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Edited Transcript of AUDC earnings conference call or presentation 24-Jul-18 12:00pm GMT

Q2 2018 AudioCodes Ltd Earnings Call

Yehud Jul 25, 2018 (Thomson StreetEvents) -- Edited Transcript of Audiocodes Ltd earnings conference call or presentation Tuesday, July 24, 2018 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Allison Soss

* Niran Baruch

AudioCodes Ltd. - CFO

* Shabtai Adlersberg

AudioCodes Ltd. - Co-Founder, President, CEO & Director

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Conference Call Participants

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* Dmitry G. Netis

William Blair & Company L.L.C., Research Division - Equity Research Analyst

* Richard Frank Valera

Needham & Company, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the AudioCodes Second Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Allison Soss with KCSA. Thank you. You may begin.

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Allison Soss, [2]

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Thank you, Melissa. I would like to welcome everyone to the AudioCodes Second Quarter 2018 Earnings Conference Call. Hosting the call today is Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President, Finance and Chief Finance 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 instructions 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 the 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 are not limited to, the effect of current global economic conditions and conditions in general and in AudioCodes industry and target market; 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 customer products and markets; timely product and technology developments, upgrade and the 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 the 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'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 this call. The call will also be archived on our Investor Relations app, which is available for free from the iTunes App Store and Google Play market.

With that said, I would now like to turn the call over to Shabtai Adlersberg. Shabtai, please go ahead.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [3]

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Thank you, operator. Good morning, and good afternoon, everybody. I would like to welcome all to our second quarter conference call. With me this morning is Niran Baruch, our Chief Financial Officer and Vice President of Finance. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the quarter, discuss trends and developments in our business and industry and the outlook for the second half of 2018. We will then turn it into the Q&A session. Niran?

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Niran Baruch, AudioCodes Ltd. - CFO [4]

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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, the earnings press release contains a reconciliation of supplemental non-GAAP financial information. Revenues for the second quarter were $43.5 million, up 2.5% from the prior quarter and up 12.3% compared to the second quarter in 2017.

Services revenues for the second quarter were $13.5 million, accounting for 31% of total revenues. Deferred revenues balance as of June 30, 2018, was $42.6 million (sic) [$43.5 million] compared to $42.4 million as of March 31, 2018. Revenues by geographical region for the quarter were split as follows: North America, 45%; Central and Latin America, 5%; EMEA, 35%; and Asia Pacific, 15%. Our top 15 customers in aggregate represented 56% of revenues in the quarter, of which 47% are attributed to our 12 largest distributors.

Gross margin for the quarter were -- was 62.3% compared to 61.4% in Q2 2017. Non-GAAP gross margin for the quarter was 62.8% compared to 61.9% in Q2 2017. Operating income for the quarter was $3.3 million compared to an operating income of $1.9 million in Q2 2017. On a non-GAAP basis, quarterly operating income was $4.4 million, or 10.2% of revenues, compared to an operating income of $2.7 million in Q2 2017.

Net income for the quarter was $2.4 million, or $0.08 per share, compared to net income of $1 million, or $0.03 per share, in Q2 2017. On a non-GAAP basis, quarterly net income was $4.1 million, or $0.14 per share, compared to net income of $2.5 million, or $0.08 per share, in Q2 2017.

Our balance sheet remains strong. At the end of June 2018, cash, cash equivalents and marketable securities totaled $58.1 million. Days sales outstanding as of June 30, 2018, were 52 days compared to 47 days in the prior quarter.

Operating cash flow generated during the quarter was $2.2 million. During the quarter, we acquired 452,000 shares for a total consideration of $3.3 million. As of June 30, 2018, and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 17.2 million shares for an aggregate consideration of approximately $90.3 million.

In June 2018, we received court approval in Israel to purchase up to an aggregate of $20 million of additional ordinary shares pursuant to our share repurchase program. The current court approval will expire on December 14, 2018. The Board of Directors today declared an annual cash dividend in the amount of $0.20 per share and in the aggregate amount of approximately $5.7 million. We expect to continue declaring annual dividends in the coming years.

Now to provide an update on our guidance. We now expect revenues for 2018 to be in the range of $171 million to $175 million compared to an original range of $166 million to $172 million. We anticipate non-GAAP diluted earning per share to be in the range of $0.51 to $0.55 compared to the original range of $0.41 to $0.46.

