AudioCodes Ltd (AUDC) 2004 Q2 法說會逐字稿

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Good morning, my name is [indiscernible], and I will be your conference facilitator.

At this time I would like to welcome everyone to the AudioCodes Second Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS] Mr Knettel, you may begin your conference.

Thank you.

I would like to welcome everyone to the AudioCodes second quarter 2004 conference call.

Let me begin the call today with a brief Safe Harbor statement concerning AudioCodes’ business outlook for future economic performance, product introductions and plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future event, conditions, performance or other matters.

These are forward-looking statements, as that term is defined under US Federal Securities law.

Forward-looking statements are subject to various risk, 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 effects 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 continuing product demand, the impact of competitive products on 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 and other factors detailed in AudioCodes filings with the Securities and Exchange Commission.

AudioCodes assumes no obligation to update that information.

Joining us today from AudioCodes, we have Shabtai Adlersberg, Chairman, President & Chief Executive Officer, and we have Nachum Falek, Chief Financial Officer.

I would now like turn the call over to Mr. Adlersberg.

Please go ahead.

Thank you, Erik.

Good morning and good afternoon everybody.

I would like to welcome everybody to our second quarter 2004 conference call.

With me this morning is Nachum, our Chief Financial Officer.

Nachum will start off by presenting a financial overview of the quarter.

I will then take it from there and expand more on the business highlights and the market trends that we have experienced this quarter, and I will provide our guidelines for overall 2004.

We will then turn into the Q&A session.

Nachum.

Thank you, Shabtai.

In the second quarter, revenues were $19.1m, which represents a 25% increase from the last quarter.

Gross margins were 57.9%, compared to last quarter, 57.4%.

The improvement in gross margins was due to higher sales volumes and favorable product mix in the quarter.

Operating expenses increased from the first quarter level to approximately $10.5m.

The increase consists of two key elements.

The first one relates to the consolidation of Ai-Logix’s results as of May 12, and the second relates to growth in R&D and sales and marketing expenses at AudioCodes, reflecting increased investment in customer-related development activity.

The increase in operating expenses was in line with out expectations.

Head count increased this quarter by 67 employees, which brings us to a total of 409 employees.

Growth in number of employees relates to adding 48 employees at Ai-Logix and recruitment of 11 employees that were previously employees on a temporary basis, and 8 new positions.

AudioCodes reported a net income of $839,000 of $0.02 per share.

Short-term and long-term cash balances were $90m compared to $100m last quarter.

The decrease in cash balances is attributed mainly to payments related to Ai-Logix [indiscernible].

DSOs came in at 48 days, compared to last quarter, 50 days.

Our guidance for the third quarter is as follows.

Based on our visibility at this time, we forecast revenue for Q3 to be around $22.5m, and we forecast EPS of $0.03, based on approximately 44m shares.

I will now transfer the call to Shabtai.

Thanks, Nachum.

The quarter has been very strong, actually, one of our best quarters so far.

To touch on the business side highlights of the quarter, we have been able to grow revenues by 25% quarter-over-quarter.

This is the second time in our history that it is growing that fast.

On a yearly basis, we have grown more than 80% year-over-year on the quarter.

The fastest growing market segment for us in terms of sales has been primarily sales of [indiscernible] products, and in this space we sell primarily through Nortel.

We have been very successful in improving our CPEs and Digital Gateways, and sales of VoIP communication also has been very successful.

We have been able to achieve after a long time, an operating income of about $0.5m, a net income of about $800,000.

In addition, this was the second quarter in a row that we have been able to show net positive cash flow.

In terms of our backlog, we enter in this quarter, the third quarter, with a very strong backlog, again, better than previous quarters.

It has been quite nice.

This time, we are entering with a backlog that is nicely above 60%.

Now, the area that has improved for us is visibility into our customer purchases.

Visibility is still not back to where it was back in 1999 and the year 2000, but, at least, in terms of quarters, we now see more than a quarter ahead.

