Greetings and welcome to the AudioCodes First Quarter 2019 Earnings Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I would now turn the conference over to Rob Fink, Mr.

Fink you may now begin..

Thank you, Operator. I would like to welcome everyone to AudioCodes’ first quarter 2019 earnings conference call. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer and Niran Baruch, Vice President, Finance and Chief Financial Officer.

Before we begin, we would like to remind you that the information provided during this call may contain forward-looking statements relating to AudioCodes’ business outlook, future economic performance, product introductions and plans and objectives related thereto and statements concerning assumptions made or expectations as to any future event, conditions, performance or other matters are forward-looking statements as the term is defined under the U.S.

federal securities law. Forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results to differ materially from those stated in such statements.

These risks, uncertainties, and factors include but are not limited to the effect of current global economic conditions and conditions in general and in AudioCodes as 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, upgrade and the ability to manage changes in the market conditions as needed, possible need for additional financing, the ability to satisfy covenants and the company's loan agreements, possible disruptions from acquisitions, the ability of AudioCodes to successfully integrate the products and operations from acquired companies into AudioCodes business and other factors detailed and AudioCodes filings with the SEC, the U.S.

Securities and Exchange Commission. Audio assumes no obligation to update information. In addition, during the call AudioCodes will refer to non-GAAP net income and net income per share.

AudioCodes has provided reconciliations of 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 it issued today and on its website.

Before I turn the call over to management, I would like to remind everyone that this call is being recorded and an archived webcast will be made available on the Investor Relations website of the company at AudioCodes.com. With that said I would now like to turn the call over to Shabtai. Shabtai please go ahead..

Thank you, Rob. Good morning and good afternoon everybody. I would like to welcome all to our first quarter 2019 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President to 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 then discuss trends and developments in our business in the industry. We will then turn it into the Q&A session. Niran please go ahead..

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 non-GAAP P&L metrics exclude the recurring non-cash items.

The earnings press release that we issued earlier this morning contains a reconciliation of the supplemental non-GAAP financial information that I will be presenting today. Revenues for the first quarter were $46.6 million, up 1.8% from the prior quarter and up 9.8% compared to the first quarter in 2018.

Services revenues for the first quarter were $14.1 million accounting for 30.3% of total revenues. The shared revenues balance as of March 31, 2019 was $52 million compared to $49.2 million as of December 31, 2018. Revenues by geographical region for the quarter were split as follows.

North America 45%, Central and Latin America 6%, EMEA 35% and Asia-Pacific 14%. Our top 15 customers in aggregate represented 63% of revenues in the quarter of which 50% are attributed to our 10 largest distributors. Gross margin for the quarter was 62.8% compared to 64% in Q1, 2018.

Non-GAAP gross margin for the quarter was 63% compared to 64.5% in Q1, 2018. Operating income for the quarter was $4.5 million compared to operating income of $3 million in Q1, 2018. On a non-GAAP basis quarterly operating income was $5.5 million or 11.9% of revenues compared to an operating income of $3.8 million in Q1, 2018.

Net income for the quarter was $3 million or $0.10 per share compared to net income of $2.4 million or $0.08 per share in Q1, 2018. On a non-GAAP basis quarterly net income was $5.5 million or $0.18 per share compared to net income of $3.9 million or $0.13 per share in Q1 2018.

Our balance sheet remained strong at the end of March 2019 cash/cash equivalents, bank deposits, and marketable securities totaled $68.4 million. Day sales outstanding as of March 31, 2019 were 53 days. Operating cash flow generated during the quarter was $8.3 million.

During the quarter we acquired 86.6 thousands of our ordinary shares for total consideration of $951,000. As of March 31, 2019 and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 17.6 million shares for an aggregate consideration of approximately $95 million.

In January 2019, we received court approval in Israel to purchase up to an aggregate of $12 million of additional ordinary shares pursuant to our shares repurchase program. The current court approval for share repurchases will expire on July 1, 2019. On January 28, 2019 we declared a cash dividend of $0.11 per share.

The dividend in aggregate amount of $3.2 million was paid on February 19, 2019. We intend to continue declaring semiannual dividends in coming years. Now to provide an update on our guidance, we now expect revenues for 2019 to be in the range of $191 million to $197 million compared to the original range of $190 million to $197 million.

We anticipate non-GAAP diluted earnings per share to be in the range of $0.77 to $0.82 compared to the original range of $0.76 to $0.81. I will now turn the call back over to Shabtai..

