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AudioCodes (NASDAQ:AUDC)

Q4 2012 Earnings Call

January 30, 2013 09:00 PM ET

Executives

Erik Knettel - IR

Shabtai Adlersberg - Chairman, President and CEO

Guy Avidan - VP, Finance and CFO

Analysts

Andrew Uerkwitz - Oppenheimer and Company

Rich Valera - Needham & Company

Operator

Greetings and welcome to the AudioCodes Fourth Quarter 2012 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. It is now my pleasure to introduce your host, Erik Knettel, Investor Relations for AudioCodes. Thank you, Mr. Knettel you may begin.

Erik Knettel

Thank you, Melissa. I'd like to welcome everyone to the AudioCodes Fourth Quarter and full year 2012 Earnings Conference Call. Let me begin the call today with a brief Safe Harbor statement. Statements concerning 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 that 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 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 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 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.

Joining us today from AudioCodes we have Shabtai Adlersberg, Chairman, President and Chief Executive Officer and Guy Avidan, Vice President of Finance and Chief Financial Officer.

I would now like to turn the call over to Shabtai Adlersberg. Mr. Adlersberg, please go ahead.

Shabtai Adlersberg

Thank you, Erik. Good morning and good afternoon everybody. I would like to welcome all to our fourth quarter and year end 2012 conference call. With me this morning is Guy Avidan, Chief Financial Officer and Vice President of Finance. Guy will start off by presenting a financial overview of the quarter.

I will then review the business highlights and summary and then discuss developments in our business and in the industry and plans for 2013. We will then turn it into the Q&A session. Guy.

Guy Avidan

Thank you Shabtai and good morning everyone. Before beginning the financial overview of the quarter, I would like to note that the following discussion will include GAAP numbers as well as non-GAAP pro forma numbers.

Our fourth quarter non-GAAP pro forma results reflect adjustment for the following two non-cash items, stock-based compensation expenses which totaled $332,000 and amortization expenses relating to the acquisitions of Nuera, Netrake and CTI, which totaled $282,000.

The full reconciliation of the non-GAAP results discussed on this call to GAAP results is currently available for review on our website and in the press release issued earlier today.

Getting to the numbers, our fourth quarter results are in line with our previous revenue and profit guidance discussed on our conference call on October 4, 2012 and include the completion of the restructuring plan to reduce annual operating expenses as our announcement on July 11.

As announced in July, the restructuring plan is generating estimated annualized saving of approximately 10% of company's operational expenses. At the end of the fourth quarter, we managed to reduce headcount by 9% compared to the end of the second quarter. The implementation of the cost reduction plan was completed this quarter. Fourth quarter revenue were 32.8 million which represent a 4.6% increase from sequential third quarter of 2012.

We saw solid demand for our Core Networking Equipment Group business especially in the unified communication and contact centers market which was partially offset by some anticipated headwind we experienced during this quarter in our Technology Group and OEM business.

As a percentage of revenues, sales in the Americas accounted for 53%, Europe, the Middle East and Africa 38%, and Asia Pacific 9%. Revenues associated with our growing Manage and Technical Services business line grew to exceed 20% of total revenue or $6.7 million in the fourth quarter of 2012.

Managed Services provide another revenue driver, which helps further bind AudioCodes high value relationship with its customers. Service revenues are also beneficial in that they are typically characterized by high gross margin and are based on the extensive experience and knowhow accumulated in the company.

Our top 15 customers accounted for 58% of our revenue compared to 53% in the previous quarter. In the fourth quarter, we had a single distributor in North America that accounted for 17% of revenues compared to 13% in the previous quarter. The increase in business with this distributor is derived from the sequential increase in our revenues in the United States.

In terms of revenues by business group, in the fourth quarter our Networking Business Group accounted for 81% of revenue and our Technology Business Group accounted for 19% of revenue compared to 81% in our Networking Business Group and 19% in our Technology Business Group in the third quarter of 2012.

