AudioCodes Ltd. (AUDC) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to AudioCodes Third Quarter 2016 Earnings Conference Call. At this time, all participants are in 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’d now like to turn the conference over to your host, Elizabeth Parker, Director of Investor Relations. Ms. Parker, you may now begin.

Thank you, Rob. I would like to welcome everyone to the AudioCodes third quarter 2016 earnings conference call. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President Finance, and Chief Financial Officer. Before beginning, we’d 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 introductions, 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 Law. 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 effects 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 in the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in 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 website. 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 website at the conclusion of the call. The call will also be archived on 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, operator. Good morning and good afternoon, everybody. I would like to welcome all to our third quarter 2016 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance for AudioCodes. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the third 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 noncash items. Today’s earning press release contains a reconciliation of supplemental non-GAAP financial information. Revenues for the third quarter were $37.2 million, up 3.7% from the prior quarter. Services revenues for the quarter were $11.3 million, accounting for 30.3% of total revenues. Revenues by geographical region for the quarter were split as follows: North America, 47%; Central and Latin America, 7%; EMEA, 28%; and Asia Pacific, 18%. Our top 15 customers in aggregate represented 61% of revenues in the quarter, of which 41% are attributed to our seven largest distributors. Gross margin for the quarter was 61% compared to 60.5% in Q2 2016. Non-GAAP gross margin for the quarter was 61.7% compared to 61.4% in Q2 2016. Operating income for the quarter was $2 million compared to an operating income of $1.3 million in Q2 2016. On a non-GAAP basis, quarterly operating income was $3.1 million or 8.2% of revenues compared to an operating income of $2.5 million in Q2 2016. Net income for the quarter was $1 million or $0.03 per share. On a non-GAAP basis, quarterly net income was $2.9 million or $0.08 per share compared to net income of $2.4 million or $0.06 per share in Q2 2016. Our balance sheet remains strong. At the end of September 2016 cash, cash equivalents and marketable securities totaled $65.1 million. DSO as of September 30 was 63 days compared to 57 days in the prior quarter. Operating cash flow generated during the quarter was $3.4 million. During the quarter, we acquired 3.4 million shares for total consideration of $15 million. As of September 30, 2016 and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 10.7 million shares for an aggregate consideration of approximately $46.5 million. In October, 2016, we received court approval in Israel to purchase up to an aggregate amount of $15 million of additional ordinary shares pursuant to this program. The current court approval for share repurchases will expire on April 2017. Now to provide an update to our guidance, we now expect revenues for 2016 to be in the range of $144 million to $147 million compared to the original range of $142 million to $149 million. We anticipate non-GAAP diluted earnings per share to be in the range of $0.24 to $0.27 compared to the original range of $0.20 to $0.25. I will now turn the call back over to Shabtai.

