Ribbon Communications Inc. (RBBN) Q4 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Sonus Networks Q4 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, February 21, 2012. I would now like to turn the conference over to Patti Leahy, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Grant. Good afternoon, everyone. Welcome to Sonus Networks' Fourth Quarter and Year Ending 2011 Operating Results Conference Call. Thank you for joining us today. With me on the call this afternoon are Ray Dolan, Chief Executive Officer; and Moe Castonguay, Chief Financial Officer. Todd Abbott, Senior Vice President of Worldwide Sales and Marketing is also here to address your questions at the end of our prepared remarks. Before we get started, I would like to remind you that a recording of this call will be available on Sonus Networks' Investor Relations website. 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 performance. Please note that 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 limitations, difficulties we may experience in expanding our customer base and in leveraging new market opportunities. A discussion of factors that may affect future results is contained in our recent filings with the SEC, 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. Finally, 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 on the Investor Relations section of our website at www.sonusnet.com. I'd now like to turn the call over to our CEO, Ray Dolan. Please go ahead, Ray.

Thank you, Patti, and good afternoon, everyone. I'd like to start the call today with an overview of our fourth quarter highlights and our SBC expectations for 2012. I'll also provide some context around our broader opportunity and how it's shaping our focus this year. Moe will then go into more details about our financial results and outlook and I'll close with the metrics I believe you should be tracking as we progress through the year. Turning to our fourth quarter highlights, total company revenue was $74.3 million, up from $66.4 million in the third quarter. Our SBC total revenue, including maintenance and professional services, was $22.5 million, up from $13.9 million in Q3. Our SBC product-only revenue was $17.5 million, up from $10.4 million in the third quarter. In the second half of 2011, we added 20 new customers, 19 of which purchased SBC solutions from us. In the fourth quarter alone, we added 12 new customers, 11 of which purchased SBC solutions. In 2011, our SBC business clearly became a material part of our overall revenue mix, representing 30% of total revenue for the fourth quarter and 20% for the full year. This is up from 14% in 2010. We expect this trend to continue in 2012. Before discussing our revenue expectations for the SBC business in 2012, I'd like to take a moment to talk about our outlook for our media gateway business. Our guidance assumes a 10% decline for our media gateway product revenue this year. While this business remains a healthy asset for us, we are providing this outlook for 2 main reasons: First, even though many service providers are still in the early stages of adopting SIP-based solutions, service provider CapEx spend is expected to be pressured in the first half of the year. Second, the media gateway business is characterized by long sales cycles and highly-customized implementations, which have contributed for the lack of linearity in our results. We will continue to invest in and support the media gateway business, particularly since it offers a unique opportunity to migrate our install based SBC solutions. But our primary focus is on expanding our sales coverage to address high growth areas of opportunity, including the SBC market. As such, we expect growth in our SBC business to more than offset the anticipated decline in the media gateway product revenue. Turning to SBC, we are guiding to full year 2012 SBC total revenue of $75 million to $80 million, including maintenance and professional services and $60 million to $65 million on a product-only basis. This performance is expected to outpace industry growth forecasts and result in an increase in our market share. Before handing over to Moe, I'd like to spend a moment on how we see the opportunity for Sonus shaping up this year and into the future. Our potential is unlocked by building a team that has the passion and intellect to recognize opportunity and importantly, to execute a strategy that takes advantage of it. We have built that team, and we are now organizing around a strategy that we believe leads to meaningful growth and value creation. There are a number of key trends which are driving this strategy. First is the consumerization of IT, also referred to as BYOD or bring your own device. This will increase the requirement of more voice and unified communication into the cloud in order to enable the delivery of a consistent set of UC functionality to a expanded set of endpoints. Enterprises are challenged to incorporate these new communication devices such as smartphones and tablets to enable new UC capability for their employees and ultimately their customers. At the top of the list of concerns facing CIOs today is the need for a flexible, scalable architecture, which can support, interwork and secure all types of traffic on all types of devices. This plays to Sonus' core strength of -- in SIP, session border controllers and enabling policy implementations across the enterprise. The second major trend we see is the increasing urgent need to unified communications. Employees are being inundated with all forms of communication, which have the potential to be counterproductive if they are not truly unified. The transition to SIP-based communication will move the current location dependent applications, which reside on the PBX, to a centralized cloud environment for access from any device around the world. SIP is now enabling service providers to offer a new class of cloud-based unified communication services, creating important new sources of revenue to offset the declining revenues from voice. Third, all these new devices and the increased points of connectivity and access to cloud-based applications have created a massive growth in the sheer volume of digital content, a trend commonly referred to as Big Data. Most of this data is unstructured so companies have been unable to gain much viable insight from it. Sonus sees opportunity in helping firms make the information more actionable via effectively linked communication capabilities. Sonus brings network intelligence, security and scale to make this a practical reality. These trends, together with the accelerated adoption of SIP underscore why our opportunity today is more exciting than ever before. Sonus has over 13 years experience managing and enabling SIP-based infrastructures. We already enable nearly 5,000 independent communication sessions per second, or more than 160 billion sessions per year. Our SBC differentiation is being proven out with our customers who value scale, reliability and the ability to centrally manage their communications networks. In short, we are prepared for these market trends and the opportunities they have created. So what does this mean for our focus in 2012? First and foremost, growth in our SBC business is expected to outpace the industry and contribute significantly to our overall revenue growth. Our customers are beginning to experience a significant increase in the volume and complexity of their session traffic, which is at the heart of what is driving demand for our SBC solutions today. We will continue to invest in our sales and marketing resources this year to extend our coverage to the enterprise. This includes launching a robust channel program, which by year end will add to our SBC momentum and traction with the enterprise market. The proof points of our progress are already showing up in our results. We commit to keeping you informed along the way as we continue to reposition our business for strong, profitable growth. So with that as the background, I'll ask Moe to take us through the details of the fourth quarter and year end results as well as our 2012 outlook. And then I'll close with a framework you can consider using to measure our success this year. Moe?

