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Operator
Greetings and welcome to the AudioCodes third quarter 2010 earnings conference call.
At this time all participants are in a listen only mode.
A question and answer session will follow the formal presentation.
(Operator Instructions).
As a reminder this conference is being recorded.
It is now my pleasure to introduce your host, Erik Knettel of Graylings.
Do go ahead.
Erik Knettel - IR
Thank you, Diego.
I would like to welcome everyone to the AudioCodes third quarter 2010 earnings conference call.
Let me begin the call today with a brief Safe Harbor statement.
Statements concerning AudioCodes business outlook, future economic performance, product introductions and plans and objectives related thereto and statements concerning assumptions made or expectations to any future events conditions performance or other matters are forward-looking statements as that term is defined under US 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, AudioCodes' ability to raise additional financing, 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, 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 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 Mr.
Shabtai Adlersberg, Chairman, President and Chief Executive Officer; and Mr.
Guy Avidan, Vice President Finance and Chief Financial Officer.
I would now like to turn the call over to Shabtai Adlersberg.
Mr.
Adlersberg, please go ahead.
Shabtai Adlersberg - CEO
Thank you, Eric.
Good morning and good afternoon, everybody.
I would like to welcome all to our third quarter 2010 conference call.
With me this morning is Guy Avidan, Chief Financial Officer and Vice President of Finance.
Guy will start off by presenting a financial overview of the quarter.
I will then follow and review the business highlights of the third quarter and discuss the developments, key highlights in our business.
We will then turn it to the Q&A session.
Guy.
Guy Avidan - CFO
Thank you, Shabtai, and good morning, everyone.
Before beginning the financial overview of the quarter, I would like to note that the following discussion that will include GAAP numbers and pro forma numbers.
Our third quarter pro forma results reflect adjustment for the following two non-cash items; stock based compensation expenses, which totaled $294,000 and amortization expenses relating to the acquisition of Nuera, Netrake and CTI, which totaled $385,000.
A reconciliation of the pro forma results discussed in this call to GAAP results is currently available for review on our website and in the press release we issued today.
Turning to our quarterly results, in the third quarter revenue was $38.3m, which represents a 5% increase for the sequential second quarter and an impressive 19% increase versus the year ago period.
As a percentage of our revenues, sales in the Americas accounted for 49%, Europe 20%, Asia Pacific 17% and Israel 14%.
Our top 15 customers accounted for 61% of revenue compared to 52% in the previous quarter.
The increase is attributed mainly to increased sales to one distributor in North America that accounted for 10.9% of revenue compared to 6.6% in the previous quarter.
In terms of revenue by business group, in the third quarter, our Technology business group accounted for 28% of revenue compared to 34% in the second quarter and our Networking business group accounted for 72% of revenue compared to 66% in the second quarter of 2010.
On a GAAP basis third quarter gross margin was 55.4% with a pro forma gross margin of 56.2%.
Our [total] pro forma operating expenses were $17.8m (sic -- see press release), up just 2% versus the sequential second quarter of 2010.
Headcount increased this quarter by 12 employees, which brings us to a total of 608 employees worldwide.
Pro forma net income for the third quarter was $3.6m or $0.09 per share.
Short-term and long-term cash balances were $59m compared to $55m last quarter driven by continued strong generation of cash flow from operation of $5.8m during the quarter compared to $1.6m during the sequential second quarter of 2010.
Year to date AudioCodes has generated $11.7m in cash flow from operations.
DSO came at 60 days compared to 62 days last quarter.
As for our guidance we wish to update our annual guidance for 2010.
We are increasing the forecast for 2010 revenue to be in the range of $148m to $150m.
We are also increasing our non-GAAP net income guidance to $0.31 to $0.32 per share.
And for our fourth quarter of 2010 we are entering the quarter with more than 45% backlog of the plan in term of revenue.
I would now like to turn the call back to Shabtai.
Shabtai Adlersberg - CEO
Thank you, Guy.
