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

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

Greetings and welcome to AudioCodes’ Third 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, Ms.

Elizabeth Parker, Director of Investor Relations for AudioCodes. Thank you. You may begin..

Thank you, Melissa. I would like to welcome everyone to the AudioCodes third 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 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 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 ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in 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 in AudioCodes’ filings with the SEC, the US 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 the 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 third 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 quarter, discuss trends and developments in our industry and business and the outlook for the rest of the year. We will turn in to the Q&A session.

Niran?.

North America 47%, Central and Latin America 8%, EMEA 30%, and Asia-Pacific 15%. Our top 15 customers in aggregate represented 57% of revenues in the quarter of which 44% are attributed to our 10 largest distributors. Gross margin for the quarter was 62.8% compared to 61% in Q3 2016.

Non-GAAP gross margin for the quarter 63.2% compared to 61.7% in Q3 2016. Operating income for the quarter was 2.6 million compared to an operating income of 2 million in Q3 2016. On a non-GAAP basis, quarterly operating income was 3.4 million or 8.8% of revenues, compared to an operating income of 3.1 million in Q3 2016.

Net income for the quarter 1 million or $0.03 per share. On a non-GAAP basis, quarterly net income was 3.4 million or $0.10, compared to net income of 2.9 million or $0.08 per share in Q3 2016. Our balance sheet remained strong. At the end of September 2017, cash, cash equivalents, bank deposits and marketable securities totaled 60.1 million.

Day sales outstanding as of September 30 were 57 days. Operating cash flow generated during the quarter was 6.2 million. During the quarter, we acquired 940,000 of our ordinary shares for a total consideration of 6.4 million.

As of September 30, 2017 and since we began to repurchase our shares in August 2014, we have acquired an aggregate of 14.5 million shares for an aggregate consideration of approximately $70.7 million.

In May 2017, we received court approval in Israel to purchase up to an aggregate of $15 million of additional ordinary shares pursuant to our share repurchase program. The current quarter approval for share repurchases will expire on November 15, 2017.

On October 24, 2017, our Board of Directors approved filing a new application with the court in Israel, requesting approval for an additional repurchase program for $20 million of ordinary shares. We expect to file a new application shortly and receive a decision from the court in the coming weeks.

Now to provide an update on our guidance, we now expect revenues for 2017 to be in the range of 154 million to 157 million, compared to the original range of 152 million to 157 million. We anticipate non-GAAP diluted earnings per share to be in the range of $0.34 to $0.36 compared to the original range of $0.31 to $0.35.

I will now turn the call back over to Shabtai. .

Thank you Niran. We’re pleased to report strong financial results and continued momentum for the third quarter of 2017. As mentioned earlier in a press release, we experienced good business momentum for several years now and have build the ground for continuous growth in the coming years.

2017 will be the 5th year in a row that we grow our new business in the UC and SIP telephony. Similar to the first half trends, our two main business lines, UC-SIP and gateways, which together comprise about above 90% of our revenues continued to exhibit healthy business trends.

As such, it provides a strong confidence level in our investment in these areas. In the UC-SIP area, we grew above 15% year-over-year and we continue to successfully execute on our enterprise voice strategy to help businesses migrate to a digital work place in all-IP world.

Continuing these investments and growing partnerships and collaboration with unified communications and SIP tracking market leaders, should support extending this success over the coming years. We will keep pounding on our key message to the world voice networks are in a ‘forced migration era’.

The first major part of it is taking place right now between 2015 to 2025. This is what other players in the market call network transformation projects, transitioning from the old TDM world to an all-IP world.

This migration process drives the evolution of unified communication and UC as a service and prosperity among UC solution makers such as Microsoft, Cisco, BroadSoft, Vonage and other over the top players. And the latest announcement by Cisco targeting to acquire BroadSoft close to 2 billion further underlines these trends.

But the other side of this ‘prosperity climb’ is the fact that more such unified communication and the unified communication and service solutions need CPE and access gear that compliment these UC application and voice in for our devices and software and end points in order to deliver a fully working solution.

And this is exactly where AudioCodes fits the big picture. We have now become the partner of choice for our CPE products in muscle dividing UC application environment such as Microsoft Skype for Business and BroadSoft. And we are building similar such position with leading service providers worldwide.

