Ribbon Communications Inc. (RBBN) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Monday, July 29, 2013. I would now like to turn the call over to Patti Leahy. Please go ahead.

Thank you, and good afternoon, everyone. Welcome to Sonus Networks' Second Quarter 2013 Operating Results Conference Call. As a reminder, today's press release and supplementary financial and operational data have been posted to our IR website at sonus.net. A recording of this call and a copy of our prepared remarks will be available there as well later this afternoon. Speakers on the call today are Ray Dolan, President and Chief Executive Officer; and Moe Castonguay, Senior Vice President and Chief Financial Officer. Please note for purposes of Safe Harbor provisions that during this call, we will make projections and forward-looking statements regarding items such as future market opportunities and the company’s financial outlook. Actual events or financial results may differ materially from these projections or forward-looking statements, and are subject to various risks and uncertainties, including without limitation, economic conditions, market acceptance of our products and services, the timing of revenue recognition, difficulties leveraging market opportunities and the impact of restructuring activities. A discussion of these and other factors that may affect future results is contained in our most recent Form 10-Q filed with the SEC and in today’s earnings release, both of which are available on our website. While we may elect to update or revise forward-looking statements at some point, we specifically disclaim any obligation to do so, unless required by law. During our call, we will be referring to certain GAAP and non-GAAP financial measures. A reconciliation of the non-GAAP to comparable GAAP financial measures is included in our press release issued today, as well as in the Investor Relations section of our website. With that, it's now my pleasure to introduce the President and Chief Executive Officer of Sonus, Ray Dolan.

Thank you, Patti, and good afternoon, everyone. I'm very pleased to announce another solid set of results. Sonus delivered a strong quarter in which we exceeded most of the guidance we gave back in April and also raised our revenue and EPS outlook for the full year. We are making steady and significant progress towards our principal goal to transform Sonus to an SBC-centric profitable growth company. Moe will take you through the full details of the quarter and our outlook in a moment. But first, I'd like to provide some comments regarding today's press release, in which we announced a number of other important developments at Sonus. I will address our key performance metrics and stock buyback program announced today in my closing remarks. Turning to the topic of management transitions. As announced today, Moe will be stepping down as CFO once the board and I have identified the right successor. I'd like to take this opportunity to express my sincere thanks to Moe, who has agreed to stay on through the year end close period, if that is necessary, to help ensure a smooth transition. Moe has been instrumental in a number of important accomplishments since joining us in the summer of 2011, and I believe our results reflect that. Some of these accomplishments include successfully buying and integrating NET, strengthening our internal processes, improving our forecasting capabilities and lowering our cost structure. With the help of Moe's leadership, we've taken decisive steps to drive cost out of our business. One particularly bright spot is in our services gross margin, which have improved dramatically over the past year and are now at 57% in Q2, a full 11 percentage points higher than the second quarter of 2012. Much of the progress in services is due to the leader of the services group, Matt Dillon, who's also stepping down as announced today. Matt's departure comes after 12 years of dedicated leadership at Sonus. He and his team can be very proud of what they've accomplished, knowing that our global services organization is in an excellent position to succeed in supporting not only our core carrier customer base, but also a rapidly-growing enterprise customer base. So I'd like to take this opportunity to thank both Matt and Moe and wish them the very best in their future endeavors. Change of course also brings opportunity. Along these lines, I'm pleased to announce that Peter Polizzi has been named as Matt's successor. Peter brings a proven track record of success leading technically-advanced multinational operations at companies like Motorola. I'm thrilled that we have someone of his caliber who can step in immediately and lead the services organization. Sonus is now a far more focused and successful company, in part due to strong leadership. But like any prosperous company, our success isn't tied to just a few people. It's the result of the 1,000-plus individuals who wake up each day figuring out how we can accelerate our growth, compete more effectively, remain strategic to our customers and partners and ultimately, drive greater value for all our stakeholders. Sonus has a firm foundation in place, and I am confident that our best days are ahead of us. I'll now turn the call over to Moe to review our financials and outlook in more detail.

