RADCOM Ltd. (RDCM) Q3 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to RADCOM Ltd. Third Quarter 2017 Results Conference Call. All participants are at present in listen-only mode. Following management's formal presentation instructions will be given for the question-and-answer session [Operator Instructions] As a reminder, this conference is being recorded, November 6, 2017. On the call today is Mr. Yaron Ravkaie, RADCOM's CEO and Mr. Ran Vered, RADCOM's CFO. By now, we assume you have seen the earnings press release, which was issued earlier today. It is available on all major financial news feeds. Please note that the management has prepared a presentation for your reference that will be used during the call. If you have not downloaded it yet, you may do so through a link on the Investors section of RADCOM's website at www.radcom.com/investors-relations. If you have any trouble, please send Mark Rolston an e-mail at markr@radcom.com and he will send it to you right away. Before we begin, I would like to review the Safe Harbor provision. Forward-looking statements in the conference call involve a number of risks and uncertainties, including but not limited to the Company's statement about its 2017 revenue guidance, future recognition of revenues under existing contracts, cash available for new opportunities, strategy, market share growth and extension of its leadership position, potential pipeline and opportunities and investments in research and development to support the Company's growth, expected continuance of the Company's momentum for the remainder of 2017, AT&Ts continuance as an important customer and key reference and its plan to virtualize approximately 55% of their network by the end of 2017 and 75% in the longer-term, industry trends, and projected sales cycle orders engagements and expanding relationship with top-tier carriers. The Company does not undertake to update forward-looking statements. The full Safe Harbor provisions including risks that can cause actual results to differ from those forward-looking statements are outlined in the presentation and in the Company's SEC filings. In this conference call, management will be referring to certain non-GAAP financial measures, which are provided to enhance the user's overall understanding of the Company's financial performance. By excluding certain non-cash stock-based compensation expenses, non-GAAP results provide information that is useful in assessing RADCOM's core operating performance and in evaluating and comparing our results of operations on a consistent basis from period to period. The presentation of this additional information is not meant to be considered a substitute for the corresponding financial measures prepared in accordance with Generally Accepted Accounting Principles. Investors are encouraged to review the reconciliations of GAAP to non-GAAP financial measures, which are included in the quarter's earnings release. I would like to repeat the information about the performance – presentation. If you have not downloaded it yet, you may do so through a link on the Investor section of RADCOM's website at www.radcom.com/investors-relations. If you have any trouble, send Mark an e-mail at markr@radcom.com and he will send it to you shortly. Now, I'd like to turn over the call to Yaron. Please go ahead.