GAAP net income for the fourth quarter was $524,000 or $0.01 per share, a decrease of $146,000 versus the year ago quarter and an increase of $1.6 million sequentially.

Non-GAAP net income for the fourth quarter was $1.1 million, or $0.03 per share, a decrease of $330,000 versus the year ago quarter and then increase of $1.6 million sequentially.

In the fourth quarter of 2012 on a GAAP basis, the gross margin was 57%. Non-GAAP gross margin was 57.7%.

GAAP operating expenses was $17.7 million compared to $19 million in the third quarter of 2012. Our total pro forma operating expenses were $17.3 million compared to $18.6 million in the third quarter of 2012.

Headcount declined this quarter by 14 employees, which brings us to a total 579 employees. Short-term and long-term cash balances were $58.5 million compared to $54 million last quarter.

The increase in cash balances is attributed mainly to an increase in net profit as well as decrease in account receivable and decrease in inventory.

As for the share repurchase program announced on October 3, 2011, we would like to inform you that through December 31 the company repurchased approximately 4 million shares of common stock at an aggregated cost of $10.7 million. DSO came in at 68 days compared to 78 days in last quarter.

While we expect demand for our products and solutions to grow at a double digit compound annual growth rate over the next three to five years, within this larger growth trend for our new products and solution, we do anticipate some of this growth will be offset by a decrease in demand for our technology products.

Our guidance for 2013 are as follows. On an annual basis we forecast revenue for 2013 to be in the range of $133 million to $137 million and non-GAAP earnings per share expected to be in the range of $0.10 to $0.14.

I will now transfer the call to Shabtai.

Shabtai Adlersberg

Thank you Guy. We are very pleased to report the second consecutive quarter of improved financial performance. As we have stated in our release earlier today, the improvement is underlined by sequential growth in revenue, return to profitability and substantial improvement in the cash flow from operations.

Growth in our networking business is being driven primarily by higher product and services sale, all in the area of unified communication, enterprise session border controllers and contact center application, all representing strategic directions for us. It isn’t prudent to realize that all the three market segments do represent fast developing sectors and application in the networking world and that they are all expected to extend future growth also over several years span. And thus they provide a very sound basis for continued growth.

Further supporting these potential is the ongoing trend in enterprise gross market with the shift to unified communication and IP based contact centers and constant growth in enterprise voice services from pure on-premise solutions to cloud voice services in accurate models.

Our continued investment in integrated connectivity, and new emerging technologies in the field of over-the-top mobility and voice quality of service, SLA monitoring and enhancement will further help to enhance our position in this market.

Guy has already covered much of the details pertaining to our financial performance in the quarter, but I'd still like to dwell on some of the more important ones that we achieve in the quarter.

We grew sequentially in sales 5.8%, a very nice growth. We exhibited good control over expense and over our OpEx. OpEx went down to 17.3 million from 18.6 million in the previous quarter, just to remind ourselves that we target 18 million on the average on a quarter level and we believe that that level is sustainable to 18 million per quarter, OpEx is sustainable over the next few quarters.

We have enjoyed big improvement over third quarter 2012 on the income line. Operating income came at 1.6 million substantially upward from a loss of 550,000 in the previous quarter.

Net income was 1.2 million compared to a loss of 400,000 in the previous quarter, so very nice developments and improvement on the income line.

Cash flow was very strong in the quarter. We have generated more than 8 million of cash from operating activities and ended up growing in our cash balance was close to 4.5 million.

Another improvement related to our inventory, inventory went down substantially in the quarter by more than 2 million to around 16.6 million, a record low. This level of inventory is now 20% lower than a year ago.

Headcount, headcount declined to about 580 employees down to 2.4% from the third quarter and down almost 9% from a year ago all in accordance with our restructuring plan announced six months ago.

As we returned to continue growth now, we have already further selective hiring mainly in the customer facing groups.

Now to some of the business trends in the quarter. As we have mentioned, we have seen strong momentum of sales in the third quarter.

