AudioCodes Ltd. (AUDC) Q2 2019 Earnings Report, Transcript and Summary

Greetings and welcome to the AudioCodes Second Quarter 2019 Earnings 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, Mr. Rob Fink, Investor Relations for AudioCodes. Thank you. You may begin.

Thank you. I would like to welcome everyone to the AudioCodes second quarter 2019 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 introduction, 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 the global economic conditions, and conditions in general, and in AudioCodes as 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, upgrades 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 of acquired companies into AudioCodes’ business; and other factors detailed in AudioCodes’ filings with the SEC, U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information. In addition, during the call AudioCodes will refer to non-GAAP net income and net income per share. AudioCodes has provided a full 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 that is posted 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. With all that said, I would like to turn the call over to Shabtai. Shabtai, please go ahead.

Thank you, Rob. Good morning and good afternoon, everybody. I would like to welcome all to our second quarter 2019 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 then, we will discuss trends and developments in our business in the industry. We will then turn it into the Q&A session. Niran?

Thank you, Shabtai, and hello, everyone. As usual, on today’s call, we will be referring to both GAAP and non-GAAP financial results. The non-GAAP P&L metrics exclude recurring non-cash items. The earnings press release that we issued earlier this morning contains a reconciliation of supplemental non-GAAP financial information that I will be presenting today. Revenues for the second quarter were $49.5 million, an increase of 6.3% from the prior quarter and a 13.8% increase when compared to the second quarter last year. Service revenues for the second quarter were $16.7 million, accounting for 33.6% of total revenues. Deferred revenues balance as of June 30, 2019 was $55.8 million compared to $52 million as of March 31, 2019. Revenues by geographical region for the quarter were split as follows: North America 41%, Central and Latin America 5%, EMEA 14% and Asia-Pacific 14%. Our top 15 customers in aggregate represented 63% of revenues in the quarter, of which 55% are attributed to our 10 largest distributors. Gross margin for the quarter was 63.3% compared to 62.3% in Q2 2018. Non-GAAP gross margin for the quarter was 63.5% compared to 62.8% in Q2 2018. Operating income for the quarter was $5.9 million compared to an operating income of $3.3 million in Q2 2018. On a non-GAAP basis, quarterly operating income was $7 million or 14.1% of revenues, compared to an operating income of $4.4 million in Q2 2018. Net income for the quarter was $4.8 million or $0.16 per share compared to net income of $2.4 million or $0.08 per share in Q2 2018. On a non-GAAP basis, quarterly net income was $6.8 million or $0.22 per share, compared to net income of $4.1 million or $0.14 per share in Q2 2018. Our balance sheet remains strong at the end of June 2019. Cash, cash equivalents, bank deposits, and marketable securities totaled $69.1 million. Days sales outstanding as of June 30, 2019 were 46 days. Operating cash flow generated during the quarter was $8.4 million. During the quarter, we acquired approximately 473,000 of our ordinary shares for a total consideration of approximately $7.1 million. As of June 30, 2019, and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 18.1 million shares, for an aggregate consideration of approximately $102 million. In May 2019, our Board of Directors approved the submission of a new application to the Israeli Court, requesting approval of an additional repurchase program for $12 million of ordinary shares following the expiration of the existing program. The application also requests the court to permit us to declare a dividend of any part of this amount. The new application has been submitted and a decision is expected during August 2019. Now, to provide an update on our guidance, we now expect revenues for 2019 to be in the range of $194 million to $198 million compared to the previous range of $191 million to $197 million that we updated following the close of the first quarter 2019. We anticipate non-GAAP diluted earnings per share to be in the range of $0.82 to $0.86 compared to our previously revised range of $0.77 to $0.82. I will now turn the call back over to Shabtai.

