AudioCodes Ltd. (AUDC) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Greetings and welcome to the AudioCodes Third Quarter 2019 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. It’s now my pleasure to introduce your host, Brett Maas with Hayden IR. Please go ahead, Brett.

Thank you, operator. I’d like to thank and welcome everyone to the AudioCodes third 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 beginning, I’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 development; upgrades and the ability to manage changes in the 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 and acquired companies into AudioCodes’ business; and other factors detailed in AudioCodes’ filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update that 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 the non-GAAP net income and net income per share to its net income and net income per share according to GAAP in its press release and on its website. Before I turn the call over to management, I would like to remind everyone that this call is being recorded and an archived webcast will be made available on the Investor Relations section of the company’s website at the conclusion of the call. With that said, I would like to now turn the call over to Shabtai. Shabtai, please go ahead.

Thank you, Brett. Good morning and good afternoon everybody. I would like to welcome all to our third quarter 2019 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President for Finance of AudioCodes. Niran will start off by presenting a financial overview of the quarter. I’ll then review the business highlights and summary for the quarter, and then discuss trends and developments in our business and industry. We will then turn it into the Q&A session. Niran?

Thank you, Shabtai, and hello everyone. As usual, on today’s call, we will be referring to both GAAP and non-GAAP financial results. The earnings press release that we issued earlier this morning contains a reconciliation of the supplemental non-GAAP financial information that I will be presenting today. Revenues for the third quarter were $51.4 million, an increase of 3.9% from the prior quarter and a 15.5% increase when compared to the third quarter last year. Service revenues for the third quarter were $16.3 million, accounting for $31.8 million of total revenues. Deferred revenues balance as of September 30, 2019 was $54.4 million compared to $44.2 million as of September 30, 2018. Revenues by geographical region for the quarter were split as follows; North America 42%, Central and Latin America 5%, AMEA 39% and Asia-Pacific 14%. 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 62.9% compared to 62.2% in Q3 2018. Non-GAAP gross margin for the quarter was 63.2% compared to 62.7% in Q3 2018. Operating income for the quarter was $6 million compared to an operating income of $5 million in Q3 2018. On a non-GAAP basis, quarterly operating income was $7.4 million or 14.5% of revenues compared to an operating income of $6 million in Q3 2018. [Audio Dip] was $4.4 million or $0.14 per share compared to net income of $4.1 million or $0.14 per share in Q3 2018. On a non-GAAP basis, quarterly net income was $7.4 million or $0.24 per share compared to net income of $5.8 million or $0.19 per share in Q3 2018. Our balance sheet remains strong at the end of September 2019. Cash, cash equivalents, bank deposits and marketable securities totaled $69.5 million. Day sales outstanding as of September 30, 2018 were 43 days. Operating cash flow generated during the quarter was $4 million. On August 6, 2019 we declared a semi-annual cash dividend of $0.12 per share. The dividend in aggregate amount of $3.5 million was paid on September 3, 2019. Now to provide an update on our guidance, we now expect revenues for 2019 to be in the range of $198 million to $201 million compared to the previous range of $194 million to $198 million that we updated following the close of the second quarter 2019. We anticipate non-GAAP diluted earnings per share to be in the range of $0.86 to $0.89 compared to our previously revised range of $0.82 to $0.86. I will now turn the call back over to Shabtai.

