Network Equipment Technologies CEO Discusses F2Q2012 Results - Earnings Call Transcript

Nov. 1.11 | About: Network Equipment (NWK)

Network Equipment Technologies, Inc. (NASDAQ:NWK)

F2Q2012 Earnings Conference Call

November 1, 2011 5:00 PM ET


Leigh Salvo – IR

David Wagenseller – VP, Finance and CFO

Nick Keating – President and CEO


Nick Farewell – Arbor Group

Peter Conrad – Kopp Investment Advisors

Craig Stephens – Stafford Capital Management


Good day, ladies and gentlemen, and welcome to the second quarter 2012 Network Equipment Technologies Inc. earnings conference call. My name is Nancy and I will be your coordinator for today. At this time, all participants are in a listen-only mode. (Operator instructions)

I would now like to turn the presentation over to your host for today’s conference, Ms. Leigh Salvo of Investor Relations. Ma’am.

Leigh Salvo

Thank you. Welcome, everyone, to our call this afternoon during which we will discuss results for Network Equipment Technologies second quarter fiscal year 2012. With me today are Nick Keating, President and CEO; and David Wagenseller, CFO.

In keeping with the Safe Harbor provisions of the Private Securities Litigation Reform Act, I want to remind everyone that we will be making some forward-looking statements and projections today, including those relating to future revenue, operating results and financial conditions. Investors are cautioned that these statements are based on current estimates and assumptions that involve risks and uncertainties that might cause actual results to differ materially from those expressed or implied in the forward-looking statements.

These risks and uncertainties include our ability to develop and commercialize new products and product enhancements, success in building new sales channels, achieving broad market acceptance for our products, the status of relations with and performance by third-party technology providers, challenges of managing inventory and production of products, certifications for new and existing products, compliance with export controls and other government regulations, federal government budget matters and procurement decisions, circumstances regarding specific sales that can affect the recognition of revenue, and other risks, including those identified in the company's filings with the SEC, including forms 10-K and 10-Q and in other press releases and communications.

The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, though an audio archive of this call will be available on the company's website for at least 12 months, the statements made on this conference call are only made as of November 1, 2011 and we disclaim any duty or intention to update forward-looking statements.

In addition to financial measures presented in accordance with GAAP, we will also be discussing certain non-GAAP financial measures that are adjusted from results based on GAAP to exclude certain expenses, gains and losses. These non-GAAP measures should not be considered a substitute for or superior to GAAP results. Please refer to the press release issued today for reconciliations to GAAP and further detail regarding the non-GAAP measures. The press release is posted on our website.

Our agenda today begins with David Wagenseller, who will provide a detailed review of our financial results. Nick Keating will then comment on the quarter’s business and operational highlights, and David will then offer some closing comments before we open the call for your questions.

At this time, I will turn the call over to David.

David Wagenseller

Thank you, Leigh. In the press release issued today and available on our website, we reported a total revenue for the second quarter of fiscal 2012 was $16.4 million, up 45% from the prior quarter and down 19% from Q2 a year ago.

Product revenue in the second quarter was $13 million, a 68% increase from the prior quarter and a 23% decrease from Q2 a year ago. Product revenue from our enterprise business was $7.8 million, up 62% from the prior year and up 77% from Q2 a year ago.

The increase from last quarter results from higher sales of our voice-over IP products for UC and other IC based applications.

Product revenue from our government business was $5.1 million, up 78% from the prior quarter and down 58% from Q2 a year ago. Additional product shipments of $495,000 to government customers occurred in the last two weeks of the quarter that were not recorded as revenue as of contractual delivery terms prohibiting revenue recognition. The increased product revenue in Q2 was expected as Q2 is typically a strong quarter for NET as a result of the US government’s fiscal year end.

The decline from prior year is partly attributable to program delays, and reduced spending by the US government customers as part of the ongoing spending constraint by the government.

Service and other revenue was $3.5 million, down $137,000 compared to the prior quarter, and down $12,000 compared to Q2 from the prior year.

