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Ascend Comm. Q3 Conference Call
A Fool Conference Call Synopsis*
By Gregory Markus (TMF Boring)
Ascend Comm. (Nasdaq: ASND)
1701 Harbor Bay Parkway
Alameda, CA 94502
800-648-3059
ascend.com
ANN ARBOR, MI (Oct. 22, 1998)
/FOOLWIRE/ — Ascend Communications
reported third quarter results after the market
closed on October 19th. Net sales grew
year-over-year by 37.0% to $370.3 million. Net
income increased year-over-year by 64.7% to
$66.1 million ($0.32 per share on a diluted basis)
versus $40.1 million ($0.20 per share on a diluted
basis) in the third quarter of 1997. Compared to
second quarter 1998 results, this represents sequential growth in net sales
and net income of 13.1% and 11.8%, respectively. Book-to-bill was
greater than 1.0 for the quarter. Analyst estimates were $0.31 per share.
Revenue gains were fueled by substantial growth in access switching
product sales. This quarter, Ascend was named number one in remote
access concentrator revenues to service providers for the first half of 1998
by industry analysts such as Dell'Oro, Cahners In-Stat, Dataquest, and
IDC.
Ascend continues to focus on increasing its investment in research and
development, increasing the company's international sales presence, and
strengthening the company's management through new hires, particularly
on the services side. Ascend's support services revenues are beginning to
grow nicely.
Partnerships. Ascend is also growing revenues through targeted
partnering. In the third quarter the company announced two
joint-development efforts with Alcatel (NYSE: ALA), which are well
under way at this time. Ascend has also worked to leverage Alcatel's
strong international presence with PTTs.
Headcount. At the end of the quarter, the company had approximately
2,586 employees, up 287 from the end of the previous quarter. Employee
turnover continues to be at-or-below acceptable levels.
Stratus Acquisition
Early in the quarter, Ascend announced its intent to acquire Stratus
Computer, which will give Ascend Stratus's best-in-class Signaling
System 7 (SS7) technology and expertise, fault-tolerant technology,
intelligent networking and Operations Support System (OSS) software,
and an experienced carrier sales and network integration organization.
That acquisition closed on October 19th, and Ascend has made rapid
progress integrating Stratus's key technologies into Ascend's data
networking portfolio for use in the next-generation network. Ascend has
also made progress on divesting parts of Stratus's business that are not
strategic to Ascend's long-term goals. Ascend has received several offers
to buy those businesses and expects to make additional announcements
within the next several weeks.
Stratus revenues for the September quarter were just over $130 million, in
line with previously announced expectations. Product revenues accounted
for 60% of the total, with service revenues representing the balance.
Product revenues were split 51% telco and 49% enterprise.
Business Unit Results
Revenues by product category were: 47% access switching, 41% core
switching, 7% enterprise access, and 5% service.
Access Switching. Revenues increased 30% year-over-year and 29%
sequentially. Growth was broad-based, with sequential increases in North
America, South America, Asia Pacific, and Japan. On a sequential basis,
revenues were down in Europe due to a tough comparison with a strong
Q2. Pricing was relatively stable in the quarter. Growth was driven by
Ascend's high-end MAX TNT product and mid-tier MAX 6000 product.
Ascend sees significant increases in voice-over-IP deployment and
believes this will be a significant driver of growth going forward. Sales to
Deutsche Telekom (NYSE: DT) and Cable & Wireless (NYSE:
CWP) are examples of this. The ability to integrate SS7 technology into
Ascend's access products will drive further sales growth.
Core Systems. Revenue increased by 53% year-over-year, but declined
3% sequentially, with strong demand for ATM and frame relay products
in both North American and international markets. The sequential decline
was attributed in part to Ascend's slippage into Q4 of a scheduled
software delivery to NTT (NYSE: NTT). Ascend recently achieved
several key customer wins, including the Bell Atlantic (NYSE: BEL)
ATM network and Frontier (NYSE: FRO). GRF revenues continue to
decline slowly. Ascend anticipated growth in sales of broadband
products, but these did not materialize in the quarter.
Enterprise Access. Revenues increased 14% year-over-year and 32%
sequentially after a disappointing Q2. Improvement was attributed to new
product introductions and a revamped distribution network.
Service and Support. Revenues increased 16% sequentially to $17.2
million.
Revenue breakdown by distribution channel was: 43% carriers, 27%
Internet Service Providers, 30% resellers and end users. One customer
accounted for 10% of revenues.
Geographic Breakdown
International revenues increased 41% year-over-year, and were flat
sequentially. International markets accounted for 30% of total revenues,
compared to 34% in Q2 1998. North American revenues increased 35%
year-over-year and 20% sequentially.
A decline in sales to Japan was offset by increases in Europe, South
America, and the Asia/Pacific region (excluding Japan). Revenues in
Europe were $51 million (14% of total sales) versus $49 million (15% of
sales) in Q2. Revenues in Japan were $26 million (7% of sales) versus
$43 million (13% of sales) in Q2.