In that regard, I will mention two announcements we made in the third quarter ’17 naming British Telecom and Portugal Telecom as customers. It is important to note though that these projects are still in the very early stage of deployment. So the potential in the future is big.

Working many years to secure this industry position, our success going forward is surely granted and we will contribute to continued growth in our UC-SIP product lines including the Session Border Controller, the IP phones and products starting things with Microsoft Skype for Business and team solutions.

We continue to experience good demand for our gateway business which was up 5% compared to the year ago quarter, but lower in comparison to the first half average in 2017. So summarizing business highlights for the third quarter of 2017; UC-SIP continued growing at about 15% year-over-year is on track to grow 15% to 20% on an annual basis.

So the business line is expected to grow to above 65 million this year compared to above 58 million last year, and we believe we will reach a level of 100 million in 2020.

We remain focused on growing and positioning AudioCodes to become the leader in the enterprise voice market and we have made important steps in third quarter of ’17 towards that goal.

In that respect, I would like to note that we have signed a resale agreement with a very successful global [work] for our Skype for Business deployments and projects, and already see a pickup in activity on that front. In the third quarter, we have been very active announcing new activities and success. Let me count and let me mention a few of them.

In the Skype for Business market, we have announced we’re going to enhance our Skype for Business Online solutions for Microsoft. We’ve launched VocaNOM, a voice dialing solution for IP phones for the Skye for Business environment. We believe that would be a very important cornerstone in achieving success for our phones and voice recognition activity.

We introduced a new mid-market phone, the 445; we believe that will contribute the further success of the IP phone business line. Next year we have enhanced our overall offering for Microsoft 365 and we just lately announced an enterprise voice management with and upgrading the performance. So that’s on Skype for Business.

In the service provider and all-IP front, we announced two wins in September. This September we announced Portugal Telecom that selected AudioCodes SIP tracking solutions for its all-IP network transformation project. In October ’16 we announced that British Telecom selected our product for their SIP tracking business.

On the BroadSoft front, we have announced an extended range of devices that now compliment the Broad cloud solution and provide complete interoperability testing with BroadSoft.

We announced a service provider Broadvox, who selected our product for process communication service and we just announced earlier this week collaboration with a company called RedSky to deliver enhanced E911 solutions.

Lastly, we have announced also that we signed up with a very large VAR in Japan that shows you that we are actually not only in the US, but also in EMEA and APAC going forward. So sum up our financial highlights this quarter, all of the numbers I mentioned would be non-GAAP.

As provided earlier, financial performance was as expected on the revenue side, but substantially better in the row with other parameters. Service revenues continue to grow this quarter. They reached a level 12.7 million, grew 12.4% year-over-year and it now represents almost a third of our business.

A very high gross margin, a very strong business going forward, as we bring more value to our customers through a combination of products and services. Gross margin was record 63.2 versus 61.9 in the previous quarter. Operating margin we announced a record 8.8% margin, which is substantially better than what was demonstrated in previous quarter.

Net income rose to 3.4 million versus 2.5 million in the previous quarter, and we continue to generate cash. We generated 6.2 million in the third quarter. We have generated 9.4 million from the beginning of the year. On the OpEx front, we have implemented a headcount reduction plan and downsized our mobility activity.

We ended the third quarter with 703 employees, a reduction of seven employees compared to the second quarter. However, OpEx did not decline compared to the second quarter as we face and still face headwinds on the FX front, while the average conversion rate for the US dollar versus the Israeli Shekel declined severely.

We believe that we will continue incur in software higher expenses going forward mainly as a result of these FX issues which we believe would improve in 2018. Deferred revenue is another area that can demonstrate the solidity and the strengths of our business. Deferred revenues continue to grow.

In the third quarter, the level of deferred revenues grew about [3%] to 34.8 million. In terms of our sales, generally sales performed well and over target as expected. There was only one sub-region, south Europe where we faced weaker conditions, but we believe that few projects with some large service provider will change that going forward.

On the other end, we enjoyed good business in Russia which is good progress and improvement over the last year. We also saw very good performance in the Dutch region which counts Germany, Switzerland, and Austria. All other region performed well or very well in context of their performance against the planned.

To note and give you a few more edifice on some specific deals. In Russia, we had a very big project selling gateways and Session Border Control to one of the largest world banks north of 0.5 million. We also had similar level of sales in to a contact center deployed by Genesys to one of the world largest enterprises that’s in the US.

