AudioCodes Ltd. (AUDC) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the AudioCodes Fourth Quarter 2017 Earnings Conference Call. At this time all participants are in a listen-only mode. A 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, Ms. Elizabeth Barker, Director of Investor Relations for AudioCodes. Thank you. You may begin.

Thank you, Melissa. I would like to welcome everyone to the AudioCodes Fourth Quarter 2017 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 events, 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 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 website. Before I turn the call over to management, I’d like to remind everyone that the 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 this 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 fourth quarter and full year 2017 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance of AudioCodes. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the fourth quarter and the full year 2017, and discuss trends and developments in our business and industry, and lastly outlook and guidance for 2018. We will then turn it to the Q&A session. Niran, please go ahead.

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 earning press release contains a reconciliation of supplemental non-GAAP financial information. Revenues for the fourth quarter were $41.4 million, up 5.6% from the prior quarter and up 9.7% compared to the fourth quarter in 2016. Full year 2017 revenues totaled $156.7 million compared to $145.6 million in 2016. Services revenues for the fourth quarter were $13.4 million, accounting for 32.3% of total revenues. On an annual basis, services revenues increased by 13.8% from the previous year. Deferred revenues balance as of December 31, 2017, was $39.4 million compared to $31.8 million as of December 31, 2016. Revenues by geographical region for the quarter were split as follows: North America, 39%; Central and Latin America, 7%; EMEA, 41%; and Asia Pacific, 13%. Our top 15 customers in aggregate represented 63% of revenues in the quarter, of which 48% are attributed to our nine largest distributors. Gross margin for the quarter was 63.1% compared to 60.9% in Q4 2016. Non-GAAP gross margin for the quarter was 63.6% compared to 61.5% in Q4 2016. Operating income for the quarter was $3.2 million compared to an operating income of $3.6 million in Q4 2016. Full year 2017 operating income was $9.7 million. On a non-GAAP basis, quarterly operating income was $4 million or 9.7% of revenues, compared to an operating income of $2.9 million in Q4 2016. Full year 2017 non-GAAP operating income was $12.8 million. Net income for the quarter was $0.7 million or $0.02 per share. Full year 2017 net income was $12 million or $0.13 per share. On a non-GAAP basis, quarterly net income was $3.8 million or $0.12 per share, compared to net income of $2.6 million or $0.08 per share in Q4 2016. Full year 2017 non-GAAP net income was $12.2 million or $0.37 per share compared to $9.4 million or $0.26 per share in 2016. Our balance sheet remains strong. At the end of December 2017 cash, cash equivalents, bank deposits and marketable securities totaled $58.7 million. Day sales outstanding as of December 31 were 51 days. Operating cash flow generated during the quarter was $8.4 million and $17.8 million for the full year 2017. During the quarter, we acquired 1.3 million of our ordinary shares for a total configuration of $9 million. As of December 31, 2017, and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 15.8 million shares for an aggregate configuration of approximately $79.7 million. In November 2017, we received court approval in Israel to purchase up to an aggregate of $20 million of additional ordinary shares, pursuant to our share repurchase program. The current court approval for share repurchases will expire on May 27, 2018. We continue to expect top line revenue growth and operating margin expansion in 2018. We expect revenues in the range of $166 million to $172 million, and non-GAAP diluted earnings per share of $0.41 to $0.46. I will now turn the call back over to Shabtai.