Earnings Statement Highlights
Gross margins were 64.0% compared to 64.2% in the preceding quarter.
New product and feature introductions and cost reductions have enabled
the company to maintain gross margins in the 64% range. R&D expenses
were 14.4% versus 14.2% in Q2.
Sales and marketing expense at 19.6% of revenues is down from 20.7%
in Q2 and a little better than planned. General and administrative expense
was 8.9% of revenue, but was 3.5% excluding certain exceptional items
(discussed below). Operating margins were 26.6% versus 21.3% last
year and 26.4% in the preceding quarter. The tax rate was 35.5%. Net
margin was 18%.
This quarter's report includes certain exceptional items. These are a $5
million one-time payment of a patent settlement to Lucent Technologies
(NYSE: LU) and a $7 million writedown of an account receivable from a
subcontractor for work done in 1996-97. Also included is an $8.7 million
writedown of cumulative working capital loans to customers (see below).
These charges were largely offset by an $18.3 million reversal of a reserve
established for the merger with Cascade.
Loans to Customers
In response to competitive demands, Ascend recently started a program
offering capital equipment financing and working capital loans to a small
number of customers, principally CLECs. To minimize any potential risk,
the company has chosen to reserve fully for such transactions and will not
recognize revenues until the amounts are repaid. If Ascend continues to
offer loans or equipment financing to customers, it will continue to write
down the amounts. This is incorporated into the EPS guidance provided
by Ascend for Q4. Ascend is also exploring other sources to provide
financing for customers.
Balance Sheet Highlights
As of September 30th, cash and investments increased $773 million.
Accounts receivable were $311 million (76 days sales outstanding versus
74 days at the end of Q2). Inventories were flat with Q2 at $132 million
(inventory turn ratio of 4.1, up from 3.6 in Q2). The company's goals are
for DSOs in the 70-75 range and an inventory turnover ratio above 4.0
going forward.
Outlook
Rapid changes are occurring in the networking space and, specifically, in
the deployment of next-generation networks. This continues to be a major
driver of spending among telcos, CLECs, and Internet service providers,
and Ascend has seen no slowdown to-date. While aggregate capital
spending appears to have slowed somewhat, Ascend believes that there
has been a fundamental shift in how spending is being allocated.
Customers say that their spending on traditional circuit-switched networks
has slowed, and at least a portion of these dollars is being focused on the
continued buildout of the next-generation network. Ascend believes there
is minimal risk that this spending will slow in the near- to mid-term.
In addition to the spending by established telcos, the emerging carriers
such as Level 3 (Nasdaq: LVLT), Qwest (Nasdaq: QWST), and
Williams (NYSE: WMB), continue to aggressively build out their
networks. CLECs also continue to be a strong source of spending and
they present the initial customer opportunities for Ascend's SS7 networks.
Recent industry research indicates that the CLECs revenue should be
doubling year-over-year, driving continued demand for access ports and
backbone capacity.
Core systems spending is currently focused on data networks, but service
providers say that they will begin integrating voice, data, fax, and
multimedia traffic. In the long-term, Ascend's recently acquired SS7
technology could have its greatest impact on sales of core systems. GRF
revenues declined slightly on a sequential basis. The company expects to
announce a replacement product for the GRF in mid-to-late 1999.
Market fundamentals for enterprise access products remain strong. ISPs
say they continue to increase their number of subscribers and that the
average subscriber stays online longer now than six months ago. There is
also no letup in demand for bandwidth by corporate users. Japan and
China are building out their next-generation networks. The current
slowdown in sales in Japan is not expected to have a major effect on
Ascend going forward.
Pricing trends on ATM access products are showing some discounting in
the industry, but price per port is essentially where it was six months ago,
at around $215-$250.
Guidance
R&D expense is expected to decline to around 14% of revenue over the
next couple of quarters. Sales and marketing expenses are planned to stay
around current levels as a percent of revenue. Guidance on the tax rate is
for 35% in 1999.
On an ongoing basis, the company anticipates continuing positive
operating cash flow.
Management's previous guidance was to expect $400 million in revenues
for Q4 1998 for Ascend (excluding Stratus). That is now revised to $410
million. In addition, the acquired business, which will now be referred to
as the carrier signaling group, is expected to provide $50 million in
revenues, for a total of $460 million.
Previous guidance was that the Stratus acquisition would be one to two
cents dilutive in Q4; that is now revised to three cents dilutive.
Consequently, the revised EPS guidance remains $0.34 for the standalone
Ascend, but $0.31 for the combined Ascend-Stratus, excluding a $305
million charge for in-process R&D, as previously announced. The
carrier-signaling group will be accretive to Ascend beginning in Q1 1999.
Guidance for 1999 remains unchanged at $2.3 billion in revenues, which
would constitute a 60%-plus gain over anticipated 1998 sales, and EPS of
$1.70, or an expected increase of more than 40%. For the first quarter of
1999, the guidance is for revenues of approximately $490 million and EPS
of $0.36. |