Another activity in the contact center is that we keep selling to one of the very successful mid-market contact center companies. This quarter we have shipped also north of 0.5 million. In the Skype for Business market, we enjoy good activity. I want to mention, I’ll just mention maybe one name where we saw again above 0.5 million to a global company.

The important thing about that deal is that the majority of our revenues came from professional services. That tells you that as we expand our offering from just gateways to Session Border Controls, phones and services and professional services, we will be able to expand substantially our offering and level of sales going forward.

Third group of companies in the business services; we have done several projects with a West European service provider with a cable company in the US, with the top three service providers in Asia Pacific in South Asia Pacific. All those projects show you that we have a very strong and live activity growing our penetration in to the market.

Now let me dwell on what we did on the Microsoft front. So this was a good quarter all-in-all. We grew more than 15% over the quarter a year ago and we grew about 7% over the previous quarter. We have seen a very nice increase in sales of our Microsoft Skype for Business online products both CloudBound 365 and Cloud Connect.

That is supporting growth in our hybrid solution which now seems to be the most important product in that space and also in Skype for Business online. So all-in-all, very solid in deploying our solution not only in on-premise solutions but also in implementation that start to utilize the Microsoft Skype for Business online cloud solution.

In September, during GigaNight, Microsoft announced schemes. This is a cloud based collaboration solution that combines chat presence, voice, fast (inaudible) more. This is a very new leading application for messaging.

This product is expected to replace Skype for Business online in coming years, but we expect on gradual and slow process in adopting it. Current offering for customers is based on Skype for Business [settle] for on-prem solution.

Microsoft announced a new release for next year vNext, which gives our customers division of continuing support for the on-prem solution. At the same time announcing teams would provide a solution for the cloud version and the online versions.

I must know that during that conference back in September, we participated in one of the most successful session ever in our history. Microsoft delivered a session about the deployments of large accounts in the Skype for Business on-prem solution.

Basically Microsoft presented successful deployments of four large companies [Cargill], BOSCH, [ZF] and [BNSF]. These four companies combined have more than 600,000 sets worldwide. That tells you the potential we face. Those are only four companies, 600,000 sets.

We’re very proud to being discussed with those four giants as a strategic vendor or product names have been mentioned throughout that session. Towards the end of the session, we were called to come up with on stage and present and join the Q&A panel. As a matter of fact, question from the audience also referred to AudioCodes as their vendor of choice.

So by the way this session audio recording is available online on YouTube for anyone that’s interested. So this allows us to be positioned as a strategic vendor at this Fortune 100 and 1000 companies and successful handle product wise competition.

As I’ve mentioned before, another note was upon is the fact that we have signed a global resale agreement with a large, very successful VAR in the Skype for Business environment and we made products with another world leading VAR in that space. I just mentioned that on all the fronts we grew very nicely.

We grew 38% year-over-year and 9.6% quarter-over-quarter. We are now well on track to fulfill our target of growing 20% from 2016. Now let me refer to an announcement that was made three days ago, where Cisco announced plans to acquire BroadSoft for an amount of approximately 2 billion.

BroadSoft is an important strategic partner for AudioCodes for many years and we’ve been doing business with them for many years. Through them we are entrenched in very long list in terms of operators using BroadSoft application in AudioCodes city gear.

When the transaction is being presented on stage, it was clear that BroadSoft which has over 19 million business subscribers and that has partnership with over 450 service providers in 80 countries is a good fit to the Cisco unified communication plans. BroadSoft solution is complementary to our existing on-premise, while that was a quote by Cisco.

BroadSoft technology is complementary to our existing on-premises and enterprise centric hosted collaboration solution, and hence this transaction should enhance Cisco overall cloud as a strategy.

Based on comments that we heard after that announcement and there was a refitting message that BroadSoft strategy of maintaining an open system and using APIs and so for development field that we have to interface and work in the process environment that will keep going on.

So believe like other comments made by analysts and other speakers at an event that Cisco first and foremost priority is to get software based, software and service recurring revenues more subscriptions and OpEx model and this is the main interest and therefore we believe that in order to be successful we definitely believe that they will work with partners who support currently BroadSoft to keep supporting them in further deploying a clear solution.

