Ribbon Communications Inc. (RBBN) Q4 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Sonus Networks Fourth Quarter 2012 and Full Year 2012 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, February 28, 2013. I would now like to turn the conference over to Patti Leahy, Vice President, Investor Relations, Sonus Networks. Please go ahead.

Thank you, and good afternoon, everyone. Welcome to Sonus Networks' Fourth Quarter and Year End 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. Also, for your convenience, we will post today's prepared remarks on our website shortly after the call. 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 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: economic conditions, market acceptance of our products and services, the timing of revenue recognition, difficulties leveraging market opportunities, the impact of restructuring activities and our ability to realize benefits from the NET acquisition. 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 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. It's now my pleasure to introduce the Chief Executive Officer of Sonus, Ray Dolan. Please go ahead, Ray.

Thank you, Patti, and good afternoon, everyone. I'm pleased to report that Sonus made significant progress this past year in our journey to transform our business into an SBC-centric company. As I discussed with you during our quarterly calls throughout 2012, we focused on 4 key metrics that we believe are foundational to our success. Those metrics were: SBC momentum, channel momentum, new customer growth and operational execution. I'll briefly address each one in turn. First, SBC momentum. We delivered outstanding results with our SBC products, gaining significant share and posting year-on-year growth of approximately 80% for SBC product revenue, including NET, and 64% excluding NET, both of which were significantly outpacing the overall market rate of growth. In Q4 2012, Sonus' preliminary share of the SBC service provider market is in the low 20s, up from just under 3% in the first quarter of 2011. Our overall product mix also shifted substantially during 2012. For the full year, 44% of our product revenue is derived from our SBC business, which is up from 25% in 2011. We expect this metric to be north of 60% for full year 2013. Obviously, we expect this metric to be influenced both by the decline in our legacy business as well as by the increase in our SBC business. Our guidance today of SBC product revenue, which is projected at 1.7x our trunking product revenue in 2013, makes it clear that we believe that Sonus is firmly positioned as an SBC company. The second key metric we laid out was channel momentum. Again, we made considerable progress in 2012. We launched our channel program, Sonus Partner Assure, and have now recruited and trained over 30 select channel partners, well ahead of our original target of 20. In concert with Partner Assure, we dramatically expanded our channel-ready products, both organically and through the NET acquisition. We now have the broadest portfolio of channel-centric SBCs, from the 5000 series to that SBC 2000 and SBC 1000 that are all purpose-built to the needs of enterprise customers seeking reduced network complexity and add capability by moving to SIP-based communications. While on the topic of the NET acquisition, let me provide an update on the status of our integration efforts. This business has delivered on our expectations and, as we said at the time of announcing the transaction, we continue to expect it to be accretive to EPS in 2013. I am as confident as ever that the NET acquisition was the right thing to do to accelerate our SBC strategy and our efforts to address the enterprise segment. The former NET team brings strong knowledge of the enterprise and is a key enabler of continued growth in Microsoft Lync deployments, essential drivers for the next leg of our SBC growth story. The acquisition also brought a hybrid SBC product, which has proven to be very strategic to the U.S. government as it seeks to secure its network. These are capabilities and skills which would've otherwise taken as many months, if not years, to build on an organic basis, and we expect they will make a material contribution to our financial results in 2013. The third key metric we laid out last year was new customer growth. This metric is important, as it speaks to our ability to leverage our products to diversify our customer base and add more SBC revenue into the mix. We made great product -- progress, adding 29 new SBC 5000 and 9000 based customers in 2012, a 38% increase from last year. Including NET, we added 180 new customers in the fourth quarter, 130 of which were SBC customers. We are also pleased to confirm a significant recent SBC customer deployment, and that is Verizon. To help support their IP network growth, Verizon selected Sonus as part of its global SIP Carrier Interconnect Platform. This customer has deployed the Sonus SBC 9000 as a pure SBC platform. We feel proud of the tremendous progress we've made in winning new SBC customers while also expanding relationships with our existing customers. The final metric was operational execution. Simply put, this means that we do what we say we will do. Clearly, the macro environment was challenging for us and many others in the industry. Our SBC results demonstrated substantial share gains, but we fell short of our forecast for the media gateway business. As we told you on our last call, we expect the current trend to continue into 2013. To be precise, legacy product revenue was down 26% in 2012 to $86 million, and we are forecasting it to be down 30% in 2013 to $60 million. Throughout 2012, we took decisive actions to reduce our cost structure, including restructurings in August and again in December. We believe these actions position us to continue to drive innovation, invest in key partnerships and meet our commitment to reaching non-GAAP profitability for the full year 2013. Taken together, I believe our results against these 4 key metrics, with the added strategic value that NET brings to Sonus and the discipline we have instilled around our cost structure, have laid the foundation for our success in 2013 and beyond. I'll conclude my prepared remarks in a moment with our expectations for the coming year. But first, I'll turn it over to Moe to discuss our results and our outlook in more detail. Moe?

