AudioCodes Ltd. (AUDC) Q3 2015 Earnings Report, Transcript and Summary

Greetings. Welcome to the AudioCodes Third Quarter 2015 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Collin Dennis. Thank you. Mr. Dennis, you may now begin.

Thank you, Rob. I would like to welcome everyone to the AudioCodes third quarter 2015 earnings conference call. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President of Finance and Chief Accounting Officer. Before beginning, we would like to remind you that the information provided during this call may contain forward-looking statements relating to AudioCodes' business outlook, future economic performance, product introduction and plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future event, conditions, performance or other matters are forward-looking statements as the term is defined under U.S. Federal Securities Laws. Forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results to differ materially from those stated in such statements. These risks, uncertainties and factors include, but are not limited to, the effect of current global economic conditions and conditions in general and in AudioCodes' industry and target markets in particular shifts in supply and demand, market acceptance of new products and the demand for existing products, the impact of competitive products and pricing on AudioCodes and its customers' products and markets, timely product and technology developments, upgrade and the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in the company's loan agreements, possible disruptions from acquisitions, the ability of AudioCodes to successfully integrate the products and operations from acquired companies into AudioCodes' business and other factors detailed in AudioCodes' filings with the SEC, the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update information. In addition, during the call, AudioCodes will refer to non-GAAP net income and net income per share. AudioCodes has provided a reconciliation of non-GAAP net income and net income per share to its net income and net income per share according to GAAP in its press release and on its Web site. Before I turn the call over to management, I would like to remind everyone that this call is being recorded and an archived webcast will be made available on the Investor Relations section of the company's Web site at the conclusion of this call. The call will also be archived in our Investor Relations app, which is available for free from the iTunes app store and the Google Play Market. With that said, I would now like to turn the call over to Shabtai Adlersberg. Shabtai, please go ahead.

Thank you. Good morning and good afternoon everybody. I would like to welcome all to our third quarter 2015 conference call. With me this morning is Niran Baruch, Chief Accounting Officer and Vice President of Finance. Niran will start off by presenting a financial overview of the quarter and an updated annual guidance for 2015. I will then review the business highlights and summary for the quarter and discuss trends and developments in our business and industry. We will then turn it into the Q&A session. Niran?

Thank you, Shabtai and hello everyone. As usual we will be referring to both GAAP and non-GAAP numbers on the call. The non-GAAP P&L metrics exclude recurring non-cash items. Today's earnings press release contains a reconciliation of supplemental non-GAAP financial information. Revenues for the third quarter were $34.2 million, up 5.6% from the prior quarter and down 12.1% from the year ago quarter. Revenues from networking products and services increased by 10.3% from the prior quarter, accounting for 90% of revenues for the third quarter. Revenues from our technology product decreased by 23.9% from the prior quarter. Services revenues increased by 3.2% from the prior quarter, accounting for 28% of total revenues for the third quarter. Revenues by geographical regions for the quarter was split as follows. North America 45%, Central and Latin America 5%, EMEA 33% and Asia Pacific 17%. Our top 15% unitedly represented 58% of revenues in the quarter of which 43% are attributed to our eight largest distributors. Non-GAAP gross margin for the quarter was 50% compared to 59.9% in Q2 2015. Operating income for the quarter was $0.97 million compared to an operating loss of $1.8 million in Q2 2015. On a non-GAAP basis, quarterly operating income was $1.9 million or 4% of revenue compared to an operating loss of $0.8 million in Q2 2015. Net loss for the quarter was $0.13 million or a loss of $0.00 per share. On a non-GAAP basis, quarterly net income was $1.7 million or $0.04 per share compared to net loss of $0.5 million or a loss of $0.01 per share in Q2 2015. Our balance sheet remains strong. At the end of September, cash, cash equivalent and marketable securities totaled $75.3 million. Days sales outstanding as of September 30 was 70 days compared to 79 days at the same time a quarter ago. Operating cash flow generated during the quarter was $1.8 million compared to $3.4 million for Q2 2015. During the quarter we acquired $1.1 million shares for a total consideration of $3.7 million. We intend to continue to buy shares under the approved buyback plan until the end of the year. This intent was discussed and reapproved yesterday at the board of directors meeting to approve the financial results for the third quarter. In addition, the board of directors has approved filing a new application with the court, requesting approval for the new research program to become effective early 2016 for a total consideration of up to $10 million in share repurchases for a period of six months from the date of receipt of court approval. Now to provide an update on our guidance. We now expect revenues for 2015 to be in the range of $148 million to $142 million compared to original range of $137 million $143 million. We anticipate non-GAAP diluted earnings per share to be in the range of $0.11 to $0.13 compared to the original range of $0.09 to $0.12. I will now turn the call back over to Shabtai.

