Elizabeth Parker - IR, KCSA Shabtai Adlersberg - President and CEO Niran Baruch - VP, Finance and CFO.

Dmitry Netis - William Blair Rich Valera - Needham & Company.

Greetings and welcome to the AudioCodes’ First Quarter 2017 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.

I would now like to turn the conference over to your host, Elizabeth Parker, with KCSA. Thank you. You may begin..

Thank you, Melissa. I would like to welcome everyone to the AudioCodes first quarter 2017 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 beginning, we’d 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 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 effects of current global economic conditions and conditions in general and in AudioCodes’ industry and target markets, in particular, shifts in supply and demand, market acceptance of new products and the demand for existing products, the impact of competitive products and pricing on AudioCodes and its customers’ products and markets, timely product and technology developments, upgrade, And the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in 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 in AudioCodes’ filings with the SEC, the U.S.

Securities and Exchange Commission. AudioCodes 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 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.

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 section of the Company’s website at the conclusion of this call.

The call will also be archived on our Investor Relations app, which is available for free from the iTunes App Store and the Google Play market. With that said, I would now like to turn the call over to Shabtai Adlersberg. Shabtai, please go ahead..

Thank you, Operator. Good morning and good afternoon, everybody. I would like to welcome all to our first quarter 2017 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance for AudioCodes. Niran will start off by presenting a financial overview of the quarter.

I will then review the business highlights and summary for the first quarter, discuss trends and developments in our business in industry and the outlook for the rest of the year. We will then turn meeting to the Q&A session.

Niran?.

We expect revenues in the range of $152 million to $157 million and non-GAAP diluted earnings per share of $0.31 to $0.35. I will now turn the call back over to Shabtai..

Thank you, Niran. We are very pleased to report solid financial results and continued business momentum for the first quarter of 2017.

As reported, first quarter revenues came better than expected and earnings results were at the high range of the guidance provided for the full year, which supports the confidence in our ability to meet the growth expectations in coming quarters.

As such, first quarter results provide strong indication that our business momentum over the past two years remains intact and that we should expect solid execution and growth of our business in coming years.

Most important, the two key business lines in the Company UC-SIP and gateways, which together comprise above 90% of our revenues, continued to exhibit very healthy business trends and thus provide us, management, with a strong confidence level that allows us to continue to make our investment going forward in these areas.

In UC-SIP, we grew about 18% year-over-year and we continue to successfully execute on our strategy to grow the business in market segments related to unified communication -- unified communications facilities, contact centers and SIP tracking, all of which keep expanding on a multiyear basis.

Supporting growth in UC-SIP is our nice growth of revenues in several of our business lines including the session border controllers, the phone business and products related to sales in the Microsoft Skype for Business market.

As for the gateways line, the consistent growing pace of migration to all-IP networks in North America and Western Europe continues to drive success in sales of gateways and SBCs in TDM to IP and IP to IP connectivity applications.

As mentioned in our press release earlier this morning, we see a major change in the direction of sales for our gateway line. While declining in revenues for six consecutive quarters in 2015 and the first half of 2016, we’ve now seen the first quarter of 2017 and on the heels of the second half of 2016, sequential growth.

In fact, the strength of the migration to all-IP allows us now to be more cautiously optimistic about this trend of stabilizing or even growing gateways revenues that will continue to develop in coming years as more service providers start the journey and the process worldwide.

The growth in gateway sales is clearly evident in North America and leading Western European countries and should continue in these countries for the next three to five or even seven years. Obviously, we expect this trend to expand and unfold into more countries worldwide year-by-year. All-in-all, it’s a global trend.

We now expect increased demand for gateways to develop and remain strong for the next five to seven years. We see similar such trends, not only in the service provider space and we expect similar such activity of moving the infrastructure from TDM to IP in the large enterprise and mid-market segments, all that with the leg of about a year or two.

At the end of the day, the anticipated shift from TDM to IP will become a must for each country with a limited window of about five to seven years for migration and implementation. The potential though is huge.

