AudioCodes Ltd. (AUDC) Q4 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the AudioCodes Fourth Quarter and Full Year 2018 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 would now like to turn the conference over to Allison Soss with Investor Relations. Please go ahead, Allison.

Thank you. I would like to welcome everyone to the AudioCodes’ fourth quarter 2018 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 we begin, 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 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 the 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 development, 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 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 the 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 this call. The call will also be archived on our Investor Relations app, which is available for free in the iTunes App Store and in 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 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 quarter and the full year and then discuss trends and developments in our business in the industry. Finally, we will present our outlook for 2019. 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 fourth quarter were $45.8 million, up 2.8% from the prior quarter and up 10.5% compared to the fourth quarter in 2017. Full year 2018 revenues increased by 12.4% to $176.2 million. Services revenues for the fourth quarter were $15.1 million, accounting for 33% of total revenues. On an annual basis, services revenues increased by 14.4% from the previous year. Deferred revenues balance as of December 31, 2018 was $49.2 million compared to $39.4 million as of December 31, 2017. Revenues by geographical region for the quarter were split as follows: North America, 46%; Central and Latin America, 5%; EMEA, 33% and Asia-Pacific, 16%. Our top 15 customers in aggregate represented 70% of revenues in the quarter, of which 55% are attributed to our 9 largest distributors. Gross margin for the quarter was 62.6% compared to 63.1% in Q4 2017. Non-GAAP gross margin for the quarter was 63% compared to 63.6% in Q4 2017. Operating income for the quarter was $5.1 million compared to an operating income of $3.2 million in Q4 2017. Full year 2018 operating income was $16.4 million. On a non-GAAP basis, quarterly operating income was $6.3 million or 13.7% of revenues compared to an operating income of $4 million in Q4 2017. Full year 2018 non-GAAP operating income was $20.6 million. Net income for the quarter was $4.5 million or $0.15 per share. Full year 2018 net income was $13.5 million or $0.45 per share. On a non-GAAP basis, quarterly net income was $6.3 million or $0.20 per share compared to net income of $3.8 million or $0.12 per share in Q4 2017. Full year 2018 non-GAAP net income was $20 million or $0.65 per share compared to $12.2 million or $0.37 per share in 2017. Our balance sheet remains strong. At the end of December 2018, cash, cash equivalents, bank deposits and marketable securities totaled $65.4 million. Days sales outstanding as of December 31, 2018 were 40 days. Operating cash flow generated during the quarter was $11.6 million and $25.6 million for the full year 2018. During the quarter, we acquired 250,000 of our ordinary shares for a total consideration of $2.8 million. As of December 31, 2018 and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 17.6 million shares for an aggregate consideration of approximately $34.1 million. In January 2019, we received court approval in Israel to purchase up to an aggregate of $12 million of additional ordinary shares pursuant to our share repurchase program. The current court approval for share repurchases will expire on July 1, 2019. The Board of Directors today declared a semiannual cash dividend in the amount of $0.11 per share and in aggregate amount of approximately $3.2 million. We expect to continue declaring semiannual dividends in coming years. We continue to expect top line revenue growth and operating margin expansion in 2019. We expect revenues in the range of $190 million to $197 million and non-GAAP diluted earnings per share of $0.76 to $0.81. I will now turn the call back over to Shabtai.

