AudioCodes Ltd. (AUDC) Q1 2018 Earnings Report, Transcript and Summary

Greetings and welcome to AudioCodes First Quarter 2018 Earnings Conference 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, Elizabeth Barker, Investor Relations at AudioCodes. Please go ahead.

Thank you, Ross. I would like to welcome everyone to the AudioCodes first quarter 2018 earnings 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 pricing and products 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 such 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 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 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. Good morning, and good afternoon, everybody. I would like to welcome all to our first quarter 2018 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 first quarter. We will discuss trends and developments in our business and industry, and outlook for the next quarter in 2018. 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 earning press release contains a reconciliation of supplemental non-GAAP financial information. Revenues for the first quarter were $42.4 million, up 2.4% from the prior quarter and up 13.5% compared to the first quarter in 2017. Services revenues for the first quarter were $13.7 million, accounting for 32.2% of total revenues. Deferred revenues balance as of March 31, 2018, was $42.4 million compared to $33 million as of March 31, 2017. Revenues by geographical region for the quarter were split as follows: North America, 39%; Central and Latin America, 6%; EMEA, 43%; and Asia Pacific, 12%. Our top 15 customers in aggregate represented 57% of revenues in the quarter, of which 43% are attributed to our ten largest distributors. Gross margin for the quarter was 64% compared to 62.4% in Q1 2017. Non-GAAP gross margin for the quarter was 64.5% compared to 62.9% in Q1 2017. Operating income for the quarter was $3 million compared to an operating income of $2 million in Q1 2017. On a non-GAAP basis, quarterly operating income was $3.8 million or 9.1% of revenues, compared to an operating income of $2.7 million in Q1 2017. Net income for the quarter was $2.4 million or $0.08 per share compared to net income of $1.3 million or $0.04 per share in Q1 2017. On a non-GAAP basis, quarterly net income was $3.9 million or $0.13 per share, compared to net income of $2.5 million or $0.07 per share in Q1 2017. Our balance sheet remained strong. At the end of March 2018 cash, cash equivalents, and marketable securities totaled $60.1 million. Day sales outstanding as of March 31, 2018 were 47 days compared to 60 days as of March 31, 2017. Operating cash flow generated during the quarter was $8.3 million. During the quarter, we acquired 1 million shares for a total configuration of $7.2 million. As of March 31, 2018, and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 16.7 million shares for an aggregate configuration of approximately $87 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 reiterate our guidance for 2018 as follows. 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 business momentum for the first quarter of 2018. Revenue came in higher than expected growing 13.5% over the year ago quarter. Better performance [indiscernible] with the continuation of our healthy business momentum in the recent three quarters. Noteworthy is the fact that this is the first time in our history that first quarter revenue topped the preceding fourth quarter revenue. Traditionally we plan for a decline of about 2% to 3% of the top line. This year first quarter was essentially stronger and ended about 2.4% above fourth quarter 2017. Looking forward to the second quarter, I am glad to know that at this stage that trend continues in the month of April. The major important key factor in this growth is the business momentum we have in the UC-SIP area, which grew about 30% year-over-year now representing more than 50% of our business. Reaching above $65 million of UC-SIP revenue in 2017 and continued growth of 15% and above in 2018 and 2019 should drive the UC-SIP business’ revenues close to $100 million in about two years from today. Growth in UC-SIP is driven primarily by our success in the Enterprise Voice business, where we became a top vendor for delivering voice connectivity and infrastructure for unified communication as a service and the contact center markets. Our strategy of close collaboration with market leaders in these segments and the investment in maintaining strong relationship with large and global system integrators proves to be essential and effective in growing this business line going forward. In parallel, we enjoyed also better business momentum in our service provider side of the business, and we see continued growth of SIP Trunking and continuation of the transition to an all IP network world. Now talking about AudioCodes in 2018, we made an important announcement earlier in the year, where we announced the establishment of a new business unit, which we call voice AI. Practically these days AudioCodes is comprised of two business units; the voice networking business unit, which you know for many years, which provides above 98% of revenue of the business. The focus is on Enterprise Voice. We have a history of 15 years. It is a mature business expanding, targeting about $200 million by 2020. UC-SIP business is the main driving force growing 15% and above annually, and we have an operating margin of about 10%. Just to remind you that the company for overall operating margin was 9.1 in the first quarter and the voice networking business unit’s operating margin was about 11%. The other business unit, which is quite young, fresh; this is the voice AI business unit. Basically it is a growing start up. We have in that business unit combined activities of voice recognition and recording, which are using advanced artificial intelligence technologies to enhance the offering and the solution we provide to the market. This year, we target a total of booking of 2.5 million for that business unit. We believe that we will see growth of about 50% in each of the first few years, and obviously we will leverage on AudioCodes, the larger company, footprint, the sales force and the enterprise contemplates to enable and allow faster ramp up in sending of voice AI solution products to the market. Touching on some of the important results of our first quarter 2018 performance, as I said, we actually grew in revenues 13.5% year-over-year. Also we have mentioned that we grew in the deferred revenue. So we grew about 7.8% from 39.3 million in the fourth quarter 2017 to 42.4 million in the first quarter of 2018. We mentioned the growth in UC-SIP. It is important to know that all the key components starting from the Session Border Controllers through the IP phones, through the management tools, through the Microsoft appliances, all four under that category, all enjoyed a very good quarter. Average revenue grew to 13.7%. That is 20% year-over-year. Growth was evidenced both on support contract and on the professional services side. We had a record gross margin. Non-GAAP gross margin was 64.5, and we believe this is – this range around 64 is definitely sustainable for growing quarters going forward. The better gross margin is due to the fact that we have a larger portion of services and better mix of products, which are software-based. Headcount remained relatively stable, about 700 employees. In spite of that, Opex grew 1.2 million in the quarter from 22.3 million in the first quarter to 23.5 million in the first quarter of 2018. This is relating substantially to the US dollar, Israeli