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DLGC > SEC Filings for DLGC > Form 10-Q on 14-Nov-2012All Recent SEC Filings

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Form 10-Q for DIALOGIC INC.


14-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto included in Part 1, Item 1 of this Quarterly Report on Form 10-Q and our Consolidated Financial Statements and Notes thereto for the year ended December 31, 2011, in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on April 16, 2012. The discussion in this Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, including, but not limited to, statements of our future financial operating results, future expectations concerning cash and cash equivalents available to us, our business strategy, including whether we can successfully develop new products and the degree to which these gain market acceptance, revenue estimations, plans, objectives, expectations and intentions. In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would" and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events are based on assumptions and are subject to risks, uncertainties and other important factors. Our actual results could differ materially from those discussed here. See "Risk Factors" in Item 1A of Part II for factors that could cause future results to differ materially from any results expressed or implied by these forward-looking statements. Given these risks, uncertainties and other important factors, you should not place undue reliance on these forward-looking statements, which speak only as of the date hereof. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

Overview

We are a leading provider of telecommunications platforms and technology that enable developers and service providers to build and deploy innovative applications without concern for the complexities of the telecommunications medium or network. We specialize in providing products and solutions that enhance the mobile telecommunications experience. Our technology impacts over two billion mobile subscribers and our network solutions carry more than 15 billion minutes of traffic per month.

Wireless and wireline service providers use our products to transport, convert and manage data and voice traffic while enabling VoIP and other multimedia services. These service providers also utilize our underlying technology to provide innovative revenue-generating value-added services such as messaging, Short Message Service, voice mail and conferencing which are also increasingly becoming video-enabled. Enterprises rely on our innovative products to enable the integration of IP and wireless technologies and endpoints into existing telecommunications networks, and to enable applications that serve businesses, including unified telecommunications applications, contact center and Interactive Voice Response/Interactive Voice Video Response.

We sell our products to both enterprise and service provider customers and sell both directly and indirectly through distribution partners such as Technology Equipment Manufacturers, Value Added Resellers and other channel partners. Our customers build their enterprise telecommunications solutions, their networks, or their value-added services on our products.

We were incorporated in Delaware on October 18, 2001 as Softswitch Enterprises, Inc., and subsequently changed our name to NexVerse Networks, Inc. in 2001, Veraz Networks, Inc. in 2002 and Dialogic Inc. in 2010.

Industry Background

The telecommunications industry has traditionally been highly regulated. However, in recent years regulatory barriers to entry have been removed and service providers with telephone, cable, and wireless networks have expanded their offerings to voice, data, and video services over a single broadband platform, increasing competition in the industry.

This increase in competition has also led to steep price reductions, which have in turn caused the revenues of incumbent telecom operators to decline. At the same time, the demand for IP-based technologies increased due to the need to reduce costs and the need to diversify revenue streams. In developed countries, services are increasingly bundled; for example, Internet access is often bundled with voice telephony and television channels. Service providers and enterprises either maintain their legacy networks or steadily plan on migrating telecom systems from PSTN to a single IP network to deliver video calls, text messaging, and location-based services and other high-demand services.

Our products allow service providers to deploy services smoothly over disparate networks. We offer a softswitch that allows new services to be implemented securely and dynamically throughout the entire network along with routing, billing, and number portability for operational savings. Our media servers enable creation of value-added telecommunications services. Our media gateways interconnect multimedia streams and include bandwidth and codec optimization. We also offer optimization of wireless telecommunication streams in the backhaul network. Our video gateway converts pictures and video streams from different compression formats seamlessly enabling the delivery of video between different network generations and multiple types and sizes of devices and screens. We also offer a session border controller with a secure proxy architecture that is transparent to the end-to-end flow of signaling messages, enabling a reduction in the time and cost of deploying new services.


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Our products meet specific customer requirements and certain industry standards, and are subject to various laws, restrictions and regulations, including, but not limited to, environmental protection, import-export controls, and political and economic boundaries, which are more fully discussed in "Item 1A. Risk Factors."

