Radcom Ltd (RDCM) 2006 Q3 法說會逐字稿

Welcome to the RADCOM, Ltd. third quarter 2006 results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded October 23, 2006. I would now like to hand over the call to Ms. [Noga Fisher] of [Fisher Caan]. Ms. Fisher, would you like to begin?

Thank you, and good morning, everyone. With me today are RADCOM's CEO, Arnon Toussia-Cohen, and CFO, Jonathan Burgin. By now we assume you have seen the preliminary earnings press release, which was issued earlier this morning. It is available on all the major financial news feeds. Before we begin, I would like to review the Safe Harbor provision.

Forward-looking statements on this conference call involve a number of risks and uncertainties, including, but not limited to, product demand, pricing, market acceptance, changing economic conditions, product technology development, the effect of the Company's accounting policies, and other risk factors detailed 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 users' overall understanding of the Company's financial performance. By excluding certain non-cash charges, 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 this press release. The Company does not undertake to update forward-looking statements.

Now I would like to turn the call over to Noni.

Thank you, Noga, and thank you all for joining us. The third quarter was another period of growth, of stability and strategic progress for RADCOM. A number of developments illustrate the positive momentum of the Company.

First, our revenues were $6.7 million, in line with our guidance and the highest they have been since 2000. In fact, this is our 12th straight quarter of year-over-year revenue growth.

We are also encouraged by the makeup of the revenues. While our repeat business remains strong, more than half of our revenues for the quarter came from new customers, both 3G and voice over IP service providers. We have now penetrated a significant number of cellular and voice over IP service providers throughout the world, and built a strong initial presence in the Far East. This represents a strong base for repeat fills.

In addition, we are pleased that our net margin has now reached 8.5%, moving us closer to our target model. As we have said in the past, once we get about $5.5 million of sales for a quarter, $0.50 of each additional $1 goes straight to the bottom line. So, the Company will become more and more profitable as we grow the top line.

All of these developments demonstrate our success as we ride the adoption wave of converged networks. Now we are working to take the Company to the next level.

I would like to take advantage of this conference call to give you more detail regarding our progress and markets, and then to outline our strategic going forward -- strategies going forward.

As I said, the third quarter was a good period for RADCOM. On a geographical basis, we continued to record a strong level of sales from 3G [cellular operators], primarily in Europe and North America. During the quarter, we increased our penetration of Europe significantly. Both of the quarter's 10% customers were from Europe -- one an existing customer and the other a new customer. In addition, we announced the sale to Telefonica O2 of the Czech Republic, expanding our foothold in Eastern Europe. In general, we had a high level of new customers during the quarter, increasing our base for repeat sales.

In parallel, we continued to build our presence in the Far East. During the quarter we established an office in Singapore. So, now we have presence in Korea and Singapore, as well as in China.

Our sales to voice over IP service providers were higher in the third quarter than ever before. This included a number of sales, including one to a voice over cable operator in the U.S., another to a New Zealand carrier for a nation-wide deployment, and several others.

In parallel, we have now begun selling the R70 Probe, our new 10 gigabit per second platform. During the third quarter, we received our first order, and after the quarter we received another from one of our [better site] customers. This is especially encouraging since the customer experience with the product and their evaluation confirmed their need for such high-performance capability.

On the technology side, the third quarter was a productive period, during which we announced several extensions to the Omni-Q. For 3G cellular operator, we announced sophisticated new correlation module. It addresses the need to trace the source of problematicals, even when it begins in a different domain or in different interface within the same domain. For example, it can identify that the dropped call in the core domain is caused by a poor radio link on the radioactive segments, or that denial of access to a specific service on the IT domain presents itself as low-bandwidth utilization on (indiscernible). These dramatically reduce the time required to solve trouble on the line, paying for itself quickly through higher service level and happier customers.

Also during the quarter, we announced Omni-Q for IPTV. Based on the powerful new R70 platform, the system measures the performance and the direction of every component in the service delivery chain. This allows IPTV service operators to take full control of the subscriber experience, even in an environment of thousands of simultaneous video streams.

From an industry recognition point of view, we were very pleased to receive another award during the quarter. TMC Labs awarded us its 2006 Internet Telephony Award for our R70 Probe as an outstanding innovation in voice over IP, cellular and IPTV service monitoring and troubleshooting.

I'd like to stop here and turn the call over to Jonathan to go over the financial reports. Then I will come back to discuss our strategies going forward and open the line for your questions. Jonathan, please?

Thanks, Noni. Since you have the results in front of you, I'll focus on the highlights of the quarter.