Thank you, Ray, and good afternoon, everyone. On our previous call, we committed to provide key statistics for both Sonus and NET, separately and combined, for Q4. Supplementary financial and operational data has been posted to the website for your convenience. Total revenues for the fourth quarter was $75.1 million, consisting of $65.2 million from Sonus and $9.9 million from NET. Combined total revenues compared to $57 million in the third quarter and $74.3 million in the fourth quarter of '11. Total SBC revenue, including products and services, was $26.1 million in the fourth quarter, $25.4 million in the third quarter and $22.5 million in the fourth quarter of 2011. One customer contributed greater than 10% of revenue in the fourth quarter, and that was SOFTBANK. Our top 5 revenue customers represented 45.4% of revenue this quarter, up from 41.3% in the third quarter and down from 54.9% in the fourth quarter of last year. We reported revenue from 504 customers in the fourth quarter, including 132 from Sonus and 372 from NET. This compares to 403 customers in the third quarter, including 132 from Sonus and 271 from NET. Looking at revenue geographically, domestic revenue accounted for 51% in Q4 versus 76% in Q3 and 67% in Q4 of 2011. Before I go on to further details on our financials, I'd like to point out the following are non-GAAP numbers that exclude stock-based compensation, write-down of prepaid royalties, acquisition costs, restructuring charges, amortization of intangible assets and depreciation resulting from the write-up of NET assets under purchase accounting. The fourth quarter 2001 (sic) [2012] GAAP results included a $7.1 million write-down of prepaid royalties on products that we do not believe we will generate revenue from in future periods. This write-down was charged to product cost of goods sold. We have eliminated this charge from our non-GAAP results, as we don't consider it part of our normal operations. Total gross margin for the fourth quarter was 59%, consisting of 59.6% for Sonus and 55% for NET. Combined gross margin compared to 58.1% in the third quarter and 64.1% in Q4 of 2011. Product gross margin for the fourth quarter was 61.4% compared to 66.3% in Q3 and 71.2% in Q4 of last year. Current quarter gross margin was affected by a lower margin legacy transaction that was booked in a prior year. Service gross margins for the fourth quarter were 55.3% compared to 46.4% in Q3 and 51.8% in Q4 of last year. Total operating expenses for the fourth quarter were $42 million, consisting of $36 million for Sonus and $6 million for NET, reflecting an entire quarter of NET expenses. Combined operating expenses compared to $38.6 million in the third quarter and $41.4 million in Q4 of last year. Consolidated headcount at the end of the quarter was 1,093, which includes 128 NET employees, versus a total of 1,095 last year. This reflects the ongoing streamlining of operations. Our net income for the quarter was $1.8 million compared to a net loss of $6.3 million in the third quarter and net income of $5.4 million in Q4 of '11. We ended the year with total cash and investments of $279.6 million. Our DSO for the quarter was 82 days, as compared to 74 days in the third quarter and 64 days in Q4 of 2011. The increase in DSO in the quarter was attributable to a higher percentage of revenue being billed in the last month of the quarter as compared to previous periods. We expect DSO to return to the 70s next quarter. I would like to provide more detail for our outlook for the first quarter ending Friday, March 29 for fiscal year 2013. Going forward, as previously stated, we will provide only consolidated results for Sonus and NET as the integration of NET nears completion. I will remind you that the outlook is provided in the press release and on our webpage. The total revenue outlook for the first quarter is anticipated to be between $60 million and $62 million, reflecting normal seasonality. Fiscal year 2013 revenue outlook is expected to be between $267 million and $271 million. Included in the first quarter outlook is anticipated total SBC revenue of $26 million to $27 million. The full year revenue outlook includes anticipated total SBC revenue, including products and services, of $120 million to $124 million, reflecting year-over-year growth of approximately 40%. Our expected annual SBC outlook, coupled with the anticipated decline in our legacy product revenue of roughly 30%, implies roughly $60 million in legacy product revenue in 2013. Turning to gross margins. The first quarter, we expect total non-GAAP gross margins to range between 61% and 62%. For the full year, we expect non-GAAP gross margins of 64% to 65%, reflecting continued streamlining of manufacturing and service operations and lower component subassembly costs as well as higher percentage of revenue from SBC solutions. For the first quarter, we expect non-GAAP operating expenses to be between $45 million and $46 million. We believe approximately $1.5 million of the sequential increase in operating expense will be attributable to seasonal increases in payroll tax-related issues. The seasonal expenses are expected to decrease by approximately $1 million in our second quarter. First quarter operating expenses are expected to be the peak quarterly rate for all of 2013. Total non-GAAP operating expenses for fiscal year 2013 are expected to be in the range of $171 million to $172 million. We believe the slight increase in operating expenses over 2012 will relate primarily to the full year effect of absorbing NET expenses of approximately $23 million in 2013 versus the $8 million included in 2012 expenses. For the first quarter, we expect non-GAAP loss per share of $0.03, and for the full year, we expect non-GAAP earnings per diluted share of breakeven to $0.01. Basic share count for the first quarter should approximate 281 million. For the full year, diluted shares are expected to be approximately 285 million. We expect to be cash flow positive from operations in 2013, with the first quarter ending cash and investments being flat quarter-over-quarter. We expect year-end cash and investments of approximately $285 million. With that said, I'd now like to turn the call back over to Ray.

