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

Rich Valera - Needham & Co. Michael Latimore - Northland Capital

Thank you, Christine. I would like to welcome everyone to the AudioCodes second quarter 2016 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 effect of global current 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 in 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 US Securities and Exchange Commission. AudioCodes assumes no obligation to update the 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'd 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 the 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, Elizabeth. Good morning and good afternoon, everybody.

I would like to welcome all to our second quarter 2016 conference call. With me this morning is Niran Baruch, with -- being promoted as of this morning to the position of Chief Financial Officer and Vice President of Finance for AudioCodes.

On behalf of myself and the Board of Directors, I would like to take this opportunity and congratulate Niran on his contribution and achievement at AudioCodes for the past 11 years and with his promotion to the CFO position. Good luck, Niran.

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 discuss 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, we will be referring to both GAAP and non-GAAP numbers on the call.

The non-GAAP P&L metrics exclude recurring noncash items. Today's earning press release contains a reconciliation of supplemental non-GAAP financial information.

Revenues for the second quarter were $35.9 million, up 3.2% from the prior quarter. Services revenues for the second quarter were $10.4 million, accounting for 29% of total revenues.

Revenues by geographical region for the quarter were split as follows. North America, 42%, Central and Latin America, 6%, EMEA, 32% and Asia-Pacific, 20%.

Our top 15 customers in aggregate represented 55% of revenues in the quarter, of which 49% are attributed to our 12 largest distributors. Gross margin for the quarter was 60.5%, compared to 60.3% in Q1, 2016.

Non-GAAP gross margin for the quarter was 61.4% compared to 61.3% in Q1, 2016. Operating income for the quarter was $1.3 million, compared to an operating income of $0.9 million in Q1, 2016.

On a non-GAAP basis, quarterly operating income was $2.5 million or 6.9% of revenues, compared to an operating income of $2 million in Q1, 2016. Net income for the quarter was $0.7 million or $0.02 per share.

On a non-GAAP basis, quarterly net income was $2.4 million, or $0.06 per share compared to net income of $1.6 million or $0.04 per share in Q1, 2016. Our balance sheet remains strong.

At the end of June 2016, cash, cash equivalents and marketable securities totaled $78.1 million. Subsequent to the end of the quarter, we used approximately $13.1 million of our cash in connection with the purchase of shares pursuant to our cash self-tender offer.

Days sales outstanding as of June 30 was 57 days compared to 60 days in the prior quarter. Operating cash flow generated during the quarter was $5.5 million.

During the quarter, we acquired 0.4 million shares for a total consideration of $1.8 million. As of June 30, 2016 and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 7.4 million shares for an aggregate consideration of approximately $31.5 million.

In May, 2016, we received court approval in Israel to purchase up to an aggregate amount of $15 million of additional ordinary shares pursuant to this program. The current court approval for the share repurchases will expire on October 7, 2016.

Under the existing share repurchase program, on July 20, 2016, we completed a successful cash self-tender offer and have accepted for purchase a total of 3 million of our ordinary shares at a cash purchase price of $4.35 per share. We reiterate our guidance for 2016 as follows.

We expect revenues in the range of $142 million to $149 million. As for the earning guidance, earlier in the year, we provided guidance of non-GAAP diluted earnings per share to be $0.20 to $0.25.

Based on second quarter results, we now expect non-GAAP diluted earnings per share to be at the higher end of this range. I will now turn the call back over to Shabtai.

Thank you, Niran. We’re very pleased to report strong financial results and continued business momentum for the second quarter of 2016.

As reported, we met the top line and the earnings targets for the quarter, in line with our guidance earlier this year. While we enjoyed growth and prosperity across the majority of our business lines, the most noteworthy ongoing thing is our success in the turnaround of the company and reemerging the growing company in the old era space.

The transformation of the company from a gateway centric company to an all-IP era is now in full gear and the transition to a focus on cloud based unified communication and contact center services and SIP tracking is well on track. We are moving to becoming a solution and services cloud based company, focused on cloud operations.

Another not a simple development in the second quarter is that we are now fairly close to the point where the UC-SIP business is roughly equal in size to our existing gateway business. The UC-SIP business now represents close to 40% of our quarterly revenues.

