Here’s the entire text of the Q&A from Comverse Technology’s (ticker: CMVT) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Questions and Answers
Operator
Thank you, sir. Your first question comes from the line of Tim Luke with Lehman Brothers.
Q -Tim Luke
Thank you very much and congratulations on the numbers. I was wondering if you guys might have been asked to provide just any regional color on how you saw the shape of demand in the third quarter and how you see it going forward. I was also wondering, David, if you could have just given some expectation to how you see the gross margin outlook going forward. And then separately, just wondering if you would clarify what specifically your expectation was for '06 for options expense diluted next year? Thank you very much.
A - Kobi Alexander
I will cover the regional activity, and David will continue with the rest. In terms of the regional activity, we have seen a strong business flow in America at both Lockheed in North America and in Eastern Europe.
A - David Kreinberg
And on the gross margin, including the effect post GSS acquisition, we're looking at somewhere in the range of 58.5% going forward in Q4 and the rest of 2006. As you're probably aware, GSS has lower gross margins than what we have on the rest of the GMS business, and that's really reflecting that effect.
Q -Tim Luke
And in the options expense data, I was also wondering, you had, what was the interest and other this quarter? It looked like it was little bit larger than the 10.8 you had last quarter, and how do you see that going forward?
A - David Kreinberg
First of all, as far as the option expense, we're estimating right now about $45 million or so, or about $0.21 per share for next year. And that is included, as I mentioned, in the difference between the pro forma and GAAP income. Right now, we're giving well less than 3%, closer to 2, approximately 2% in option grants per year to our employees. We expect that that number won't change significantly. Regarding the interest and other, I mentioned that actually interest net of the minority interest was about $13.5 million this past quarter. That was up sequentially. We did see the effects of higher interest rates, higher interest income than last quarter. We've looked at over of $1.7 million of higher interest income this quarter than compared to last quarter. Going forward, we would expect that number in Q4 to be about $13 million, and going into next year about 12 million per quarter. Of course, this reflects the paydown cash for the GSS acquisition.
Q -Tim Luke
Any color on the sharp rise in your backlog lastly? What was the makeup of that?
A - David Kreinberg
Obviously, once again, we're very happy to see a rise in the backlog. It was very nice for us. We do believe some of that is coming from things that we would not have expected typically Q4 coming a little bit earlier. But it was really primarily in the CNS business throughout the product life.
Q -Tim Luke
Thank you very much, good quarter.
Operator
Your next question comes from the line of Thomas Ernst with Deutsche Bank.
Q - Thomas Ernst
Good evening and thank you. I'm a little surprised; I guess you told us that we should expect mild accretion out of the GSS deal looking forward. I'm surprised you're able to achieve breakeven to accretive right away here in this current quarter and next quarter. I'm wondering how you do that. I guess we understood that that was a business that was mildly losing some money, and I imagine you got some transition costs that you cannot pull into your adjusted number. Is there some sort of cost restructuring here to affect this plan? Is there any risk?
A - David Kreinberg
First, we didn't say, we said that there would be mild accretive for year, and we still believe that's the case. We're not breaking it out if it's going to be mildly accretive this quarter. Bottom line is, when we look at the overall effect of the business combined, we're very comfortable with our guidance.
Q - Thomas Ernst
Okay. So the health of the business helps out to cover any weakness potentially I guess, if I interpret that right?
A - David Kreinberg
I wouldn't say there's any weakness there. We're very happy with what we see so far.
Q - Thomas Ernst
Any issues, say if the deal comes in later, would there be a potential issue where you have more cost say than in Q1 of next year if the deal doesn't close until the end of December, or in January?
A - David Kreinberg
Obviously, like I said, the guidance assumption is really reflecting a mid-December close. Right now, we are targeting it and we believe that within the next couple of weeks the deal should be closed. Obviously if it gets pushed out somewhat, this will have an effect both on, some effect on the top line, but also have reduced expenses going out. So I don't believe that there would be any risk to our guidance of $0.18.
Q - Thomas Ernst
Follow-up to the previous person's question on backlog. It does look like a much stronger Q3 I guess than we're used to. I'm wondering if you could help us understand, does not mean that your Q4 pipeline, is that as strong as you're used here in a Q4, or do you think the seasonal effects we're used to seeing in your bookings in Q4 might be affected because of the strong Q3?
A - Zeev Bregman
We will not be surprised if the backlog will increase also at the end of Q4, although some of the impact of Q4 already went into Q3.
A - David Kreinberg
But the pipeline continues to be very strong.