Thanks, Moe. Before we open up for questions, I'd like to provide some context for our 2013 guidance and lay out our critical performance objectives to be addressed going forward in our quarterly calls. As I said in my opening comments, we made significant progress in 2012 towards our core goal to transform Sonus into an SBC-centric, profitable company. We are focused, and we have a plan to get there, but there's more work to be done. The 4 themes that will guide us going forward are as follows: First, continued SBC growth. The midpoint of our annual SBC guidance implies approximately 40% total SBC revenue growth this year, which again implies share gain, as it is well in excess of current market forecasts. To be clear, these results are expected to reflect our continued focus on the service provider market while also establishing our presence in the enterprise SBC market. We plan to report these metrics separately each quarter in 2013. Second, we expect to drive new customer growth, both with service providers and enterprise customers. We expect this to be achieved in part through our direct sales force but primarily through Sonus Partner Assure. We will continue reporting new customers each quarter in 2013. Our third key metric for 2013 is the percent of revenue that we generate from the channel and from enterprise customers. We plan to disclose channel-related and enterprise-related revenue each quarter in 2013. Finally, profitability. We are planning to drive Sonus to long-term consistent profitability. Starting in 2013, we expect to be at least breakeven to slightly positive on a non-GAAP basis for the full year, and we expect to begin generating cash from operations for the full year as well. Our approach will allow us to continue to invest as appropriate to ensure that we innovate and maximize market opportunities going forward. Our focus will be on revenue growth, margin expansion and cost control. Some of our efforts in 2012 are already leading to improved margins in our services area, and we expect to see improvements in product margins as well over the course of 2013 as we continue the integration of the former NET. As Moe mentioned earlier, Q1 should be the peak of our operating expenses for 2013, and we will continue to look for internal efficiencies going forward. As we deliver on this commitment, we will share our progress each quarter. In closing, I'd like to thank you for your time today. I personally want to thank our team at Sonus for their tireless efforts in driving our success, and I want to thank our shareholders for their continued support. We're excited about the future of Sonus, and we look forward to sharing our progress with you each quarter. With that, operator, please open the call for questions.

[Operator Instructions] Our first question comes from the line of James Kisner with Jefferies & Company. James M. Kisner - Jefferies & Company, Inc., Research Division: Congratulations on announcing your win with Verizon. Could you talk a little bit about like perhaps how does this win might look from like a share perspective? Are you dual sourced with another vendor? How do we -- help us think about -- that may help us think about how to see this directory, this opportunity going forward?

It's Ray. I'll ask Todd to handle that one, please.