In the second quarter 2016, we grew 10.1% over the previous quarter and above 25% over the year ago quarter. Assuming we continue the strength of growth, UC-SIP should be comparable in size to our gateways business in the second half of 2016 and should pass it early 2017.

Within this category of business, progress has been made across business lines, including the Microsoft Skype for Business market, the SBC business line, the emerging IP phone business, our One Voice Operations Center network management services and more. Key to our success are two major activities.

The migration to cloud based services and the evolution to a solution and services company. Regarding our activity that relates to cloud operation, most notably our two areas in which we have increased activity and progress for cloud operation, those are in the Microsoft Skype for business and the SBC.

In the SBC area, our software SBC products and virtualized editions are integrated and deployed in enterprise virtualized data center as well as private and public cloud. These solutions comply with the [indiscernible].

Our software and virtualized SBC products as related to cloud operation represents a quarter, 25% of our total SBC revenue in the first half of 2016, compared to less than 13% in the same period in 2015. So we have almost doubled our operation into cloud related SBC in 2016.

We are doing similar such efforts in the Microsoft Skype for business segment, CloudBond 365 and the recently announced Cloud Connector Edition appliance for the Microsoft environment, enables service providers worldwide to offer advanced unified communication and business productivity services as a Microsoft Cloud PBX solution. That is a cloud related activity.

CloudBond 365 facilitates the full features of the services, the service provider private cloud. And Cloud Connector Edition appliance enables reselling Microsoft Cloud PBX services to the local PSTN.

I will also say a few words about solution. We have long ago decided to abandon the best of breed product approach and go for a solution mode.

And that is helping us tremendously in winning market efficiencies. As just mentioned, our One Voice for Skype for business solution, our One Voice for contact center solution or browsing solution, the combination of our session border controllers with IP phones and the One Voice Operation Center network management service and services and a few more elements, all contribute to our success in the field.

So solutions are the key, I would say, strategy that enables our future going forward. Now, before I proceed to more details some of the developments in our business, let me touch on some significant data points on the financial front, all of which are non-GAAP numbers.

Quarterly revenues increased 3.2% sequentially and 10.7% over the year ago quarter. UC-SIP grew above 25% compared to the year ago quarter.

Now, this UC-SIP revenue compare roughly on a quarterly level with gateways revenue, we expect that the past lumpiness in our quarterly revenue will fade gradually and it will provide for a more consistent quarterly revenue growth going forward. Service revenues, growing annually above 10% a year for the past 3 years, grew 11.5% year-over-year.

Gross margin was a record 61.4%, compared to 59.9% in the second quarter of 2015, a year ago. The increase in gross margin is related to higher service revenues and growing sales of software products driven at consistent shift to cloud solution.

Net income was $2.4 million or $0.06 compared to a net loss of $537,000 in the prior year period. Quarterly cash from operating activities was $5.5 million and $8.2 million in the first half of 2016.

This is the right point to mention that we generated cash for years on a very consistent basis. As I just mentioned, we have generated $14.1 million in 2013, $6 million in 2014 [ph], $17.5 million in 2015 and now $8.2 million in the first half of 2016.

Gateways business continue to decline moderately. In second quarter 2016, gateway revenue declined 5.3% sequentially and increased surprisingly 7.3% over the year ago quarter.

On a semi-annual basis, gateways revenue declined 6.3% compared to the first half of 2015. On the OpEx front, we are right on our plans with operating expenses at $19.55 million, exhibiting good control of operating expenses.

Operating margin grew to 6.9% from 5.7% in the previous quarter. We target to reach above 8% in the fourth quarter of 2016 and grow to above 10% in 2017.

Headcount grew to 669 employees, an addition of 10 employees over the first quarter of 2016. Leveraging on revenue growth and on the gains [ph] from the Chief Scientist, Israel Chief Scientist this year and the next two years, we keep adding R&D in customer facing position to support growth in coming years.

Now, to more details on developments on the business line side. First, let me touch on the Microsoft Skype for business second quarter results.

We enjoyed the operation on second quarter 2016 with top line revenue growing above 40% over the year ago quarter and above 30% sequentially. With Microsoft continued push towards PBX and Skype for business online, we saw increased activity around our CloudBond 365 and Microsoft new initiative for Cloud Connector Edition for fewer in aggregate voice solution.