shekel, conversion rate, which was in a bad spot in the first quarter, and we hope we will see improvement in that. That is definitely a substantial and [indiscernible] on our performance. Operating margin, we already are close to our target of 10% company overall. As I've mentioned before in the voice networking we reached above 11%. Net income, we grew about 56% year-over-year, which is remarkable. Cash flow was again strong 8.3 million. This is on the heels of three very strong and consecutive years in 2015, 2016 and 2017, when we grew more than – we provided more than $15 million of positive cash flow for each of the years. Relating to one very important geographical aspect of our business, in 2017 we grew significantly in EMEA as compared to other regions. Revenue in EMEA in the first quarter of 2018 was 37% as compared to 27% a year ago, meaning in the course of the year we jumped more than 35% in revenues coming from EMEA. We are enjoying several big and large countries in Europe, which provides a lot of this growth. This reflects our investment and success mainly in the Western Europe region and in some leading economies in that space. On the Gateway front, we have seen a decline of about 5% compared to the year ago quarter. The main decline came from the product sales. Gateway services revenues were fairly in-line with expectation and did not decline. When discussing Gateway product decline, it is important to know that discussing service providers or IP projects there is some similarity in the way that Gateways and MSBRs use SIP for network transformation. The fact is they are both using [indiscernible], the overall resulting decline was moderate. We have seen growth in MSBR revenue mainly due to [national] projects in all IP North America and Western Europe. Touching on the broader aspect of our products, where we focus, as indicated previously, we have now become the partner of choice for SIP products in most of the leading all IP and UC application environments such as the markets of Skype for Business and Teams, [indiscernible]. And we are building similar such positions with other service providers worldwide. Touching on some other parts of our business. Microsoft, this was a very successful quarter. First quarter grew 30% year-over-year and more than 15% over the preceding quarter. These results reflect continued good business momentum on the Skype for Business front, mainly in light of Microsoft’s announcement of continued support of the Skype for Business server on premise. We also serve continued projects of Skype for Business online and evidenced that the hybrid market does exist and continues to grow. Still in view of some of the latest announcements and increased focus on Teams versus Skype for Business some of our customers’ projects were delayed as a result of the fact that they had to consider different alternatives for deployment. At Enterprise Connect 2018, about a month ago, Microsoft announced AudioCodes as a launch partner for both the Teams phone, and the Teams [indiscernible] business. AudioCodes [indiscernible] by several global system integrators and service providers, mainly in Europe and by several large enterprises. First quarter 2018 was also a good quarter in terms of sales of Skype for Business online appliances, where two of our solutions, the CCE and cloud have both enjoyed higher revenue than before. We also enjoyed very strong quarters on our IP phone for Skype for Business markets, and we have seen more market feedback with the introduction of certain [IP phone] models. Touching on some of the deals in that space, we enjoyed a large number of [$1,00,000] projects each. I can give you an example of a large accounting firm deploying in the UK, a large bank deploying in Asia-Pacific, a regional bank, a company – a global leader company also based in Asia-Pacific, and in the US also some very strong accounts. So very successful quarter for Skype for Business. Going into another front, which is the SBC. SBC enjoyed very nice growth. Grew more than 30% year-over-year. All in all, we target for 2018 to grow more than 20% compared to the previous year. We have got good momentum in that space too. It is a high margin – high growth margin product; services are pretty strong in that space and contributes about 35% of our revenue. So very solid, very strong business. Going forward, in terms of our geo split, we have about 45% sold into EMEA, 30% into North America, and then we sell close to 10% both in [Asia-Pacific]. To mention some of the projects we enjoyed, we have a large OEM in that space, which has increased its purchasing with us for enterprise SBC. We have seen an enterprise voice modernization project that is using both of our SBCs and routing in Europe. We have continued an expansion of an existing American base, [Ai-Logix's] team from worldwide and also a very strong beginning with a Genesys contact center base solution in EMEA. On more activities on the SEC front; we have launched our WebRTC SDK for web. We do see a lot of momentum in that space, lot of interest from customers. We believe that our WebRTC solution is currently superior to other solutions in the market than we do expect to see growth in that space going forward mainly in the context of the market. We also about to launch a more advanced solution for or Micro Services as we see for cloud deployments and we believe that once it's deployed maybe in the second quarter, we'll see increased sales too. So, only now we're very successful core to the SBC itself. And I mention also that in our active phone business we enjoyed very nice growth compared to previous year. We grew by more than 30%. Again, most of our sales oriented Skype for Business markets in some or targeting those who have contacts, their application. Going into our service provider by result; we have seen growth. This is consistent growth of CPE to some of the largest service provider both in North America and in Europe. So, service provider CPE grew also targeting mainly SMB and branch offices. Providing more color on the services booking. Booking grew almost 30%, I suppose to the invoice which was recognized then which was about 20%. Key growth was in the professional services area where we grew a 100% from last year. It is still a small amount but that show our focus and ability to provide growing professional services to some of our largest customer. So, all-in-all, very chunk on year. Substantially, we have seen these services providers in the EMEA and the Asia Pacific region. Going into the Voice.AI business, we've seen very nice activity on the Voca the voice recognition side of the business. We have seen increased opportunity win in Israel. We started to work and promote the solution in Germany. We have seen first year success there and we in view of that success we believe that we will start deploying more this solution in other countries. In SmartTAP which is our recording solution, basically we do see new developments coming in the next few quarters. Summarizing the call, I'll go to our guidance and outlook. As mentioned by Niran, outlook remains very positive. Our main voice connectivity business is well on track with good performance and position. In the market, we see nice pickup in activity in our Voice.AI new initiative. Reference to the guidance, we are not changing these that is only the first quarter in the year. So, we are not changing as Niran mentioned the range of throw in these and range of earnings and that is pretty much substantially would have prepared this an update to the quarter. I'll turn the call now to the Q&A session. Operator, please?