The majority of it came from networking which has recovered and showed close to 5% sequential growth. Services in more so professional services are emerging strongest diverse source of revenues and stability for our business.

In the fourth quarter, services grew more than 20% over the third quarter. Professional services grew more than 40% in the quarter.

Microsoft Lync Environment, two of the most living factors in sales in Q4 were Microsoft Lync and then our activity in the contact center. With growing number of Microsoft Lync opportunities, we saw larger sales in this business segment. Sales in the fourth quarter grew 20% above third quarter and are substantially above the average level in overall 2012. In the contact center market, growth in sales grew more than 15% over the third quarter.

Getting to a third growth engine in our business enterprise session border controllers. That was a substantial performance in the quarter. The Mediant 4000 SBC that we have introduced in August, third quarter was key in growing sales. That product which covers few thousands of concurrent sessions opened for us huge portion of the market that has been closed for us for so many years.

Sales of session border controllers grew above 25% in the quarter and are now in the running rate that’s above 10 million annually. Just to remind us all, we saw a market study issued by Infonetics in October. We have been named third runner up in that sector and we have an aim to capture 6% of that market. We do believe that with a growth in the Lync environment and contact center environment we will see our market share growing up.

Another source for encouragement is new product sales. We do define certain products such as the enterprise SBC, the IP phones, the enterprise routers and professional services combined as a new product sales. The contribution of new product sales in the fourth quarter was very substantial. Actually it has been more than double than level we have seen in the second quarter of 2012.

New growth engines product sales are now above 10% of company sales and from early trends in January we see continued growth mainly in the unified communication related sales of enterprise SBCs, IP phones, enterprise routers which embed advance voice capability et cetera.

As mentioned before, together with new professional services practice on top of this emerging new growth engines, we do expect solid growth going forward.

Now getting back to the largest opportunity we'll face in next several years or the opportunity going forward. Strategically we have invested heavily in the (inaudible) those three key growing segments, which I've mentioned before unified communication, IP evolving contact centers and SIP trunking. We have aligned ourselves with world leaders in those segments. In the unified communication market, we focus primarily on the Microsoft Lync ecosystem which is the fastest growing and the main share leader in the space.

We've seen and this is based on an Infonetics report that came out in December of 2012, Microsoft is taking lead with continued strength, it's a driving force in this space and is now 33% license share in the third quarter of 2012. If you compare Microsoft Lync performance against other competition from Cisco and Avaya, we've see Microsoft increasing licenses and we see a decline in the other two.

Now AudioCodes growth is a derivative of Microsoft Lync penetration and its Lync revenue has been growing more than 35% annually. We do expect that we will see our revenues from that ecosystem growing substantially.

What separates AudioCodes from the pack from our competition in that space is the fact that AudioCodes is the only single source provider for Microsoft buyers for complete end to end voice solution? We do provide all of the products, all of the expertise, service solutions, practically a complete headache removal for the Lync voice ecosystem.

As we look ahead to 2013, AudioCodes stands well positioned to extend its presence within the billion dollar market for unified communications. We believe that our leadership in the market for Lync voice ecosystems is the only single source provider for Microsoft partners for end to end voice product and services solution, is a clear competitive advantage within one of the most attractive segments of the communication sector. With the recent launch of our AudioCodes One Voice for Lync offering in early January, we are simplifying and accelerating voice enablement of Lync implementation with a complete portfolio of products and services.

This includes among others, IP phones, mitigate with enterprise session border controllers, survival branch appliances, session experience manager and more advanced complete Netrake management and assessment tools support and professional services. This is today by far larger and much more advanced solution than any of our competitors in the market.

Just to mention a quote from Microsoft on that press release, General Manager of Marketing, Lync Marketing said, we see articles one was for Lync program as an opportunity to accelerate the climate of voice-enabled Microsoft Lync deployments. I’m glad to inform today, two weeks after that announcement, that since we announced that solution initiative, we have now more than 35 Microsoft partners in North America, Europe, Asia Pacific and Latin America would join this One Voice for Lync program with us as their names are listed on our website.