Thank you, Niran. We are very pleased to report solid financial results for the first quarter of 2019. Touching on the highlights of our financial performance, in revenue we grew 9.8% compared to the year ago quarter pretty much in line with our guidance for 10% growth for overall 2019.

EBITDA grew to $5.9 million compared to $4.2 million in the first quarter of 2018, an increase of 40%. Same for net income which grew 40% on a year-by-year basis and most important, we continue to improve our operational efficiency compared to the year ago quarter.

Operating margin improved from 9.1 in first quarter 2018 to 11.9 in first quarter 2019, a direct result of growing revenue on a consistent basis while keeping expenses at the controllable level.

Based on performance in the first quarter of 2019 and the business outlook connectivity thus far in April, we do not anticipate any change in our business trends they should be strong, the way they have been in the first quarter in previous years.

At this stage we continue to see strong underlying trends in both the all-IP migration market and the UK adoption mainly in the Microsoft team space that should keep the momentum in our business in coming quarters. As such we’ve strong confidence that 2019 is to become another strong year of growth on tiers of previous three years growth since 2016.

Now let's discuss some of the highlights of the business line in the first quarter of 2019. Key to our success in this quarter is the consistent progress in our networking business which grew 14.9% year-over-year to $44.5 million. The networking business now accounts to 96% of our business in this quarter.

As presented in the past, the major factors supporting this growth is the strength of the UC-SIP business which grew approximately 15% in booking year-over-year. We now target a revenue level of above $110 million in 2019 compared to about $93 million in 2018.

In our UC-SIP business we saw nice progress mainly in the SBC market or MSBR line in our one voice operation center management suite. We also saw early signs of growth in the Microsoft team space. At the same time we enjoyed very strong demand for our gateway business, which grew more than 20% compared to the year ago quarter.

This is substantially due to the continuation of evolution, the global migration of the PSTN to all-IP, while we see signs of continued trends among Tier 1 service providers to migrate their networks. This migration to all-IP is generally project that spends over several years, so we expect this trend to continue in coming years.

In past few months we saw three Tier 1 service providers in Europe which are wrapping up their purchases with us.

As mentioned on our previous calls, key to our solid performance in these segments for several years now is the fact that we became the partner of choice for CP products in many of the leading all-IP, UC and UCaaS application in the enterprise and service providers.

We are confident that we should be able to maintain this pleasant position in our SIP business in coming years. Now let's talk about what's behind that success. It's all sole point one direction that's connectivity. AudioCodes has been always a leader in that space building connectivity for host RP networks.

So it's obvious that we enjoy good business in both the gateway and the UC-SIP lines for several quarters in a row in order to explain the momentum we enjoy in the last 2/3 quarters, it makes sense to take fresh look into the combination of group business lines that falls into the category we call connectivity.

Gateways session for the controls and MSBR are all network elements which are used to build and connect voice networks. So it makes sense to combine them all into the connectivity group. Revenues for connectivity kept growing in previous years. Just to give you some data points. In 2016 connectivity revenues were $104 million.

Year after that in 2017 revenue rose to $116 million demonstrating about 10% annual growth year-over-year. In 2018, the previous year revenue grew to $131 million growing about 14% year-over-year. When we're looking to the first quarter of 2019 connectivity revenues reached $37 million which represents an increase of about 20% year-over-year.

And for the full complete year of 2019, we estimate the 2019 connectivity revenue should top $150 million in the range of $150 million to $160 million providing growth of more than 15% on an annual level.

So as you can see we are ramping up our connectivity revenues, which is substantially the majority about 75% of the company revenues and it's all tied up to two very strong underlying growth trends.

One is the all-IP immigration, the other one is the move to digital workplace where productivity Unified Communication and Unified Communication as a service collaboration services are the key to the growth. Now so far we've been discussing about the majority of our revenues. The fact to that we are investing heavily into new direction in the company.

I'll be talking about two main efforts in the company one which relates to our activity for migration to the cloud. At this stage majority of the work is going towards the Microsoft Azure cloud and second I'll be talking about our investment in voice AI.

Getting to our Azure cloud focus, early April we announced the availability for a direct route SBC on the Azure marketplace. The SBC was first deployed mid 2018 and since then through several months of testing.

We already have data from the first quarter of 2019 demonstrating an increase in the use of the direct route as we see on the Azure and see nice ramp up in recent months. Yesterday we announced the availability for one voice operation center solution on the Azure marketplace.

As most of you know, our one voice solution for Microsoft Skype is very successful and has already contributed to tens of millions of sales in previous years. We now aim to pour to that success on the enterprise premises side to the enterprise cloud operation. We now plan to migrate the complete one voice solution to Azure.

