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AudioCodes Ltd. (NASDAQ:AUDC)

Q3 2012 Results Earnings Call

November 5, 2012 9:00 AM ET

Executives

Erik Knettel - Investor Relations

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 Third Quarter 2012 Earnings Conference Call. It is now my pleasure to introduce your host Mr. Erik Knettel, Investor Relations for AudioCodes. Thank you, Mr. Knettel you may begin.

Erik Knettel

Thank you, Jessie. I would like to welcome everyone to the AudioCodes' third quarter 2012 earnings conference call. Let me begin today with the 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 disruption 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 for third quarter 2012 conference call. With me this morning is Guy Avidan, Chief Financial Officer and Vice President for Finance. Guy will start off by presenting a financial overview of the quarter.

I will then review the business highlights and summary for the third quarter. I will report on progress made in our restructuring plan and then discuss development in our business and industry. We will then turn it into the Q&A session. Guy, please go on.

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 third quarter non-GAAP pro forma results reflect adjustment for the following two non-cash items, stock-based compensation expenses which totaled $407,000 and amortization expenses relating to the acquisition of Nuera, Netrake and CTI, which totaled $282,000.

The full reconciliation of the non-GAAP pro forma 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 third quarter results are in line with our previous revenue guidance discussed in our conference call dated July 24, 2012 and includes significant progress towards our plan to reduce annual operating expenses, that announcement issued on July 11.

As announced in July, the restructuring plan is expected to generate estimated annualized savings of approximately 10% of company's operational expenses. At the end of the third quarter, we managed to reduce headcount by 7% compared to the end of the previous quarter. The implementation of the plan is expected to be completed in three to six months during the period of the plan, we will monitor closely our business trends even hire selectively in our growth areas.

In addition to the cost saving components of the restructuring plan the company continues to focus its investments in innovations around AudioCodes' key strategic initiatives in the area where unified communication, enterprise communication, and business services.

Third quarter revenue now $31.4 million, which represents 1.1% increase from the sequential second of 2012. Aside from some headwinds, we experienced during the quarter in our Technology Group and OEM business, we did see solid demand for our Core Networking Equipment Group business especially in the unified communication and contact center market.

Geographically, as a percentage of revenue, sales in Americas accounted for 50%, Europe, Middle East and Africa 34%, and Asia Pacific 16%. Revenues associated with our Manage and Technical Services business line was approximately 17% of total revenue or $5.4 million in the third quarter of 2012.

Managed Services provided recurring revenue driver, which helps further by an AudioCodes high value relationship with its customers. Our top 15 customers accounted for 53% of our revenue compared to 46% in the previous quarter. In the third quarter, we added a single distributor in North America that accounted for 13% of revenues compared to 11% in the previous quarter.

In terms of revenue by business group in the third quarter our Networking Business Group accounted for 81% of revenue and our Technology Business Group accounted for 19% of revenue compared to 80% in our Networking Business Group and 20% in our Technology Business Group in the second quarter of 2012.

GAAP net loss for the third quarter was $1.1 million or $0.06 per share a decrease of $581,000 versus the year ago quarter, while GAAP net loss improved $927,000 sequentially.

Non-GAAP net loss for the third quarter was $419,000, or $0.01 per share, a decrease of $693,000 versus the year ago quarter while non-GAAP net loss improved $993,000 sequentially.

In the third quarter of 2012 on GAAP ratio the gross margin was 66.8%. Non-GAAP gross margin was 57.5% and compared to 57.5 on a GAAP basis 58.2% on a non-GAAP basis in the previous quarter. The 17 basis point erosion gross margin this quarter is predominantly attributed to a higher than usual inventory write-off.

GAAP operating expenses were $19 million compared to $19.6 million in the second quarter of 2012. Our total non-GAAP operating expenses were $18.6 million compared to $19.2 million in the second quarter of 2012.

Headcount declined this quarter by 43 employees, which brings us to a total 593 employees. A decrease in the [select] implementation of our global operating expenses reduction program, short-term and long-term cash balances were $54.1 million compared to $60.7 million as of June 30, 2012.

The decrease in cash balances is mainly attributed to financial activities including non-payment and the repurchase of Treasury stock as well as the decrease in payable deferred revenue as well as the quarterly net loss.

Net cash used for operating activities was $1.2 million this quarter compared to net cash used of $4.6 million and net cash use of $405,000 in the third quarter of 2011. DSO came in at 78 days compared to 80 days last quarter.

