Shabtai Adlersberg - President and Chief Executive Officer Ofer Segev - VP, Finance and Chief Financial Officer Chris Harrison - IR, KCSA Strategic Communications

Rich Valera - Needham & Company Dmitry Netis - William Blair Michael Leonard - Oppenheimer Mike Latimore - Northland Capital Markets

Thank you, Jeffy. I would like to welcome everyone to the AudioCodes fourth quarter and Full Year 2014 Earnings Conference Call.

Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Ofer Segev Vice President, Finance and Chief Financial Officer. Before beginning, we would 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 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, uncertainties and other factors that could cause actual results to differ material from those stated in such statements.

These risks and uncertainties These risks, uncertainties and factors include, but are not limited to, the effect 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 development, upgrades and the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in company's loan agreements, possible disruptions from acquisitions, the ability of AudioCodes to successfully integrate the products and operations from acquired companies into AudioCodes' businesses and other factors detailed in AudioCodes' filings with 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 new 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 Fourth Quarter and Full Year 2014 Conference Call. With me this morning is Ofer Segev, Chief Financial Officer and Vice President of Finance.

Ofer will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the quarter and the full year and discuss trends and developments in our industry and business.

We will then turn it into the Q&A session. Ofer?

Hello, everyone. As usual, we will be referring to both GAAP and non-GAAP numbers on the call.

We disclose non-GAAP numbers to help you understand the underlying performance of AudioCodes, the non-GAAP P&L metrics include recurring non-cash items. Today’s earnings press release contains the reconciliation of the supplemental non-GAAP financial information.

Revenues for the fourth quarter were 39.1 million, up 7.9% year over year. Revenues for the year were 151.6 million, up 10.5% from 2013.

Our revenues from networking were up 13% in the quarter, accounting for 89% of revenue and were up 14.5% for the year representing 87% of revenues for the full year. Revenue from our legacy technology products which we model to decline 10% on an annual basis, declined 21.5% in the quarter compared to Q4 last year and declined 10.5% in the whole 2014.

Services revenues which are mostly recurring annual agreements were up 25.6% in the quarter from the year ago quarter and up 29.6% for the year, representing 21.8% of total revenue. Revenue by customer geographical region for the quarter were Americas 53%, EMEA 33% and Asia-Pacific 14%.

Our top 15 customers in the aggregate represented 58% of revenues in the quarter of which 41% are our seven largest distributors. For the year, top 15 customers represented 47% of revenues of which 35% are our eight largest distributors.

Non-GAAP gross margin was 59.9% for the quarter and 59.4% for the year, up 180 basis points from the year-ago quarter and up 140 basis points from 2013. Operating income for the quarter was 2 million up 55.7% from a year-ago quarter.

Annual operating income was 3.5 million, up 27.8% from 2013. On a Non-GAAP basis, quarterly operating income was 2.9 million or 7.4% of revenues, up from 5.9% of revenues a year ago.

For the full-year operating income was 7.4 million, up 31.4% from 2013. Net income for the quarter was 946,000 or $0.02 per share.

For the full year, we had a net loss of 86,000. On a Non-GAAP basis, quarterly net income was 2.5 million or $0.06 per share, up from 1.9 million or $0.05 per share for Q4 last year.

For the full year, net income was 6.08 million or $0.16 per share. Our balance sheet remains strong.

At the end of December, cash, cash equivalent and marketable securities were 85.7 million. Days sales outstanding at December end was 73 days compared to 67 days at the end of 2013.

Operating cash flows were 2.4 million for the quarter and 6 million for the full year. We continue to buy our shares under the approved buyback plan.

We bought shares for $2.5 million in the quarter and $5.3 million in the whole of 2014. Now going into 2015, our guidance, we continue to expect top-line revenue growth and operating margin expansion in 2015.

We expect revenues in the range of 162 million to 167 million and non-GAAP diluted earnings per share of between $0.26 to $0.30 per share. Now back to you, Shabtai.