Thank you, Ray. Good afternoon, everyone. Before I provide the results, I want to take a moment to reflect on my planned departure from the company. The past 2 years have been exciting and highly rewarding for me personally. I've been able to work with a great team and board. And I'm deeply grateful for having had that opportunity. It has also been a pleasure speaking with our shareholders and the investment community. There's a strong foundation in place at Sonus and the time is right for me to explore my next challenge. I look forward to continuing in my role until my successor is named, and I'm committed to working closely with Ray and the board to identify a new CFO and ensure a seamless transition. Now turning to our Q2 results. Total revenue for the second quarter was $69.2 million, compared to $63.3 million in the first quarter and $57.6 million in the second quarter of 2012. Total SBC revenue, including products and services, was $29 million in the second quarter, $30 million in the first quarter and $19.1 million in the second quarter of 2012. Our top 5 revenue customers represented 47% of revenue this quarter, down from 50% in the first quarter and down from 54% in the second quarter of last year. We reported 2 10% customers in the quarter, Verizon and AT&T, both of which purchased SBC products and services. We reported revenues from 539 customers in the second quarter. This compares to 541 customers in the first quarter. Looking at revenue geographically, domestic revenue accounted for 74% in Q2, compared to 69% in Q1 and 73% in Q2 of 2012. Before I go into further details on our financials, I'd like to point out that the following are non-GAAP numbers that excludes stock-based compensation, acquisition costs, restructuring charges and write off and amortization of intangible assets. Total gross margin for the second quarter was 64.8%, compared to 61% in the first quarter and 57.4% in Q2 of 2012. Our second quarter performance reflects improvements in both product and service gross margins. Product gross margins for the second quarter was 69.9%, compared to 64.9% in the first quarter and 66.3% in Q2 of last year. Product gross margins can fluctuate quarter-over-quarter based on software content and product mix, but clearly improving on an annualized basis. Service gross margin for the second quarter was 56.6%, compared to 55.4% in Q1 and 45.7% in Q2 of last year. Total operating expenses for the second quarter were $41.5 million, compared to $44.7 million in the first quarter and $41.7 million in Q2 of last year. Consolidated headcount at the end of the quarter was 1,039, compared to 1,042 at the end of Q1. Net income for the quarter was $3.2 million, this compared to a net loss of $6.4 million in the first quarter and a net loss of $8.6 million in Q2 of 2012. We ended the quarter with total cash and investments of $304 million, which is significantly better than forecast and a good indication we are making progress towards our goal of generating cash from operations for the full year. Our DSO for the quarter was 52 days, compared to 71 days in the first quarter. The improved DSO in the second quarter reflects excellent collections and improved linearity of shipments. I would like to provide more details for our outlook for the third quarter ending Friday, September 27 and for the fiscal year ending December 31, 2013. I will remind you that the outlook provided in the press release is also available on our IR website. Total revenue outlook for the third quarter is anticipated to be between $68 million and $72 million. We are raising our fiscal year 2013 revenue outlook to between $274 million and $278 million. Included in third quarter outlook is anticipated total SBC revenue of $28 million to $32 million. Total SBC revenue for the fiscal year remains unchanged at a range of $120 million to $124 million, reflecting year-over-year growth of approximately 40%. With regards to the second half of the year, as we told you on the last quarter's call, we continue to expect our fourth quarter to be our strongest quarter, representing over 30% of our SBC product revenue, as was the case in the fourth quarter of 2012. Turning to our legacy product revenue outlook. We currently expect an annual decline of approximately 25% in our media gateway product revenue, which implies roughly $65 million of legacy product revenue in fiscal 2013. This reflects a slight improvement from our prior outlook, which called for a decline of approximately 30% in fiscal 2013. Turning to gross margins. For the third quarter, we expect total non-GAAP gross margins to range between 64% and 65%. For the full year, we continue to expect non-GAAP gross margins of between 64% and 65%, reflecting continued streamlining of manufacturing and service operations and lower component subassembly cost. For the third quarter, we expect non-GAAP operating expenses to be between $42 million and $43 million. The slight increase from Q2 primarily reflects an increase in product development and related costs. Total non-GAAP operating expense outlook for fiscal year 2013 remains in the range of $171 million to $172 million. For the third quarter, we expect non-GAAP earnings per diluted share of $0.01. And for the full year, we have increased our profit estimate and now expect non-GAAP earnings per diluted share of $0.01 to $0.02. Fully diluted share count for the third quarter is anticipated to be approximately 287 million. Full year weighted average diluted shares are expected to be approximately 286 million. We expect to be cash flow positive from operations in 2013, with third quarter ending cash and investments of $300 million to $305 million, excluding any reduction related to possible stock buybacks. We expect year-end cash and investments of $305 million, again excluding any reduction related to possible stock buybacks. With that said, I'll now turn the call back over to Ray.

