Greetings and welcome to AudioCodes’ Second 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, Investor Relations for AudioCodes.

Thank you, Park. I would like to welcome everyone to the AudioCodes second 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 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 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 second 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 the summary for the second quarter. I’ll discuss trends and development in our business in industry and outlook for the rest of the year. We will then turn into the Q&A session. Niran, please go ahead?

Pardon me, perhaps you have your line muted. [Technical Difficulty] Deferred revenue balance as of June 30, 2017 was $33.8 million. Revenues by geographical regions for the quarter were split as follows: North America 45%; Central and Latin America 7%; EMEA 30%; and Asia Pacific 18%. Our top 15 customers in aggregate represented 55% of revenues in the quarter, of which 48% are attributed to our 11 largest distributors. Gross margin for the quarter was 61.4%, compared to 60.5% in Q2 2016. Non-GAAP gross margin for the quarter was 61.9%, compared to 61.4% in Q2 2016. Operating income for the quarter was $1.9 million compared to an operating income of $1.3 million in Q2 2016. On a non-GAAP basis, quarterly operating income was $2.7 million, or 6.9% of revenues compared to an operating income of $2.5 million in Q2 2016. Net income for the quarter was $1 million, or $0.03 per share, compared to a net income of $0.7 million, or $0.02 per share in Q2 2016. On a non-GAAP basis, quarterly net income was $2.5 million, or $0.08 per share, compared to net income of $2.4 million, or $0.06 per share in Q2 2016. Our balance sheet remains strong. At the end of June 2017 cash, cash equivalents, bank deposits and marketable securities totaled $61.2 million. Days sales outstanding as of June 30 were 60 days. Operating cash flow generated during the quarter was $2.4 million. During the quarter, we acquired 438,000 shares for a total consideration of $2.9 million. As of June 30, 2017 and since we began to repurchase ordinary shares in August 2014, we have acquired an aggregate of 13.6 million shares for an aggregate consideration of approximately $64.4 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 court approval for share repurchases will expire on November 15, 2017. We reiterate our guidance for 2017 as follows. 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’re very pleased to report solid financial results and continued momentum for the second quarter of 2017. Second quarter results provide strong indication due to our business momentum continues and that we have laid out the ground for continued growth and solid execution of foreign business in coming years. Similar to the first quarter trends are two main businesses, two main business lines UC-SIP and gateways, which together comprise above 90% of our revenues, continued to exhibit healthy business trends. As such, it provides strong confidence level in our investments in these areas. In UC-SIP, we grew about 15% year-over-year and we continue to successfully execute on our enterprise or a strategy to help businesses migrate to a digital workplace in an all IP world. Investing and collaborating with unified communication, contacts center and SIP tracking market leaders should support extending the success over the next several years. We have now become the partner of choice for CPE products in most of the leading unified communication and contact center application environments and building few of our such position with leading service provider worldwide. The key product line supporting continued growth in the UC-SIP or the session border control line, the active phone line and products starting Microsoft Skype for Business solutions. As for the gateways line, as mentioned in our press release this morning, we continue to see good demand mainly as a result of the continued migration to all-IP networks, mainly in North America. While we see initial similar such demand in Europe, the trend there is still in its initial phase. We now see network transformation and migration to all-IP, it’s an ongoing trend extending well to 2025 and beyond. So this should create a very good support for the company revenues going forward. The…

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question today comes from Rich Valera of Needham & Company. Please go ahead.

Thank you. Good morning. So, Shabtai, it looks like, you’re keeping your overall guidance unchanged, but it looks like gateways are performing better than you expected coming into the year and you’ve kind of, I think, up to your target for gateways. But it looks like the UC-SIP side is performing under where you thought, it sounds like, you’re at around 15% versus the 20% target. So one, just wanted to gauge what you think the right target is for this year for the UC-SIP, is that now more like 15% for the year? And then if you could dig into why you think the Skype for Business piece of that is slower than you expected? I know, coming into the year, you talked about a pretty robust pipeline of Cloud PBX trials. I just – I guess it sounds like those aren’t converting into implementations. But I think, if you could give more color on that, I appreciate it. Thank you.

