Tekelec Q4 2007 Earnings Call Transcript

| About: Tekelec (TKLC)
This article is now exclusive for PRO subscribers.

Tekelec (NASDAQ:TKLC) Q4 2007 Earnings Call February 7, 2008 4:45 PM ET


Jim Chiafery - Director of Investor Relations

Frank Plastina - President and Chief Executive Officer

William H. Everett - Executive Vice President and Chief Financial Officer


Scott Coleman - Morgan Stanley

Brian Modoff - Deutsche Bank

James Falkoff - Robert Baird

Natarajan “Subu” Subrahmanyan - Sanders Morris

Roger [Kuchen] - George Weiss Associates

Todd Koffman - Raymond James

Larry Harris - CL King


Welcome everyone to the Tekelec fourth quarter 2007 earnings conference call. Conducting today’s call will be Frank Plastina, President and CEO; Bill Everett, Executive Vice President and CFO; and Jim Chiafery, Director of Investor Relations. (Operator Instructions) I would now like to introduce Jim Chiafery.

Jim Chiafery

I am joined today by Frank Plastina, President and Chief Executive Officer; and Bill Everett, Chief Financial Officer of Tekelec.

Hopefully by now, you have access to a copy of the slide of supplemental materials posted to our website tekelec.com. You can access the slides by hitting the link labeled Investors and then clicking on the Investor Relations homepage. From that location you can also access the press release issued earlier today.

As a reminder, there will be a telephone replay of this conference call available for seven days following the call. You may also listen to a rebroadcast on our website at anytime during the next 90 days. All of this replay and rebroadcast information can be found in the Investor Relations section of Tekelec’s website.

I should note that during the course of this conference call, we will make projections or other forward-looking statements regarding future events or the future financial performance of the company. I would like to caution you that such statements reflect the company’s current intentions, beliefs and expectations and that actual events or results may differ materially.

Please refer to the 2006 Form 10-K filed on February 27, 2007, the Q1, Q2 and Q3, 2007 Forms 10-Q and other documents the company periodically files with the SEC, as well as our recent press releases. These documents discuss important risk factors that could cause actual results to differ materially from the company’s projections or forward-looking statements.

Also, unless explicitly noted, all financial results and metrics during our call today are non-GAAP results from continuing operations and exclude the results of our SSG business unit for all quarters of both 2007 and 2006, as well as exclude the results of our IEX call center business for all quarters of 2006.

Please see the slides of supplemental material posted to our website for information reconciling non-GAAAP to GAAP measures.

With that said, I’d like to turn the call over to Frank Plastina.

Frank Plastina

This has been a year of tremendous progress for Tekelec and the results are reflected in today’s announcement. The highlights included the following. We simplified and strengthened our organization by evolving from a business unit structure to a single organization focused on portfolio integration and the acceleration of new product delivery.

We continue to expand our core signaling expertise. Just this week we announced the acquisition of Estacado Systems, a software development company whose leadership team was instrumental in the creation of SIP and many of its advanced features. The combination of our in-house expertise as well as the iptelorg and Estacado acquisitions has significantly enhanced our intellectual property associated with SIP in particular. As a result, we are well positioned to transition today’s networks to an all-SIP environment.

As a result of our continued investment in R&D, Tekelec filed 83 patent applications and was issued 42 patents during 2007. This increased our portfolio of issued patents to 160. The company expanded its geographic footprint by adding seven new customers in the fourth quarter and 23 new customers for the year, all outside of North America.

Tekelec gained market traction across our portfolio of major products. The company received orders from 30 customers for our newest performance management and monitoring release IAS 2.0. Of the 30, 18 were new performance management customers and 12 were upgrade customers, many of which are Tier 1 service providers.

We are again seeing momentum in our performance management and monitoring order book and are looking forward to 2008. We continue to see traction on our new products. We received orders for TekMedia from five existing Eagle customers in Q4 and in 2007 we initiated ten new customer trials with Tier 1 service providers for TekCore, TekMedia and TekPath, six of those in the past six months.

During Q4 of 2007, we significantly exceeded our expectations for order input. In fact, it was a record quarter. We had our strongest quarter ever for orders in our North America and CALA regions.