Our Products

Our products include both Next-Generation products that serve the growing mobile and IP networks and also connect these disparate networks together, as well as Legacy products that serve the TDM networks.

Our Next-Generation products and solutions are offered in four main categories:

Service Provider Infrastructure: These products serve in the core or edge of a service provider network and make the fundamental connections that allow networks to function. Our service provider product portfolio includes a Class 4 softswitch, network signaling products such as Sigtran for SS7 over IP networks, and media gateways that connect IP and PSTN networks. Dialogic has also invested in expanding our SBC product line and we now have SBCs that reside at the edge of a network for peering or access from one type of IP network to another.

Our Next-Generation switching solution consists of the Dialogic® ControlSwitch™ System, a Class 4 IP softswitch and service delivery platform comprised of numerous IMS-compatible software modules. This product suite allows our customers to customize and tailor solutions. Our gateways enable telecommunication from one type of network to another and convert from one type of media stream format to another and/or one type of signaling format to another. Our Dialogic ® Bordernet™ 2020 product is a combined gateway and SBC that supports IP-to-IP transcoding for network peering applications and mediation, thereby eliminating the need for separate SBCs in an environment where only the mediation function is required. Our Dialogic ® BorderNet™ 3000 Session Border Controller is a compact, highly reliable security and session management platform for access to mobile and fixed VoIP networks. In 2012, we also introduced a high performance Dialogic ® BorderNet™ 4000 SBC that will enable peering for both wireless and wireline IP-based service provider networks.

Bandwidth Optimization:These products serve in the core or edge of a service provider network and address the capacity challenges of networks by optimizing the media traffic on these networks. Our bandwidth optimization products consist of our Dialogic ® I-Gate® 4000 family of media gateways and enable service providers to gain more bandwidth out of their existing infrastructure. The I-Gate 4000 SBO Mobile Backhaul solution can deliver high quality data and voice optimization for both 3G and 2G networks and can deliver up to 50% additional bandwidth over existing infrastructure. The I-Gate 4000 SBO Core and Core-X optimize VoIP traffic in 3G mobile and next generation switching networks in the core of the network.

Value-Added Services / Cloud Enablement: These platforms enable our customers to build advanced telecommunication applications such as messaging, IVR, conferencing and SMS applications that may be delivered by our customers either via a cloud delivery model or via a stand-alone solution model. The Dialogic® PowerMedia™ software solutions act as media servers that allow our customers and partners to build rich value-added service applications including voice mail, IVR, contact center, facsimile, conferencing, speech recognition, unified messaging, SMS, CRBT, and announcement systems. PowerMedia performs multimedia processing tasks on general-purpose servers without requiring the use of specialized hardware (available in Linux and Windows versions) and uses our existing APIs and industry standard APIs as the programming environment to support high density advanced multimedia features. These advanced multimedia functions include transcoding a variety of video codecs, transrating different screen sizes and enabling mobile video conferencing of a variety of different mobile devices.

Mobile Video: We offer Dialogic® Vision™ gateways that can connect SIP-based video and multimedia services to both voice-only and video/3G enabled mobile devices. The ability of these gateways to simultaneously support video and voice-only calls simplifies the routing and switch logic needed to support video and voice services.

Our Legacy products and solutions serve the TDM only markets. While all networks are moving to IP or mobile based networks, TDM networks still exist and will continue to exist for many years. As such, there will continue to be demand, albeit decreasing demand, for the TDM products to connect to these existing networks. Our Legacy products are offered via an array of traditional network and/or media processing boards that range from two-port analog interface boards to octal span T1/E1 media and network interface boards. These products connect to and interact with an enterprise or service provider based circuit switched network, and support a suite of media processing features, including echo cancellation, DTMF detection, voice play and record, conferencing, fax, modem and speech integration. The boards are grouped into four media board families,
i.e., Dialogic® Media and Network Interface boards with various architectures, Dialogic® Diva® Media Boards, Dialogic ® CG Series Media Boards and Dialogic® Brooktrout® Fax Boards.

