BroadSoft's CEO Discusses Q3 2012 Results - Earnings Call Transcript

Nov. 5.12 | About: BroadSoft, Inc. (BSFT)

BroadSoft, Inc. (NASDAQ:BSFT)

Q3 2012 Earnings Call

November 5, 2012 5:00 PM ET

Executives

John Kiang – IR

Mike Tessler – President and CEO

Jim Tholen – CFO

Analysts

Brent Bracelin – Pacific Crest

Simona Jankowski – Goldman Sachs

George Notter – Jefferies

Dmitry Netis – William Blair

Catharine Trebnick – Northland Securities

Sanjit Singh – Wedbush

Rich Valera – Needham & Company

Operator

Good day, ladies and gentlemen, and welcome to the BroadSoft Q3 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll have a question-and-answer session and instructions will follow at that time. (Operator Instructions) I would now like to turn the conference over to your host for today, Mr. John Kiang. Sir, you may begin.

John Kiang

Thank you, Mary. Good afternoon, everyone, and thank you for joining us on today’s conference call to discuss BroadSoft’s results for the third quarter ended September 30, 2012. This call is also being broadcast live over the Web and can be accessed in the Investor Relations section of the BroadSoft website at www.broadsoft.com.

With me on today’s call are Michael Tessler, BroadSoft’s President and Chief Executive Officer and Jim Tholen, BroadSoft’s Chief Financial Officer. This afternoon, BroadSoft issued a press release discussing its financial results for the third quarter ended September 30, 2012. If you would like a copy of the release, you can access it on our website or the SEC’s EDGAR website.

We would like to remind you that during the course of this conference call, BroadSoft’s management may make forward-looking statements, including statements regarding the company’s future financial and operating results, future market conditions, the plans and objectives of management for future operations, the effect of our recent acquisition of Adaption Technologies and the company’s future product offerings. These forward-looking statements are not historical facts, but rather are based on BroadSoft’s current expectations and beliefs and are based on information currently available to us.

The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements, including but not limited to those factors contained in the Risk Factors section of the company’s Form 10-K for the year ended December 31, 2011 filed with the SEC on February 29, 2012, its Form 10-Q for the quarter ended June 30, 2012 filed on August 6, 2012 and in our other SEC filings.

All information provided in this conference call is as of November 5, 2012. Except as required by law, we undertake no obligations to update publicly any forward-looking statement made on this call to conform the statements to actual results or changes in our expectations. Also in light of Regulation FD, we advise you that it is BroadSoft’s policy not to comment on our financial guidance other than in public communications.

Please note that when we discuss EPS, we are referring to diluted EPS. In addition, certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude the impact of non-cash stock compensation and amortization expense related to acquired intangible assets, non-cash tax expense and non-cash interest expense on our convertible notes. Collectively, these items totaled $6.8 million in the quarter. We have provided reconciliations of these non-GAAP measures in our earnings release, which is available in the Investor Relations section of our website located at www.broadsoft.com.

Additionally, non-GAAP license cost of sales for the quarter excluded $385,000 in stock-based compensation expense and $730,000 in acquired intangible amortization expense. Finally, we define non-GAAP tax rate as the rate calculated by dividing on an annual basis our estimated non-GAAP pre-tax income by our anticipated cash tax.

I will now turn the call over to BroadSoft’s President and CEO, Michael Tessler. Mike?

Mike Tessler

Good afternoon and thank you for taking the time to discuss our third quarter 2012 results. We had another solid quarter with revenue growing 13% year-over-year to $40.2 million. Billings grew 45% year-over-year to $45.4 million and we delivered non-GAAP earnings per share of $0.35.

We had strong revenue growth in Europe along with strong order growth across all geographies. We had one customer account for over 10% of revenue in the quarter who had not previously been a 10% customer. And from a product standpoint, we had a strong hosted Unified Communications and SIP trunking orders from customers globally.

In the third quarter, we came in at the low end of our revenue guidance range. However, we continue to feel very pleased with the trajectory of our business. We had very strong billings, both on a Q3 and a year-to-date basis. We recently announced significant new products and go-to-market enhancements and we just completed an extremely successful users’ conference. I’d like to now provide some details about the latter two items.

