Ribbon Communications Inc. (RBBN) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Sonus Networks Third Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, November 7, 2012. I would now like to turn the conference over to Patti Leahy, Vice President, Investor Relations. Please go ahead, ma'am.

Thank you, and good morning, everyone. Welcome to Sonus Networks' Third Quarter 2012 Operating Results Conference Call. Thank you for joining us today. As a reminder, a recording of this call will be available on our website at sonus.net. Speakers on the call today are Ray Dolan, Chief Executive Officer; and Moe Castonguay, Chief Financial Officer. Todd Abbott, Executive Vice President of Strategy & Go-to-Market is also here to address your questions at the end of our prepared remarks. 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. 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, any statements related to our acquisition of NET or their financial results and outlook, 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 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. 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 at sonus.net. Please that we have provided a new supplementary schedule in the Investor Relations section of our website, which includes financial and operational metrics for Sonus on a standalone basis going back to Q1 of '11 and for Sonus and NET beginning with Q3 of this year. NET results reflect a partial period from August 25 through September 28. It's now my pleasure to introduce the Chief Executive Officer of Sonus, Ray Dolan. Please go ahead, Ray.

Thank you, Patti, and good morning, everyone. Sonus delivered solid third quarter results in an increasingly challenging macro environment. I'm particularly proud of our SBC performance, which grew 78% year-over-year and 37% sequentially. These results exclude NET's partial period contribution, and they continue to be significantly ahead of the SBC industry growth rate. Before Moe covers our results in more detail, I'd like to address 2 key themes with you. First, I'll address the outlook of our consolidated business; and second, I'll review some of our key accomplishments. Turning to our outlook first. The external environment has become more challenging than we anticipated, even as recently as our Analyst Day. A weak macroeconomic environment has caused our service provider customers to scrutinize their CapEx spend much more closely. Many service providers are now deferring the purchase of additional TDM assets, while leveraging their existing gateway capacity and focusing their resources on new revenue-generating IP service infrastructures. The fact that our third quarter is normally back-end loaded due to the summer months prevented us from seeing these trends early enough to revise our guidance prior to Analyst Day. The trends are now clear to us and embedded in our guidance for Q4, which implies approximately 30% year-over-year decline in our media gateway product revenue. We expect this could continue into next year. Fortunately, our SBC growth engine is benefiting from favorable industry trends around SIP trunking and unified communications. In fact, excluding NET, our SBC product revenue is expected to grow in excess of 65% year-over-year in 2012, or 3 times the industry's rate of growth according to Infonetics. Our revised annual outlook, which Moe will cover in more detail in a moment, includes total SBC revenue expectations at the high end of the range previously provided and a decrease in our media gateway product revenue outlook. As we navigate through this economic and market uncertainty, we will continue to adjust our operating expenses in order to meet our commitment of non-GAAP profitability in 2013. This environment is, without a doubt, challenging, but make no mistake, this is a challenge we are prepared to win. We are making excellent progress in transforming the mix of our business. And frankly, the faster we get through the challenges associated with our media gateway product revenue, the faster we will reach our goal of being a consistently profitable growth company. This brings me to my second theme, which is our recent key accomplishments. A key operational milestone in Q3 was closing the acquisition of NET, a leading provider of SBC solutions for enterprise Microsoft Lync UC deployments. The SBC 1000 and SBC 2000 will be key contributors to our enterprise UC business, which is an important source of our future growth. To highlight this point, we won 40 new customers in the quarter, 11 from Sonus standalone and 29 from NET. This count reflects NET's partial quarter contribution. NET closed a total of 83 new customers in the full calendar third quarter, which is up 43% year-over-year. All NET wins are enterprise customers, and 3 of the Sonus wins are enterprise customers. 100% of these new customers were SBC-driven deals. Sonus and NET recognized revenue from over 400 customers in the third quarter, and we expect this to continue to expand in the coming quarters, as our channel program ramps and we continue to benefit from NET's enterprise UC business. The NET acquisition also increased the competitiveness of our SBC product portfolio. Sonus now has 4 of the 7 Microsoft Lync-certified SBCs in the market. This is significant, because Microsoft is one of the leaders in the Gartner Magic Quadrant for Unified Communications, which is an important validation for customers in their vendor decisions. Sonus has the broadest SBC product portfolio deployed in the market today, ranging from our SBC 1000 and 2000 for small offices and branch offices, our SBC 5100 for larger enterprises and small service providers and our SBC 5200 for the largest enterprises and carriers. Our SBC 9000 also continues to resonate with our large service provider customers. The strength of our SBC offering is clearly reflected in our results. This quarter, including NET for the partial period, 61% of our product revenue was SBC-related, and 45% of our total company revenue was SBC-related, clear evidence that we are making the pivot to being an SBC growth company. In a nutshell, Sonus is increasingly competitive. We're taking market share and we are driving strong SBC results. Recently, Sonus was recognized by Gartner as a leader in the Magic Quadrant for SBC, reflecting our clear SBC vision and execution strength, which is a significant milestone in our transformation and confirmation of the commitment we've made to being a leader in the SBC market. I want to remind you that participation as a leader in the Magic Quadrant is an important validation for customers in their vendor decisions. To summarize, while our legacy business continues to face external pressures, Sonus has the right focus, the right team and the right strategy to overcome this challenge and continue on our growth trajectory. Our SBC growth engine is on track and is growing faster than the market. We are well positioned to take advantage of the growth opportunities in front of us. I'd now ask Moe to take us through the third quarter results and outlook in more detail. Moe?