As upto now, only about 30 to 40% of businesses moved to Voice-over-IP North America; and globally, we believe that there is substantially lower percentage that has shifted to IP.

As mentioned several times in the past, key to the success is the many, many years of huge investments in adapting our products and technologies to our partners, ecosystem, specification and earnings [ph] probability.

Another big advantage we have developed over competition is the complete solution approach which we took several years ago and which allows us to provide higher value to the end-customer versus a single product. So summarizing the business trends for the first quarter of 2017 and talking about the implication going forward.

UC-SIP is on track to grow to close to $70 million of sales in 2017 versus about $58 million in 2016, another year of about 20% growth. We are confident in our ability to continue this business growth and reach close to a $100 million revenue level in 2019.

We remain focused on growing and positioning and/or establishing AudioCodes to become the leader in the enterprise and/or business voice market. And we have made important steps in the first quarter of 2017 towards achieving that goal.

In line with the global trends for digital transformation, the all-IP process drives transformation in the enterprise base too. In the first quarter of 2017, we announced our EVM initiative.

EVM stands for Enterprise Voice Modernization that is meant to help organizations modernize and upgrade for their voice networks for the new all-IP era supporting their new infrastructure for unified communication and contact center applications, obviously supporting business services too.

We continued in the first quarter to grow our CPE business and are gradually becoming a most successful partner of choice for CPE gear worldwide for application partners and customers.

The fact that we are a global company and we have operations in many countries in the world, allows some of our partners in North America expand their services in other parts of the world using our infrastructure and services in these countries.

In the first quarter, we continued to evolve our business to the cloud era with growing deployments of cloud related products and solutions such as virtualized SBC for enterprise and service provider operations and appliances for the Microsoft Cloud PBX, the Skype for Business online.

Finally, we continued to buy back our shares, as mentioned by Niran. Now that would be a longer term plan for the Company in coming years, with the aim of improving return value to shareholders. Now, let me touch some of the financial highlights, non-GAAP of the first quarter.

Revenue came in at $37.4, which is 7.5% year-over-year, which is right on where we want to achieve with our annual goal. We basically were about 1.1% lower than the fourth quarter. This is better than what is usually expected; usually in the first quarter, we use to decline about 2% or 3%. I’ve mentioned UC-SIP; revenue growing 18% year-over-year.

Service revenues which are now 30% of the Company revenues, kept growing, increasing 11.6% over the year-ago quarter. Gross margin was very high, record basically, 62.9% versus 61.3% in the first quarter of 2016. We are growing steadily on an annual basis. I’ll just mention that we were at 58% in 2015, 59.4% in 2014, 60% in 2015, 61.5% in 2016.

So, we’re growing on a consistent basis. Why? Very simply, more services; migrating our solutions and products to contain much more software components. Operating margin improved to 7.3% versus the 5.7% a year ago. Headcount decreased five employees to 695 from the 700 employees we had in the fourth quarter of 2016.

In first quarter 2017 we added though sales and marketing position as we plan to expand globally this year and next two years to support growing sales. Net income increased to 2.5% versus $1.6 million a year ago. Cash flow from operations was 0.9% -- $0.9 million versus the 2.7 we did in the first quarter of 2016.

Deferred revenues continued to grow in the quarter. We reported $31.8 million in the fourth quarter of 2016. We ended up with $33.1 million at the end of the first quarter. Now to sales. Generally, sales performed to the target. Results came right on what we planned them to be. We also see some strong start for the second quarter of 2017.

In the Americas, I’d like to note that North America enterprise sales were very strong. Also, we see some good initial signs for increased levels of activity in the service provider space. In Central America, in Latin America we performed better than expected.

We believe that the economic recovery showed in some major countries such as Brazil, Mexico and others will help our revenue grow in coming quarters. EMEA was relatively okay. We felt some weakness in one or two countries but we don’t believe that that signals any change for the business. We believe that that will improve in coming quarter.