So that is probably the end of my introduction (inaudible) and we’ll now turn the call to the Q&A session.

Operator?.

[Operator Instructions] our first question comes from the line of Rich Valera with Needham & Company. Please proceed with your question. .

It looks like you took down your growth target for your UC-SIP business. You had been looking for 20% for this year; it looks like now its 15%. In the last quarter you had talked about some softness in the Skype for Business part of that business.

Just talk us through what’s behind that moderated expectation? Is it in fact kind of a softer, near-term outlook for the Skype for Business that you guys do?.

Naturally, as the business grows, I think everybody should expect that a larger business will demonstrate slow growth. So while we grew 30% and 25% and 20% in the previous years, reaching a level of 65 million and growing to 100 million. We are moderating expectations. We do believe that we will do more than 15% which we did this quarter.

You may have a point in that the announcement of things to be provided in combination with Skype for Business may in some areas maybe something that may slow the business a bit, but it’s not really. But when we plan this quarter and the fourth quarter and as we plan next year, I don‘t see much effect to that.

Simply because the UC-SIP business is built out of a lot of activities, Microsoft is one of them, BroadSoft is another one, Genesys is another one, the service provider PSN [Shadow] is another one.

All-in-all there are so many different factors that affect the success of that line that we simply want to be more realistic and 50% and above is the right growth cycle that we want to assign to that business..

I appreciate the law of large numbers, but I’m just trying to understand kind of what at the margin from what you were expecting only a quarter ago you’d kind of had reiterated the 20% target and now a quarter later, we are talking about 15. So it seems like something changed there, and I’m just trying to get a better handle on what that was. .

Again, really there’s not much change I can tell you. I can just provide you more details that I think in the previous quarter we grew around 18.x, this quarter we grew 16.7. So listen it’s a quarter-by-quarter fluctuation, I don’t think we should look at such low details.

I think we are very confident in the strong growth that we have of 15%, but that is something that we stick to and that’s how I think we should refer to it. .

And it sounds like the gateway business had another quarter that was probably a little better than you were looking for. When you headed in to the year I think you were looking for that business to be down for the year. Starting the year you were positive on the third quarter as well as I think for the first half.

Can you kind of give us your updated view on that gateway business for this year and maybe for longer term?.

Definitely, as I mentioned contrary Voice over IP history that’s between ‘96 to 2015, the previous let’s say 20 years.

When inspecting to the period that’s between 15 and 25, it’s going to be what I mentioned, a forced transition in each country and we expect there was a leading economic country such as the US and Germany and France and the UK to be in front of that. It’s no longer a choice.

The service provider and the communication authorities in these countries have set sudden date for inforce transition from the old TDM network to in all-IP. So that continues to drive the gateway business.

Just to give you an example, on the British Telecom side, we’re starting with gateways in all that activity, and the gateways do provide an interface to SIP tracking position. In the future, that gateway business will evolve to become also in succession for the controller business.

But all those transformation that has to connect tens of thousands and millions of businesses. The element that is needed in most of those transitions side-by-side with the softswitch and/or the UC application is gateways. So we expect gateways to continue to sell very nicely.

Actually we are adding features and capability to our gateway line, simply because those are required by customers.

So the gateway business is very much alive and we believe that it will maintain a very nice level, either flat, up or down a few percent, but all-in-all very solid, by the way also very profitable because our investment in it is very limited. So that by the way provides cash infusion to be invested by our other activities in the UC-SIP etcetera. .

Our next question comes from the line of Dmitry Netis with William Blair. Please proceed with your question..

A couple of questions from me, maybe going back to the gateway question Rich just asked. Can you frame, I think you said it’s going to be flat this year. Do you expect gateways given the project that you on-boarded in the last few quarters.

Would you expect gateways to be flat again next year or does that kind of go back to the normal secular decline pattern and I think it was 10% to 15% decline. So if you could help us understand what to expect for gateways going in to the next year. .

I’ll try to model it Dmitry. If you take the new accounts, so I’m confident we relied on more accounts for the next year. If you’re talking about previous accounts, they will expand the solution. We think it’s known that we provide to Verizon in this case, we work with Comcast, worked with Deutsche Telekom.

Those projects have just begun, so we can very much be assured that the activity will go on. So I will tell you that we will need another 12 months or so to provide a more sound or analytic backed response. But I’ll tell you that in my view next year it could go anywhere between minus two, three points to plus three points or either flat.