Orders for Q4 were $186.2 million up 34% from $138.4 million in Q4 of last year and up from $109.2 million in Q3 of this year. Orders for all of 2007 were $459.2 million up 16% compared to $396.1 million last year and this set a new annual record. This order growth resulted in a book-to-bill ratio of 1.62 for the quarter and 1.06 for the full year. Our backlog at December 31, 2007 stands at $417 million compared to $346.1 million in September and $389.6 million at December 31, 2006.

We maintained a very strong balance sheet in 2007 and we generated over $52 million in cash flow from continuing operations during the year. After completing our $50 million stock repurchase program, we ended the year with $419.5 million in cash and investments and $302.3 million in working capital.

I will now turn it over to Bill, who will go into more detail on the results for this past quarter.

William H. Everett

I’ll provide some additional comments on our fourth quarter and full year results. In addition, I will give our annual guidance for 2008. First, let me provide more detail on the results from continuing operations for the fourth quarter.

Please refer to Slides 4 to 12 which provide both our GAAP and non-GAAP results for the fourth quarter and full years 2007 and 2006, along with the associated reconciliations. Unless otherwise stated all of our financial metrics represented on a non-GAAP basis from continuing operations.

Revenue for the fourth quarter 2007 was $115.2 million compared to $125.1 million for the fourth quarter of 2006.

We generated consolidated gross margins of 62% and net income from continuing operations of $14.9 million, or $0.21 per diluted share during the fourth quarter of 2007. This compares to gross margins of 56% and net income from continuing operations of $17.4 million or $0.24 per diluted share for the fourth quarter of 2006.

Operating margin from continuing operations for the fourth quarter of 2007 was 15% compared to 11% in Q4 of last year. Revenue for 2007 was $431.8 million compared to $443.3 million for 2006.

For 2007, we generated consolidated gross margins of 61% and net income from continuing operations of $48.3 million, or $0.66 per diluted share. This compares to gross margins with 61% and net income from continuing operations of $54.2 million, or $0.75 per diluted share for 2006. Operating margin from continuing operations for 2007 was 13% compared to 15% in 2006.

In the fourth quarter of 2007, we had three customers which each represented more than 10% of our total revenue, Orange Group, Telecom Italia and Carso Global Telecom, which includes the America Moviles and Telmex group of companies. For the full year 2007 we had three customers which each represented more than 10% of our total revenue, Carso Global Telecom, AT&T and Orange Group.

As Frank previously mentioned, we established a functional organizational structure in the third quarter, and as a result, we now have a single reporting segment. Therefore, we are reporting our operating results only at the Tekelec consolidated level. However, we do provide comparative revenue detail for our major product categories.

Please refer to Slides 21 through 24 for a breakdown of our revenue by the respective product and service categories for the last eight quarters. As a result of the change in our reporting structure, we have also a changed our product and service revenue reporting to report separately the first year warranty, which is included in the price of the product and related installation services.

The amounts allocated to these items for accounting purposes had previously been reported as a component of certain of our product revenue. These amounts have been reclassified in the prior year and earlier quarters of the current year to report revenue on a consistent basis.

Under our revenue categories, total product revenue for fourth quarter of 2007 was $83.3 million compared with $92.7 million in Q4 of last year. The major reason for this decline was the decrease in performance management and monitoring product revenue as a result of the delay in getting our new version of IAS into the marketplace in the second quarter of 2007.

However as Frank noted, orders for our performance management and monitoring products were strong in the fourth quarter and in fact were a record for this product line.

On a full year basis, total product revenue of $303.7 million was down 8% compared to $329.2 million in 2006. Warranty and extended warranty revenue in the fourth quarter of 2007 was $18.7 million, up 2% compared to $18.4 million in the fourth quarter of last year. Professional and other services revenue was $13.2 million, down 6% from the same period one year ago.

For the full year 2007, warranty and extended warranty revenue of $71.6 million was up 6% compared to $67.5 million in 2006. Professional and other services revenue of $56.5 million was up 21% compared to $46.7 million in 2006. Our warranty revenue continues to grow as a result of the continued expansion of our installed base of customers.

The increase in services revenue in general is due primarily to our success in obtaining new customers, particularly in international markets. New customers require a greater amount of installation, training and other professional services at the initial stage of deployment of our product.

Next, I would like to comment on the geographic breakdown of revenue and our continued strong international performance. Slides 18 through 20 provide a breakdown of revenue by region.