We have been the first company to release the Cloud Connect Edition appliance during the second quarter 2016 and we have enjoyed much interest. I can say that our early adopter campaign has generated around 100 leads from partners, system integrators and end customers.

In the second quarter, we saw increased activity with service providers in EMEA and Asia Pacific who have evaluated the adoption of Cloud PBX in contraction with Skype for Business server to service our customers in large and mid-sized businesses. Similar to the first quarter of 2016, we saw meaningful increase in the level of IP phones sold in the Skype for Business market segment.

In the first half of 2016, sales of IP phones in the Skype for Business ecosystem were almost equal to the overall revenue in 2016. Building on completing pending Skype for Business Cloud PBX certification, we believe we will see accelerated growth for IP phone sales into the Skype for Business environment in second half of 2016 and beyond.

We also won a big deployment project with potential of few tens of thousands of phones and are in various stages of bidding more projects similar to the one we just won. Biggest half of this IP phone win to-date was made in the second quarter with more than 20,000 phones in one bid over two or three years.

We expect to become more competitive in the second half of 2016 to work and enhance our portfolio and have more models which will substantially increase our alignment offering. We have also reinforced the value for One Voice for Skype for business by introducing a new advanced session routing manager which substantially increases the value for One Voice solution for large and mid sized enterprises spread globally or nationwide over tens, hundreds and thousands applications.

We already enjoyed first such large customer win. Moving on to the session border control area, just like Skype for Business segment we enjoyed a strong second quarter with topline revenue growing above 40% over the year ago quarter and around 10% sequentially.

In terms of market activity, we saw several large customer wins both in the enterprise space and the service provider space. We won multi-million dollar opportunity in EMEA and others in North America in the enterprise space and several core areas, we see opportunities with service providers all centered around our new offering of software SBC and virtualized SBC products.

We’ve increased service on software and virtualized SBC products for private cloud implementation we have seen in the first half of 2016 sales of software and virtual SBC reaching several million improving more than 200% over the first half of 2015. Two notable developments in the quarter were increased rate of opportunities win based on solutions combining sales of session border controllers with our One Voice operations in network management server offering unique system capabilities for large enterprises.

Also, introduction of a new state-of-the-art SBC based voice based solution which provides more resilient HD quality alterative [indiscernible] a lot of business going forward. In terms of ranking, we continued to be part of the top three vendors in the enterprise as we see space next to Cisco, and Oracle, in having 13% market share.

To IP phones business, already mentioned the success in the Sky for Business ecosystem. All in all in that line we supply our phones to several owners, revenue grew above 50% over the year ago quarter and around 20% sequentially.

We are on track to achieve growth of 50% in 2016 over 2015. We expect above 50% revenue growth in 2017 and beyond as we had more models complete certification activity with several UC as service vendors and become more recognized in the market.

As to our network management server solutions, we enjoy the very strong quarter, revenue grew above 80% over the year ago quarter and around 50% sequentially. Also a newly introduced innovative session routing manager called ARM which enables large enterprises to better manage and route calls over a large and multi-size voiceover IP network, so much success in the quarter.

We enjoyed refresh wins and paved the ground for more customer wins with initial trials in several proof of concept activities. Lastly, I will come to our guidance and outlook.

We are now changing at this time our revenue guidance which remains at $142 million to $149 million. Regarding earnings guidance as indicated by Niran, we now guide for the higher end higher end of the range guided earlier in the range to be between $0.20 to $0.25.

As for the next quarter outlook, we believe growth in the third quarter will continue and we plan right now for 3% to 4% growth in the third quarter compared to the second quarter. And with that, I have completed my introduction and we’ll turn the call over to the Q&A session.

Operator?

Thank you good morning gentlemen. Shabtai, it sounds like a nice growth quarter for your UC-SIP business, you said 25% plus year-over-year growth there.

And I think you were at around 20% year-over-year growth in the first quarter. And I think last quarter you talked about that being kind of a 15% long-term growth business for you, is that still how you’re thinking about that or do you there could be upside to that long-term growth target for the UC-SIP business?

Right, we do witness huge growth, we definitely think we can maintain at least 15% a year, we should be able do several quarters growing to 20% year-over-year. We need to remember that the UC-SIP is a combination of several business lines, and while one is clearly advanced and mature like the SBC and it is growing 20% a year.