So this was actually a win that was -- the deployment started well over a year ago. It's a multiyear rollout, and the rollouts will continue. As the success of their SIP service continues to expand, it will drive continual demand. So we are the -- we're the prime SBC within that platform, but that's as far as I can go just based upon the confidentiality of the customer. James M. Kisner - Jefferies & Company, Inc., Research Division: Fair enough. Okay. So -- and I know you're saying that you want to report just combined the company results. But just trying to understand the growth rate going forward and sort of what the key drivers will be in terms of applications and also just organic versus inorganic. Could you help us think about -- I know you've talked about a number of applications in the past, but how much of this is -- of your expectations are driven by interconnect and service provider versus enterprise? Or even more granularly, SIP trunking versus hosted PBX? Could you just talk about those aspects of your guidance?

Yes, sure. So this is Todd. Let me just kind of take you through in the order that you gave it. So from a service provider standpoint, we see continued growth from an interconnect standpoint. SIP traffic across the interconnect is continuing to grow, and as more and more SIP trunking is deployed and the beginning of cloud services is deployed, it's just going to continue to drive increasing capacity requirements for the interconnect. So we've got a nice funnel of interconnect, and a lot of our international growth and new customer growth is coming from new interconnect customers. So interconnect continues to be the primary source of SIP trunking. It is also a continuing, or I guess I should say, is continuing to grow as a market, and we're participating in that. We're still very early from a penetration standpoint, still about 12% in the U.S. and less than 5% in Europe and even less in Asia. We're excited that we're seeing some markets now beginning to adopt SIP trunking. As an example, we now see the beginnings of movement in Japan, where a year ago, there was really no movement of enterprise SIP trunking. So as that market continues to grow, there's going to be opportunities -- or develop, I should say, there's going to be opportunities to compete for the access side of SIP trunking. And as they continue to grow, it's going to just continue to drive more and more demand on the interconnect side. So we see good solid growth coming from the SBC side from those primary 2 sources, as well as partnerships with those cloud providers selling into the SME space for our big drivers of SIP trunking. On the enterprise side, we are now through the launch of our product and the launch of our channel, the integration of NET. So we enter this year with a full year of opportunity to go and compete and grow our enterprise business. The 5000 really just started to ship in late July, so we didn't have a full year of activity to bring that product into the market, and our channel really started to come online from a recruiting standpoint in Q4. So we have the advantage of starting now to gain some share in some spaces where, 12 months ago, we weren't really able to effectively compete. So the enterprise -- well 5000, as well as with the link deployments of the NET base, that gives us a great platform to be able to drive some significant growth in the enterprise. James M. Kisner - Jefferies & Company, Inc., Research Division: Would you say perhaps that one is growing faster than the other this year in terms of your expectations?

Well, for us, enterprise, from a year-on-year comparable standpoint, is going to be significantly growing because it was -- enterprise was such a small piece of our business. We don't see the interconnect really tailing off much on a year-on-year, and SIP trunking is all -- is in the early stages and don't see that slowing down. So those -- we see those 2 markets continuing at a nice pace. James M. Kisner - Jefferies & Company, Inc., Research Division: Okay. Last one, and I'll pass, if that's okay. Just as a follow-up on interconnect. Are you still making the VoLTE is a 2014, 2015 event? I'm just kind of wondering, is it just sort of natural to think that you would see the interconnect side would also sort of be pulled through as VoLTE is launched? Does that make logical sense?

Yes, and yes.

It's still a '14 -- I'm sorry, Ray, go ahead.

I would say, yes, we still think it's a '14 to '15. And yes, it will probably drive broader SBC growth in the interconnect side as VoLTE gets rolled out on the wireless side.

And there was just a study done in Mobile World Congress, actually a poll of those attending, and the -- only 7% expected to deploy VoLTE voice widely here in 2013. It really starts in '14, '15 based upon that survey, as an additional data point.

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

I want to shift to the -- with the drag of the legacy gateway business expected to continue into 2013 and probably beyond that, your expense structure looks pretty high relative to what your combined revenues are. It can be something in excess of 63%, 64% of revenue. And while I see you took the headcount down about 70-some-odd people in the fourth quarter and you're slightly under where you were at the end of 2011, I'm just wondering what we should anticipate as far as additional actions in 2013 to get the -- particularly on the gateway side, the expense and the revenues more in line with each other?