Thank you, Niran. We’re pleased to report record financial results for the second quarter of 2019. All in all, this was one of our best quarters ever and quite successful on many fronts. Key highlights I would like to mention are the following. First, we are sitting in a very strong market, a market that develop fast, and we, AudioCodes, have got a great market position in it. We will discuss mark-to-market trends and data that were key factors in our success during the past three to four years, and which provide strong support for continued success in the next five to seven years. I’d like to mention that the quarter is very successful in creating new partnerships, we’ll talk about that. Our second quarter 2019 financial performance was great, we’ll discuss that. We will review some of the key activity area for us such as Microsoft Teams, cloud-related activities, service providers to All-IP migration performance, our services and more. I’ll just add that entering the second half of 2019, we plan to introduce new area of investment that we believe will be very significant in the future. I’m talking mainly about the meeting space, where we believe that we can take advantage of our assets that we have today, and adding more capabilities, product and services, we believe that we will be successful in a completely new area for us. Now let’s talk a bit about the markets. Actually, if one looks into market forecasts of size of the market, the UCaaS, UC as a Service market, it’s a fast growing market these days. Just to highlight some data points from Frost & Sullivan and Stephens, in 2018, the market size was about $14 billion, and we add about 13 million to 14 million users. Now if we go forward to 2022, which is just three years ahead, the market will almost double to $27 billion. And the number of users will be somewhere around 26 million, 27 million. So, we’re talking about a very fast developing market both in terms of revenues. It’s no question that, that market attracts a lot of companies, a lot of vendors. And we have seen in the first half of 2019 during the first quarter and second quarter, we see that the competition in the UC as a Service market and Contact Center as a Service market is heating up. There’s growing emphasis on collaboration and video first and meeting first versus communications in the past. We just saw in the second quarter successful IPO of the company Zoom, and also, we’ve seen Slack going public. So, a lot of activity of companies trying to get into the market, I’ve mentioned the names, we worked with and which are competing for market share: Microsoft, RingCentral, Zoom, Cisco, Google, Amazon, Slack and more. At the same time, that is the enterprise market if we look into the service provider market, we’ve seen that the migration process to All-IP ramps up. As in the previous quarter, we’ve seen that activity mainly in North America and some countries in Europe. For us, mainly it’s Germany, Italy and the Netherlands. We’ve seen continued trends of voice.ai, which disrupts the contact center markets. We’ve been very active on that. We’ve added capabilities. We’ve added technologies. We won many new projects. And we believe we are making the right steps, and the right investment to be successful also on the voice.ai market. So very strong action, I’ll just mentioned one data point, one more data point, that last week, Microsoft in their Inspire conference announced that now teams as about 13 million daily active users as of the end of June 2019 and compared that to only 3 million in August 2018. So very steep rise, very strong demand for Teams in the market. Now let’s talk a bit about the new partnerships that we have created. We became engaged substantially with two more new partners. In fact, understanding that while the world of UC as a Service is developing fast and most of the players and software vendors will lack connectivity products and which also lack the deployment and integration services offering in their portfolio, it is only natural that they will turn to a player like us. So, they need to create partnership with a voice infrastructure partner that just like us. Make us – that fact makes us unique and natural partner for such collaboration with many partners. During the second quarter, we’ve engaged with two new such partners in discussion of our products, unique features, capabilities, roadmaps, collaboration and go-to-market. This is an ongoing trend for us and we will continue in the next foreseeable future as many of these UC as a Service players, do need to ensure connectivity and integration players as the market evolves with new requirements and need to support deployments worldwide. Touching on the highlights of our financial performance. In revenue, we grew 13.8% compared to the year-ago quarter. That’s pretty much above our initial guidance for the year, which stood at 10%. EBITDA grew to $7.4 million in the quarter compared to $4.8 million in the previous year, an increase of 54%; same for our net income, which grew 66% on a year-by-year basis. Most important, we continue to improve our operational efficiency compared to the year-ago quarter. Operating margin improved from 10.2% in the second quarter last year to 14.1% in the second quarter of this year. This is a direct result of growing revenue on a consistent basis, while keeping expenses at a controllable level. Based on the initial backlog for the third quarter of 2019 and the business activity we’ve witnessed so far in July, we anticipate the continued trend of improved financial performance for the third quarter and the whole year. As seen in 2018 and first half of 2019, we continue to see strong underlying trends in both the All-IP migration market and UCaaS adoption mainly in the Microsoft Teams space that should keep the momentum going on in our business in coming quarters. As such, we have strong confidence that 2019 is to become another strong year of growth over the tiers of previous three years and that’s hence the updated guidance. Talking a bit about the business side networking, so key to our success in the quarter was our consistent progress in our networking business which grew 16.6% year-over-year to $47 million. The networking business now accounts for 95% of our business in the quarter. As presented in the past, the major factors’ supporting this growth is the strength of the UC-SIP business, which grew about 20%. In our UC-SIP business, we’ve continued to see that as far as mainly the session border controller market, MSBR and our management suite. We also saw nice products in the second quarter in the Microsoft Teams space. We’ll talk about that later on. At the same time, we have enjoyed the very strong demand for our gateway business, which grew more than 10% compared to the year-ago quarter. Again, this is substantially due to the continuous evolution of the global migration of the PSTN to All-IP. So, as we mentioned on previous calls, for practical purposes, we are the partner of choice for CPE products in many of the leading All-IP UC and UC as a Service application in the enterprise and service provider space. We are confident that we should be able to maintain this leading position in our CPE business in coming years. As mentioned again, connectivity. Connectivity is key in our DNA. As I’ve mentioned in the investor call previously in the first quarter of this year, connectivity solution which embed a combination of group of business line including gateways, session border controllers and the multiservice business routers enjoyed strong momentum in the past 12 months. Just