AudioCodes Ltd (AUDC) 2005 Q2 法說會逐字稿

Good morning.

My name is Jody and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the AudioCodes' second quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] Thank you.

Mr. Knettel, you may begin your conference.

Thank you, Jody.

I would like to welcome everyone to the AudioCodes second quarter 2005 earnings 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 events, conditions, performance or other matters.

These 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 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 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, 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 and Chief Executive Officer, and we have Nachum Falek, 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.

Thank you, Erik.

Good morning and good afternoon, everybody.

I would like to welcome everybody to our second quarter 2005 conference call.

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

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

I will then focus on the quarter highlights and we'll expand on the progress that we have made in our business this quarter.

We will then turn this into a Q&A session.

Nachum?

Thank you, Shabtai.

In the second quarter, revenues were 28.5 million, which represent 6% increase from the last quarter.

Getting into geographical and product mix, America accounts to 52%, Europe to 24%, Asia Pacific, 15%, and Israel, 9%.

We had one customer above 10%.

Our top 15 customer accounts to 54% of revenues compared to last quarter 56%.

In terms of revenues by business groups, then in the second quarter of 2005, the technology business group revenues consisted 50% of sales and the networking business group revenues accounted to 50% as well.

Gross margin was 59.2% compared to last quarter, 59.4%.

The decreasing gross margin is due to different product needs in the quarter.

Operating expenses increased from the first quarter level to approximately 14 million.

This increase relates mainly to growth in R&D and sales and marketing expenses, also reflecting increased investment in customer-related development activity.

The increase in operating expenses was in line with our expectation.

Headcount increased this quarter by five employee, which bring us to a total of 477 employees.

AudioCodes reported a net income of 3.1 million, or $0.07 per share.

Short-term and long-term cash balances were 250 million compared to 210 million last quarter.

The increase in cash balances is attributed mainly to a positive cash flow from operations and financing, which were offset by a negative cash flow related to investment activities.

DSO came in at 57 days compared to last quarter DSO of 49 days.

Our guidance for the third quarter is as follows.

Based on our visibility at this time, we focused revenue for the third quarter to continue to grow modestly, up to a level of 5% compared to second quarter revenues level.

We focused in the share of $0.07 to $0.08 based on approximately 44 million shares.

This guidance is based on an initial backlog that is above 50%.

I will now transfer the call to Shabtai.

Thank you, Nachum.

We are very pleased to report yet another growth quarter.

This is our 16th consecutive quarter of growing revenues and profits.

Key highlights of this quarter is our ability basically to continue and execute in our plan and strategic objective according or our Voice over IP networking business.

This now has reached a level of 50% of our revenues from almost 0 in 2002.

Highlighting key achievements on the financial side this quarter, we continued our very nice growth of 49% over the second quarter in 2004.

And 6% growth over Q1 in 2005.

We also demonstrated strong operating margins at about 10% and very strong cash flow of about 5 million.

Now to the markets and our performance in the markets.

What we have seen this quarter in the market is a slower Voice over IP market.

We saw that mainly in North America markets and to a lesser extent in Asian Pacific markets.

Europe was strong.

You can see in our revenues that grew from 21% last quarter to 24% this quarter.

When we tried to identify factors and reasons for slow progress in North America, I think we can note the consolidation process between large incumbent service providers that delaying execution and deployment of new networks.

And we have also seen a larger focus over the large operator on fiber to the premises, triple play, and IP TV projects.

Seeing that has pushed in a way spending on building Voice over IP solution further into 2006 and '07.

We believe working side by side with some of our customers in the service providers market, we saw lower pace in evolution view due to relatively complex architecture.

When you go to a Class 5 type deployment.

If you compare it to a Class 4, more emphasis on features and functionalities.

That slows up the process.

When we went to check with our market analyst that we used, we have also noticed that our -- the report we're using from [inaudible] do indicate that, while they've predicted for 2005 for the low and mid-density gateway to grow 28% this year, in their update based on the first quarter of 2005, they've basically reduced that rate to almost 0.

Basically meaning that market that was forecasted to grow from 220 million to 280 million this year, is basically going to remain quite flat.

Relative to North America, Europe was very good.

We had good sales in the wireline market, both in East Europe and West Europe.

We believe that fragmentation larger number of more carriers and fluency of service providers allows for deployment of Voice over IP in those areas.

In terms of sales, sales in Europe grew from 4.5 million last quarter to 5.9 million this quarter.

We've also seen better activity in Asia Pacific.

That has translated also into growth in revenues.

In terms of market segments, basically, the cable market seems to be quite active.