Thank you, Ray. Good afternoon, everyone. Total revenues for the fourth quarter were $74.3 million, up $7.9 million from third quarter revenue of $66.4 million and down $8.7 million from fourth quarter 2010 revenue of $83 million. Our SBC revenue grew nicely every quarter in 2011. Total SBC revenue, including products and services, was $22.5 million in the fourth quarter, $13.9 million in the third quarter, $10.8 million in the second quarter, $4.8 million in the first quarter and $12.2 million in the fourth quarter of 2010. Three customers each contributed greater than 10% of revenue in the fourth quarter and they were: CenturyLink, SOFTBANK and Verizon. These customers purchased a combination of our products and services, which in all cases included SBC. Our top 5 revenue customers represented 54.9% of revenue this quarter, up from 51.5% in the third quarter. We reported revenue from 115 customers in the fourth quarter. This compares to 107 customers in the third quarter. Looking at revenue geographically. Domestic revenue accounted for 67% in Q4 versus 63% in Q3 and 72% in Q4 of 2010. While the percentage of domestic and international revenue will vary by quarter, our objective is to increase the percentage of our revenue that comes from international markets over time. Before I go into further detail on our financials, I'd like to point out that following are non-GAAP numbers that exclude stock-based compensation and amortization of intangible assets in both 2010 and '11, we also exclude restructuring charges incurred in 2010. Total gross margin for the fourth quarter were 64.1% compared to 64.2% in the third quarter and 64.4% in Q4 of 2010. Product gross margins for the fourth quarter were 71.2% compared to 72.8% in Q3 and 67.7% in Q4 of last year. Service gross margins for the fourth quarter were 51.8% compared to 49.4% in Q3 and 58.1% in Q4 of last year. Total operating expenses for the fourth quarter were $41.4 million, up $2.2 million from $39.2 million in the third quarter and up $3 million from $38.4 million in Q4 of last year. A majority of the $2.2 million Q4 '11 sequential increase in operating expenses was attributable to the incremental people-related expenses. Headcount in the quarter increased slightly to 1,095. Our net income for the quarter was $5.4 million compared to net income of $4.1 million in the third quarter and net income of $15 million in Q4 of 2010. We ended the year with total cash and investments of $385 million, up $6.3 million over the third quarter of 2011. Our DSO for the quarter was 64 days as compared to 60 days in the third quarter and 57 days in Q4 of 2010. Now I'd like to provide more details for the first quarter ending Friday, March 30 and 2012 full year outlook. Total revenue outlook for the first quarter is between $57 million and $59 million, reflecting normal seasonality, as well as a cautious server spending environment. Fiscal year 2012 revenue outlook is between $270 million and $280 million. Included in first quarter outlook is SBC product revenue of $7 million to $8 million or total SBC revenue of $10 million to $11 million, also in line with first quarter seasonality experienced last year. The full year revenue outlook includes SBC product revenue of $60 million to $65 million and total SBC revenue, including products and services, of $75 million to $80 million. For the first quarter, we expect total non-GAAP gross margins to range between 62% and 63%. For the full year, we expect non-GAAP gross margins of 59% to 61%, reflecting the introduction of new lower session count SBC solutions. These margins should improve as volumes increase and our repeat customers buy more session count licenses for their existing products. For the first quarter, we expect non-GAAP operating expenses of between $43 million to $44 million. Approximately $2 million of the sequential quarterly increase in OpEx is attributable to seasonal increase in expenses that are included in fringe benefits such as FICA taxes, federal and state unemployment taxes and 401(k) match. These fringe benefit expenses will decrease by approximately $1 million in the second quarter. Our first quarter operating expenses are currently forecast to be the highest quarterly expenses for the year. We expect lower operating expenses in engineering, sales and marketing and G&A in our second quarter of 2012. Total non-GAAP operating expenses for the full year 2012 are expected to be in the range of $165 million to $170 million. The increase in operating expenses over 2011 relates primarily to increased personnel costs, including sales and marketing, as we continue to expand our sales coverage domestically and abroad, to address our increased market opportunity in both enterprise and service providers. For the first quarter, we expect a non-GAAP loss per share of $0.02 to $0.03. And for the full year, we expect a non-GAAP loss per share of $0.01 to $0.02. Basic and diluted share count for the first quarter should be approximately 280 million and for the full year, approximately 282 million. With that said, I'll now turn the call back to Ray to provide his concluding remarks.

