Soapstone Networks Inc. Q2 2008 Earnings Call Transcript

Soapstone Networks Inc. (SOAP)

Q2 2008 Earnings Call

July 17, 2008 8:30 am ET

Executives

 

William Leighton – Chief Executive Officer

William Stuart – Chief Financial Officer

T.S. Ramesh – Vice President of Finance and Principal Accounting Officer

Inna Vyadro – Director of Investor Relations

Analysts

 

Shao Wang – Lotus Financial Investment

Derek King - Treble Holland Capital

 

Presentation

 

Operator

Ladies and gentlemen, thank you for standing by and welcome to the second quarter earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Inna Vyadro, Director of Investor Relations.

Inna Vyadro

Thank you and good morning. Joining me today are Bill Leighton, Soapstone’s CEO; Bill Stuart, our CFO; and T. S. Ramesh, our Vice President of Finance. This morning Soapstone issued a press release that was distributed by Marketwire and First Call. A copy of the announcement and the conference call are available on our website at www.soapstonenetworks.com.

I would like to remind you that during this call we may be making forward-looking statements, including our plans and objectives for future operations, as well as our expectations for product delivery, customer activity and financial performance.

These forward-looking statements are neither promises nor guarantees but are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Those risks and uncertainties are further described in our press release and presented in detail in our Form 10-K and 10-Q as filed with the SEC.

Additionally, during the call we will also discuss various non-GAAP financial measures. A reconciliation of non-GAAP financial measures is provided, along with the financial tables in our earnings press release, which as previously mentioned is available on our website. Our press release was also furnished to the SEC on Form 8-K this morning.

At this point I would like to turn the call over to Bill Leighton.

William Leighton

Thanks, Inna. Good morning, everyone, and thank you for joining us.

This morning we reported second quarter revenue of $3.9 million which was all related to our previous router business. We reported a GAAP net loss of $4.3 million, or $0.29 per share for the second quarter ended June 30, 2008. We ended the quarter with $105.4 million in cash and cash equivalents, up from $104.5 million as of March 31, 2008.

In the second quarter, our main focus was continued execution of the product road map to bring our provider network controller, or PNC, to general availability, building a healthy funnel of opportunities through our partners, and creating pull for our product with carriers.

I’m pleased to report that we are succeeding on all three objectives. We are on track to meet the target for GA in Q3, and we expect that the PNC will be deployed running live customer traffic in the second half of the year.

Our sales funnel is very healthy, and we are actively engaged with a variety of prospects, including Tier 1 and Tier 2 carriers, large enterprises and utility companies. We are responding to an increasing number of RFI/RFP opportunities. The role of a resource and service control plane such as a PNC is well understood by customers as a required component of a complete Carrier Ethernet solution.

Current market trends continue to validate the need for the Soapstone solution. Carriers have recognized that the key to providing differentiated services is to make service offerings work better by delivering a consistent quality of experience to their end customers while improving the ease of doing business with a carrier.

These factors are important to end customers as well as for doing business with other carrier partners as part of a global service offering. Service quality needs to be managed on internally supplied resources and also across resources owned by these other providers.

The variability of the customer experience can only be reduced by precise control over resource and services, which in turn requires predictable circuit-like connections, instrumentation to measure quality, and a service control system such as the PNC to actively respond to deviations in performance.

Carriers have embraced Carrier Ethernet as a technology foundation to support long-term cost reduction, circuit-like behavior, as well as rich OA&M to support service party objectives and the PNC provides the control system to enable all this.

These past few months, we have seen a number of vendors and carriers announce support for either PBB or PBB-TE or both. This has included carriers and vendors whose endorsement of a Carrier Ethernet technology represents a visible departure from their previous focus on MPLS. We are excited about the new opportunities created for Soapstone through the continued adoption of Carrier Ethernet.

The PNC’s ability to provide real-time provisioning and assurance functions for managing services across heterogeneous networks is unique in the industry. For PBT, the PNC provides restoration while solving the need for external path computation.

For PBB, the PNC addresses weak deterministic performance and provides service admission control functions that are higher order functions tied to the services layer. The role of the PNC in PBT or PBB is to make Carrier Ethernet service-ready.

Service providers depend on the full lifecycle process, and they want to integrate the service-ready resources provided by the PNC into that lifecycle process. To this end we also focused this quarter on demonstrate a pre-integrated solution from the OSS to a PNC controlled multi-vendor transport network.

At TeleManagement World Nice in May we demonstrated the use of standards to facilitate the connection from the OSS to a multi-vendor transport network with the PNC providing management of the transport resources.

Most recently at NEXCOM, Soapstone continued the work we started at TMW and demonstrated standards-based integration from OSS to network equipment. We aim to solve the very real practical challenges faced by carriers, namely the need to rapidly introduce new equipment into their networks that allows them to tap into the functionality and price points of Carrier Ethernet platforms, which requires integrating these solutions with their OSS back office systems.