We believe that triple play and the fight for the end user really drives competition and drives a large investment by cable companies.

We were involved in such projects, I'll touch that in a minute.

We see a lot of activity, mainly design, in planning activity towards IMS.

IMS represents more large service providers.

The network architecture that will combine wireline and wireless services and, therefore, there's a large emphasis on that.

And we try to focus on winning designs that relate to IMS.

Notable trend in the market in two areas.

One is fixed mobile convergence, again, driving Voice over IP.

We believe we will see that translating into revenues in 2006.

Mainly, again, it's the fight over the end user voice services that's taking place between incumbents and wireline service providers against wireless providers.

Another phenomenon that we believe will drive growth of Voice over IP is the very fast evolution of Wi-Fi.

We believe that the adoption of Voice over IP could be used as the Voice over Wi-Fi solutions.

We see many of the next new models of [inaudible] basically offering Voice over IP capability next to our capability.

All in all we believe that, while 2005 is -- will translate into lower growth compared to 2004, our assumptions are that we will see continued ramp-up in evolution in the second half of 2006 and 2007.

That's our belief.

In terms of what we did internally in those area, networking grew 50%.

We've been at 45%.

In the previous quarter, that's more than 10% core growth.

Technology revenues were flat.

Similar trends to the one that we have witnessed in the first quarter.

And we are taking steps to seek growth in the technology business line as well in 2006 and going forward.

Another very encouraging data point is that our sell through system integrated grew to 32% versus 21% in the first quarter.

Again, representing 50% growth.

And that, basically, indicates less tendency on our OEMs and more direct sales through our system integrated in the fields.

In the wireline space, we've been involved in two large Voice over IP network deployments.

In Europe and in Asia Pacific.

Each one of them was basically a deployment of thousands of media gateway low-density media gateways.

We also had in the wireless space, good progress with OEM, two large OEMs where we have -- we are still working with them to make our product embedded in their solutions for similar network and IMS related networks.

In the cable space, we had a very good quarter.

We had two design wins on top of the first that we had in the first quarter.

One was relatively small.

The other one is very important.

Basically, the frame equipment that we have with large MSO that will allow us to deploy cable-ready Voice over IP ready media gateways in several countries.

We just started deployment in a few of these countries.

And we believe that already in 2005 and 2006 we will see such large deployment.

At the same time, we started deploying our gateways into HOT Telecom cable company, a cable telephony company in Israel.

That deployment started last year.

We further continued shipments in the large sale this quarter, and we believe that the network will grow and so will our shipments into that network.

We continued to build our relationship with large original system integrators, and at the same time, we do have a growing pipeline of potential projects where we are embedded, our products are embedded through partners.

We believe that any of these large projects could be potentially large upside for us.

In terms of what we use on the sales front, we keep growing our investments in establishing local presence in large countries.

This quarter we have increased our efforts in Brazil, South Korea, and we're going to deploy local sales in Germany and Russia.

At the same time, we are investing in restructuring our sales to better fit the sales models that target at the same time OEMs on one end and service providers on the other end.

On the product front, our key investments really go more and more into the core media gateways, the mid-density and the high-density.

We do believe that we have currently one of the leading products for converged wireless and wireline media gateways.

We are investing in features, in signaling capabilities in interfaces and at the same time, we are looking into cost reduction.

At the same time, we are investing in the next-gen platform, which is called ATCA.

All in all, we've seen this quarter success in continuing our push-pull strategy in promoting our product to service providers, and at the same time fulfilling those needs through our large OEM system integrators.

Key achievement or key product in that regard was the fact that our mid-density gateway platforms have just started to ship in Q1, continued to sell very well in the second quarter, and we actually did that in February.

All in all, that is the picture in the different markets.

Cable is strong and should grow.

Wireline, we keep winning new projects with service providers and at the same time, we believe that wireless will start to contribute to revenues in 2006, more so in the second half of 2006.

With that said, we have a large pipeline of potential projects that could provide upside to what we do today.

Getting back to our projection and planning for the rest of 2005, this quarter, this summer, where traditionally our revenues are relatively lower, we perceive usually lower growth in the quarter compared to other quarters in the year.

Still, I would note that we have entered that quarter with strong backlog with nicely above 50%.

Our visibility is just the same as it was before, about one or two months into the quarter.

Back in Q1, we started to see better flow and broader base of projects that's relating to our networking business.

And we believe that would provide for us a strong base for continued revenue growth in coming quarters.

With low growth right now in the overall Voice over IP market, and a corresponding slower growth in all revenues, we now plan on a growth of 30 to 40% in 2005 compared to 2004.