Thank you, Niran. We’re very pleased to report strong financial results and continued momentum for the fourth quarter and full year 2017. This financial result cast a very strong business momentum in the fourth quarter, and in fact for the second half of 2017. I’m glad to say we see similar such continued trends in January this year. This is a 10th sequential quarter now, that’s our business momentum picks up fairly steady, all that since the second quarter of 2015 upon the impact of the global oil crisis. UC-SIP which represents about 45% of revenues, the main business that attracts most of our investments since 2009 continues to grow as planned. And in 2017 we have closed another year of growth that’s about 15% annually. Crossing the $65 million of revenues in 2017 and continued growth of 15% annually in 2018 and 2019, should bring the UC-SIP business revenue close to $100 million in 2019. Growth in UC-SIP is driven primarily by our success in the Enterprise Voice space, gradually become sub-vendor for delivering voice connectivity and infrastructure for market segments such as the unified communications market and contact center markets. Our strategy of close collaboration with the market leaders in both segments and strong allies and relationship with large and global system integrators proved to be essential and quite effective in growing our revenues in this market segment. In parallel we enjoyed good business momentum in our service provider side of the business, where we see continued annual of SIP Trunking at the rate that’s above 20% across the regions. In addition, we saw continued growth in network transformation projects conducted by Tier 1 service providers in several countries, most notably the U.S. and Germany. These are projects intended to our businesses, transition from the old world of TDM to an all-IP world. One important geographical aspect, in 2017 we grew significantly in EMEA as compared to other regions. Revenues in EMEA were about 27% of the company over revenue in the first quarter of 2017, enriched 39% in the fourth quarter of 2017, a jump of over 40% in course over the year. On the Gateway front which represents also 45% of our business, we enjoyed good business in 2017. Earlier in the year the plan for Gateways calls for a decline in revenues of about 5% compared to 2016. I’m glad to say that we actually saw a reverse in the trend and that in fact revenues grew above 6% compared to previous year. We attribute this mainly to network transformation project in all-IP in North America and West Europe understanding that the trends of network transformation is supposed to pick up in coming years, we do not expect any material adverse change in sales of Gateways in 2018. To provide more color, as for the relative strengths in the Gateway business I’d note the following two examples. Second half of the year we won a large multimillion dollar RFP for gateways to support the migration to all-IP with one of the world leading service provider operating in many countries, and we believe that the potential of this win will start to unfold over the next several years. Also in 2017 in December we announced that AudioCodes was selected by Thailand’s True Corporation for all-IP transformation. True in Thailand largest broadband internet provider, a leading mobile operator with tens of millions of subscribers, and the largest fixed-line phone operator in the Bangkok area. Also according to a latest market report from HIS, we keep gaining market share in the Gateway market as we become a consolidator in this space. As indicated previously, we have now become the partner of choice for CPE products in most of the leading all-IP and UC application environment, such as Microsoft Skype for Business and BroadSoft. And we are building such position with leading service provider also. Now to some other business fronts, let me recap on Microsoft. In 2017 we have seen growth, although slower than in previous years. All in all, we grow in 2017 about 15% down from about 20% the year ago. We have seen some very substantial increase in sales of products with the new emerging cloud online. Microsoft now places a much more focus on Teams, which is a cloud-based collaboration solution, it combines chat presence, voice, file sharing and more. In fourth quarter 2017 we have not seen yet any impact on revenues. We know that voice will come on Teams later in 2018. However, we have strong activity that’s plan to support the addition of voice in Teams. Right now, we do support all the different types of work in the Microsoft environment. We support both on-prem cloud online and Teams. We also work very closely to become an early stage partner for Teams in connection with Microsoft effort to provide PSN trunking as the fee for service – provider services. In terms of our global activity, in North America we believe that almost all of the access partner supporting Microsoft Skype for Business and Teams are aligned with AudioCodes. In EMEA we see growing pipeline of opportunities brought to us by two very strong global system integrators. In Asia-Pacific pipeline was growing mainly through Japanese operators. In November we announced collaboration with SoftBank on Skype for Business. SoftBank, which is a leading Japanese telecom service provider, deploys AudioCodes products and solution and business customers part of using Skype for Business online office service. I’ll touch to large deal, we serve on Skype for Business in previous quarter. We’ve done a very large with a larger national airline in Latin America, also we have own a very big project within American multinational office supply retail chain, which has over 1,000 stores in North America. Touching on the front of the SBC, 2017 has been a record year for SBC. All in all, we grew 25% over 2016. The first quarter by itself was a record quarter. We grew above 35% over the quarter the year ago and 20% from the previous quarter, so all in all, very strong performance for SBC. I should make a note that almost 25% for SBC solution sold was implemented in [indiscernible]. So that leads to some improvement on our gross margins. In terms of the geo split, North America was the leading region with about 40%. But then we have lots of activity in West Europe, and we saw activity there above 30% of