Just two weeks ago, almost 900 individuals from over 35 countries joined us from Scottsdale, Arizona, where we celebrated the 10th anniversary of our annual users’ conference, BroadSoft Connections. At this year’s event, the energy and excitement around our newest capabilities and the growing success of our customer’s hosted communication services was the highest we’d experienced. I kicked off BroadSoft’s Connections with the introduction of UC One, which I believe is one of the most strategic announcements we’ve made in the last several years.

The UC One combines all the critical elements of Unified Communications into a single platform that our service provider customers can leverage to launch a wide range of different solutions. It also brings together our core competencies around user experience, mobility, openness and go-to-market support.

The most visible enhancement of our UC One platform has been to the user experience. In addition to making usability improvements to our BroadTouch Business Communicator client, we’ve also integrated new capabilities, further bolstering our industry-leading user experience. Now in addition to providing end users with actives from a single interface to all other communication services, including audio and video calling, instant messaging and presence and Web collaboration, we’ve added new functionality, which is one-click file and desktop sharing.

With our client available on a variety of platforms from smartphones to tablets to PCs, we’ve made it extremely easy for users to move seamlessly between their various communication devices, giving them the flexibility to choose how and when they want to communicate. We all know that the primary criteria for judging the quality of the service is how easily users can interact with it. Therefore, we will continue to invest in the usability of our clients because we believe an intuitive user experience is critical to our customers winning and retaining the end user.

One of the greatest benefits to enterprises of hosted Unified Communications is the ability for employees to look many location, home or office, with access to the same superior set of communications features. This creates demand to extend UC to mobile devices. To deliver, we have fully integrated mobility to all of our capabilities, making it a core competency in our BroadWorks application server.

For example, for mobile network operators, we now have a new server component with service control function which interconnects 2G and 3G mobile networks with BroadWorks. We have seen a growing request by mobile network operators to support Unified Communications solutions now before they move to all-IP networks. We can now leverage our service control function to introduce fixed mobile convergence offers today.

We will continue to optimize our clients, cloud and software solutions to enable mobility in all of our services across the widest range of devices to enable users to communicate from any device anywhere. To validate our UC One strategies, this summer we completed a global market research study with end users that proved invaluable. We obtained a deep understanding of these users’ current communication needs and their preferred communication devices.

Out of this research, we developed a set of predefined offers that have been tailored to meet the needs of specific market segments from small to medium-sized businesses to large enterprises and also including vertical overlays. These offers highlight the unique communication requirements for each segment and they have been designed to promote the rapid adoption of our customers’ Unified Communication solutions by the segment they serve.

So to summarize, UC One is a comprehensive platform that brings together our broad range of Unified Communication services, including audio and video calling and conferencing, PBX features, instant messaging and presence, text messaging, Web collaboration, client user interfaces and mobility. Other important elements of the UC One solution include our extended APIs that enable our ecosystem to integrate communication services with other vertical applications and our go-to-market practice that helps speed the option of Unified Communications services by our service provider customer users.

UC One demonstrates our continued commitment to our customers of providing innovative solutions that include all the elements they need to win in the hosted Unified Communications market. Our customers’ community established hosted voice as the preferred method for enterprise customers, fundamentally disrupting the legacy PBX business forever. Our addressable market is now exploded beyond hosted voice and with UC One, our customers can now deliver on the promise of hosted Unified Communications, once again leading the industry.

Now let me discuss some progress on our cloud business. You may have seen Verizon’s announcement last month about their new small and medium-sized business hosted communication service, Virtual Communication Express. With this service, Verizon is utilizing our BroadCloud PBX service we discussed first at our Analyst Day, which enables the delivery of advanced communication features, including mobile integration from our cloud infrastructure.

By leveraging BroadCloud PBX, customers are able to get into market with this new offer in less than 12 months. The rapid adoption of hosted Unified Communication services by enterprises globally has created a need for service providers to explore alternatives for faster delivery methods of these services to their end users.

With BroadCloud PBX, our customers have the potential to speed time to market and therefore accelerate time to revenue. We had the opportunity to discuss BroadCloud PBX in detail with many customers of BroadSoft Connections and we’re extremely excited by the growing interest in leveraging this service delivery model.