A - Kobi Alexander
And we're very happy with the backlog.
Operator
Your next question comes from the line of Marianna Wolk with Susquehanna Financial Group.
Q - Marianne Wolk
Thanks. I had a couple of questions about the GSS acquisition. First of all, was there any contribution of that to your backlog this quarter, and does your guidance reflect some of the recent wins GSS has been able to achieve? And then the second question regarding GSS was whether you thought the long-term margin potential could be closer to some of the peers which are achieving 15% plus operating margins? Thanks a lot.
A - David Kreinberg
The backlog reflects not one single penny from GSS. Obviously, the acquisition has been closed, so it's not included at all in our backlog. Regarding the guidance, it assumes what we know today about the business of GSS. Obviously, when we did due diligence, it was, we went through the pipeline and assume it's what we know about the business going forward, including any recent wins.
A - Paul Baker
And to clarify a comment that Zeeve made, I'm sure when Zeeve said he would not be surprised to see backlog up in Q4, he was referring to organic backlog, not backlog benefiting from the GSS acquisition.
Q - Marianne Wolk
Historically, GSS has had a backlog of approximately 120 million. Does that seem reasonable for us to assume?
A - David Kreinberg
No. I believe the backlog was less than 120 million. It was closer to 100 million I believe as of the end of last quarter.
Q - Marianne Wolk
And then regarding the margin potential?
A - David Kreinberg
As far as the operating margins, we have stated that we have a goal within Comverse to get to mid-teens operating margins, and we believe that we'll be able to get over the longer term GSS up to company-wide averages.
Q - Marianne Wolk
And then a final question, did you have any 10% customers in the backlog this quarter?
A - David Kreinberg
We do not have any 10% customer in backlog this quarter.
Q - Marianne Wolk
Great, thanks very much and congratulations.
A - David Kreinberg
Thank you.
Operator
Your next question comes from the line of Tom Roderick with Thomas Weisel Partners.
Q - Tom Roderick
I just wanted to dig a little bit deeper on this backlog number; obviously quite an impressive jump there, and the last question was just around whether there's a 10% mix in the backlog. Well, maybe you can go a little bit deeper. Can you give us some color as far as what's in the backlog from the CNS side of the equity? Are you seeing particular strength here from prepaid billing? Is it pretty broad-based? Do you see InSight really driving that? Just any color you can offer around that would be helpful. Thank you.
A - David Kreinberg
First, the increase in the backlog, let me give you some color. The increase in the backlog was all on the product side, not on the service side. So it was all on the product side. When we look at what products, the big three coming from the NextGen products constituted in the backlog continued to be InSight, our real-time billing and our data products.
Q - Tom Roderick
Great. And when you think about the strength of those products, are you seeing customers coming back for second- and third-phase capacity purchases that might otherwise see higher margin business, or are these still, does this reflect new customers purchasing some of these products for the first time?
A - Zeev Bregman
It's a mix. It's a mix of new customers buying new products and repeat orders throughout the year for product line.
Q - Tom Roderick
Okay. On the gross margin side, it looks like we may have had a similar sort of issue as last quarter where your R&D has gone down, perhaps even pushing some of those resources up into the professional service side to help out with some of the prepaid billing work. Is that the case again this quarter, or how should we think about the gross margins here as a function of being down just slightly, but overall operating margins being up nicely?
A - David Kreinberg
So on the gross margin one, we did have again a significant customization expenses that moved up into the cost points in the R&D line. In addition, we did have some large initial sales to some large customers that also affected somewhat the gross margin.
Q - Tom Roderick
Okay, very good. Thank you very much.
Operator
Your next question comes from the line of Sterling Auty with J.P. Morgan.
Q - Sterling Auty
Thanks. David, on the guidance, you mentioned the deferred revenue and GSS. Just to be clear, the guidance for next year is after you subtract out what you lose from the deferred revenue write-down?
A - David Kreinberg
Just to be clear, what I said is the $1.5 billion assumes the historical deferred revenue for GSS. On a GAAP basis, there will be some write-down to that deferred revenue which would cause the GAAP revenues to be somewhat lower than that historical deferred revenue balance.
Q - Sterling Auty
Can you give a sense as to how much deferred revenue you might expect to write down?
A - David Kreinberg
Right now, it's very pulmonary. We're working through that with the evaluation people and with the auditors. So it's a very preliminary number. As an order of magnitude, it could be as much as $25 million next year.
Q - Sterling Auty
Okay. And then, let me attack it this way. What kind of operating margin assumption would you be looking at for GSS? in other words, what's embedded in the guidance in terms of operating margin for GSS?