We're very pleased to report another sequential quarter growth in the third quarter 2010.
It has been strong growth both financially and in terms of the progress we've made on fuel for our strategic initiatives.
We sense good momentum of the market of which we see continuation in the current quarter.
And we thus feel confident to raise our guidance for the whole 2010, as Guy mentioned a minute ago, both on the top line reaching close to $150m and on the earnings side setting the stage for $0.31, $0.32.
This is the sixth quarter in a row of growing revenue and profits, and as we continue to invest into our business, expanding sales operations in emerging countries and hiring new employees, we feel we are a building a [strong] position in the market and foundation for continued growth in 2011 and beyond.
Most important, and this is the biggest achievement in this quarter, is the recovery in our Networking business.
This is -- was the focus of our strategic effort and investment.
And in the third quarter sales in Networking grew more than 10% above second quarter 2010 all in all bringing our Networking portion of the revenues to 72% compared to just 66% a quarter ago.
Just like to mention that the strength has been [apparent] across all the business lines in the Networking business.
All in all, industry activity [in terms] of our service provider and enterprise accounts in the third quarter was equally good and looks solid for the rest of the quarter and next year.
We focus more and more on becoming a mainstream [master] key market provider for both the enterprise and the residential markets with emphasis on integrating our quite extensive access portfolio coupled with mobility for unified communication and collaboration applications.
We made great steps in growing our enterprise business in that venue.
Unique focus is placed in our efforts on growing our presence in emerging markets mainly through expanding [global sales] and customer facing teams, adding new value-added resellers and investing in our distribution channels.
And we will talk about quantitative numbers that indicate such growth.
Before we get to the business highlights and recent development in the market, I'd like to get quickly to some of the financial highlights for the quarter.
Revenue grew 5% quarter over quarter, 19% year over year.
The operating income grew very nicely 22% quarter over quarter, to $3.7m, 130% over third quarter 2009.
Net income grew in the third quarter 25% quarter over quarter to $3.55m and more substantially 130% year over year versus a year ago.
We've been able to sustain gross margin at above 56%.
OpEx grew only 2% from previous quarter.
One of the key achievements in the quarter relates to a key financial indicator that you always focus on and that is the operating income.
As a Company we set for ourselves a target to reach at least 10% percent and then grow beyond that.
In the third quarter of 2010 operating income is now 9.7% versus 8.3% for the second quarter.
Cash flow has been very strong and positive.
Cash grew to a total of $58.6m and we generated $5.8m from operating activities.
We keep hiring.
Headcount was -- we grew by 12 employees ending up with 608 employees.
And again, as Guy mentioned, backlog is strong entering into the fourth quarter 2010.
In terms of product sales, the two key markets for -- or regions for us, North America and EMEA were very strong.
In North America we achieved good performance.
We increased sales 10% over the second quarter.
In EMEA, which was the strongest performance for us, we've seen more than 10% growth.
That has been coupled with a less-than-expected performance in two other regions, Latin America which grew over second quarter but still we're looking for further improvement, and then a similar performance in Asia Pacific.
One key difference from previous two quarters is that chipsets -- sales of Technology and specifically chips went down to normal and now they are at 20% less the level achieved in the second quarter 2010.
So all in all we're coming back to Networking becoming the key (inaudible) for us, being 72% of all our revenue and Technology 28%.
Two new phenomena that we observe in the quarter.
First of all, we increased substantially sales through distribution and channels.
That allows us to increase our sales reach.
That has been happening substantially in North America and now we have a more sound, a more diversified customer base.
In our top 15 customers, [two] of our largest distributors are stronger than before.
Another key area that we haven't mentioned so far is services.
We have now we believe that we will end up 2010 with services providing above 10% of our revenue and we work to increase that portion of revenues going forward.
In terms of our activity with solution [buyers], we mentioned that key in the quarter was our focus on -- two areas.
One is mobile VoIP, second one is the residential gateway, which grew very nicely in revenue.
And I'd like to mention that we invested for the last two years substantially into several new products.