Okay. Thank you, operator, and thank you all for joining us today. We were very pleased with our execution during the third quarter as we continue to make great progress on our key initiatives. To start, we're very excited about the new NFV contract we signed with the world's leading top-tier service provider. As we stated in Q2, we finalized the very comprehensive NFV trial with this customer and are pleased to have formalized the relationship which covers assurance for virtualized network domain and provide the framework for additional orders by the operator. We expect the revenue from this initial phase may contribute over $5 million of revenue in 2018 and can potentially grow above that within the contract framework. Additionally, our relationship with AT&T continues to grow as we signed another expansion during the quarter. AT&T continues to reiterate how important network virtualization is to increase their operational efficiency. On their most recent earnings call they highlighted the significant efficiencies they continued to realize by moving to a software-defined network. In particular, AT&T stated that as of the third quarter, 45% of the network functions were virtualized and reiterated its ability to reach 55% by year-end with a longer-term goal of 75% or more. As a result, we continue to expect AT&T to remain an important customer and key reference for the Company. So, we continue to play a major part in their network virtualization strategy over the coming years. We continue to expand with other customers as well, signing a three-year contract extension with Globe Telecom, the leading operator in the Philippines, with over 60 million customers to monitor their mobile network and assure their future transformation to NFV. We originally signed an agreement with them in 2011 and since that time we've received two multi-million dollar expansion orders. Our virtual solution is resonating well in today's environment and we will be virtualizing our implementation with this operator supporting their migration to NFV. The Company continues to focus on the operators that are either planning or migrating to NFV or those that have already begun their NFV transformations. We continue seeing the industry gravitating around OpenStack as the operating system for cloud networks, as well as ONAP being the open source standard for advanced service and network orchestration. During the quarter the Vodafone Group, one of the world's largest service providers with operations in 26 countries has joined ONAP as a platinum member. We're closely following the industry trends which are very favorable to RADCOM, as AT&T continues to drive the underlying architecture and requirement and we're a major part of this ecosystem. We believe that as more service provider transition to NFV, the technology maturity and standardization with ONAP will drive more operators to transformation their networks. Our product leadership coupled with a very advanced cloud-native product has generated significant interest amongst leading operators, and we continue to execute lab trials and workshops that demonstrate our deep network expertise, virtualization know how and product leadership. This is invaluable for operators migrating their networks to NFV. We expect these activities to yield additional engagements with more operators. We continue our R&D investment to assure we can aggressively move in all fronts to engage with multiple operators, while we're continuing to advance our product and providing both our current and potential customers the validation they need to see that RADCOM is a long-term partner for their assurance needs. Given our strong and growing pipeline of opportunities, we're confident that our investment in infrastructure will continue to pay-off, allowing us to capture additional opportunities with our recent underwritten public offering, we've added approximately $30.2 million. This ever strong balance sheet will allow us to executive on our strategy, facilitating engagements and delivering of additional project for multiple top tier operators. Now moving onto our results for the third quarter. We're very pleased with our third quarter results as you can see on Slide 5. Revenues for the quarter increased by 25% year-over-year to $9.6 million. Our GAAP net income was $1.2 million or $0.10 per share. We achieved a non-GAAP net income of $1.7 million or $0.14 per diluted share. Similar to the past few quarters we are focused on continuing a very close relationship with AT&T, executing on newly won top-tier contract, expansions with current customers, turning trials into new customers all this while we're investing in our engineering resources as we move to a new phase and prepare for more top-tier operators. The ongoing progress during the third quarter highlights the advantage of being the first mover in this space and to participating in the most aggressive transformation today. Our approach to demonstrating a very planned cloud-native platform coupled with our deep knowledge is resonating with customers and we expect the momentum to continue during the remainder of the year and beyond. So to summarize, we were very pleased with our executing during the third quarter, given the RADCOM remains the go-to-NFV framework for virtual probe based service assurance and customer experience management. We are well positioned to maintain the momentum. With that, I will stop and turn the call over to Ran Vered, our CFO to discuss the financial results. Ran, please.

Thank you, Yaron. Since you have the financial results, I will just go over the highlights in Slide 6. To help you understand the results, I will be referring mainly to non-GAAP numbers, which exclude share based compensation. Revenue for the quarter was $9.6 million, up 25% year-over-year. Our gross margin for the quarter was 68% on a non-GAAP basis. This was impacted by peak in AT&T project delivery efforts, which is the part of for operating expenses into cost of revenues as most of our revenue this quarter was from AT&T. This shift in the gross margin has neutral impact on our operating income. We expect 2017 annual revenue from AT&T to be somewhat above 60% as the result of the expansion order will silence them in the third quarter. As a reminder, we expect gross margin to continue to fluctuate depending upon the mix of each quarter's revenue. Our gross R&D for the quarter on a non-GAAP basis increased to $2.2 million from $1.8 million in the third quarter of 2016. Also we received approximately $155,000 from Israel Innovation Authority during the period compared to $385,000 in the third quarter of last year. As a result, our net R&D for the quarter was $2 million compared to $1.4 million last year. After the end of the quarter, we received approval from the Israel Innovation Authority for an additional grant for 2017 impacting the first quarter with an additional approximately $800,000 of grants. Sales and marketing expenses for the quarter decreased to $2.2 million on a non-GAAP basis from $2.3 million in the third quarter of 2016. G&A expenses for the quarter on a non-GAAP basis totaled $790,000 compared to $690,000 in the third quarter of 2016. Operating income on a non-GAAP basis for the quarter was $1.519 million, compared with $994,000 for the third quarter of 2016. Net income for the quarter on a non-GAAP basis was $1.669 million or $0.13 per diluted share. On a GAAP basis, as you can see on Slide 5, we reported net income for the quarter of approximately $1.183 million or $0.10 per diluted share. At the end of the third quarter, our headcount was 202 employees. We expect this numbers to increase by approximately 10 to 15 employees over the course of the coming months. Turning to balance sheet as you can see on Slide 9, our cash and cash equivalents as of the end of the quarter were $33.6 million. This combined with our recent public offering versus the Company on very strong footing for interesting stock opportunities. Now turning to guidance, with our current visibility, we're updating our fiscal 2017 guidance range to $36.6 million to $37.8 million, as the revenue recognition for our new award in [indiscernible] we will be in 2018. As a reminder, we view and continue to manage our business on an annual basis because our quarterly results can fluctuate due to the timing of implementation milestones. That ends our prepared remarks, Yaron and I will turn it back to the operator, so we can take questions.