Right, thanks, Rich. So first, on the UC-SIP. Actually, it’s not that it’s trending for the lower part of the 15% to 20% range Actually, I said over 15%, it was closer to 18%. So we’re not pretty being divergent from our goal. I think we will finally end up being the – around, let’s say, 17%, 18%, could be 19% now. It really should grow with coming quarters mainly because some of our business line among them mainly the SBC in the phone line, both actually sell better than expected. So we are optimistic on the UC-SIP. UC – well, gateway increase, the overall was just in line simply because we have a very small part of our business related to those technology in application and that part was a bit weaker in the quarter, but that’s really a very small part and not significant. So this is where you may have seen some lower performance. Regarding Skype for Business, we actually, as I’ve indicated on one end, we have seen very high interest in the market for our appliances switch embed Microsoft Cloud Connect Solution. The thing is that at this stage, the market is still kind of waiting for Cloud PBX to become more complete and more mature. And that process, we knew it will – it was due to be – to occur somewhere and near mid-year. We’ve seen press release. We do expect another release in the – towards the end of the third quarter. But all in all, except for a slight delay, I think, we definitely see good prospects in the market. But all in all, customers who are waiting for Cloud PBX to become more future rich and enterprises, which targets more on-prem, those delayed their decision. So that’s the source of what we see. But we do believe that that will probably come back, I would point more to the first quarter of this year and beyond.

Got it. Just to clarify, [indiscernible], the closer to 18% number you’ve referenced, was that for the first-half for UC-SIP, or for the second quarter?

That was for the second quarter. I don’t – simply don’t recall the first quarter numbers, so…

Got it.

...definitely second quarter, yes.

Just wanted to clarify. So, I mean, to maybe summarize your comments on the Skype for business, it sounds like just perhaps taking them a little longer to get a more mature version of that Cloud PBX out there, that’s the kind of markets looking for, and you think you might….

Right, and but still, yes. Yes, that’s correct. But again, I mentioned that, we see tremendous interest by very strong players in the market who wait the newer versions and are really because this is a segment of the market, mainly the mid-market, which is will probably be better by that product. And I think those players do anticipate much demand in that area. So, yes, we’re optimistic on that.

Got it. And then, if you could just maybe breakdown the gateway performance a little bit, you’ve historically broken that down into kind of the enterprise and the service provider piece. Can you give us any incremental power on how those two pieces are performing relatively?

So actually, it’s – I don’t have the breakdown here with me. But I – since I know some of the main accounts, we have some large accounts something to build up in the service provider space, that is apparent for more than a year now, both in North America and with other service provider – leading Tier 1 service provider worldwide. On the other hand, when I think about the over-the-top companies, when they expand from the market business to the SMB and mid-market, there’s always comes stage, where in order to provide a complete solution, they need to use those gateways in projects. So we see demand in both. Think about the world using today, I would say, hundreds of millions of wired phones on the desk. And think about all that number to be replaced to IP Phones somewhere, let’s say, 20 years from today. The expense that’s related to changing all those phones is tremendous. An IP Phone, an average phone will sell today for between 40 and 100 and some, depending on quality and on features. We all understand that while it’s relatively easy to replace the core of the network from a plus five switch into a soft switch. Replacing all that – those phones by businesses, by the end-user is very costly. So gateway that sales for, let’s say, $10 support is substantially more cheaper than a IP Phone that would sell for that purpose. So this is why you would see, and I don’t think, it will go down anywhere in the next five, seven years. There will always be high demand for those gateways to help connect current phones into the new evolving IP network, simply because the budget that’s needed to replace all those phones is not there and nobody will make that spending these days. So that’s why gateway are being required both on enterprises and service providers.

Okay. That’s it for me, Shabtai. Thank you.

Sure.

The next question is from Dmitry Netis of William Blair. Please go ahead.

First of all, thanks for taking my question. Good quarter, guys. Little bit of a follow-up on the guidance and Rich’s question there as far as the top line guidance. I think, a 7%, as you’re guiding, you would be kind of towards the upper-end of that range $152 million, $157 million. So I think, what I’m – I guess, if you could maybe you can help us understand September/December quarter of how are you thinking about the ramp, the more back-half loaded or fourth quarter loaded and September maybe more flattish through the June quarter results. Can you kind of explain what the pipeline looks like and how the revenue may end up – and if whether there’s, you foresee maybe much of an upside to that 7% guide, any opportunities where you see or you may potentially see that number?

Thank you, Dmitry. Yes, we usually our fourth quarter is the strongest one. So you can assume that we will see growth in third quarter, but rather small compared to what we expect in the fourth quarter. Usually, it’s largely associated with more significant service opportunity. So all in all, we will see fourth quarter larger than first quarter growth.

Okay. And as far as some potential opportunities you guys thinking like as far as big deal that are landing at the end of the year fourth quarter, what are some of those deals there maybe areas of Skype for Business, is there gateway, service provider, any of the vertical gives you confidence that you can end up at the high-end of that guide – guidance range. You could help us understand where that strength is coming from?