Thank you, Niran. We are very pleased to report strong financial results and continued this momentum for third quarter 2016. This is one of the best quarters in the past year. As reported third quarter revenue came at the top range of our guidance for revenue growth of the previous quarter, and earnings came better than guided earlier this year. We enjoyed growth and prosperity across from all business lines, most notably in the UC-SIP business activities, which grew more than 20% over the year-ago quarter, growth that supports our stated target for sustained annual growth of 15% to 20% of this business in 2016 and over the next coming years. With continued projected growth in the unified communications and IP business services markets and the global trend of service provider migrating their voice services to all-IP networks year-by-year over the next 10 years, we believe we have strong foundation for growth and confidence in the strong and healthy business in coming years. Not less important is the perennial [ph] process we took in continued effort on moving the company’s focus from being a product vendor to a solution and services company. This major change increasingly helped us to improve our competitive position and offering in this space. In order to better understand the results of this quarter and simplify things, I’ll say that our business today is roughly comprise of two main business lines, the gateways and UC-SIP, each contribution about 40% of the overall business and the technology legacy business line that altogether contributes about 20%. What worked best for us this quarter, were the developments in the two key business lines. The gateway business line held nicely at pretty much the same level as previous quarter, while the UC-SIP business kept running above 20% over the year-ago quarter as planned. As far as gateway revenues are concerned, while we witnessed relatively large decline in our gateway business in previous years starting from 2015, it is important to know that we see some moderation of that trend in 2016. And we believe that this has much to do with the accelerated trend of moving toward IP by service provider and enterprises, where a large infrastructure of TDM based PBX and phones on premises in the access part of the network need to transition to IP transport in the SME and SMB segments. We see increased pace of RSPs and proof of concept trials by service provider, mainly in North America and in Europe to start migrating with their voices’ network to IP. Most important, the UC-SIP business now represents close to 40% of our quarterly revenues. As of the third quarter 2016, the UC-SIP business is comparable in size to our old gateway business and providing 15% to 20% annual growth. And it is becoming the key business line starting 2017. Just to remind us all, that UC-SIP business basically represents the recent two, three years effort and new go-to-market on the solution and services strategy, that relies on a combination of products starting the new emerging cloud service world and comprising of Session Border Controllers, business routers, SIP phones, Microsoft related cloud connection gear and our network management server products. Before I proceed to discuss some of the developments in our business and sales, let me touch again on some of the more significant data points on the financial front, all of which are alias non-GAAP numbers. As Niran mentioned, revenue grew nicely 8.7% year-over-year, 3.7% quarter-over-quarter. As I mentioned, before UC-SIP grew 20% above last year, 5% on a sequential basis. Service revenues which is one of the more found and constantly growing businesses of AudioCodes, reached a level of $11.3 million that’s 17.4% increase over the last year quarter, and 8.6% over the previous quarter. We have achieved in this quarter record gross margin, gross margin came at 61.7% compared to 60% a year ago and 61.4% in the previous quarter. All that is a result of a growing share of services in our business, which is now above 30% of revenues, and which is carrying better gross margin than products; the gross margin for services are above 75%. Adding to that the growing sales of software products, driven partially by the consistent shift of cloud solutions, we do expect that gross margin will at least stand in that level, if not, grow further going forward. On the operating expenses front, we had good control of OpEx, as you’ll see when I’m talking about our headcount, we invested in third quarter in adding resources to our marketing and sales team worldwide to become more effective in new markets in more countries. We have witnessed improved bottom-line performance. Operating income was $3.1 million compared to $1.9 million a year ago, and $2.5 million in the previous quarter. Operating margin reached 8.2% versus 5.4% a year ago, 6.9% previous quarter. We are well on track to get above 10% in 2017, that’s our belief, that’s our planning point. Net income came at $2.9 million versus $1.7 million a year ago, $2.4 million a quarter ago, again a very nice performance. Cash flow from operation, as indicated by Niran, was $3.4 million, altogether in the first three quarters of 2016 we had positive cash flow from operation of $11.6 million. Just remind to you, that last year we did $17.6 million. So we are producing cash on a very consistent basis proactively every quarter. So that is the basis for strength and confidence in continuing our buyback operation. We kept growing headcount to support business expansion for us in our business. Headcount grew to 692 employees, in addition of 23 employees over second quarter 2016, leveraging on quarterly revenue growth and on the grants that we received from the Office of the Chief Scientist in Israel this year and for the next two years. We keep adding R&D and customer-facing positions to support growth in coming years. As Niran mentioned, on our financing operation we completed a tender offer of 3 million shares at $4.35 per share completed on July 20. And we - thereafter, we did a buyback of 372,000 shares, altogether as mentioned in aggregate of 10.7 million shares since August 2014. Going to our sales worldwide, we generally have aggregated plan. We enjoy better-than-expected performance in North America, where we topped the planning, the internal planning. We also saw a very nice increase in Asia Pacific. Asia Pacific now becomes a fairly important market for us and we’ve seen sustained growth over previous four, five quarters. And we believe that will keep growing. We also show relatively nice performance in Europe, we’re focusing on the key contributors, the largest economy in the continent; we have achieved very nice performance. So all in all, very good performance on the sales side and we believe that should be the plan going forward. To put some color on some of the deals or transaction we had in the quarter, I’ll mention few transactions. We had a big large contact center deal in Asia Pacific, altogether above $0.5 million. We also saw another $0.5 million purchase order from a very large car manufacturer in Europe, that’s in the Skype for Business markets. Skype for Business generally, I’ll touch that going forward, but all-in-all we saw nice large enterprise POs [ph] in that quarter. We enjoyed more deals, mainly in North America and in EMEA. Business services also enjoyed a good quarter. We’ve got few deals both in Latin America, in Europe, in Australia. All in all, we feel we are fully confident in the expansion of our business. Touching on the markets of Skype for Business developments in the quarter, we enjoyed a relatively good third quarter 2016. This top line revenue growing above 20% over the year ago quarter. And they were pretty much on the similar level with the previous quarter. With Microsoft’s continued push towards Cloud PBX and Skype for Business online we saw further activity around the relevant products including our CloudBond 365 and Microsoft’s new initiative for Cloud Connector Edition for pure and hybrid voice. We are now positioned for service evaluation with numerous service providers worldwide. And we saw increased activity for service providers mainly in EMEA and Asia Pacific. More meaningful is the progress we made with our IP phones, the Skype for Business market. We saw substantial increase in the number of opportunities and revenue compared to previous quarter, and above 50% growth in sales compared to the previous quarter. Building on completing pending Skype for Business Cloud PBX certification processes, we now believe that we will see even further accelerated growth in fourth quarter 2016 and 2017 and beyond. Last, I’ll touch our guidance. As indicated by Niran, we have raised earning guidance for the full year 2016 to be in the range of $0.24 to $0.27. As for the next quarter outlook, we believe growth in fourth quarter 2016 will continue pretty much on the same track. And we plan for another 2% to 3% sequential revenue growth over the third quarter of 2016. All in all, we are quite optimistic going into 2017, and believe that the type of growth we saw in 2016 will continue with UC-SIP driving and becoming more meaningful and continually growing at 15% to 20% in earnings. And with that, I’ve completed my introduction and we’ll be open for questions. Thank you, operator.

Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from the line of Rich Valera with Needham & Company. Please proceed with your questions.

Thank you.

Good morning.

Good morning, Shabtai, so nice to see the strength in your UC-SIP and Skype for Business, business lines. And it sounded like you called that IP phones as being especially strong there. I think you mentioned 50% growth. Can you talk about why you think you’re seeing such strength there? Is there any change in the competitive landscape that’s driving that or is there something that you’ve done to drive that? And how do you feel about the sustainability of it?

Yes. I think most of the growth and the strength coming from the fact that we have a business line that’s becoming much more mature. And we are, again, in order to be able to sell in the Skype for Business ecosystem and/or other partners’ markets we need to go through a very long processes of certification and adjusting to certain feature list. We have been behind in previous quarters. We now believe that we are fairly close to - closing that gap that has been fairly evident in the third quarter operations. We just participated in a big Microsoft event in September where we announced a new executive phone. We got more endorsement from Microsoft on that. We believe we will be a fair bidding company in that space. So we believe that this year, we’ll grow at least 40% in revenue compared to last year. But we believe that in 2017 that growth rate will accelerate, actually we expect to grow more than 50% next year.

In the IP phone line?

Yes.

Got it. I’m wondering if you could provide a little color on the other pieces of that UC-SIP business, particularly your SBC lines and the services component if it sounds like - certainly services sounds like it’s doing pretty well - but if you could give a little color on SBC and services, that would be great.

Yes. As we see, we had a relatively good quarter, was in par with performance of previous quarter. We do see some new development. We just want a very lucrative SBC deal with one of the world’s largest system integrator to provide a global SIP tracking solution based on a very advanced solution we have. That solution is already used by another world leader. So we’re working with one large North American provider. We’re working with one European provider. And all in all, we make progress with our virtualized implementation for SBC, et cetera. Business routers also picked up in the third quarter, mainly due to the ongoing emergence of the all-IP migration process. Services definitely are strong. Think again at the - coming to the bottom of it, the fact that we now provide more complete solutions and services attached touch to it makes us a much more attractive supplier at large enterprise deals, simply because we will bring more of what’s needed. And when we bring that and - I’ll mention by the way one more component that I haven’t mentioned yet. That’s the module we introduced earlier in the year. We call it ARM, that’s AudioCodes Routing Manager. That’s a routing engine that helps monitor and provide policy to enterprise traffic, voice traffic on a worldwide basis, very useful. That product in combination with SBCs help us win some very large deal, which is still not be interested in its revenues yet, those are design wins. But at this stage, we believe that with that product we are on the front, and we do not see yet competition in that space. So all in all, when you combine all of this into a solution and you provide the required services to it that would always to be better than a vendor providing a specific product. So that’s I think the bottom of it.

Got it. Thank you. And a couple of modeling questions, I miss the - I think you set an operating margin target for 2017. Shabtai, if you could repeat that. And one another one is just what share count should we use for the fourth quarter? Obviously, it will be below the average share count for the third quarter, but wondering if you could give us sort of a rough idea of what share count we should use for fourth quarter? Thank you.