Thanks, Moe. I'd now like to review our progress with the 4 key performance metrics for 2013 that we identified to you at the start of the year. Turning first to SBC growth. SBC product revenue and SBC total revenue were both up over 50% year-over-year, which is great progress. Looking forward, we have provided a slightly broader range than normal for SBC guidance in the third quarter. This guidance accounts for the possibility that a couple of transactions could score either in Q3 or Q4. Our full year outlook remains the same and for a third straight year, our SBC business is on track to substantially outpace market growth. The next key operational metric I will discuss is new customer growth. We secured 190 new customers in Q2, 85% of which are new SBC customers. This marks a quarterly record for new customers and further validates that we are winning in the marketplace. I'm pleased by the raised awareness, not only for the SBC category, but also for Sonus, as customers and partners seek to understand how we can help them navigate the rapidly growing world of SIP-based communications. Our relationships with our customers continue to expand and are becoming increasingly strategic. We've also developed a burgeoning set of partnerships with industry leaders such as Microsoft, BroadSoft, Juniper and most recently, F5. These partnerships, coupled with our solid technology roadmap, position Sonus to take advantage of emerging industry trends including NFV, SDN, cloud-based communications and the rapid growth in UC and mobility. The third key metric for 2013 is the percent of product revenue we generate from the channel and the enterprise. These are new areas of growth for Sonus in 2013. The channel contributed 16% of total product revenue in Q2, and we continue to expect the channel to contribute between $32 million and $40 million for full year total product revenue. We're seeing strong interest from a cross section of partners, ranging from global systems integrators to traditional network resellers. UC solutions providers, particularly those that resell Microsoft Lync, comprise a significant part of our partner base. We have recently expanded the program to include distributors to make it easier for our partners to buy from us. Recall that just 1 year ago, our partner program launched with a 1-tier channel program, a handful of channel partners and no distributors. Today, we have about 300 channel partners, approximately 40 of which are Sonus Select partners, and we have a 2-tier program with more than a dozen distributors. We've made solid progress in the channel. Enterprise was 21% of our total product revenue this quarter. Our momentum here is driven by an increasing number of enterprises making the move to UC, cloud services and SIP trunking. Sonus has the appropriate portfolio to help them, be it for small branch offices or Fortune 100 corporations. For the full year 2013, we continue to expect enterprise to contribute $35 million to $40 million of total product revenue. And just to help you with the math, total product revenue for the year has increased to a midpoint of approximately $165 million. The final key operational metric I will discuss is our path towards profitability. This has been a major focus and we are making solid progress. We are delighted today to post a profitable quarter and raise our guidance for the full year. We expect to be firmly profitable on a non-GAAP basis for full year 2013. We've also raised our year-end cash outlook based on strong operating performance. As you can see, Sonus didn't just deliver a great quarter, we are creating a great company and that is driving market-leading SBC growth and long-term profitability. This leads to the final topic in my prepared remarks, which is the stock buyback program announced today. When I joined Sonus almost 3 years ago, I pointed to 3 major assets that attracted me to take this role. These included a great customer base, a strong and innovative team and a solid balance sheet. This combination gave us the opportunity to think clearly about our strategy and make the proper investments in our business. As we see our strategy successfully taking root, we feel very good about our future. Our customer base is growing, our team is stronger than ever. We have used our balance sheet to turn the company around and create an SBC-based growth company, both organically and through the NET acquisition. Now is the right time to begin returning excess capital to our shareholders. That concludes our prepared remarks this afternoon. I'd now like to open the call up for questions. Operator?