Additionally, I can tell you that we have already signed more than five new first end customers for the One Voice solution. I would also mention that some of the new enterprises we see in the fourth quarter are in the Lync environment.

And with that, I’ve concluded my presentation for today. Thank you very much. Operator will take you to Q&A.

Question-and-Answer Session

Operator

Thank you. We will now be conducting the question-and-answer session. (Operator Instructions). Our first question comes from the line of Andrew Uerkwitz with Oppenheimer and Company. Please proceed with your question. Mr. Uerkwitz, your line is open. Please proceed with your question.

Andrew Uerkwitz - Oppenheimer and Company

Shabtai, could you give us your view here on the voice-over IP adoption in Lync? It looks like Lync is doing quite well, but some enterprises are not adopting the voice side of it. Could you kind of give us your thoughts of how you see that playing out, what is going to be the catalyst there longer-term and how that is going to shake out?

Shabtai Adlersberg

Yes, I will try to do my best on that. Unified communication primarily (inaudible) Lync, is focused at least from the customers and initial deployments on two key functionalities which are presence and instant messaging. Usually, those are the first productivity tools that customers select to start with. VOIP is coming on these days. Voice is primarily more about our collaboration, mobility and there has been some slowness in starting with voice application about two years ago, we have seen some pickup in the past six months. We do believe that going forward and especially with our announcement of One Voice Lync, the ability to deploy first actually a plan, design, implement and deploy provision, a complete voice solution end-to-end will be much easier. So we believe that we will see acceleration of that in 2013.

Rest assured, that any customer who has deployed Lync and is not using the voice today will definitely transition either this year or next year to retiring the old PBX. So all in all, complexity is playing for us, allowing us to create advantage and then by providing a complete solution we do believe that with the Microsoft introducing mobility, we have heard early this year, we do believe that voice would pick up as well. All in all, we have huge infrastructure of Lync that will be developing for us.

Andrew Uerkwitz - Oppenheimer and Company

Do you think it's on the IT manager who just doesn't want to upgrade or doesn't want to change out the PBX? Or is it just a matter of the budget, say, previously could handle the presence and the next year's budget is going to do the voice? What's kind of like your experience talking with these projects? How is the IT manager kind of looking at it?

Shabtai Adlersberg

Okay, well before we go to that, I'll just mentioned that we've seen much emphasis from Microsoft on licenses and licenses not necessarily included voice in the past, so we do believe that part of the reason for voice not being developed two years ago and last year was primarily because the emphasis was on pure (inaudible). That is changing now and we know that as of fiscal year '13, at Microsoft there is emphasis on voice too, so that’s a change.

Also from the IT manager point of view as you have mentioned, there is usually no forklift in such situation. Usually the move and position to Lync would be first to deploy the presence in IM and then add gradually the voice. I do believe that mobility is a key factor and the fact that Microsoft will be introducing Lync mobility, we understand in the next few weeks. That will definitely make a change in deploying voice in Lync too.

Andrew Uerkwitz - Oppenheimer and Company

And then if I could just ask one quick one here. Could you kind of review kind of the strategy or the thought process behind you moving more towards the service aspect of the voice-over IP? Because it looks like your competitors are not going in that direction. So could you guys talk through your thought process there?

Shabtai Adlersberg

Yes, well I think we haven’t focused on it, but I think we really, in many ways, the milestone here in the company is doing that. We are changing strategy from a company that focuses on best of breed products, and we've been always very good in deploying gateways and session builder controls and other standalone products. We now move to more complete solution and services that are needed to deploy those solutions. Now we do see that the end customer has substantially higher appreciation for a complete service and solution.