Finally, before I turn the call over to Jim, I’d like to point your attention to the greater than $10 million increase in long-term deferred revenue on the balance sheet. While this increase was due to a few deals, it was primarily the result of a single large order with one of our Tier 1 service provider customers. We’re obviously extremely pleased by the order and believe that it shows that service providers value BroadSoft as a trusted strategic partner.

It also shows their confidence in our technology leadership, strong financial position and most importantly, our demonstrated success in bringing to market innovative, carrier-class hosted UC offers. As our customers become more comfortable with deploying hosted solutions, we feel that over time, we can see more of these types of large deals and they’ll span a range of market offers from large enterprise-centric UC to Voice over LTE. Given the size and complexity of these deals, they may flow under the balance sheet before we can recognize them as revenue.

Let me now hand the call over to Jim who will go through our financial results and our outlook for the fourth quarter and full year. Afterwards, I’ll be happy to answer any questions. Jim?

Jim Tholen

Thanks, Mike. I’d like to take a few minutes to cover some of the key financial highlights. For Q3, our total revenue was $40.2 million, up 13% from a year ago. Software license revenue was $21.6 million, up 24% year-over-year driven by our hosted Unified Communications, Trunking and Consumer businesses.

Maintenance and professional services revenue of $18.6 million was relatively flat year-over-year. I’d like to note two things. From Telstra that had previously been deferred on the balance sheet. And, two, professional services revenue is essentially flat for both Q3 and the year-to-date period. So our core maintenance business continued to grow nicely year-over-year.

Final point, note that revenue associated with our BroadCloud business including Adaption Technologies’ direct revenue of $600,000 in Q3 are included as part of our services revenue line.

There are a couple of deals that we had expected to recognize as revenue in the quarter that instead are in short-term deferred which resulted in our coming in at the lower end of our guided revenue range. Billings, which we defined as revenue plus change in deferred revenue were a key highlight in the quarter. In Q3, they were $45.4 million, up a very strong 45% year-over-year and 21% quarter-over-quarter. For the first nine months of the year, billings up $115.9 million were up 31% year-over-year.

On a geographic basis, we saw a very strong year-over-year growth in EMEA and strong growth in the U.S. Asia-Pacific revenue declined on a year-over-year basis partially due to the significant deferred revenue recognized in the year-ago period. From an orders’ perspective, we saw strong growth in all regions. Orders from existing customers contributed 93% of total software billings. Tier 1 customers represented a very solid 46% of total software billings in Q3. Non-GAAP EPS was $0.35 in the quarter. Cash flow from operations was a strong $9.7 million in the quarter.

Now on to the cost side. Our non-GAAP gross margin for Q3 was 84% with software license gross margin at 92% and maintenance and professional services margin at 74%. Non-GAAP software license cost of sales was $1.8 million, down nearly $600,000 from the second quarter. The biggest contributor to the sequential decrease was a decline in expenses associated with the sale of third-party software in conjunction with BroadWorks implementations.

For Q4, I expect license non-GAAP cost of sales to be in the $2 million range and overall non-GAAP cost of sales could be between $7.1 million and $7.3 million.

We achieved non-GAAP operating income of $10.5 million in Q3 resulting in an operating margin of 26%, up from 24% in Q2, 2012. Non-GAAP operating expenses of $23 million were slightly below our cost forecast. On a non-GAAP basis, our tax rate was 2% and diluted earnings per share was $0.35 on net income of $10 million.

On the balance sheet, net cash, cash equivalents and investments were $183 million at quarter-end driven by $9.7 million in cash from operations, offset by $22 million used in the Adaption acquisition. Accounts receivable were $42 million, up $1.7 million sequentially. Deferred revenue was $54 million, up $5.2 million sequentially. The sequential increase was due to a $10.2 million increase in long-term deferred and a $4.9 million decline in short-term deferred.

As Mike mentioned, the increase in long-term deferred was primarily due to a single Tier 1 service provider order. Revenue recognition of the project, the majority of which is software, is dependent on the delivery of certain features. At this point, we expect this order to become revenue in Q4, 2013 or Q1, 2014. We should have better visibility on the timing when we provide 2000 guidance next year.

Given the impact that deals of this size can have on our income statement when they are recognized as revenue, we continue to believe that in addition to GAAP revenue, our billings metric is a valuable measure of our business activity and underlying growth.