A - David Kreinberg
Next year, we're really looking at integrating GSS together with the rest of the business, so we're really not building the supply chain. And looking at this separately, it's really going to be integrated as part of the overall business. So it's really difficult to break out these separate margins for that. When we look at the billing group overall, like I said, we do believe that over the longer-term, we'll achieve overall corporate operating margin.
Q - Sterling Auty
Okay. It's a little tough to do this I think for the fourth quarter, but I'm going to ask anyway. If you were to look at just kind of the Comverse before, including GSS, what percentage of the revenue that you would expect from kind of organic Comverse would come out of the backlog next quarter?
A - David Kreinberg
That's really, can range in any given quarter. The backlog is typically, again, just what's in backlog doesn't include anything over a year. Typically, the backlog on the product side is recognized over the next two to three quarters.
Q - Sterling Auty
Okay. And then last question is, some of the carriers, your carrier customers, are starting to do a little bit more on having their solutions kind of managed by the vendors. I'm kind of curious strategically how you're thinking about whether you stay just kind of a predominantly product Company, or do you kind of morph into providing both the products as well as maybe managed solutions in an increased fashion going forward?
A - Zeev Bregman
In our hosting facility, we are hosting applications to customers. Some of our mobile IM customers are using the hosting to provide services. And in addition, the ESPN content delivery is being done also on the hosting, as an example. So we have hosting and managed services as part of our business, both full-year and business offerings to our customers, and we're seeing increase in demand and we are building the capabilities to provide this.
Q - Sterling Auty
Great, thank you.
Operator
Your next question comes from the line of Daniel Meron with RBC.
Q - Daniel Meron
Hi, good afternoon, and congrats on the very good quarter and outlook. A couple of questions here. First one, can you provide a sense on the pricing environment? Do you see any improvement there, or is it pretty much stable?
A - Zeev Bregman
Well, we are looking at the pricing environment and we're checking it before the quarter every quarter. And when we look at the trends over the last two years, we don't see any meaningful trend. It's basically flat.
Q - Daniel Meron
Okay. And that's across product lines, or is it sub products?
A - Zeev Bregman
It's in all product lines. I mean, we are looking at the meaningful product lines because others, it's much more, it's not only significant in terms of finalizing by trends. But if you're looking at the main product lines and the large product lines, we don't see, we see that the trends continue and similar trend is flat, more or less.
Q - Daniel Meron
Thank you, Zeeve. And then on a number of InSight customers that you had this quarter versus the previous quarter?
A - Zeev Bregman
We currently have more than 55 customers using InSight, and the, so we are seeing that we continue to be successful in launching it.
A - David Kreinberg
And also, many of those InSight customers are buying or starting to buy multiple services that are going on top of the InSight platform.
Q - Daniel Meron
Thanks. And what are the services that you're seeing most of the demand for? Is it mostly in the, do you see uptick in MMS data, gateways and all that?
A - Zeev Bregman
When we are looking at the application that we see over InSight, it's video applications, video mail, video IVR and other video services. We do see call completion services and we have some e-mail services that we have recent success in; e-mail applications based on the InSight. We do have some next-generation IVR customers that are using the platform. And so we see a large variety of applications that they're running on the platform.
Q - Daniel Meron
Great. And then last one for me. Now that you are starting to a digest obviously the GSS Canyon acquisition. Would you be looking for more acquisitions down the road? And if so, in what areas specifically?
A - David Kreinberg
We continuously look at acquisition opportunities. We do have a healthy pipeline. We do look at acquisitions all three of the major areas, which is on the messaging side, on the content side as well as on the billing side.
Q - Daniel Meron
Thank you, David; good luck going forward as well.
Operator
Your next question comes from the line of Will Power with Robert W. Baird.
Q - Will Power
Thank you and good afternoon. You all alluded to increasing interest in applications like mobile IM and mobile video, but I wonder as you think about some of your core data products: messaging platforms, gateway products, are you still seeing new greenfield opportunities there, or is most of that more related to upgrades and add-ons? And what does that kind of mean for growth in those business?
A - Zeev Bregman
Well just to give an example, this quarter, we added seven MMS customers and we added seven SMS customers. And so we do see demand both in new customers and both in additional applications.
Q - Will Power
And then just a follow-up to guidance. Can you give us a sense for what we should think for in terms of '06 tax rate? Will that look like '05?
A - David Kreinberg
We expect the '06 tax rate to be about 15% effective rate.
Q - Will Power
Great, thank you very much.
