Earnings Call Transcript - AUDC Q2 2020

Operator, Operator

Greetings. Welcome to the AudioCodes Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. I’ll now turn the conference over to Brett Maas with Hayden IR. Brett, you may begin.

Brett Maas, Host

Thank you. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President of Finance and Chief Financial Officer. Before we begin, I’d like to remind you that the information provided during this call may contain forward-looking statements related to AudioCodes’ business outlook, future economic performance, product introductions, plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future events, conditions, performance, or other matters. These forward-looking statements are subject to various risks and 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 global economic conditions in general and conditions 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, possible adverse impact of the COVID-19 pandemic on our business and results of operations and other factors detailed in AudioCodes’ filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information. In addition, during the call, AudioCodes will refer to non-GAAP net income and net income per share. AudioCodes has provided a full reconciliation of the non-GAAP net income and net income per share to its net income and net income per share according to GAAP in the press release and is posted on this website. Before I turn the call over to management, I’d like to remind everyone, this call is being recorded. An archived webcast will be made available on the Investor Relations section of the company’s website at the conclusion of the call. With all that said, I’d like to turn the call over to Shabtai. Shabtai, please go ahead.

Shabtai Adlersberg, CEO

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

Niran Baruch, CFO

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 discussing on this call. Revenues for the second quarter were $53.5 million, an increase of 8.1% compared to the second quarter last year. Services revenues for the second quarter were $17.1 million, accounting for 32.1% of total revenues. The amount of deferred revenue as of June 30, 2020 was $65.1 million, compared to $55.8 million as of June 30, 2019. Revenues by geographical region for the quarter were split as follows: North America, 41%; Central and Latin America, 7%; EMEA, 40%; and Asia-Pacific, 12%. Our top-15 customers in aggregate represented 60% of revenues in the second quarter, of which 42% are attributed to our 9 largest distributors. Gross margin for the quarter was 66.7%, compared to 63.3% in Q2 2019. Non-GAAP gross margin for the quarter was 66.9%, compared to 63.5% in Q2 2019. Operating income for the quarter was $8.8 million, compared to an operating income of $5.9 million in Q2 2019. On a non-GAAP basis, quarterly operating income was $10.7 million, or 20.1% of revenues, compared to an operating income of $7 million in Q2 2019. Net income for the quarter was $6.6 million, or $0.21 per share, compared to net income of $4.8 million, or $0.16 per share in Q2 2019. On a non-GAAP basis, quarterly net income was $10.5 million, or $0.32 per share, compared to net income of $6.8 million, or $0.22 per share in Q2 2019. During the quarter, the company raised $85.4 million in net proceeds from the public offering of 2.6 million ordinary shares at a purchase price of $35 per share. At the end of June 2020 cash, cash equivalents, and bank deposits totaled $170.4 million. Day sales outstanding as of June 30, 2020 were 51 days. Operating cash flow generated during the quarter was $10.7 million. Now to provide an update on our guidance, we reiterate our guidance for revenues for 2020 to be in the range of $214 million to $222 million. We are now raising our guidance for non-GAAP diluted earnings per share to be in the range of $1.18 to $1.24, compared to the previous range of $1.09 to $1.13 that we updated following the close of the first quarter 2020. I will now turn the call back over to Shabtai.