mentioned some data points, in 2016, 2017 and 2018, connectivity revenues were respectively $104 million, $116 million and $131 million. In the second quarter of 2019, connectivity revenue reached $38.6 million, a gain of about 25% year-over-year. For the complete year of 2019, we now estimate the 2019 connectivity revenue will top $155 million providing growth of more than 17% on annual basis. Sales were very good in the quarter, we actually hit on almost all the targets worldwide, remarkably well performed certain regions including North America, which was also noteworthy for a large booking that was not still shift in the quarter. We’ve seen very nice performance in Germany, in the DACH region, in the Benelux, Netherlands and Belgium, Italy and few more countries, so all in all great quarter from the sales point of view. We are biggest project concentrating three key areas. One is still Microsoft Skype for Business markets, where we have deployed both in the U.S., Benelux, Latin America and Germany with large enterprises. We also enjoyed nice opportunities of contact center deals a few hundreds of thousands each in the U.S., in Europe and in India. And then business services, we enjoyed a very large number of projects mainly in Europe, in Mexico and South Africa, so all in all, a very successful quarter in terms of sales. Touching on our Microsoft performance in the second quarter, definitely better performance than the first quarter for the year, we’ve seen slow start simply because Skype for Business is still not growing, and we estimate that it will not grow far beyond where it is today, but we’ve seen nice move on the team side. So, all in all, we grew about 20% over the previous year – quarter. And I should say that the market was heating up. As I mentioned before on the UC as a Service market collaboration, and we’ve just mentioned name like Zoom and Google and Amazon and Slack will present strong competition in the conferencing meeting space. And therefore, we see a lot of intensive activity of Microsoft in the market with Teams. As I mentioned before, second quarter in this year was better than the first one. We’ve seen 25% increase. We believe that customers are still evaluating Teams as a full UCaaS solution and Microsoft roadmap for additional features is still pending. So, we believe that we will see substantially faster ramp up or a success entering into 2020, but so far so good on that front. We’ve seen – and we are communicating with the partners, so we get some data about voice minutes that were growing for Teams. So, we know that at this stage, there are a few thousands of tenants that already carry voice traffic to the – from the PSTN towards Teams. So, all in all, we’ve seen a very nice growth in the traffic, I’ll mention numbers later. Also, our session border controller is now officially approved on Azure, and even more than that, it’s approved as Microsoft IP [co-sale] [ph] on Azure. And that means that Microsoft sales teams will get compensated for the session border controller consumption on Azure, and that will be a big driver, we believe to push our sales of SBC on Azure more than before. Also, we enjoy very nice success with our phones that were developed specifically for Teams. We do have a star product, the C450HD phone, which is acknowledged by many customers to be very useful and we have seen very strong interest and the shipping of that product. In terms also I’ve mentioned that we’re growing teams 25% quarter-over-quarter. Most of – in terms of market share. So, most of the sales went into North America about 45%, we have seen another 25% or more, actually 30% in Western Europe. And then the rest – the nice thing about it, by the way that Teams sells all over the world. And I would tend to saying that, that is right now one solution that is sold substantially better worldwide than other competing products and that’s a great advantage. We’d also say that majority of sales in that area of Teams are primarily phones and SBCs, so we do not expect major diversion in terms of our product sales from – the move from Skype for Business to Teams. I’ve just mentioned that in terms of number of users enabled on Teams, we have seen more than doubling at the end of the second quarter from the end of the first quarter. And also, we have seen very strong rise in number of businesses that were enabled more than 50% in number of businesses that were enabled at the end of the second quarter compared to the first quarter. Now I’ll touch a bit on our activities migrating into the cloud. As we all know, a major trend in the industry is the major shift of enterprises and service providers worldwide to cloud services and operations. In the past 24 months and more so going forward, we are investing major efforts to deploy our One Voice portfolio to align with these enterprise and service providers and SaaS customers. Our Mediant Cloud Edition, SBC uniquely supports critical scalability, dynamic elasticity and a – the reliability in private and public cloud, which give us a perfect solution for small to large cloud installation and presents advantage over competition. Since the introduction of the Mediant SBC and One Voice operation center in Azure marketplace on April, we have seen consistent and significant increase in trials and daily downloads by enterprises worldwide. Moving to AWS, we recently announced the [interop performed in] [ph] SBC with Amazon Chime Voice Connector. This enables IP-PBX contact center solution and UC system including Microsoft Teams’ customers to connect to Amazon’s SIP trunking services. The SBC is available for a deployment on prem or in AWS, and will soon be listed in AWS marketplace. We now plan to have the complete One Voice solution available on Azure, AWS and Google Cloud platform with same code base and feature parity. We’re now working intensively to make this start, as we have customers awaiting proof of concepts and deployments. We believe that the availability for ever-expanding One Voice portfolio in leading public cloud positions us as ideal partner to enterprise UC as a Service and Contact Center as a Service. Touching a bit on our very strong success in the service provider market in the quarter, this was a record quarter ever. We grew 100% over the year ago quarter, we grew 40% over the previous quarter, so all in all great performance. I just mentioned that we have announced previously the Deutsche Telekom is a strong partner for ours. So, we’ve seen a large wrap-up from Deutsche Telekom in the quarter, another strong European service provider was also a customer. We note two new design wins in Europe, one in Germany, one in Scandinavia. And also, we have continued to invest in our SD-WAN solution just to be able to support better connectivity and SLA in the network. I’ll touch also services, which to some of our investors seen in the first quarter of this year performance, an increase of only 3.4% year-over-year. It’s a problem. So, we’d like to say that in the second quarter, we have substantially recovered from that there. Services grew 23.5%. So, all in all, if you combine the two, and we all know there are some shifts of project and some recognition rules and services that make this course and the growth not flat, but could be a bit active. So, all in all, but if you combine first quarter and second quarter and we look at the first-half performance, then we have seen a very steady performance of 13.4% growth in our services. And with that, I believe I have completed my introduction and I’d like to move the call to the Q&A session. Operator?

