Greetings and welcome to AudioCodes's Fourth Quarter and Year End 2020 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] It is now my pleasure to introduce Brett Maas, from Hayden IR. Thank you Brett, you may begin.

Thank you. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President of Finance and Chief Financial Officer. Before we begin, I'd like to remind you that the information provided during this call may contain forward-looking statements related to AudioCodes' business outlook, future economic performance, product introductions, plans and objectives related thereto, any statements assuming assumptions made or expectations as to any future events, conditions, performance, or other matters are forward-looking statements as the term is defined under U.S. Federal Securities Laws. Forward-looking statements are subject to various risks and 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 global economic conditions in general and conditions 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, the timing of product and technology developments, upgrades, and the ability to manage changes in the 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 of acquired companies into AudioCodes' business, possible adverse impact from COVID-19 pandemic on our business and results of operations and other factors detailed in AudioCodes' filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information. In addition, during the call, AudioCodes will refer to non-GAAP net income and net income per share. AudioCodes has provided a full reconciliation of the 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 that was posted on the Website. Before I turn the call over to management, I'd like to remind everyone that this call is being recorded. An archived webcast will be made available on the Investor Relations section of the company's Website at the conclusion of the call. With that said, I would like to turn the call over to Shabtai. Shabtai, please go ahead.

Thank you, Brett. Good morning and good afternoon everybody. I would like to welcome all for the fourth quarter 2020 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of 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 trends and developments in our business and industry. We will then turn it into the Q&A session. Niran?

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 earning press release, that we issued earlier this morning, contains a reconciliation of the supplemental non-GAAP financial information that I will be discussing on this call. Revenues for the fourth quarter were $58.7 million, an increase of 11.1% over the $52.8 million reported in the fourth quarter of last year. Full year 2020 revenues were $220.8 million, an increase of 10.2% over the $200.3 million reported in 2019. Services revenues for the fourth quarter were $21 million, up 19.9% over the year ago period. Services revenues in the fourth quarter accounted for 35.8% of total revenues. On an annual basis, services revenues increased by 16.7% compared to the previous year. The amount of deferred revenues as of December 31 2020 was $69.2 million, up from $62.2 million as of December 31 2019. Revenues by geographical region for the quarter were split as follows; North America 14%, EMEA 35%, Asia Pacific 19% and Central and Latin America 6%. Our top 15 customers represented an aggregate of 63% of our revenues in the fourth quarter of which 49% was attributed to our 10 largest distributors. GAAP results are as follows; gross margin for the quarter was 71.4%. Operating income for the fourth quarter was $12.1 million, compared to an operating loss of $26 million in Q4 2019. Full year 2020 operating income was $38.4 million compared to operating loss of $9.6 million in 2019. Net income for the quarter was $8.4 million or $0.24 per diluted share, compared to a net loss of $8.2 million or $0.28 per diluted share for Q4 2019. Full year 2020 net income was $27.2 million or $0.83 per diluted share, compared to $4…

Thank you, Niran. We're very pleased to report record financial results for the fourth quarter and the full year 2020. Let me talk first about several major milestones achieved throughout the quarter and the full year. First and foremost is the strong financial performance, which Niran just provided a detailed description of it. I'd like to stress some of the most important achievements, which are strong expansion of our gross margin, operating margin and jump in net income, strong cash flow positive cash flow, all I'll discuss further on in the following. Then it's the evolution of our enterprise business. Now close to 80% of our business, growing 17% year-over-year. Third is the resurgence of three new growth engines for 2021 and going forward, namely Microsoft Teams, context center, and conversational AI, all in the enterprise space heading into 2021. Then it's the rapid transition before a solution in services to real time cloud communications, much was achieved in 2020. We now invest full force and accelerate investment in these areas driving the momentum into more real time cloud communication solutions. On top of this, we have substantially moved our focus in sales. So the recurring revenue model as compared to the previous years, where the majority of sales was done as CapEx transaction. To highlight this last point, in March 2020, we have announced our AudioCodes live initiative, which is a portfolio of professionally managed services designed to offer AudioCodes voice expertise products and solution to enterprises via a flexible subscription based managed service model. We have already made nice progress in the second half of 2020 and now see the momentum building up into 2021. Now let me touch on the achievements made on the financial front. Overall company top line revenue grew 10% about 10% year-over-year. However,…

Thank you. We will now be conducting a question and answer session. [Operator Instructions] Our first question is come from the line of Rich Valera with Needham & Company. Please proceed with your questions.