Thanks, Moe. Before opening it up for questions, I'd like to offer some metrics for you to consider measuring us against, as we continue to reposition Sonus for strong growth and value creation this year and into the future. First, SBC momentum. Do we continue to outpace industry growth and continue to shift our revenue mix towards the high-growth SBC category? I believe the answer will be a resounding yes. Second, channel momentum. Does the channel contribute to our growth? By mid-year, we will launch a channel with a set of quality partners which expand our coverage globally and into the enterprise markets. This channel launch will include a portfolio of channel-ready products. Third, customer growth. Do we continue to add more customers overall and increase the number of enterprise customers we are winning? We have secured more new customers in the second half of 2011 than the previous few years combined, so we are confident our pipeline of enterprise and service provider new accounts will deliver an expanded portfolio of customers from which to grow our business. Finally and simply, execution. Do we deliver on the expectations we set for you each quarter? It is our goal to deliver on those expectations and provide a greater level of transparency and predictability into our business as part of our ongoing communication with you. I believe we will deliver on all these metrics this year. We commit to keeping you informed of our progress along the way. To this end, today, we are also announcing that we will host another Investor Day on Thursday, September 13 in New York, by which time we will go deeper into our progress, our opportunities and our strategy. We will provide more details about this over the coming months. That's all of the prepared remarks we have today. Now I'd like to ask Patti to transition us to the Q&A portion of the call, where Moe, Todd and I will be happy to take your questions.

Thank you, Ray. Grant, could you please provide our callers with the instructions on how to ask a question?

[Operator Instructions] And the first question comes from the line of Paul Silverstein with Crédit Suisse. Paul Silverstein - Crédit Suisse AG, Research Division: Ray, if I could ask a handful of questions regarding SBC, do them one at a time. First off, can you give us the total SBC customer count?

We don't -- we're not providing that, Paul. Paul Silverstein - Crédit Suisse AG, Research Division: Any reason why not?

I don't have that available to me right now. I'll think about that. Do you have another one? Paul Silverstein - Crédit Suisse AG, Research Division: Yes, I have several more, if I may. Can you give us some insight on the nature of the SBC customers? You mentioned 11 new ones in the quarter -- I'm sorry, 12 new customers total, 11 new SBC customers. Can you tell us the nature, are these enterprise customers? Carriers? Can you give us some insight into some of the bigger wins that you've had and who you're coming up against?

Okay. Do you want to get them all out there? Do you have a couple more? Or do you want me to answer that one? Paul Silverstein - Crédit Suisse AG, Research Division: Go ahead and do that one, and I have a couple more, if I could.

Well, the nature of those customers are largely service provider. As we build the channel and the enterprise-centric portfolio, I think that will shift. But for now it's principally the service provider and there's a mix of Tier 1s and others. Paul Silverstein - Crédit Suisse AG, Research Division: Can you tell us how many Tier 1s?

No. I mean, it's a blend, Paul. Paul Silverstein - Crédit Suisse AG, Research Division: All right. Are these -- are you coming up against Acme, Ericsson? Can you give us some insight?

Yes, they're all competitive wins and all of the major players are competing. Paul Silverstein - Crédit Suisse AG, Research Division: All right. And finally, can you talk about pricing and margins? I heard your comment about the lower session count perspectively having an adverse impact. But to what extent are you or anybody else using aggressive pricing to impact margins?