All other regions performed fairly well. Now, let me give you some highlights of some of the notable deals we had in the quarter. First, in the Skype for Business markets, we had a very large project on premise’s project for a retail network in North America. That project alone provided close to a $1 million of revenues in the first quarter.

We had obviously few more deals. We won a major deal with a very large and advanced technology company in the U.S. again selling our phones and SBCs. Touching the contract center market, we had great success in that market. We have gained probably a new good partner in that space, which we never sold to before 2017.

We have also supplied a lot of products to another player in that market. In both cases, I’m not referring to Genesys. We enjoyed good sales in other two accounts, one of which was in Russia. Again, we see some recovery also in Russia and that is a contract in the markets. Touching the third market, business services.

We continue to enjoy increased success in the over-the-top service providers markets. And also we have seen some good activity with one large tier 1 service provider in EMEA using our enterprise SBC and access SBC. Quick recap of Microsoft operation in the first quarter. That was a very successful quarter for us.

Actually it went up to 45%, up from the first quarter of 2016. That represents somewhat a recovery in that market from the fact that Microsoft is now balancing its message between cloud deployment and hybrid deployment. So we saw recovery in the on-premises markets versus a year ago. Cloud PBX adoption for use remains low for production.

Although we saw very substantial increase in Cloud Connector Edition appliances, which were both, by many parties over the world to support testing and initial proof of concepts. Our appliances for the Cloud Connect were selected by several major service providers.

So, we have much belief that when more advanced releases of Cloud PBX will be delivered to the market mid of this year, we will see impact on growing Cloud Connector Edition and Cloud PBX solution in the market, second half of 2017 and in 2018 for sure. We’ve seen big growth in selling our phones into the Skype for Business market.

Actually, we went up more than 50% from the year ago quarter. And we believe that on an annual basis, we will grow in similar way between 50% and 60%. All-in-all, we enjoyed our good sales into the Skype for Business server edition which goes into large enterprises.

I’ve mentioned already the one retailer that basically drove much of our sales in that space. In the SBC area, we’ve also been successful. Revenue grew 18.2% over the year ago quarter. All-in-all, we target for this year to grow another 20% on the SBC side.

That has been also a record quarter for the virtual SBC, which went up above 20% over the prior quarter, which signifies much higher growth. So, all-in-all, we moved very nicely from other base product into software-based product virtualized SBC which will, as I mentioned before, continue to improve our gross margins.

Most of sales went into mainly North America and then into Western Europe. So, all-in-all, two very strong provisions for us in terms of our SBC sales. In terms of sales, we won a big tier 1 service provider account in Europe. We sold SBCs to a very large U.S.-based large enterprise.

And we won few more in the international markets, in EMEA, in Latin America and few more areas. Most important, in the first quarter of 2017, we launched the enterprise voice modernization program, which is based on a new universal communication architecture.

That is promising to be a very-advanced competitive solution for the enterprise space, which we’ll have to move to all-IP. The EVM, the Voice Modernization program aims to basically provide large enterprises that are built of multi-vendor PBX environments with the solution that will unify the overall global infrastructure.

And that program basically talks about an overlay network of Session Border Controllers with the centralized routing and management server that provides a very advanced and unique solution to enterprises. We increased our activity regarding the deployment of our SBCs in the cloud. We also are deployed in various clouds including Amazon.

And we believe that we will see more increased sales in that environment. I’d like also to mention one very, very big win in the service provider space in the region of Asia. Now, coming finally to our guidance for 2017 and outlook.

Regarding revenue, we now have better confidence in reaching the higher range of the 152 to 157 range we announced earlier in the year, basically talking about all-in-all 7% growth in 2017. We remain conservative; we may be surprised by the growth of the gateway business that can push that number higher.

First quarter 2017 performance and business momentum provides good support also to our plan to reach revenue level for $180 million in 2019. Regarding earnings, we expect to grow above the 25% increase over 2016, which we announced earlier in the year with no better by mid-2017.

I should add though that we may face some FX headwinds in the second half of the year because of the lower U.S. dollars versus the Israeli shekel conversation rate. On buybacks, as reported, we purchased about 1.1 million shares. We do plan to continue our program in 2017 and already submitted an application for approval by the Israeli court.