Thank you, Niran. We are pleased to report record financial results for the fourth quarter and full year 2018. 2018 has been the third consecutive year of growth for AudioCodes, and in many respects, our best year ever. Touching on some of the highlights of the performance in the fourth quarter on a year-by-year basis, revenues grew 10.5%. EBITDA grew to $6.8 million compared with $4.4 million in fourth quarter 2017. That’s an increase of close to 54%. Net income grew close to 65% on a year-by-year basis. Clearly, this is strong performance on the quarterly year-by-year. Now to the annual perspective, while growth in annual revenue in previous two years was 4.2% and 7.7% year-over-year, growth in 2018 was a record 12.4%. Same goes for the annual operating income, which grew from 7.2% in 2016 to 8.2% in 2017, leaping to 11.7% in 2018. EBITDA grew to $22.2 million in 2018 compared to I’m sorry, compared to $14.5 million in 2017, again an increase of 53%. Earning wise, we reported $9.4 million in 2016, $12.2 million in 2017, and a record $20 million for 2018, a leap of more than 100% in 2 years. Swapping earnings per share, we reported $0.26, 2016; $0.37 in 2017; and now $0.65 for 2018 again a fantastic year of growth and performance. Entering 2019 and based on the input so far, we do not anticipate any change in the business trends going forward. At this stage, we continue to see strong underlying trends that should keep the momentum in our business in years to come. The strength of our business is related to two fundamental key trends, which support our continued business momentum. The steady evolution in growth in the underlying markets we serve, first, is the global digital transformation trend to move in the enterprise towards the digital workplace; and the second one is the global transition of networks to all-IP. Key to our success in 2018 is the consistent progress in our networking business, which grew 13.8% year-over-year to $162.8 million, and which accounts to about 92% of our business in 2018. The major factor backing this growth is the strength in the UC-SIP business, which grew above 30% in 2018, to a level of above $90 million per year. At the same time, we enjoyed a solid and stable gateway business, which declined earnings slightly, and as stated, it’s around $60 million per year. This is substantially due to the ongoing evolution in global migration of the PSTN to all-IP. In our UC-SIP business, we saw nice progress among all of these components including ESBC, our business routers line, the IP phone line, our One Voice Operations Center, management suite, and products related to our Microsoft Skype for Business and teams. Global Services also demonstrated very solid growth and strength. I will touch that point later on. The main driver behind the strong growth in our UC-SIP business were the continued growth in the enterprise voice, connectivity in the enterprise voice area and infrastructure for Unified Communication, Unified Communications as a service and the Contact Center markets. As mentioned on our previous calls, key to that solid performance in these segments for several years now is the fact that we became the partner of choice for our customer premises equipment in many of the leading all-IP and UC application in the enterprise and service provider space. We are confident that this leading position in our CPE business will prevail in coming years. Providing a quick outlook into first quarter 2019, I’m glad to know that at this stage the trend in our business continues in January, the first month of this quarter. Now to some to very key developments in 2018, the evolution or ability to generate operating cash flow from activities and deferred revenues. In the past three years, in 2015, ‘16 and ‘17, we generated more than about $17 million to $18 million a year. 2018 has been outstanding in that respect. We have been able to generate $25.6 million in 2018. Same goes to our deferred revenues, which continue to grow at a very steady pace. We started out in 2013 with merely $16.4 million. 2017, we saw $39.4 million; and at the end of 2018, we saw $49.2. That’s an increase of 25%. So, strength in operating cash flow and strength in deferred revenues tell you the story for AudioCodes for the future to come, we will keep growing. Touching some other financial KPIs, OpEx was increased pretty much according to plan, and headcount was relatively stable, we are around 705 employees. Touching on our sales front, on a quarterly level, fourth quarter was very successful. We basically achieved above our stated plan. Generally, sales performed very well to and above the target. Remarkably performed very well were North America enterprise, North America service providers and several countries in Western Europe. If we touch the annual level on sales, in 2018, again sales performed very well to and above the target. That was a record year for AudioCodes since inception. Again, the best performing regions on an annual level were North America service providers and several countries in Europe. Touching on one key business, the Microsoft space, last year in 2018, business reached above $70 million that is a leap of more than 30% from the year ago, which ended at about $55 million. Fourth quarter showed similar such growth trends. We saw growth of 30%. All