While we expect demand for our new products and solutions to grow at a double digit compound annual growth rate over the next three to five years, were still affected by decreasing demand in our technology products.

We are forecasting that revenues in the fourth quarter 2012 will be higher than third quarter revenues, and the company will return, to a non-GAAP operating profit in the fourth quarter head of our initial plans.

As for our share repurchase program, originally announced on October 3, 2011, we would like to inform you that during the third quarter the company will repurchased approximately 1.3 million shares of common stock at aggregated cost of $2.5 million.

As of October 1st, 2012 AudioCodes successfully completed the authorized stock repurchase program having repurchased 3.96 million shares through the program since its inception at an aggregate cost of approximately $10.7 million.

And with that, I will turn the call back over to Shabtai.

Shabtai Adlersberg

Thank you, Guy.

Very pleased to report we've turned to sequential growth and improved financial performance for the third quarter of 2012. Key business performance improvement indicators for the third quarter include, among others the following: first, we are delighted to reverse the trend in the top line revenues from a series of declining revenues – this is the first quarter, which is increased in revenues, we believe that's not the only one coming from it.

For the first time we have exhibited growth in revenues which changes even more attractive when we take into account that we're talking about the summer quarter which traditionally is weaker than the other quarters in the year.

Second indicator is our ability to lower quarterly loss substantially, to $1.4 million in the previous quarter to around $400,000 in the third quarter. In fact, taking into account the impact of our restructuring plan, we have good reason to believe that even if plans for Q4 growing revenues will not materialize we will be able to show operational profitability in the quarter, as we plan for further growth, we believe that our return to profitability in Q4, is on the right track.

Third indicator - our ability to reduce our OpEx, headcount and have better cost control all that with a post [figure] operational business improvement in Q4.

Key driver to the success in delivering into the results during third quarter, are three key fundamental drivers. First, in [few owners] the company has enable to [plan it's] and focus and converge, our growing market segment. Focusing investments in recent years growing markets and applications such as the unified communication market, contact center market, and the move to IP based contact centers and business communications services, (inaudible) represents, all those segments represent sustained solid demand for products and solutions in our areas.

And the growing shift to cloud computing which further accelerate that, so we're looking at the very healthy demand cooperator. Second, is the very good pick up in activity in thrust in two of our leasing business lines, in the networking business for years we've been investing and developing the SBC and the MSBR.

New lines side by side is the current communications lines, since third quarter we have seen substantial increase in sales of SBCs and MSBR. In both areas, we introduced new products, I'll talk more about that, those product continue with much to the growing number of actual wins in the quarter and those were we've been able to increase shares and results going forward.

And again coming back to the restructuring plan and to cut back and cost control which is the determined approach, we think which addresses the plans, this is what we have implemented more than 70% of the plan and this is where we are, business diverse a very solid basis going forward.

During Q3, we started from a very week August, but September came very strong. September was a very strong month, in terms of designing and sales. We have seen the same trend in October, so the in Q4 is one of the best we had in several quarters now [actually].

In the quarter we've seen growing number of markets of things related to opportunities in many regions, most probably in North America, and we have also maintained good cooperation with members of the Lync [for management] here is in Microsoft. We also had some very good success in the contact centers market, related to activities with Genisys Asia Pacific seems to be growing very nice, we see a lot of activity in contact centers deployed employee there and we've been able to take far significant - some of the last design wins that region.

One new product that we introduced in July the Mediant 2000 SBC has made a dramatic change in our ability to serve session border controllers. That to give you Q4 best market the enterprise session border controller market, (inaudible), it's about $160 million this year, but is predicted to drove more than $200 million in three years from today.

Now the majority of that market is being services by session border controllers with the range of session capacity that spans around few hundred, and up to 2003 begin basic level being lacking some of the higher densities in the past, the introduction of the Mediant 2000 in July and we have with new session border controller were leased plan basically drove much success very fast ramp up in the new wins fulfills in Q3 and we believe that we will see continuation of that trends in coming quarter like what we've mentioned that in the new market study that [in France] issued in October about a month ago, AudioCodes was named #3 in that market lack of the term [ACME] packet and we've been able to growing market share from 5% to 6% in the past six months.