Shabtai Adlersberg, CEO

Thank you, Niran. We are pleased to report strong financial results for the second quarter of 2020. As mentioned earlier in the financial release, we experienced good business momentum during the quarter in both the enterprise and service provider segments. Team collaboration is currently at the forefront of enterprise communication platforms, largely due to the pandemic, which has prompted companies to enable employees to work from home and implement collaboration systems like Microsoft Teams. This shift has made such tools essential for maintaining business continuity and recovering from the ongoing crisis. Consequently, UCaaS as a cloud service and collaboration have become crucial to business resilience in the evolving digital workplace. Recent data from Nemertes, a global research-based advisory firm, highlights significant growth in collaboration usage over the past few months. They report that 42% of enterprises currently utilize more than one team collaboration application, and this number continues to rise. According to their findings, Microsoft Teams leads the market with a 14.3% share, followed by Cisco WebEx Teams at 27%, Slack at 9%, and Google Chat at 8.5%. Another study by Eternity indicated that from February 17 to June 14 this year, Microsoft Teams usage skyrocketed almost 900%, while Zoom increased by 680%. Additionally, a Globus study of over 545 organizations found that 91% now support remote work, up from 63% before the pandemic, and currently, 72% of the workforce is home-based compared to just 34% previously. Video conferencing has emerged as a fundamental technology for remote work, with more than 91% of companies currently using it to facilitate this. Nearly 30% indicate plans to conduct all meetings via video. As a result, we experienced growth across major market segments, including the U.S. market, contact centers, and service providers in all IP migration markets. Our financial performance in the second quarter was strong. Revenue growth remains on track with our guidance to achieve a 9% increase in revenue this year, with an 8.1% growth in the second quarter alone bringing the first half of 2020 to 9.9% growth compared to the same period in 2019. While we saw significant growth in SIP usage exceeding 20%, declines above 15% in gateway revenues and around 1 million in technology revenue constrained overall quarterly revenue growth to 8.1%. Service revenues grew by 3% year-over-year. However, considering the seasonality of quarterly service revenue and a reported 25% year-over-year growth in Q1, our average services revenue growth for the first half of 2020 stands at 13.2%. Regarding gross margin, we continue to focus on expanding our software products and solutions over hardware offerings, shifting the company increasingly toward a communication software model. Software products and related services account for approximately 35% of total revenue in the quarter, up from 25% a year ago, with a specific 50% growth noted in the second quarter compared to the previous year. This improved software mix contributed to a gross margin increase to 66.9% compared to 66.1% in the prior quarter and 63.5% in the same quarter last year. Operating expenses were significantly lower than anticipated, largely due to reduced travel, HR expenses, and favorable foreign exchange rates. OpEx fell to $25.1 million from $26.5 million in the first quarter, leading to an operating margin of 20.1%, a record for the quarter, compared to 15.2% in the previous quarter and 14.1% year-over-year. Net income saw significant growth as increasing sales combined with reduced operating expenses resulted in earnings of $10.5 million, up from $7.8 million in the previous quarter and $6.8 million from a year ago, reflecting a 54.4% year-over-year increase. Our cash flow remained strong with $10.7 million generated from operating activities, aligned with our annual plans. In terms of headcount, we saw a year-over-year increase of 4.4% for full-time employees, and combined with outsourced headcount growth, we achieved an overall increase of 5.2% year-over-year, adding over 40 positions, demonstrating our confidence in ongoing business expansion and future success. Deferred revenues also grew, reaching $65.1 million, a 16.7% increase from the second quarter of 2019. As noted in our previous investor call, we emphasize that the steady growth in revenue and deferred revenue enhances our ability to meet top line targets for the upcoming quarters. Reviewing our networking business, it grew 10.5% year-over-year, reaching $51.9 million, which now constitutes 97% of our business in the second quarter of 2020. The networking business has seen consistent growth, with an overall increase of 11% in the first half of 2020 compared to the same period in 2019. The networking line comprises two main segments: UC-SIP and Gateways. The UC-SIP segment grew significantly during the quarter while the Gateway segment faced declines. UC-SIP has now contributed nearly 70% to our business revenue for the quarter, supported by substantial year-over-year sales growth in OIC and MSPR product lines. Revenue increased in our central network management software and advanced routing solutions, while the IP phone segment remained stable year-over-year, which we attribute to a new normal affecting on-premises device sales. Significant growth in the UC business line surpassed previous expectations of 15%-20%, carrying a gross margin of nearly 70% and contributing to overall company growth. Conversely, the Gateway segment experienced a revenue decline exceeding 15% compared to the previous year, resulting in it