I don't believe it's really the principal way anybody's competing at this point. But some of our initial design wins are at low session counts. And as a result, they're at low aggregate prices in general and they're more hardware centric than software centric, where follow-on sales will be higher margin. That was the purpose of that comment.

And the next question comes from the line of Subu Subrahmanyan with TheJudaGroup.

I want to revisit the gross margin question. As you'd mentioned, there are some deals with lower session count. But traditionally, we've thought of session border controllers as higher margin than your gateway business, which has been a 58% to 62%, maybe at the higher end of the range margins. So if you can just talk about dynamics between both those businesses and what kind of run rate we should think exiting the year as you start filling up the session count? The other question I had is from an application perspective, are there any particular applications in which Sonus is doing particularly well between carrier interconnect, access and SIP trunking?

Yes. So on the gross margin question, Subu, we've guided there where our gross margin should be in the 59% to 61% range in the aggregate for the year. Our trunking business has generally been a slightly higher margin business than our SBC business to date. And I would expect that trend to probably continue for the balance of this year, and then I would expect that to -- the SBC business, to grow into 2013 from a margin point of view. On the...

I think the other thing to point out on the margin piece. If you look at the acquisition cost of new customers and the margins of trunking versus the new -- the margins from new customers of SBCs, we're actually starting off at a much stronger position than what you would historically see us starting off with a new customer in trunking. So while the initial margin on a new SBC might be lower due to the more hardware content and lower session count as Ray and Moe talked about, the starting point is much higher than the traditional business, and the upside leverage continues to be quite strong. And your second question, the application...

And if I can follow up on that, over a 2, 3 year period to our customers, should expect SBC gross margins to be closer to industry gross margins? Would seem to be somewhere in the high 70s, low 80s kind of range.

Yes. Yes is the answer.

Yes. The other question on the table is, our principal success. And I would say, interconnect, peering and SIP trunking would probably be our biggest application design wins to date. Does that answer your question, Subu?

Got it. Yes. And for the SIP trunking, it goes to the carriers, so the Tier 1 carrier success could be for SIP trunking deployments because of their -- you're going to through them as the reseller, is that right?

Yes.

And final question is, were any of your 10% customers primarily SBC or was it a mix of your trunking business and the media gateway side and SBC?

They were all a mix, Subu.

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

Couple of quick questions. Back to the SBC, is there a way to divvy it out between, were some of the wins more domestic or international? I'm not sure if you can give the color, but I had to ask.

Most of the -- most of the momentum in the last quarter has come out of the U.S.

Okay. That's good to know. And then also just sorry to ask a request, how many of your top customers -- top 5% of your top customers generated how much revenue, 55%? Did I get that right?

That's correct.

Okay. And then one last question. It looks like the enterprise launch is slated for second -- first half, second quarter? Is there any particular reason why that program, when we were with you in November, we talked about it possibly coming out in first quarter. Is there any relationship to why is there more of a second at the end of the first half kind of launch?

Really driven more by trying to identify from a marketing standpoint when's the best timing to leverage events and other activities in the market. And as well to give us a bit more time to make sure that the product is ready to hit the ground running with that launch.

And then on the new hires, you hired a significant amount, you had said 100 people you were targeting in Q4. Of that, how many will be really targeted towards the enterprise?

Well, if I can just go back and address the issue. We had a big growth in our headcount in Q3 Where we hired approximately 90 people. It was only a limited number of people that actually brought in Q4. In 2012, we will be growing in sales and marketing. And obviously that was focused -- those people will be focused at the enterprise, as well as Tier 2 and Tier 3 service providers.

But we don't break those details out.

Okay. And then I'm sorry one last question. You had mentioned Verizon, was it Verizon Wireless or Verizon Business that was a 10% customer?

We don't differentiate. It's all Verizon. We don't get into specifics relative to any particular customer.

And the next question comes from the line of Jonathan Kees with Capstone Investments.

I wanted to ask on -- for the commentary. I didn't hear anything in terms of order pushout. So there wasn't any order pushout from this quarter into Q1? It sounds like fourth quarter wrapped up or still contains some more pushouts from Q3?

So Jonathan, no, we did not have any material pushouts that were contemplated in the guidance we gave you when we talked to you on Q3, from the fourth quarter out. I don't remember -- what was the second part of your question on Q3? Could you clarify that, please?

I'm sorry, you said there were no order pushout included in the Q4 guidance?