Yes. So, Steve, thanks for your question. I'll hand off to Moe in a second to get into any details. But we do see, as you said, the legacy business continuing to track down 30% year-over-year. We've taken our expenses down twice. There may be some additional opportunities for streamlining going forward, but I think a lot of the efforts that we've already accomplished will continue to run off into 2013 rather nicely. So I feel good about our expense structure, and we'll just continue to drive where we can. But I don't -- I wouldn't want to set your expectation of it to be another major process there unless we can get our arms around something that I don't see at this point in time. Moe, do you have some comments on that?

That's the only thing that I would add is that we -- we're constantly looking to streamline operations. We have indicated in our press release that we do intend to take upwards of a $2 million charge for restructuring efforts in the first quarter.

Just as a follow-up. So conceptually, your plan is to grow the revenues into the expense base as opposed to bringing the expense base down to the currently level's revenues?

Well, Steve, as I said in my comments, it's actually 3 things, is: To grow the top line. And I think that's going to be easier now with the proportionality of our growth business and our legacy business. The math will start work in our favor from the standpoint of growth. That's one. Two, we're going to drive hard for margin expansion, and I tried to lay that out in the call. I'm happy to speak to that just a little bit. We've done some service margin expansion through cost reduction. We will also do some product margin expansion through a comprehensive suite and to hand through the supply chain. Greater level of integration to a single contract manufacturer, and then we will also drive a design for manufacturing FX [ph] throughout all of our product lines so that we can constantly drive cost down and expand our product margins. And then finally, there'll be expense control. But what I'm trying to say is proportionally, I don't think expense control is going to be the largest lever in 2013. We've done a lot of that work in 2012. We'll continue to manage expenses, but we're also going to drive for revenue top line growth and margin expansion.

Okay. And then just as a third follow-up and a second follow-up. Long-term operating model of the company, can you just kind of review where that -- where you currently see that being? And how many years out do you think that would take to reach the kind of levels?

Can I just ask you to clarify your question, Steve? The operating model...

Yes, long-term growth margin objectives, long-term expenses as a percent of revenue objectives and leading down to long-term operating margin targets.

Yes, I'm not prepared to lay those out on this call, Steve. What I will tell you is that we benchmarked ourselves against our industry peers, and I believe we have a number of opportunities to focus on margins specifically. I don't believe OpEx as a percentage of revenue is as far off industry standard as our margin opportunity, our margin expansion opportunity is. And so that's -- we're going to spend our time in all 3 of those categories, but I would say the principal focus operationally will be there.

Our next question is a follow-up question from the line of James Kisner with Jefferies & Company. James M. Kisner - Jefferies & Company, Inc., Research Division: Just to clarify just on -- back on our facts for this last quarter. Am I imagining things, or did you guys actually deliver OpEx below your updated guidance from your Analyst Day? And if so, kind of what drove the variance there?

Moe, do you want to go ahead and handle that?

Yes. Yes, it was lower. We did indicate it was $42 million, and that was in fact lower than we had provided for guidance. It does reflect the ongoing streamlining of operations and the restructuring activities that we took in the quarter. James M. Kisner - Jefferies & Company, Inc., Research Division: Okay, great. So what about -- just switching gears briefly here. On the recent acquisition of the competitor, I'm kind of wondering if that perhaps might be positive for you in that Lync ecosystem just sort of given that -- finished adversary relationship of Microsoft and the new owners? You think, at the margin, that might potentially help you guys out in the Lync environments?

Yes. So, James, great question. This is Ray. I'm going to hand it off to Todd in a second to talk about the market dynamics. I would say more broadly, it validates our strategy of focusing on SBC growth well over a year ago and driving the company to being an SBC player of substance. And our share gains and our results make me really pleased that we did that. It also shines a bright light on the sector and the importance of the SBC as part of the overall network architecture for people to move to cloud-based unified communications. So that puts energy in the sector, if you will, and causes a lot of people to sit up and listen. I'll hand it off to Todd to talk about what it may, in fact, do from the standpoint of momentum in the marketplace as it plays out. Todd?

Yes, and I think your instincts are right that it is going to open up some partnerships that may not have been -- may have been much longer to develop, and the acquisition of NET and the partnerships with both the ecosystem and Microsoft itself only is an opportunity to get stronger going forward.

We have no further questions registered at this time.

Well, thank you, everyone. We appreciate you joining this evening. We are on track for another transformative year. We look forward to updating with you -- updating our progress with you and speaking to you on our next earnings call. Thank you very much, and have a great evening.

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.