During the fourth quarter of 2007, revenue outside North America represented 62% of our total revenue. Specifically, revenue from the EAAA and CALA regions represented 36% and 26% respectively of total revenue compared to 55% and 12% in the same period of 2006.

For the full year 2007, revenue outside North America represented 57% of total revenue compared with 47% in all of 2006. We expect international orders and revenue will continue to represent more than 50% of our consolidated total over the long term.

Now let me turn to consolidated gross profit margins. The company’s consolidated gross profit margins were 62% in Q4 of 2007 compared to 56% in Q4 of 2006 and 66% in Q3 of 2007. Consolidated gross margins were 61% for the full year 2007, essentially flat with last year.

Our strong gross margin performance in the fourth quarter of 2007 compared to the fourth quarter of 2006 was due primarily to a shift in revenue mix from lower margin monitoring products to higher margin signaling products, particularly extension and upgrade revenue related to our Eagle platform. These higher margin transactions were offset in part by higher service costs on international contracts.

R&D expenses for Q4 of 2007 were $22.6 million compared to $19.4 million in Q4 of 2006. For the full year 2007, R&D expenses were $89.4 million, compared to $73.5 million in 2006. This increase in R&D spending was due primarily to investments in developing transitional products to help our customers deal with network interoperability and protocol mediation issues, and to assist them in migrating to next gen networks.

In addition, our success in winning 23 new customers outside North America this year has required investment in ITU feature development to respond to international customer requirements.

Sales and marketing expenses were $18.2 million in Q4 of 2007, down from $19.2 million in Q4 of 2006 and up from $15.8 million in Q3 of this year. The decrease over the prior year is due primarily to reduced sales commissions due to lower revenue relative to last year. Our sales and marketing expenses increased sequentially due to traditional fourth quarter trade show activity and higher commission expense.

For the full year 2007, sales and marketing expenses were $69.2 million, compared to $70.8 million in 2006, reflecting lower marketing and advertising related expenses in 2007 relative to the prior year.

G&A expenses were $13.3 million in Q4 of 2007, compared to $18.8 million in Q4 of 2006 and $10.7 million in Q3 2007. The decrease over the prior year was due primarily to reductions in bad debt expense, personnel-related expenses, and lower professional fees. The increase sequentially was due to principally to increase bad debt expense of $1.4 million, certain one time IT costs and increased incentive compensation.

G&A expenses were $46.8 million in 2007, down 21% from $59 million in 2006, due primarily to reductions in personnel-related expenses, bad debt expense, and professional fees.

We continue to benefit from cost control initiatives and resulting reductions in operating expenses. With the decrease in our G&A expense we have been able to fund our increased investment in R&D, resulting in only a modest increase in overall operating expenses.

Our GAAP financial results for the quarter include the impact of stock-based compensation under FAS 123(NYSE:R). Pre-tax stock-based compensation from continuing operations for the fourth quarter was $3.6 million compared to $5.2 million in Q4 of 2006, and $3.4 million in Q3 of 2007. Pre-tax stock-based compensation from continuing operations in 2007 was $15.7 million compared to $20.6 million in 2006.

We have provided a summary of the impact of stock-based compensation from continuing operations by line item on Slides 25 and 26.

Total stock-based compensation from continuing operations is declining due primarily to changes in our equity compensation policies. Our stock options, stock appreciation rights, and restricted stock units outstanding have been reduced by approximately 53% since the beginning of 2006. This has resulted in a decline in our stock option overhang to approximately 16% at December 31, 2007. We define the stock option overhang as outstanding common stock equivalents divided by common stock outstanding.

The company incurred $1.8 million dollars of restructuring costs in Q4 in connection with completing the previously announced realignment to a functional organization. The cost savings from this restructuring is reflected in our 2008 guidance.

We exited the fourth quarter with a very strong balance sheet. Please refer to Slide 27 for certain key balance sheet metrics. After completing our $50 million stock repurchase, cash and cash equivalents and short-term investments at the end of the fourth quarter totaled $419.5 million, down from $431 million at the end of September and down slightly from $424.4 million at the end of the 2006.