Thank you. Good morning. Shabtai, first question around your long term top line growth target of 13% to 15%. Just wanted to clarify, are you thinking about that as kind of a 2023 target? Or just what timeframe that is? And then, what specifically do you expect to drive the acceleration of the top line growth over that timeframe? Thank you.

Okay. Yes. The answer to the first question, yes. We view that range is applying to 2023. Where does the confidence come from? So last year, we grew 10%. What drove it was 18% in enterprise and decline of about 10% in service provider. We believe that service provider decline will basically flattened out. So in our plans and assumptions, we do not see the service provider business declining substantially from where it is today. Once we keep growing 17% on the enterprise, you will see gradually every year growth in the top line. So, in our guidance, if you take the mid range fees, 245, that represents roughly 11% growth. And we believe as we will step up into any new single year, you'll see that growing at least to 13%, if not more.

Got it. And then maybe this one is for Niran. Your product gross margins were very strong in the fourth quarter. And just wondering if you can talk about what drove them to be so much stronger? Was there anything non-recurring in that? And how you're thinking about your gross margins in 2021?

Yes. So indeed the gross margin of the product was very high relatively to previous quarter. What drove that is the product mix, as Shabtai mentioned, SBC grew very nicely. And this is a very high gross margin. And most of it is actually software and services. With regard to 2021, as Shabtai mentioned, on our longer three years model, we believe 67% to 70% gross margin is achievable.

Okay. That's overall gross margin.

Yes.

Got it. And then just a final one for me, clarification on the SBC business. You said I think it grew to close to $100 million. If you could just say sort of what that was on a percentage basis for the entire year. And then, could you clarify what percent of SBC was in fact software this year? It sounds like that percent must have gone up based on what you said. But just wondering if you can provide the actual percentage of SBC revenue that was software based in 2020?

Right. So yes. First, yes, we have approached the $100 million level in SBC. That's a number. I don't have here with me, the right split between so for an hour. But again, I want to urge you to change a bit the way it's being perceived. Guys, listen, all of our hardware was developed seven, 10 years ago. Okay. It's 1000 million 800 [ph], a long lists of hardware products. But that is something that was developed. And we do not engage in it. Just to give you an idea that out of 350 employees in R&D, there are about 15 guys in hardware, all doing fixes and the flag issues, et cetera. And the load is one load. We do release a new workload every seven to nine months. And that's basically a load that's going to be sitting on everything, both into virtual machines that's running on public clouds, on data centers, and then running on top of hardware. On hardware, that new servers that were designed several years ago, but still the customer pays for the intellectual property, the SBC naturally for the hardware. So, all-in-all, I think as time goes by -- and one more by the way, very important point to make. When you're talking about data centers at premises and/or in the cloud, you talking about software. And this is what we sell. We sell virtual software. However, when you go to offices, when you go to branch offices, which every large company has, there's no way. If you want to optimize cost and efficiency for those branch offices, you need to use a hardware device. That's how the device is going to include a firewall, a router, and SBC switch and few more. So calling this an SBC hardware is really doesn't make sense. It's all about software. So that's the way you should look upon it. And I'm not mentioning the gross margin, but you can bet that the gross margin on the hardware and software combined is very, very high, north of just throw a number, north of 80%, 85%.

Right. Okay. Thanks for that clarification. And I'll pass it along. Thanks.

Okay. Thanks.

Thank you. Our next question comes from the line of Raimo Lenschow with Barclays. Please proceed with your questions.