In terms of the markets we operate in, we have been very successful in continuous growth of sales through our partners.

At this stage, substantially, Nortel and 3Com.

With both companies, we have engaged both on active sales into the field and further product development that will provide increased revenue, we believe, down the road.

Sales to the carrier space this quarter increased primarily through sales of high-density VoIP communications boards, digital and analogue city gateways and [indiscernible] products.

We see very strong [utilities] carrier activity in the telephone market as a result of embracing VoIP for deploying voice services, and we see that mainly in developing countries.

Still, some more prominent ones are [indiscernible] areas or regions, or Latin American and Eastern Europe.

One area that has increased substantially in our activities response to [RFPs] with carriers in many area, mostly for tracking gateway and city devices.

In terms of our mix of sales between the carrier space and the enterprise, this quarter, AudioCodes, and I am including the fact that at this point Ai-Logix, the mix has increased to 70:30 in favor of the carrier space.

This is us [this quarter], this was at 60:40.

I would like to highlight two continuing strengths that make our growth trunk.

One is the openness and willingness of OEMs to look further into our products and embrace them as part of their portfolio.

So, we add continuity evaluation for our gateway technology and performance, and that has included new OEMs.

OEMs, basically, are more open to a collaboration at this stage.

We have increased activity in the [wired LAN].

We have some designs that we have been able to make.

In the cable space, we also gained CableLabs qualification this quarter, and also 3G is being delayed to 2005. [I think we’ve seen] increased activity with the large [NECs] [indiscernible] prepared for when the market operator.

We believe that in the second half of 2004, we will sign one more OEM agreement and we believe that we are becoming more and more a common choice for [indiscernible] in developing countries for [indiscernible].

As a result, we will be investing substantially in increasing our channel development activity and on signing joint system integrators in developing countries.

In support, all the activity will be OEMs and to some integrators, we will continue to grow our investment in R&D.

At this stage, we have more than 200 people in our R&D and we will keep up our [indiscernible] of the program.

That is how we will be able to differentiate ourselves.

Again, we believe that in the industry we are probably one of the few companies having that large map of R&D resources put into this field, and we believe that will create a differentiating edge for us.

All in all, we believe we can make a very sound company infrastructure that will enable growth into the future.

In terms of our business plan focus, we will primarily focus on three areas, the low- and mid-density gateways, the [indiscernible] market and the VoIP communication boards.

To expand a bit more on the gateway opportunity, right now we have focused on the low- and mid-density area.

We believe that we will start playing more on the high-density area in 2005.

All-in-all, we are looking into an opportunity that this year, including enterprise and carrier, is just below $800m according to [Synergy].

It should grow to $1.2b in 2007.

However, our focus is primarily much more on the carrier space, and there because it is much more appealing.

Synergy estimates the market this year in 2004 to be around $290m, and that should grow to $650m in 2007, a growth of 125%.

The other area we feel very strong is the Media Server market.

Here, we are talking about a more niche market and more complex processing which is [indiscernible] for us.

The market today is around $35m.

We believe we will capture at least 30% of it through [indiscernible] of sales with ongoing efforts to increase our products in that space, and that space will present for us an opportunity of holding $200m in 2007.

Roughly with the Mid-Gateway market growing at a rate of 40% annually, and us being able to grow at much lower [indiscernible] rates on an annual basis we believe that we continue to pick up more market share, and we should be ale to continue to grow in this growing market.

All-in-all, we are strategically positioning ourselves to a very strong and leading position in our markets.

The amount of investment that has to be done in order to penetrate those markets is very high use of the complexity of the Gateway and Media Server technology, and due to the fact that [indiscernible] keeps evolving.

And we believe that customization will take place and we will remain one of the few leading companies continuing to invest in these [indiscernible] markets.

We believe that that situation will continue and, therefore, we will be looking into more M&A opportunities, the small and private companies [indiscernible] continue and prosper in that area.