revenue. We have got products on the various fronts, on voice infrastructure, monetization of Skype for Business for service providers, managed services for service provider and then trunking and access in other area. Now let me touch the announcement that we made yesterday. Yesterday we announced a new business unit Voice.AI. The new unit is intended to leverage on our existing technologies in certain areas such as speech recognition and call recording, and add to it, artificial intelligences and machine learning technologies in order to enhance productivity and to be able to deliver actionable impacts from business to voice communication. It is very known that global communication remains one of the most effective masthead for complex and critical business transaction, yet most of the verbal communication is not recorded and is not converted into actionable insight that can help enhance business productivity. If you’d compare voice to data, anything that’s done with data today in the enterprise with emails, with file transfer, with other forms of data, it is all recorded, it can all be searched, it can all be utilized in order to perform various business processes. Voice is completely abandoned in this regard. We know that voice is recorded and logged in contact centers for sales calls and sometimes also by companies for service calls. But all in all, we all know that a call on the phone with a business partner and/or internally could be a business review which is attended by 10 or 15 different people. You have people on the phone. At the end of that meeting very little of the conversation becomes effective, few action items are being generated, but it’s really most of the content, most of the contribution is lost. So we believe that by utilizing the technology I’ve mentioned artificial intelligents technologies on top of our recording and voice recognition technologies can bring new very effective solution to that market. We believe that we will position until our businesses become more productive simply because we can capitalize on a very large global installed base of enterprise partners and customers where we deployed SBCs and gateways and endpoints. And several of these are located in some very important network junctions that are being used to conduct internal and external communication of large companies. So all in all, we are very – as you can imagine very enthusiastic about this activity. In fact, if I’ll just try to give you a new angle on articles, you can think now for the quarter, really comprising of two business units. One which is the traditional large, which you know its performance for many years that constituted at this stage above 97%, 98% of the business is our voice networking unit, and it is about $155 million in revenues, it has global footprint, it has large installed base of customers and partners, it is growing nicely, it is profitable and basically very dominant in growing revenues. On the other hand we now have a new business unit that’s fairly young, quite advancing technology, but still very small in revenue. And as you can imagine we’ll have – going forward, we’ll have basically develop for ourselves a new growth engine for years to come. If you look on AudioCodes history you’ll find that in the past 20 years or so AudioCodes has always been enable to reinvent itself every six or seven years. So we started this technology back in the 1990’s, we’re started the Gateway line back in 2002 and 2003. We started the UC-SIP in 2009. And today in 2017 we started out the Voice.AI business. Now coming back to some key points in our financials, Niran has mentioned most of the most important points. I’ll just point that last quarter was a very strong one, we grew almost 10% over the quarter a year ago, which tells you a bit about increasing growth rate of our business. We have exiled in terms of our operational performance, so operating margin include a first time 89.7%. Actually if you now think about the Voice.AI business basically impact on the main business you can assume that the main business, the voice networking unit, has performed in terms of operating margin above 10% quite nicely. Cash flow was very strong. This is the third year in a row that we generate above $17 million a year. The one strong point is the OpEx front; headcount at the year end was 698 employees versus 703 by the end of the third quarter. However, we face strong headwinds on the currency front where the average conversion rates for the U.S. dollar versus the Israeli shekel declined severely. This is the main reason behind the pickup in OpEx for the fourth quarter, which is about $1 million compared to the previous quarter. Touching on an annual basis, so in 2017 we grew in revenue 7.7% above 2016, compared to 4.2% driving growth from 2015 to 2016. In terms of earnings we basically grew 28.9% in earnings in 2017. And if you compare 2015 to 2017 you can see that we have basically doubled earnings in two years. Gross margin great performance, we eat for the first time, 52.9% on an annual basis. Cash flow, I have mentioned, very strong that allows us to be very activity on our buyback and I think you’ve seen part of the return on investments coming from that process. All in all, coming now to outlook and guidance, so outlook is very positive on our side, our main voice connectivity business is well on track with good position in the market. And we have a new initiative Voice.AI which opens for us new horizons and new growth engine. Reference guidance, as Niran mentioned, regarding revenue we now guide for a range $166 million to $172 million assuming current business trends continue we should aspire for 8% to 10% revenue growth over 2017, which will be a pickup from 2017. Regarding earnings, we expect to grow earnings above 20% in 2018 setting for the range of $0.41 to $0.46. There is a much depends on the new Israeli shekel to U.S. dollar conversion rate. Right now the rates range about $3.4 to $3.5 is not favorable and this is the basis for our guidance. On buyback as reported we purchased $1.3 million in fourth quarter of 2017 and we have a program in place for another 3.5 months, and I assume that we will keep performing on this program. With that I have ended my introduction and I will now turn the call back for the Q&A session. Operator?