Now I would like to provide guidance for the fourth quarter and full-year 2012. For Q4, 2012, we expect to deliver revenue in the $43 million to $48 million range. We also expect non-GAAP diluted EPS of $0.33 to $0.48 per share. For the full-year 2012, we continue to expect revenue in the $162 million to $167 million range.

Non-GAAP diluted EPS is now expected to be in the range of $1.30 to $1.45 per share. Our guidance for Q4 is inclusive of $800,000 in revenue and $0.02 of dilution from the Adaption Technologies acquisition. Our full-year 2012 guidance is inclusive of $1.4 million in revenues and $0.04 of dilution from Adaption. We continue to expect the acquisition to be non-dilutive to earnings for the full year 2013.

I want to give a little color on our wider than normal guidance range for Q4, our final and typically largest revenue quarter. The difference between our achieving the high end of the guidance range versus the low end for Q4 is not only co-related to the number of deals that close during the quarter, but also to whether customers choose to do some fairly typical end of year buying versus buying incremental license on a more just-in-time basis.

This uncertainty on end of year buying is exacerbated by the broader macro uncertainty concerning certain risk provider CapEx. The wider EPS guidance range for Q4 is a reflection of the revenue range and the high incremental margins we should achieve if we were to hit the high end of the revenue guidance. From a longer term perspective, given the very low penetration rates of hosted Unified Communications, we continue to believe our underlying market has long-term growth rates in excess of 20% and that we will continue to maintain or expand our market share.

With that, let me turn the call back over to Mike.

Mike Tessler

Thanks, Jim. Jim and I are now happy to answer any questions. Operator, can you please open the call?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) Our first question comes from Brent Bracelin from Pacific Crest. Your line is open.

Brent Bracelin – Pacific Crest

Thank you. First question really is on the quarter. Jim, could you talk a little bit about license revenue being down 4% sequentially? You talked about kind of two deals slipping here this quarter, but it looks like the short-term deferred revenue was also down sequentially by $4.9 million. So are you seeing an impact because of the macro relative to kind of the success-based model?

Jim Tholen

Yeah. Hey, Brent I think it was more revenue recognition than macro effect. As we mentioned in the prepared comments, billings and particularly software billings, were pretty significantly positive in terms of growth. And it was a couple deals that we had expected to be able to pull into revenue that ended up being deferred that move the needle there.

Brent Bracelin – Pacific Crest

Yeah. I guess if I took out the $10 million long-term kind of benefit that you won’t see in the short-term, it does look like billings would still be kind of negative. So I guess I’m just trying to understand the short-term trends that you’re seeing versus kind of the benefit of this one longer term contract that might not even be recognized till the end of next year.

Jim Tholen

Well yeah, but just because it’s long-term deferred it doesn’t mean, it’s not part of current trends, right? There are a couple of features that need to get delivered either late 2013 or 2014, but it’s still to me billings are billing.

Brent Bracelin – Pacific Crest

Okay. That’s fair enough. And then just shifting gears to the guidance for Q4, clearly you’re seeing some service disruptions kind of on the East Coast, power outages in the Northeast obviously. What’s your kind of current view? I know you kind of gave the wide guidance range. Is it just too early to predict whether you’ll see kind of the typical budget flush or what’s the best guess at this point or is it a wild card?

Jim Tholen

Well it sounded like two questions. One was I think implicitly are we seeing a business impact with Sandy, and then two, sort of more generally on the wide guidance range. On the first, no apparent impact on the business right now with all that’s going on in the Northeast with Sandy. Two, the wide guidance range, yeah, as we said in the prepared remarks, I think it’s a little early in the quarter right now given how this quarter seems to be playing to know what end of the year budget buying look like and gives us a little bit of caution in guidance. I think pipeline looks really good, sales activity looks really good. It’s just a question of what are the size of the orders that are going to come in from carriers when they make their end of year purchase.

Brent Bracelin – Pacific Crest

Okay. That’s helpful. My last question is really on that $10 million sequential increase in long-term deferred revenue. Is that tied to a VoLTE kind of contract or is that a new feature service deployment option with the milestones not potentially being hit till the end of next year?

Jim Tholen

It’s mostly not a VoLTE. There’s a little bit of mobility involved, but it’s our core Hosted Unified Communications product.

