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AudioCodes Ltd. (NASDAQ:AUDC)

Q2 2013 Earnings Call

July 30, 2013 09:00 AM ET

Executives

Erik Knettel - Grayling, IR

Shabtai Adlersberg - President and CEO

Guy Avidan - VP of Finance and CFO

Analysts

Andrew Uerkwitz - Oppenheimer & Company

Rich Valera - Needham & Company

Operator

Greetings and welcome to the AudioCodes Second Quarter 2013 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. Thank you, Sir. You may begin.

Erik Knettel

Thank you, Brenda. I'd like to welcome everyone to the AudioCodes Second Quarter 2013 Earnings Conference Call. Let me begin the call 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 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 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

Hi, thank you, Erik. Good morning and good afternoon everybody. I would like to welcome you all to our second quarter 2013 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 for the quarter and then discuss trends and developments in our business and in the industry. 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 second quarter non-GAAP pro forma results reflect adjustment for the following two non-cash items, stock-based compensation expenses which totaled $373,000 and amortization expenses relating to the acquisitions of Nuera, Netrake and CTI, which totaled $218,000.

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, second quarter revenue were $33.7 million which represents 4.4% increase from the sequential first quarter of 2013. We saw solid demand for our Core Networking Equipment Group business with a sequential increase of 8% in revenues.

Sales of our Unified Communication and Enterprise SBC offerings drove the increase, following the growing demand for Lync Unified Communications and SIP trunk services. This growth was vastly offset by some anticipated headwinds we experienced during this quarter in our technology group.

In terms of revenue by business group in the second quarter our networking business group accounted for 86% of revenues and our technology business group accounted for 14% of revenues, compared to 83% in our networking business group and 17% in our technology business group in the first quarter of 2013.

Revenues associated with our growing managed and technical services business line were 18% of total revenues, or $6.1 million in second quarter of 2013 compared to 19% or $5.9 million in the second quarter 2012. Managed services and professional services helped 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 know-how accumulated in the company.

As a percentage of revenues, sales in the America accounted for 50%; Europe, the Middle East and Africa, 35%; and Asia-Pacific, 15%. Our top 15 customers accounted for 54% of our revenues compared to 50% in the previous quarter. In second quarter, we had a single distributor in North America that accounted for 18% of revenues, the same as in the previous quarter.

GAAP net income for second quarter was $441,000 or $0.01 on a per diluted share basis, an increase of $2.5 million versus the year-ago quarter and an increase of $370,000 sequentially. Non-GAAP net income for the second quarter was $1 million or $0.03 per diluted share, an increase of $2.4 million versus the year-ago quarter and an increase of $341,000 sequentially.

In the second quarter of 2013, on a GAAP basis gross margin was 57%, non-GAAP gross margin was 57.5%. GAAP operating expenses were $18.8 million compared to $18.6 million in the first quarter of 2013. Our total pro forma operating expenses were $18.3 million compared to $18.2 million in the first quarter of 2013.

Headcount increased this quarter by 28 employees to a total of 611 employees out of them 22 relate to the MailVision asset purchase and 6 new employees relate to the organic growth in sales and marketing.

Net cash provided by operating activity was $4.1 million this quarter compared to $2.7 million last quarter and net cash used in operating activities of $4.6 million in the year ago quarter. Short-term and long-term cash balances at quarter end were $57.5 million, same as the end of previous quarter.

DSO came in at 72 days compared to 70 days last quarter. In May 2013, AudioCodes completed the asset purchase of its affiliate company MailVision. MailVision is an Israeli company which develop market and license Voice over IP solution for Mobile, PC, Web and Tablet devices for the telecom operators, service providers and telco over the top.

While we expect demand for our new product and solutions to grow at a double-digits compound annual growth over the next 3 to 5 years with its largest growth trend for our new product and solutions, we do anticipate some of this growth to be offset by a decrease in demand in our technology and legacy products.

Hence, for guidance, we would like to upgrade our annual revenue guidance for 2013 as follows. On an annual basis, we forecast revenue for 2013 to be at a higher end of our previous guidance of $133 million to $137 million. We are also upgrading our full year 2013 guidance for non-GAAP earning per diluted share which we now expect to be in the range of $0.12 to $0.15. I would now transfer the call to Shabtai.

Shabtai Adlersberg

Thank you, Guy. We are very pleased to report another growth quarter and improved financial performance. This quarter March, the fourth consecutive quarter of sustained growth in revenues and profits since the turnaround of May 2012, a year ago when we realigned our activities into a consistently growing, well balanced and diversified business for years to come.