This demonstration was the largest multi-vendor showcase at NEXCOM and included Amdocs Cramer OSS, Soapstone PNC, and a multi-vendor network comprised of Endo Networks, Cisco, Extreme Networks, Hammerhead Systems, Nortel and Telco Systems.

The response from customers and partners to the showcase was very enthusiastic and validated the need for pre-integrated off-the-shelf solutions to accelerate time to revenue for services.

It also confirmed the key role that Soapstone PNC plays in provisioning and monitoring transport resources in adjusting the network in real-time to close the gap between the intended behavior of a service and the actual behavior, enabling carriers to provide a consistent quality of experience to end customers.

In summary, I am very excited about the opportunities that lay ahead for Soapstone and our products; the acceptance of the PNC by partners and customers, and our continued leadership in this new market for a next-generation resource and service control framework.

I will now turn the call over to Bill Stuart.

William Stuart

Thanks, Bill, and good morning, everyone. This morning we reported our results for the second quarter of 2008. The revenue, all of which was associated with the legacy business for the second quarter ended June 30, 2008, was $3.9 million, compared to $2.6 million in the preceding quarter ended March 31, 2008.

Service revenue was $2.7 million in the second quarter of 2008, and the same $2.7 million in the prior year’s second quarter. The three- and six-month periods ended June 30, 2007, included $26.9 million and $45.3 million in router product revenue from the legacy router business.

As announced before, the company shipped its last router products in December 2007, and has exited the manufacturing and sale of router products. In the second quarter of 2008 the company recorded as product revenue certain revenue deferrals of $1.2 million from prior years’ product shipments in connection with the termination of certain customer terms and conditions.

On a GAAP basis, the company reported a net loss of $4.3 million or a loss of $0.29 per share in the second quarter of 2008 as compared to net income of $12.1 million or $0.82 per share in the prior year’s second quarter.

GAAP net loss for the six months ended June 30, 2008, was $8 million or $0.54 per share compared to GAAP net income of $18.1 million or $1.24 per share for the comparable six-month period of 2007.

In calculating GAAP earnings per share, the number of shares used in the calculation for the 2007 period have been adjusted to include the dilutive effect of stock options, warrants and restricted stock grants.

Additionally, GAAP net loss and income for the second quarter and six months ended June 30, 2008 and 2007 includes certain non-cash equity-based charges associated with Financial Accounting Standards Board Opinion 123R; restructuring expenses associated with the 2006 restructuring program, and credits for certain inventory utilization.

Comparative quarterly GAAP consolidated statements of operations along with comparative non-GAAP consolidated statements of operations, excluding these charges and credits, and a reconciliation between them accompanies our press release and can also be found in the Investor Relations section of our website.

For the remainder of the call, all references to our results will relate to financial measures excluding these previously mentioned charges and credits. Such information should not be considered superior to, in isolation from, or as a substitute for GAAP results; rather we believe these non-GAAP measures provide useful information to investors and analysts in assessing the core operating results of our business.

On a non-GAAP basis, the company reported a net loss of $3.2 million or a loss of $0.22 per share in the second quarter of 2008, as compared to net income of $12.7 million or $0.86 per share in the prior year’s second quarter.

On a non-GAAP basis, the company reported a net loss of $6.5 million or a loss of $0.44 per share for the six months ended June 30, 2008, as compared to net income of $19.2 million or $1.32 per share in the comparable six-month period of 2007.

In calculating non-GAAP earnings per share, the number of shares used in the calculation for the 2007 period have been adjusted to include the dilutive effect of stock options, warrants and restricted stock grants.

Revenue for the quarter was $3.9 million, comprised of $2.7 million of service revenue and $1.2 million related to deferral of prior year’s product shipments and reported this quarter as product revenue.

Revenue for the prior year second quarter was $29.6 million and included product revenue of $26.9 million and service revenue of $2.7 million. AT&T accounted for the predominant share of product revenue in the year earlier quarter.

Revenue for the six months ended June 30, 2008 was $6.6 million and was comprised of $5.4 million of service revenue and $1.2 million reported as product revenue for reasons described earlier. Revenue for the prior year’s six months ended June 30, 2007 was $50.1 million and included product revenue of $45.3 million and service revenue of $4.8 million.

Our gross margin for service for the quarter was 64.2% compared to 86.7% in the prior year second quarter. Service gross margin for the six months ended June 30, 2008, was 64.6%, whereas service gross margin for prior year’s six months ended June 30, 2007, was 83.0%.

The decline in the service gross margin in the current periods as compared to the comparable prior year periods was primarily due to higher labor and labor-related costs, facility costs and depreciation expenses directly associated with support functions.

Total operating expenses for the quarter was $6.8 million compared to $9.3 million in the prior year second quarter. Total operating expenses for the six months ended June 30, 2008, were $12.8 million, whereas total operating expenses for the prior year’s six months ended June 30, 2007 were $18.2 million.