in all, we have seen in the markets of space, a migration focused from Skype for Business to Teams. Teams is getting warm reception in the market and in 2018, we generally been quite busy adapting our One Voice solution products to Teams from our current Skype for Business portfolio. We started in mid-2018 with migrating that growth as we see, and we plan to complete the transition by mid-2019 with other components of the One Voice solution. As for why would that positive above trends in these markets, well, in December 2018, Spiceworks released the results of a survey examining the adoption of collaborating chat applications in businesses across North America and Europe. Skype for Business continues to hold the number one spot with 44% of businesses. Focus is that by the end of 2020, Skype for Business will be used by 53% of the users. Teams just starting out two years ago, today we see about 21% of businesses using Microsoft Teams up from just 3% in 2016. Looking forward at the end of 2020, it is forecast that Teams will grow from 21% to 41% of users to use Microsoft Teams. That tells you the potential we have in our business going forward. I’ll just mention one more data point there, if you look on a worldwide basis, well, penetration of Unified Communication and Unified Communication as a Service was about 20% in North America, and only about 4% on a global basis. There is much to be achieved in coming years. We see accelerated adoption in North America growing beyond 4% a year and same goes for the global expansion. About Microsoft Teams, we see early signs that Microsoft will balance the use of Teams and Skype for Business in a coexistent mode. This presents good opportunity for us in 2019 to keep selling in the Skype for Business Server space and in the hybrid topologies. We have many more plans to invest heavily in 2019 in the Microsoft ecosystem in various areas to capture the potential that I’ve just stated about a minute ago. Going into the Session Border Controllers, that is a key component of our UC-SIP. Session Border Controllers grew north of 25% year-over-year, same goes for the fourth quarter of 2018, very healthy business line. On a geo split, we have seen almost equal deployment percentages. We have seen about 30%, close to 35% in North America. In West Europe, we’ve seen between 30% and 35%. Asia Pacific was about 15%, and some of the parts of the world capturing smaller percentages. In terms of what was the key activity in 2018, so we have been able to increase our service provider market share. We have deployed managed Enterprise Session Border Controllers and carrier SBC. We have penetrated into the hosted Contact Center space. We have started to work with several key leading vendors in that space. We cannot name partners. We have deployed in those hosted Contact Center space, technologies such as Virtual SBC, WebRTC, et cetera. We also have deployed SBC in public clouds. We’ve been the first to deploy decomposed Session Border Controllers on AWS on Amazon, and then we’ve been the first to be certified on Microsoft Azure, direct route SBC. So plenty of growth in 2018. Going to the key themes that will dictate our priorities in 2019 in the SBC space, we will invest heavily in cloud SBC, in WebRTC that will streamline voice connections over the internet in good quality of service and then we’ll keep investing in the Microsoft Teams. We will invest also into the service provider business, both access and interconnect, security application, transcoding application, et cetera. Side by side with our success in Microsoft and the SBC, we’ve been able to be quite successful in the service provider part of the business. We saw continued growth of SIP Trunking, UC as a Service, and deployment of CPE devices and continuation of the transition to an all-IP world. All-in-all, revenues in the service provider segment grew about 40%, and we do see increased and continued growth in 2019. We’ve been able to win some very promising significant design wins in the fourth quarter of 2018. Among them, two Tier 1 service providers in Europe and one Tier 1 service provider in North America. All-in-all, we are very successful mainly in the EMEA, mainly in Germany and few more countries. Getting to our annual service booking, services are very strong leg in our evolution. Basically, services this year capturing about one-third of the company revenues, in 2018, global services grew 14.4% to $56.3 million. Services bookings grew 18.6% with professional services bookings growing to 20%. So a very nice increase in 2018, about 18.6%, and professional services contributing much of that growth. Now back to our guidance that Niran provided earlier. We feel very confident in our ability to continue and perform in 2019. All-in-all, the business strength and our execution allows us to be fairly confident in our – providing guidance for the new year. As Niran mentioned, the mid-range for revenue growth would be around 10%. So our guidance is from $190 [ph] million to $197 million. In terms of earnings, we guide – we would plan for at least – a growth of at least 20% in our earnings in 2019, again coming out of the $0.65 in 2018, we now guide for the range of $0.76 to $0.81 in 2019. And with that, I have completed my introduction. Operator, we’re good to go on the Q&A session.