In regards to Ai-Logix, we got completely the acquisition this quarter.

The second quarter of 2004 has been better than expected for them.

They are profitable at this stage.

We believe that they should be able to grow beyond their original plan of growing 30% in 2004, and between two entities in the company, the VoIP communications boards in Ai-Logix, we expected to work on realigning our product lines will become [indiscernible].

[Indiscernible] growth into 2005, again, we would like to plan on an organic growth of at least 40%-50%, but we do believe that we have a very unique opportunity to grow beyond that, again, using M&A activities.

So, we will continue to invest our resources into creating more opportunities in our strategic clients, meaning Gateways, Media Servers and Boards.

Complete this overview in terms of guidelines for the rest of 2004, we will outperform our original plan for 2004.

We will grow about 70% on top line year-over-year, [indiscernible].

We plan on continuously improving our gross margin on a quarterly basis, [toward] high 60s, mainly due to a more favorable product mix.

We believe that we will achieve net income of 10% by year-end.

This far, we have done 2.4%, and we plan to achieve 15% net-- I’m sorry, operating income, by mid-2005.

All-in-all, we are positioning to a profitable operation earlier than expected, about one quarter at a time and, as a result, we should see earnings this year somewhere between 8% and 10%.

That is my overview.

Now, I turn it over to the Q&A session.

[OPERATOR INSTRUCTIONS] Our first question today will come from Carter Driscoll of IRG Research.

Good morning, gentleman.

Sorry, should I say good afternoon.

Congratulations on a very strong quarter.

If I may, a few questions.

First, can you break out at all the contribution from Ai-Logix?

I know you talked about further integration going forward and it might not be possible on the latter half of this year, but could you at least break out what you think they contributed in the second quarter and maybe highlight what they might contribute for the balance of 2004?

Are we still on top line?

Hi, Carter.

We will not breakdown Ai-Logix separately, and starting this quarter, we will report Ai-Logix revenues as part of the top systems product lines.

And this quarter the systems product line was 39%, up systems 50% in [indiscernible] accounts, so 11%.

And our geographical sales mix was 61% in North America, Europe 12%, Asia Pacific 17% and Israel 10%, and we had one customer above 10%.

Okay.

Okay, maybe just to add top of that, just to make it clear, again, as Nachum said, we will not breakdown, but I will just say that we continue to grow internally on spend error [indiscernible] rated with before this [indiscernible] 10% and above, and, as I have mentioned before, Ai-Logix did better than expected.

Okay.

Have you at least changed your assumptions about what their contribution might be?

Could it be higher for 2004 than you had originally guided, I guess, to $8m-$10m on the top line?

Could you at least comment on that?

Yes, basically, I think it should end up 2004.

If not better, then at least on the high end of this range.

Thank you.

Your inventories spiked a little bit.

Can you comment at all?

As far as I can tell, they grew about 36% quarter-to-quarter.

Could you at least break down what form they currently reside in and whether this was a planned expansion, obviously given your very strong guidance?

Yes.

Basically, I think we are looking into ramping [quarters] going forward, and when we are growing on 25% on quarter-by-quarter basis, our inventory needs to be billed that way.

Even more, two more phenomenons -- one is that lead times today from certain semiconductor companies get to be longer, and we should be adjusting those components just enough to get caught in not being able to deliver.

The second is that once we start to work with large companies such as Nortel and others, when they enter in your field and/or forecast not only for the coming quarter, but for the quarter beyond that, we need to cover ourselves for more purchases.

I think only now we should see a big increase in inventory going forward, that is compared to the quarter a year ago.

Do you anticipate at least a leveling off of the inventories, or a least a slowing in the growth rate and the back half of this year?

Hard to say, at this stage.

We will take your note.

We will make our calculation.

I guess we will come back to you with-- If we would like better analysis of what percentage of our going-forward revenues the inventory will look like.