Brent Bracelin – Pacific Crest

Okay. Thank you. I’ll cede the floor.

Operator

Thank you. Our next question comes from Simona Jankowski from Goldman Sachs. Your line is open.

Simona Jankowski – Goldman Sachs

Hi. Thank you so much. Just a couple of clarifications also on the $10 million deal. First of all, can you just clarify if this was an existing customer or a new customer? And if it’s an existing customer, is this a new service, or how that differs from what they may already be doing with you? And also, did you receive the cash upfront?

Jim Tholen

So, we have to be very careful in talking about this new order. It’s from an existing customer. It is – I mean in a way it is a new service, but it’s an extension of the service they’re already doing with us and we will be getting most of the cash flow over the next six months.

Simona Jankowski – Goldman Sachs

Okay. Got it. And would you be able to narrow down the region geographically?

Jim Tholen

Simona, we’re really not able to.

Simona Jankowski – Goldman Sachs

Okay. I wanted to follow-up also on the Verizon win with BroadCloud. You know, I thought that was pretty interesting because I think a lot of how you had initially positioned BroadCloud was that it would enable perhaps smaller Tier 2, Tier 3 carriers to get into the market or even some of the channel partners, who are currently selling on-premise PBX equipment, this would give them a way to sell some of a hosted service. So have you expanded now the target market for the product offering or was Verizon more of a one-off?

Mike Tessler

Well, it’s Mike. I think that we probably see different reasons for different carriers. So I think we talked about, when we did the Analyst Day for example as we identified that there would be the ability to sell Hosted Unified Comms to a broader range of customers that may not have the expertise to build that service offering themselves, and as you described, well, channels or resellers that may not be able to build the capability themselves.

I think the other thing we’re seeing as we start to roll that out was that, there is also the situation where carriers want to move quickly. The market is the manning of service and their own implementation cycles would be too long and by really kind of having us run the service for them that would short-circuit the overall delivery time cycles and they can get to market quicker. And I think Verizon fits into the latter one of those scenarios. So I would say that, our goal right now is to market the both sides of that for – continue to look at opportunities that might be with alternate channels and resellers and those kind of things, but also look at service providers that are looking for a different service delivery means to get to the market more quickly.

Simona Jankowski – Goldman Sachs

So, for service providers who are more in that latter bucket who are choosing the service because of the time to market, I mean is this a permanent solution for them then or would it be something that allow some time to market and then they would look to bring that in-house in a year or two?

Mike Tessler

In most cases, the conversation we’re having, Simona, is that this would be kind of a permanent outsourcing. And what might happen is – and I think we’ve described that in the past. We might have situations where they may use our technology to build service offer one and they may outsource service offer two. Especially in the larger carriers I think we’re going to see kind of a mixed bag.

Simona Jankowski – Goldman Sachs

Okay. And then just last quick one, is there any update on VoLTE relative to timing there?

Mike Tessler

No. I think the – my previous comments on VoLTE are consistent. I think we’re still seeing end of next year start and kind of billings end of next year and revenue into 2014.

Simona Jankowski – Goldman Sachs

Okay. Thank you very much.

Operator

Thank you. Our next question comes from George Notter from Jefferies. Your line is open.

George Notter – Jefferies

Hi. Thanks very much guys. I guess I wanted to ask about BroadCloud in vis-à-vis BroadWorks. Obviously BroadCloud is a SaaS model, BroadWorks is a perpetual software license model. Can you just kind of talk about the progress you’re making right now with BroadCloud and then the impact on the financials? What percentage of the revenue stream would be BroadCloud right now? What percentage of the customers? I mean any metrics you can kind of give it to help understand the transition and how it’s progressing, that’d be great.

Mike Tessler

Well I’ll cover the trends and then Jim wants to kind of cover some of the numbers. I think we’re early on in BroadCloud PBX. I think maybe the clarifying – and I think it’s important, I think we did that in the Analyst Day, but just kind of do that again. For a couple of years now, we’ve had a line of products in the cloud, which were really complementary to BroadWorks.

So the idea was that we had a large number of customers that had implemented BroadWorks in their network in their kind of core network element and we were overlaying the BroadWorks implementation with BroadCloud UC elements out of our cloud, so kind of a dual delivery strategy kind of a core networks element in the network and these ancillary things like web collaboration and some messaging and presence coming out of a cloud delivery model.