Operator
Your next question comes from the line of Scott Sutherland.
Q - Scott Sutherland
Great, thank you, good afternoon. Thinking about your guidance for '06, can you tell us what you're assuming for GSS contributions so we can kind of think about you one last time as separate two companies?
A - Zeev Bregman
One last time, Scott, just for you. We are assuming about $180 million out of the $1.5 billion GSS.
Q - Scott Sutherland
Yes. I just kind of take it now, you're talking about integrating the two companies. I'm not sure you're going to be giving that in the future.
A - David Kreinberg
Right.
Q - Scott Sutherland
And then also when I look at operating margins, I'm looking at your three segments here, and it looks like CNS is still the lowest on the totem pole for operating margins. Is that where you see the margin expansion getting up to the mid-teens, or do you see it from any of these other two segments?
A - David Kreinberg
First, one of the segments is already there, which is Ulticom. We do see continued growth in the operating margins. We are very happy with the operating margin increase in CNS this quarter of 190 basis points, and we're up to 9.6% of sales. And we do believe that we will be able to get all of the units up to the mid-teens.
Q - Scott Sutherland
Okay, great, thank you.
Operator
Your next question comes from the line of Shaul Eyal with CIBC World Markets.
Q - Shaul Eyal
Thank you, good evening and congratulations on a good quarter and guidance. Two quick questions from me. Zeeve, RSP activity in the converged billing side, have we seen any strengthening on that front? What is the current status?
A - Zeev Bregman
We are seeing activity, we are seeing some strength. I believe that the news on the acquisition created more interest and we're being approached by more customers at this point.
Q - Shaul Eyal
Fair enough. Maybe just on the EPS guidance for '06, kind of a flat quarter between the fourth and third quarter in '06, $0.21. Seemingly, the fourth quarter has been the strongest one of the year. We all remember what your fourth quarter '04 looked like. Any particular reason for that?
A - David Kreinberg
We have a long way to go between now Q2, '06, Shaul.
Q - Shaul Eyal
Fair enough. Congratulations again.
Operator
Your next question comes from the line of James Faucette with Pacific Crest.
Q - James Faucette
Thanks, good afternoon. Just a couple of more model-related questions. First of all, as far as what the headcount was in the just-completed quarter and then how going forward that will change after the GSS acquisition closes and how we should think about increased operating expenses as a result of the acquisition split between R&D and SG&A?
A - David Kreinberg
So right now, as of the end of October, we had 5367 employees. GSS is bringing about 900, just over 900 employees, so that's going to be added to the cost base of the Company. From what we're seeing on the R&D and SG&A side, we are looking at starting the year at about $78 million R&D in that quarter, SG&A about 94 million and then increasing each of those numbers throughout the year.
Q - James Faucette
Okay. Great. And as far as I guess a business development standpoint and getting a better appreciation for maybe how your mix is developing, I noticed that your inventories at this time are quite a bit higher, especially relative to your revenue outlook than, say, they were last year. Can you give us a little bit of insight into what is driving increase in inventory levels and what implications that may have on your working capital. Thanks a lot.
A - David Kreinberg
I don't think that we saw any major increases in the inventory turnover this quarter.
Q - James Faucette
Not from a quarter to quarter basis, but are you just looking at this time last year?
A - David Kreinberg
Yes. Well, what we are seeing now is a huge backlog increase compared to last year and we are really building up to strengthen the backlog to be able to deliver going forward. So that's really the reason that we've done that.
Q - James Faucette
So from a sales mix standpoint, should we take that you're seeing an increase in new deployments, or is that still too much of a stretch for you?
A - David Kreinberg
I think that is a little bit of a stretch. Like Zeeve said, backlog does constitute a mix of new and repeat business.
Q - James Faucette
Okay, great. Thank you very much.
Operator
Operator Instructions Your next question comes from the line of Jason Willey with Moors & Cabot.
Q - Jason Willey
Good afternoon, guys. I was hoping to get an idea maybe of where we're at and kind of the IT messaging upgrade cycle. I'm wondering if you could give us any sense of what your impression is on the number of Tier 1 operators that have made decisions on kind of the IT messaging upgrade?
A - Zeev Bregman
With InSight, we're upgrading some of our customers, and those are competitor customers to IT messaging. Some of them is a full-scale upgrade and some are just extensions. We don't have those statistics in terms of which part of the market, but I think that most of the carriers are either a complete or in the process to start this upgrade to IT messaging.
A - David Kreinberg
But when you look at our installed base, we're just over 15% of our installed base upgrading right now.