Thank you, Niran. We are very pleased to report good momentum and recovery in our business. We returned to growth in revenues after one quarter only and improved financial performance for the third quarter of 2016. As stated in our press release earlier this morning, we continue to grow our networking business and deliver above 10% growth in the networking revenue. We saw healthy demand across most networking business lines which now contribute about 90% of the quarterly revenue. Touching on the highlights of the passing third quarter, I believe we can confidently say that we were able to recover nicely from two of the three main reasons for the shortfall in the second quarter this year and emerged back to growth in revenue and profitability. To remind us all, we have three key reasons for the miss in second quarter '15. First one was lower sales in countries suffering from weaker economy, some of which is related to the crisis in oil prices affecting the economy of these countries. Among these we have mentioned Brazil, other Latin America countries and Russia. Unfortunately, in the third quarter of 2015, we have not seen much change on that front and we do not expect any major change in next few quarters. In order to mitigate this factor, we are adjusting for the loss and the missing revenue on the geographical basis. Second factor was the miss in the contact center business revenue which declined by several millions in the second quarter compared to the story we had. This was a result of several number of small hundred, thousands of dollars opportunities which were pushed up to the third quarter. I am glad to inform that we have recovered fully, nicely back to the level expected for the contact center business in the third quarter. In fact, it's a result of the improving OEM relationships with partners in this space, we experienced now a good pipeline of customer wins and product sales and we believe we are on the right track to benefit from the momentum in this area. The third factor related to lower growth we encountered in sales to the market of Skype for business market segment. While we grew in the second quarter only about 10% quarter-over-quarter, this was mainly due to the announcement of new release for Skype for business and Microsoft's new initiative of cloud PBX. I am glad to report that in the third quarter of 2015, we grew nicely above 15% quarter-over-quarter and above 20% year-over-year. Another very important achievement in the third quarter is our execution on the cost reduction plan announced at the end of July. In the original plan in July, we expected to generate an estimated annual savings of 5% to 10% in our OpEx in the following six to 12 months. In the third quarter, we achieved already 4% of the stated goal and reduced the quarterly run rate to about $19.4 million. As announced in our press release this morning, we intend to continue to focus on improving OpEx control in 2016 and beyond. Now to the product front. Sales of SBC products and services showed a very nice increase in the third quarter exhibiting above 20% growth quarter-over-quarter. With the broad SBC product portfolio with growing sales in software SBC which now account, together with our SBC [blade] [ph] to 15% of this core SBC revenue. We are confident that our SBC revenue and business plan will continue to grow going forward. Key drivers in SBC sales growth were related to sales for SIP tracking applications and managed enterprise service providers. On the media gateway sales front, we saw stable revenue compared to the previous quarter, which was encouraging in terms of the overall trend of annual level of media gateway sales. We believe that the all-IP migration trend of tier one service providers will support sales of media gateways in coming year. Our services business continued to exhibit solid growth. In terms of bookings, we grew nicely, 14.4% over the previous quarter. On the front of network transformation, which is the focus of large tier one service providers in the U.S. and globally, we made good progress with more service providers beyond the wins of the two large multi-year projects we mentioned in the second quarter. We now believe that these network transformation effort into an all-IP network will be a major focus for us in the next five to seven years. The pipeline we see now is more than $100 million over next seven years in the ten to 15 projects we compete on. Obviously, the overall potential globally over these five, seven years will be substantially larger as we make more progress into the service provider space. We have also continued our focus on developing and selling more complete end-to-end solutions and software solutions, bringing more value to our end customers. Finally, as we continue to adapt and align our offering towards solid industry trends such as NFB and SDN, and the migration into hybrid and pure cloud environments, we are confident in our ability to prosper in the market in coming years. Now let me touch on some more significant financial data points, all of which are non-GAAP numbers. As Niran mentioned, revenue grew 