Revenues for the period were 6.7 million, up 14% year-over-year and 18% compared to the second quarter of 2006. This is in line with the guidance that we gave last quarter.

As Noni said, this is our 12th straight quarter of year-over-year revenue growth, and our highest revenues since the year 2000. The majority of our sales continue to be to wireless operators -- about 55% in the quarter. 40% of our sales were to the wireline operators, a very high percentage compared to the past. And sales to equipment vendors were slightly less than 5%. More than half of our sales for the quarter were to new customers. This is an indication of our success in penetrating new markets and increases our base for potential repeat sales in the future.

On the geographical basis, our revenues continued to come mainly from Europe and North America, with Europe accounting for about 45%, North America for about 30, Asia-Pacific, including China, for an additional [13]%, and South America for about 10%.

3Although our sales in the U.S. were not as high as they were in the second quarter, we were still able to maintain a 70% gross margin, which is an encouraging achievement. Over the next few quarters, we will see if this develops into a trend that will result in higher profitability. As always, we expect some fluctuation in the gross margin, depending on the mix of sales.

On an operating basis, our expenses are up by about 20% year-over-year. This is in line with our work plan for building the Company to the next level of sales. It reflects the addition of a new layer of management for ours sales organization, the expansion of our presence in the Far East, and, of course, continual investment in extending our technological edge.

On a GAAP basis, we recorded 131,000 of non-cash charges during the quarter as part of our implementation of the FAS 123R standard. This requires us to recognize the fair value of share-based incentives as compensation expenses. In the earnings release, we have detailed the allocation, which affected all of our expense categories. Over the first nine months of 2006, FAS 123R has added 364,000 to our expenses, and we expect the total for the year to be about 500,000.

On a non-GAAP basis, excluding these charges, net income was 701,000, or $0.04 per share. This is up 42% compared to the third quarter of 2005, which also does not include share-based compensation. As you can see, the net line is rising as a percent of revenues; that is, net margin is now 8.5%. As our revenues continue to rise above our breakeven point, we expect the net margin to rise towards our long-term target of 20%.

Turning to the balance sheet, cash and bank deposits were 11.4 million at the end of September. Current and long-term deferred revenues as of the end of the quarter were at 2.9 million, similar to the level at the end of the second quarter.

As to guidance, please keep in mind that our results for any one quarter will vary depending on the timing of individual large deals. Nevertheless, we have visibility for a strong fourth quarter, enabling us to predict revenues of 7.4 to 8 million. As we have mentioned in the past, next year we are considering moving to an annual framework for our guidance.

We will update you at the [year-end] conference call. Back to you, Noni.

Thank you, Jonathan. I will finish up with a discussion of our plans going forward.

As you know, the strategy we have been following was, first, to build ourselves to about $25 million to expand our sales and marketing organization, and then to pursue the next level of sales, both through organic steps and through potential M&A activity. We are pleased to have progressed through the first and second steps, and are now moving into the third phase.

To support our organic growth, we continue building our presence in the Far East, and [are] now working to penetrate tier 1 service providers in both wireline and wireless markets. To improve our positioning in this area, we have initiated a discussion with equipment vendors regarding marketing partnerships.

As for our M&A plan, we are (indiscernible) exploring opportunities, with the goal of carrying out a transaction in 2007, depending on the opportunities that materialize and our financial position.

So, that's it for the quarter. In summary, we are pleased with our progress, especially our success in penetrating new customers, in building our European sales, and in expanding our voice over IP sales. We are very pleased to see significant rise in our net income as our revenue grows and we move towards our target -- to our targeted profit model. To take the Company to the next level, we are now pursuing a strategy for organic growth, while also exploring M&A opportunities. As part of our strategy, we are working to establish partnerships with top-tier vendors. Overall, we are pleased with our progress and optimistic regarding the prospects.

As always, thank you for your support of RADCOM and for participating in this conference call. With that, we'll be happy to take questions.

(OPERATOR INSTRUCTIONS). Blaine Marder, Loeb Partners.

Congratulations. A couple of questions. One, were there any deals or any revenue in the quarter that perhaps you didn't -- you weren't able to book in this quarter that you were hoping to that are going to get pushed into next quarter?

You mean they were not booked or not recognized?

Yes, that's correct.

Recognized.

The only deal that I think that we need to remember is the deal that we talked about in the last quarter -- that means the second quarter -- that was deferred -- that was not -- that same deal was not recognized in the third quarter.

There are always some deals that are not recognized. We have some backlog, but it's not significant to mention.

Noni, do you feel good about, heading into 2007, that you can grow the topline faster than you did in 2006? I think you were originally looking for 20 to 25% growth. Do you feel good about that potentially in 2007?