The reduction in operating expenses resulted from the elimination of development costs associated with the legacy router business, partially offset by an increase in development costs for Soapstone software and increased sales and marketing expenses.

Depreciation expenses recorded in operating expenses during the three- and six-month periods in 2008 were $0.2 million and $0.4 million. We expect our operating expenses for the second half of 2008, excluding depreciation and certain non-cash equity-based charges to be approximately $16 to $18 million as we continue to increase our spending and development, sales and marketing. Capital expenditures are projected to be $3.5 million to $4.5 million in the second half of this year.

Total ongoing head count, including both on and offshore contract labor at June 30, 2008, was 137, which was an increase of 14 from March 31, 2008, and 29 since the beginning of the year.

Interest income in the quarter was $0.6 million on an average invested cash and investment balance of approximately $105 million. Interest income continues to fluctuate in line with average quarterly cash balances and current interest rates.

At June 30, our cash, cash equivalents and short-term marketable securities were approximately $105.4 million, an increase of $0.9 million from the previous quarter. The increase was primarily due to a favorable change in working capital resulting from the prepayment of our 2008 services from our principal customer, partially offset by the net loss in capital expenditures.

We expect our cash balance to decline during the balance of this year as we invest in the development and sales and marketing of the PNC product. However, we estimate that our total combined cash position is sufficiently strong to support expected operations for the foreseeable future.

Our receivable balance at June 30 was $0.3 million. Accounts payable and accrued expenses totaled $3.9 million at June 30. Deferred revenue at June 30 was $4.5 million. The balance remaining in deferred revenue primarily represents the deferred and unearned portion of customer maintenance and support revenue which will be amortized into service revenue over the remainder of this year.

After 2008, the company does not expect to record any service revenue resulting from the support of its router products, and accordingly is expected to have completely exited all activities associated with its router products.

We continue to have no debt.

In conclusion, we are now in the execution phase of our go-to-market strategy having shipped our beta of the PNC in February. We have seen market validation for our products and we expect to have the PNC in general availability in the third quarter.

This concludes my prepared remarks, and we will now open up the call to your questions.

 

Question-and-Answer Session

Operator

Our first call comes from Shao Wang – Lotus Financial Investment.

Shao Wang – Lotus Financial Investment

Good morning. A couple of things, I’m wondering if you can comment on what you think head count might be at the end of December quarter?

Totally separate, any progress that you can talk about, in terms of incremental or new betas that you might be pursuing or that might be close?

Also, I’m curious about what I perceive to be relatively cautious spending patterns for various mid-tier carriers around the world. I’m wondering if you’d agree with that comment and whether that might have an impact on the opportunities you’re pursuing? Thank you.

William Stuart

Shao, we’re not projecting the head count through the end of the year. We’re going to continue to hire, and as you can see, the expenses could be continuing to grow over the second half of the year. But I’d hesitate to put a specific number out there in terms of head count. You should just expect to see it continue to grow at a pace that would equate with the increased spending. I’ll turn over the other questions to Bill.

William Leighton

We have several other betas lined up for the second half of the year, and so we expect to see more of that as we go forward.

As far as the spending patterns in the mid-tier carriers, we haven’t been seeing that. I think one of the drives towards Carrier Ethernet is the lower price points and lower costs in CapEx as well as lower operating expenses.

So we haven’t seen what you call is a cautious approach towards spending in this environment. In fact, a lot of the Tier 1s have upped their CapEx plans for the year.

Shao Wang – Lotus Financial Investment

Okay, good enough. Thank you.

Operator

Our next question comes from Derek King - Treble Holland Capital.

Derek King - Treble Holland Capital

Good morning. Given that Soapstone’s market cap currently represents a significant discount to the company’s cash balance, have you considered liquidation as a possible alternative to enhance shareholder value, and if so, does management have an estimate of possible liquidation costs?

William Leighton

We’ve looked at a whole range of alternatives, and we continuously do on what to do. But our current view is the best investment is the investment we’re making in Soapstone in the ongoing product. But we haven’t done a complete liquidation analysis in quite some time, as that’s usually not the best alternative.

William Stuart

In fact, over a year ago, we paid a dividend of $2.00 per share, out of the cash which had been generated out of the router business, as we could see that we were going to continue to generate some cash, and decided at that time that we were going to invest that cash in our new business in Soapstone.

Given the progress that we’re making with that product today, it wouldn’t seem to make any sense from the standpoint of our shareholders to go down a path of liquidating the business.

Two years ago we had been in the mode of looking at other strategic alternatives and decided at that time to focus the company on one customer and to position it to be profitable.

We did so, but decided we didn’t have a future in the router business, exited that business, and in the course of doing so generated a lot of cash, but made the strategic decision to invest in Soapstone, seeing the opportunity that we saw for that product.

Considering the progress that we’ve made with Soapstone, it wouldn’t seem to make any sense for us at this point to be looking at something like liquidating the business.

Derek King - Treble Holland Capital

Thank you.

Operator

We have no further questions. That does conclude our conference for today.

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