now accounting for less than 30% of second-quarter revenue with a gross margin close to 70%. Regarding our performance in the Microsoft ecosystem, revenues grew about 20% after a strong first quarter, particularly due to increased opportunities in Teams. We've observed a significant drop in cash revenues from business-related areas and a slowdown in IP phone sales as organizations adapt to remote work setups, a trend we believe will continue. Initial data from Microsoft's investor call revealed that 69 organizations with over 100,000 users have transitioned to Teams, alongside over 1,800 organizations with more than 10,000 users. This indicates strong adoption at the enterprise level, clarifying why we see success in this domain. A survey conducted from February to June reported that Microsoft Teams grew from 11.4% to 34.3%, marking a 300% increase, while Skype for Business fell from 75% to 44%. Zoom grew 127% during this period, and Cisco WebEx increased by about 50%, while Slack saw a 33% growth, placing Teams at the top with over 300% growth. In our AudioCodes Live initiative launched in March, which involves delivering professional services for the Microsoft Teams environment, we continue to invest in advanced networking solutions to facilitate rapid user growth in Teams. We anticipate better support from Microsoft field sales to enhance the use of voice services concerning Teams as a positive catalyst for our future efforts. Notably, we reported over $80 million in product and service sales in 2019, primarily from Skype for Business, with only about 10% from Teams. The second quarter marked a significant shift, with Skype for Business experiencing a drastic decline while Teams surged, growing over 336% year-over-year and nearly doubling from the previous quarter. As we track our performance each quarter, we monitor two key indicators: the closure of sales opportunities and the creation of new opportunities. In the Microsoft space, new Teams-related opportunities doubled year-over-year, whereas opportunities for Skype for Business fell more than 50%. Now, let me highlight a few key projects from the second quarter. One example is a large North American food manufacturing company with 150,000 employees, a customer for seven years that has deployed Skype for Business with our solutions. They have recently started rolling out Teams, and in the second quarter, we secured a half-million dollar deal for a Session Border Controller for Direct Route, delivered in partnership with a significant value-added reseller. Another project involves a Fortune 500 packaging manufacturer using thousands of SIPs with Teams under a fully managed service, with our professional services contract exceeding half a million dollars. Additionally, we've partnered with a major Brazilian bank using our solutions within their Genesys contact center environment, where they've begun to roll out Teams alongside our products for building their Teams voice network—a half-million dollar contract secured in the second quarter. Lastly, we continue to support a large pharmaceutical enterprise that has transitioned from legacy IP PBX to Skype for Business and now Teams, generating around $3 million with this account and securing a Virtual SPC project for Teams in this quarter. Turning to the SBC business line, we anticipate a very strong year, projecting revenues to exceed $80 million in 2020, representing over 30% growth. Omdia's recent report highlighted a 24% year-over-year growth in our SBC revenue, positioning us second among enterprise SBC vendors with a 17% market share. This quarter set a record for the SBC segment, with revenues surpassing $20 million, marking over 10% growth quarter-over-quarter and more than 50% year-over-year, while maintaining a gross margin above 85%. We've observed strong activity in both service provider and enterprise sectors, geographically diversifying revenues with 36% from North America, 38% from Western Europe, and the remainder from Asia Pacific. Our software content within the SBC line has also increased significantly, moving from 26.8% to almost 40%, highlighting a shift towards virtualized SBC deployments in both public clouds and private data centers. In terms of new client contracts, we've engaged with a leading communication vendor in Asia Pacific needing a high-capacity SBC platform. Additionally, we secured a major e-commerce account that needed to transition over 10,000 customer support agents to work from home. This client has invested in our VoIP Gateways and SBCs, and the integrated WebRTC gateway differentiates us in the competitive landscape. We also see rising demand for contact center solutions for agents working from home, prompting us to develop superior quality monitoring and delivery capabilities. We're excited about our voice.ai gateway, which connects existing chatbots to voice and telephony channels, generating over 50 opportunities, with 20 relating to second-quarter efforts. Additionally, our collaboration with Google for the One-Click program aims to connect U.S. and U.K. phone numbers to chatbot developers, enhancing lead generation prospects in the growing chatbot market. As for our services division, bookings increased by 6.3% in the second quarter compared to last year, with professional services bookings growing over 40%. Finally, regarding our guidance, we remain confident in our revenue forecast for 2020, projecting between $214 million and $222 million. Additionally, we are raising our guidance for non-GAAP diluted earnings per share to a range of $1.18 to $1.24, up from the previous range of $1.09 to $1.13. Now I'll turn the call back to Shabtai.