Gross margin as a percentage of revenue was 37%, up 3 percentage points from the prior quarter and down 12 percentage points from Q2 of the prior year. Product gross margin was 36.2%, up 6 percentage points compared to the prior quarter and down 20 percentage points from Q2 of the prior year. The increase was primarily from higher product revenue absorbing fixed manufacturing costs. The decline in product margin from the prior year was the result of numerous factors including first, aggressive pricing in highly competitive sales situations, second, a large credit in Q2 of the prior year for cost of goods sold for a duty refund, third, less overall government revenue, which typically includes higher gross margin of legacy products, and fourth, lower overall product revenue that has to absorb fixed manufacturing costs.

Service and other gross margin was 39.8%, down 2 percentage points from the prior quarter, and up 26 percentage points from Q2 of the prior year. Service and other costs are relatively fixed and small fluctuations in revenue can affect service gross margins. The large increase compared to the prior year resulted from the expiration of our revenue sharing arrangement with CACI International, which expired in December of 2010.

Operating expense in the second quarter was $13 million, up $1.2 million from the prior quarter, and up $143,000 from Q2 of the prior year.

Fourth quarter operating expenses were $11.6 million, down $1 million sequentially and down $773,000 from Q4 last year. Under our 445 [ph] fiscal structure, our fiscal quarters are normally 13 weeks long, but an extra week must be added every six years or so. As a result, the second quarter of fiscal 2012 included a catch-up 14 week, which resulted in additional expense or fixed cost incurred during the extra week.

The remaining increase was primarily sales compensation related expenses from the increased product revenue. The increase from the prior year was offset by lower outside legal expense.

Total company headcount was 246 employees at the end of Q3, an increase of 3 from the prior quarter, and a decrease of 2 from a year ago. Sales and marketing expense was $5.2 million in Q2, up $744,000 compared to the prior quarter and up $185,000 compared to Q2 of the prior year. The increase from the prior quarter was primarily from higher compensation related expenses attributable to higher product revenue, and one additional week of fixed salaries.

The increase from prior year includes higher compensation related expenses offset by the reassignment of technical sales support personnel to our service organization for the increased support requirements following expiration of the CACI arrangement.

R&D expense was $5.1 million in Q2, up $315,000 from the prior quarter, and up $521,000 from Q2 of the prior year. A portion of the increase compared to the prior quarter and prior year resulted from the additional week of the fixed salary expense. And the additional increase from the prior year resulted from increased compensation related expenses for higher headcount to support new product development.

G&A expense was $2.6 million in Q2, up $125,000 compared to the prior quarter, and down $563,000 compared to Q2 of the prior year. The majority of the increase from the prior quarter was prior consulting fees, partially offset by lower audit fees. When compared to Q2 a year ago, the higher consulting fees were offset by significantly outside legal expense.

Other expense was $38,000 in Q2 compared to income of $34,000 in the preceding quarter, an income of $33,000 in Q2 of the prior year, which was primarily from foreign exchange fluctuations and realized gains on our investment. Net interest expense was $456,000 in Q2 compared to $447,000 in Q1, and $347,000 in Q2 of the prior year. With lower cash balances and lower yields on our investments, the declining returns on our portfolio are offset by the interest expense from our debt.

The company reported a net loss of $7.5 million of $0.25 per share in Q2. On a non-GAAP basis the net loss was $6.7 million or $0.22 per share. Turning to the balance sheet, cash and investment balances were $45.4 million at the end of Q2, down $8.7 million from the end of Q1. The reduction resulted primarily from cash used for operations.

Accounts receivable were $11 million, up $3.6 million from Q1, primarily from higher revenue. DSOs were 66 days, increased 7 days sequentially and remained in our target range of 60 to 70 days. Net inventory, including long-term inventory classified in other assets of $373,000 was $5.6 million at the end of Q2, unchanged from the end of Q1.

Now I will turn the discussion over to Nick Keating, our CEO.

Nick Keating

Thank you David for covering our second quarter results. As I do each quarter, I would like to give all of you some detail on our continued initiatives and the developments in our Federal government and enterprise business.

As expected, our Federal government business saw an up tick in the quarter as a result of the government’s fiscal year end. However, budget and spending deferrals continued to impact business. We are still experiencing a decline in Federal procurements due to these factors, but we expect that orders will be released once the government passes the new budget.

The highlight in the second quarter in our government business was in the tactical area, as we continue to work with our installed base to address the current needs as well as initiatives to convert legacy users to an all IP environment. Wins included our first UX series to the US Marine Corps. UX will be placed in the Marine Corps lab located in California, where collaboratively we will do extensive testing of the products as a prerequisite to implementing these units into the Marine Corps network.