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

Thank you. Good morning, Shabtai. So, it looks like the SIP, the UC-SIP business was well ahead of your expectation. Just wondering if you can break down at all what drove the upside in that business. And then you previously talked about that being kind of a 15%-ish growth business and you basically double that in the first quarter. Do we still think 15% is the right number, if not what? And then just on the Gateways, I know I think we talked about that possibly being kind of a low single-digit grower this year. It looks like it was down kind of mid single-digits in the first quarter. Any change in your thoughts on the Gateway outlook as well. Thank you.

Right, thanks Rich. So, on the UC-SIP, basically we do plan on annual growth that's between 15% and 20%. The first quarter was substantially better. As mentioned before, UC-SIP is deployed in two key markets, which are unified communication and contact centers. We have seen good momentum in correctly all of the different categories of products in that space; which are the SBC; the IP phone; the NFV; or the operation center management solution. The routing solution which is very attractive and grow dramatically in the quarter and the Microsoft cloud related appliances. Now, growth in UC-SIP was almost equal between products and services. So, a very good quarter. Going to the Gateway. Only now the Gateways business was almost kind of flat with previous quarter but there was distinctive difference between products and services. Products and I've mentioned that products declined about 5%; between 5% and 10%. On contrary, services grew and the combination of product and services really gave us a result which is less than flat but not that declining. We do expect that going forward we will probably see continued decline on the product side. We do not expect much change in the services side. So, declining of the overall gateway business will be moderate. Still I will also make a comment of quotient that this is the first quarter only and will be in better position to make a call after the second quarter or even third one as to, means the true trend in the gateway business in 2018.