Operator, Operator

Thank you. And our first question comes from the line of Tal Liani with Bank of America. Please proceed with your questions.

Tal Liani, Analyst

Hey, guys. Thank you very much for the comprehensive overview of the quarter. I want to ask you, I want to go back to basics and understand first of all within Microsoft. What's the current use of voice in unified communication? And what are the efforts done? What's the outlook for increased use of voice, because I understand that it's about unified communication and about Microsoft meetings, but it's more about the use of voice within the platform? So that's not number one? And number two, can you talk about your efforts with other players other than Microsoft meetings? And what can you do for other players? Thanks.

Shabtai Adlersberg, CEO

Okay. Tal, Sorry, I was on mute. Thank you, Tal, thank you. Regarding voice, voice is definitely probably one of the most important ingredients in unified communications. You know, when you run statistics, statistics say that voice is the most preferred medium of communication. Now Teams provides the voice capability for that internally. There’s no need for voice services outside of it. But, once you want to get a dial tone, once you want to talk with third-party organizations, you want to dial them, or get a call, you need to add voice services. That is on the connectivity side; very simple functionalities, sometimes very complex in terms of implementation, but essential to having a full, comprehensive, unified communications solution. However, I now think about the new world that's emerging. And that's the world that knows to process the content and knows to take voice content and produce results from it. So, if we were talking about virtual agents, if you want to save costs and provide a service substantially faster than waiting on the line for an agent, you now have technology that takes the voice part for that, and basically can apply speech-to-text, natural language understanding, machine learning, a few more technologies that will now take advantage of the content itself. So, connectivity is key to connect to other organizations. Content processing is key. Thus, voice is primarily a key technology within every communication solution. And that's the approach we take. Now regarding your question about collaborating with other organizations, we definitely try to do that. We have partners. I can name a few: we work for many years now with companies like 8x8, RingCentral, and Vonage. We have announced certification for Zoom; we have growing opportunities with Zoom in 2020. We have announced partnership with AWS Chime. So all-in-all, we're very active; we work with several legacy names like Alcatel. We also collaborate with companies in the contact center market, such as Genesys, along with two more of the leading companies in the graphics market. We try to widen our interactions, and we aim to work with more parties. However, at the end of the day, it seems that the majority of our growth and successes will depend on Microsoft Teams, which is obviously a very dominant and successful player in the market.

Tal Liani, Analyst

Great. Shabtai, I'd like to follow up on your first answer. Can you share how clients are responding to the analytics? What is the competition like in this area? I assume there are other solutions that can integrate with any voice company to offer analytics. What advantages do you offer that make customers choose you over others? And how are clients responding to your offering?

Shabtai Adlersberg, CEO

Right. We enjoy the fact that we are a well-known brand and established vendor and supplier in the enterprise world. So we have access to a lot of large enterprises I mentioned before, making it easier to sell to existing customers. Second, the company’s early establishment; being public for more than 20 years shows our advanced, sophisticated telephonic capabilities, allowing us to invest resources into projects that are important to us. We find ourselves preferable with customers, due to the strength of our brand and capabilities. All-in-all, one more data point is we note that products, when you take a standard product like a router, or firewall, it's tough to compete if Cisco leads the router market; other companies have a hard time to break in. However, with cognitive services, speech, text, and text-to-speech; you're discussing specific languages, and here the picture varies. We find ourselves being able to penetrate several markets simultaneously, thus, we're likely more successful because we possess the scale. If AudioCodes can sell to the U.S., Germany, U.K., Japan, and Australia, our capability to invest resources toward achieving results becomes substantially more effective than a smaller platform focused on just one market. So, overall, I think we're in a very advantageous situation.

Tal Liani, Analyst

Shabtai, I'm just going to squeeze in one little, one small additional question and that's for Niran. Your revenues were roughly in line for the quarter, roughly in line with expectations, but your gross margins were almost 200 basis points above. And your operating margin was a lot more, almost 400 basis points above. So first, what drives this great margin performance? And second, what's the sustainability? What's the outlook for the next few quarters; what are the puts and takes for margins?

Niran Baruch, CFO

Okay, so actually what drives the gross margin to 66.9% was mainly the increase in software revenue, which I already mentioned in the call; more professional services and all-in-all product mix benefited there. This quarter, we saw more revenues from SBC, which is in a high gross margin, and then less revenue is related to phones, which is in the low gross margin. We believe this is sustainable for the coming quarters and may even improve as we are selling more and more software revenues.

Samad Samana, Analyst

Hi, good morning. Thank you for taking my questions. Maybe one to start with on a follow-up on Teams is clearly outstanding. How much of that was Skype for Business customers migrating to Teams versus maybe organic net new Teams customers using voice? And then I have a follow-up question. Hello?

Shabtai Adlersberg, CEO

Sorry to disappoint you Samad on that. I really do not have the data with me now. I will look into it and I will provide the answer. But we've seen, I can tell you that we are seeing definitely a mix between Skype for Business customers and new customers, with some of the examples that you have already heard about using Skype for Business and moving. But I don't have the actual division with me right now.