Thanks. Congrats on a strong finish to the year. Shabtai, can you go a little bit deeper. When you say you on the CC side, you want to go closer to the end user and talk more on that little bit on premise focus client as well. That sounds to me more like Avaya type customers. Do I read that correctly? Like, how do I have to think about that strategy? And then I had one follow up.

Okay. So yes. We've not mentioned names. And this is not really limited to one player or more. I think when you going to large end users, you find probably some resistance in moving the solution to clouds, simply because in terms of cost, is going to be substantially more expensive for them. So large companies do not necessarily rush to move to cloud. Still the more advanced solution are going to be applying into the cloud. So some of these end users find themselves with a need, let's say for WebRTC, just to provide high quality of service to their own based agents. And/or, they need to use conversational AI just to be able to automation of customer calls and self-service. So we find a need in the market, and not only with the name you have mentioned, to really be able to upgrade the capabilities of on-prem solutions. And we've seen large number. I mean, I think, more than 10 just in the second half of 2020. So we believe this could be a trend that we can work in. And by the way it happen also with Genesis accounts or other accounts, that's the trend.

Yes. Okay. And then, how do you on the Team side, how do you think this will play out? Like, in terms of where are we in terms of your penetration on new Teams deployments? And where do you see that overall Teams trend going? Thank you.

All-in-all as I've mentioned, we've been growing nicely in terms of our quarterly sequentially in new accounts on Microsoft Teams. And actually looking into the chart in front of me, relatively the pace of Skype for Business customer moving into Teams is kind of flat. So we're talking about more than 100, I would tell you, more than 100 accounts a quarter moving. But then on your accounts and Teams we see like about 20% growth in terms of number of new accounts. So it's going forward. And again, I want to stress the point I was making that, while Microsoft was very explicit in convincing customers to use Teams for collaboration and meetings, there was no much pressure on them to move to Teams voice and the customer could have keep using his old PBX. As conversational AI capabilities grow, meeting capabilities grow, there will be anybody that stuck with an old PBX will just add few more dollars for his license and we'll move into a more comprehensive advanced voice solution. So, we believe that we should see -- I don't think we'll have a problem keeping up with the 10%, 20% growth per year in Microsoft Teams.

Yes. Okay. Perfect. Thank you, Congrats.

Sure. Thank you.

Thank you. Our next question is come from the line of Ramsey El-Assal of Jefferies. Please proceed with your questions.

Yes. Sorry. This is Samad Samana. Not quite sure where Ramsey name came from. But thanks for taking my questions nonetheless. And congrats, again, on a strong finish to the year. Maybe just the first, Shabtai. On the Skype for Business installed base, how much of that do you believe is left to convert over to Teams for voice? And what percentage do you think realistically you could convert over to Teams for voice?

Tough for me to answer that question simply because one needs to assume that will be certain portion of the end user would rather stick to on-prem installation and not move to the cloud for many reasons. It could be security and others. And quite frankly, I don't have a very detailed analytic tools that would allow me to look into the specific accounts. It's a trend. I can tell you -- the only data points I can give you is that as I mentioned before, that it has been growing throughout the year. In the last two quarters, I see that number of old Skype for Business accounts flattening above 100 and some. But really have no idea on how it's going to keep. But we'll reporting, that's the only thing I can do.

Great. And this one may be for Niran or for you or whoever wants to take it. But we appreciate all the disclosures that you give around kind of full year numbers and growth rates. But is there any chance or is there any philosophical thought around giving, reporting the dollars around how big your Microsoft business is kind of more precisely on a quarterly basis, just given that that's -- as you noted that that's the most important part of the business on a go forward basis. We're just seeing if we'll maybe get more color on that on a consistent basis in dollar terms going forward?

Yes. So, Samad, hi. We are not providing it on a quarterly basis. The numbers we provide are not audited by our auditors. They are based on internal reports that we have. So we can provide it historically on a quarterly basis.

Got you. And then maybe just a last question. We saw the news around the buyback extension. Just curious, maybe more broadly speaking, what the philosophical approach to that will be? And how we should think about the execution of that or just maybe the logic behind asking for an increased buyback?