We have expanded upon our experience with voice solutions to include data and video. We believe that the continued demand for services by mobile users will drive increasing demand for bandwidth and, as a result, we have continued to invest in data optimization products for our portfolio to enable mobile operators to expand their bandwidth in the mobile backhaul access portion of the network. We are also actively expanding products enabling video applications to mobile devices. Our customers and partners are


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increasingly adding video to value-added service application and our products support key video codecs, perform video transcoding and transrating functions from one codec type to another, and enable video play/record and video conferencing. We also support the new voice functionality such as high definition voice codecs.

Critical Accounting Policies and Estimates

Management's discussion and analysis of our financial position and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with U.S. GAAP pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. If actual results differ significantly from management's estimates and projections, there could be a material effect on our financial statements. Certain reclassifications have been made to prior periods to conform to the current presentation.

As of September 30, 2012, our significant accounting policies and estimates, which are detailed in our Annual Report on Form 10-K for the year ended December 31, 2011, have not changed except for the following.

The accompanying unaudited condensed consolidated financial statements have been prepared assuming that we will continue as a going concern. For the nine months ended September 30, 2012, we incurred a net loss of $33.1 million and cash used in operating activities was $7.9 million. As of September 30, 2012, our cash and cash equivalent balance was $2.7 million, of which $2.2 million was held by subsidiaries outside the U.S. and could be subject to tax implications if repatriated to the U.S. As of September 30, 2012, current bank indebtedness was $10.7 million and debt with related parties, net of discount, was $64.2 million. Based on our current plans and business conditions, we believe that our existing cash and cash equivalents, expected cash generated from operations and available credit facilities will be sufficient to satisfy our anticipated cash requirements through 2012. We will need to either raise additional funding to fund future operations or to implement a business plan where cash flow will fully fund operations. However, there is no assurance that additional funding will be available to us on acceptable terms on a timely basis, if at all, or that we will achieve profitable operations. If we are unable to raise additional capital to fund our operations, we will need to curtail planned activities and to reduce costs. Doing so may affect our ability to operate effectively.

On March 22, 2012, we amended the second amended and restated credit agreement dated October 1, 2010, or the Term Loan Agreement with Obsidian, LLC, as agent, and Special Value Expansion Fund, LLC, Special Value Opportunities Fund, LLC, and Tennenbaum Opportunities Partners V, LP, as lenders, or the Term Lenders, which extended the maturity date to March 31, 2015, reduced the stated interest rate to 10% from 15% and revised the financial covenants. On April 11, 2012, $33.0 million of outstanding debt (face value) under the Term Loan Agreement and $5.0 million of outstanding stockholder loans, or the Stockholder Loans were cancelled in exchange for convertible promissory notes, or the Notes, which Notes were converted into approximately 8.0 million shares of our common stock on August 8, 2012. These actions were determined to be a troubled debt restructuring and were taken to improve our liquidity, leverage and future operating cash flow. We also took certain restructuring action during the nine months ended September 30, 2012, designed to improve our future operating performance.

We are required to meet certain financial covenants under the Term Loan Agreement, including minimum EBITDA (as adjusted), minimum liquidity, minimum interest coverage ratio and maximum consolidated total leverage ratio, each beginning in the quarter ending June 30, 2013. Specifically, the EBITDA (as adjusted) covenant requires $16.9 million of EBITDA (as adjusted) for the four quarters ending June 30, 2013. In the event that forecasts of EBITDA (as adjusted) are reduced from anticipated levels, the covenants may not be met and we would be required to reclassify its long-term debt under the Term Loan Agreement to current liabilities on the consolidated balance sheet.