Yes, we largely plan on increased effort in the enterprise space. The North American business is very strong for us, growing very well, getting more positions there. We expect larger deals in the Skype for Business market. The fact that, we own close to a complete solution. There’s no such solution in the market that is anywhere close to what we offer. We also have some capabilities that do not have a match. So we believe with our position with large enterprise is getting stronger and stronger. We may add more direct path to some of that effort. So all in all, we believe in a very strong enterprise business going forward.

Okay, great. And then, you said Skype for Business maybe coming back at the end of the year. I’m just curious, obviously, you’re on the ground, you’re seeing what’s happening today. Microsoft had their inspired conference – partner conference a couple of weeks ago. Was there any change in strategy and direction that could affect your business coming into 2018 timeframe? Any anecdote you potentially could share with us, if there was any change or any strategic direction being said at that conference?

Right. So much of the change anticipated relates to Microsoft action. And as they have just started the New Year in July 1, we anticipate a big conference – end user conference is planned for September Ignite. And we hope that we will see towards that event changes that Microsoft is applying in that market that will allow both increased progress on both Cloud PBX and on the on-prem. So we’re optimistic that we will see that’s coming. So we would take a quarter from today, I think, we will see some change in the market.

Okay. And then just kind of going through the – some changes in the industry, I see some of your competitors are emerging and maybe that’s more of a service provider side of the equation. Can you foresee any potential impact to your business either on enterprise side, or this service provider side, how do you view this transaction positive, neutral, no? I suppose it’s not negative, but given potential disruption, but anything you can talk to as far as the impact of that consolidation. Could it be better actually because of the pricing environment has opportunity to kind of get better, given the consolidation in the industry. Any of those factors affecting your business, I would love to hear from your thoughts there?

Right. So both companies – both Genband and Sonus had a focus substantially more in service provider market. So with the combined company, I would assume that that focus will remain. We put more effort into the enterprise space. So, in fact, anyone may have his own opinion. But I think we’re seeing good environment for us in the enterprise space. So we – for us that combination does not signal anything that’s negative. Beyond that, obviously, in the past, we almost never crossed way with Genband. We definitely, we’re competing with Sonus for an opportunity. So – and so we’ll see that continuing, but maybe to a lesser extent.

Okay. And then maybe one last question on the financial side of the equation. I look at the gross margin this quarter assuming about 100 basis points under last quarter’s result. Just to see like what drove that? I know you mentioned a major deal, or is there something else going on? And how do you foresee that margin occurring through the end of the year? Is there going to be a upward pressure kind of neutral steady flow where we are and where we enter the Q2, and for the direction of the moderate gross margin would be helpful here?

Right.

I mean actually, I have one question on the OpEx.

Yes.

Go ahead.

Okay. So just touching on the gross margin, I think that previous quarter, where we reached 62.9 was a one-off quarter. We had a sudden mix of product constellation, which allowed us to deliver more higher gross margin. We seem to be coming back to where we were planning all along for the full-year of around 61.5% to 62% gross margin. So it’s nearly, it’s not representing any pressure on prices. It’s simply an issue of mix of products, mix of hardware versus software. As I mentioned before, there was some application area, which was weaker that which is software-based. So that affected the margin, so that’s the source for that.

Okay. So less software revenues, what sort of drove, you had higher software content in the March quarter, so less software in June, what…

It’s an application. It’s the application, one application area, which was higher in the first quarter and lower in the second quarter.

Okay. Now that geographies potentially has had an impact here. So you mentioned a major deal in one of those bigger contributors this quarter that that was not a contributor here to downward pressure on the margin from Q1 to Q2 time?

Yes, actually, that deal, we won it. It’s still not recognized. So we’ll see the benefit of it in the second-half.

Okay.

We just heard and I just mentioned that we won it – yes.

I’m sorry…

No, I mentioned that we won it, but it will not – it’s not recognized in terms of the financials.

Okay. And I apologize on my present call. I just want to throw in one last question on the OpEx. You’d mentioned it’s going to be lower in the second-half, so you’re putting up some leverage there on EPS. It sounds like margins are stable, gross margins are stable and revenue obviously stepping up here. So you did a math, it – the EPS actually steps above the range that you reiterated coming in kind of the upper 30s, it’s high, lower, depending how much lower obviously OpEx goes. But if it’s lower than Q1, Q2, which is what you said by 2% to 3%, you should be well above that guidance range on EPS, which you gave. So what – I’m just trying to understand the conservatism of maintaining that EPS guidance?