Right. So we ended third quarter 2016 with 8.2% operating margin. We plan to the cross 10% operating margin in 2017. So that’s in reference to the first question. In reference to the second question, for the third quarter of 2016, we had 34,000,971 shares [ph]. And we believe we will see another drop in number of outstanding shares to about, so the 3,000,800 [ph]. That’s based on the buyback process that we just initiated last week.

Got it. And just to be clear, the 10% is that for the entire year 2017 or hitting that like in the back half?

No, no, no. That’s on a quarterly level. But I assume, again, yes, we have got good chances. Usually, first quarter is lagging the first [ph] quarter, so we will see some drop there. But I expect that as of the second quarter of 2017 will be above 10% on a quarterly basis.

Got it. Thanks very much.

Sure.

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

Great. Thanks a lot. On the product versus service mix here, should we kind of look at the product growth and service growth in this quarter, in the third quarter? Is that the type of growth rate you’re expecting for those two categories over time?

Okay. As far as services are concerned, I believe that we usually plan for 10% to 12% growth annually. So from that you can derive the quarterly growth. As far as products, we do believe that we will grow as I’ve mentioned, UC-SIP at 15% to 20%. However, for the whole company you need to combine that with the gateway. And as we all know in the gateway it’s tied up to some quarterly fluctuations, so it’s pretty difficult. This year we will see declining gateway products of around 10%. We will probably need to model that also going into 2017. So I think that towards the beginning of 2017 we will provide a more calculated figure as it takes into accounts those gateways and UC-SIP.

Got it. And then how do you generally think about the growth rate of legacy technology area, is that stable, is that going to decline a little bit?

It’s going to decline a bit. We will definitely see between at least 5% to 10% decline. But again, this is unfortunately kind of a cash-counting [ph] stage and we’re not investing in it so.

Fair, okay. And then on the Skype for Business commentary is a lot of attraction that you’re getting in Skype for Business, is that on-premises deployments of Skype and the hybrid or are you seeing solid uptick in the Cloud PBX arena as well.

Well, the majority of the business we see is the continued on-premises business. We see - basically most of or almost all of the companies we started with the server edition, which is the premises edition, continue with it. As far as Cloud PBX, we see some - we see quite interest in testing it, in evaluating it. We are involving in pretty large number of evaluations. But I cannot say at this stage that Cloud PBX is comparable in pace to the server business.

I mean, say, you’re seeing interest in testing Cloud PBX, is that the pure Cloud PBX or is that more of a hybrid deployments?

Usually, Cloud PBX is being considered for pure solution. So - but you feel free. We have invested in CloudBond, which targets hybrid implementation. There’s definitely continued efforts on that. So anybody who started with CloudBond continues with it. CloudBond has definitely an advantage when it relates to hybrid implementation. And there are a quite significant number of - and our enterprises really do not want to move all of their facilities into the cloud. I mean, if you’re talking about more branches or small facilities, those facilities are prone to go to cloud. But with headquarters and large facilities, I believe there’s some hesitation as to CIO giving all of their ability to control their network completely into the cloud. It will be a process. It’s going to happen, but it’s not happening yet.

And then on the SBC business, do you expect the SBC category to grow kind of in line with the overall UC-SIP category?

Yes. This year will grow. This year will grow above 15%. I expect such growth in 2017.

Right, and then, can you add just a little bit about the contact center vertical? You mentioned one deal. I’m guessing that was an on-premises deal, but I’m not sure - what are the prospects around contact center, both on-premises and cloud at this point?

So in the contact center market or go to market relies heavily on partnering with Genesys. And at this stage, Genesys is OEMing a full portfolio for products starting from gateways to SBCs to phones to network management modules. Genesys just announced few weeks ago that the acquisition of interactive intelligence, which is also a pretty significant player. So all in all, our play in that market is fairly solid tied up to the success of partners and we definitely see some growth there.

Okay. Thank you.

Okay. Thank you.

Thank you. At this time, I’ll turn the floor back to management for closing remarks.

Thank you, operator. I would like to thank everyone who attended our conference call today. Based on good business momentum and execution on our plans in the first nine months of 2016, we believe we are on track to achieve another year of growth and progress, and continue to build a growing profitable business for coming years. We look forward to have you on our next quarterly call. Thank you very much. Have a good day.

This concludes today’s conference. Thank you for your participation. You may now disconnect your lines at this time.