In the third quarter we basically saw a very significant ramp up in these new products and specifically in relation to mobile VoIP and to the residential gateway market.
So all in all, very nice (inaudible) those activities that you may recall we have announced collaboration with Vonage Mobile on our mobile VoIP initiative.
And we have also announced the Home&Go initiative and a few more design wins that we still cannot mention.
In terms of our products we're very glad to see the recovery and basically [record quarter] for two of our key selling products.
One is the mid/low-density integrated MSBG product that has been substantial, quite substantial this quarter.
Again sales through value-added resellers and distribution makes these products becoming more and more available to more service providers and more enterprises.
As I said with that we've seen the residential gateway (inaudible) quite successful and we do anticipate a large growth from that activity in 2011.
Finally, on the product side, I'll also mention another winner, which is the Mediant 3000.
This is a high/mid-access voice-over-IP device.
Again record quarter, I think we're doing very nicely on our traditional business while developing new revenue sources for us.
In terms of our partners' activity we have mentioned to you in the past, Genesys is a good partner.
We are extending our operation with Genesys and in fact we --- at least one new product direction that's going to launch in 2011 and we believe that we have good chances of working and strengthening the cooperation with Genesys.
Microsoft is becoming a more and more visible and stronger player in the enterprise telephony market.
There's a launch that's expected of the product, it's called [Link].
Should be launched fairly soon.
And we do know that lot of effort's been invested both at Microsoft and in our Company to take advantage of this new push to the market.
I'd like to mention that we have few more initiatives, product initiatives with Microsoft, one of which I'll mention, this is the SBA, the survivable branch application and that is something where we are being perceived as a leader in the market and first to certify with them.
A few more partners, BroadSoft is a good partner.
We expect to broaden and extend our relationship with them and sales though collaboration.
And also I'm glad to announce a very important design win in the SMC market that relates to mobility in the enterprise to the market leader which we cannot name.
All in all, we're looking forward to identify key growth area for 2011 and beyond.
I think at this stage we are focusing on two.
One is mobile VoIP both for service provider and enterprises, and the second one is the enterprise SBC.
In terms of mobile VoIP, we enjoy this year [records] that we've not seen initially here.
And in terms of revenue that is visible to us.
It is all driven by the increased pace of selling smartphones in the market and the explosion in usage of mobile data services, that basically broadens the use of mobile data infrastructure.
If that trend continues and we see no evidence for changing that, it means that the mobile data infrastructure is going to be substantially larger than that of the voice -- the voice infrastructure.
And then we believe that even prior to 4G and LP we will see mobile VoIP becoming very important in taking advantage of driving voice to IP over the data infrastructure.
So, all in all, a very, very strong growth.
We have developed for the past 18 months comparative solution providing both a variety of clients for smartphones which range from the iPhone to Android-based smartphones to Symbian-based and a few more, (inaudible) and at the same time developing a service delivery platform with a partner.
We work with other (inaudible) to provide a complete solution to service provider.
We will invest substantially in trying to become the leading quality-of-service player in that area, basically taking advantage of the huge investment we've done for the past 15 years in various quality -- voice quality enhancements, packet (inaudible) and a few more.
And we are seeing quite an enthusiastic reaction in the service provider market with a lot of will to test those type of solutions going forward.
I'll mention again the Enterprise Session Border Control market.
We invest much in that space.
This is the first year it's starting to sell.
And we do expect that in the coming year we will grow substantially again I think by integrating our CDM and PSDN capability and bringing to [third parties] also our capabilities in (inaudible) coding we will create an offering that will allow us to become a player, a substantial player in that market.
That has been primarily my introduction to the call.
And we will now take questions.
Erik Knettel - IR
Operator?
Operator?
Operator
(Operator Instructions).
Our first question comes from Ittai Kidron with Oppenheimer.
Please state your question.
Ittai Kidron - Analyst
Hi, guys.
Congrats on a good quarter.