Thank you. [Operator Instructions] The first question is from Alex Henderson of Needham and Company. Alex, please go ahead.

Great. I was wondering if you could tell us what share – ending share count would be if you take the ending share count plus the share count on the offering, just so everybody is on the same page on the share count?

13.2 million shares.

And the second question is can you explain that gross margin explanation again. Not sure I quite gathered why it dipped down and why that doesn't impact? And so, is there an offset down in the R&D line or something?

Yes, exactly. It did – yes, exactly. It's an offset to the R&D and sales and marketing, it was just a shift from mainly from R&D to comp of revenues because the peak of the revenue affected this quarter.

So, if that's the case, what the size of that, not that I don't – I mean, I assume that doesn't happen again in the fourth quarter, right?

It depends on how much revenue we're going to recognize on the fourth quarter from AT&T, but it was the impact of roughly $800,000 from OpEx to cost of revenues.

Okay. So we should assume then going forward a reversion back to 71 and put $800,000 back into the expenses to get the forecast on expenses going into the December quarter?

That is correct.

All right. And the $800,000 in NRE, I assume you don't have any guidance for 2018 on that?

No, we don't. And as we discussed just you know the recent quarter when actually we declined some of our projects sum for a grant. We made an appeal and actually we just got it, just after the quarter-end, an offset $800,000 compared to what we discussed in the last quarter. And for 2018 we just don't have any guidance yet.

We submit the plan just at end of 2017 and we get responses during Q1 but sometimes into Q2. So only then we know.

I see. Okay. Then just couple of details. The headcount in T as a percentage of revenues?

Sorry.

Yes.

The headcount in T as a percentage of revenues?

So what's the question, we mentioned it.

We mentioned the headcount is 202 employees and we expect that in the coming months, something between 10 to 15 employees will join.

Right. And AT&T as a percentage of revenues?

Sorry. 78% in Q3 and for the year – for all 2017 would be somewhat above 60%.

Tad about 60.

In the quarter it was 78%?

Correct.

And does that take the $800,000 down or is just going to adjust for anything about sort right, that's just straight revenues?

Yes, straight revenues.

Okay. Good. Can you talk – last question, then I'll take the floor. Can you talk about where you are in terms of how many active trials you have going, and where you are on those trials? Can you give us any sense of the scale of the customers that you're doing trials with that have not been closed?

So we continue to engage with the multiple additional – multiple top-tier carriers. Everyone I think that we're engaging now is either a group or a very large OpCo, or an OpCo that's part of a very large group. So everything has a strategic importance. The progress is a lot depended on at this stage on their NFV strategy, some are slower to move and some are starting to move. The ones that are starting to move, we're already taking into consideration, would be able to convert some of them into wins in 2018. Now I don't know yet if to give cadence on exactly when is the next win, but I think you saw our execution, this year we've landed a very significant one and we feel very good now about the pipeline and actually feel good about the way that the industry is moving. And you know this is why we mentioned the Vodafone joining ONAP and now everything being corralled around ONAP. So it's an industry that's being disrupted. It's very hard to predict exactly the pace. But I think, again, we feel very good about it. And maybe one last comment we're starting to look at how we look at next tier and growth and things like that, and we already see some line of sight when we're at today into 20% growth. So, we're starting to gravitate around the thinking of how next year will look like, and this is like our very initial preliminary view.

Okay, I'll hit the floor. Thanks.

The next question is from Dmitri Netis of William Blair. Please go ahead.