The initial target for that to happen is mid 2019 and we are working intensively to meet that target. We believe that the availability for one voice out of Azure will help substantially in ramping up new organization and businesses project in their transition and on-boarding process to new Skype for business and teams implementations.

Now to our second growth engine which is the voice AI business. We announced that activity early 2018. Now we have two main activities in that group one which is development of technologies internally and one that counts on the use of voice AI technologies and currently services of the major cloud players.

So on the internal activity we've been involved in developing speech recognition machine learning and NLU technologies. We have been dealing mainly with a long list of projects that had to do with free speech call routing. We've been engaged in developing conversational voice parts. I'll give you a list of project we implemented immediately.

We have developed transcription capabilities and also speaker identification capabilities, so very intensive, very strong investment in technology itself. To give you some perception in what we do in the conversational voice bot, we have developed and delivered a both driven payment solution for the government.

We have been developing an appointment scheduling voice bot using advanced technologies. Voice driven journey player, cleaner for the Israeli railways, conversational ticket booking voice bot, road navigation bot and we continue to develop activity in that area. So that's activity that's based on internal investment.

At the same time we understand that in order to be able to deliver solution and services over a long list of different languages in different parts of the world, it is important that we have access to cognitive services on the largest cloud cognitive services namely Microsoft Azure, Amazon AWS, and Google Cloud platform.

So in February of 2019 we announced the voice AI gateway. The voice AI gateway is a flexible and scalable solution that allows integration of bots and cognitive services with private and public voice communication networks and solution.

In nature, the voice over AI gateway is a multi cloud solution, which offer integration and orchestration of multiple cloud services with all of the big names that I've mentioned before. We basically target a relatively young but growing fast market. It's the markets of the chatbots.

Chatbots are growing very fast according to several market inputs where the market was estimated to be lower than 1 billion in 2017, but should grow to about 3 billion in 2023, so growth rate of more than 20% a year. Now the whole idea is to enable voice access to chatbots.

Our slogan is voice up your chat bot and basically we target chatbots which are very successful and put into service to entertain customer inputs and interaction between users and services and we basically look to allow them a voice access.

So it will be easier to access all those chatbots true voice from your phone, or your desk phone rather than sit in front of a PC or tapping on a smartphone. Since announcements back in February of this year, we have many inputs from many organizations.

I can point to one good example of a very large service provider who has got a very successful bot operation with services more than 10 million of calls on a daily basis that's using a chatbots and for them to be able to increase the level of participation is to enable voice access to it growing the percentage of people interacting on a automatic basis from where it is today to a higher number typically by 50%.

So with that you know I've covered the key development in our business just touching on some financial highlights. We've seen a very nice increase in our deferred revenues. We ended the first quarter in 2019, it's about 51 million. That's growing about 22% year-over-year. Gross margin came in line with our plans and budget.

Headcounts was relatively stable and most important we've been able to generate cash. Cash flow from operations came at 8.3 million, which is very strong and gives us confidence to the operation. Touching on the sales front, all in all sales performed well and according to plan across all region.

We had remarkable performance in North America and in the Western Europe markets and all in all we’re very pleased. We have finished above the target usually in the first quarter every year, we target a decline of about 2% or 3% compared to the fourth quarter stating fourth quarter this year we actually went above that, so good performance.

Again, now we've been successful on three key fronts. The markets of UC and UCaaS markets, the contracts in the market and then the business services market, all in all very successful for us in sales process. Let me touch on two key other areas in what we do.

Microsoft Skype business teams is key area for us representing a place in 2018 about 40% of revenues. In the first quarter, we grew above 10% year-over-year in North America and Western Europe.

We witness a key shift in the Microsoft Surface towards teams in collaboration which is driven substantially from the cloud and less emphasis on Skype for Business which is installed on premises. Still in the first quarter of 2019, we have seen significant projects and base with Skype for Business deployments.

We have two remarkable ones, one with a large bank in Europe the other one with a large healthcare organization in the U.S. To support this shift we are migrating our products run on Azure. Early April we announced the availability for SBC on Azure. Yesterday we announced the availability for one voice operation center.

We do intend to migrate all of the software, one voice components no later than the third quarter of 2019. Due to the transition to teams, we are seeing new and significant opportunities also for use of management pack.

We're talking about organization which have tens of thousands of employees and for them the use of the UMP solution is a very important and beneficial. The shift to teams also brings the IP phone vendors into a new level playing field.