Thank you, Niran. We’re very pleased to report record financial results for the third quarter 2019. Following on the heels of success of previous quarters, third quarter 2019 performance represents our best quarter ever both on the business side and the financial fronts. Top line advanced 15.5% over the year ago quarter. Net profits rose 27.6% year-over-year. In fact, targeting about $200 million for 2019, this year represents the second year in a row, where top line growth will be above 12% annually and earnings keep growing on an annual basis of 30%. In summary of the third quarter performance, I would point out the following; the unified communication and collaboration market continues its multi-year expansion, a trend expected for the next – at least next three to five years. And so we are operating in a fast-growing market. We have created for ourselves a strong market position as a dominant voice infra and connectivity player. As such, we are a natural choice for partnership with the leading UC&C market leaders. Investment and activities we perform in alignment and collaboration with market leaders have played – has played key factor in our success during the past four years and should provide strong basis and support for continued success in the next three to five years. We maintain and continue to create new partnerships with market vendors and market entrants such as with Microsoft, with Cisco and BroadSoft operations, RingCentral, Zoom, Amazon and Dolby, among others. At the same time, our growing customer base across the enterprise and service provider space provides us with a strong basis for continued success. We continue to improve our operations efficiently to be very efficient, underscoring our financial success is our ability to improve quarterly operating margin to 15.5%. This is a record in our history. Most important to mention is that side-by-side with a strong networking business success, we are investing in a series of growth engines designed to fuel our growth further in the future. We increased investments in key areas such as the Microsoft Teams, clouds related activities, service providers, all-IP migration programs, voice.ai, professional and managed services for enterprise customers and more. Last, I’ll mention that only few weeks ago, we announced investments and entry into a new space for us, namely the meeting room and technologies markets. Early October, we announced entry into the market in collaboration with Dolby. Our Room Experience Solution suite are designed to address a wide range of customer room environments from other rooms to large rooms and board rooms. The solution includes a comprehensive portfolio of devices built around Dolby hardware and audio technology in order to deliver an exceptional audio experience in these rooms, rooms of all sizes. The initiative includes also Meeting Insights enterprise software solution, designed to easily capture, organize, share and distribute enterprise meeting contents using AudioCodes state of the art voice.ai technology. Adding to our ongoing success in the Microsoft Skype for Business and Teams market and Cisco BroadSoft market, in third quarter we created new partnership with new UC&C partners. During the quarter we have engaged with two new partners in discussion referenced our products, unique features, capabilities, workout plans and collaboration on the go-to-market side. We now collaborate with Zoom Video Communications on the Zoom Phone program. Two weeks ago, Zoom announced that our session board of controls in our desk phones went through certification for the Zoom Phone program. We also announced collaboration with Dolby, as I’ve mentioned earlier. Just to add, also this earlier in the year we announced collaboration with Amazon Chime Voice Connector, enabling enterprises to enjoy reliable and effective inbound and outbound calling. So partnering with leading unified communication and collaboration vendors in an ongoing effort should support growing our business in the voice infrastructure space going forward on both the connectivity and the integration services. As the market evolves with new requirements in new regions, our partners can rely on a strong technology infrastructure player that has international breadth across all world regions. Touching on the highlights of our financial performance, in revenue as I’ve mentioned before, we grew 15.5% compared to the year ago quarter, definitely above our initial guidance for the year of growing 10% in 2019. EBITDA grew to $7.9 million compared to $6.4 million in third quarter 2018, an increase of 23.4%; same for the net income, which grew 27.6% on a year-by-year basis. Most important, we continue to improve operational efficiency, operating margin improved from 13.5% a year ago to 14.5% in third quarter 2019, a direct result of growing revenue based on a very consistent basis while keeping the expenses at a well-controllable level. Based on initial backlog for the fourth quarter of 2019 and the business activity so far in October, we anticipate continued and improved financial performance for the fourth quarter and the full year 2019. The basis for this is simple, as seen in 2019 and now the first nine of 2019, we continued to see strong underlying trends in both the all-IP migration market and the UC as a Service adoption. Those trends should keep the momentum in our business in coming years. As such, we have strong confidence that 2019 will result in a strong year of growth on the heels of previous three years since 2016. Key to our success is the consistent progress in our networking business, which grew 19.6% year-over-year to $49.8 million. The networking business now accounts to 97% for our business in this quarter. So practically for all purposes, networking is our business. As presented in the past, the major factor supporting this growth is the strength in the UC-SIP business, which grew above 15% year-over-year in third quarter 2019. In our UC-SIP business, we continue to see nice progress, mainly in the SBC market, our multi-service business routers line in our OVOC management suite. We also saw nice progress in third quarter of 2019 in our Microsoft Teams IP Phone business. At the same time, we enjoyed strong demand for our gateways, which grew more than 15% compared to the year ago quarter. This is substantially due to the continuous evolution of the global migration of the PSTN to all-IP, where we see signs of continued trend among Tier 1 service providers in North America and Western Europe to migrate their networks. As mentioned in 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 in the service provider market. We are confident that we should be able to maintain this leading position in our CPE in coming years. Last, I will get to connectivity. As I’ve mentioned in our Investor Call earlier in the year. Connectivity solutions are key to our success in the networking business. Connectivity related to the combination of the business line of gateways and session both controls in some business routers and related network management so for. Connectivity now enjoys very strong momentum in the past 12 months, and it seems that it will continue going forward. In third quarter 2019, connectivity revenues reached $37 million again of about 11.4% year-over-year. For the complete year of 2019, we now estimate that connectivity revenue will top up $155 million, providing growth of more than 13%, 15% on an annual basis. And as you can see, it is more than 75% of the business. So the business is really in a good shape these days. Touching on some highlights from the sales side. Generally, sales performed very well to significantly above the target. We saw very nice results in North America, which performed very well both on sales and on bookings. We also saw some very good activity in Western Europe in the DACH region, which includes Germany, Switzerland and Austria, and also in Benelux, which is Netherlands and Belgium. We also saw a very nice activity in South America, so all-in-all very strong quarter. Just to touch on some highlights. In the Skype for Business market we enjoyed a big project with large a American multinational consumer goods that employs close to a 100,000 employees. As you can imagine, this is just the start of a project that should last many years going forward. Same for more projects in that area. A Large bank in South America, a few hundreds of thousands of dollars working with Germany, leading company in the vehicles market on the contact center side, I can mention several contact center projects in the U.S., Western Europe and in India, altogether a much in collaboration with Genesys, which is leading in this area. At the same time, we enjoyed some very strong business – in the business services side of the business. We enjoyed a very big project larger than $1 million in South America for an