Thank you, gentleman. Nice results in the quarter. A couple of questions. On the kind of going back to the AT&T extension, can you discuss what application? Is this an additional kind of application you're providing? If I did the math correctly, it would imply about $2 million additional order, just for the year if you go from kind of a 55% to 60% that sort of implies $2 million. So that is your order it sounds like? And you seem to have received it all in September quarter. Is that; A, what application; and B, will we see additional expansion within that application as we go into 2018?

So I don't know – like if you – if the question is, is it around the new system or something like that, it's more of several things lumped together into one activity, so – and in one expansion although. So, I can't really point it into a certain direction. It's in the nature of everything that we've been doing; the mobile network and rolling it out and all of the technologies. It's a lot of things that they needed us to do around it.

So is that a one-time thing Yaron, or is that kind of a new development that will give rise to additional orders as you bring in new feature or functionality to that piece of the network or that part of the network?

This expansion is a one-time, but we expect different types of expansions as they need – they need them to occur, some of them also one-time in nature over the years. So it's built into their model that they do expansions on this product – on this project here and there.

Okay, great. And then on the going back to the Tier-1 contract you've announced last quarter, it sounds like it's a $5 million what you're baking into the model and that's the 2018 event? Can you discuss, is it Q1 you're going to get most of that in Q1, Q2? How should we think about the revenue recognition there?

We didn't disclose exactly which quarter. We're more comfortable saying something more like that first half that it will impact, but the – it tied to milestones that are tied to their milestones. So it can fluctuate between quarters. And also the $5 million you need to think of is an initial number, but the framework itself is a bigger. We didn't disclose the size of the framework. And also there's things that we're discussing with the operator, so beyond the framework that they sign. So, we're in an active positive relationship with a lot of potential. But is going to take time and also to grow that potential, it's something very strategic and we're making also the right investments in how we operate with this top-tier carrier.

Yaron, do you think that relationship could grow to be larger than your current AT&T's project relationship or orders that you've committed to or been committed?

Potentially, yes, but, a multi-year view; so beyond 2018 and maybe even beyond the start of 2019.

Okay, very good. And then as you kind of you look at one – two standards sort of developing you mentioned OpenStack and then ONAP, obviously AT&T is driving the ONAP initiative and you had mentioned Vodafone now stepping in. Does it – it does sound like and correct me if I'm wrong, but the standardization that just happened over the last six, nine months, is that giving a push to some of the Tier-1 operators that's been dragging fleet potentially waiting for these standards to evolve? Are we at the stage where it's pretty clear the way it's going to go kind of the NFV initiative and the two camps developing here, and as a result there will be additional Tier-1 engagements that will be pulled in or reaccelerated from here on? Is that a fair characterization or we're not there yet?

I think we're not there yet. I think we're like one step before. I think the industry is gravitating. So I would say the industry now is divided basically into two families. Okay, one family is initiatives that are gravitating around the open source initiative and ONAP seems to be the winner, but it will need to take a little bit more time to really declare the winner, but also to mature the ONAP standards. So ONAP started from AT&T going and open sourcing ECOMP, then bringing China Telecom and China Mobile on board, then additional carriers they started to join of course, the initial ones joined the ECOMP also became a part of ONAP. And now they're walking on the new architectures and open source codes and things that are beyond the AT&T architecture, so it will be more fitting than to like the things that AT&T architectures initially for themselves. So that takes some time, but I think definitely it's in the right direction, it's definitely a move, and a significant move to what we saw let's say like seven, eight months ago. And I think this industry just think about the telecommunications in some cases in this NFV is being like reinvented, okay, so moving these networks to the cloud. So, the carriers are starting to adopt it. I don't think anyone is saying, okay, look, this is not going to happen and then something else will happen. I think it's just the pace that it will happen. I think now we see an initial step in (something), but we haven't reached the, let's say, acceleration, cookie cutter, faster each stage that everybody is doing it. The second thought by the way is not the open source initiative, it's the network equipment provider initiatives. Ericsson is coming with their own initiative, Huawei is coming with their own initiative, and Nokia coming with their own initiatives. They all gravitate around some sort of an open stack architecture, but it's a commercial open stack architecture where they provide all the underlying infrastructure. They basically provide the cloud running on an open stack architecture, but they add like their flavor to it. So we see already the carriers starting to adopt some of them. By the way, that addressable market is also very addressable to us because it's still – it's running open stack and open standards and we're integrating to it and we're actually part of the proof of concepts and activities that we've done, we're in both architecture. So, we are I think in a very good position to enjoy these types of progressions that are happening in the industry.