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

Thank you. Congratulations, Shabtai, on the nice results and outlook. You mentioned service provider several times in your comments. It sounds like service provider was an area of strength in ‘18 and as you move into ‘19. And I just wanted to clarify, it sounded like you mentioned three specific Tier 1 service provider wins, and I was just trying to understand if those were during ‘18 or if those were ones you had already won during ‘19? And what do you attribute your sort of increasing strength with service providers too if you could speak on it? Thank you.

Sure. Thanks, Rich. All-in-all, yes. Service provider segment was very strong in 2018, grew more than 40%. Basically, it’s a segment where our ability to penetrate new service providers is basically kind of limited to no more than between five to 10 new service provider a year, however, each of these service provider being a large one will contribute many millions over several years. Now in 2018, we have been able to add more wins. I’ve mentioned three of them, two in Europe; two Tier 1 service provider in two different countries in Europe and then we’ve mentioned one service provider in the U.S., all our new wins not wins that we have done before.

Got it. And can you give any more color on sort of what is driving that stronger service provider business? Is it something in your portfolio that’s different this year or something that’s changing in their requirements?

Yes. Well, it’s a process. It’s a process that we invested for the past 5 years, 7 years in building as much as complete portfolio of products for the service provider space, mainly customer premises equipment, CPE products. We keep improving our performance on our routing capability, on adding more features, on supporting the new technologies in the Wide Area Network’s access. So it’s really more the very mature, very advanced portfolio. We do not see much competition there. Obviously, Cisco is in the space, few more little companies there, but our investment shows us that we are making progress in that space and we should be well based in that segment for the next 5 years, 7 years, very hard to see anybody else that will penetrate that space shortly.

Got it. And then on the UC-SIP business, another very strong year, it sounds like 30% plus growth there and that was better than kind of the 20% plus I think you’ve been looking for heading into the year. Can you give us a sense of how you see that business, how you see the growth rate of that business going forward? Is it sustainable in kind of that 20% or better range? And any color on the Teams versus Skype for Business Dynamic? I know it sounds like you’re thinking they’re going to be in a co-existence mode. I guess a quarter ago you thought that Teams still had a couple of quarters before it was really kind of up to speed, but maybe that has changed. So just any color on the Teams versus Skype for Business dynamic would also be appreciated? Thank you.

Right. So, yes, we generally guide for UC-SIP to grow between 15% and 20% a year. Indeed, 2018 was a surprise. We saw much better growth. At this stage, it’s difficult to assume that we would be able to repeat that 30% growth rate in 2019, but we definitely believe we will do at least 20%. Basically all of the components in that business line, if you take session border controllers which grew 25%, the phone business which grew nicely above 40%, the MSBR business which grew close to 50%, the management – the voice management suite product goes into Microsoft space. So, we have reason to believe that we will see 20% and north of that in 2019. As to Teams, yes, we said and we do see that in the field, we believe that Teams will be much more mature for voice deployments starting in mid-2019. Everybody is investing at this stage, ourselves and our competitors. We definitely do see – whereas the growth, interestingly enough, while the emphasis moved from Skype for Business into Teams earlier in the year, we still saw very strong year in Microsoft space from Skype for Business, which means that large companies, which invested already in that space will keep investing. Obviously, majority of our investment these days goes now into Teams and we should be able to play as you have mentioned the co-existence play between premises deployment and Teams deployment.

Okay, very good. Thanks for that. I will get back in the queue. Thank you.

Sure. Thank you.

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

Okay. Thank you, operator. I would like to thank everyone who attended our conference call today. With continued good business momentum and execution in 2018, we believe we are on track to achieve in 2019 another year of growth and expansion for our business. Continuing to invest in our markets, we believe we will be paving the road for further growth in future years. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day. Bye-bye.

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