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

Thank you. Shabtai, I’d like to follow up on the Microsoft commentary you provided. So, it sounds like Skype for Business isn’t really growing but Teams is. But you suggested that the Teams’ sort of voice offering isn’t really mature yet and you see some features coming on that. So, can you just talk about what maybe you think is still needed in Teams to make that really take off and sort of how you view the trajectory of that Teams business for the balance of the year?

Yeah, so I’m – again, Teams presents a big, big promise. And – but we’re talking here about very large enterprises. And these enterprises usually do make their homeworks. And before they make sure that a complete set of features that they have been used to in Skype for Business is still not implemented in Teams, they will not make the move. But we do know and we work already with few enterprises, which already took the leap and basically are doing that. So, we’re simply waiting on Microsoft’s committed roadmap to complete and deliver those missing feature in the second half. But we’d like to see that – and some of these customers still are trialing, starting to deploy and then all in all report good, good performance and quality. So, we do expect the same feature to continue into the second quarter, meaning Skype for Business – and by the way, there are enterprises which, say, we do not want to move all of our operations into the cloud. We’ll stay with Skype for Business or we’ll have some mixed operations. So, we still expect Skype for Business to be a good market for us, and but still not ramping, growing fast. On the other hand, Teams is growing very nicely. And we believe that as the missing feature will be completed, second half, we will be fully ready for a strong ramp-up beginning of 2020.

Got it. And then in your prepared remarks you also made reference to the fact that, I think, you expect product sales to be roughly similar into Teams’ environments relative to Skype for Business environments. Is that correct? Can you just provide a little color on how you think product sales will be into those respective Microsoft environments?