Thank you, Ofer. We are very pleased to report continued momentum and record financial and business results for the fourth quarter of 2014 and for the full year.

This is the tenth consecutive quarter of improved financial performance. In 2014, we grew the company revenue by 10.5%, but more important, annual networking revenue grew 14.5% after growing 12% in 2013.

Networking which is now 89% of revenue as of last quarter is growing very fast. We continue to see strong demand across our business lines and continue to build partnerships with enterprise communication application market leaders, both of which should support continued expansion of our networking business in coming year.

And so based on current business outlook, we believe 2015 will exhibit similar revenue growth rates and will be delivering the third year in a row of networking business growth of 12% to 15% annually. The key message from the fourth quarter and from overall 2014 is a solid progress we are making in our enterprise networking and business services market, which are at the core of the company strategy and go-to-market.

As reported, we made good progress and achieved new record sales in the most important business lines for us, including Microsoft Lync, market ecosystems and the Enterprise SBC and services. This progress substantiates our leadership in the voice solution market, in areas of unified communication and collaboration, real-time business communication services and contact centers.

Shifting our strategic focus to enterprise and focusing on building partnerships, grow sales in the enterprise market to 73% of revenue in 2014 and should provide a very sound basis for business expansion going forward. No less important is our shift in strategy from a best of breed product company to a solution selling accompanied by product led services.

Providing an end-to-end comprehensive high performance voice solution and attaching to it a comprehensive services portfolio is in general superior to our competitive strategy of focusing on best of breed product. It also helps to endorse enterprises and businesses with the need to plan, design and deploy a rather complex network on a global basis or nation basis, but with several sites fairly complex situation.

[Client] [ph] solution supports larger deal sizes, improves overall profit margin and support strong return, working relationship with our end customers. Percentage wise, services grew to 23% of company revenue in 2014 versus 20% over the year-ago quarter.

Now, let me touch some of the financial highlights, all of which are mentioned in a non-GAAP numbers. So, quarterly revenues rose 7.9% year-over-year to 31.1 million and 0.5% over the previous quarter.

I’d like to turn your attention to the fact that the rather small increase in quarter-over-quarter, revenue growth is attributed to on one end growth of 1.8 million in networking was 5.6 over the previous quarter, and decline of 1.7 million in legacy technology line which dropped to be in 11% in the quarter. So all-in-all, we’ve done great on networking and only decline in legacy technology direct for the top line, with a few hundreds of thousands.

So referring to networking is [indiscernible] for growth going forward which represents 89% of our business. Quarterly networking revenues increased 13% year-over-year, and 5.6 quarter-over-quarter.

Full year 2015 networking revenues increased 14.5% year-over-year. More important gross margins, quarterly gross margin improved to 59.9.

The full year 2015 gross margin totalled 59.4. This is up from 58% a year ago.

Based on current product mix, the annual target for 2015 is to obtain a gross margin of at least 60%. Operating margin, quarterly operating margin improved nicely to 7.4; but stated growth is to reach 10% operating margin at the end of 2015, the fourth-quarter of 2015 and a longer-term financial model for the company would be to obtain an operating margin of 13% to 15% in 2017.

On the OpEx front we have done good job, controlling expenses down to 20.5 million already at the second quarter of decline in OpEx. As discussed in previous quarters, non-favorable FX exchange rates in 2014 and investing in and building the new cloud R&D Center in Beersheva is waited upon our annual expenses in 2015.

Important to note that both our non-issue anymore going to 2015 and we expect less than 2% to 3% increase in OpEx in 2015 compared to 2014. Same with headcount where we had good control and grew only seven positions to 661 employees, about 1% of grown.

In 2015, we plan on increasing headcount by no more than about 3% to about 680 employees. Now going to the bottom line, full year 2014, non-GAAP net income total 6.8 million, up 26.5% year-over-year.

While planning for higher profit in 2015, we are still pleased with the ability to grow profits in such a way in view of the FX and cloud center headwinds which were not anticipated originally. Services business is growing very well for us.