But, all in all, I think we have been a bit above 50% and we should continue to see that going forward.

And again looking at next quarter we have plans for $22.5m of sales.

That means that inventories, as you say, should cover more than 50% of that, meaning above $11m-$12m a quarter.

So, all-in-all, I believe the inventory is in good shape and even [indiscernible] to support our next growing sales.

Just last, if I may, I know you [indiscernible] in- -given, particularly, you think you are likely to win in terms of that OEM in the back half of this year, could you at least comment, likely to be on the waterline side, or could we possibly see a substantial win on the cable or possibly the wireless side?

We talked about wireless activity.

It is not an issue of winning, it is an OEM that we have been shipping with in the shipping with in the past, and now both parties see the need frame that in an [indiscernible].

[Inaudible] It is more a question of declaration or of when you actually announce that relationship then, whether you have secured that one, obviously.

Yes, and we are designing at this stage.

Great, thanks very much, gentlemen.

Congratulations.

The next question comes from Randy Rosen, Oscar Greaves.

Hi, guys.

A very good quarter, nice, as well.

I have a question regarding the market opportunity in the North American market, especially when you have strong relationship with Nortel, and also when the cable operators are investing heavily on most of VoIP equipment.

Can you, Shabtai, maybe discuss that a little bit?

Sure.

Right now, we believe that most of the opportunities in 2004 and feel, at least in first part of 2005, we will lie [indiscernible] LAN market.

Basically, we see both facilities carriers and ILECs deploying more VoIP.

The alternative carriers are more on most of the system [CTs] side, and some of the carriers, the large ones, are providing services to the enterprise through [indiscernible] solutions against CT devices.

We are designing at this stage into any wireless projects, and more designing in North America, and as far cable goes, we are increasing our efforts in this space, but I, my belief, is that we will not see any substantial sales of cable before the second half of 2005.

Beyond that, we are active in cable in Europe.

We have some few designs and one very nice and [indiscernible] design means based on [indiscernible] cable [indiscernible].

Nachum, two questions for you.

Any 10% customers this quarter and also what was the cashflow from operations?

We had one customer above 10%, and in terms of cashflow from operations, it was positive this quarter as it was last quarter.

We have already two quarters in a row of positive cashflow from operations.

And how much of it?

We do not break it down in terms of each quarter, only on an annual basis.

Okay, thank you.

The next question comes Jonathan Half of UBS Warburg.

Thank you.

Hi, good afternoon.

Nachum, I just want to get some clarity on some of the comments you have made.

Firstly, regarding the visibility improving, I believe you said that you seek beyond- -or you have view of visibility beyond one quarter.

Can you tie that in with your usual remarks regarding the backlog coverage?

I believe last quarter was above 60%, if I recall.

Yes, okay.

Two different things.

When we are talking about backlog, we are referring specifically to the core we are at.

So, when I said we are nicely above 60%, I was referring only to the first quarter of 2004.

In terms of visibility, it means that not only we have backlog for Q3, but we are starting to see better backlog piling up for Q4.

Okay, so for Q3, right now, you are backlog is above 60% of the guidance?

Yes.

Okay.

Now, in terms of the growth rates you gave, I think, if I heard you correctly, you said at least 70% growth this year.

Even though I have over 80% growth, I believe, on my numbers, and I think given the guidance that you gave in your results today, I am just trying to figure out if that is- -if I am miscalculating something, or is there some seasonality?

I am just trying to figure out what the number should be for the year because it does not add up.

Right, we are not providing overall guidance for 2004.

All I have said, is looking into the guidance we provided for this quarter and on just on looking ahead for the fourth, I said that we should see revenues about 75%.

You can, maybe, interpret that more as a caution presentation on my side.

Okay.

But, at this point in time, you don’t see any reason why sequentially Q4 should be down from Q3?

Correct.

Okay.

Finally, from me, next year, did you say 40%-50% growth was what you were hoping to grow at?