5.6% to $34.2 million as planned. Gross margin improved nicely to 60%. We expect to continue and improve our gross margin going forward, mainly as a result of growing our services business and software sales, which provide better gross margin than our product sales. On the bottom line, third quarter earnings at $1.6 million versus a loss of $540,000 in the second quarter of 2015, were better than anticipated. This is mainly due to the fact that we had lower than expected OpEx at $18.7 million. This is our original plan and versus the $20.2 million OpEx in the second quarter. The excess in OpEx reduction in the quarter is attributed mainly to onetime cost savings in payroll implications and better currency hedging activity. We expect fourth quarter OpEx to be higher. We believe it will be around $19.4 million. The cost reduction plan headcount declined by 19 employees versus the 656 employees we had in second quarter '15. Net cash provided by operating activities was $1.8 million. Net cash provided by operating activities for the past 12 months was $12.2 million. Now let me go through some highlights for sales in the various regions. In North America, we saw recovery in enterprise sales which recovers from a decline in the second quarter. Sales into the Microsoft Lync, Skype for business, grew nicely but the pipeline for new opportunities in North America is weaker than before in anticipation in the market for the launch of the market cloud PBX. So we will have to watch that activity going forward. In Latin America, sale in the region is mostly based on selling service providers in various countries. In the second and third quarter, sales into Latin America dropped successfully by about $600,000 in each quarter. In addition to that, loss came mainly from Brazil where economic and political situation affected the overall market in this country. In EMEA, saw sales in the region improving compared to the second quarter. In general, sales into the stronger economies such as Germany and the Dutch region, U.K., France and Benelux were on target, while sales in South Europe were lower than anticipated. Sales in Russia continued to be weak. In Asia Pacific, we enjoyed great success. Asia Pacific provides the best sales performance in the company these days and we see continued growth and success in our networking business over several quarters now in a row in Asia Pacific. So with sales execution in the Microsoft and contact center market segments, in addition to growing contribution of the service provider segment. Let me throw a bit more light on the markets of network business activity and provide more details. So we were able to grow sales in that sector buy more than 15% quarter-over-quarter and more than 20% year-over-year. We saw significant run rate revenue from large enterprises who started Lync rollout, one to three years ago. So we now enjoy a lot of the wins that we have been able to generate in the past two or three years. We saw Microsoft continuing its push for the cloud PBX, which may limit in the future or on-premise sales. But we are confident that for the next three to five years, we will see hybrid implementations, combined cloud and on-prem implementation and that we believe will be a solid portion of the deployment. We continue to enjoy good success with our One Box go to market and got the attention of several, some very large service providers. In the third quarter, we won a very large global systems integrator who selected One Box as part of its official solution, that is a big win after investing many years in penetration efforts. Now to our updated guidance that we have provided earlier on the call. We now plan on revenue growth of 3% to 5% in the fourth quarter comparing to the third quarter. So we have trimmed down the guidance on revenue range to be in the range of $138 million to $142 million. We now anticipate non-GAAP diluted earnings per share to be in the range of $0.11 to $0.13, compared to the July announced range of $0.09 to $0.12. Lastly, to our share buyback program. During the quarter, we acquired 1.1 million shares for a total consideration of $3.7 million. As of September 30, we have acquired an aggregate number of 4.7 million shares for an aggregate consideration of US$20.3 million. During the month of October, we have acquired an aggregated amount of 4.95 million shares. We continue to buy in the market everyday up to the limit that we are being allowed to be buy share. As stated earlier on the call and as discussed and decided yesterday on our November 2, board of directors meeting, we intend to continue buying shares under the improved buyback plan until the end of the year and apply to the court for an approval of the new plan for 2016 with an approved budget of another $10 million. I am confident and I am expressing the board's confidence, that execution so far on the buyback program and both of their -- yesterdays decision, reflect on our confidence in the company's ability to succeed and prosper in the future. I have now completed my introduction and we will turn the call back to the Q&A session. Operator?