Accounts receivable were $147.1 million at the end of December, up from $109.8 million as of September 30, 2007, and up from $133.1 million at December 31, 2006. The year-over-year increase in receivables reflects increased billing activity late in the quarter, due to the high volume of book/ship business and the billings related to the high volume of orders received during the quarter.

The increase sequentially is due principally to the high volume of orders in the fourth quarter and the seasonally high billings associated with renewals of our extended warranty offerings.

Our DSO at the end of December was 69 days compared to 60 days at December 31, 2006. This higher DSO reflects in part slower moving billing and collection terms on our international customer contracts, which are becoming an increasingly larger part of our total orders and revenue stream.

For 2007, we generated positive cash flows from continuing operations of $52.5 million compared to $45.4 million in 2006. In Q4, we generated positive cash flows of $25.8 million from continuing operations compared to positive cash flows of $33.8 million in Q4 of last year.

We are providing our initial guidance for full year 2008 orders, revenue, non-GAAP consolidated gross margins, and GAAP and non-GAAP EPS. We estimate revenue for the full year 2008 will range from $455 million to $465 million and that the book-to-bill ratio will be approximately 1 to 1. This forecasted revenue range represents revenue growth of approximately 5% to 8%.

We expect non-GAAP consolidated gross margins for the full year will range between 59% and 61% and non-GAAP EPS will range between $0.72 and $0.76 per diluted share for 2008. This represents non-GAAP EPS growth of approximately 9% to 15%.

We expect our non-GAAP effective tax rate will range between 28% and 30% and that the share count used to calculate diluted non-GAAP EPS will be approximately 72 million shares. Finally, we expect GAAP EPS will range between $0.55 and $0.59 per diluted share. Please refer to Slide 28 for our GAAP and non-GAAP guidance for 2008 and the associated reconciliations.

We further expect the quarterly distribution of our orders will be similar to that of 2007 resulting in orders being significantly higher in the second half of the year than in the first half. Additionally, we expect our revenue to follow a similar pattern to that of 2007. As noted previously, we continue to expect volatility in our quarterly revenue and operating results as a result of applying the residual method of accounting for revenue recognition.

I will now turn to Frank for some additional comments.

Frank Plastina

We continued our focus on execution in the fourth quarter and delivered strong results reinforcing our strategy. We view the quarter and full year result as a positive step in extending our leadership position in core signaling solutions as well as building momentum for related network applications such as number portability, performance management and monitoring, flexible routing and messaging.

As I noted at the beginning of the call, during 2007 we evolved from a business unit structure to a functional organization, improved our product planning as a result and streamlined our operations. As networks continue to migrate, our customers depend on us to provide them with the industry’s most advanced signaling solutions.

Customers are buying from Tekelec due to our depth of knowledge and track record as well as our ability to support a transition to the next generation network at the pace dictated by their business needs. We added 23 new customers during the year and seven new customers in the quarter.

Of those seven customers, four purchased signaling, two purchased both our signaling and performance management and monitoring solutions and also we had a Tier 1 service provider purchase our performance management and monitoring solution independent of signaling.

As a reminder, the Tekelec performance management and monitoring solution delivers monitoring plus the network visibility required to ensure that traffic is managed properly and routed in the most efficient and cost-effective manner. Tekelec also had its largest performance management and monitoring order quarter in history in Q4. We achieved this performance milestone on the strength of the IAS 2.0 solution. We now have 30 customers who have purchased or upgraded to IAS 2.0.

The key selling points included improved multi-protocol, end-to-end call tracing and a flexible architecture that enables the creation of prepackaged key performance indicator reports in addition to custom reports. The solution can be deployed on multiple server platforms enabling customers to reduce footprint and power consumption.

For the total year, we added 23 new customers covering Asia, Africa, Europe, Central America, the Middle East, and the Caribbean. Tekelec’s products are now in 66 countries across the world and in 17 of the top 20 growth countries as ranked by expected new wireless subs additions in the Pyramid Research October 2007 report, “The Next Billion”.

In addition to signaling and performance management and monitoring, we also have momentum with our network transition solutions. Specifically, we have secured TekCore trials with six Tier 1 service providers. Two of these customers are testing our TekCore’s CSCF solution to support IMS based applications. Four of the trials include our TekCore SIP Signaling Router, our SSR solution which addresses transition challenges service providers face in operating and evolving next generation networks.