If future covenant or other defaults occur under the Term Loan Agreement or under the Revolving Credit Agreement with Wells Fargo Foothill Canada ULC, or the Revolving Credit Lender, we do not anticipate having sufficient cash and cash equivalents to repay the debt under these agreements should it be accelerated and would be forced to restructure these agreements and/or seek alternative sources of financing. There can be no assurances that restructuring of the debt or alternative financing will be available on acceptable terms or at all. In the event of an acceleration of our obligations under the Revolving Credit Agreement or Term Loan Agreement and our failure to pay the amounts that would then become due, the Revolving Credit Lender and Term Loan Lenders could seek to foreclose on our assets, as a result of which we would likely need to seek protection under the provisions of the U.S. Bankruptcy Code and/or its affiliates might be required to seek protection under the provisions of applicable bankruptcy codes. In that event, we could seek to reorganize its business or the Company or a trustee appointed by the court could be required to liquidate its assets. In either of these events, whether the stockholders receive any value for their shares is highly uncertain. If we needed to liquidate its assets, we might realize significantly less from them than the value that could be obtained in a transaction outside of a bankruptcy proceeding. The funds resulting from the liquidation of its assets would be used first to pay off the debt owed to secured creditors, including the Term Lenders and the Revolving Credit Lender, followed by any unsecured creditors such as the convertible promissory notes, before any funds would be available to pay its stockholders. If the Company is required to liquidate under the federal bankruptcy laws, it is unlikely that stockholders would receive any value for their shares.

In order for us to meet the debt repayment requirements under the Term Loan Agreement and the Revolving Credit Agreement, we will need to raise additional capital by refinancing its debt, raising equity capital or selling assets. Uncertainty in future credit markets may negatively impact our ability to access debt financing or to refinance existing indebtedness in the future on favorable


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terms, or at all. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include different financial covenants, restrictions and financial ratios other than what we currently operate under. Any equity financing transaction could result in additional dilution to our existing stockholders.

Results of Operations (amounts in 000's)

Comparison of Three Months Ended September 30, 2012 and September 30, 2011

Revenue



                                                                   Three Months Ended September 30,
                                              2012                           2011                      Period-to-Period Change
                                                  % of Total                     % of Total
(USD and $000's)                     Amount        Revenue          Amount        Revenue            Amount             Percentage
Revenue:
Products                            $ 32,140               76 %    $ 36,604               77 %    $      (4,464 )               (12 )%
Services                              10,251               24        10,817               23               (566 )                (5 )

Total revenue                       $ 42,391              100 %    $ 47,421              100 %    $      (5,030 )               (11 )%

Legacy vs. Next-Gen
Legacy                              $ 13,527               32 %    $ 17,239               36 %    $      (3,712 )               (22 )%
Next-Gen                              28,864               68        30,182               64             (1,318 )                (4 )

Total revenue                       $ 42,391              100 %    $ 47,421              100 %    $      (5,030 )               (11 )%

Revenue by geography:
Americas                            $ 17,867               42 %    $ 20,445               43 %    $      (2,578 )               (13 )%
Europe, Middle East and Africa        13,350               31        16,381               35             (3,031 )               (19 )
Asia Pacific                          11,174               27        10,595               22                579                   5

Total revenue                       $ 42,391              100 %    $ 47,421              100 %    $      (5,030 )               (11 )%

Revenue

Total revenue of $42.4 million for the three months ended September 30, 2012 decreased by $5.0 million, or 11%, from $47.4 million for the three months ended September 30, 2011.

Our product revenue was 76% of total revenue at $32.1 million for the three months ended September 30, 2012, compared to 77% of total revenue, or $36.6 million for the three months ended September 30, 2011, a decrease of $4.5 million, or 12%. The decrease in product revenue is primarily attributable to project timing and associated revenue recognition of Next-Gen products, as well as a slower than expected sales of Legacy products, compared to the corresponding 2011 period.