In addition, the Marine Corps, the defense Information Systems Agency and NATO continue to supplement and build out their existing networks during the quarter. We continue to work with these agencies on their longer-term IP-based transition plans.

Turning to our revenue business, we again saw revenue growth both sequentially and year-over-year as we added more than 55 new unified communications customers. Sales in the second quarter represented a cross-section of vertical industries, with concentration in industrials, food and beverage, education and technology. Through our network of integrators and resellers, with significant direct touch by our sales and sales engineering professionals, our UC product portfolio continues to generate wins with key customers worldwide.

Our two best performing regions during the quarter were once again the European Asia Pacific organizations. Regional highlights included the following. North America working with a tier 1 systems integration carrier partner, we continue to move ahead with the significant global rollout for a multinational company. Additionally new customer wins in the region in the second quarter included a global leader in business process outsourcing, providing financial transaction automation and document management services doing business in 50 countries with 2500 employees in 14 international offices.

A $9 billion New York Stock Exchange gas production, storage and handling company with more than 18,000 employees in 40 countries. Another New York Stock Exchange listed company offering human resource and business solutions with 56 offices throughout the United States. A $3 billion Canadian company, listed on the New York and Toronto stock exchanges, in the power generation and electricity distribution business, and a major Canadian university with over 36,000 students in more than 300 buildings in a large metropolitan area.

In the Asia-Pacific region, notable new customer wins included a Taiwanese stock exchange listed ODM, OEM service provider with more than 10,000 employees. A leading China-based enterprise in the power transmission and solar energy business, which is a subsidiary of a Fortune global 500 company. A major Chinese semiconductor manufacturing company with more than 9000 employees with offices throughout Asia, the US and Europe, which is listed on the New York and Hong Kong stock exchanges.

One of the largest breweries in the world traded on the Tokyo stock exchange with 4000 employees and sales of close to $8 billion. A Singapore headquartered medical care and emergency assistance company with employees in over 70 countries and a vending machine sales and service company, with more than 700 employees and 58 branches throughout Japan.

Turning to Europe, we were part of the first project win by Microsoft, entirely voice for one of the largest cities in France, with 162 sites. Other wins include a major public university in Spain, specializing in science, technology and humanities with approximately 13,000 students, the IT subsidiary of a major French bank with more than 7 million customers, a Belgian company specializing in managed networks and hosting, with 1000 employees in 25 offices.

A 2 billion euro French publicly listed developer of software applications to the design and production of secure personal devices with over 10,000 employees in more than 40 countries, serving customers in more than 150 countries. A French distilled beverage producer and distributor, whose ADRs are traded on the US over-the-counter market, and on Euronext Paris, and who has more than 18,000 employees around the world, and a 1 billion euro German supplier of filling and packaging equipment for the beverage industry, with over 5000 employees.

In the Australia and New Zealand region, wins in the second quarter included an educational services organization in New Zealand with 1000 employees and 70 offices throughout the country, and an Australian-based construction company building more than 10,000 homes a year globally in Japan, China, the US, South Korea and Australia, and who is also the number one homebuilder in Australia.

Finally in the Middle East, new customer wins in Q2 included a United Emirates beverage and food products distribution company with over 1600 employees. A diversified Turkish manufacturing company serving customers in the automotive, machinery, defense, heating and transportation industries with more than 2000 employees, and a Turkish oil and gas production and distribution company with revenue in excess of $2 billion.

On the product front, we are seeing continued demand for both our BX series and tender products, as well as strong early adoption of our new UX series. The UX series is a high-performance mediation platform that offers state of the art network and signal processing technology. The UX series platform is designed to deliver the networking, gateway, enterprise session border controller; trunking and survivability features needed for a range of unified communication deployments.

The UX 2000 was designed for larger enterprise customers, and the UX 1000 is being developed for small to mid-sized businesses, or for branch office locations. Release 1.3 of our UX platform is now generally available. With this release, we have introduced some powerful enterprise solutions like Link E911 support for routing emergency calls. The US is the only platform in the market today to provide true media bypass visibility, a great tool for network monitoring.