Q - Jason Willey
Okay, thanks. And what about your sense on market share in the voice mail segment now?
A - David Kreinberg
We believe that we continue to gain share.
Q - Jason Willey
And then, David, just a quick question --.
A - Zeev Bregman
In terms of voice mail, we believe that our win ratio is ahead of 50% and we believe that our market share is around 50.
Q - Jason Willey
Okay, great. David, just a quick question. I want to make sure on the current quarter that I understand correctly, that the $3 million tax benefit that Ulticom saw, that is in your pro forma number?
A - David Kreinberg
No. We had an Ulticom tax benefit that you mentioned on the other side of the house in CNS. We had some added tax expense this quarter. So it really wasn't a one-for-one wash, but it was pretty much a wash. So the number is, we did not pro forma that, the benefit from the Ulticom side or the expense on the CNS side out.
Q - Jason Willey
Okay great. Thanks a lot.
Operator
Your next question comes from the line of Larry Harris with Oppenheimer.
Q - Larry Harris
Yes, thank you and congratulations on the results for the quarter. Earlier it was indicated that you were seeing strength in terms of orders or the pipeline in the Americas and Eastern Europe. Any thoughts, any commentary with respect to Western Europe or the Asia-Pacific region?
A - Zeev Bregman
We looked at the particular area, we said that America and the Eastern Europe are particularly strong. We see healthy business also in Asia-Pac and in Western Europe.
Q - Larry Harris
So you're not seeing any signs of a slowdown or change in spending patterns in Western Europe, for example?
A - Zeev Bregman
We do not see any pattern of weakness. On the contrary, with the launch of 3G, me we do see some additional demand for our services.
Q - Larry Harris
Great. Okay, super, thank you very much.
Operator
Operator Instructions We have a follow-up question from the line of Sterling Auty with J.P. Morgan.
Q - Sterling Auty
Thanks. You mentioned the seven MMS and SMS customers that you gained in the quarter. Could you just review for us the competitive landscape, where you actually sit in terms of the solution offering and who you're seeing the most competitively for those wins?
A - Zeev Bregman
On SMS, it's the two leading providers are us and the logical CMG, and this is where we are competing. On the MMS, the market is more cemented and we are getting, replacing infrastructure in those, as well as traditional competitors.
Q - Sterling Auty
Okay, thank you.
Operator
We have a follow-up question from the line of Daniel Meron.
Q - Daniel Meron
Can you maybe provide some color if there's any progress with your efforts with the cable or wireline business in the enhanced services business, and if there is any possibility that the recent GSS acquisition last year supports your efforts there?
A - Zeev Bregman
We have activity in the cable market and we believe that our GSS acquisition is going to position us even better in this market. They are providing mainly billing for many cable operators. So we believe that we will leverage this offering additional services to these customers.
Q - Daniel Meron
And then on the wireline side?
A - Zeev Bregman
On the wireline side we do see an increase with the markets becoming more and more competitive and with the either integration or disintegration of wireline and wireless carriers. We do see more demand for the value-added services from provisional customers. For example, we started to launch ring tones also on the wireline front, and this is a signal for the increased competition in this space.
Q - Daniel Meron
Okay, and what is the composition for wireline versus wireless, or maybe if you have any specifics on cable?
A - David Kreinberg
We don't have specifics on cable, but wireless continues to dominate well over 90% of the business today.
Q - Daniel Meron
Thank you, David. That concludes my questions here. Thank you.
Operator
We have a follow-up question from the Scott Sutherland.
Q - Scott Sutherland
Thank you. Just a quick question. Of your 55-plus InSight wins, how many of those would you say are competitive wins that had some other vendor in there?
A - Zeev Bregman
I believe that it's more than 20%.
Q - Scott Sutherland
Okay that's it. Thank you.
Operator
We have a follow-up question from the line of Tim Luke.
Q -Tim Luke
Sorry, I just wanted to know, if you could just reiterate what the contribution from GSS is in the calendar fourth quarter and in calendar '06 to the revenue number. I missed that.
A - David Kreinberg
For calendar '06, we said it was about $180 million. And in Q4, assuming we close in mid-December, we are estimating about a $20 million contribution.
Q -Tim Luke
Great. Thanks very much, guys.
Operator
We have no further questions.
David Kreinberg, Chief Financial Officer
On behalf of everybody here at Comverse Technology and all the participants here today, we want to thank you very much for taking part in the conference call and we wish you all a great evening. And happy holidays, everyone.
Operator
This concludes this evening's conference call. You may now disconnect.
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