Okay, very helpful. My last question sort of goes to the competitive landscape, if there is any change that you're seeing now that you won two large Tier-1s, you are kind of continuing to expand within those Tier-1s, clearly the product is resonating. How the competitor is responding to that? Anything you see? We did see some consolidation in service assurance base and virtual probe space this quarter. Is that a testament to the market sort of coming into its own? And if so, does that potentially kind of help you given maybe some initial near-term disruption from these consolidation plays or is there – or do you see anything else out there? So just kind of give us some sense what competitors are doing from your vantage point.

Okay. So, again, this is my view. I think what – the industry, the probe-based service assurance is fragmented in a way on the legacy equipment side and software is also legacy when you look at this virtualization effort. Everybody knows NetScout acquired Tektronix of NetScout has a large portion of that legacy space and then there is different companies mostly private companies that have much smaller portion of the market, that we're at the size of RADCOM before we won like pre-2016, so when we were running you know at the $20 million range, some are little bigger, some – I think none of them perhaps – all my information is correct, the three digits revenue mark. So, we don't see any significant announcements or movement or – we're not seeing also from the customers any discussion that those are better product than we are. We see once in a while some companies claiming to say that they do something in software or they do something in NFV. But when we scratch the surface we don't see that there is anything mature for sure not production mature and nothing that we're hearing is impressing customers. So we feel pretty good that we continue to maintain a significant leadership that our biggest differentiator, you know is the fact that we're running in a full cloud-native architecture with very high automation, everything is built to be AT&T standard and now to this additional top-tier carrier. The combination of these two carriers working and pushing with us also together with Globe now that's starting to migrate to NFV. We're in a very good position and we feel that we can probably maintain it in the near future. For sure, we will maintain it from the leadership and product leadership, we don't see anything coming up or not hearing about anything from the industry basically.

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

Thank you.

The next question is from [Mike Arnold]. Please go ahead.

Hi, Yaron, Hi, Ran. I had a quick question about the new world leading top-tier operator you disclosed this quarter. In the past you sort of discussed that a lot of these trials where RADCOM used to lose. I was curious if this was a competitive bake-off situation or if the customer only trailed you software?

It wasn't a formula RFP. This customer is very familiar with additional players in the industry or was already familiar, and they weren't familiar with us and they spent I think almost like six to seven months in a very deep reviews and labs and certifications and working with their cloud teams et cetera. That's was the situation. They were very impressed from the get-go, so from the first time that we showed them the technology.

Okay. So I guess my next question is, I'm curious did they invite their incumbent vendor to participate in the – in RFP?

It wasn't in RFP.

Wasn't, okay. But the incumbent vendor wasn't really a part of this particular trial, they weren't invited to it?

So the way it typically works and this is not only for this trial, it's for many – this industry behaves almost very similar, all the carriers. When you have an incumbent vendor, okay, then you are very familiar with their technology, so you don't need to invite them. They are already running in your network.

Okay, okay.

[Operator Instructions] The next question is from [George Marema]. Please go ahead.

All right, thank you. Good morning Yaron. I was trying this new Tier-1 you won in Q3, is the contract with them a software-as-a-service style deal or is it more like a license deal like you had with AT&T?

It's a bit complicated, okay because those are – it's a license deal but it looks like more like a subscription deal, so it can grow gradually.

And how does this scale, does it scale with additional traffic, different network elements? How does it scale up?

Both, exactly those two.

Okay. On this recent capital raise what was the rational to raise an additional $30 million capital base, so you have almost $65 million on cash and you are not losing money. What's the rational for that?