In fact assuming business trends continue in 2018 and 2019 as previously in 2016 and 2017, we see this program continuing on an ongoing basis for the next two years. And with that, I have concluded my presentation. I’d like to turn the session back to Q&A.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of Dmitry Netis with William Blair. Please proceed with your question. .

Good morning, guys..

Hi. Good morning..

Okay, great. Couple of questions. I just want to revisit each of the segments and just make sure I understand kind of the guidance as far as the growth rates are concerned. Your gateway business, you mentioned grew sequentially for three consecutive quarters. You had guided previously for 8 to 10% decline.

It looks like you may be guiding for a flat to maybe up, some growth this year in gateways. So, just want to confirm that is the case. In UC-SIP, I think the guidance previously was 20%. So, is it -- I think in the press release I’ve seen something to the order of 15 to 20. So, just want to make sure you’re still guiding to 20% for UC-SIP.

And also, if you could recap the Microsoft Skype for Business segment and whether you’re on track there to complete the year at 25% growth. I think that’s the number I have here, and that is relative to I think what you said was 45% growth in the Q1. So, if all my numbers are correct or incorrect, I’d love you to rehash all of those three segments.

Thank you..

Sure, Dmitry. So, let’s touch them one by one. UC-SIP, we guided for 20%; we still guide for that. In the first quarter, we grew 18%, which we believe we are on track to do the 20%. So, nothing has changed here. On the gateway side, as I’ve mentioned before, we witnessed some very nice growth over the last three quarters.

As a matter of fact, already in the beginning of this quarter, we see further growth. So, on a long-term basis, in the past, we guided for an average decline of 7% for the gateway business in 2017, 2018 and 2019. We could be surprised. My feeling is that this year, 2017, we will not see the decline.

And as a matter of fact, I do believe that we have good chance of reversing that. Would we just stabilize or go down 1% or 2% or grow 1% to 5%, that is still [indiscernible] I mean it’s -- we just did one quarter, we still have three left. But all-in-all, substantially better environment supported by the transition to all-IP.

Finally, to a Microsoft, indeed the first quarter did provide huge increase over the first quarter. You know our plans for the year. We have about 20% growth in Microsoft.

But, based on the first quarter, we may anticipate further growth that is supported mainly by better premises sales, the fact that Cloud PBX will allow by midyear coexistence of the cloud with be on-prem solution and the growth of our phone business.

So, all-in-all, we maintain our guidance for Microsoft; and again, it will be unfold second quarter and going forward..

Okay, great. So, just to follow up again on Microsoft side of things.

So, you said 20% with potential upside to do better than that as you go through the year?.

Right..

What has changed or what is changing? It looks like, maybe Microsoft isn’t as religious about their Cloud PBX as they were in the past and are now enabling the customers….

That is correct. We see signs….

Go ahead..

That is correct. I mean, two years ago -- two years ago it looked more like black and white. I think in the past 12 months or more realization is that large enterprises would like to speak, certain part definitely, if not the majority of them would like to stick with an on-prem implementation.

They definitely started trial with Cloud PBX, and I’m confident that three or five years into the process the mix between premises and cloud will move more to cloud.

But in 2107, 2018 and as far as I can see now, the on-prem is -- I think this realization that the on-premise service solution is going to be supported driven forward and is going to be a hybrid mode that will prevail in the market. And we are definitely built for that.

We introduced CloudBond 365 for combined premises and cloud operation more than 15 months ago. We also came with Cloud Connect Edition appliance and we follow much of the direction that Microsoft is charging.

And we believe it’s all-in-all, our ability to provide a comprehensive solution that helps both premises, cloud and mixed environments to enjoy Skype for Business that will come into play..

Got it. So, they’re pushing hard on premise and maybe hybrid while they’re trying to figure out their Cloud PBX strategy, which will come in at the way of time, understood. Real quick on the Avaya impact. It sounds like you have been able to recognize the $645,000 worth of business that you booked or were about to book in Q4 that came in Q1.