[Operator Instructions] So our first question comes from the line of Subu Subrahmanyan with Juda Group.

It's Subu with the Juda Group. 2 questions. First, from the SBC market, Ray, how are you thinking about growth in the market versus the pace you're at? And was the -- for this quarter, was the product and service mix in line with kind of how you thought about your expectations, given product revenue was down a little bit on a quarter-over-quarter basis? And then, if you could talk about the competitive environment, especially with Acme Packet Oracle deal?

Sure, Subu, thanks for your question. I count 3 of them in here, kind of the growth, I guess, I'd bundle the growth in the competitive environment and then the mix issue, which is a great question. So we still see the growth in the marketplace, long-term CAGR about 15%. We don't see much change there. We actually -- I believe that going into the next year, we'll start to see even further acceleration. So I think the SBC market as a whole is very vibrant. And competitively, the Oracle-Acme acquisition just raised the awareness. That's happened since the day that, that transaction was announced. It's raised the awareness as to where the SBC fits in this march to the cloud for cloud-based UC in the enterprise, and the service provider community as well, for that matter. With regard to mix, your question's a good one. We did see a greater mix of service as a percentage of total and that's, I believe, a trend that's likely to continue throughout this year. And if we continue to see that trend, we'll either have to raise our total, lower our product or shift our mix. But at this point in time, I see our outlook for our total being the same. In fact, it will likely come in towards the high end of our total range. It's just a matter of managing the right mix. Looking at that, realizing, even though that we are in our third year of healthy growth, it's still early days in SBC, and for us, we're trying to get our arms around just how companies let these projects out, how much is upfront, design services and then maintenance services that are attached to product versus product. But that's the issue of mix that you're pointing to. I hope that's responsive to your question?

Yes, if I could clarify, Ray. You said you did see greater percentage of service as a mix this quarter, but for the full year, you expect it in line with kind of what you thought. Can you remind us what you'd expected for the full year? And you mentioned a high end of total range, was that for overall revenues in the year that you were talking about?

Yes, so just to repeat, our guide on product is still $98 million to $102 million. And our guide on total is $120 million to $124 million. So yes, we're seeing the total revenue likely to come in at the midpoint to high end of that range, and so the market in total is strong. We may end up achieving that by a higher services mix, which could put pressure on product and we're just going to manage that and we'll disclose that as we report our third quarter results.

Our next question comes from the line of James Kisner with Jefferies & Co.

So here's a -- I'm going to ask this question in a way that I hope that you can actually give us some information here. So just thinking about applications for your Tier 1 North American SBC customers. You've historically talked about interconnect being the primary driver. Is there any change to that in the large North American Tier 1s? Are there other applications that are driving their SBC purchases for you right now in any material way?

Yes. Thanks, James, for the question. Yes, we're starting to see some SIP trunking, particularly as both of those companies go after the enterprise as a channel. It's early days, but we remain strong and our results are still principally attached to the peering as an application, but I'm very encouraged by some of the trends that are going forward in SIP trunking.

Okay, so and you still -- is there any change at all, I guess do you think there might be any VoLTE revenues for you this year? I mean, you've always '14, '15, not this year. Is there any change to that?

We haven't seen any change in our outlook to VoLTE.

Okay, great. And just on operating expenses, it seemed like your SG&A came in, or I should say sales and marketing, came in very light, at least relative to my expectations, and overall OpEx was light. And I was wondering was there perhaps either some of that activity got pushed into next quarter? Or was there incremental savings you didn't expect? Could you just elaborate on perhaps the OpEx being a little lighter than I think you guided?

OpEx did come in a little bit lighter. Some of that was helped by foreign exchange. Some of that was attributable to the idiosyncrasies around our first quarter, where our operating expenses are always higher for payroll-related issues. And the guidance we provided it was for a slight uptick in operating expenses for Q3, primarily related to increased R&D spending.

Got it. And if I could sneak in one more. On the buyback, should we -- I mean, given that there are limited uses of balance sheet cash, is there any read that perhaps post the buyback, M&A might be a slightly lower priority than it was before this buyback was announced?

Yes, thanks for your question, James. The buyback announcement, I don't believe has any material impact on our ability or interest in M&A.