Thank you, Ray, and good morning, everyone. On our last call, we committed to providing key statistics for both Sonus and NET, separately and combined for Q3 and Q4. For your convenience, we have posted today's prepared remarks and supplementary financial and operational data on the IR section of our website. Our press release issued earlier today reflects Sonus operating results for the third quarter ending September 28, 2012, and NET's operating results for the period August 25 through September 28, 2012. Before I go into details of our financial results and outlook, I'd like to point out that the numbers I'm going to discuss are on a non-GAAP basis, with the exception of revenue. Non-GAAP financial results exclude stock-based compensation expense, amortization of intangible assets, acquisition-related costs, restructuring charges and depreciation resulting from the write up of the NET assets under purchase accounting. Total revenue for the quarter was $57 million, consisting of $49.9 million for Sonus and $7.1 million for NET. This total compared to $57.6 million in the second quarter of 2012 and $56.4 million in the third quarter of 2011. Our total SBC revenue was stronger than expected in our third quarter. Third quarter total SBC revenue was $25.4 million compared to $19.1 million in the second quarter and $13.9 million in the third quarter of 2011. One customer contributed greater than 10% of our total combined revenue in the quarter, and that was Level 3. Our top 5 revenue customers represented 41% of revenue in the third quarter, down from 54% in the second quarter and down from 52% in the third quarter of 2011. We reported revenue from 403 customers in the third quarter, consisting of 132 from Sonus and 271 from NET. This compares to 123 customers in the second quarter and 107 customers on the third quarter of 2011. Looking at total revenue geographically, domestic revenue accounted for 76% versus 73% in the second quarter and 63% in the third quarter of 2011. Total gross margin for the third quarter was 58.3%, consisting of 59.1% for Sonus and 51.8% for NET. The combined gross margin compared to 57.4% in the second quarter and 64.2% from Q3 of '11. Product gross margin for the third quarter was 66.3%, consisting of 69.9% for Sonus and 49.4% for NET. This compared to 66.3% in Q2 and 72.8% in Q3 of '11. Service gross margin for the third quarter was 46.4%, consisting of 45.6% for Sonus and 61.1% for NET. This compared to 45.7% in Q2 and 49.4% in Q3 of '11. Total operating expenses were $38.6 million, consisting of $36.2 million for Sonus and $2.4 million for NET, as compared to $41.7 million in the second quarter and $39.2 million in Q3 of '11. Our Q3 operating expenses were slightly lower than our previous outlook, reflecting lower compensation costs. Headcount increased to 1,172 employees, which included 136 employees related to the NET acquisition. Our loss for the quarter was $6.3 million or $0.02 per share versus our outlook of $0.03 loss per share. This compared to a net loss of $8.6 million or $0.03 for the -- in the second quarter and a profit of $4.1 million or $0.01 in Q3 of '11. We ended the quarter with total cash and investments of $303.3 million. Our DSO for the quarter was 74 days, compared to 65 days in the second quarter and 60 days in Q3 of '11. This reflects longer collection period in the channel, including NET. Now I'd like to provide our outlook for the fourth quarter ending December 31, 2012. Immediately after providing our Q4 outlook, I will provide the summary full year outlook. As Ray discussed, due to the uncertainty around service provider spending, principally as it relates to our legacy media gateway revenue, we are revising our Q4 outlook. Our total revenue outlook for Sonus and NET combined is $77 million to $81 million, consisting of $67 million to $71 million for Sonus and approximately $10 million for NET. Our Total SBC revenue outlook for Sonus and NET combined in the fourth quarter is $25 million to $26 million, consisting of $21 million to $22 million for Sonus and $4 million for NET. Fourth quarter combined non-GAAP gross margin is expected to be 58%, consisting of 60% for Sonus and 45% for NET. The company continues to streamline operations to reduce operating costs as part of a corporate-wide restructuring plan. In our fourth quarter, we expect to take a restructuring charge of approximately $6 million, consisting of $5 million for facility, consolidation charges related to NET acquisition and $1 million of severance and related expenses. We expect combined non-GAAP operating expenses of $44 million to $45 million, consisting of $38 million to $39 million for Sonus and $6 million for NET. In Q4, we expect combined non-GAAP earnings of breakeven to $0.01 profit. Diluted share count for the fourth quarter should approximate $282 million. We expect our Q4 closing cash and investment balance of approximately $270 million. This reflects the redemption of an additional $8-plus million in NET debt that was not previously forecasted to be redeemed, as well as product shipments that are projected to be back-end loaded in the quarter. Our 2012 full year outlook is as follows: Consolidated revenue outlook has been reduced to $256 million to $260 million, consisting of approximately $239 million to $243 million from Sonus and $17 million from NET. We expect total SBC revenue for Sonus and NET combined of $87 million to $88 million, consisting of $81 million to $82 million for Sonus and $6 million for NET. As Ray stated earlier, our full year SBC revenue outlook is at the high end of the range of our previous outlook. We expect total combined non-GAAP gross margin of approximately 60%. The total non-GAAP operating expenses for full year 2012 were expected to be approximately $170 million to $171 million. We expect a combined non-GAAP loss per share of $0.06 to $0.07 for the full year. For full year, basic shares should approximate $280 million. I'll now turn the call back over to Ray.