The TekCore SSR is an IETF standards based product and the standard was co-authored by one of the individuals who have just joined us as a result of the acquisition of Estacado Systems. Our customers want the flexibility to choose best-in-breed solution elements that fit their evolving business requirements. Standards-based equipment ensures they are not locked in to any one solution or vendor.

As we mentioned on last quarter’s call, one of our TekCore SSR engagements is with the subsidiary of a global European based carrier. Their current challenge is network integration and service interoperability between their fixed and wireless networks, including SIP based application servers.

The challenge in operating a transitional network is the complexity of managing many SIP variants and multiple network elements. TekCore addresses the network complexity by providing protocol mediation and a consolidated operational view of the entire network. TekCore also serves as a session layer router used to interconnect MSC servers to SIP-based PBX call servers, and IP Centrex.

This deployment is an example of an application that we believe will drive demand for the TekCore SSR. Most importantly, the TekCore SSR enables the eventual migration to IMS via a software upgrade to the TekCore CSCF. It solves a customer need now, and it positions the network for the future. This is one example of many of the transitional challenges we expect to solve with our TekCore solution.

We also expanded our messaging market footprint in 2007 with five new customers for our TekMedia solution. Also, two more Tier 1 customers are in trials for our TekMedia based SMS firewall solution. TekMedia’s modular design enables service providers to deploy specific functionality they need as well as the flexibility to add newer SMS capabilities like firewall support for spam control and anti-spoofing.

TekMedia is also being deployed by our customers to handle SMS Mobile Advertising. The TekMedia SMS Mobile Advertising application enables the service provider to add predefined text randomly to mobile terminated SMS messages from different advertisers or sponsors. This opt-in feature provides the ability to offer incentives to subscribers to have their message sponsored by advertisers. Moreover, this new application allows the service provider to increase the revenue they generate from SMS.

Our ongoing investment in number portability solutions has enabled us to continue winning orders as countries mandate number portability. During 2007, Mexico and Brazil mandated number portability and Tekelec was well positioned given our base of Eagle signaling solutions in those countries. Tekelec sold its number portability solution into 10 new countries during 2007 including Mexico and Brazil. We have now sold our number portability solution into 27 countries around the world.

In addition to these new mandates, we are also seeing service providers begin to upgrade their legacy number portability systems creating a replacement opportunity for us over the next few years. While number portability is all about subscriber routing information within the PSTN, ENUM is all about subscriber and network routing information in the IP world. We are now transitioning our expertise in number portability to ENUM through our TekPath solution.

A Tier 1 North America wireless service provider deployed our TekPath ENUM solution for their IMS trials during 2007. ENUM, or electronic number mapping, essentially bridges PSTN and IP networks by assigning an IP address to the telephone number enabling the seamless delivery of calls between the two domains.

We are also contributing significantly to the development of an ENUM provisioning specification that will be published this month. This spec supports inter-operator exchange of VoIP peering routing addresses.

In closing, we view the fourth quarter and total year results as a solid foundation for the future. We have continued to build on our leadership position in core signaling solutions with our new customer wins. Our focus on the IAS performance management and monitoring portfolio resulted in a record quarter for orders for that solution and, as we discussed we are also gaining traction with our new solutions.

I will now open the call for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Scott Coleman - Morgan Stanley.

Scott Coleman - Morgan Stanley

In terms of the orders this quarter, I’m wondering if you could help us understand how the strength there matches up with your customer strength from 10% customers this quarter. Was it mainly the same three customers you named out or where there some folks that you didn’t name that really drove the growth that we should see on that 10% customer list as we go through ‘08?

William H. Everett

We had three customers both for the quarter and for the year and they were largely the same with the exception of AT&T for the year. They ranged between 10% and 13%, so no customer is more than 13% of either our quarterly or annual revenues.

Scott Coleman - Morgan Stanley

That’s for both the quarter and the year.

William H. Everett

Yes. That’s correct. Now, with respect to the other part of your question about, were there other important customers that were driving our order book? Not numerically, not statistically, but Frank may want to comment on some of the other customer wins we had.

Frank Plastina

Scott if you look at our order book it’s pretty well spread across the large groups, particularly the wireless service provider groups around the world. What we really in particular were pleased with in the fourth quarter was the breadth of the order book both CALA and North America had record orders. And our European and Asia region also did well and that translates into a nice breadth of customer group as well.