To best illustrate this change, let’s review the change in our bottom line results. We stepped form a lot of $2.2 Million in the first half of 2012 to a profit of $1.7 Million in first half 2013. And as evident from our new improved better guidance earlier in the call, we are confident in our ability to generate sustained growth in revenues and earnings in coming quarters.

Continued growth in Unified Communication, and contact centers, SIP trunking and SBC and recent stronger trends in cloud voice and hosted telephony all point in one direction. All of these segments represent a strong driver for us to slowly target market expansion and continuously evolving opportunities and thus represents strategic directions for us.

Underlining these trends is a very nice increase into our networking business. Networking business now represents 86% of revenues and we have marked up the legacy issues beyond us, the legacy business is now down to 14% only. We can now report 8% increase in networking of core and 14% year-over-year. We believe that this 15% annual growth rate give or take is sustainable for coming years.

Clearly our markets grow and support it; we have a good collaboration in partnerships aligned with leading partners from the software and networking industry. Business is well balanced and diversified towards combination of products, solutions and services and more of software products. And our company resources and abilities are pretty well positioned and aligned at this stage to capturing the benefits which are continuously developing for us.

Before I dwell into more details regarding the core, I would like to take the opportunity and make a point regarding our strategy and position into market if it relate to industry trends. Industry trends clearly shows a transition of the traditional network equipment player into two groups. The first one is the application delivery players such as the process in Microsoft and many more and the other group is the networking infrastructure group which includes players such as CISCO, AVAYA and other including our self.

Being an infrastructural company our strategy has evolved through the years from, a pure play product company into a full voice solution company, delivering solutions, services and products in different market segments namely, Unified Communication, contact centers, SIP trunking, et cetera. It is therefore important to note that we focus on an end-to-end voice solution play, which helps enterprises and service providers in their migration and position to an all IT network. So the emphasis here at AudioCodes is on combination of products, solutions and services and not on a specific single product line.

On top of this, with the rapid changes in technologies in our space, transition to pure cloud, hybrid cloud architectures, on prime solution, web RPC, session border controllers over the top, (inaudible), etcetera. Our position is a provider of a full voice solution access gain in all of the different products. And this would be the right perspective through which we would, be looked at and compared against other players in the industry.

Now to specific highlights, we’ve seen four straight growth quarter since July 2012 restructuring. This consecutive batch, this quarter we have seen the third consecutive best , initial back log for the quarter, very strong beginning for this third quarter. July has been fairly strong and better than previous months in the year in terms of new final of purchase orders and opportunities created. Most legacy issues are now mostly behind us, technology acts as opportunities in the media service business line.

I mentioned again that networking is now 86% of revenue through 8% of previous quarter with 14% over last year. We've seen good products across all key programs, among them the link, Microsoft link program, the contact center, services are on track and then the session border controller and the new branch business. This has been the best quarter ever for our CT business line that includes the combination for analogue mitigate with low density Digital Media Gateway Session Border controls, business routers, IP phones and services. We also started selectively final (opportunities) developing for us into branch of it’s rather its segments, with a need to support voice services through cloud and all sort of operations. I've also mentioned our relationship with our partners or currently best time ever. Among them, I'll mention Microsoft, VIAO, Genesis, (Brothersoft), SIEMENS, AT&T, BT.

I'll skip the financial highlights, those were mentioned by Guy, but I'll just say again that in the last three quarters we have been able to generate in the course of the past three course, almost $15 Million net cash. We have been able to drive inventory substantially down from close to $20 Million year ago to roughly around $14 Million this quarter. And we believe that we are on track to present good financial and operational control over expenses. As we can see from our OpEx we have got good control of expenses, including the new acquired assets from a division.

In terms of ourselves, generally we have seen sales pretty much in line to the initial plan, in terms of original performance North America, Asia-Pacific, West Europe, this according to plan, the only weakest region in our plan was Central and Latin America and we believe this is just a testing phenomenon.

To highlight some of the doubts we had, and I will get to the Lync activity, but we have pretty nice list of new opportunities in the Lync space. I will mention a few; one big accounting firm in North America using our SBC and we want large office implementation; a large known consumer company from Europe, that's about a million project size. This is a classic Lync deployment and it’s going to roll out, started to roll out in second quarter and will generate a run rate of quarterly sales of about $200,000 in coming quarters. We have seen a very unique sales of our call recording, solutions, smart app into the Lync environment with one of the world’s largest banks and that represents a potential above $1 Million. We just received the initial PO and then we have a large Lync project with a very large retail company in North America, deploying 1000s of our (NYSE:NL) gateways in 1000s of their stores and using our session both the controls in their data center. I also mentioned 2 projects in the (cross sectional) market; one with our largest partners or sales during the quarter topped $1 Million, combination of gateways, Session Border Controllers and IP phones and then with a very nice (construction) project in Asia, again comprising to gateways, Session Border Controllers. As I have mentioned before and we still might penetration is the right of business which grow for us in coming years. We have a huge deal in the classified replacement area in Asia-Pacific link above a million and few more deals.