Thanks, Moe. In closing, we continue to improve our competitive positioning in the SBC market. We remain very encouraged by the SBC demand we're experiencing and our ability to meet that demand. We are responding pragmatically to this changing environment. We continue to focus on our growth opportunities, streamline our operations and reduce costs, so that we drive the profitability next year. We'll be happy to take your questions now. Operator, please open the line.

[Operator Instructions] Our first question, coming from the line of Subu Subrahmanyan with JudaGroup.

Ray, could you talk through the media gateway business? I think you had suggested that you think next year could be a similar 30% kind of growth or decline number? Can you talk about what you expect broadly for the SBC market directionally? And anything you can say for Sonus? And on a net basis, do you think 2013 can be a growth year for the company?

Thanks for your question, Subu. So media gateway SBC in total. And I want to be -- I want to caveat, this is -- we're not guiding, we will on our Q4 call, guide into next year. But broadly, we see the trends in the gateway business probably continuing into next year. Until we know more, we're operating under that assumption, and so we carry that going forward into our thinking next year, and when we model it, we'll let you know what that is. On the SBC side, we continue to see industry growth around 20%, and we expect to gain share, but we don't have a more specific information for you on that number now from the standpoint of your modeling. We'll let you know on the Q4 call on that. And it's too soon to tell, because the total comes from the 2 pieces. What we will say is we'll try to -- the results that market allow us to have will be very aggressive in gaining share to the extent we can in the SBC market. And we'll make our expense adjustments around that profile. Okay?

Understood. And can you talk about enterprise versus carrier for the SBC market? What do you think the growth rates are? If you can desegregate that for next year. And where those share gains for you could come from next year?