We have listened to customer feedback over the months, and included several powerful applications to better integrate with our customers enterprise networks. I would like to recognize the outstanding work of our manufacturing partner Plexus. We started working closely with the Penang, Malaysia team over the summer, and they responded quickly to our needs. We work together to source the UX 1000 in Asia, while the manufacturing team rapidly prepared a near production ready process so that we could validate much of the orders and manufacturing flows in advance of pilot production.

We have built more than 100 preproduction UX 1000 units, and are in the process of distributing them internally for testing and validation, and also shipping them externally to key distributors and resellers, as demonstration units. We expect to commence regular production in November, with general availability shortly thereafter. We’re also working on release 2.0 of the UX series, which we expect to release by year-end.

SIP Trunking is a major business opportunity for telecom operators. With the VX series and UX series our objective is to provide carriers with innovative VoIP solutions for enterprise Security, monitoring, and routing the VoIP flow including SIP Trunking services. Our platforms allow investment optimization, configuration and monitoring, and scaling of Microsoft Lync deployments to the existing infrastructure at a customer site.

Achieving certification from career providers and independent laboratories is another key driver to sales growth and the pursuit of new market opportunities. During the second quarter we announced qualification of our VX series, with Verizon Business Services, enterprise customers can now securely connect Microsoft Lync deployments with Verizon business SIP Trunking services using the VX, acting as an enterprise session border controller.

We also achieved certification of our VX series with IP directions in a leading provider of SIP trunking and high-value add carrier services in France. In addition, our UX series is being adopted by pure IP as a component of pure IP’s SIP trunking service both at the core and at the age of the network for customers deploying Microsoft Lync server 2010. Pure IP provides secure trunking services in the UK and New Zealand. In the last quarter we also expanded certification of our UX services as a enterprise session border controller, with US-based XO Communications, a large SIP trunking service provider and with US-based IntelePeer, a leading provider of on demand cloud-based communication services.

Our ongoing certification program ensures that we are meeting the stringent requirements of service providers that allow enterprises to deploy our session border controllers as an interconnect point between Microsoft Lync, other voice networks and SIP trunking service providers. Our VX series is now qualified as a session border controller for Microsoft office 365 unified messaging deployments. This enables companies to move their voicemail to the Microsoft cloud.

As a result of this certification, we have already closed some business related to offering voicemail service in the cloud for a leading provider of service performance assurance services in France, who has replaced their legacy voice mail with Microsoft exchange server 2010 unified messaging as we continue to leverage our strong global market position and our technology leadership to drive higher levels of sustained revenue growth for the long-term.

An important initiative we are pursuing is our global partner program. The goal is to construct a best in class channel program by investing in partner enablement and capabilities, as well as robust program development. We believe this commitment to our channel partners will create a strong indirect sales infrastructure that complements our direct sales force, and help meet the expanding demand for UC solutions in the global small and medium-sized business market.

In summary, there are three factors regarding the future of our business I like to emphasize. First, the product lines that are providing growth today are the new products that we have designed specifically for global enterprises, who are seeking solutions to cost effectively migrate to next generation IP networks, particularly for unified communications and enterprise session border controller applications.

Secondly we are pursuing new opportunities with our installed Federal government base and we see positive interest from these customers as we introduce solutions to protect their current investment while promoting new IP-based applications for future deployments. And third the partnerships that we have secured with leading systems integrators and distributors are facilitating the expansion of our sales in more than 100 countries around the world.

Before I turn the call over to David, I want to mention that in two weeks we will be participating in the SRA Conference in San Francisco, and in early January at the Needham Conference in New York. We hope to see many of you there.

Now I will turn the call back to David for closing remarks. David.

David Wagenseller

Thank you Nick. Our Enterprise business now generates the majority of our product revenue, and we expect that to continue in the second half of the fiscal year. Our government business, which was down in the first half is still difficult to predict, and therefore we remain cautious about our forward-looking projection. Overall, we expect total revenue in the second half of the fiscal year to roughly match our results in the first half with potential upside in the fourth quarter depending on the rate of adoption of our soon to be released UX 1000 product.

Finally, the lease of our former manufacturing facility here in Fremont expires in December. The cash savings will be approximately $350,000 per quarter.

Operator, this concludes our prepared remarks. We would like to open the call now for Q&A.

Question-and-Answer Session


(Operator instructions) We have a question coming in from the line of Nick Farewell from Arbor Group.