all-IP peering project, where we want not only the SBC part of this, but also professional services, same goes for a service provider in South Africa. Same goes for some, quiet a large, long list of projects in Western Europe among them, project with service providers, such as Deutsche Telekom and Telecom Italia and others all-in-all shipping many millions. So all-in-all, very successful quarter in terms of customer wins and shipments. I’ll give you one more example in – this should give you some understanding about the potential capacity and potential for us. So let me highlight one specific Skype for Business enterprise project. We were awarded a multimillion Microsoft UC deal. It’s a leading U.S. hospital with three distributed data centers, 25 buildings and about 30,000 staff members. The significance of this deal is that in fact, we are offering all of our entire One Voice portfolio solution and we’re able to address the various requirements of the customer and a company as their journey becoming a long-term trusted advisor. As you can imagine, again, this project is only in its initial innings. We beat competition who were offering just SBC or just IP phones, because the customer really appreciated the value of a single vendor that is capable of delivering all of the required solution for high-capacity SBC, site resiliency and complementing Gates with IP phones, room devices and professional services. We further offer the customer or AudioCodes routing manager that is used for driving IT operational excellence. Our professional services organization delivered planning and design, project management and customer activities as well as IT training. There’s another huge costumer in North America, service provider with which we have been fulfilling a multi-million dollar deals that’s long term. Its few years now that we work with that service provider. Part of their business services strategy, they were operating a hosted UC solution based on one of our competitors of business routers, but decided to replace it with routers coming from us. So with our MSBR that’s our all-in-one device that includes all telephone interfaces needed for the business customers and mainly multi when connectivity our customer is able to launch operational efficiency, communication services to their business customers. Let me touch a bit on Microsoft third quarter performance. So all-in-all business was very good, revenue grew 10% compared to the year ago quarter. All-in-all sales in the Skype for Business application area were pretty much similar to the second quarter, the previous one. Still need to mention that future gaps in Teams’ voice continue to delay deployments in Teams. However, we started to see better environments sales of IP phones in the Teams environment. This better momentum is evident in early fourth quarter too. We see a report of steady growth in our voice minutes for a direct route SBC for Teams. So that’s encouraging, all-in-all we all know that the web conferencing and meeting space market in communication – unified communication and collaboration has become fairly competitive lately. Targeting to collaborate with our partners, we have launched a new room experience, product and solution suite in collaboration with Dolby. And as reported, we’re going to deliver a tri-polar capability in the devices, in the management tools, and also, on the Meeting Insights. We also started to work more closely with Microsoft on the Azure space, who were firstly that wins – who won in that space in collaboration with Microsoft field sales. So all-in-all, we believe we will be growing there too. So all-in-all, our ability to support customers on the Azure marketplace is fairly good. We see more enterprises, contact centers and service providers expanding in Azure. So definitely, on the team direct route SBC on the contact center, back-end and on managed services for communication and collaboration. We also announced, a few months ago, collaboration with AWS. So we are – our SBCs are being used in the AWS Chime Voice Connector. This has start a new project for us. AWS is starting to bring us into new numerous opportunities for their SIP tracking devices. So all-in-all, nice progress on that. On the service provider side, we enjoyed great CPE quarter. This is a record quarter. We grew more than 100% year-over-year. Main revenue contribution came from the all-IP CO1 service provider. We believe that this year, we will grow substantially over 2018, more than 50% at this stage. We are – most of the activity went on in Western Europe, Deutsche Telekom, which is ramping up significantly and canceling contracts for the old network for single and dual E1 customers. This is quality sale for us. 2020 seems to be on par with similar run rate for those types of customers. We will be introducing a new improved performance router later in the year; we’ll add another big service provider, Tier 1 service provider in Germany, telecom Italia project runs very well for us; working with two large U.S. service providers and expanding our sales in that front. And also, we’ve made progress in our SD-WAN solution, and we are close to finalizing the first quality design with a very large Tier 1 service provider in the U.S. On the services side, quarterly service revenue increased 16.2% year-over-year to $16.3 million. In terms of invoicing, we experienced similar growth in the first nine months of the year compared to the same year last year. We keep growing our professional services in 2019. The Americas, North America and CALA had a record quarter in terms of professional services and highest invoicing quarter ever. EMEA exhibited in such trend a record invoicing. All-in-all, professional services orders were received from – just to give you an idea for the size of that operation, orders were received from over 160 customers worldwide. We also saw in the quarter increased demand for our managed services offering where large enterprise customers can rely on our global spread of resources and experience and system solution and management capabilities. I’m also glad to report that our activity on the technical support went up, and we scored fairly high in the customer feedback survey we did. On the Voice AI side of the business, we announced, a few months ago, the Voice AI gateway. Voice AI gateway allows access from practically any phone, any voice terminal or mobile phone to the part of the cloud for their cognitive services, and we are enjoying quite a success. At this stage, we have more than 20 different customers who are trialing the new development. A month ago, we announced Meeting Insights, which is a product we are all excited about. Meeting Insights is an enterprise solution that turns meetings into continuous productivity by capturing and sharing every idea, action and opinion from any meeting through our advanced Voice AI technology. Enterprise corporate meetings are strategically important, bringing together key team members and driving decision, execution and planning. Basically, we all know that sitting in meetings, meetings may generate an untapped value of business intelligence data, expert opinions, ideas, concepts, discussion of different approaches and actionable insights, most of which are typically lost as soon as the meeting ends. Meeting Insights seamlessly delivers multi-model and real-time access to key meeting moments, decisions taken and resulting action items. Meeting Insights ensures that everyone in the organization, whether they are attending a meeting or not, can simply and efficiently get access to that meeting, analyze it and use it for its own purposes. The solution relies on our advanced Voice AI technologies, among them, speech recognition, machine learning, natural language processing, keyword spotting and intense spotting, et cetera. Key focus is placed on connectivity of the solution to the enterprise information system, various information systems, such as exchange in our CRM and the connects, which will allow quick access and brief summary of the key topics discussed at a meeting. Now before I finalize my part of the talk, I’d like to come back to the guidance, the new guidance we provided right now. So with the first nine months of revenue in 2019 is fully ahead of our original plan, we are now updating our annual guidance. Our updated revenue guidance is now $198 million to $201 million compared to the previous range of $194 million to $198 million. On the earnings side, we now focus growth of more than 30% in 2019 compared to 2018. We now forecast an annual range of $0.86 to $0.89 compared to our previous guidance of $0.82 to $0.86. And with that, I’ve completed my part of the presentation on the call, and I’d like to move the call to the Q&A session. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Rich Valera from Needham and Company. Your line is now live.