Sure. I'll start that question. I'll offer the opportunity for Todd to chime in as well. He's here on the call. On the service provider side, we see continued growth. It may be on the 20% level. We think the higher growth rates are probably available in the enterprise segment, in general. And for us, the opportunity to grow in the enterprise space is off of a very low base. And remember, we spent a lot of this year getting ready for that. We built our whole product. We launched the 5100. Streamlined, we even made the 5200 more channel friendly. And now we have the 1000 and 2000, all of which are Lync-certified. So there's a lot of opportunity for us to grow into the enterprise, and we see the enterprise, particularly in North America and ultimately globally, but on a slower pace, adopting SIP trunking and moving into UC. So I think there's an opportunity there. I think if the industry growth rate is 20%, it's probably slightly more than that on the enterprise side and slightly less than that on the SBC side. And I would expect us to gain share in both categories. Todd, do you want to add any color on that?

I think you said it right. I mean, I think, the 2 primary drivers are going to be channel and the extended product line from NET.

Our next question, coming from the line of James Kisner with Jefferies & Company. James M. Kisner - Jefferies & Company, Inc., Research Division: So I just want to understand the SBC strength here -- I mean, this is clearly better than you expected. And next quarter, you expect there a lower number, but I see you raising guidance for the full year. Just would you say that some of the strength this quarter came at the expense of Q4 to some orders hitting Q3 that you didn't expect in Q4? Or could you just give a little more texture on the dynamic around the SBC strength, and your expectations for Q4?

Yes, I don't think -- and thanks for your questions, James, this is Ray. I don't think any of our results in Q3 came from pulling in Q4. And the adjustments made to Q4 are modest, and the aggregates still leave us on the high end of the range. We're learning more about NET, we're learning more about the 1000, 2000, and it's -- basically, it's trajectory as it wins but takes longer -- takes multi-years to deploy in a very robust way across these large enterprises. So our guidance isn't about pulling it in. It's just about having a good Q3. As far as Q4 is concerned, Todd, do you want to comment on where we look going forward?

I mean, I think we see continued robustness in that business. We believe we're going -- that we're positioned well to continue to take share. We're still seeing good growth from an interconnect standpoint. But as Ray said, I think it's just continued execution and momentum in our SBC business. James M. Kisner - Jefferies & Company, Inc., Research Division: Okay. But you are theoretically guiding down Q4 SBC revenues. So is it just more caution or -- I'm just trying to reconcile that with what you're saying, it's not coming maybe -- it's not lower because of Q3 strength. Just -- you're going sequentially, so I'm not knocking it, but I'm just curious. There were some change there -- what the change is?

It's really all of the above in your answer, James. Some of it is just the math that -- Q3 being higher, I'm reluctant to guide to a higher year yet, so we're a little bit cautious just taking -- but it's a modest takedown from the standpoint of the product side. And if we can beat that, we will. But I think that -- our guidance represents what we think will happen in Q4. James M. Kisner - Jefferies & Company, Inc., Research Division: Okay. And just a quick follow-up here. Just on cash, I know you're not guiding to next year, but your cash burn here is something that should be a little bit more than expected? And I'm just wondering is $270 million the -- now the -- going to be the trough? Do we think that's the end? And just could you also just talk a little bit about the convertible debt and not -- I think you said that you didn't expect them to be redeemed. Can you explain that a little bit more, why you didn't expect that to be redeemed? Did you expect that to be redeemed later or what?

Sure. The issue relative to the bonds are that we did not have the ability to call those, however, the bondholders have the ability to put them to us. And we were surprised given the rate of 3.75% that anybody would give up that rate. However, 8-plus million of them were redeemed. And therefore, that was not expected when we had provided our earlier guidance relative to cash. With respect to the forecast of $270 million, it is close to, we believe, the trough in cash.

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

One quick housekeeping item first. The $87 million to $88 million, is that product SBC revenue? Or is that combined products and services?

That was total SBC revenue.

Combined.

Okay, total. Great. And then my other follow-on question is could you provide more color on how the channels are going with the acquisition of NET? Because it seems like that will drive a lot of your SBC business going down the road? And just more on how well you are doing with that channel -- with the channel?

Sure, Catharine. This is Ray. Thanks for your question. I'll Ask Todd to do that. We're making some really good momentum there. And you can describe that, right, Todd?