This is our original plan that was targeting growth of 40% to 50%.

We plan to maintain high gross margin at the high 50s.

At the same time, we will keep investing in R&D and sales expansion and supporting our capital.

That is driven larger -- the majority of the increase in our operating expenses in the second quarter.

As Nachum has guided, we believe we will continue to grow this quarter up to 5%.

We're trying to be cautious on that front.

And with a minor increase in R&D sales and marketing this quarter compared to the first half of 2005.

We should be able to generate earnings of 7 to 8%.

And with that, I'd like to turn the session into Q&A.

Erik?

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Vivek Arya with Merrill Lynch.

I have three questions.

The first one is why is the technology segment slowing down?

Is it because of internal reasons or is it because of external reasons?

Okay.

We have no clear indication that the market is growing.

It's really much more complex.

We believe that solution architecture do change with Voice over IP.

And while many of the, what you would call enterprise related services, solution in the past, which were called CPI applications where in the '80s and '90s sold through the use of PCI boards, we believe that with new architecture, the Voice over IP using media gateway spreads on a wide area network through IP links.

We believe that part of the demand for boards and blades is really turning into media gateways.

We are, though, trying to assess that approach better.

I have mentioned in our press release that we have basically done internally a restructuring that basically completes our activities in the markets and sales and business into separately managed business lines with more focus on each of them.

We believe that that renewed focus on the blades on the chips will allow us to provide more growth, but we do not believe that that will affect 2005 results.

We believe that will be more 2006 and on.

All in all, should we see more growth in the technology line in 2006 and on, we still believe that growth there should be slower and should be more in the range of 20 to 30% for the year.

All right.

Second question, Shabtai, even though your networking sales went up, I'd assume networking is a higher gross margin segment for you, I saw that gross margins actually came down sequentially, whereas OpEx increased faster than the increase in sales growth.

So is that a trend there or is that just something temporary?

What should we expect the gross margin and OpEx trends to be as more of your sales come from the networking segment?

Right.

All in all we believe that our volume into networking will grow.

My assumption would be a natural decrease in our gross margin towards maybe 55% when you go into higher volume they usually are lower prices, and while we are still working on the cost reduction, we do believe that as a trend, we should see lower gross margin.

I would put for 2007 a target of 56, 55.

On the OpEx, as I have mentioned in my previous call, we basically, a) planned for high growth in 2005 and therefore we planned on higher standings, that's one fact.

Second is that we have deliberately chosen to invest more in the first half than in the second half, simply because felt we want to be ready with some of our solution in 2005 earlier than sooner.

That is translated in the second quarter to indeed a larger growth in expenses of 8 to 10 versus revenues which were only 6%.

We do -- we already started a few weeks ago, looking to our expenses.

We do not plan for the second half of 2005 any similar trend.

As a matter of fact, we will plan or substantially lowering the growth of expenses.

All in all I believe that we should modify and get back to grossing our expenses that's more correlated to the growth in revenue.

One last question, Shabtai, if I may.

The cable Voice over IP segment has been very strong for you.

But in the past you had mentioned that cable Voice over IP is actually a smaller market.

So I'm just trying to get a sense for what do you expect?

Is that going to be a big growth market for you?

Or is it just been busier and something else might have to replace it next year?

Thank you.

Actually, you're right that we mentioned that we believe, and I think we have heard that from one of our competitors in the field, that cable Voice over IP media gateway market will never go beyond, I believe the number was mentioned 200 million a year in 2008 or '09.

We actually look at that as a positive advantage for us because it's a niche market.

There are not too many players in that market.

We believe that market, which would capture very substantial policy.

If you compare that with the IMS world, we would meet much of the market size would be substantially larger, few billion.

I believe that there we would meet strong competition.

So all in all, I think it's a good market for us.

Thank you.

Sure.

Your next question comes from Alex Henderson from Citigroup.

I was wondering if you could give us a little bit more sense of how you see the transition to fiber to the ax impact in the deployment schedules and the scale of the equipment deployed within the Bell operating structures.

Does it -- the result in more smaller units that are more success based and is that an offset to some extent to the large Class 5 collapse programs that had been talked about a year and a half, two years ago?

Well, it's, a) hard for me to relate to that.

We're not involved directly to any of those projects.

Also, the emphasis, I believe, in the first stage of those networks would be to basically plan them more for video use and data use.

So, it's hard for me to say whether gateway will be used more in the access end or more core network.

It's only a guess that I can make.

I'd rather not do that.