What we announced with the acquisition of Adaption was the moving of the BroadWorks capability into our cloud and really then announcing BroadCloud PBX as a different way to consume really the complete service. So, all the services are now being delivered out of the cloud. And clearly as we just announced, it’s still – the BroadCloud PBX is a very small, small portion of our revenue. And we think we’ll grow into 2013 as we talk about when we announced we had two launch customers. And now we’re in market. We’re now in dialogue with a number of other customers about investigating that as a service delivery model. So it’s still very early on in the BroadCloud PBX side.

George Notter – Jefferies

Got it. I’m sorry. Jim, were you going to mention any metrics there just to, I guess, kind of underscore that? I mean, how many customers now are you guys talking about that are moving to the BroadCloud model for what you’ve traditionally sold to the BroadWorks? Is there a number you can put around that? And, I guess, also when you say that the revenue impact is very small, I guess, when you go to a SaaS model I would imagine that indeed that would be very small. But it could be a reasonable amount of revenue that you’re foregoing when you take that customer into a SaaS model. I guess, I’m wondering if that plays into kind of the revenue story on Q3 as well?

Jim Tholen

Yeah, George, I don’t really have a metric to share but just to highlight a couple things that Mike said, it’s very early. No evidence now currently that there is a this kind of a substitution effect or delay from customers that might have been buying BroadWorks to look at BroadCloud PBX. So, it’s early, but we just don’t see the evidence. And so, I don’t – there’s no tie with BroadCloud and being at the lower end of guidance for Q3. And I do think overall BroadCloud for this year is less than 5% of revenue and my expectation is that that proportion next year will be quite a bit bigger. Obviously, we haven’t guided to 2013. But I think we’ll see it having more of an impact in 2013.

George Notter – Jefferies

Got it. Great. Thanks.

Operator

Thank you. Our next question comes from Dmitry Netis from William Blair. Your line is open.

Dmitry Netis – William Blair

Hey, guys. Just kind of following up to George’s question here, again on BroadCloud, but curious to see if BroadCloud would be typically sold to new customers or would you foresee maybe some of the existing customers that are buying new BroadSoft licenses today, perpetual licenses to kind of also migrate to BroadCloud over time?

That’s number one. And number two, if you could also give us a bit of an update on the two mobile operators that you’d mentioned last quarter that came out of Europe and you said you had some traction in Europe with those operators and it was kind of the Adaption acquisition that made you get those customers. So, how that’s tracking, number one, and, number two, whether that deal that you got the $10 million deal that’s related to the Adaption acquisition that you’ve made? Thank you.

Mike Tessler

Dmitry, it’s Mike. So, first of all, on your first question, I want to reiterate, we’re not really seeing the cloud delivery – I just want to make sure that everybody gets it – as substitution. I think right now it’s really a – it’s either a new – it’s going to create opportunities at customers and channels that really don’t have the expertise to launch or it will be a delivery means for a new service that one of our larger carriers like the one we described with Verizon. Verizon has been a longstanding customer with a lot of different projects and this was a means to get into market a lot faster in a situation where they couldn’t basically build it all themselves.

So I think it’s kind of where I wouldn’t – I don’t see it, I don’t see the deal flow as being substitutional, it’s more of being additive to our business. And as I think, on George’s question, I think as everybody is aware, the SaaS stuff grows extremely small and you have to kind of build that pipeline and then slowly build the revenue up. So, I think, we’re very excited. We think the cloud delivery model opens up additional opportunities and additional services for us to get through to market with.

On your second question on the mobile operator side in the remarks I made, I think one of the things that we are seeing, we did mention two of those last quarter at the earnings call, we are seeing a number of mobile or converged operators looking quite interested in going to market with fixed mobile converged offerings really with the goal of delivering kind of a single subscription to the end user or to the employee, if you like, for both either a fixed or mobile end point.

And the technology that I talked about in the prepared remarks, the FDF is really an enabling technology that we announced and really brought to the market at our user’s event last month. So, we’re certainly seeing not only those two customers but a lot more customers interested in this service control function, the FDF function that we launched that enables us to go to market with a service integrating 2G and 3G networks.