Okay. So two key points. One is, the FX issue, we had a very favorable U.S. dollar versus Israel – and new Israeli shekel rate in the first-half. We will not have that in the second quarter. We hope that, the shekel will not get stronger again, but we have a new budget that’s based on the current level. So we expect fully not negative surprises here, maybe positive surprises. We also did some, as I’ve mentioned, elimination of 15 positions in view of the worsening of the conversion rate. Also, it’s really the second quarter that was substantially higher than the first quarter, if you look into the numbers. Second core OpEx was $0.5 million higher. With the changes that we have made and the new plans, we now expect third quarter and fourth quarter to be lower than the second one, but a bit above the first one. So that’s the picture on the OpEx front.

Well, that’s right. But even with that type of guidance, I understand you’re going to come out better on OpEx. I guess, there is going to be – and I assume you’re buying back the shares. So there’s positive pressure from lower share count and lower OpEx on the EPS. So we will end up essentially just looking at the model and looking at the top line gross margin that’s higher than the upper-end of that range of 30%, again, 31%, you’re looking above that for the year?

Well, okay, I’ll – again, I’ll mention two things. Again, we tried to be conservative due to the fact that we have the FX currency issue. And the second, we simply try. We need to control those fluctuations in gross margin. On the buyback, I just mentioned that, although we continue to do the buyback basically on every single day. Due to volume limitation, we’re not buying at a rate that we both in the past. So that affects our ability to gain more on that front. But all in all, I think, we took all those factors together. We came up with a budget plan. That budget plan we felt we could not – we had no reason to change the guidance, that’s the bottom thing so.

Okay. Thanks, Shabtai. I’ll take the rest offline. Thank you very much. Congrats on a quarter.

Okay. Thanks, Dmitry. Sure, bye.

Our next question comes from Mike Latimore of Northland Capital Markets. Please go ahead.

Great, thanks. Thanks a lot. On the – you mentioned maybe some large Skype for Business deals that are in the pipeline for the fourth quarter. I see those are on-premise deals, is that right?

Yes, right now you should assume that any large deal is taking place with the on-premise release.

And you also said that, obviously there will be another release of Cloud PBX later this year. Will that shift do you think you’re focused to pure cloud, or will they continue to emphasize hybrid approach?

So I think there is realization and I think it tends to do not only with Skype for Business, but for the overall market approach, where there was some very simplistic start in the past that when cloud comes, everybody moves to cloud. I believe that we’ve seen that not only in the Skype for Business, but in other areas too that larger enterprises really prefer to have much better control or more full control over the operation of their communication infrastructure. And for that reason, many of them choose, we know for a fact in Europe, for example, take Germany. We know that majority of enterprises do prefer to keep on-prem solution. They will definitely use cloud solution where it helps in branch offices in smaller locations. But I think all in all, while everybody initially saw that there will be a swift move swift move to the cloud by everyone fairly fast, I think right now the hybrid approach is becoming substantially more. And this is being – we see message is coming from our partners, including Microsoft. We are combining on-prem for the larger facilities for headquarters and using cloud for smaller facilities. That will be probably the solution of choice for the next several years going forward. So that will basically when you have a better cloud solution and you have commitment to advance the on-prem solution, that would be the best combination for the end user. And I think that is the new scenario that’s been created in the market.

Yes. I think you said, the mid-market, the Cloud PBX in these levels are high there. I guess, is that kind of globally, or is that more centered in Europe or U.S.?

That’s globally. Actually, we are working with several service providers and we see demand coming from companies on the size of a few hundreds to small number of thousands, which are looking for Cloud PBX to provide a solution.

All right. And then with regard to Avaya, are you seeing kind of orders from Avaya still?

Yes. We keep working with Avaya. And although, the business is smaller than it used be compared to two, three years ago, we definitely work with Avaya.

Okay. And one of your competitors is partnering with firewall companies to address the security market. Is that something that you see opportunities around?

Again, I’m sorry, I missed that.

Yes, one of your competitors is partnering with firewall companies to address…

Oh, okay.

…security services. Is that an opportunity for you as well?

Yes, I think, we definitely agree with that security is a very important capability. We have our end solution, we have our own alliances, and we definitely work to increase that. So yes, we see that as an opportunity for us too.

Got it. Thank you.

Okay. Operator?

There are no further questions at this time. I would like to turn the call back over to Shabtai Adlersberg for closing remarks.

Okay, thank you. I’d like to thank everyone who attended our conference call today, relying on good business momentum and execution on our plans in the first-half of 2017. We believe we are on track to achieve another year of growth and continued to build growing profitable business for coming years. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a good day. Bye-bye.

This concludes today’s conference. You may now disconnect your lines. Thank you for your participation.