Well, shifting the question then, can you talk a little bit about the competitive landscape in the North American market, how you see your position relative to the players that you're working with selling product versus the couple of guys that you don't actually sell to?

Yes.

In north America, we primarily work with our partners.

We work with Nextel [ph] networks, in some cases with other people that we have.

And we basically believe that they get more successful in selling to the large incumbents.

We will be embedded in their solutions.

We have mentioned in the past, other partners.

We have mentioned Lucent, we have mentioned Freecom [ph], just to name -- there's a recent win that Freecom announced on winning the other [inaudible] network, if all goes well and everything goes well in the first step of the trials, we will be embedded in that.

So, for our sales in North America would be substantially two partners.

Can you do the same now for the Western Europe geography, please.

In Europe, it's different.

In Europe is definitely different.

We do not see the large OEMs working directly there.

We basically go from market directly through system integrators.

What Europe, it's really combined.

We go direct, sometimes and sometimes [inaudible].

Okay.

Thank you.

Sure.

Your next question comes from the line of Steve Levy with Lehman Brothers.

Hi, Shabtai, it's Marcus Kupferschmidt.

A couple questions we wanted to dig into.

The first thing is, if you look at the customer base for your -- for the technology business, I would assume it's a rather diverse customer base, although your largest customer, I believe, was a customer of that business as well.

Should we assume it's a relatively diverse customer base even within the AI-Logix acquisition?

Yes, very diverse.

So the fact that you're seeing some slowdown right now in that, I mean, if I look at 50% of the revenues come into that group, it's down slightly?

It's been down around a year, call it flat.

You pointed -- you don't think it's really a function of the overall market at all?

It's just some near-term technology changes?

Yes.

In the technology business line, yes, I think that's the best way would be to relate to the technological changes in architecture, solutions.

We do not see any other evident trends.

Basically, we do not see competition winning over us in Voice over IP to sales to OEM.

So it's more the market change.

Okay.

Then in terms of the financial guidance, the comments about gross margin, they could potentially decline from here over the coming 12, 18, 24 months towards mid-50%.

Is that a bit of a change from prior commentary?

I thought it was more expected to remain in the high 50%.

Marcus, it's Nachum.

Looking, what we can see from this point, we can just say that gross margins should stay at high 50s in the near term, and as Shabtai mentioned, looking at '07, might go down to the 55, 56%.

But, looking at the rest of the year.

Looking at the beginning of '06, we can estimate, obviously, but say that we will stay at the high 50s.

Okay.

And in terms of -- previously we talked about reaching a 15% net margin by early 1Q '06 or maybe even fourth quarter 2005.

Is that still possible at this point with this slightly potential lower revenues than what you're expecting?

Yes.

Good question, Marcus.

Actually, I think, at least on our side, we are convinced now that trying to attain 50% would be quite difficult with the continued investments, specifically in our products and customer programs.

We would be selling mostly our standard products.

That would be achievable.

That was our objective, initially.

We find out throughout the course that each new large OEM has its own requirements, its needs for customization, adapting to standards.

We found ourselves investing more in terms that target to make all the various different specification fit.

We really believe that, again, long-term we should be there.

Whether long-term is '07 or '06, it's hard for me to say.

But definitely 2005 we are now close to 11%.

I think we would try to grow to 12 or about that, but we would not do that as an objective for ourselves now.

Okay.

So just to be clear, you think we could exit the year around the 12% level would be your goal?

Yes.

Our goal would be 12, 13% this year, yes.

Okay.

Thank you very much, Shabtai.

Sure.

Your next question comes from the line of Rami Rosen with Oscar Gruss.

Hi, Shabtai.

Can you compare the level of backlog and visibility that you have at this point to what it was a quarter ago?

Yes.

I think we are on par.

Similar, maybe even a slightly better.

The problem is that usually we witness in the summer lower August, which may have an effect on that.

So while we have good entry into the quarter, we still have in front of us the month of August.

Now, looking on the different geographies, maybe I misheard it from your opening statement, but when you're looking at the next quarter, APAC should be -- activity in APAC should be better than let's say this quarter and Europe should be down?

It's too soon to comment on that.

I do not -- Europe should remain roughly the same.

Asia Pacific, we are investing more.

So most chances are that we would remain on similar levels for APAC.

Again, just to mention again that we just placed several sales persons in the different countries.

We have a presence in South Korea that starts at the beginning of this month.

We have replaced management in China.

We have better business in Japan and more sales in Southeast Asia.

So all in all we believe that on the longer term, Asia Pacific should grow about 15% but I'm not sure that will happen this quarter.