Nick Farewell - Arbor Group

Nick, can you hear me?

Nick Keating

Yes, I can. Thank you.

Nick Farewell - Arbor Group

Could you give us a little more feedback if it is possible on the initial, I guess you call them the beta units, I’m not sure the UX 1000 with just might be arriving at either your shop or maybe you have been able to get them some of your resellers or distributors?

David Wagenseller

Yes. We go through three stages of releasing a product. The first stage is beta-1 and we have had beta-1 units since July August. The second phase is what we call preproduction, and typically we will release somewhere between 50 to 100 units in pre-production. We decided to release a little bit more than 100 units in pre-production. We started getting delivery of those in the last month. Those are used both internal testing and validation, and as sales units by our reseller and distributor channels in order to develop end-user interest.

And we have been sending those out. We have been continuing to send them out, and we do it on a prioritized basis with priority going to the resellers or integrators or distributors that have the largest sales opportunity. For instance two weeks ago was the Microsoft TechEd conference in Johannesburg. We had two units on the floor running live, and we were doing live demos of the units. We have done a similar training exercise. We held a sales training both with our internal sales personnel and with some of our key distributors in Europe.

The first week in October we had working units here, demonstrated them, and we continue to do that now on a regular basis. We are also in competitive bake offs right now in a number of locations, and over the next couple of weeks we will be bringing units in for valuation in a bake off competitive environment. We expect in the next two weeks to freeze the code and that is really the last step in leading to general availability of the product.

In mid November, we will release the production units at the Plexus Penang factory. Those units will go into full production then in mid-November, first with the boards, and then in early December into final assembly. They will be sent here. We will load the latest version of the code, which at that point will be GA, and we expect assuming that there are no delays of hardware or software nature to begin shipment in the last couple of weeks of December to customers that have indicated interest in placing orders.

I would expect that we will begin taking orders in the next couple of weeks based upon the milestones that we have achieved so far. Does that help you?

Nick Farewell - Arbor Group

Yes, it does. And how, what is your experience so far with the stability of the software, clearly there are always glitches, but given the very short timing two weeks to freeze, it would suggest that you haven’t encountered anything major, is that a fair assumption?

David Wagenseller

Keep in mind that the code for the UX 1000 is the same code as the UX 2000. There are some things that we are putting in the 1000 that have not yet been released in the 2000. For instance, because this is going into smaller offices and branches where there is usually a high percentage of analogue lines in addition to all of the IP or T1E1 lines, we will be releasing codes to support analog interfaces.

That is new code and that code ultimately will be run both on the 1000 and the 2000. but that is where some of the new development has taken place, the other ready is that we have we have cost reduced significantly the 1000 and as a result some of the silicon that we have in the UX 2000 is not in the 1000, i.e. the Marvell chip that we have in the 2000 is not in there. There is another Marvell chip, but it is low performance chip.

What we have done from a CPU standpoint is that we are using the embedded CPU in the Mindspeed digital signal processor to act as the master CPU for the UX 1000. What that has then caused us to do is to develop additional software that will enable the ARM processor within the Mindspeed DSP to act as the CPU. That is new code that obviously is some of the additions that we have made.

But if you look at most of the application code on the 1000 it is the same as the 2000. And when we release 2.0, 2.0 will run concurrently on both the 1000 and the 2000. So that is a key milestone for us also.

Nick Farewell - Arbor Group

And so do you go back and do you redesign the 2000?

David Wagenseller

No, not at all. In other words, the software on the 2.0 release will be fully backwards compatible and inter-operate with earlier releases of the UX 2000.

Nick Farewell - Arbor Group

It is very difficult I understand to provide any certainty or guidance when the government business is at best unknown, but setting aside the government potential volatility, would you expect the enterprise side of the business to be up sequentially, and if not, would that solely be a factor of not being able to deliver 1000 say in the latter part of December.

David Wagenseller

No, I think that the key issue for us on the enterprise sequential business is really going to be the rate of adoption. You know we did mention in the script that we are in fairly broad deployment with this international network, working together with a large worldwide telecom carrier. That network is starting to ramp pretty aggressively and based upon all the forecast, we are going to have a lot of installs in Q3 and Q4, but one customer obviously won’t do it.