Our next question comes from the line of Paul Silverstein with Cowen and Company.

A couple of quick questions. One, Ray, I think perhaps you guys stopped giving it a while ago, but book-to-bill, is that something you could give us?

Our book-to-bill was slightly below 1.

Also, I think James or Steven might have just asked, but I want to make sure. Your commentary was on the AT&T and Verizon SBC, in terms of you're feeling good about SIP trunking but it's principally peering, is that correct?

What he -- James framed the question as North American Tier 1 SBC customers. So it limited the question to that. Did you want to broaden it, Paul?

No, let me -- couple of things. You haven't announced -- I don't think you've previously announced, I know you said they were 10% customers that took SBC revenue, but the question is, I don't think you've announced them previously as taking SBC, is that correct?

It is for one. It isn't for the other. Yes, that's correct.

Yes, okay. So one of them is newly announced, maybe they were taking it previously. And you're telling us that it's principally peering, but there is some SIP trunking, or was the SIP trunking more an optimistic statement looking forward?

No, there is -- it's the former. It's principally peering with some SIP trunking, because both of them are active channels in the North American market for the SIP trunking into the enterprise.

All right, one more question from me. Ray, is my math right that the increase in the guidance is all in the legacy media gateway part, not that you have anything to be embarrassed about in the SBC side, but that the increase is essentially you feeling better about the media gateway business?

That is correct. Our SBC guidance is unchanged and the entire change in our top line is from the gateway business.

All right. And I apologize, one last question. And by the way, Moe, congratulations. We'll miss you, very happy for you.

Thank you.

And I do want to thank you for your help over the past year. On the SBC, with respect to margins, the margin uplift that you're seeing, the nice progression, I trust that a good part of that is on the SBC side? I know you probably [ph] got products and services, but if you look at your SBC and media gateway, surely some of that improvement, if not much of it, is on SBC. Can you give us some insight there?

Sure, Paul. So we do break out product and services. A good bit of our margin improvement year-over-year, as we called out in the prepared remarks, is in the services piece. But even the product piece has in fact improved year-over-year. And that's better design for manufacture, it's also slightly better software content as these deployments mature. And so I think you should anticipate that those margin improvements will continue going forward.

Right, but Ray, the specific question, and I trust it's a given, but I'll ask anyway, is some if not most of that improvement is the SBC product as opposed to your legacy media gateway?

Correct.

Our next question comes from the line of Catharine Trebnick with Northland Securities.

And my first -- I have 2 quick questions. One is basically, last quarter you had discussed that some of the NET assets, that roughly was 10% of the revenue. Could you give any color to how the federal or government performed for you this quarter overall?

There wasn't a material government transaction in this quarter, Catharine.

Okay. And then also, can you give us some more color on the NFV products or SDN, and when you expect to have some of those available first to carriers, and what timeframe you're seeing for possibly scoring in these types of infrastructure changes to the carriers' network?

Well, if we go back to our September Investor Day, Catharine, those, these have been some long develop issues. Most of our partnership agreements have involved some level of SDN development. Either we're hosting an application on our SBC, or our SBC being hosted on another box. I'm not going to lay out specific guidelines, but I'm very, very pleased by the pace of the teams' move into software and how it's helping us partner up, if you will, with some of the best brands in the industry, as solutions come together there. As we have more to say about it, maybe early next year, we'll come forward with some plan to talk about our roadmap again, but we're making great progress there.

Okay. Now, and any RFPs circulating from the carriers that are asking for that to be on the roadmap?

I think every carrier around the world is at least interested in and asking for that. Some with very detailed operational goals and others just because it's one of the hot topics and they want to understand where everybody's head's at. So, but I wouldn't connect it directly to RFPs and purchase orders at this stage.

Our next question comes from the line of Ryan Hutchinson with Lazard Capital Markets.

Couple of questions. First a clarification, Ray. I wanted to explore the composition of this SBC revenue and I appreciate the explanation on the front end here, but I'm still a bit confused as to the mix. And it looks obviously like SBC services is growing significantly, faster than SBC product. So is this a function of revenue recognition and were bookings -- from a bookings perspective, was it in line with what you anticipated? And tied to that, is that the primary reason for the potential variability from Q3 to Q4? Just a better explanation, I think, would help resolve some confusion around that. And then the question would be just around the federal business. Last quarter, obviously, you pointed that you expected federal to decline, which it did. But are there any material changes going on there with respect to management that we should be aware of?