Jim Tholen

And just, Dmitry, to clarify – the Adaption acquisition really didn’t have anything to do with either of those two available operators or with the $10 million order that we referenced in this quarter. That was all core BroadWorks, core BroadSoft.

Dmitry Netis – William Blair

Got it. Okay, that’s very helpful. And Jim, if I may, just one quick clarification on the cost of sales and gross margin impact. I think you had mentioned $7.1 million to $7.3 million next quarter for the cost of sales. Is that correct?

Jim Tholen

Correct, yes.

Dmitry Netis – William Blair

Okay. So it’s getting back to where it was sort of at the start of the year. And do you expect that to kind of level off at these levels? In other words, are we looking in that 84%, which is – gross margin – which I think is at the high end of your long-term target range of 82% to 84%. So what’s your sort of take on the gross margin going forward?

Jim Tholen

Yeah. So, I think, again, we’re not guiding to 2013 but we – you’re right – we’re in the quarter in that for – and then implicitly for Q4 we’re at the higher end of the long-term model. I think, you’ll see growth in cost of sales but not dramatic growth as we layer on more and more BroadCloud. But again I think it’s all built within our model.

Dmitry Netis – William Blair

Right. And should we still expect more leverage to come from the license’s cost of goods sold versus the maintenance?

Jim Tholen

Well, we’re already pretty solidly in the 90s, so there’s only so much you can do.

Dmitry Netis – William Blair

All right. Thank you very much. Keep up the good work, guys.

Jim Tholen

Thank you.

Operator

Thank you. Our next question comes from Catharine Trebnick from Northland Securities. Your line is open.

Catharine Trebnick – Northland Securities

Oh, good afternoon. So, Mike, could you give some more color on your demands in Europe and how solid they are? It seems in just in general to get a better feel for? And then, you also noticed, said that Asia-Pac had been down. Any change in some of the demand trends in Asia-Pac? And then, the last question is around adaptive technologies and more of an explanation around I believe, it’s called the Rialto is the web provisioning and how much that’s been integrated into BroadWorks or BroadCloud? Thanks.

Mike Tessler

Hey, Catharine. I think that was three questions. Okay. Let me try.

Catharine Trebnick – Northland Securities

Okay.

Mike Tessler

All right. The first one, I think, on your demand question I think we’re actually seeing – let me step back and make sure again on the demand side, we typically kind of see two things. We obviously have to sell our technology into the service provider and then really we look at how the service providers do as they go to market with a new service and how they are – what we call sell-through to their end users. And we’ve had – I think in the European market we’ve seen some really good movement on both sides.

We’ve seen some nice new deal flow, but we’ve also seen a really good increase in end user demand. And back to the question that both George and – sorry, Dmitry asked, we’re seeing very good interest and sell-through with operators that are going to market with fixed mobile converged offers. So, generally European market is growing. It’s certainly as everybody is aware, European operators went to market with this technology later than the U.S. market, and so, we’re – obviously, their deployments are a little bit staggered, but we are seeing some really good sell-through now happening in a number of geographies inside of Europe.

Your comment in APAC is more of a – the down comment is really more of a revenue recognition thing, revenue was down, but I think the demand in Asia is still continuing very strong. We’re seeing good sell-through in the markets. We’ve been in Asia for quite some time. So really no change in the trends in Asia-Pac. And I would say that Australia, New Zealand is a market which is adopting hosted at a fairly brisk rate, and that’s clearly a pretty big growth market for us, and a place we’ve been for quite some time.

And then on your third question, on Rialto, which really is the OSS, the Operational Support System, the IT system that is one of the assets that we acquired in the Adaption Technologies acquisition. That technology is really integrated into our BroadCloud PBX offer. It really serves as the IT billing, quoting, kind of the glue that brings BroadCloud PBX to market and today is fully-integrated into that BroadCloud PBX and being integrated across the complete BroadCloud set of services as we roll that out.

Catharine Trebnick – Northland Securities

Okay, thanks. Appreciate it.

Mike Tessler

Okay.

Operator

Thank you. (Operator Instructions) Our next question comes from Sanjit Singh from Wedbush. Your line is open.

Sanjit Singh – Wedbush

Hi. Thank you for taking my questions. I had a quick question on the business units. You mentioned strength in UC, SIP and consumer. And I think that’s a little bit different than last quarter. I think there was a little bit of sluggishness in consumer. Is there anything changing with the consumer business? Are you seeing more momentum from end user demand standpoint that’s causing that business to tick up here this quarter?