Shabtai, if you can give me some color on the mobile VoIP, the session, the enterprise session border controller and the home gateway.
How much revenue in total were those three opportunities, and how do you think about growth going into next year?
Shabtai Adlersberg - CEO
Okay.
In meeting with investors, the application for the residential market is substantially more mature.
This is a product line that we started about three years ago.
I think we sold about 2m last year.
This year we expect sales of -- in the residential market to reach above -- about, I'm sorry, about $10m.
But we do anticipate a substantial increase next year, one that would be above 50%.
So that is be an established line, selling a few millions a quarter already.
The other two, mobile VoIP and enterprise SBC, this is the first year.
Both I think started selling around second quarter.
This is still minor in terms of contribution, less than -- we believe that sales will be less than $5m this year.
But again on VoIP we do expect substantial growth next year.
In each I would expect more than 100%.
Ittai Kidron - Analyst
Can you describe the margin profile of these product lines?
Is the home gateway on par with the corporate average or below?
Shabtai Adlersberg - CEO
No.
Okay, so let's go one by one.
In the residential market we expect lower margins.
Obviously, it's a large volume sale and usually margins are in the range of 30% -- around 30%.
However, one of the players (inaudible) and that is what we have done with this Home&Go, we intend to specifically couple and bundle software applications to that line.
We believe much of the revenue going forward will allow us to increase the margin on the residential market once it's going to enjoy faster applications.
In terms of mobile VoIP, basically most of its products that's based in software and therefore the margins are very high.
As far as the enterprises, we still think we similar margins to those that we enjoy today.
Ittai Kidron - Analyst
Okay.
Now if I take these products and I strip them out of your 2010 model, it looks like your core business is growing low single digit percent on a year-over-year basis.
Is that basically -- how should we also think about the business going into next year, the core relatively flattish and what's driving the growth is really those three new opportunities being added into the mix?
Shabtai Adlersberg - CEO
No, no, I don't think so.
I think if we'll do a calculation -- I think I've mentioned that in two of our top-selling product, the Mediant 1000 MSBG and the Mediant 3000, the first quarter has been a record quarter.
And if we grow our enterprises and grow the value-added reseller network and expand cooperation with solution partner, you'll see more and more SIP trunking and enterprise SBC in other functions, unified communication application, driving more our sales.
The only -- if you would refer to the old application of trunking gateway, that is correct.
But that is a very small part of our business; that is less than 10% of our business.
So should --- based going forward.
Ittai Kidron - Analyst
Okay, and Guy --
Guy Avidan - CFO
If I can add to what Shabtai just said, we mentioned 19% year-over-year growth.
Even if we take out the new products that Shabtai mentioned, the historical products, just taking the [first] product is (inaudible) year-over-year than the single digits you mentioned.
Ittai Kidron - Analyst
Okay, very good.
And Guy, regarding the OpEx, you've -- you had a very good control over that through the year with these opportunities now maturing and reaching next year some sort of an inflection point.
Do you see a need to start raising your OpEx a little bit faster pace?
Or do you still think about $300,000 to $500,000 steps from one quarter to another?
Guy Avidan - CFO
We expect to keep the same growth pace in OpEx.
We have the infrastructure in place to grow.
The only things that we're growing are, as mentioned before, is direct expenses related to sales.
Ittai Kidron - Analyst
Very good.
Good luck, guys.
Shabtai Adlersberg - CEO
Thank you, bye bye.
Operator
(Operator Instructions).
Our next question comes from Robert Katz with Senvest.
Please state your question.
Robert Katz - Analyst
Good morning, Shabtai and Guy.
Very good quarter, congratulations.
It's nice to see you got your business back on track.
Can you elaborate more on how mobile voice will impact your business?
And also on the relationship with Vonage, as an example of how you play in that -- the role you play in that market?
Shabtai Adlersberg - CEO
Right.
Well, let me start with your second question.
I think the Vonage [exactly] is very important that it portrays the potential.
Vonage is [$2.5m] about (inaudible) service provider, global service provider.