Samad Samana, Analyst

Okay, that's helpful. And then maybe just as a follow-up to that. If you think about customers that are adding voice to Teams through AudioCodes, do they typically share any characteristics in terms of maybe the average size of the customer? Or is it usually a full end-to-end deployment? Or is it a phased rollout? How should we think about the ramp that individual customers have rolling out voice into Teams?

Shabtai Adlersberg, CEO

That's actually a very interesting question. In the past, when Microsoft was selling primarily Skype for Business, large companies always took their time to do a pilot, deploying it with several branch offices, and then continued the deployment on a quarterly basis over coming years. However, I think this is a completely different situation right now with Teams. Organizations are moving out of necessity; nobody has the time to wait for a prolonged deployment. Because actually there’s no deployment—I mean, we’re not talking about deploying Microsoft servers on-prem; you're talking about using a cloud service. So actually, you can think about companies going online with Teams all across the company, unless they want to first try it with a small group. So that’s regarding that; I'm sorry, your first question was Samad?

Samad Samana, Analyst

No you got them both, but just to get that rollout cadence. And maybe just one final financial question. Clearly, the earnings was a solid performance this quarter. How should we think about the investment philosophy for the back half of the year on expenses since, if I heard the guidance correctly, there isn't much change; the guidance was just reiterated. So is the upside planning on being reinvested or how should we think about OpEx trends going forward?

Shabtai Adlersberg, CEO

OpEx indeed decreased from a level of 26.5 million in the first quarter to 25 million in the second quarter. This was mainly related to decreased travel expenses and HR-related expenses. I could tell you that our planning for the second half of 2020 is to continue saving in these major travel and HR-related expenses. Moreover, we have a better FX rate, as the Israeli Shekel strengthens against the dollar. As such, we believe the OpEx will increase, but not by much compared to the second quarter of 2020.

Rich Valera, Analyst

Thank you. Shabtai, you've noted the conflicting dynamics in the Microsoft business with Skype for Business declining and Teams growing quite rapidly. How do you think that nets out for your year outlook perspective from Microsoft? And then taking that a level higher, UC-SIP sounded like its all very good growth overall. So how do you think about kind of UC-SIP outlook for the year? Do you think that's kind of a 20% or better growth business overall for the year? Thank you.

Shabtai Adlersberg, CEO

Thank you, Rich. Yes, that is indeed a very interesting question. As I've mentioned before, take our 20 plus revenue for the second quarter. One more data point is that Teams and Skype for Business were basically around the same level, give or take a million. Now, the real question is how fast Skype for Business declines, as purchase orders or Skype for Business-related equipment decline versus growth in Team. We anticipate a very strong pickup in Teams. I'm confident that at least based on data we have today, the growth in Teams will continue to outpace the decline of Skype for Business. Also, let's bear in mind that every time a business line is dropping, the majority of the drop occurs in the initial phase, and then it stabilizes. So all-in-all, we're pretty confident in our abilities to keep growing Microsoft revenue for the rest of the year, and we believe we will see continued growth next year. I’ll also mention that we are continuously trying to increase our new products and services offered in that environment. So indeed, our offerings for Skype for Business were modified over the years gone by, while on the other hand, we're making greater investments in new offerings and opportunities for Teams. That said, we believe Teams will be fully successful. Yes, definitely. Services essentially has two components. One is the maintenance contracts, and the other is professional services. Maintenance contracts typically increase over the years at a rate of between 11% to 15%, and we believe we will see the same trend this year. I mentioned already that if you take into account the first half of the year, the growth was at 13.2%. However, there's another component, which accounts for professional services, and here, I think the picture is substantially brighter. We are growing significantly in this area. There’s much need, required, by the way; philosophically speaking, while companies may be productive and efficient, implementing new large projects becomes much more challenging when teams are distributed all over the place. You can assume that the desire to utilize more services from a provider is undoubtedly increasing. Therefore, we believe that professional services globally will become a much more successful area for deployment. This is where we will focus our efforts.

Operator, Operator

Thank you. We've reached the end of the question-and-answer session and now I will turn the call over to Shabtai Adlersberg for closing remarks.

Shabtai Adlersberg, CEO

Okay, well thank you operator. I would like to thank everyone who attended our conference call today. With continued good business momentum and execution in our markets in the first half of 2020, we believe we are on track to achieve another strong year of growth in our business. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.

Operator, Operator

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