Thank you. Good morning, Shabtai. Wanted to dig into Microsoft a little bit, you mentioned it sounds like they grew about 10%, which is actually a little slower than your overall business. But could you just give a sense of where they stand in terms of the Skype for Business, the Teams transition and how you see that business playing out over the next couple of quarters as maybe Teams catches up from a feature functionality standpoint to Skype for Business?

Right. So Microsoft is transitioning their unified communication and collaboration solution from Skype for Business, which is an on-prem solution and was the key deployments and implementation in previous years. As they’re moving to a UC as a Service solution, named Teams, and basically, that transition is now taking place about mid-2019 and is growing and growing pace going forward. One thing that we’ve seen lately is that because of the success of the web conferencing application in the market, where there were new players growing, such as Zoom Video Communication and others, major focus in partner activity went from overall Teams to Meeting First or Video First, and as such, some of the development for Teams’ voice were pushed a bit. So what we are experiencing in 2019 is basically a delay in completion of features, which are needed to provide a comprehensive -- full comprehensive Teams’ voice capability. On the other hand, I can tell you, and as I’ve already reported earlier in the call that we’ve started to see phones, IP phones. With Teams starting to grow, we see more interest and deployment by more customers, and that trend is evident also early this quarter. So we believe that and based on what we hear from our partners is that we should see Teams’ voice coming into full gear, somewhere in the first half of 2020. At the same time, with much activity going on on the meeting space and as much investment in coming up with new devices is more functionality, if everybody understands the application of voice recognition technology and machine learning technology will come into effect also in the meeting space. So there’s much that goes on in terms of development, we believe that we will see 2020 already better than 2019. So we should forecast for more than the typical 10%, 11% that we are witnessing this year.