So that's for the session border controllers. At the same time we've introduced a new Multi-Service Business Router, the Mediant 850, again we are catering to our those service provider deployment, where the ability to provide state-of-the-art combined media gateways session border controller and routed function in a single ancillary unit that it is desirable and the ability to support advanced Voice services such as Lync compatibility and few more functionality becomes very important.

We've announced a major win with (inaudible) usually leading service provider that asked us is that we've been competing against the top-tier players in that market, you know the names among of them is Sony-Juniper and others, and I think that win is a vote of confidence to the path of technology we've arranged market.

We do have plans to introduce more products going forward so stay tuned again this product has been a very important in terms of ability to drive new business in networking SBC and MSBR.

When you have had that you've seen much interest in the market is the area both quality and service assurance. As Voice traffic grows over IP networks and those – like everybody in the industry understand those networks have been primarily been designed to handle data network and to be able to give data throughput nothing necessarily to support three times voice and video functions, it would become quite important to the others to monitor voice quality to identify presence in the networks to be able to such, features and attachment to them. And we've seen a lot of interest in our specialist experienced manager product and services around that. So that would be another key driver for our growth going forward.

Okay, so for our business focus, we continue to focus on our enterprise and business services go to market. We've been very successfully growing a solid network of distributors, channels in North America in places we will be developing more emphasis on not only going through the channels but also on operating some direct touch and touching some of more renowned names, [logic operators] that would drive service sales.

We are being basically pushed I would say by our customers in clients to provide more than just a product set we are basically being pushed to be more to voice access to provide an end-to-end core solution. And when I'll come to talk about Lync which service that the very broad portfolio of product we bring to market makes our acquisition a perfect product for our end-to-end solutions, the world's seamless touch quote when we announced our work with Microsoft Lync to certify our IP phones at that time we've made then by Microsoft product manager.

We are investing primarily in partnerships, we've worked very closely with some of the leading clients and that will assure more and more success. We've discussed many times for our collaboration with – we're doing the Microsoft Access systems, Genisys, Avaya, (inaudible) Siemens, and few other large companies. That's the basic that we drive our business going forward.

On our activity where the Microsoft Lync we've seen very good quarter, a lot of activity happening in new opportunities, at this stage that occurs represents the most comprehensive services itself required for Lync, that includes Media Gateways Session Border Controllers, survivable branch office appliances, IP phones, element management, quality of service management and services. We are a growth partner of Microsoft, we have worked with some of the Fortune 1000 known names, among them Earnest and Young, RadioShack, Ebay, Honeywell, and few more.

We do line up that very closely, with some of Microsoft's gathered some bigger players, among them AT&T, workers from Global Services, and Dell, HP, to name a few. One more success we had I the SBC, MSBR, in our front-end specialties, and we've tried much of the activities going forward. I'd like to mention too that we will be active in much more in the mobility market, enterprise mobility we had a chance to ask Mobility [BX] capability in very evidence to bring on the right trend is very known and we will see much activity in that front.

And one more piece of growing agents for us will be the IP phones, we have been investing in the three or four years in IP phones, we make some transitional which will make them more attractive in certain environment and we believe that in 2013, we'll see much growth in the area.

To touch on some of more instances that we open for going forward in driving in 2015, going forward are the VSP capability, the insurance [cutting] solutions, think will be very key, high-definition res is catching up very nicely, in many areas, we'll see that in over-the-top type of solutions. In both our LED markets and again our investments in money for growth in providing solutions and to shift to cloud computing and visualize type of product type of trend that we will follow.

That's my introduction for the call and we will now go for the Q&A session. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Thank you. And our first question comes from the Andrew Uerkwitz with Oppenheimer and Company. Please proceed with your question.

Andrew Uerkwitz - Oppenheimer and Company

Hey, great thanks guys for taking my question. Since that around Microsoft Lync. Are you seeing more from synergies - you're seen more enterprises adopting the voice feature for that or that's top pretty low percentage and then just from the general enterprise perspective how do you turn up or see the drivers got in the next years they are going to be clear this small businesses or either it's a mid size kind of driving the growth.

Shabtai Adlersberg

Okay. In terms of Microsoft Lync of opportunity, I would tell you that the growth we are planning for the level of voice project activity looks good enough and sufficient. We know from some of our work with the largest some of our working clients is that it's an integrating that a large project - these large enterprises will start to kick in next year.