Scott Coleman - Morgan Stanley

I’m just curious from a bigger picture perspective. Wireless infrastructure generally speaking has been very disappointing, a very disappointing market in 2007. From where you sit, is this is a leading indicator of a change in terms of whether it is capacity utilization or something that could drive a stronger overall market as we move into 2008?

Frank Plastina

I think to really answer your question you have to separate access and core spending. There clearly was a slowdown on the access piece of the network. What we depend on is traffic growth and sub growth which is really what drives the needs of the core.

We didn’t see as big a change in CapEx budgets or focus on the core. In fact we saw more interest in handling some of the complexity that all of these multimedia services are leading to. So what we are seeing is quite the opposite, we are seeing an emphasis back to the core bus service providers because they see that as their competitive advantage and we see them trying to share access as much as they can even with their competitors.


Your next question comes from the line of Brian Modoff - Deutsche Bank.

Brian Modoff - Deutsche Bank

Frank, in talking about this large carrier that you’re doing, the signaling for with TekCore in Europe, you were supposed to have installed some boxes into their network in Q4 and be up and running in live traffic in the front half of this year. Can you give us a status on that? What do you think the implications of that win could be if it proves to be successful with other vendors or other carriers in Europe?

On performance and management, how do you think that is going to play out this year, obviously you had a bit of a down year, down 25% in revenues this year from last on a cumulative basis. Yet you seem to be saying you are seeing some good order trends there, how do you see that shaking out in ‘08?

Frank Plastina

On the TekCore question, it is a European based global carrier, the subsidiary is actually in the CALA region just to be clear on that one. We have installed the units. It is the TekCore SSR functionality that is being deployed. What we are working with now is we are essentially in between the MSC vendor and the IP PBX vendor in that network, and working all the interoperability challenges with that.

We’re pretty far along, we think we are going to go to live or cut to live traffic this quarter. So we’re actually doing quite well. It is installed and it is being tested vigorously right now. So that’s the status of that one.

We also added, as I said on the call, five other TekCore trials over the past six months or so. So we’re getting some pretty good momentum on the trial stage, which for us, in terms of our selling cycle is absolutely crucial to proving in the concept and proving in the technology and making everybody very comfortable that this particular product is hardened enough to put into the core of their network.

On IAS, really what happened was we had that slowdown in the first half of ‘07 due primarily to not getting IAS 2.0 out in the timeframe that we had planned originally. That’s delayed our order book.

The good news is we managed to keep the customers with us and we got that order book flowing again in the fourth quarter. We didn’t lose momentum to the competition. We were able to hold onto the customer base and then upgrade them when IAS 2.0 was available. That translated into a record order book in the fourth quarter. We now see a nice funnel building and we like the prospects for 2008 for monitoring.

William H. Everett

If you look at the product revenues you see that the product revenues are lower in ‘07 versus ‘06 and that’s largely because of the delays that Frank talked about, in terms of introducing the new product. But just I think to address the question you are probably thinking about but not really asking, is what does this mean in terms of total orders, and our total order book in this product line this year was essentially the same as last year. It was a very strong fourth quarter.

So moving into 2008, we have momentum in terms of the orders picking back up again, and what you’re really seeing in terms of revenue is the time delay as a result of the lower orders in the first half of the year.


Your next question comes from the line of James Falkoff - Robert Baird.

James Falkoff - Robert Baird

My question is on North America. Two quarters ago, you had a shortfall there and now you’ve got record orders. What have been the triggers that have caused things to improve and what are your feelings on the sustainability of that?

Frank Plastina

We think it’s primarily base demand on traditional signaling. We saw a pickup in the second half, both on book/ship business and new orders with all of our major wireless service provider customers in the US, and they include AT&T, Verizon and T-Mobile in particular. All of their businesses are doing quite well. Their net subs continue to grow, and more importantly their traffic continues to grow, both SMS and voice traffic.

That’s playing into our core strengths and our traditional strength in signaling. We also continue to try to up sell that base of customers with some of our new products, and we did start having some initial success on IAS and monitoring into those Tier 1 customers as well. So, it’s a combination of the two. It’s really fundamental base demand for signaling extensions and then some of our new products gaining some traction.