Jim Tholen

Actually, I think last quarter was a pretty reasonable consumer quarter. We noted that the first two quarters were a little light on trunking after a very, very strong 2011. And what we saw this quarter was trunking really having a very nice, really good order flow. And, actually interestingly, not just in the U.S., although from a small base, we’re seeing more trunking activity outside the U.S. Consumer, we did – as we noted have a nice consumer revenue quarter, but we had that earlier in the year as well.

Sanjit Singh – Wedbush

I appreciate the answer. A quick follow-up on the implementation cycles and the deployment at your installed base. I think earlier in the year, there was more of a delay between initial sell-in and then the sell-through basis, has that changed now versus earlier this year?

Mike Tessler

I think the – I’m not sure that the cycle time from technology acquisition to going to market kind of in a macro way has changed. I mean, it varies quite a bit on the service offer. It varies with the expertise of the service provider in the region. There’s a lot of variables, but I think, generally, that cycle has not changed dramatically.

I think that what has occurred in some situations is that as the overall market for hosted Unified Communications has started to grow and as service providers have started to recognize the size and the opportunity, they certainly are applying more resources to it. And frankly, back to the question that was asked before, I think that sometimes drives the desire by those service providers to look for alternate service delivery means, and then that would drive them to looking at and using our BroadCloud PBX offers instead of doing their own build. So I think that the trends are pretty consistent than where we were at the beginning of the year.

Sanjit Singh – Wedbush

Thank you. I appreciate it.

Mike Tessler

No problem.

Operator

Thank you. Our next question comes from Rich Valera from Needham & Company. Your line is open.

Rich Valera – Needham & Company

Thank you. A quarter ago you were pleasantly surprised by your strong pipeline closure rate and that’s what led you to increase the guidance for the year. Just wondering have you seen any change at all in your pipeline closure rate in this last quarter that has made you perhaps more cautious than you’re a quarter ago?

Jim Tholen

Well, Rich, I mean, I guess at some level, we didn’t change the guidance. So we’re seeing – I think our expectations now are similar to when we up the guidance last quarter. For the year, I guess, the quick answer is we’re not seeing appreciable change in the business. It feels kind of normal BroadSoft solid. What gave us hesitancy of narrowing the guidance going in is just – really is uncertainty in our mind on what the end of the year buying really looks like.

Rich Valera – Needham & Company

Do you have any sense if that’s due to concerns from your operator customers on their demand side or are they just trying to make smaller expenditures just out of caution?

Jim Tholen

Yeah, I think it’s the latter, is that they’re trying to – it’s a matter of CapEx, size of CapEx and CapEx deployment. So therefore do they take advantage of volume buying at the end of the quarter, as we’ve experienced the last couple of quarters, or are they more constrained overall, and therefore they just buy for near-term need.

Rich Valera – Needham & Company

Understood. Final one from me, just trying to understand if you guys understand how Verizon is positioning the BroadCloud-based Virtual Communications Express versus their IPSI product, which was based on your perpetual licensed BroadWorks platform, any sense of how those two have positioned together? And whether or not – I guess, this kind of goes a little bit back to the cannibalization question, do they overlap, and might one draw from the other?

Mike Tessler

I think it’s not wise for us to comment on how they’re positioning the various services. We have a number of services running in the Verizon network, and then obviously one that we’re running, so it’s – we don’t like to comment on how our customers are using those various services.

Rich Valera – Needham & Company

Maybe ask it another way. I mean, have you seen any impact on your demand for perpetual licenses for their IPSI offering based on the new Virtual Communications Express, or would it be too early to know at this point?

Mike Tessler

I think it’s way too early for us to know. We just – I mean, the service was launched on October 4, so don’t know.

Rich Valera – Needham & Company

Right. No, no, fair enough. Okay. Thanks, gentlemen.

Mike Tessler

Thank you.

Operator

Thank you. I show no further questions at this time and would like to turn the conference back to Mr. Michael Tessler for closing remarks.

Mike Tessler

Well, thank you. Thank you for being on the call today, and for your continued support. We look forward to updating you on the progress in the coming months. Thank you and good night.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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