Maybe it's too early at this point, but do you have any initial indication regarding growth in 2006?

It's too early.

Just very rough in general assumption would be that with current trends, I don't think we would see any further growth in the beginning of 2006.

But again, I think we should be more into Q4 to make such comments.

So in general, would you view 2006 as kind of a second half back loaded year?

Yes.

That would be my assumption at this point.

Okay.

Thank you.

Your next question comes from the line of Jonathan Half with UBS.

Yes, thank you.

Hi.

Just trying to reconcile between your guidance for the year and the comments you're making regarding this quarter.

If I understand you correctly, Shabtai, you said 30 to 40% growth in '05 over '04.

That -- at the low end of that, that would indicate a meaningful decline in Q4, which usually tends to be a seasonally strong quarter.

I'm just trying to get a sense of, is that -- what kind of scenario, or what has to happen for that to take place and on the other hand, how do you get to the 40%?

That's kind of a wide range for a fourth quarter, if you follow what I mean.

Well, our assumption for this quarter would be growth between few percent up to 5%.

We obviously believe that the fourth quarter should represent a lot of growth.

Too early to say, but from today in July, I would say that I would expect more towards the 10%.

I didn't make the exact calculation, so I'm ready to do it together with you.

We did 7% in the first quarter.

We did 6% in the second one.

I think if you would compare overall 2005 over 2004, you would find that we would grow about 30%.

Okay.

Maybe I'll take this offline with you, because I have -- if you see sequential growth in Q4, I have closer to 40 with 30 being very unlikely.

Maybe I'll take that later on offline.

Okay.

One more question, please, regarding the operating expenses.

Just from the comments you made, it sounds like sales and marketing is where you're investing a little bit more of your operating dollars compared to R&D.

Is that fair and should we be modeling faster growth there?

Yes.

Just, I have indicated that our sell-through system integrators service provider grew from 21% to 32%.

That means that in many cases we do need to support the more in the field.

That means more field support, more sales, and more investments in marketing and sales.

Also, the fact that we have complete operations to be much more business line structured means that we would add marketing positions to each different business line.

That is the major areas where we would grow our own market and sales.

Great.

Thank you, and good luck.

Thank you, Jonathan.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Keith Dalrymple from Halpern Capital.

Good morning.

I have two quick questions for you.

One, can you give a little color behind the business split that is the OEM versus the systems integrator business split?

In particular I'm curious does this reflect a change in your strategy in why would that be?

Would this reflect weakness in large OEMs or does it potentially reflect a shift in the way customers are buying gear?

Okay.

No, it does not make any change in our strategy.

Basically, our go-to-market strategy for the service provider market is usually that large operators, large service providers are fulfillment strategies to go through us.

In some areas where the push is smaller and lack of interest to the large OEM, we go to those projects directly.

But in any event, in any such case, we do what is required to make sure that we do not get into any situation of conflict.

Okay.

And secondly, can you comment on the competitive landscape in Western Europe.

Have you seen any shifts there in the past couple quarters?

Not substantial changes.

We see more competition from similar companies coming from North America.

We see Cisco, we see some of other companies coming from China.

And, of course, we have the European companies competing for our projects in that area.

Great.

Thank you.

Sure.

Your next question comes from the line of Jeff Meyers with Intrepid Capital.

Thanks a lot.

My questions have already been asked.

Thanks.

Your next question comes from the line of David Fore with Sucare [ph] Capital.

Couple questions.

First could you repeat the geographic mix you gave out at the very first of the call.

Yes.

No problem.

America accounts to 52%, Europe, 24%, Asia Pacific, 15%, and Israel, 9%.

Great.

Just want to follow up on some of the previous questions on the annual guidance or the forecast for 30 to 40% growth.

It looks to me that if you basically keep your numbers flat from 3Q to 4Q, again, applying the 5% revenue growth in 3Q '05, you get somewhere close to, I guess, well below consensus for your high end of your 40%, or 30, 40% growth for the year.

I want to clarify, is that what you're implying here with this current guidance?

Basically, we gave only guidance for the third quarter, which is up to 5%.

It's true.

We didn't give any guidance for the fourth quarter, but we will be at the high range of the 30 to 40%.

Okay.

Okay.

Thank you for clarifying that.

[OPERATOR INSTRUCTIONS] At this time, there are no further questions.

Mr. Adlersberg, are there any closing remarks?

Yes.

Thank you very much.

I'd like to thank everybody that joined our conference call today.

And we look forward to seeing you in our next conference call.

Thank you.

Thank you.

This concludes today's conference call.

You may now disconnect.