We now feel that we are the same line with other companies in that just to remind everybody that we came late to the Skype for Business market so we do expect that in the team's IP phone market will be among the leaders. We see significant opportunities building up our IP phone some of which are voice multimedia.

Also we have announced a partnership with Jabra in our device manager, now enables to manage in combination not only our phones but also Jabra headsets, which is big advantage to end-users who can now basically manage the two different devices under one management suite. On the SBC line we saw a revenue increase nicely more than 30% year-over-year.

Target this year it's grown more than 20% from 2018. We've seen good product sales growth. We kept growing UC-SIP line into the service provider market and all in all the majority of sales in the SBC about 80% were made into North America and EMEA.

Only now we've seen nice spread of sales in two different market segments of SBC's some into the service provider market a licensing deals, the contact center deals and [indiscernible]. So all in all a very successful quarter for SBC. Last I'll touch the service provider city market. Here we do see very strong growth.

In first quarter 2019, we grew 26% year-over-year. Again the main contribution came from three very much West European tier one service provider and we believe those project will last several years going forward. So very strong, also second quarter this quarter has got a very strong start already in those projects.

So we anticipate growing this year in service provider city line above 30%. That's basically sums up my review of the business plan. I'll just get back to our guidance. I’ll mention that as we advance our 2019 revenue plan and met the quarter targets.

We are updating our annual guidance and stepping up the lower range about 1 million which is now 191 to 197. On the earnings side we capitalized on the increase of 40% earnings in first quarter 19 year-over-year and therefore we now forecast a new earning range of $0.77 to $0.82.

And with that I've concluded my presentation and I'd like to move the call to the Q&A session.

Operator?.

Thank you. [Operator Instructions] Our first question is coming from the line of Rich Valera with Needham & Company. Please proceed with your question..

Thank you. Good morning Shabtai.

You mentioned the UC-SIP bookings growth I'm wondering if you can give the revenue growth number for the UC-SIP business in the quarter?.

We're not providing the UC-SIP, we never provide the numbers themselves on a quarterly basis..

I was asking for the growth rate of the UC-SIP business year-over-year..

Year-over-year? So year-over-year again we plan for 15% to 20%..

Yes, I was asking specifically in the first quarter though normally you give a quarterly number there?.

The booking, yes, so booking grew 15% and I think invoicing was around 10% or so..

Got it..

Recognition recognized..

I just want to -- that business grew about 30% year-over-year I think for the whole year last year and I think actually in every quarter. So any anything going on there which is just a bit of lumpiness or do we have, I think you're planning on growing that business closer to something close to 20% for the year.

So is this just kind of a bit of lumpiness? Anything else going on in that quarter or in that business that we should think about from a growth perspective?.

Generally, no. Well the key line in that which is more than 50% of that is the SBC and as I've mentioned the SBC grew more than 30% in the quarter. As I mentioned previously in previous quarters the transition from Skype for business teams is causing some delay in customer decision about our deploying project.

If you recall I said that we do expect the market to get back to the same race we enjoyed in the past in the second half of 2019.

So what you can read into that lower than usual revenue growth is the fact that there's still some delay in team's project to become effectively growing and then the IP phone line which is very strongly tied to the type of solution being offered as team's project just to get out the IP Phone was a bit lower but that's about it..

But it sounds like you have a nice collection of teams’ specific phones that should benefit as your team's deployment pick up. .

Yes. Actually I can tell you that we recently got some data from basically the end of the first quarter and then we've got obviously the new data coming in for April that shows some very significant wrap-up in team's phone.

So we believe that what we have been lacking maybe in January and February we now starting to see in March and April a very strong comeback. That's why we're not paying too much to that revenue initiative..

If you could just talk more generally on what you see from a product and revenue perspective for a Skype for Business on-prem deployment versus a team's sort of you know teams is inherently a cloud product.

So how do you see the differences for you from a product and revenue perspective and those two different points of scenarios?.

So let's take them one by one. On Skype for Business obviously we've been very successful and deployed many projects. Some of which by the way still do continue. We do have examples of large corporations both in North America and West Europe which being big really preferred to have an on-prem service solution.

So a new, new such wins also let's not forget that when we talked in the past about winning an account that doesn't mean that that account was purchasing 100% of its needs. I would estimate that at this stage you know all of the wins in the past really deployed only between 20% and 40% over there in need.