Services activities exhibited very impressive growth. In 2014, revenue grew 30% over 2013 to a record level of 33 million compared to 25.5 million a year ago.

Most notable is the growth in professional services, which posted more than 50% growth in the fourth quarter in bookings and is expected to continue to grow above 35% in 2015. So, let me point out what our targets for 2015.

The key objectives for the 2015 annual operation are as follows. On the business front, we plan to increase our leadership in the enterprise voice solution area in several partners’ ecosystem.

We intend to increase the solution selling and services over our selling of products. We intend to keep growing the momentum in the Lync voice space and protect our No #1 position in the Lync voice market and we will keep developing our Session Border Controller line and the associated SIP Trunking for business services.

On the financial front, objectives are grow revenues by 10%, grow profits also of 50%, achieve operating income of 10% by Q4 2015 and grow annual gross margin to 50% and above. Now let me start some of the business highlights we think.

It’s few years now that we focus much more on enterprise than on the service provider market. In the enterprise voice market we partnered with the leading Unified communication and collaboration application vendors and build their voice networking foundations.

We work closely with Microsoft, which is already finding Unified communication for the Fortune5000 companies worldwide, working with BroadSoft delivering IP-PBX services, working with companies like Avaya Genesis and Interactive Intelligence in the contact center market, taking customer interactions to the next level. In 2014, about 73% of our revenues were related to enterprise customers, and we believe that will keep growing.

Just turn your attention to the fact that in 2012, our overall sales into the enterprise voice market was about 60%, which grew to 69% in 2013 and to 73.4% in 2014. Even more important is our go-to-market in very close relationship with some top partners.

I have mentioned the names about 44% of our revenues in 2014 relate to those of five partners. Another evidence for the strategy and now solid it is looking at the overall revenues derived from the ecosystems of those partners in last three years.

In 2012, we sold more than 47 million in to the ecosystems of the top five. In 2013, we grew to 54 million, about 20% selling to the same ecosystems and in 2014 we grew again 20% to 66 million.

This is a very-very sound trend and this is where we put in most of our resources and passion and the fact that we’re selling to the end customers, we are not selling OEM and that the majority of the transaction are not greater than few hundreds of thousands to tens of thousands, it means that there is much stability and consistency in the growth pattern of that strategy. Now let me touch Microsoft Lync, how we did in that ecosystem.

We have seen a great success. All-in-all, we met our stated goal of growing at 36% in that market and reaching 30 million of sales which represents about 20% of the company revenues.

Even more successful is one specific product we introduced middle of the year, One Box. We’ve already seen a very nice contribution from it to sales and I’ll get to it further.

It’s important to know that selling in the Microsoft Lync environment means that selling to enterprises translates to continued momentum in large enterprises projects which usually stand over a two to five years and which support sales of few hundred thousand a year for each of these single end customers. To give you some examples of some of the names that we’ve been selling during 2015, we over three years we sold more than 1.5 million to a very large NASDAQ 100 global IT software vendor.

We sold about 900,000 in the past three years to one of the world largest semiconductor maker. We sold into two very large accounting firm, part of the big four, and again sales to each of these companies was north of half a million.

We sold to two large Delaware pharma companies with tens of thousands of employees worldwide and we won recent, very important win in selling to a large North American based railway company. All-in-all this is a very sound, very strong trend, and we believe that will keep us growing forward.

So in 2014 we grew to 30 million up from 22 million a year ago. We believe that that is a sustained growth rate and we believe we should be able to cross 30% growth on an annual basis in 2015, ’16 and ’17.

If we are successful doing that we’ll have more than doubling our revenues in 2017 reaching somewhere around 65 million just in the Lync environment. Both are the growth enablers in that market, it is the strategic channels that we have built throughout the years.

It’s our One Voice for Lync solution selling. It’s our brand at the channels and the enterprise and the best-of-breed products we have.

Basically, if we break down revenues in the market of Lync ecosystem, we combine them into the three different groups. One is connectivity, which combines gateways, SBCs and SBAs services, which combines basic services and professional services.