First of all, we do feel good because of a few reasons. One is that we believe that we succeeded in maintaining and even expanding the technology difference between what we saw -- what we -- our competitors and ourselves. We do see opportunities with voice over IP growth that we talked about. We do see increasing the pipeline, which [indicates] for us.

I must say that we did expect the 20%, as you said, and I think that what we see is that the market is not maybe growing in the same pace as we expected. But we do believe that the extension of the markets to voice over IP, the extension also of the 3G -- we believe that will give us the growth. We will announce the year end the exact expectation, but we do feel comfortable that the growth is there. And we have a good reason to believe that we have -- we are positioned to take advantage that.

Very good. In terms of acquisitions, what are you looking for exactly? And then, what financial parameters will you put around any acquisition?

We are looking for a company that -- we're not looking for technology; we are looking for expansion of being able to come to the same customers we are selling today with other products that have the value of their own. We are looking for a company that are maybe a little smaller than us, but not a startup -- someone who is ready to have a base in the market -- that has a similar gross margin and are selling to the same guys that we are selling to. That means that expanding it will make our marketing -- the sales and marketing more efficient, and we will have more -- we'll have more to offer to the same customers, which make it -- ourselves more efficient.

We believe that we are looking for a company that each one of us can continue the business as a standalone, but also the combination may bring additional value to the customers. We believe that this is the approach. It's not only for us, but this is an approach that is right, and we'll implement it in many test equipment companies, and that's what we are looking for.

Concerning the financial [status], in order to materialize that, we need to be in a situation where such a merge will make sense to both sides on the -- on the terms, which means that either a cash or stock change, or something like that. But we are planning to, or hope to be able at this point when we'll have this opportunity ready, to be able to execute such a transaction that will make sense for both sides.

Jeff Meyers, Intrepid Capital.

Maybe you could just talk about some of the big RFPs that you guys are seeing out there, and maybe tie that in with the sort of partnership programs that you have. Which partners have been working out well for you guys, and which relationships are just starting?

First of all, this is not the only way to, as you know -- that we've succeeded in tier 1 to sell certain not only through partners, but also direct like we've done. We announced the British Telecom that we have, and we announced the tier 1 (indiscernible) service provider in the U.S. So, we do believe that we have the ability to penetrate these guys also by ourselves. And in fact we do see such progress in Europe of penetrating tier 1.

We do believe that we have two or three partners of vendors, equipment vendors. We -- at this point we are not in the stage that we can tell who they are, but (indiscernible) is one of them. We already have two or three deals that were closed in the last few quarters, and we believe that all of them are potential for additional business.

(OPERATOR INSTRUCTIONS). [Adam Foukes].

This is actually [Nadir Kadawi] for Adam Foukes. (indiscernible) I was wondering if you can expand a little bit on the markets. I guess one of the comments made is market is not doing as expected. Could you elaborate a little bit and give us an idea on what markets specifically (indiscernible) in terms of wireline, what's in wireless, which is triple-play, please? And also, if you can [explain] the same things towards geographical region. Thank you.

The one thing that we see is that, on one hand, we do see growth in the pipeline; on the other hand, it's funny to say that, but we don't lose too many deals. In many of the deals that we are involved, either we close them or -- in most of them either we closed or they are delayed for the next few quarters, which gives us an indication that things are a little bit slowed down than they used to be, on the growth at least.

We do see there is expectation. We do see that there is a need for the product. We do see progress. But if we look at what was expected from what customers are telling us from the implementation, both in the wireless and, of course, in the wireline, we see a delay in the progress of the implementation.

I don't think it's an indication. I think that we already are beyond the issue of whether it will happen or not; it will. It is happening today. But I do see that although we did spend to our forecasts and guidelines, we did see quite a few projects that was postponed for next quarter or the quarter after that. So, that gives me some indication that things are not as fast as they used to be again. But they are there, they are going to happen, and we feel that we have a good positioning (indiscernible) for these projects.

Could you talk to (indiscernible) markets, if you are (indiscernible) markets at the present?

I don't think that I can tell you that it's according to (indiscernible) really spread around. I must say that the Chinese market, we -- for instance, we did expect this year for their license. As we said to all, we didn't put it on our guidelines, because this is something that we believe that as soon as the license will be granted, it will stick -- it will still take six to nine months, if not even more than that, to close business.

But for instance, in China, we were expecting that the license would be granted at the end of last year or even during this year. We don't see it yet happening. So, this is just one example.