I think the key thing right now is to see both the previous customers that we had that up to now have been on the R2 release, at what point did they move over to the Lync release,

And then accelerate their deployment based upon probably buying UXs as opposed to VXs. And then the other key for us is these new customer wins, and I think you can see from the ones that we highlighted, most of them, obviously not all 55 that we mentioned, but certainly the ones we highlighted here are pretty good sized customers.

And you know, in one case, we saw one of these new customers order 4 units immediately 4 more units right after that, and quite frankly we don’t know how quickly they are going to ramp, but two of these wins that we had last quarter and this quarter are managed networks being managed and deployed by Orange Business Services, which is the integration and services arm of France Telecom. And in general, based on our experience that either if it is a managed network, or if it is an integration provider like Dimension Data, or AT&T or one of the others, if they are in there managing the deployment for a multinational, it goes much faster than if the multinational uses their own IT infrastructure to deploy.

Some of them take a long time because they use existing resources rather than dedicating new resources for the deployment. And likewise we see others like Accenture that are pretty steady state. We know every quarter a certain amount of money that they are going to order from us. But again there is no clear pattern. I mean one of the big installs that we did last quarter was a very major university in the United States, Indiana University, and they deployed within a relatively short period of time. I was thinking 60 to 90 days they deployed their network.

So you really have to look at each customer do a profile, meet with them, and then likewise see what we can do to provide services to them to help them in accelerating their deployment.

Nick Farewell - Arbor Group

No, one additional thought and that is would are the implications from a revenue standpoint of a customer upgrading from R2 to Lync?

David Wagenseller

I don’t think there are any implications from a customer standpoint as it relates to the Microsoft license that they have. Most of these customers have an enterprise license with Microsoft that entitle them to upgrades from different releases as part of their overall enterprise contract. Likewise, the VX is Lync compatible and Lync certified. The only financial implication to a customer would be if they wanted to run the Microsoft small business appliance software embedded inside one of the platforms, and that is only supported on the UX.

So what we have seen is customers that do want the embedded server SBA functionality, then taking and migrating their VXs to a location where it is not necessary and then putting an UX in as a replacement.

Nick Farewell - Arbor Group

Okay. So there might be some modest incremental (inaudible) that depends on the size of the network, but in general, modest incremental revenue?

David Wagenseller

Yes. Now when they do that, some of the things that they may well implement we are seeing this happen is that a lot of them that used R2 did not implement SRTP. So if they do decide to go to Lync voice encryption, SRTP, they would have to get a license from us for the SRTP features that is an upgrade. That is not embedded into the base license. So there could be upside in revenue for us in that case.

Nick Farewell - Arbor Group

Actually I have one last question, and that is while nothing is optimal, if there was such a thing in the mythical world of being optimal, as you deliver product, are you finding the or do you expect the gross profit margin on the UX 1000 to be notably better than the 2000, and if not, why not?

David Wagenseller

So, I expect the gross margins on the UX 1000 to be better than the UX 2000. The UX 2000 was really designed to be an really high performance packet processing platform. As such, we added an enormous amount of silicon, and other CPU processing capability to be able to handle very large complex UC applications. For instance, not only does the UX 2000 do voice, it also, we will be coming out in the future with a high-speed data card for data transmission but also data translation.

So you'll be able to take legacy data and then convert over to IP and run it over the network on the UX 2000. Furthermore, the UX 2000 is designed for high performance video codec transcoding. We have not implemented that yet, but because of the amount of packets and the amount of bandwidth in the 2000 you have the ability of handling both high-speed voice, high-speed data, and high-speed video with the opportunity in the future to be able to take, now you say, assuming that we can get appropriate licenses to the proprietary video codecs we want to be able to offer codec translation from the various vendors.

Some do follow a standard so that's easier, some have proprietary solutions and that's more difficult. Now, when you do all of those things that also requires incremental licenses both hardware upgrades from the data card standpoint to software license upgrades, and as a result there will be incremental revenue for the installed units and higher gross margins also in the 2000 as we have more features being accessed than we saw in the early what I would say smaller deployment environments.

So a lot of the units went out initially only had you know, 2 to 4 T1s because they were not being used in very high-performance environments. As they start migrating more user traffic on, then you will require additional capabilities both for the installed units and the future units that are purchased. So I expect in the long term that the margins on the UX 2000 will go up but from what we can see so far the margins on the 1000 should exceed the margins on the 2000. You know, there could well be other issues that we run into, but we’ve modeled all of our, you know, and since we have preproduction runs we are getting across data from Plexus. There is a few cases where prices are coming in a little higher but in most cases they’re right on plan or slightly below what we estimated the cost to be.