Yes, let me take the second one first, because it's a little easier and I'll go deeper into the first. There's no material changes with regard to management, if you mean Sonus management on that. And I don't really see any material change in the federal market relative to our prior guide. So I hope that's responsive to your question, Ryan. With regard to SBC composition, we are seeing greater services as a percentage of total. As I said, that's potentially just customer buying patterns. I don't believe it's material rest of the business, and it leaves my view of our SBC growth trajectory largely unchanged. The point is, we guided to that, giving you our best guess as to that mix and we've now seen a couple of quarters with strong services components. It's not a rev rec issue. I wouldn't lead you to that conclusion. But if we continue to see this pattern changing, I actually think it has a very healthy component to it and obviously, whenever we give you a number and we don't hit those numbers precisely as we do, I'm responsible and accountable for that. But the healthy component of it is that people are looking at some fairly large projects that have large service components and maybe smaller initial buy purchases than we had first modeled in our outlook. So we'll talk more about it in Q3 if we see these patterns continue and we'll recast the mix more formally, but for now, that's the best explanation I can give you. I'm happy to take a follow-up question from you if I didn't hit what you were looking for.

No, that's fair. And then finally, Verizon and AT&T are 10% customers, were they 10% SBC customers?

Not all of their purchases in either case were SBC. We're not breaking out what their purchase patterns were. We don't do that with any of our customers, but there is a blend, in both cases, of SBC and legacy products.

Our next question comes from the line of Steve Cohen [ph] with Provo [ph] Partners.

Ray, I was hoping that you'd go into a lot more detail on those partnerships with F5 and Juniper, et cetera. Are those partnerships that is being initiated by a customer of both of yours? Are you initiating those? How much effort is required typically, either in terms of time or [Audio Gap] How do you split that up? Is there any cross-selling? And the bottom line is basically how would you want investors to be measuring the success of any of these programs?

Sure. Thanks, Steve. I think these partnerships have the potential to have profound long-term effects. I have been wanting us to be a better partner since the day I joined, and frankly, our product lines were complicated and difficult to partner up with technically, and they were pointed at legacy markets that people don't invest in, from the standpoint of partnerships. We have solved both of those issues and we're attracting partners for those 2 core reasons. Now I'm not going to speak to whether they're customer-driven, but there are customers involved in all of our partnerships that we discussed. And sizable customers that see the merit of us hosting other applications in our SBC, such as the Diameter solution, or our SBC being hosted in another core network router or other thing for that matter. So as customers engage on those, as they're comfortable disclosing their engagements or if they've become major customers to both companies, we'll disclose them in our results, but I'm not going to pound the table on the partnership issue, other than to say, for our size, I believe it is extremely important for us to be partnered broadly in this marketplace because the shift to the cloud is causing fundamental architectural shifts in the marketplace, that the SBC is mission critical to, and we need to be agile and we need to partner with a lot of companies that are embedded in these large networks, or hope to be embedded in these large networks. And I like our odds with all of these partnerships. Is that helpful to you, Steve?

Yes, that was very helpful, Ray. Just as a follow-up, are these current partnerships strictly on the development side? Or is there cross-selling arrangements as part of it?

There are -- we are engaged with customers in all of these cases.

But is it that Juniper and/or F5 is specifically selling your product or inviting you guys in on a call? Or is it just that you happen to have a customer in common?

I'm not going to get into the sales and marketing tactics, Steve, on it, because I don't want to start and go down the rabbit hole of reporting out on a customer engagement that's on a hypothetical mode. When we have something to say on customer wins, and we're authorized to do so, we will clearly come back to you, okay?

[Operator Instructions] At this time, there seems to be no questions on the phone line.

Thank you very much, operator, and thank you to everyone attending today and for everyone that's been supporting Sonus for as long as I've been here. I very much appreciate it. We look forward to growing with you in the future. Have a great day.

Thank you. Good night.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.