Right, so on Skype for Business the key product that we are selling are on one hand connectivity, which is gateways and SBCs. We’re selling phones. And, obviously, we’re selling some management software and solutions. On the cloud area, you still need connectivity. You still need to reach headquarters and branch offices from the cloud. So, as we see, we’ll continue to be sold and actually will replace, in many cases, the role of gateways instead of connecting to the PSDN, to the central offices, you will be connecting to clouds. And phones will keep being used, although we all know that along the years, we’ll some reduction in the percentage of phones being sold versus headsets. We have mentioned earlier in the call; we do see lot of interest in the meeting space. So are expecting more devices to be sold in that area, meaning conference phones, different sizes of conferencing devices such as for other rooms or medium rooms, large rooms. There will be a lot of equipment. So, all in all, I do not think that transition from Skype for Business to Teams will change dramatically or in any way the percentage of products, other products sold versus Teams versus Skype for Business.

Great. That’s helpful. And then, when you’re talking about the UC landscape, you mentioned, a lot of major companies, some that have UC offerings that you were working with. Of those, I knew Microsoft and I know Cisco. But you mentioned a number of others that I hadn’t really heard before as customers. Can you repeat that list and kind of talk about your relationship with some of those companies that haven’t been sort of regular mentions in recent conference calls?

So obviously, we’re tied by nondisclosure agreements, so can we talk really as you have mentioned about Microsoft and Cisco. We also announced a few months ago, partnership with Amazon, selling our SBC in conjunction with their SIP trunk services. There are few more names that we sell, UCaaS players. And I think, I’ve mentioned before that, take analog gateways, which is a very common product that needs to be sold to support offices. And many of the players lack them. So, we have seen business in the past with companies such as 8x8 and Vonage and RingCentral and few more. And there are few more names, but I’m not allowed to talk about. So, all in all, everybody needs infrastructure. And there are only a few companies who can accomplish that, so not competing with them, becoming a very natural partner to all of these companies.

Got it, take it that the two new partners you signed this quarter fall into that nondisclosure agreement?

Yes, yes.

Fair enough. And then, just looking at the updated guidance for the year, to get to the midpoint of your EPS guidance, basically you kind of flat-line at $0.22 per quarter for the next sort of two quarters, that would kind of get you to the midpoint. And, I mean, historically you’ve tended to always have some improvement in the back-half EPS-wise or are we just being kind of conservative? Was maybe Q2 a bit of an unusual degree of upside from some lumpiness or how should we think about that back-half EPS?

Okay. All in all, I’ll tell you that, A, we intend in view of an increased potential activity with partners going forward for the next 18 months, we will definitely add resources on – I mentioned that it’s going to be controlled and – but we still need to add resources to support new activities. Also, there are some moving parts in our OpEx. It has to do with locations. It has to do with onetime – we had a company event in the second quarter. We’ll have some change in the U.S. dollar exchange rate versus shekel, Israeli shekel. So lately, the Israeli shekel become very strong, that will affect our finances for the third and fourth quarter. We are hedged about 50%. All in all, there are some moving parts. We would like to act conservatively. We believe we will grow. But all in all, I think we are in good shape, to try and beat that flat number that you mentioned.

Okay. That’s all for me. Thanks very much.

Sure. Thank you, Rich.

Thank you. Our next question comes from the line of David Kreinberg with Globis Capital. Please proceed with your question.

Hi, Shabtai. Congratulations on a great quarter. I just missed one thing. What was the gross deferred revenue number again at the end of the quarter?

Again, can you repeat, David, gross…?

What was the gross deferred revenue number?

Oh, deferred revenues, I think it was – it grew from about 55 to – from 56 to – okay, again, I’m being corrected. Deferred revenue grew from $52 million to $56 million.

$52 million was the Q1.

Yes.

So sequentially, you grew from $52 million to $56 million. But I believe that number at the end of 2018 was $42.6 million. So, if that’s right, you grew 30% year-over-year on the deferred revenues, is that correct?

Yes, that is correct, yeah.

Okay, great, tremendous. Thank you.

Sure.

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I’ll now turn the floor back to Mr. Adlersberg for any final comments.

Thank you, operator. I would like to thank everyone who attended our conference call today. We’ve continued good business momentum and execution in the first half of 2019. We believe we are on track to achieve another year of growth for our business and top the initial guidance provided at the beginning of the year. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.

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