So, some of the upside you may have seen was due to that Avaya PO that you received previously in Q4, correct? Did I get that correctly?.

Yes. That is correct. Yes. I think the fact that we got paid in the first quarter basically signals this -- it’s considered to be important supplier to the Avaya portion going forward, even under the Chapter 11 framework.

We believe that we may now have more opportunities, simply because we may find more cooperation with Avaya as much as we can find with other partners in the market, trying to replace Avaya.

So, all-in-all being the most advanced comprehensive supplier of CPE gear to the overall industry and that includes of the names you can think of, put aside Cisco. We will continue to enjoy surfing that environment.

Avaya, everybody recalls was a top tier telephony vendor with huge installed base and the thing that being able to provide solution to that environment and operate to more advanced environment is a big advantage for us..

Do you have a number Shabtai for Avaya for the year that’s included in the guidance? I think it was….

We do have a number. Obviously, I cannot talk about it. But all I can say that Avaya started out the year -- became minor, few millions in 2016. But it’s still too early to talk about the impact on 2017 but give or take, a positive or negative impact, it cannot be substantial in 2017.

I think that going forward in two or three quarters, we’ll know better the impact..

Okay. Very quickly, last question on the contact centre side.

Do you have an opportunity to play into this new deployment that Amazon had introduced or Amazon Connect? Is there an opportunity to play there? Maybe I’m just trying to connect the dots as far as the good partner quote, unquote that you mentioned on the call, would that be Amazon by any chance?.

Right. No, obviously, when Amazon entered into the UC space, was announced a few months ago when they’ve announced their partnership with Vonage and then later on when they announced contact center markets. Usually, as far as I understand and I maybe wrong, but we target substantially larger operations in our organizations. Okay.

So, we usually target is our solution is the enterprise markets which is 10,000 employees and upward and/or the midmarket, which is few hundreds of employees and few thousands. I’m not sure that the Amazon offering relates to such big companies.

And I would tend to think, I may prove wrong that the solution presented would be satisfactory and good for the micro business and/or the SMB I know that current reflects more this or sophisticated future.

So, this is the way we see it, nothing embedded in that, but all-in-all we do not think at this stage that that will have an impact on our contact center operations..

Got it. Thank you, Shabtai. I appreciate these comments and I apologize for my colleagues on the line that I have taken maybe a little bit more time than usual. Thank you very much. I’ll take the rest offline..

Sure. Thank you..

Thank you. Our next question comes from the line of Rich Valera with Needham & Company. Please proceed with your question..

Thank you. Good morning, Shabtai. I wanted to follow-up with a couple of questions on the gateway business.

First, can you say, what was the year-over-year performance of that business in the first quarter of this year? And then, can you give us the base revenue number for 2016 for the gateway business so we can get a sense of what a difference between being down 8% to 10% versus being flat might mean for your revenue for this year? Thank you..

Okay. The first question, I don’t have the exact number here, but I believe that we were up more than 10% on the gateway side comparing first quarter 17 to first quarter of ‘16. I’m sorry. I missed the second part of the question..

What the total gateway revenue number was for 2016?.

Oh, okay. I believe the number was between $60 million and $70 million..

$60 million to $70 million? Okay..

Yes..

Got it. And then, I think you kind of covered this, but Skype for Business was very strong I guess 45% up year-over-year. And it sounds like the bulk of that growth was from the on-prem part of your Skype for Business.

Is that correct?.

Yes..

Okay.

So, It’s kind of Microsoft somewhat changing strategy, it sounds like where they’re more willing to entertain on-prem or hybrid deployments than maybe they were a year ago?.

I think it’s a bit difficult to read into it, simply because let’s not forget, there is one basic phenomenon that we think many people do tend to ignore.

When people talk about Skype for Business, usually they talk about the licenses and the must use functionalities when activating those licenses would usually be presence into messaging and collaboration over PC clients.