Your next question comes from the line of Natarajan “Subu” Subrahmanyan - Sanders Morris.

Natarajan “Subu” Subrahmanyan - Sanders Morris

My question was on orders for the full year calendar ‘08. You are looking at a book-to-bill approximately flat after a very strong orders growth year this year based on the fourth quarter. Can you talk about trends in orders? Was there were some pent-up demand which caused 4Q to be that strong? And what you would expect in terms of order trend and why you do not expect some growth in calendar ‘08?

Frank Plastina

Subu, our orders guidance is really based on what we’re seeing in the marketplace today and what we are hearing from our customers. It factors in the strong 2007 second half order input. There is no question customers are still clearly being careful about CapEx spend.

However, there is also a focus on handling the traffic and complexity at the core of the networks, generated by the move to higher bandwidth and multimedia applications as I mentioned earlier. This latter requirement is creating a healthy funnel for our current and next gen products, as you’re seeing in the higher trial activity.

How quickly we turn that into orders is still a challenge for us to guess. I think the best way to put it is the funnel remains healthy and we were able to turn a lot of those funnel opportunities into orders in the second half of ‘07. We are going to continue to try to do that in ‘08.


Your next question comes from the line of Roger [Kuchen] - George Weiss Associates.

Roger [Kuchen] - George Weiss Associates

Could you clarify the equity ownership of some of the non-core assets such as GENBAND and BroadSoft? What is the strategy and timing of potential monetization of these assets?

Frank Plastina

In terms of the two, the BroadSoft and GENBAND, we’d love to monetize those as quickly as possible. We don’t hold them for any strategic reason. I think that’s something that we said in the past. They really are just held on the balance sheet now for investment purposes. We will monetize them when the opportunity arises.

The market for new offers in telecom equipment is not very robust right now. So I’m not sure what the timing will be, but we feel they are both very good assets. They are being carried on our books at we feel a pretty low book value. So we are looking forward to making some gains and monetizing them over the next few years.

Roger [Kuchen] - George Weiss Associates

Could you remind us what the equity stake is?

Frank Plastina

In BroadSoft it is just under 10%; and in GENBAND, it’s 19.9%.


Your next question comes from the line of Todd Koffman - Raymond James.

Todd Koffman - Raymond James

What is the timing at which something that’s sitting in backlog would get recognized over?

William H. Everett

Todd, it varies depending on two factors. One is what major product line it’s in and then secondly what region it’s in. Generally speaking, we use an average it depends between six to nine months depending on the circumstances. Obviously some convert faster if it’s book/ship revenue.

But IES products tend to have a longer conversion cycle because there is more time required at the customer site to do the installations and to configure it so it meets the customers’ network configurations, and on more of the traditional STP signaling products, the conversion rate is little quicker. But our international customers take a little longer.

Domestic customers are much quicker because they are a much more mature customer base in terms of our products. So depending on as I said depending on the mix of products, it is anywhere from six to nine. It could be as long as 12 depending on the circumstances and the location of the customer.

Todd Koffman - Raymond James

Could there be any of the backlog that goes beyond 12 months?

William H. Everett

It’s possible. Sometimes there is a little bit that carries over, but that would be because there is an unusual circumstance in getting a customer acceptance. For example, we have one this year in Pakistan where it has been difficult given the circumstances to actually get the acceptance. So it’s been in backlog for more than 12 months. But generally speaking, most of our backlog converts to revenue in 12 months.


Your next question comes from the line of Larry Harris - CL King.

Larry Harris - CL King

Looking to cash flow in fiscal ‘08, are there any particular items be it changes in capital spending or particular milestones with respect to software releases that could have a significant impact on cash flows? And also I noticed, of course you’ve completed the share repurchase program. What are your current thoughts with respect to the possibility of acquisitions?

William H. Everett

With respect to cash flows in 2008, just as a jumping off point, we had about $52 million of cash flow from operations, continuing operations in 2007. So, that’s I think the right benchmark in terms of a starting point for looking forward. And based on normal growth in our business, we would expect some improvement in that over a little bit in 2008 versus 2007.

There are really no structural differences assuming for a second we don’t do another stock repurchase program, the CapEx levels and the conversion rates for receivables into cash and our payable structure and so forth. The working capital components are not significantly different.