Got it. And then, just with respect to your guidance. You mentioned the strong trends as like you'd seen in the first quarter continued into the first month of the second quarter. And historically, you've tended to be sequentially up in that second quarter. Do you, can you give any sense of where we would expect to be on that second quarter relative to the first that we think we're sequentially flattish off that stronger first quarter than typical or any color there would be helpful.

Right. It's still early to make a call as I've mentioned. First quarter was substantially better than planned. Second quarter that is well. So, very difficult to say this stage we will see further substantial increase in second quarter or just a mild growth. Only now the business is good and we do not -- we expect 2018 to be an up year, substantial. So, too early to make a change of the guidance but we feel very good about second quarter.

Got it. So, one more if I could. Just, you mentioned the Shekel being a headwind on the expense line. How should we think about OpEx going forward, should we use that first quarter OpEx baseline as kind of the right level to use going forward?

Yes. So, I think we've seen substantially most of the increase in OpEx in the first quarter. This is simply because not going to too much details but the first quarter we did not add any hedge and we were not in good position. So, I've mentioned that OpEx in the first quarter had jumped 1.2 million. Still we were able to provide a lot of success. Or I do believe that going forward, or as second, third and fourth quarter will not be substantially different or may even be lower, since we started to see some better conversion rate. In April, and also there's another factor which is tied up to approval of vacation which is usually higher in the first quarter than in the other quarters. So, taking these two factors into account, we do not expect whereas OpEx serious for the year. We may see even some relief.

Got it, that's helpful. Thanks very much, Shabtai.

Sure. Most welcome.

Our next question is from the line of Dmitry Netis with William Blair. Please proceed with your questions.

On here on Shabtai. Thank you for taking my question and good results, guys. I'll phrase the question a little bit differently but sort of on the same track as Rich just enquired. As far as the guidance goes, I mean it sounds like you're tracking well ahead of the plan; your bookings are up 30%; invoice is up 20%; differed is nicely up. I get, some of the nuances around the product versus services and gateway assumptions. For media, assumptions for media gateways. But you are essentially coming in right now at the higher end of the guidance. So, what's the reserving tone here with respect to reiteration of this 169 to 172? Why wouldn’t you kind of raise that guidance if think as so well aligned as you go through the year? And --.

Right. Well, the only reason would be that this is the first quarter and we just pass for a month in the year. If nothing will change, we may see some guidance update in after the second quarter. But this stage was simply would like to be more conservative.

Just conservatism. Okay, that’s helpful.

There's no other reason to it.

Got it, that's helpful. Thank you. And then on the bottom line, similar question. It sounds like CapEx was up, it was up substantially but your explanation was that is due to Israeli Shekel and effect. I'm not sure what something else in there but you do expect that to come down as you go through the year. So, as revenue improved and OpEx stayed flat to better than Q1, shouldn’t that put some positive pressure on new EPS? Where has to the guidance range already, that seems rolling in your into the remaining quarters of the year. So, that guidance also was maintained for the year. So, I'm just wondering why didn’t you change that either?

Again, we want to be on safe grounds. We just went through the first. We're only, we do not see major substantial change in the year but before we go through another quarter and verify the trend would like to be more cautious.

Okay. It sounds that you just have more control on the bottom line than into the top line which is why I phrased that question separately.

Right.

Okay, alright. I understand it, this is conservatism. I'll just simply move on. Alright. And just the next couple of questions. You may I would like to touch on your channels. Maybe it's starting with Microsoft, you mentioned some nice pickup of the serve types of business; server business. Do you anticipate that business decline as teams kind of become to go to standards with their introduction of a hybrid voice services in June. Is that something you're watching and you expect the pickup in that line of business and will that sort of move the revenue from kind of the traditional on-prem type of business server to more of a cloud type of deploymental teams?