That’s a helpful overview. Thank you. Wanted to explore huddle rooms a little bit for you, it sounds like you’ve announced the partnership here with Dolby, and if I’m not mistaken, they’re providing all the hardware and you’re providing your voice.ai technology. Just wanted to understand that the revenue model there, how do you sell that voice.ai technology? Is that a subscription or perpetual license? And just give us a sense of your kind of revenue opportunity in that huddle room space.

Right. So at this stage we’re still not in the recurring revenue. So all for ourselves are CapEx. In this specific example that you presented, basically the conferencing device is part of an overall solution sale. So side-by-side, with our ability to provide gateways, SBCs, phones, we will provide the conferencing device. Obviously, the hardware comes from Dolby. Our technology and software will help complete everything that’s needed from the user interface and the solution architecture to connect that device to the Teams solution. We will add, on top of that, two key elements; one, which is the management solution or one voice operations center, which will have the conference device part of the overall company devices; and also, we will apply our Meeting Insights, which will basically provide a software solution that helps to analyze and process the content of the meeting. Now going forward, we will sell devices just as we’re selling our phones these days. But on the software side or the Meeting Insights side, we definitely, we will look to go more for a service model. So on Meeting Insights, we believe we will go to the Software as a Service approach.

Okay. I guess, the follow-on, and sort of you mentioned that you had I think 20 customers or so trialing your Voice AI gateway. So I guess, the same question. How do you see that revenue model playing out? Is that going to be an upfront purchase, plus a recurring service or software revenue stream?

Right. The Voice AI gateway indeed will deviate from our traditional CapEx approach. We do intend to sell it as a service, and it will be basically charging based on a recurring basis. So you will pay as you use it.

Got it. That’s interesting. I think you mentioned in your prepared remarks that gateways were up 15% year-over-year, which is a pretty impressive and maybe surprising number. And I think that’s on the strength of these network transformations with large service providers. So can you just lay out how you see that? I think it sounds like you expect another strong year next year, but off of some probably difficult comparisons. So just wanted to get a sense of how you’re thinking about that gateway business, and in particular, the driver of the big network transformations with some of your big Tier 1s.

Right. So the success of 2019 is driven mainly by several, no more than four or five, large service providers. And from what we know now, about four of them are going to continue to ship for us in 2020, and we already have another new big Tier1 service provider that will be joining. So all-in-all, I think the business is fairly good, fairly stable. And we’re talking about – I’ve mentioned so far, five, six, seven countries. Let’s not forget, it’s a global process and trend. We know a very big country where we have done the first steps this year in terms of testing, integrating, making sure that service will work. And we already have plans to start shipping in 2020. And so it’s a process that should pretty much continue into the next at least three to five years. And then, give or take, we will have years that will be stronger than others, but all-in-all, a very strong business. I would also mention that this is a strategic point that usually is overlooked. We’re talking about products that are based on hardware. And as we all know, that the trends in the world that most of the players and organizations are flocking away from hardware. Basically, everybody goes into either software and/or services. We do the same, right? I mean, I’ve mentioned Meeting Insights, I’ve mentioned Voice AI gateway, those will be SaaS products, and we’ll offer in the future more of such products. However, on the hardware side, keeping – when product gets to end of life. We are probably the only vendor that’s left out there, and I would not say only, but one of the very few vendors left out there, that who are capable of basically having access to all of the different projects are either running and/or initiated because other products are going end of life. And we know for a fact that other companies are not that committed to it. So we enjoy the fact that year-by-year, players and competition are deserting the space of hardware solution. And us enjoying good profitability and dominance in that field, we’ll keep enjoying that for coming years.

Got it. And one more, if I could. You mentioned, I believe that your gateway was certified for use in a Zoom phone deployment. Can you give us any color on what visibility you have towards the ramp of that business with the Zoom phone-related business?

So we work with our partners. And obviously, we are exchanging information about potential opportunities brought into and – it suppresses just started earlier, mid this year. So it’s only in the beginning, fairly early to make a call on where it goes, but it’s a good start, and we are on it.

Got it. Okay. Well. That’s it me. Thanks for taking all my questions, Shabtai.

Sure. Thank you, Rich.

[Operator Instructions] Ladies and gentlemen, we’ve reach the end of our question-and-answer session. I’d like to turn the floor back over to management for any further or closing comments.

Thank you, operator. We would like to thank everyone who attended the conference call today. With continued good business momentum and execution in the first nine months of 2019, we believe we are on track to achieve another strong growth year in our business. We look forward to your participation on our next quarterly conference call. Thank you very much. Have a nice day. Bye-bye.