Yes. So with the portfolio of partners that came with the NET business was some 350. We had identified that we were going to continue to allow them to -- not allow them, but to bring them into our Partner Assure program. As resellers for the legacy, NET now SBC 1K, 2K. We expected that there would be a subset of those that would migrate to a higher level of category that we call Partner Select, which is the ability to now sell the complete SBC line from 1K up to 5k. We thought that, that would be -- that's some 20 to 25 globally. The interest level is now much higher than that. It'll be probably closer to 40 to 50 partners that are going to move through the training and certification process, that's basically based on their interest. So we feel pretty good about where we are from -- on a cooperation of the NET channel into the Partner Assure program.

Our next question, coming from the line of Jonathan Kees with Capstone Investments.

I wanted to start with a couple of housekeeping, if I may. What was book-to-bill for the quarter?

John, this is Ray. Thanks for your question. Book-to-bill was below 1 in the aggregate. On the SBC business, it was close to 1.

Okay, 1. All right. And then did you provide a NET, SBC product revenue number breakout?

The SBC product revenue breakout for the quarter -- our outlook. Are you asking about outlook or were you talking about our actual results?

Outlook, sorry. Actually both, yes.

Our outlook, SBC product revenue was $21 million to $22 million for the quarter and our total SBC, including services, was $25 million to $26 million. For the full year, that equated to product revenue of $68 million to $69 million and $87 million to $88 million for the -- for everything combined.

And, Jonathan, this Patti. We have the supplementary data out on our website as well, which will give you the historical, at least for Q3 data, for NET.

I guess what I'm asking you is the -- the NET, SBC product revenue number breakout for the guidance. Is that -- do you have the total revenue?

Yes. It's a -- it was $3 million to $4 million for NET product revenue.

For Q4?

For Q4.

Okay, $3 million to $4 million. Okay, great. All right. And my main question's the DSO, you spiked up and you talked about longer collection period in the channel, including NET. So going forward, are we looking at that as the new norm? And, I guess, this is a question more for Moe?

Well, certainly, as we continue to expand our channels, we do expect longer credit collection cycles, and therefore the DSO should be more lengthy. And that's why you saw the jump from Q2, which was 65 to 74. And NET has traditionally experienced longer DSOs -- or higher DSOs than we have. So we would expect them to be in the 70-day range, likely going forward.

Okay, okay. And then the other question is you talked about the media gateway business being worse than expected since -- even worse than from Analyst Day. A lot of it's because you're back-end loaded year. And I guess, looking at your top 10 customers, AT&T didn't make it there. And almost consistent in the past is -- I guess, is it fair to say that most of the media gateway business was domestic, the weakness there, and primarily with your 10% customers?

Yes. So, Jonathan, this is Ray. Thanks for your question. It was across the board. But given that our gateway business is heavily weighted to domestic, the shortfall would be heavily weighted to domestic, but I think it was a market-driven issue as opposed to any one single customer.

[Operator Instructions] Our next question, coming from the line of Steve Cohen [ph] with Provo Partners [ph].

Considering how quickly the legacy revenue outlook deteriorated at the end of the quarter, what changes might you be making as far as your short-term forecasting abilities?

Steve, thanks for the question. While we meet and we have continued to meet, myself and Todd, as well as other sales leadership with all of the major accounts, make sure we understand what their business models are and what their forecasts are. And so that's what we've been doing, we doubled down those efforts so that we can think through 2013 more pragmatically. And we reference other industry trends as well, both in research as well as in other companies' announcements. So that's what we're doing from the standpoint of our forecast capability. And as I said earlier, we're most likely to guide the continuation of this into next year, once we get our arms around the data between now and the end of the year.

Just as a follow-up. At the Analyst Meeting, there've been quite a bit of discussion in the fourth quarter, and you had alluded to some very specific projects that gave you the confidence that you would be able to get the big quarter. Are those projects delayed? Or are those projects no longer a viable opportunity?

I'll ask Todd to probably put some color on that, Steve [ph].

Some of them have pushed and some of them, we believe will, not return based just on prioritization of spending and focus of the service part of market.

Ms. Leahy, there are no further questions at this time. I will now turn the call back to you.

Thank you, Susie. Well, we appreciate the time you've taken with us -- to be with us today. And we look forward to seeing as many of you as possible during this outreach period. Thanks a lot. Have a great day.

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. Have a great day.