Yes.

Is that organic growth?

Yes.

That is organic growth.

Okay, and just, sorry, was- -the number of shares, you said, was 44m for the next quarter?

Yes.

Okay.

With appreciation and amortization, please, in the quarter?

For the quarter?

Yes, please.

Okay.

It is around $650,000 on a quarterly basis.

$650,000, okay, great.

Thank you and good luck.

The next question comes from Ittai Kidron of CIBC World Markets.

Congratulations on a great quarter.

I wanted to shift the focus to the M&A activity.

Obviously, you have been active over the past year with two acquisitions.

Shabtai, what exactly are you guys looking for?

Are you planning any M&A in the near term, and what I mean “near term” in the next maybe six months?

Maybe you can elaborate your vision on M&A at this point?

Right, as I said before, we are obviously looking into the two M&A bills that we did, the [indiscernible] purchase last year and Ai-Logix this year, both seem to be successful and on a nice track.

So, obviously, on our side that helps us throughout the company and captures more market share in specific areas.

We are [indiscernible] the three more strategic bill [indiscernible], so that was one of them.

That has not been in the other four.

So, that [indiscernible] M&As including for us.

We look for ourselves to become an equipment supplier, a prime supplier to some of the largest OEMs and, through projects, to sell [indiscernible] carriers.

So, for us, it is important to increase our product portfolio and become a supplier with more products in its portfolio so that our entry into the carriers would be much more easy.

In terms of timing, I am not- -I do not think we will plan intentionally to do any more transactions this year, simply because we would like to be able to absorb the one deal that has been made.

But, at the same time, we continue to evaluate and identify more opportunities.

We definitely want to grow [indiscernible] than the 50% organic growth in 2005.

We will evaluate and we will make all that is necessary also on the financial side, just to be ready for that acquisition when and if it comes.

Okay, and is it possible these acquisitions will be larger than what you did so far, and, if that is the case, do you see yourself going back to the market and trying to raise more capital to finance this?

It is a rule, I think, we will look for acquisitions that can improve market positioning, improve market share, but also contribute to the top line.

So, all in all, I believe that we should look at opportunities that should be larger assuming they will bring more revenues.

I am sorry that I missed your second part of the question.

Would you need more capital to finance such acquisitions?

We are totally cash positive.

We are getting money into the company, but not at the rate that they feel would be right.

We do not think that we would bill for an acquisition that is a few tens of millions more above.

We would probably fund ourselves an acquisition that we need to raise [indiscernible] funds.

Okay, and could you elaborate more on the RFP activity?

What has changed and how has it changed over the past six months in both terms of volume and the number of deals and size of the deals and also what verticals are you seeing more and more activity coming from?

Right.

So, basically, one can make a very clear distinction between large carriers and small ones.

The small ones, certainly, do not bill through that form of process.

So, we are usually responding to their needs through [indiscernible] system integrators in the countries that we work in.

When you are talking about larger companies, a larger provider, there we go through our formal RFPs and simply the pace has been increasing.

One very permanent example to that is in Brazil.

We see a lot of activity in Brazil.

We see large [NEP] activities, meaning our [indiscernible] telecom equipment vendor, such as Nortel and some Alcatel [indiscernible] some that we are connected with, such as Ericsson, all active in with selling to RFPs.

That is an [indiscernible] growing phenomenon these days.

That is great.

Congratulations and good luck.

The next question comes from Frank Marsala of First Albany Bank.

The question, really, I have is can you assess for us the competitive environment that you are seeing right now?

We have good growth in media gateways and in media servers and is the competitive environment getting more difficult or how do you assess that?

I do not think that we are getting more competent companies competing with us.

Again, one needs to refer to specific areas.

Think on the wireless side, probably the largest more successful company is definitely CISCO.

There are other large companies sending high density gateways, but at least on [indiscernible] focus at this stage which is the lower [indiscernible] gateway.