And then another group combines IP phones, One Book and so forth. We've been growing very nicely.

We believe that growing forward percentagewise; both services and the other group will start to contribute substantially more than just connectivity. So we see connectivity keep growing at least 10% a year, but more of the growth will come from the new introduction in that ecosystem.

As can you imagine, AudioCodes strategy would be to add continuously more and more components to a market where we feel strong and confident in our ability to sell and we have the channels already put in place in the market. In terms of regional analysis, we grow very nicely both in North America and in EMEA and we believe we’ve also seen lately some nice growth in Asia-Pacific and we believe that will keep growing 2015.

Again let me touch the One Box 365. It is providing a very effective solution to bringing enterprises voice alongside of its 365 in both pure cloud and hybrid on-prime configurations.

Our solution is proven to be successful in the first weeks of the deployment. It is for us, one of the fastest-growing products in the company history.

We believe that the introduction of higher capacity One Box enterprise [inaudible] announced earlier this month will have further increased the success of these product line. And we believe that already in 2015 we will see contribution of several millions more revenues from that products family.

Thus before concluding my part of the session, I will touch some of the highlights in the SBC markets, SBC sales grew more than 70% year-over-year. We’ve seen our market share doubling from 6% to 12%.

We now stand side to side with [inaudible] in that market. Most of all, the sale went into the Lync space about 50% for our sales in North America with the interaction in the broader market and that has picked up nicely in 2015.

We have seen new wins in managed SBCs markets via service provide and that will contribute to recurring revenue and brands awareness of the Lync environment. We’ve penetrated Session Border Controller in the core for services providers.

We’ve seen a first NFV [ph] customer for us in the SBC area. All-in-all, we are very pleased with the progress we have done and we assume similar growth of 40% to 50% in 2015.

And with that, I've concluded my section. Thank you very much.

Back to you operator.

Good morning gentlemen. So a nice quarter-over- quarter increase in gross margin and it sounds that you are now looking for the 60% gross margins going forward, which I guess is a hundred bps up from where you were thinking last quarter.

So, I was just wondering if you could give us some color on what's going on with the gross margin and your confidence in keeping it at 60% or better level going forward. Thank you.

I think shifting our focus to enterprise from service provider helps us in the fact that the mix of products sold to enterprise carry larger gross margin. Also, most of our services are applied through the enterprise segment.

So, again growing services and professional services contribute to larger gross margin. All-in-all we believe that adding services and software solutions will help maintain and grow that level.

So we definitely feel confident we should grow gross margin going forward.

Thank you for that. Wondering if you could you give any highlight on -- the developments in your -- your cloud development center that, part of your -- that you established as part of the OCS grant, so give us a sense of what you are developing there and when those products might start contributing to the top line?

Just to remind everybody, the original goal was to set up a center that will employ 100 engineers by the end of 2016; we started out in April-May, 2015. We already have on board about 50 employees there.

We intend to add about 20 this year. Majority of the development done in that new development center is related to what we call the One Voice Operation Center.

That is a key product, I haven’t mentioned it before, I have mentioned EMS and SEM, EMS stands for Element Management Solution and SEM stands for Session Experience Management. All-in-all it’s a set of services and software which resides in the clouds in or on-prem and basically provides the [glue] [ph] logic to just take products installed in many places in the networking in gateways, SBCs, phones and other products and routers and basically make it a full-working solution allowing companies to control all of their voice network very efficiently from their network operation center from the NOC.

So, we’re doing well and growing the staff there. The projects are going on.

We already got first delivery to the market. Our IP phone solution is very successful lately in past few months since we released the EMS for IP phone, which basically allows you in the Lync environment, it allows you basically to manage your phone in a very easy way, while it could be deployed over thousands of miles in different locations.

Usually without a good management tool, it’s very hard to maintain, add, delete subscriber, change addresses, et cetera. So the first delivery of the OVOC, One Voice operation center already have been delivered and we intend to deliver more such components in 2015 and going forward.

That’s very helpful. And you mentioned a very strong growth you were seeing in your professional services in ’14 and expected to continue to see.