Now getting to the specific business lines, I will start with Lync. As we all know Microsoft Lync is a very successful growing business line for Microsoft. In their recent financial release, they have mentioned that Lync revenues grew in second quarter 30% over previous quarter.

And they have said that 90 out of the fortune 100 companies are now using Lync and there are more than 5 Million people – enterprise were deployed. This is a huge infrastructure for Lync voice that has been created and we believe being the dominant in leading company deployment of voice solution that market segment, that we will enroll that final in coming years.

According to report from (inaudible) Microsoft keeps growing in the UC market and that is to some extent on the expense of its two largest competitors CISCO and (inaudible). Beyond that I will mention that Microsoft is saying that, right now 70% of fortune 500 companies uses Lync, there are more than 40 Million Lync licenses sold which is huge, again infrastructure for rise in coming years and nice important point which is federation. Federation basically allows one employee from a company call another employee from another company through Lync federation mechanism. Right now they have 4000 federated organizations, again huge potential for us to grow in coming years.

Coming to our numbers, in that market segments, we can say that we have seen by now 100% growth since 2011, 2 years ago. 2013 is on track to show 30% growth year-over-year, at this stage we are deployed at 100s of enterprises globally, many of the fortune 500 customers. We have a large global (inaudible) community on a global basis and second quarter is very unique into two key terms, we have mentioned in the past that we won several multimillion multiyear project. In the second quarter we have seen the deployment of those projects starting to kick in, so two large companies, an accounting company and a pharmaceutical company started a very initial deployment thinking 3, 4, 5 locations out of 10s and 100s of locations, so that shows a momentum in deployment of Lync Voice.

Also I would like to mention that in the second quarter we have seen the largest number of new large enterprises initiating Lync Projects and we have seen those mainly in North America and West Europe. So all in all, Lync represents for us a very successful activity. I will mention two more data point, one is that, one goes for Lync is now capturing now a lot of attention in position with more than a 150 resource around the globe and we have got a good strong relationship with few large global system (inaudible) one in North America, getting us into large enterprise deals, one with global (inaudible) getting us into deals in Asia-Pacific and other regions and with a very known computer server company with now we are part of their formal Lync offering.

Getting to our SBC activity, again growth are there for us, we grew 8% quarter-over-quarter. The key areas in application in which out session by the controllers have been deployed in were Lync, the contact center, market and we have seen just the beginning of deployment in the access and will be talking more about the access SBC in the coming months. Definitely the growth clearly evidencing clouds services, voice moving into the cloud and also telephonic helps to build the momentum towards the need of session by the controllers in the access side of the business and that would be a new market segment for us in coming months. Definitely will help us more than double our revenues at this stage. We have announced in the quarter, our development in the software SBC area, that is a major development for us. Two main reasons; one, when you are software based, our ability to be deployed in data centers and cloud applications becomes much, much easier as with being used with silver products software only. Second is the fact that we will be able to rapidly increase our capacity in terms of concurrent number of SBC sessions running at the same time.

We will be delivering as we have announced 4000 concurrent sessions based on the software SBC architecture in Q3. And we target 10000 in January of 2014, and we will probably grow at that capacity as we move into 2014. And that pretty much covers most of the opportunities at this stage. We expect 2014 therefore, to become much more strong for us in terms of our SBC simply because more than doubling and tripling our concurrent session capability will offer for us more segments in the market. We also see very positive developments in the developments of WebRTC. We believe that will help drive much of our enterprise session for the (inaudible) business. Again I’ll mention our Mediant 4000 Session Border Controls which is now (trying) substantially quarter over quarter.

And basically that pretty much is my presentation for today. And I’d like to move now the session to Q-and-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 & Company.

Andrew Uerkwitz - Oppenheimer & Company

You mentioned that your backlog was pretty good. What changed the visibility and why do you think the better visibility is sustainable into the back half of the year.