Right. So, we're watching closely and we are working very closely with our partners to make sure that as soon as voice is deployed in team. In middle of this year will be among the first one to deploy and we're very pleased with the first few customers. In terms of from effects, on our revenue we I would again tend to be more cautious who will put like a six months delay on that. So, I think the key impact of that new introduction middle of this year will probably be seen in early 2019. But all-in-all, we do enjoy great business with the overall the deployed Skype for Business on-prem. And the online solution and we've seen growing revenues and growing we need to expand our networks in few more accounts. So, we believe that hopefully with the introduction of voice in teams, this here I think much of the uncertainty of sales where the happiness will trend away and we will -- but we will see the effect of that on the maybe nine months from today.

Okay, that's helpful. And some of the specificity if your main providers will rely with around those projects that were delayed when customers can ship with some Skype for Business online to maybe teams. It's just how do you pick up some of that business in your server, mark business or customers are simply kind of holding off and waiting for the teams' release. How, anything you can provide there would be helpful.

Yes. I think that are very trend position in the Microsoft it seems Skype for Business market, comes from the fact that we are able to deploy any of the architectures that a customer will choose. Some of them will choose and on its traits on-prem solution, some will favor in hybrid solution combining, on-prem and cloud. And some of the nuance will probably go with the new teams' solution. So, our ability to play all of the tree different alternative, plays great to our ability to be successful in the market. So, we are staying very close to any new development. We have been working on each of the previous seven eight years to be on top of any new development and provide a solution to it. So, the situation is manageable.

Good morning and --.

And I believe that because we invest this efforts, we are one of the more successful vendors in this space and the one that's usually kind of before selection when selecting the voice connectivity and the infrastructure solution.

Okay thanks, Shabtai. And the next question around focuses around Cisco and their acquisition of BroadSoft clearly your clearly your major partner. On the Voice side, Voice or this side, have you seen any changes of ships there, with respect their approach to SBC, selling SBC into those BroadSoft environments?

So, we've -- our product has been designed into the BroadSoft solution and are now part of the BroadSoft solution that's sold by Cisco. We are, we need to remember our debt is. At the end of the day, customer did buy those products is the service provider. And we do have a very strong position with those service provider. Just to mention that about a month ago with a very big event here in Israel which is called Accelerate 2018, where many close to 200 people came from around the world, mainly service provider to participate. So, our relationship with the service providers will basically determine how success or will be in the growth of Cisco environment. And right now on in the first quarter of 2018, we have not been changed and as we believe that as long as we remain competitive and still interoperable with the breadth of solution. We will be successful.

Okay. That's helpful, very helpful. That makes sense. And then, lastly maybe on the buyer and then coming out of bankruptcy, you had some kind of pockets of weakness I suppose when they were in bankruptcy. Now, that they're out of it, what have you seen out of this, the ecosystem, has that business gotten better or stayed the same. Any color there on that front would be helpful too.

Well, nothing to note. I mean, the business was just about the same and no change, no change now. Not better, not worse.

Did you anticipate the buyer's deployment? Yes, I mean I know they have some as we see that they acquired years ago but is there a relationship there that can get better or you don’t expect that to happen anytime soon?

No idea, quite frankly. We're definitely talking to all of the potential partners in this space. And as you know, things evolve over time. We still need to be consistent with our superiority in this city space. We hope that at some point, that will be useful also for on a such like a way but at this stage I have no evidence of that.

Right. But nothing stops the channel partner or the consultant, the reseller, that's all your eyes will see with their profit center deployment for example.

No, after we look at it. No, nothing changed, of course.

Okay. My last one and I'll kind of drop off the line. It's regarding the media gateway. Just wanted to see I guess the kind of product services, the shift, make shift potentially as you go through the year but your guidance was below the mids, they didn’t go pitch it growths. Has that guidance change at all or I suppose that guidance included both product and services. So, anything you can help us; whether you're reiterating that or not, just give us a sense of that. Thank you.

Okay. We do expect gateway services to at least remains that in our growth simply because as each year goes by, we do sell -- we used to be selling each year about 60 million of products to the market. And those products need service. So, just to mint in the amount of gateway product that is accumulating these days in the market. And therefore, we should expect services to continue to be a successful business.

Okay. So, flat through the year for product and services combined. Is that your guidance for media gateway business?

I would say if I have to make a call, I will say flat to minus five.

Flat to minus five?

That's my guess at this point.

Okay. Thank you Shabtai, I appreciate that. I'll jump back in the queue.

Sure, thank you.

Thank you. At this time, I'll turn the floor back to manager for further remarks.