I'm not sure if you actually gave the dollar amount of professional services in ’15. Is that a number you can give out?

I don't have the exact number with me, but I can tell you that it is about 15% of the services. I've mentioned services reached 33 million, recognized services, actually booking was at least 15% higher but out of those 33 million I believe that professional services are about 15%.

Five zero, 50%?

No, 15.

Sorry 15, okay, thank you. Sorry about that.

And then just on the Lync, obviously seeing some real nice traction there, I just wanted to clarify, I think this is already sort of been put to bed but the Lync did undergo a rebranding late last year to using the Skype brand, and just wanted to clarify that that doesn’t change anything with respect to your relationship of what you’d provide into a Microsoft Lync environment?

Right, well we haven’t seen any change and we do not hearing about any changes coming. We know that -- we have been told the purpose is to increase the attractiveness of the Lync solution by attaching to it the hundreds of millions of Skype users worldwide and enabling a rather easy consumer to enterprise easy communication.

We do not -- we believe actually that will be a good catalyst for a better business. The more by the way visible change which we think happening is the move of Lync from being a on prem solution only, to a solution that could be deployed also in the cloud and so we see much work and planning definitely in terms of networks and architectures in moving the solution to be not only on-prem bases but also cloud and hybrid based and obviously coming back to One Box product family that helps in providing Lync licences from the cloud.

Great, that's very helpful. And just final one if I could, I don’t know this is for Ofer.

Any color you would be willing to give on the first-quarter revenue expectations maybe relative to the fourth quarter. Should we expect maybe flattish sequentially or any color you would be willing to give, that will be appreciated.

I think it’s seasonally like it has been in previous years, it’s, call it a flattish quarter with might be a slight decline like 2014 versus 2013. So, we don’t see any change in seasonality.

Okay. Very good.

Thanks very much gentleman.

Great. Thank you.

I have a quick follow up to Rich’s question on the services side. Could you guys discuss the growth in 2015?

I believe Shabtai you mentioned that on the call, I didn’t catch that number. I know you did 33 million which is I believe it’s roughly 29.5% growth this year.

What do you expect for 2015? What is the growth going to look like?

Again we will play conservative year, but we trust at least 15% growth in 2015.

Okay. I see that's the number I missed.

Okay, great. And then, again going back to your guidance, actually I have two questions on that front.

One is – as you [indiscernible] senses here with your 7% to 10% growth outlook, what are some of the drivers to get you to the low end of that guidance and also the high end, some of the inhibitors of growth as well as some of the catalyst that will get you to that 10%? Can you discuss that?

That’s number one and then maybe for Ofer if I look at the gross margin guidance of 50%, and when I use sort of the middle of the range for your top line gross projection and then I think you said to expect OpEx to be up in the 3% range. If I do that EPS basically will wind up north of $0.30, so I am just trying to get a sense of how you get to that 26 to 30; what if some of the -- again inhibitors to that number that you’ve provided on the bottom line.

Thank you.

Okay, so this is Shabtai let me start with the first question. So generally, I have said that our plan basically is to grow annually between 12% to 15% on networking, we’ve done that in previous years, we see no reason for that to change in each of the coming years.

Actually if you do the math of 10% or 11% a year for the next three years, you can see we have put for ourselves the target to reach 200 million by 2017. But still while we do 12% to 15% on networking, we still have Legacy, that’s about 11% and when we are talking here about the technology we also need to take into account and we don’t know when that will start to act and that is at some point gateway sales in the enterprise will either be flat or start to decline.

So we need to put some protection against such phenomena. So, just trying to be conservative with our guidance going forward, we see networking growing 12% to 15%.

We may see some setback from legacy of -1% or -2%. All-in-all, when you put all of that into the equation and some instability in the markets within Russia, current turmoil with currencies, we may see, we gave that guidance.

But the priority is to get to 10%.

Okay. Then second question please.

Thank you.