There are smaller lines which grow above that, IP phones and the network management grow 50%. However there is another line, the multiservice business routers, which is not growing that fast for any specific industry market segment.

So just to be on the safe side, we will deliver I believe at least 15% annually, we target to do 20% annually, we will probably do somewhere in the middle in several quarters.

That’s helpful color, thank you. And I was hoping you could elaborate on your Cloud Connect solution that you referenced for Skype For Business and just want to understand is that exclusively for deployment of Skype For Business Cloud PBX option and what you actually provide in that solution?

The Cloud Connect addition appliance is sold only for the markets of Skype for Business online solution or Cloud PBX, the solution - the appliance comprises of markets of provided software that is embedded on our Mediant 800 and other series appliances. We do provide few more elements on this.

So we always try to come up with a more comprehensive solution just that their actual business solution and this is what we do. So we [indiscernible] SBC allows it to connect breakout to the service provider IP network and in some cases we will provide more but that is what we do.

That's great helpful thank you. And then Niran question for you and by the way congratulation on your promotion.

But wanted to get the best estimate of the current share count, obviously you bought back I think 400 K shares and that probably wasn't fully reflected in the ending share count and then you bought back 3 million after the end of the quarter. So wanted to get your best estimate of kind of where the share count today and maybe roughly what we would expect to see for a third quarter share count?

Thank you.

You are right about the 400 K that we purchased this quarter that most of it is already reflected in the number of shares represented for Q2. With regards to the 3 million shares which we bought part of the tender offer, two third will be reflected this quarter and the remaining 1 million will be reflected in Q4.

This is due to the closing date on July 20, so you can estimate 2 million shares less for Q3.

Better that’s that's great. And then just one final one, you mentioned that UC-SIP it sounds it’s closed 40% revenue.

Can you give us a sense of where the gateway business is as a percent of revenue is that also around 40% of revenue now, just wanted to get a sense of the relative size of those few businesses?

Yes, roughly in the second quarter of 2016 there were apart by only about 3% or 4%, so yes gateway business is now down to somewhere around 43% give or take.

Within the UC-SIP is the multiservice router or the SBC, the larger subsegment, how do you see for something else?

Yeah. The largest contributor to UC-SIP is the SBC business, which is roughly I would say 40 to 45% of the overall mix of UC-SIP.

And then on the pay for business opportunity you've been highlighting, how much of that is driven by kind of pay for business hybrid where there is on-premise and a cloud options combined versus sort of the pure Cloud PBX?

Okay so far in terms of sales, all sales are related to Cloud One 365 and it is being sold for several quarters now. The CCE is fairly new, just been announced, we believe we will see samples being sold in the third quarter, we will not see pickup in volume before the latter part of the year.

You may have given this, but what percent of revenue was UC-SIP in fiscal ‘15 overall?

Well, I think I gave the number, I will give you, UC-SIP business was about 46 to 47 million in 2016, so you can do together the math divided by 140 [ph] like 35% plus.

You're not going to be breaking out technology versus network anymore?

It doesn't make sense, I can give you technology, I believe was shy of 10% this second quarter but networking really is a combination of gateways and UC-SIP and while gateways declined and UC-SIP grows, makes no sense to use networking anymore. So we will break out in the future mainly to UC-SIP to gateways, technology and legacy, we have a very small part that applies to application, I’ve not mentioned it on this call but we have like three application we sold, today the level is nothing more than 1 million a quarter, that is roughly the division.

And maybe just – can you just touch on some of the trends in – among your other important partner ecosystems like [indiscernible], Interactive Intelligence, Genesis, any kind of notes, anything worth nothing there?

Well, I can tell you that in the same quarter, we have actually increased, I did not touch that on the call, but we have much more activity with several of our logics partners among the market like Genesis, Interactive and others. So, yes there was definitely, I think our value as a partner to allowing our partner to provide a complete system solution is becoming more and more clear and we become much more important to our partner, so that’s an activity that grows on an ongoing basis.

Thank you operator, I would like to thank you everyone who attended our conference call today. Based on a good business momentum and execution on our plans in the second quarter of 2016 and first six months of 2016, we believe we are on track to achieve another year of growth and progress and continue to be growing profitable business for coming years.

We look forward to have you on our next quarter call. Thank you very much.

Have a nice day. Bye-bye.