I think we don't see that on -- in one market stronger than others. I can say that we do see Europe progressing well, and we do see South America as a potential market that is growing even faster than we expected. Far East is a little bit slower than we expected. But overall, I don't think there is a big difference -- except for what I described -- (indiscernible) big difference between our main market of Europe and the U.S.

One other question related to that. I was wondering, when these customers (indiscernible) customers keep postponing their [trial dates] -- what is a typical reason now? What is a driver for them to actually buy the product? (indiscernible) they are all now delaying their projects, new projects, rollouts of new services? Why do you think that is kind of delayed?

I think that, first of all, I don't see they are delaying the service; I think that the decision -- the decisions take more time. They are -- they put projects as they expected it to happen, and it takes them more time to make the decision. I think that we do see an issue of budgetary -- I'm not saying concern, but a slowdown by the budgetary side of the business. I don't think that the need is there, (indiscernible) services are being launched. But they are looking for a way to slow down expenses. Again, this is very general, so it's not something that I can say for -- but just what we feel when we approach the market.

One other question on VoIP business. Are you a player in the VoIP business? Following on to that question would be -- one of your competitors in that particular market (indiscernible) has an OEM relationship with one of the larger vendors. I believe there was a discussion in the past about (indiscernible) partnering with someone like that. Could you give us an update on that please?

First of all, the voice over IP was an important -- always was important in (indiscernible). I think that even when we were more in the test equipment, this was one of the major areas that we played in. We do see in the last quarter, as we indicated, a nice progress in the voice over IP monitoring. [We've] always had monitoring, troubleshooting and testing. But the monitoring side of the business, we did see a nice increase last quarter.

You have to remember that if you compare it to cellular and the cellular typical bid, the typical size of a deal was about 1 to $1.5 million. In the voice over IP it's around a $300,000 to $500,000 initial deal. But it's important because we believe that voice over IP implemented in (indiscernible) so the progress and the repeat business is very promising when you close a deal of, say, voice over IP.

We -- I'm not sure exactly what relation you are referring to with [Briggs], but as I said, we are looking for such relations. We already have a few sales with one of the vendors, and we are trying to expand it with this vendor. And we are in discussions with the other vendors for cooperation where they are -- when they would be the front for some of our business.

We believe that for tier 1 this is very, very important. We believe you cannot rely on a single vendor. A single vendor is always based on his success in the business. You have to talk with more than one vendor -- one vendor; the same as the vendor themselves are looking for a few alternatives. So, we believe that our program that we started about almost a year ago is coming now to a stage where it's close to being another source of revenues for the Company.

One last question. On the M&A activity, you mentioned you're looking for small companies with complementary products. I was wondering if you can give us some idea of what kind of products would make [componentry] for your business?

If you look at our customers, they're buying equipment for monitoring the network. Now, it could be a company that is doing active testing in cellular; it could be a company that is doing a radio, either a test drive or optimization tools; it could be some kind of OSS where we can implement the extraction of the information and, by that, completing the solution. There are some carriers that we look. We even look at some companies that are doing more active solutions, like shaping and [polishing] and things like that. So, there are quite a few alternatives of selling to the same customers and expanding the -- and expanding the offering to the customer.

David Kanen, Pointe Capital.

Congratulations on the quarter and the guidance. If you could take me through the 10% customers again; did you say that there were two of them, and then one was new, one was existing?

Yes.

That's correct. We (indiscernible) from Europe.

Okay. Was one of them the Czech carrier, or those two are exclusive of that?

No; it's exclusive of them.

I see. So, the Czech carrier was not a 10% customer then?

Correct.

In the past, one of your large customers you've announced as a North American CDMA carrier. What percent of revenue were they in this quarter, if at all?

They were less than 10%, as we mentioned (indiscernible) 10% were European carriers. And so they were less than the 10% that we're talking about.

In your guidance for Q4, are you assuming any contribution from that particular customer? Are there still fairly meaningful deployments left, or that's pretty much completed?

It's completed the first stage, but we are looking for the next stages and expansion. But it's not necessarily coming [in the] second quarter or every quarter; it's the kind of thing that may come the beginning of next year. We don't expect anything significantly (indiscernible) or 10%, but it's -- some quarters it's more significant than others.

The way it looks to me is that there's -- there must be a lot of new business, the fact that this business really can contribute to Q3 and the Q4 guidance. So, that tells me that there's a lot of new activity, which I take as positive. Can you tell me -- you said that this quarter, I think, 50% was from new customers. What was that number in Q2?