We have at least two to three such projects that we are working on the initial stages right [focused concepts] according to clients known to us we will see in 2013 deployment in large enterprises so it's a gradual process I would, basically also know that for us we care much whether it would be close voice in the initial stage or we will be close voice at a later on edition. But any company that has started to use Lync for a time I presence, is as such that, the functionality will be enhanced to include voice is high and that will happen in the course of next year. So all I all those are good opportunities for us.

If I have heard correctly your second question related more to the larger enterprises right?

Andrew Uerkwitz - Oppenheimer and Company

Sure, yes.

Shabtai Adlersberg

That's so, basically activity versus these large enterprises integral to our large system integrator partners and we're working with few of them we have to and been inactive, we now see in other one. We do believe that there's a much, there's really confidence level, that enterprises basically developed with type of solution and I think again our drive become with a complete end-to-end solution, meaning we take responsibility and charge for our voice parts makes up a sensitivity because it's allowed the customer to be much more confident that in that - in the Lync solutions for Microsoft and on the other end our ability is to provide directly to the mid-market or the large integrators to the larger enterprises at the end of the day, an end-to-end solution approach makes sense and we will have to move that further along.

Andrew Uerkwitz - Oppenheimer and Company

Hey, great appreciate the color thanks guys.

Shabtai Adlersberg

Sure.

Operator

(Operator Instructions) Our next question comes from the line Rich Valera of Needham and Company. Please proceed with your question.

Rich Valera - Needham & Company

Thank you, good morning. Question on operating expenses levels [audio gap] gross margin to be back up into that sort of 60 – 50ish percent range of 59 once you are back from normalize write-down level?

Shabtai Adlersberg

Generally, yes, we expect in Q4, we expect to be back on the Q2 level, which was 58.2% on a non-GAAP basis.

Rich Valera - Needham & Company

Actually that's helpful. And then bigger picture looking at your networking business, granted you've had obviously with the technology business rolling off which you should have acknowledge its legacy, but networking has been down pretty significantly for rather few quarters, and just wanted to understand that other components of that, I know some things sound like they're still growing you mentioned SBC and few other noteworthy - high growth areas but what the different components of networking maybe what's been dragging it down recently and when do you think those components turnaround and actually start growing again? Thanks.

Shabtai Adlersberg

Right, so basically this quarter, we have not mentioned that specifically but networking related sales to grew 2.3% over Q2. Now in terms of the bigger picture, we have seen at the beginning of the year decline in some of our Media Gateway business in two key areas, one was specific one OEM collaboration with a large player in the carrier VoIP market, which after many years working together. We believe that their revenues went down and therefore our revenues went down. So high-density media gateways that is something that one specific customer we lost. Then we saw also in the beginning of the year, declining our Government business.

Now when we go to the other side feature of we're – what has driven networking sales higher this quarter, basically it's mainly two types of areas, one is again the cooperation is will or - is upon us that increase the sales of gateways NBCs and Survivable Branch Appliances SBA in their solution, meaning Microsoft [Genecity] et cetera.

Second is that three specific business plans, the SBC, the MSBR, and the IP phone, are witnessing growth. And therefore going forward into 2013, we will see some – we don't see much change in the media gateway business, which we roughly predict to be about flat. We will see definitely a substantial growth coming from SBC, MSBR and IP phones.

Rich Valera - Needham & Company

Great, that's helpful. And then try and give any comments on the momentum in the business, sounds like in your prepared remarks that you had a strong finish to Q3, and a good start to Q4, which would certainly I think lead you to conclude – you're probably going to be up in Q4, so just wanted to get a sense of your confidence and the visibility towards being up in Q4, given that strong start to the quarter.

Shabtai Adlersberg

Actually, you've said it yourself. We had good September, similar good October, and we've have a size backlog that's been developing in the beginning of the quarter, we have high level of confidence that we should be able to growing revenues in Q4.

Rich Valera - Needham & Company

Okay, that's helpful. Thanks Gentlemen.

Shabtai Adlersberg

Sure.

Guy Avidan

Thanks, Rich.

Operator

And at this time I would like to turn the floor back over to management for any closing remarks.

Operator

Okay, thank you operator.

Shabtai Adlersberg

In summary of our call, we look forward to continue to grow networking business in coming quarters and the years and follow-on the momentum in growing distinctly the markets and industry. I'd like to thank everybody that attended our conference call today and we look forward to have you on our 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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