Shabtai Adlersberg

Again I think you pretty much talk to our diversified portfolio and solutions. Our ability basically to rely on opportunities coming from different market segments as I mentioned Unified Communications, Contact Centers, SIP Trunking et cetera. And then sell a combination of products and solutions, basically that gives a broad base for our ability to grow. And we mentioned April was also a very strong initial month in the quarter for us last quarter. So I think we will see that trend and basically if we look internally on those initial backlog trends that is the key reason. Also as I mentioned, we entering multi-year projects in Lync and other spaces and that basically translates into pipeline of purchase order on account of a single project throughout the year. So that gives rise to more initial backlogs in the quarter.

Andrew Uerkwitz - Oppenheimer & Company

One more quick one. You touched on your One Voice solution for Lync. I think, that’s a fairly new initiative. What’s been the general feedback from partners, customers, and at this point even though it’s early, is that meeting and exceeding expectations?

Shabtai Adlersberg

Actually we are very pleased with what we see so far. Seeing one vote of confidence is that at this stage as I have mentioned we have more than 150 different resources around the globe signing to that program. Basically, each project and I think, this is one of the reasons for us to move from mere product focus into a solution focus is that each deployment is very unique, in terms of its being deployed in every enterprise in a completely different infrastructure and combination of trunks and old equipment and PBS, et cetera. So the value for the customer at the end of the day, the enterprise is really much more in the conclusive comprehensive solution tying together all the different pieces of connectivity, the gateways, the session border controllers, the SBAs, the phones, the management system, the voice quality solutions. So our ability basically to provide complete solution, really give relief to the end customer and therefore that is valued sometimes even more than the product itself and that is basically why we would see that phenomenon.

Operator

Our next question comes from the line of Rich Valera with Needham & Company. Please proceed with the question.

Rich Valera - Needham & Company

Thank You. Question on your SBC revenue comments you made. Shabtai, you said you saw a path towards doubling the SBC revenue, is that in this year, year-over-year in 2013 versus 2012.

Shabtai Adlersberg 

No. What I said was that, we have been so far focused on the enterprise market and with the new software SBC an ability to deliver higher capacity, reaching 10,000 concurrent session and above and few more functionalities we will be able to create a completely new segment for us in the SBC markets which is the Access market and that basically will open for us in 2014 the ability to (a) continue growing the enterprise but even more important penetrate the completely new segment SBC markets for us which is the Access market.

Rich Valera - Needham & Company

You were suggesting sort of it’s more of a doubling of your TAM, your addressable market, is that what the comment was, I’m just a little confused by the comment.

Shabtai Adlersberg 

Yes, yes. The TAM definitely will more than double, the Access market is probably one of if not the largest segment in that market. And basically it will open for us a lot of [front pool] [ph] corporation with [after] [ph] telephony companies with voice moving into the cloud et cetera. So definitely we will see acceleration for session border controller sales in 2014.

Rich Valera - Needham & Company

Just a related follow-up on the software SBC. It sounds like that the driver of that R&D effort was to penetrate the access market, is that fair, just wondering, what’s sort of the end market driver of your software SBC initiative here.

Shabtai Adlersberg

Yeah. One of the consideration obviously is that, if you want to be deployed in data centers and sometimes in cloud infrastructure you need to become very flexible and standard products. Now, obviously in those installations standard servers from large companies such as HP and DELL and IBM and others or the key infrastructure and thus our ability to deliver very unique specific communication technology as a flexible software that can be customized and sized to the actual specific application really helps us, rather than having to come in with a proprietary hardware, that’s a much more difficult to scale and transport different needs of data centers and cloud infrastructure.

Rich Valera - Needham & Company

No, that makes perfect sense and just one more detail follow up there. So is your software SBC virtualized i.e. it’s actually running on a hypervisor do you plan to do that?

Shabtai Adlersberg

It is virtualized, since day one.

Rich Valera - Needham & Company

Okay, and can you say which hypervisors it runs on or is it getting too far on the [inaudible].

Shabtai Adlersberg

I would like to leave it. We will cover that and get back to you. But I know that right now we are basically running now on at least one virtual environment server.

Rich Valera - Needham & Company

Perfect. Thanks very much, and nice results gentlemen.

Operator

It seems there are no further questions at this time. I would now like to turn the floor back over to Mr. Adlersberg for any closing comments.

Shabtai Adlersberg

Thank you, operator. In summary of our call, I am glad to say to say that we just reported another good quarter for growth a fourth consecutive quarter since mid 2012. Based on current business outlook in early Q3, we believe we will exhibit continued growth in second half 2013 and build a sustainable and profitable operation for coming years. I would like to thank everybody who attended our conference call today and we look forward to have you on our next quarterly conference call. Thank you very much. Bye-bye.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines. And thank you for your participation.

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