Right. So the idea is that sometimes the market gets irrational, right? I mean, we all know those times. And we have our view on the fair value of what we do compared to the value of other assets in the market. And when we'll find it beneficial for us, we will engage on the buyback. It's not that we intend to go for the same strategy when we at. We're going to count the multiples, et cetera. But all-in-all, I'll tell you that we are -- I'm glad to say that we are big producers of cash flow before paying the $10 million or $11 million to the Israel Innovation Authority, we have produced about $50 million. One of our board members told me, it's a half of a offering, right? So we producing a lot of cash. In terms of cash allocation and I've been answered that question a few times, priority goes into M&A then to dividend payments and then to buy back. And again, we will weigh the situation over time and decide accordingly.

Great. Congrats on the quarter and nice to see the stock having a strong move this morning. Take care.

Thank you, Samad. Thank you.

Thank you. Our next question is come from line at Walter Pritchard with Citi. Please proceed with your questions.

Hi, thanks. I'm wondering if you could just talk to, you mentioned some pullback from the selling into the UCaaS providers and instead focus on the end users. So you just talk a little bit about that decision? And how you're seeing as the Teams adoption goes forward? How you're seeing customers choose conductivity options there? And if there's been any change relative to what you've seen more recently?

Yes. I think there's some confusion. I've not mentioned that in conjunction with UCaaS. In UCaaS, well, A, in UCaaS we do it for a long time, right? I mean, we selling sometimes indirect and/or direct to the end users. Is certainly what I've mentioned on the call related more to the contact center market, where I go to market up to the last year was substantially on working with the vendors themselves to reach to the end users. We've found that with the more I would say -- the move to cloud, which really moves the world from being an on-prem market to being a twofold on-prem and in cloud market. We found that in order to service better, the on-prem portion of it, we better develop a direct go-to-market for those. And obviously, you can imagine that we will use the same sales force. At this stage, we have more than 200 people both in terms of salespeople in pre sales, and any sales manager getting into account would be able to sell not only a UCaaS solution, but also a contact center solution. So that's -- it's not -- and one big clarification, we're not selling contact center, guys. I mean, let's be very clear about it. We do sell complimentary technology and solution that helps to improve. Okay. So we selling WebRTC. We're selling our SBC for access. We're selling a technology called Click-to-call is allows calling over the internet. We will be selling conversational AI. So those were -- those will be the type of solutions that we will be selling.

Got it. And then just I guess, relative to Microsoft and Metaswitch, in terms of their own offerings on that, and you talked about your SBC as a service that rolled out in the quarter. What are you seeing in terms of the market with the customers looking at those different offerings and understanding it's quite early?

We haven't seen any of that. Quite frankly and not seen, we may. But right now, we are developing our own offering. As you've heard, we develop SBC as a service approach. We're developing managed services approach. We believe this will be competitive even if ever you know that happens.

Great. Thanks for taking my questions.

Sure. Thank you.

Thank you. Our next question is come from the line of Tal Liani of Bank of America. Please proceed with your questions.

Hi, guys. Good morning. Good afternoon. Few questions. First, can you give us an update on Zoom? You had an announcement before. I just want to know, what's the experience so far? Second, can you -- I want to understand how it works with Microsoft Teams. And sorry for the very basic question. But how does the sale cycle happen? Meaning, do you sell to them? Or do you sell to the enterprise? Who's selecting the technology behind it? I just -- I'm trying to understand the drivers. Maybe we'll do -- we'll take one by one. We'll do these two and then I'll ask my other questions.

Okay. As related to Zoom, we have a thin layer of Zoom phone activity earlier in 2020. But towards the fourth quarter, we've seen some uptake. We also been reported that we see more opportunities coming up in 2021. Zoom announced about few weeks ago that they've reached a level of 1 million Zoom phone users. So, we do expect that going to 2020 to 2021, we will win more Zoom phone accounts. I think the only thing that's left is really to wait for the next six, nine months and then provide more information. But we'll definitely see change from 2020. As to Microsoft Teams, always, the discussion is at the end of the day with the CIO and the IT manager of the end users. And basically, he is the one that's making the decision. How we fulfill that? Usually, it's been fulfilled by partners. So we have partners in the field, which based on the final solution proposed to the end users. That end users is buying the equipment in voice solution from the partner, and the partner in return buys it from us.