We don't mention the exact percentage; we just mentioned that a majority of this quarter was from new customers. And if we look back at the first and the second quarter, the majority was actually repeat sales and not new customers. So, your observation is correct that we are also very pleased that -- the fact that we have succeeded in penetrating quite a lot of new customers is very important for us to build the business going forward.

Last question. I missed the breakdown geographically of revenue. If you could just repeat that.

No problem. In Europe we had 45%; North America, 30%; Asia-Pacific, and we include China there, for another 13%; and South America, about 10%.

Great. Thanks very much. Good luck next quarter.

Blaine Marder, Loeb.

Jonathan, the balance sheet -- you seem to be building receivables somewhat. Do you expect that balance to come down in the fourth quarter or any time in the near future?

First of all, your observation is correct; it has gone up. When we look at our sales -- and as you're all aware, that a lot of our sales are in the second half of the quarter. And that means that they are still on the balance sheet at the end of the quarter, and as we increase our sales for the quarter. So, we do expect that to increase. So, on the one hand, it's good that we have more revenue; on the other hand, there is that higher amount of amounts receivable. And until we get to a steady state, I think that you can expect them to stay higher and not go down.

Next, when I look at your quarterly profitability back to the first quarter of 2005 when you turned profitable, you make most of your money in the second half of the year. That was the case both in '05 and '06. Would you see that pattern again for '07, or would you expect it to kind of normalize out and make a little bit more money in the first half of the year?

I'll divide the question into two. We see the second half as stronger than the first half, yes. And if we go back and we look at our basic model, and then we can see that any sales that we have above the breakeven point -- which is, as Noni mentioned, about 5.5 million per quarter -- so, if we succeed in increasing our sales above that point also in the first half of the year, we should see net income also for the first half of the year.

Although if you look at 2007, our expectation is that the second half will still be stronger than the first half, but the first half should bring [in also money].

Very good. And then finally, the gross margin -- what do you attribute the strength in the quarter to the gross margin with the North American sales where they were? What caused that gross margin strength?

I think that, as we have explained before, and looking very carefully at our expenses, and specifically here in the cost of sales, I think that we have managed to actually manage these expenses and keep them lower than we might have expected about half a year ago. And we're all very pleased about that. And as we mentioned before, we are looking at it. And hopefully, if we continue this way, we will be able to contribute more to our profitability also from the cost of sales that, even at this level, is enough.

Steve (technical difficulty), please state your company name.

[USA and Fleet]. Noni, would you tell us -- fourth quarter, typically, you have a push from people to spend their allocated funds by the end of the fourth quarter. Are you seeing deals that you thought would be third-quarter deals, and now that we're good into the third quarter, folks are paying a little bit more attention to them and trying to get them closed by the fourth quarter?

Yes we do. We do see that -- of course, we always -- we always see the fourth quarter as an opportunity, not only for business that we anticipated, but sometimes the -- by changing a location budget to get (indiscernible) budget that was not first allocated, and then at the last minute was changed. And we do see some projects that are coming in like that. But we do see projects that were delayed or were planned to be closed in the fourth quarter.

Okay. So, as I look at that, do you -- are you able to quantify the ones that have bled from the second and third quarter into the fourth quarter, the ones that have leaked into the fourth quarter? Can you tell us in terms of dollar amount what we might be looking at?

This is part of it. It's very -- we have the numbers, but we don't really provide them because it's part of our regular way of estimating the quarter. What we do usually when we start a quarter, we do take each of the projects (indiscernible) profitability of getting this business, and whether they are delayed from the third quarter or new for the fourth quarter, it's not really irrelevant; it's more [with the program].

Sometimes we see projects that were postponed from the third quarter. And when we look at them, we say, you know, it's not only postponed for the fourth quarter; that really was postponed for first quarter or something like that. It depends on the [progress]. Sometimes you are [in] RFP situation, and then suddenly the customer comes back and says you know what? I have to restart the whole thing because I didn't think of some of the issues (indiscernible) which can cause six months delay in a project. So, in every point in time, you have to put the -- each project to evaluate it and see what are the chances of closing it in the next -- in the current quarter.

(technical difficulty). Before I ask Mr. Toussia-Cohen to go ahead with his closing statement, I would like to remind the participants that a replay of this call is scheduled to begin two hours after the conference. In the U.S. please call 1-866-276-1002, in Israel please call 03-925-5929, and internationally please call 972-3-925-5929. Mr. Toussia-Cohen, would you like to make your concluding statement?

Thank you, [Barry], and thank you all for joining this conference call and for the support during the quarter. Talk to you again next quarter. Thank you.

This concludes RADCOM, Ltd.'s third quarter 2006 results conference call. Thank you for your participation. You may go ahead and disconnect.