So it’s in that range. .

And then on the SBC side of the business, I think you made a commentary and it kind of made sense that Microsoft is going through a transition and lumping the Skype well killing Skype for Business online and developing its own product within teams’ environment.

Would that essentially spark a pickup in your SBC business in support of the premise environment, and have you seen any of the Microsoft Skype for Business server premise environment – premise deals rather spike as a result of this change of this transition that’s going on. .

So the way we see it is that at Ignite I think the on-prem solution got a new life.

Microsoft announced a new release called vNext to be delivered in the second half of 2018, saying that gave a lot of support for all the larger enterprises, Skype for Business customers, who now have assurance that Skype for Business server for on-prem deployments will be evolved will be supported. So that’s in place.

Skype for Business online is really not going to be killed. It’s going to transition and more of the investment will go in to teams. Teams will replace it.

But all-in-all when you’re talking about either Skype for Business online and/or you’re talking about teams, when you want to provide PSTN calling you need to connect and usually those are Session Border Controls that help to connect.

So Session Border Controls will keep selling in the on-prem solution for the Cloud Connect solution in another new version for the team solutions. So all-in-all in an all-IP world or SBCs are used to connect between location and operators, SBCs will keep growing in to a very strong business.

And definitely the announcement of teams gives us a new phase of deployment. .

And any evidence yet of the Skype for Business server business being kind of a pickup yet or is that still early?.

No. I’m telling you third quarter has been very strong. We see projects, just yesterday we mentioned there’s a large world leading accounting firm that we signed about five years ago, so that the deployment over the past few years is not really reached even 50% of its deployment.

So all of these large companies, and I’ve mentioned by the way those four companies in the session that has altogether 630,000 SIP. A very small portion of that has been deployed. So you can assume that these companies will continue now that they have assurance for continuation of the on-prem.

And I think to be realistic; guys don’t expect large companies to go fully cloud. Small companies will go cloud immediately.

When you’re talking about companies who employ tens of thousands and hundreds of thousands of employees, those companies most of their operation in many cases will remain on-prem when private cloud will be a better solution maybe some of it will move to cloud.

But the fact is that cloud really serves today mostly F&Bs and starts to serve also some need market companies. But large companies, majority of them will employ for many years going forward on-prem solutions. .

I was just referring to this change that Microsoft just made, that that’s for additional business or not. But we could talk about it offline.

What I also wanted to ask real quick is, is there any way to frame DT British Telecom and DT Portugal Telecom opportunities as far as number of lines that are transitioning from TDM to IP? Any sort of guidance you can provide on potentially how big these projects could be or what it means in terms of lines. .

Usually they do not or we do not expect a firm number. I’ll just mention that about three years ago we signed with Deutsche Telekom. When we negotiated the contract, the potential discuss was about 10 million supplies. So that gives you kind of an indication for when you’re dealing with a large tier-one service provider in a leading western country.

Those are the numbers, you go to smaller service provider you talk about a few million. So we haven’t stretched really yet the potential in that case. The world use different statistics.

I think in the US the market is more advanced mainly with the micro business and the 10-20 employees, but when you go worldwide a very small penetration, less than probably 10%. So the potential is huge and it’s going to last for the next 10-15 years. .

Okay, so BT is probably similar sized to Deutsche Telekom, so we could expect maybe about a similar size, 10 million lines (inaudible). .

Right. Yes. I just wanted to mention also, by the way Dmitry; you just reminded me that we haven’t mentioned it. But we announced this quarter that we won the RSP for a large global service provider, name was not mentioned in that call. But yes, there’s another one, just fine. .

One last real quick question on services, it’s done really nicely this year.

Do you expect that level of growth maybe high-single digits, low double-digits to continue going forward? And I think part of it as you said maybe predicated on this Microsoft Skype for Business deployments that you’re working through in professional services that are attached to that.

So can we expect similar growth next year?.

Yes. Right now we predict services growing at about 10% to 12% annually and we do not see any reason that that trend will change. .

Thank you. Mr. Adlersberg there are no further questions at this time. I’ll turn the floor back to you for any final remarks. .

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

We look forward to your participation in our next quarterly conference call. Thank you. Have a nice day..

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