Nick Farewell - Arbor Group

Thank you. I appreciate it.


And our next question comes from a line of Peter Conrad from Kopp Investment Advisors. Your line is open.

Peter Conrad – Kopp Investment Advisors

Hi, can you hear me?

David Wagenseller

Yes, I can hear you fine Peter.

Peter Conrad – Kopp Investment Advisors

All right. Good. How are you doing?

David Wagenseller


Peter Conrad – Kopp Investment Advisors

So, I wanted to see if I could drill a little deeper in the new customers that you referenced on the enterprise side, 55 new customers. Can you in any way quantify what percent of the potential at those customers was seen in revenue this quarter? Just to help me understand how far into that potential we maybe?

David Wagenseller

I think it's realistic to say that the initial orders probably do not represent more than 2%, 1% or 2% of the potential long-term deployment opportunity.

Peter Conrad – Kopp Investment Advisors

Okay, good. Very encouraging, and maybe can I slice this a little different way and I don't know if you look at it this way or not but if you look at your enterprise revenue in the quarter what percent is new customers and what percent is follow-on orders from existing customers?

Nick Keating

Most of the enterprise UC revenue was from existing customers. So these new customers typically are coming off of pilots, they're buying their pilot equipment and they're putting together the plan for deployment. We saw a couple of them that started to deploy very quickly but I would say that the normal profile is, it takes another quarter before we start to see them ordering in greater quantities.

Peter Conrad – Kopp Investment Advisors

Okay, all right, great. As you release the UX 1000 here this quarter assuming everything progresses as planned, is there any pent-up demand that you have in hand to be fulfilled or is that what you're going to send the sales folks out to try to gather here over the next few weeks?

David Wagenseller

We have been briefing our resellers and a number of customers really for about the last nine months on the feature functions of the 1000, and so the capabilities of the unit we also provided not to exceed pricing so that they knew that from a list price standpoint the price was not going to be higher than that. Allow them then to look at our pricing and compare it to the other solutions that are in there in the market and to validate the competitiveness of the 1000 against let's say the competitive base.

Likewise this is a key factor in two other areas. When you get into an office environment of less than 100 employees with average voice utilization, the price point is such that the 2000, which was purpose built for much larger locations is just not cost competitive where the 1000 kicks in is really as we get to offices or branches or satellite locations with 100 or less users, and then the 1000 is very cost competitive and very functional. As I look at so many of the customers that we have, you might have 50 major locations and as many as 5000 smaller locations. It would not surprise me to see the ratio of one UX 2000 for every five to ten 1000s, but that assumes broad deployment by these large users.

Peter Conrad – Kopp Investment Advisors

Quite an opportunity and are there any impediments to Plexus in ramping production of this new product for you?

David Wagenseller

We don't believe so. The plant that we selected and of course, we had an option of a number of Plexus locations. This is really their high production facility in Asia. I'm very familiar with the facility. I have worked with them in the past. They build for instance a lot of Juniper’s equipment there. They are adding their fifth building now. So they have scaled rapidly over the last few years.

Their business has been growing notwithstanding the worldwide recession, and you know, I'd have to be buying probably in excess of 100,000 units a year before I would begin to wonder whether they have any excess capacity, but we always have the ability of having the boards’ built in plexus and then assembled and assembled in some of the other Plexus facilities both internationally and in the US.

Peter Conrad – Kopp Investment Advisors

Well. I look forward to that challenge.

David Wagenseller

We too.

Peter Conrad – Kopp Investment Advisors

Lastly, I mean you know, based upon how you are talking about things here would it be surprising if the enterprise doesn't grow on a sequential basis in the December quarter recognizing visibility is not great, but still wouldn't it be surprising?

David Wagenseller

It would be but I think that the key thing right now is the deployment plans of both the current installed base and the new customers that we close the quarter. And as I said historically I've seen the trials converted to orders, some orders for other locations but an awful lot of planning on the part of the IT staff where I think you'll see deployments quicker is when there is a systems integrator or it's a managed service from a company like Orange Business Services, which is the integration arm and service delivery arm of France Telecom.