And in your view, what's the win rate? Or can you tell us about the competitive landscape in these kind of accounts?

We believe that due to the fact that we have captured over the years to develop a very comprehensive portfolio not only product, but really solutions, where we combine several products and add on top of them a management solution, a recording solution, and analytic solution and few more, lately, also conversational AI of Voca type. Our offering is substantially more comprehensive than competition. The only competition we had in the past is now seems to be focusing much more on service provider business. So, quite frankly, I think we're doing fairly well in this Teams environment. No tough competition, always competition, but not too strong.

Great. Shabtai, two more quick ones. One is, can you discuss the environment in 2020 and the sustainability? Meaning, in 2020, employees started working from home. We had to invest in collaboration tools, Teams one of them. Do you have concerns that you have tougher comps for 2021 and that corporates bought what they needed, and now they can slow down? Any concern about sustainability of what we've seen in 2020?

I'm an optimistic guy, so tough for me to be pessimistic on this. I'll tell you the following. Okay. In contact center, it's pretty obvious that we just started a completely new cycle, right? Work from home, we've seen WebRTC growing substantially faster, conversational AI is growing fast. Same for our SBC solutions that need to support cloud migration. So in contact center, we really are in the first inning of the thing. As we go for Microsoft Teams, again, I have no reason to believe that we will "see" customer already got their needs back in 2020. And there's no more accounts. Quite frankly, as I mentioned, only about 10% of Microsoft Teams users have applied Teams voice. And we believe that's a huge, huge growth area for us. So I do not share. But again, we will go through the year. But in every single quarter since the beginning of the year, we've seen growth. I've mentioned we grew in fourth quarter 30% over the third quarter. So right now I have no evidence that it's slowing or changing.

Got it. My last question is a stupid question. Not that my other questions were very smart. But in your press release, you mentioned, just you went through -- that's what happens when you get a COVID vaccine. That's my last question is, you mentioned in the press release that you've got court approval for buyback. Stupid question, just to understand the law -- to understand the kind of the procedure. Why is there court's approval? Why can just the board decide? I don't know how it works with Israeli companies?

Hi, Tal. This is Niran. In Israel, whenever you would like to distribute dividend or to do buyback, you need to file an application to get the court permission for that. Unless you have sufficient retained earning over the past two years. If you would go to our GAAP financials, you will see that we already bought back or distribute dividend more than the two years gap profit. That's the reason.

Got it. Thank you. Congrats on a great quarter.

Thank you.

[Operator Instructions] Our next question is come from the line of Robyn [Indiscernible] at Focus Capital. Please proceed with your questions.

standards: So this is my question, the competitive dynamics there. And is it correct that your solution would not believe it if they roll this UCaaS alternative? Thank you.

Right. You're definitely right. Okay, definitely this competition arising from the middle of 2020 by UCaaS other UCaaS players such as ringcentral, an eight by eight, telling customers, okay, you have settled on Microsoft Teams. But for telephony, either you already using mine, or you want to use mine instead of using, Microsoft telephony in order for you a solution. I'll tell you that that is a fair competition. But I will tell you that I believe that long term, the capabilities and the services that we are offering for Microsoft Teams, voice and telephony, will super see those offered by other companies. Businesses voice, this is the only thing we do. And just we coming out with meeting inside, I don't think you will see any comparable capability in other companies. So yes, it's a competition we know how to fare.

Thank you.

Sure.

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

Okay, well thank you, operator. I would like to thank everyone for attending our conference call today. With continued good business momentum and execution towards the end of 2020. We believe we are on track to achieve another strong year of growth and expansion in 2021. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day. Bye bye.

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day or a great evening.