In many ways, if you will ask and we know about the majority of the large enterprises we work with, deployment of voice Skype for Business has never reached a level that’s higher than 10 to 20% in those large enterprises.

Simply, it means that any large enterprise that has got tens or even hundreds of locations, the deployment is gradual and it means it spans over several years. So, what we have seen in the Skype for Business market in first quarter was really a combination of two elements, two components.

One, which was expand of the old design wins we had in prior years, could in 2016, 2015, 2014 and 2013, and then, I believe a smaller percentage of new wins in the enterprise market. So all-in-all, we’re enjoying the fact lately and Infonetics Research charge that puts Microsoft with 57% market share.

So Microsoft is a large power in that market, commanding about 50% market share. We are the most advanced successful voice leader there. So, as the markets keep expanding, we will expand and that’s what has happened in the first quarter. And when Cloud PBX will kick in, I believe that we will again expand our solution into that too.

But we’re glad to say, as said in the presentation that we’re seeing -- the enterprise market seems to be making a comeback after there was some false assumption that it will move quicker to cloud operation..

Got it. That’s helpful clarification. And then, just wanted to revisit your longer term thoughts on the gateway business. I guess going back maybe a year or year and a half, this business declined pretty sharply and you kind of looked at it as a long-term, as you said, declining business as maybe 8 to 10% per year.

And now, we’ve had a few good quarters. And we’re talking about it being a long, potentially being a long-term flat or maybe even growth business. And I am wondering what kind of gives you the confidence to make that projection longer-term.

It seems like potentially what we’re seeing here is a lot of volatility and tough to perhaps draw longer term trends off of this volatility. I just wanted to get your thoughts on that.

I guess particularly maybe the distinction between service provider gateways and enterprise because looking at some of your competitors, it doesn’t look like there has been any change in the long-term decline in the service provider gateway market but maybe enterprise has different characteristics.

So, a lot there, but just wanted to get your thoughts on kind of the longer term view of the gateway market. Thanks..

Sure. So, yes, Rich, actually, you are right on the point with the latter part of your question. Indeed, one need is to make a big distinction between service providers and enterprises. Let’s touch enterprise. The market for enterprise gateways is solid.

We just saw again in other report few days ago, again from Infonetics which puts the enterprise gateway market fairly solid, also declining a bit, few percent a year, I wound tend to think about maybe 2% or 3%. But all-in-all, it’s very solid. On the service provider market, you need to differentiate between applications.

So, what’s going down really is more the peering, the international connection, those type of installations. Those have basically grown to maturity and now declined.

But when you talk about the move to all-IP and you talk mainly about the small businesses, the micro businesses that our -- penetration of Voice-over-IP [ph] to those small businesses has never occurred. And the over-the-top guys by the way do represent that.

And as you can see them growing very fast, it tells you that there is much need for gateways in that market. Actually you can think about growth of gateways connected or related somewhat to the over-the-top growth. And we just talked about the small business.

But when you think about the midmarket, this is a thing where AudioCodes will shine simply because the deployment gets to be much more complex; you’re talking about companies of hundreds of employees with location and facilities all over the nation or global. And this is where -- very comprehensive, lot of gateways, and SBC will come into play.

So, I think the all-IP process, and the SMB [indiscernible] market. And let’s not forget, it’s only North America at this stage and maybe Germany. And you have still more than 120, 150 countries. So, the solid basis to believe that demand will be good.

And when we look into charts from our internal database, we see for the past so many quarters an increase in North America, more than three quarters actually in North America. And so, this allows us to believe that we will enjoy growth in several years going forward. That is the change from what used to be until a year-ago..

Thank you. Mr. Adlersberg, there are no further questions. I would like to turn the floor back to you for any final comments..

Thank you, Operator. I would like to thank everyone who attended our conference call today. Relying on good business momentum and execution on our plans in the first quarter of 2017, we believe we are on track to achieve another year of growth and continue to build a growing profitable business for coming years.

We look forward to have you and participate in our next quarterly conference call. Thank you very much. Have a nice day..

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