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

Yes. Thank you. Shabtai, I wanted to ask a question on your new business unit, the Voice.AI unit. It sounds like doing the math that was about $10 million – would have been about $10 million of revenue last year. Just wondering what are the products today that comprise that revenue? And how do you think about the growth trajectory of that business and what’s some of the incremental products you might develop that would drive that growth? Thanks.

Yes. Thank you, Rich. Well, in fact both activities, VocaNOM and SmartTAP have been much more in a development status in the past few years. So while we have – and today we have about 40 people on both activities, most of it about 75% to 80% has been invested in technology development in R&D. We have added the activity regarding the AI and machine learning, and different networks in 2017. So we did much less in sales and right now we are just trying to go upwards, in fact, sales have not been hard, you will do $2 million to $3 million a year. We do expect though a growth of at least 80% to 100%, in fact, we may incur more growth, but that is just to tell you that we have – our Voice.AI has been generating less revenues – the negative operating impact. That means that our main business basically has a much better operating margin.

Right. Got it. And so when you’re selling this business you’re going to sell this to sort of like an overlay, analytics overlay. I’m just wondering how you’re going to market this to your customers?

Okay, great question. Actually, basically the basis for the optimism we have is that SmartTAP is a recording solution is being sold for the past three, four years. Now we have tens of customers worldwide using it. We about to announce our compliances with a new standard, we’ve just made obligatory in 2017. That allows us to access too many customers who already implemented SmartTAP as a good infrastructure for recording calls across the organization. And now think about entering the AI stage. Any company that would use new AI-based technology, it needs a reference database of calls that were recorded for a long time to come up with a new solution. So if you want to process your sales calls and/or you want to process your service calls and/or analyze meetings, you need to create a very deep and long database of recorded calls. Then SmartTAP is exactly the solution for that. SmartTAP will allow you to record and make record those calls up for your AI before launching any AI application. Just accumulating the calls and creating the large infrastructure that would allow you when you go to operate these AI technologies you’ll be ready to do so. So we will use SmartTAP, it’s a very efficient and installed based solution to upscale our business in Voice.AI.

Got it. That makes a lot of sense. And just wanted to get a little more color on the Media Gateway market, it sounds like that’s nicely performed your expectations in 2017, and the driver there appears to be significant network transformation project. So just wanted to get your thoughts on that business in 2018, sounds like you’re expecting a similar trajectory which would be kind of, I guess, low to mid single-digit growth. Is that a fair characterization of your expectations for Media Gateway?

Yes. Well, the experience we have with the new current environment which is really driven by those all-IP projects. Indeed in 2007, we reversed from a plan of decline to actually finishing upward, and that is based on activity mainly in North America and mainly in Germany. As you can – and we’ve already seen in some other countries, some initial steps to move itself, the service provider and infrastructure to IP. So we believe this is going to be a step staged process, where more countries will enter that. So understanding that that needs to be a world trend, but will take patient steps in many countries over the years, we have no reason to believe that we will see much change but we will have to go through 2018 to indeed assess whether that assessment to our debt assumption is true or not.

Got it. Thank you. And just one more from me on the stock buyback. You have been pretty consistent with buying back stock now for a while. Is there any reason to think that would change in 2018?

We always thought when we did that that would be one of the best investments we would make for us with cash flow that we generated. In 2019 I think we will look into that as well, that’s would be a continued theme in our mind. But at the same time, maybe with the new Voice.AI we will be looking around for more technology and/or activities that can argument and further jump the operation. So, yes, it’s always an assessment of the share price, the proceeds, the funds we have and what’s lying ahead and what makes sense more to do, but, yes, we will be active.

Got it. Okay. Thank you. That’s it from me.

Sure. Thanks.

Thank you. Our next question comes from the line of Dmitry Netis with William Blair. Please proceed with your question.

Thank you. Nice ending to the year, guys. Well done. Just a couple of questions from me. Just on this annual guidance, I’m kind of following up on Rich’s question. I think if I hear you, you’re blessed to low mid single-digit growth on the Media Gateway front, implied in that guidance would be over 20% growth in UC-SIP. So I’m just trying to get a better perspective. Is that the expectation that the UC-SIP business will grow 20% in 2018?

We’ve not specified 20% of the growth factor. We will definitely – we believe we should grow at least 15%. In the past we quoted more, 15% to 20%. It remains to be spent. We see – well, the main business line in that category – as we see growth above 20%. We have few more alliance there including our business routers, the Microsoft cloud appliances, the phones, IP phones, and the management sales for us. So, all in all, I will not change guidance as to above 20%. I think we will be above 15%.

Okay, above 15%. So then – what – where – maybe we could ask the question differently then. Service revenue growth versus product growth; how are you thinking about that? What is the service revenue growth expectation for 2018?

So service will keep growing. In the past two years, I don’t have the data in front of me, but I think we grew definitely above 10%. I think we grew somewhere 10% to 15%. We’ve seen a reason for the trends on the service side to change, but services are growing faster than products. That may change when we start to grow our Voice.AI, where products are relatively young and the majority in revenues would be from product versus services. But all in all, for the networking unit services grow faster than products on the Voice. AI we’ll see products growing faster.