Right. So when we guided to our Q4 number, we didn't see anything fall out of that quarter in any material way?

Okay. And so, there's no order pushout included in the Q1 guidance then?

Right. It is what it is, the guidance there, correct.

Okay, great, great. And for 2012, it sounds like, especially with your cautious comments about service provider CapEx and then the fact that you're ramping up or that you're initiating and bringing online your channel program, it sounds like most of your growth from SBCs in 2012 will be with enterprise. Is that a way of thinking of it in terms of where the traction will be?

No, our emphasis will shift and we'll increase our exposure to the enterprise, which is a large market and growing. But I think our results will still be principally service provider, at least through the first half and then even substantially in the second half as we ramp the channel.

Okay, all right, great, that helps. You mentioned that you're going to grow faster than the market and you're going to be taking market share. So can I ask what you see in terms of the general market growth rate for SBCs or the latest in terms of that?

Well, the research and various company guidance has been fairly wide. I'd say in the aggregate, it's probably about 25%. It might be a little lower than that in the service provider side and a little higher than that in the enterprise, which starts off a smaller base, but I would say 25% is a reasonable market estimate where most people are converging and we expect to grow beyond that.

And the next question comes from the line of James Kisner with Jefferies. James Kisner - Jefferies & Company, Inc., Research Division: I guess my first question, I want to drill down on the strength in Q4 here. I know you guys don't want to break this up, can you give us any kind of feel for 9000 versus 5200. I guess I'm kind of wondering here in Q1, you've got a pretty substantial downtick expected for SBC. It's more than seasonal. One interpretation might be, you've got less software bridge happening sequentially. Is that correct interpretation? I guess relatedly, did you -- how many customers that weren't 10% customers that were meaningful SBC customers this quarter?

So James, we don't break out the 9000, 5200. We just report the SBC in the aggregate because we see them as a unified product portfolio. With regard to your comment on Q1 being down more than seasonal, we don't see it that way, but we don't see any major exposure there that's related to say, 9000 or 5200 or follow-on software sales. I don't believe we have any major SBC wins outside the 10% customers. Todd, do you want to talk about that?

No, I mean, I think we're still working on expanding the customer base and the mix and that's one of the reasons we've talked about some of the progress momentum on new accounts. Frankly, we need to continue to grow that to have less of a seasonal dip. So given the fact that we're still very much SP oriented, there still is a degree of seasonality to our business. When you look at it on a year-on-year and a business, the SBC business is actually up significantly, but it does have a quarter-to-quarter dip.

If I could just clarify on that point, if you go back to Q4 of '10, we did $12.2 million and that fell to $4.8 million in Q1. This last fourth quarter, we did $22 million, and that's going to drop to $10 million to $11 million. So the dip is actually less this year, year-over-year. James Kisner - Jefferies & Company, Inc., Research Division: I guess I don't understand how -- why you're seeing such a huge dip sequentially, and why that happens every year. Is it -- are you getting flush on SBCs at the end of every year that's different than the rest of your business that is it very volatile? Is there any reason why that's happening?

Because it tends to be very project driven in the SP space. And the first half of the year tends to be deployment with what was installed and what was sold and ordered in the second half of the previous year. And the only way we're going to get out of -- that's been the cycle with our business now for a number of years. And frankly, the only way we get out of that is by continuing to diversify the customer base and getting to a much more transactional nature to the business by bringing in lower end SBC product portfolio and expanding with the channel in the enterprise. James Kisner - Jefferies & Company, Inc., Research Division: Okay, just one final question, thanks for that explanation. Any thoughts on how much VoLTE impacts your guide for the year? What's your outlook for access oriented mobile SBC deployments this year?

Yes. It's virtually not in our guide, James. We see VoLTE as a really 2013, 2014 issue. I know others view it as sooner than that, that's our take on that industry.

Grant, do we have anyone else queued up for a question?

There are no further questions at this time. I would now turn the presentation back to you.

Okay, thank you, Grant. So as Ray mentioned, we will be hosting our Investor Day on Thursday, September 13 in New York City. Please save the date. We hope to see you all there and we will communicate further details in the next couple of months. This does conclude our results conference call. Thank you, again for joining us. We appreciate your interest in Sonus Networks. Grant, will you please provide our callers with the replay instructions again?

Actually, you have those instructions.

Okay. So the replay instructions are -- will be available on our website, and you can get those details on the Investor Relations portion of the sonusnet.com website. Thank you very much.

Thanks, everyone.

Ladies and gentlemen, that does conclude today's call. Thank you for your participation and ask that you please disconnect your line.