Yeah. I think you are right if we did the math I think we built into it that if we are seeing a higher, top of the guidance growth may increase expenses to take advantage of the growth and increase some sales and marketing ahead of what we currently played and then it would be a little bit more conservative than just to make sure that we don’t miss.

Great. Thank you very much.

Thanks a lot. I think you gave the SBC growth rate in the quarter, but I didn’t quite get that.

Can you repeat that?

Actually, we did not provide the quarterly growth in SBC. We just talked about the annual growth, which was 70%.

Current result, I got it. And then on the services gross margin, how should we think about that, and when you add any more professional service, would that be a detriment to gross margin or do you think you can hold services gross margin also look stable?

I think the gross margin will pretty much be stable. The growth in the -- the annual recording, this is very high gross margin.

Basically it’s essentially we don’t -- we had very few people on -- and a lot of new customers. And professional services is a little bit lower than that but on an average it’s higher than the product gross margin and I think it helps relative product.

It’s a very sticky with the customers, so I think going forward the gross margin would stay the same.

And then the -- just on your technology category, what do you think are the sort of accelerated decline there and kind of what is your general view on that category make shifts?

Okay, the situation in that line is very simple, it’s that we’re selling in the technology line, three lines of products, chips, communication blades and blade for recording applications. The chips sales are pretty stable.

Also we can anticipate that behavior and trend in the blades for recording, purchase order for communication blades is coming from all the established accounts which really have no control if not too many accounts, so on a quarter basis, you would see some change and we have seen first quarter that has really been the case we went down substantially from previous quarter by 1.7 million. That is not something that we control.

However, the more at higher side, we have no efforts invested in that, so it’s really type of cash go.

And just last question. Just in a sort of SIP Trunking Arena, how are you seeing that as a driver in 2015 versus 2014.

Is it a same kind of driver, better or worse, you know like that. Just color on SIP Trunking, that would be good.

Generally, I would say that the market is growing in similar growth rate. I would tell you that AudioCodes is much more mature in its ability to provide solution in that market in 2015, this was the point we were at entering into 2014.

So, I expect that we will sell more and also our collaboration with partners like [indiscernible] each partners may help to increase with SIP Trunking revenues.

Okay. Thank you.

Sure.

Hey guys. So, I have a question on the guidance on the operating margin at 10% that was entering 2015, correct?

Yes.

So on that, what's the risk that as you have increased presence in the market, there is step up level of competition which either forces you to offer more discounts or increase more for sales and marketing, it seems like a pretty aggressive target given your operating margin progression over the last couple of years.

If you look at the Q4, we exited at 7.4. So we got to do the math to increase revenue and controlling expenses, we should be able to do, and at 10%.

And our competition, there is always competition. I think our position in the market which is a little bit different in the competition really issuing the -- offering a full solution verses a product-based offering only, I think will give us the edge and essentially we do see this specifically in the Lync markets where the great edge over the competition.

And we will have to be with competition. That’s life in the market.

Alright, and have you seen any change in competition, the aggressiveness in your competitors that it has become as you’ve increased your market share?

No. We haven’t seen anything over the last few months that’s we knew.

Okay, then I have one other question. You have mentioned of bookings growth, professional services, I think, can you just clarify by the numbers of the gross booking?

We didn’t give the number for the booking, but unlike in the product where the people send us their purchase order and we ship the product. Essentially the booking and the sales are the same.

In the services space people, sometimes they order for two to three years on the support side and also professional services, whenever they have a large project, sometimes they order the services ahead of time and we recognize the revenue on the services only when we do the work. So, it is something new for AudioCodes but it’s something new which is good.

This will give us better visibility and going into each quarter where higher level of visibility on the services side.

Okay. All right.

Thanks a lot. That’s all.

Thank you, operator. We would like to thank everyone who attended our conference call today.

Based on the strong business momentum and execution in the past two years, we believe we are on track to achieve a third consecutive year of growth and success in 2015 and to continue and build a sustainable profitable business for coming years. We look forward to have you on our next quarterly conference call.

Thank you very much. Bye-bye.