So the fact that kept growing and I've mentioned that we kept growing in Microsoft space in North America and Western Europe by more than 10% it means that there's a continuous expansion of networks that have been started to deploy in recent years and we do expect that thing to continue but as I've mentioned Microsoft focus and think also Microsoft numbers from last week their main focus is on cloud on Azure and in that environment teams is the solution that's being recommended.

As any new solution it takes some for organization to evaluate it some part of it by the way the collaboration part of it is very advanced. The voice part of it is still lagging missing some capabilities.

We attribute that delay in voice features and capability in things to the fact that we have seen some slow development but we've been assured and we have our discussion that this big push big effort to bring the missing capabilities voice into teams.

So we expect the teams will now be growing very fast and that's evident by the numbers of the phones we sold into teams environment. We can see clearly on that by the way we got numbers of sales for the crowd.

It seems the teams are now starts to develop and that's a phenomena of the past in months, so I think going forward we going back to what we've seen previously..

And then on the -- you mentioned you've got three large service provider deals in Europe that is sort of ongoing projects and that they're driving a significant service provider CPE.

Can you remind us what those CPE are and it sounds like you have good visibility but just talk about the visibility on those projects for this year and beyond?.

Right well I should remind everybody that those projects are very large in nature and each is of a few millions.

Usually it takes between 12 and 18 months to get selected to agree on the missing feature to develop them, to be tested in the lab of that large Q1 service provider and then after everything is clear then we start deployment and this is exactly what happened. We are beyond that 12-18 months initial period. We started to deploy it earlier this year.

We expect the process to lasts between two, three or maybe even more years going forward. The products specifically are mainly gateways and MSBR.

MSBR is an equivalent of an integrated access device where you have a combination of a gateways with ADSL interface and I would also tell you that due to the specific nature of design implementation we use, we now start to see a very interesting phenomena where an MSBR that was sold DM 500L which is capable also to run our SBC application.

We start to see some requirements for adding the SBC software on top of the MSBR just to enable future SIP trunk services and cognitive services and other things, so very important project and with our very nice future ahead..

And then if you could just talk a little bit is it really about the voice AI business in terms of the size of that? I know you haven't given that number before but I think last quarter you said you expect it double it potentially this year.

Anything you can add to kind of the expectations for that business this year?.

So yes, we've been running up our resources and capabilities in the past year. We saw very nice designing activity earlier in this year. We now expand our production into Europe. We do expect also, we basically had only one language available for us last year. This year we'll have more than three or four languages.

By using the voice AI gateway we will be able now to increase the span of languages to tens of languages. So we definitely are confident in our ability to double our revenues this year and grow further next year. We are receiving a lot of good feedback on those projects.

Just an example this week I think we are scheduled to go to air with three conversational bots in three different applications. So the number is growing very nicely..

And then another product when you mentioned it the gateways are kind of seeing a resurgence and they were actually up 20% I believe in the first quarter which is kind of a surprise. It sounds like that's tied to these service provider projects that you referenced. So just wondering how you're thinking about that gateway business for all of 2019..

So, I'm very optimistic. You can assume that if you went up with gateways in the first quarter and because the majority of the need came from those large service providers that we should see similar as such trends. I also know from initial data regarding this quarter, second quarter that again we will see increasing gateways.

So all in all I think there was some very wrong assumption made by many people in the past that gateway is going away. Well, based on the numbers we have and what we can present our gateways are not going anywhere for the next 3-5 years. They're still with us in the last three years we had flat.

This year we will grow and I will not be surprised because don't forget the all IP migration now happens mainly in the U.S., Germany and other countries in Europe, Australia maybe but we're talking about 100 countries. So many other countries and among them you can count UK, you can count Japan.

You can count some very large countries where the whole migrations haven’t started yet. So I'm confident that we will keep selling gateways for a long time..

Got it and just one more for me. I noticed a $23 million operating lease showed up on the balance sheet.

Can you talk about what that is?.

Sure. Hi, this is Niran. As of January 2018, we implemented the new GAAP standard ASC 842. This new standard required us to record operating lease right of use asset and operating lease liabilities for all operating leases with a duration longer than 12 months.

The implementation of this standard result the right of the asset and the right of their operating lease liabilities of approximately $31 million..

Got it. That makes sense. Thanks very much gentlemen..

[Operator Instructions] Thank you. I'd like to turn call back to Shabtai for closing remarks..

Thank you very much operator. I would like to thank everyone who attended our conference call today with continued good business momentum and execution in the beginning of 2019. We believe we are on track to achieve another year of growth for our business. We look forward to your participation in our next quarterly conference call. Thank you very much.

Have a nice day. Bye-bye..

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