At least on the digital side, we feel very strong.

On the wireless space, I think we are a little ahead of the pack, but as the market is not a good [indiscernible] yet, we have not able yet to transfer that into sales that [indiscernible] competitive landscape is not too bad.

The market segments we are entering after and a bit late than other areas is the cable market where there is one private company called [Numura], based in San Diego, that is leading that market with relationships and sales, and now that we have acquired the qualification, we will compete again and we believe that we can present a much more mature, stable, strong [indiscernible] company, can invest much more resources, and we believe that we will gradually improve our position and compete very well with it.

So, all-in-all, I think on a level term, competitively, we feel quite comfortable.

The other question I have really is a question about what are the elements of a next generation network that I had seen when I was walking around Supercom that I- -how it was getting a lot of play and the element called a session border controller, I am wondering what your level of- -what you can tell us about that space.

I understand it is a pretty hot space, but where do think it could fit in the next generation network?

Is that something you guys are thinking about and interested in?

Just give me some help there.

Unfortunately, we are not- -our activity in the market is still not related to that.

We have talked to some of these companies, but, at this stage, are not actively pursuing activity in that space, but I think we definitely will see some pick-up in that space, but I am not sure that it is a level that, at this stage, could be defined as large.

In terms of market opportunity, I am not current with the latest market studies, but I would assume that it is in the low part [indiscernible].

Okay.

Thank you very much.

The next question comes from Robert Katz of Sun West International.

Hi, Shabtai and Nachum, great quarter.

I have a question about your large OEM, or the one that you think you are going to pick in the second half.

Are you shipping boards, sub-systems or systems and is that for the gateway or BDS server?

Generally, usually we are not giving those details, but it is in the gateway business.

The gateway business.

Yes.

What are they doing for media servers, or do they not focus on that side?

Again, I cannot provide more details.

We are [indiscernible].

Okay.

In terms of your overall revenues, how do they break up between gateways and media servers?

Do you that with you?

Roughly, we believe that we have [indiscernible] that are, at this stage, roughly 25% of our revenues this quarter, and probably gateways, digital gateways, are around 15%.

We have also [NL] gateways.

All-in-all, the gateways should be about 40% [indiscernible].

What type of growth rate do you see in those two different product categories?

Are they different or about the same?

It is hard to predict at this stage.

I mean, we are just in the second/third quarter of growth, but I would expect that our gateway- -it is hard to answer that question at this stage.

We would look for both to grow by at least 10% quarter-over-quarter, but because [indiscernible] to say any more than that at this stage.

Once again, what was the guidance for Q3?

In terms of revenue, we said it is going to be $22.5m, and in terms of earnings, it will be [indiscernible].

Right, thank you very much.

[OPERATOR INSTRUCTIONS] The next questions comes from Jonathan Half of UBS.

Thank you.

I just have a follow-up.

Should we be expecting any material change in the breakdown between the products in Q3, or should we be expecting a similar breakdown?

Probably similar.

Sure, okay, and when is the next payment to the Ai-Logix shareholders due, and just based on your comments this quarter it appears that it is likely to make that payment, is that fair?

The payment is due on the first quarter of 2005, as we said on the last conference call we think that payment will be around 10m dollars.

Okay, thank you.

The next question comes from Ittai Kidron of CIBC World Markets.

Just one follow-up question.

With regard to Nortel, by now, are you done with all the contingency payments to Nortel with regard to US acquisition, or are there more milestones left to be paid out?

The last milestone will be- -the last payment will be in the fourth quarter of this year.

Okay, and if you continue on your current run-rate, do you expect to pay that payment?

Yes.

At this time, there are no further questions, Mr Adlersberg.

I will return the all back over to you.

I would like to thank everybody that took part in our conference all today.

We look forward to see everybody in our next conference call.

Thank you, bye bye.

That concludes today’s AudioCodes second quarter earnings conference all.

You may now disconnect.