I would say each year as we’ve increased the percentage of our business that’s being done overseas with particularly Tier 1 carriers in international markets; we tend to have less favorable billing and collection terms. But a lot of that, I’d say is baked into our existing cash flows that we are reporting today. So, there will be a little pressure in that direction, but largely as our business grows, we would expect it to generate some additional cash as we move forward.

Frank Plastina

Regarding the acquisition part of your question, Larry, our strategy hasn’t changed. We still are focused on smaller tuck-in type acquisitions in the $25 to $50 million range. We purchased Estacado. That one is significantly below that amount; that was actually less than $5 million.

But it fits into what we’re trying to accomplish, meaning if there is an opportunity out there us to buy intellectual property or knowledge or a team that has some specific knowledge that enhances our story, and that story is defined as anything having to do with that signaling and control area of the network, then we will take a hard look at it.

We see the opportunities continue to grow in that part of the network. We see from all our customers a lot of questions, a lot of concerns on how they will handle the onslaught of additional complexity that multimedia applications add to a wireless network that has tens of millions of users. That’s really the challenge that they need to solve, and that’s the challenge that offers the opportunity for Tekelec because that’s really what we do best.


Your next question is a follow-up question from the line of Brian Modoff - Deutsche Bank.

Brian Modoff - Deutsche Bank

In terms of if you are looking at ‘08 and ‘09, what do you think the split would be between your TekCore product and your traditional Eagle STP products? How would you see that playing out this year and next?

And then in terms of a trigger to upgrade to TekCore CSCF function with your SSR solution, what would be the trigger that would cause an operator to say we are going to do an upgrade to CSCF function in our network and we are going to use Tekelec? What would drive them to do that?

And then can you give me if you would a regional breakdown of what you are seeing by region in terms of interest level between your various TekCore products, SSR and messaging, and what are the drivers for that?

Frank Plastina

In terms of Eagle versus TekCore no question the near term revenue opportunity is still Eagle. In fact, the new customers that we brought on in the fold in 2007, those are still being handled with Eagle and a lot of the opportunities, at least in the near term were just enhancements to the Eagle that offered or allowed us to break into various networks.

There are still a lot of legacy signaling platforms out there that cannot evolve even to SIGTRAN alone SIP. That opportunity for us to take that install base away from the legacy Alcatel and Nortel Lucent type of equipment is still there. And that’s really what is driving a lot of the new customer business.

The evolution story on Eagle, which evolves to that TekCore IMS environment, is really what’s driving the decision towards Eagle. That story is superior to what Huawei is offering or some of the other signaling competitors that we are facing today.

In terms of why a customer would want to go from SSR to IMS or what the driver would be, it really would be application driven. It would be the service need that forces them to somehow combine the legacy environment with the all-IP environment. If they are staying in an all IP environment and don’t really want to bring in some of the legacy applications, they may just use TekCore for SSR and some other all-IP type features. SSR as you may recall is an all IP story.

It’s taking SIP, one SIP variant and doing the mediation and converting it to another SIP variant, so a MSC Softswitch can talk to an IP PBX, that’s an all IP story. If somehow an 800 number service or some legacy service needs to be brought into that fold, that would trigger the software upgrade to TekCore as a CSCF in a 3GPP architecture type of view.

In terms of regional breakdown, it really isn’t a regional story it’s more of a customer story. To the extent that a particular market and customer have subsidiaries or sister companies rather that have both fixed and wireless components, we are seeing more traction with the TekCore story there because they are dealing with ways for those fixed and wireless networks to talk to each other. That has been a bigger driver than the standalone wireless entities or the standalone fixed entities.

The second type of customer that is going towards TekCore is the standalone wireline entity and the reason for that is they are trying to do some convergence type of services such as fixed mobility that allows them to start getting some wireless traffic back onto their network if they don’t have a sister company that’s wireless.

And if it’s a wireless company standalone that doesn’t have a sister company that’s fixed, that would probably be the third grouping and probably the type of company that would go to IMS later in the cycle.


There are no further questions.

Frank Plastina

I would like to thank all of you for participating on the call today. And I would like to thank all of you for your continued interest in Tekelec. We are very pleased with the progress we have made and we believe that the signaling control layer of the network will be an area of focus and investment for service providers around the world. And accordingly we will continue to tailor our investments to meet that need. Thanks again.

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


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