First of all, we had decent balance sheet before as you mentioned. We work with the top-tier carriers. These carriers, they work with the Ciscos of the work, the IBMs of the world, the Ericksons of the world et cetera, et cetera. Companies that are completely different size than we are, companies that have been around for many, many and they have never been in any type of trouble and the reason why they did business with them in the past is that – they all have to probably pay premiums for it is that some of this because they are very large company. Now when you move now with this disruption that's happening, it allows companies that our software into DNA, cloud into DNA like ours, to really make an impact hence won AT&T hence we won this additional top-tier carrier. But one of the things that we need is to have the – now I'm exaggerating to make a point, but to have the optic of Cisco. And this is the main reason why we wanted to do the offering, we engage now with two, we believe that we will be engaged with more. All of them top-tier they all look at your viability and they want to do business with you, they want beyond the field, verbal assurance that we will be around for years and years to come with a growth strategy with very firm financials. And now we even have a better position and that will help us. The mid-term looking beyond that is that we did some portfolio expansion when we started AT&T. I mentioned I think in some of the calls that we are looking to do some portfolio expansions in the future. One of the ways that we will want to do – that we might want to do portfolio expansion is using M&A as a tool, so this will allow us to start to look at this type of approach as well. Again, not under any type of pressure but to make sure that we bolster our offering and we will continue to be very aggressive and disruptive and innovative.

Okay. And the secondary offering is sold very, very fast. Was there a strategic investor involved?

No.

Okay. Your relationship with VMware, can you describe how deep that relationship is or how that works?

I don't think we disclosed any type of relationship with VMware, so I can't discuss it.

Thank you, Yaron.

You're welcome.

We have a follow-up question [Mike Arnold]. Please go ahead.

Hey, guys. One more quick question about Vodafone, that you brought up on the call. I think on September 11, if I get the timeline here right they announced they joint ONAP, but I believe that very next day on September 12, you guys put out a press release that David Amzallag had joined RADCOM as a Special Strategic Advisor, who of course, the former head NFV at Vodafone. I'm just curious why and how some of these players are choosing to work with RADCOM. If you could give us any color on that. Thanks.

So I'm not sure I understood the question why does David Amzallag want to work with RADCOM?

Yes, I'm just curious, you know you are attracting some thought leaders in the industry. I'm curious why they are coming to work with you?

Okay. So look, I think even whey you take like a broader look and the entire leadership of the Company, we were able to attract over the course from including myself by the way, and maybe I'll brag about the team and not myself, but top talent in the industry, this I think has to do with the leadership and has to do with the growth strategy that we've executed and I think you've seen in the last almost two years that how we've grown the R&D and how we're able to execute and do that. So, we have a very compelling strategy. Okay, we're disruptors in the market, in an industry just getting disrupted, okay. The industry is split into two, okay, where the major big huge players are the ones that are getting disrupted. And then smaller companies like ours that are growing are able to disrupt them whether you know they are public like also, but also private as well with this technology shift. This has very strong appeal to people that really understand the industry. And I believe that someone like David is – someone that was influenced by that appeal, but is of course not the only one.

Okay. Thank you very much again.

Yes. So just to summarize, we have very, very strong technology, we get to work now with – we've increased the number just now of the major operators we work with. Okay, so all of our teams get to do cool stuff in a disrupting industry and push business ahead and be successful.

Okay, great. Thank you.

You're welcome.

We have a follow-up question from [George Marema]. Please go ahead.

All right. Thank you. Yaron, about a week or two ago AT&T had their AT&T Summit and during the Summit there was a lot of disclosures around their, how they tie into their different platforms, service orchestration into their integrated cloud. And a lot of the stuff they are using, they talk about marketing and cyber security and all these other capabilities around this integrated cloud. And I was wondering that since they use, it seems like they use packet inspection in technologies like that. Would RADCOM have any opportunities in something like that?

So we have a lot of opportunities in AT&T. So we're sitting in a major part of their architecture, supporting their transition to NFV. They are very, very innovative company all the time they launch new offerings, they expose their platforms outside and they push everything forward and they were making a lot of it public. So I think the answer is yes, we have many opportunities in AT&T to do a lot of work both on our core just blocking and tackling and also our new initiatives that they bring, since you know all the package flow through our solutions. So we can do a lot of innovative stuff with them in the future. I would say that the number one priority for us now is to make sure that they are successful in their NFV migration, okay. Don't expect like us coming up with the crazy innovative stuff with them every quarter now. But definitely in the future and we've already started discussing some of these things with them.

Okay. Thank you.

There are no further questions at this time. This concludes the RADCOM's Ltd third quarter 2017 results conference call. Thank you for your participation. You may go ahead and disconnect.