it really is going to depend on how exactly the mix plays out between appliances, chassis and pure software sales, as well as there's always the play of support and maintenance and professional services in the NAVL business. So there's moving parts. We still think that, that range that we have generally guided to, which is low- to mid-60s, is still a good range.

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

So you expect your gross margins to improve sequentially into the back half off of the first half level then?

Charles Constanti

So Q1, again, non-GAAP, Q1 was kind of within that range, it was 61.8%. So if you just looked at the full first half, it's not too different than our -- it's at the low end of our model. But -- so we would expect for the second half to be in that range of low- to mid-60s.

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

It also sounds like from the commentary you've made about decelerating order rates and some potential for sliding of orders into the fourth quarter or even out of the year depending on acceptance and timing, that you might be looking at a book-to-bill above 1 in the back half of the year, to build a head of steam into '15. Is that a reasonable prognosis, based on what you're looking at?

Charles Constanti

That would certainly be what we would hope to see, is book-to-bill that's greater than 1, but...

Operator

At this time, there are no further questions. I'd now like to turn the presentation over to Mr. James Brear.

James F. Brear

Thank you, and thanks, everyone, for joining the call. And we look forward to speaking with you in the next 90 days. Thank you.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!