And I think we are basically trying towards the end users requirements. And that is the shift. We saw that about two years ago and this is why while some people did not understand why we invest in IP phones and why we do engage in more products. The idea was always, unified communication is going to be one of the largest markets in the world. There is an open network solution Lync, Microsoft Lync that’s developing. There is a room for companies with clear competence on voice to play there. And that was the strategy that we have basically initiated two years ago. And therefore we have developed so many different pieces of equipment. Obviously other people take best of breed approach and will try to compete on a gateway side and/or session by the controller only or IT funds only but we do believe that our comprehensive solution bundled with services that will be a winning factor. I think for an end customer, it will much easier to get a complete working and suppose a solution from one vendor than having to deal with four, five, six or seven different parties.

Operator

Thank you. (Operator instructions) our next question comes from the line of Rich Valera with Needham & Company. Please proceed with your question.

Rich Valera - Needham & Company

Shabtai, I was wondering if you could talk about what percent of your revenue was derived from Lync-related sales in the fourth quarter and how you see that trending through 2013.

Shabtai Adlersberg

Okay, well usually we do not report on the breakdown of sales into specific segments. I will say generally that in 2012 Lync was above 15 million of sales. We do expect that in 2013 we will grow in the Lync environment more than 30% - 35%, so those are the numbers we can quote.

Rich Valera - Needham & Company

And then, with respect to the competitive landscape for your business, you mentioned you are kind of the only end-to-end supplier. I think one of your major competitors here is NET, recently acquired by Sonus, or at least last year acquired by Sonus. How do you see them in the marketplace and how has that transition been? Has it been disruptive, i.e. beneficial to you? And how do you differentiate yourselves from them, because they talk a lot about their Lync certification as well?

Shabtai Adlersberg

Right, well I don’t one can compare between the two companies. We do provide a complete solution end-to-end solution including phones including gateways session border controls, session experience management will come with unified management and a complete solution. NET acquired by Sonus do compete on a very narrow basis on the gateway side and on the integrated gateway and session board controller side. So, we do see than as competition on that partial area but not in the full context and I do believe that an end costumer facing a decision to go with several vendors among them NET Sonus or choosing a more complete fully working solution. In my mind, I think the answer is known. So that’s how I relate to that competition.

Rich Valera - Needham & Company

And then the technology segment has obviously been declining for a while here. It had a pretty big decline in 2012. Can you give us any sense of where you think we are on the revenue trajectory of that relative to 4Q levels? Do we think we've found some stability here, or should we expect to see further declines to some level in 2013?

Shabtai Adlersberg

Right. To a certain level we have seen in the last two quarters, since the middle of 2012, we have seen some stability. To give you numbers, in 2011 we sold about 34 million in debt (inaudible) in 2012 we came down to 24 million. We do not see any more such broad changes going forward. So, we do believe that we might see 10-15% decline from the 24 million level, but we do not see a major decline as we have seen in the past two years.

Rich Valera - Needham & Company

And finally, I don't know if you gave any color on how the first quarter is looking, but either way, I wonder if you could talk about how you are thinking of the first quarter from a revenue sort of seasonality standpoint, and if we think these expense levels from the fourth quarter are about the right level to model going forward or if there might be any variation from them. Thanks.

Shabtai Adlersberg

Right. So, usually the first quarter at AudioCodes is roughly about flat or, give or take a few hundred to thousands. This is the plan. We do not see major deviation this year. Also we are at the end of January and January usually is a slow start for the year, so there is no ability for us to give you any differences. In our plans Q1 should be around Q4 give or take. In terms of (inaudible) we do expect keep managing expenses on an 18 million level the quarter, so we do not see major change in the core for that.

Operator

Thank you. Mr. Adlersberg, no further questions at this time, I'd like to turn the floor back over to you for closing comments.

Shabtai Adlersberg

Okay, thank you operator. In summary of our call we look forward to growing our business in 2013 and further build the infrastructure for continued prosperity in coming years and follow on with the momentum that we have generated in the second half of 2012. Finally I would like to thank everybody for participating in our conference call today and we look forward to have you on next conference call. Thank you very much, bye, bye.

Operator

Thank you. This concludes today's teleconference; you may disconnect your lines at this time, thank you for your participation.

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