Peter Conrad – Kopp Investment Advisors

Great. Well, thanks for the responses there and look forward to seeing the progress.

David Wagenseller

Thank you.

Peter Conrad – Kopp Investment Advisors

And there is a question from the line of Craig Stephens from Stafford Capital Management.

Craig Stephens – Stafford Capital Management

Hi Nick.

David Wagenseller

Hi Craig.

Craig Stephens – Stafford Capital Management

I want to have you go over if you can, can you give us an example of a government customer that has migrated to IP. I mean you're still in the talking stage or is this actually happening?

David Wagenseller

We have seen very little government customers convert over to a Microsoft UC product. Up to now the majority of UC installs in the US government are either Cisco or Avaya, and they're the two dominant players in the UC space. There are pilots going on right now, but I cannot point to a very large deployment comparable to some of our enterprise deployments.

Now that is not the case outside of the United States. We are starting to see large government departments internationally I mentioned the City in France this is going to be a very large deployment it has a variety of locations, if I remember it's about 60,000 city employees and it's going to be a large network in Europe. That by the way is being managed by both the integration arm of Belgian Telecom and possibly another integrator if that happens.

But where we see the integrators come in we see that. I didn't go in to a lot of the other government wins, but we had you know, the prosecutor's office in Australia is a win. A lot of governments one of the boroughs in London is a win, the financial oversight board in Iceland, and on and on and on. So you're seeing state, municipal, provincial even national governments. If you remember a while back I pointed out that we are working on the internal city network for Oman, Jordan.

So it is happening at the federal, state, provincial and local government level. It is just not happening in the US government today for Lync, but that's because that Cisco and Avaya have been the installed incumbents for a long period of time and Microsoft is the new provider going forward. Having said that though they have an installed enormous base of exchange users and Lync is part of that overall office suite, and you know, started out on the backbone of the exchange servers.

So I think it will happen, my guys in government say that the US government typically lags three to four years of enterprise deployment and that's a proper step. You know, we are now into the first anniversary of Lync as a product. That would say to me that we are probably going to see some minor deployments in the next 12 months and more broad deployment as Lync starts to compete more successfully. And again when you are a new product, our government agencies tend to be risk adverse of early technology deployments and tend to go with those that have been vendors with them for a long time and we’re not talking about Microsoft Office, we're talking about Microsoft voice, which is relatively new to the US government community.

Craig Stephens – Stafford Capital Management

I have one other question too. Since a lot of these system integrators are big carriers around the globe, is there an opportunity to penetrate that space with them specifically.

David Wagenseller

Well, I think the carriers are going to play an increasingly important role in the UC space in about three or four different ways. You see this one international project. This is where they're functioning as both the integrator and the outsourcing partner and so in the case of this global network I keep referring to, the owner of the network is actually the carrier who then provides it as a managed service to the customer. That's one example.

Craig Stephens – Stafford Capital Management


David Wagenseller

What you're going to see also is increasingly hosted UC by the carriers themselves and they will deliver that hosted UC via SIP trunking services. That's why the cloud, the hosted service and the enterprise session border controller market are all interrelated because they are all going to be part of a delivery plan by the carriers to provide services not only for small and medium-size businesses but it's my belief that large enterprises will look at carrier delivered services for UC, and for SIP trunking as an alternative to managing it themselves internally.

And this could be very cost effective because you're spreading the cost over a large capital base that the service providers has and two, the advantage of SIP trunking is that you buy your bandwidth on as needed rather than on a leased line basis, and so you only pay for as much as you consume and you don't pay for the connection you know, when there is not services going over the network.

I think this whole trend could be very positive and profitable and incremental for carriers worldwide. That's why you're going to be seeing us every quarter announcing new certifications and new programs. So we have a very active program worldwide to engage with all of the service providers that will be offering enterprise session border controller or hosted UC or any number of other services that they can come up with cloud-based services, whether it's Lync-based or incremental to Lync. I think our addressable market and I think their addressable market is going to look very different in the next couple of years.

Craig Stephens – Stafford Capital Management

Thank you very much.


And we have no further questions in the queue.

Leigh Salvo

All right. If there are no further questions, I want to thank everyone for joining us today. This concludes our call for the second fiscal quarter of 2012. Thank you.


Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may disconnect. Have a great day.

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