Our services revenue was 24% of total revenue at $10.3 million for the three months ended September 30, 2012, compared to 23% of total revenue, or $10.8 million for the three months ended September 30, 2011, a decrease of $0.6 million, or 5%. The decrease in services revenue was the result of decommissioning of our Legacy products in customer networks, partially offset by customer expansions and upgrades of our Next-Gen products.


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Cost of Revenue and Gross Profit



                                                                       Three Months Ended September 30,
                                                  2012                           2011                      Period-to-Period Change
                                                      % of Total                     % of Total
                                                       Related                        Related
(USD and $000's)                         Amount        Revenue          Amount        Revenue            Amount             Percentage
Cost of Revenues:
Products                                $ 11,070               34 %    $ 13,700               38 %    $      (2,630 )               (19 )%
Services                                   5,118               50         5,358               50               (240 )                (4 )

Total cost of revenues                  $ 16,188               38 %    $ 19,058               40 %    $      (2,870 )               (15 )%

Gross Profit:
Products                                $ 21,070               66 %    $ 22,904               62 %    $      (1,834 )                (8 )%
Services                                   5,133               50         5,459               50               (326 )                (6 )

Total gross profit                      $ 26,203               62 %    $ 28,363               60 %    $      (2,160 )                (8 )%

Cost of Revenue

Total cost of revenue of $16.2 million for the three months ended September 30, 2012 decreased by 15% or $2.9 million from $19.1 million for the three months ended September 30, 2011.

Cost of product revenue of $11.1 million for the three months ended September 30, 2012 decreased by 19% or $2.6 million from $13.7 million for the three months ended September 30, 2011. The change is primarily attributable to lower standard product costs, as a result of the decline in volume and a reduction in salaries and benefits due to the decrease in headcount.

Cost of services revenues of $5.1 million for the three months ended September 30, 2012 decreased by 4% or $0.2 million from $5.4 million for the three months ended September 30, 2011, as a result of the decrease in headcount compared to the corresponding 2011 period. Cost of services includes the direct costs of customer support and consists primarily of payroll, related benefits and travel for our support personnel.

Gross Profit

Gross profit of $26.2 million for the three months ended September 30, 2012 decreased by $2.2 million, or 8%, from $28.4 million for the three months ended September 30, 2011. Gross profit margin increased to 62% of total revenue for the three months ended September 30, 2012 from 60% of total revenue for the three months ended September 30, 2011.

For the three months ended September 30, 2012, product gross profit decreased by 8%, or $1.8 million, from $22.9 million for the three months ended September 30, 2011 to $21.1 million for the three months ended September 30, 2012. Gross profit margin increased from 62% of total product revenue for the three months ended September 30, 2011 to 66% of total product revenue for the three months ended September 30, 2012. The decrease in gross profit on product revenue is primarily a result of an overall decline in product revenue.

For the three months ended September 30, 2012, services gross profit decreased by 6%, or $0.3 million from $5.5 million for the three months ended September 30, 2011 to $5.1 million for the three months ended September 30, 2012, due to revenue recognized on a contract for which there were no associated costs incurred during the period. In the normal course of business, we may experience fluctuations in our gross profit margin as revenue is recognized on significant contracts. Gross profit margin remained consistent at 50% for the three months ended September 30, 2012 and the three months ended September 30, 2011.


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Operating Expenses



                                                                        Three Months Ended September 30,
                                                  2012                           2011                       Period-to-Period Change
                                                      % of Total                     % of Total
                                         Amount        Revenue          Amount        Revenue             Amount              Percentage
Research and development, net           $  9,266               21 %    $ 13,540               29 %    $       (4,274 )                (32 )%
Sales and marketing                        9,261               21        12,664               27              (3,403 )                (27 )
General and administrative                 7,375               17         9,391               20              (2,016 )                (21 )
Restructuring charges                        457                1         1,674                4              (1,217 )                (73 )

Total operating expenses                $ 26,359               61 %    $ 37,269               79 %    $      (10,910 )                (29 )%

Research and Development Expenses . . .

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