They represent the understanding of the need to support mobile VoIP for practically people on the move.
Any smartphone, any (inaudible).
So (inaudible) I would say interest lies with many other service providers, fixed line and in the future we'll see more.
I can mention activity but basically there's an announcement by SK Telecom from three months ago where they recognized the huge growth of data usage in the network and therefore basically say that they would basically see mobile VoIP growing on those networks.
And we have mentioned before, that this stage, ongoing basically sales processes, and our initial third quarter (inaudible).
And just in the course of the past few weeks we have signed another two or three deals.
Most of those deals at this stage are pretty small, less than $100,000, simply because this is the first but represents few thousands of subscribers that start to launch this service.
We do expect that next year we'll have between at least five and 10 more providers such as Vonage, and that the average number of users will grow to be tens of thousands rather than few thousands.
So all in all, if you look forward into LPE, LPE is exactly about that, carrying VoIP on top of the data on top of the IMS architecture.
So the eruption of mobile VoIP prior to full ([GOSD] simply happens because of the massive growth in Internet access to smartphones and video sharing and downloads, etc.
So next year I would probably expect to see a few hundreds of percent growth in the mobile VoIP area.
Robert Katz - Analyst
Thank you.
And can you also elaborate a bit on the financial arrangement, or how this would impact your business model?
Selling into the mobile VoIP market?
Shabtai Adlersberg - CEO
Okay.
So basically just, of course, this is not an analysis.
But think, the majority of the products sold these days still fall into the category of media gateway and multi-service business gateway.
And this is where the margins are pretty around where we want them today.
I think in the future we'll see two deviations from that, and that came up in my answer to Ittai previously.
On one hand, on the residential products we'll see lower margins.
And that will be one effect.
The other one would be the evolution of software and application solutions that we have (inaudible) are the clients and a few more products that we have not mentioned yet in this call such as the SIP proxy for Microsoft, etc.
So we expect that we will have a bunch of software and applications bringing high margins from the other end.
It remains to be seen going forward how the overall margin will develop.
I think we want to be able to get a feeling for that before three or four quarters from today.
So in essence I don't think we expect substantial change simply because we still, the majority of the business is still around the gateways and MSBGs with current margins.
And the new ones, the new products will --- one will decrease it, the other one will increase it so it's going to be a combination.
We'll get to know what the mix is, we shall.
Robert Katz - Analyst
Great.
Now two other quick questions.
One is can you address the difference in the size of the session border control market for the enterprise versus some of the more carrier-focused SBCs up there.
And secondly, can you talk to the business model, the operating margins.
You are bumping up against the 10%.
I think your guidance probably gets you there.
And where do you think that can go, going forward?
Guy Avidan - CFO
Regarding the second question about the operating model, we are getting close and hopefully in the next coming quarters we will be able to see the 10%.
And can you please repeat the first question about the E-SBC?
Robert Katz - Analyst
Yes, can you elaborate on the size of the E-SBC market versus the more traditional SBC market that's being addressed today?
Shabtai Adlersberg - CEO
Okay.
So basically based on forecasts we've seen, I believe the number came from Infonetics, I think they project enterprise SBC market to be about $50m this year.
But we do expect that in three or four years that will grow substantially above $500m.
So it still remains to be seen, but practically in a developing IP network-oriented world, you'd need a session border control between any two networks communicating.
So we expect that market to be very big.
Robert Katz - Analyst
Thank you, guys, and congratulations again.
Erik Knettel - IR
Thank you.
Operator
There are no further questions at this time.
I'll turn the conference back over to Mr.
Adlersberg for closing comments.
Shabtai Adlersberg - CEO
Thank you, Operator.
In summary of our call, we would like to say that we are very glad to see you all on our call.
We would like to thank you for attending our conference call, and we look forward to have you on our next call in a few months.
Thank you very much and bye bye.
Operator
This concludes today's teleconference.
You may disconnect your lines at this time.
Thank you all for your participation.