Got it, okay. Thanks, Shabtai. And then just kind of looking on the Q1 side, I’m actually modeling it down just purely given the seasonality factor in the March quarter. You are coming off of a very strong December. Was there some pull in business, financial demand, how are you feeling starting the year? It sounds like you are upbeat given the guidance. So what should the model for Q1 look like? Are we looking more of a flat quarter in March down quarter in March? Give us a sense of how we should be modeling it?

Right. So, traditionally we have usually settled in a lower first quarter versus the fourth quarter. So in our budget and plans, I think would factored in about 2% or maybe 3% decline. The trends in generally point to a better quarter, so right now we still in the first week of January or second week, we’re not that active. So it still early to call on the quarter, but all in all, we definitely have good thoughts better than anticipated for the first quarter of 2018.

All right, that’s helpful. And then couple of questions on the product side. So I look at the SBC, you have the record year end quarter, very strong obviously. What do you attribute this to? Was this more of a competitive environment changing? Vis-a-vis [indiscernible] or maybe Acme Packet, but anything you can tell us A, what drove the business trends and B what the competitive environment looks like would be good.

Okay. So to give you a better sense, first we operate in two different market segments, the enterprise and service providers. In the enterprise, we are sitting very well, the fact that we are dominant and leading on the Skype for Business front and Teams, and also on the contact center, which I haven’t mentioned so far, but the contact center has been very good for us. And as we see it’s fairly an important product in that area. So all in all in the enterprise space we feel there is less competition at this stage because of two key factors. One, one of our key competitors Ribbon Communication is focusing substantially more on service providers. Second is that to sell Session Border Controllers in the enterprise market, you need to partner with the application vendors. And there is another player there Oracle, we do not think that Oracle is playing a partnership game with our AI. So all in all, the environment in the enterprise space is really good for us. We don’t see much competitive pressure there. On the service provider, which is on the company by the way on company scale, service provider is about 20% of our revenues. We have no play at all in the quarter as we see market which is usually competition varies between Huawei, Ericsson and Nokia. On the access part of the network we do have – definitely we do have a play and we feel that we are fully competitive there. So we put singular emphasis on the access and cloud efficacy, so that gives you a feature.

And back to the enterprise side, is there any change from Cisco-BroadSoft combo? I mean, are there more aggressive, less aggressive? What are you seeing out of that combo?

It’s too early to make a call. I think the transaction is not closed yet. From some discussion we had, we have no sign that things are going to change dramatically. But again, we will have to live through that experience. So all in all we don’t see much change on that front.

All right, good. And then last question on the network transformation almost a bit of a follow-up to Rich’s question. The way I want to frame it is this way, how many network transmission projects, so maybe RFPs are out there. Is there a number or do you see that pace of these projects accelerating at this point in time? And what are you expose more toward either the Nortel DMS replacement or the Alcatel-Lucent 5ESS, where do you see you can have the best bang for your buck given the product you have?

Yes, okay. So let me go one by one. North America is the most active in this network transformation process. And that process is going on for a quite few years. We are working with several Dutch companies and we don’t see at this stage I think the process in North America has not crossed yet, I will say even in my mind even it’s 30% or 40% in terms of – the overall potential. So we definitely working with some known names I’ve been mentioned in the past like Verizon and a few more operators. In Germany, Germany is second country with much activity working with the telecom. We are working with – in 2017 by the way we enjoyed much success I think we can count between six and eight different new service provider in Germany which are starting to work with us on that. We know this activity in France, in the UK, we’ve seen some in Switzerland. I’ve mentioned True from Thailand, it’s a representative of the large – a very large tens of millions of subscribers from Asia Pacific. But we know for a fact that in Asia Pacific that whole process is really being pushed more into the 2020, 2025 year. I just mentioned another one huge service provider that is operating in EMEA and then another is in where we won – in RFP it just was decided back end of 2017 which means we can expect another five, seven years of deployment of that product. So all in all I would say, again that the whole process is really in transit and we expect some very meaningful years ahead of us.

All right, that’s very helpful. Just to clarify you said that the penetration rate in that network transformation initiative that hasn’t quite crossed the 30% yet. Is that fair?

That’s my – I said 30% to 40% but that’s my personal assumption, yes.

Okay. Thank you, Shabtai. Keep up the good work. Thank you.

Sure. Thank you, Dmitry.

Thank you. There are no further questions at this time. Mr. Adlersberg, I’ll turn the floor back to you for any final comments.