[Operator Instructions] Our first question is from the line of Rich Valera with Needham & Company. Please proceed with your question.

Just I was hoping you could able to give a little more color on your thoughts on the Skype for business trajectory. I think you said that in the short-term you expect lower on-prem sales there as Microsoft pushes for the cloud-hosted version of that product. But longer term you are optimistic of seeing some rebound I think as you see hybrid installations. Can you explain, give a little more color on which products should we don’t expect to be selling near term and why would we see a rebound in those products over time? Thanks.

Sure. So, well, the general market nature of Skype for business is looking much more focused on the cloud, cloud PBX. Which means mainly one thing, that the network will increasingly point more and more towards the cloud. Now one is -- before we go into all kinds explanations, one needs to segment the market into small organization and larger ones. Small offices, small organizations, I would probably look at below and/or 100 employees, will definitely enjoy a cloud-only operation, pure cloud operation. And therefore in such implementation, there will be a need mainly for two kinds of product. One would be the IP phones, the second one would be a new sort of a cloud gateway and/or appliance that will help connect that small office to the cloud. However, when you go into larger organizations such as mid-market, 100 to 1000, and/or into large organization, you need to think about companies who have got many facilities spread either in the nation or global-wide. And there I think CIOs, at least from what we hear, tend to rely on an hybrid implementation. Meaning, small offices in remote areas will enjoy PBX type service but larger companies will still need to rely on kind of an on-prem implementation towards acquiring larger facilities. That means that, again, in that architecture IP phones will be sold. We believe that there will be a need for that cloud appliance that will provide quality of service, will provide connectivity, resiliency to IP network. So all in all, we will miss -- what we will be missing in coming years is mainly SBA sales. SBA stands for survivable branch office appliance, which used, and still by the way, still is connecting to the PSTN and will connect the PSTN over the next good two or three years but will vanish three to five years from today as resiliency will count dual One, dual IP connection rather than relying on the PSTN. So that’s the key change.

Got it. That’s helpful. And within that context, what's your feeling of the near-term trajectory of that business. I mean it was up obviously very nicely in 3Q quarter-over-quarter. Do you expect that to continue to improve sequentially as we move into fourth quarter?

Yes. I think we went to like six to nine months of hesitation in the market before organization could analyze and understand the meaning of the new Skype for business release. All in all, my belief is that while we showed in the past growth rate of above 30% year-over-year, I think this year and going forward, at least this year any maybe part of next year will more like 15% to 20%. But I am confident that as Skype for business gets deployed and people gain more confidence in the release and the launch of Skype for business and cloud PBX, I think we will see continued growth of about 20% annually.

Great. That’s helpful. And then just on the gateway business, last quarter you spoke about meaningful decline, I think especially in the low and mid-density gateways and maybe some questions about whether that was heading into kind of a secular decline after several years of relatively stable performance. Just wanted to get your thoughts on the, generally speaking, the media gateway business and do you think we have kind of reached a level of stability or are you thinking there could be further declines as we move into next [year] [ph] in that business?

Okay. Where we are sitting today, we should talk about gateway -- and I think for us, I need to go to another two to three quarters to solidify my assessment. But I would tend to think, we divided the gateway sales into three key segments. The mid-high, the low-mid and then the analog. We definitely see decline in the mid-high but that segment has reached a level from which we believe that at least for the next two year, we will not see any major decline. The low to mid segment was very successful for us until six months ago. We believe that there is much confusion on the Skype for business market and what we suffer from weak economies has contributed to lower sales in that segment. On the third segment, which is the analog media gateway, we actually see very significant growth. It's all related to what we call the all-IP transformation trend. What's happening is that the world moved to IP previously mostly in large and mid-sized organizations. And in those organizations, the main connection was through high-capacity trunks, [indiscernible] etcetera. The lower end market, which is the analog line was really moving last towards IP and was basically pushed by the channels to buy reduced cost TDMs. Now that the network is going to transition fully into IP and in the next five, seven years, it will -- old PSTN lines will be terminated. There is a big push by the large service providers to get all those small analog offices on to IP. The only way to do that would be through the use of analog gateways. So we have seen those trends are very strong in the past five, six months. We also have been to events such as hospitality events. If you think about large hotel networks, names like Marriot, Hilton and others, which have millions of rooms. Each hotel, you know, 500 rooms etcetera. Those networks do no plan on replacing the phones with new IP phones because that would be too costly. So the only way to go IP would be to put a large capacity analog gateway which we just announced, by the way, two weeks ago. So just to conclude, we will see lower sales in the mid-high range and I think we will see support for higher sales in the analog range. So all in all, either stable and/or declining slowly but we definitely will not see a collapse coming through.

[Operator Instructions] Our next question comes from the line of Mike Latimore with Northland Capital. Please proceed with your question.

Hi, this is [indiscernible] for Mike Latimore. I have got a couple of questions the business segments. Could you tell me how much is network revenue?

I am sorry, again, what was the question?

How much -- the network revenue?

Oh, networking. Yes. Networking revenues were 90%.

[Operator Instructions] At this time I would like to turn the floor back to management for closing remarks.

Okay. Thank you. Thank you, operator. We would like to thank everyone who attended our conference call today. We enjoyed a good business environment in the third quarter of 2015 and executed on our plan and we believe that we have set the pace for continued growth and momentum in the next coming year. We look forward to have you on our next quarterly conference call. Thank you very much. Have a good day.

This concludes today's conference call. Thank you for your participation. You many now disconnect your lines at this time.