I will now turn the call back over to Shabtai.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [5]

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Thank you, Niran. We're very pleased to report record financial results for the second quarter of 2018. It's now the fourth quarter in a row where we exhibit accelerated growth relative to previous years.

Let me touch on some of the highlights of the quarter. We've seen a very strong revenue growth in the first half of 2018. We grew 12.3% compared to the first half of 2017. We now focus about 10% growth for the full year, which represents acceleration in revenues, growth over previous years, where we compare to 7.7% growth in 2017 and 4.2% growth in 2016.

Growth in revenues translates well into profits. Assuming no meaningful change in our business in the second half 2018, we now target to grow profits this year about 30% compared to 2017 on the heels of profit growth of close to 30% in 2017 and about 60% in 2016. All in all, we now exhibit great business momentum and continued growth in profit since 2015. This progression, which we believe will continue in 2018 and beyond, is well supported by 2 key trends: first, steady evolution in strength in the underlying markets we participate in; and second, our strong position and leadership in the market segments we serve.

Another highlight of the quarter is a substantial improvement in operating margin. We've reached 10.2% of operating margin in second quarter 2018. We anticipate further growth in the second half. That is a combination of the operating margin in our networking business with the new investment in Voice. AI. We estimate our investment in Voice. AI to be between $3 million and $4 million this year. As such, the main business, the networking business, runs now at about 12% operating margin.

Another highlight for the quarter is the acceleration in our UC-SIP business. Previously, we quoted annual growth rates of 15% to 20%. We are glad to say that this year, we see accelerated growth. As reported, second quarter 2018 provided more than 30% growth year-over-year, similar to what we've seen in the first quarter of 2018.

All key business line, including Session Border Controllers, the IP phones, our One Voice management suite, the MSBR and services demonstrated very solid growth and strength.

Another important highlight is our continued strong cash flow from operation. In the first half of 2018, we generated $10.2 million. 2018, chance to become the fourth year in a row where we generate cash in excess of $17 million, $18 million a year. We expect to generate similar level of cash flow in the second half of the year, which will translate approximately to about $0.65 of cash flow per outstanding share.

As stated many times in the past, this is now a recurring statement for the past 5 years. Underlying the solid performance is our continued close collaboration with market leaders in these segments, namely, Microsoft and Genesys. On top of that, the investment in maintaining strong relationship with large and global system integrators, which proves to be essential and effective pillar in our strategy.

In parallel to our success in the enterprise space, we continue to enjoy improved business momentum in our service provider side of the business, where we see continued growth of SIP trunking and continuation of the transition to an all-IP world.

Now backing this secular growth trend in our business is the solid performance in our 2 key businesses: the UC-SIP business and the Gateway business.

In the first half, UC-SIP, as I mentioned before, grew more than 30% compared to the first half of 2017. In fact, we now predict that the UC-SIP business revenue will achieve above $85 million this year compared to above $65 million in 2017. At this rate, we are targeting to achieve $100 million of revenues of UC-SIP product in services next year, pretty much preceding our initial multi-year plan to reach $100 million of business only in 2020.

Growth in the UC-SIP business is driven primarily by our success in the Enterprise Voice business, where we've become top vendor for delivering voice connectivity and infrastructure for UC and UC-as-a-service and contact center.

On the Gateway business side, we saw good revenue stream in the second quarter of 2018, slight decline of less than 5% compared to second quarter 2017. Backing this trend is the growing face of migration to all-IP networks in leading economics, such as the U.S., Germany, Australia and other countries. Key to our solid performance in these segments for several years now is the fact that we have become the partner of choice for CPE products and equipment in most of the leading all-IP and UC application environments, and we are building similar such position with leading service providers worldwide. We are confident that this leading position will prevail in coming years. Now with very short and brief outlook into the third quarter, the current quarter, I'm glad to know that at this stage on July 24, the trend in both businesses continues to be along the same lines that we have seen in the first and second quarters in 2018.

Quick update on our activities in Voice. AI. Just to remind everyone on the call that in Voice. AI business, we focus primarily on delivering actionable items derived from processing voice interactions content rather than deal with the voice connectivity as we do in our mainstream networking business.

In the second quarter, we continued to invest and evolve technologies in the area of speech recognition, deep neural network, machine learning, natural language understanding, et cetera. We have had very good momentum in new projects and customers wins in Israel. We are becoming de facto a leading provider of call steering solution for enterprises. I believe that at this stage, we have crossed more than 100 businesses here in Israel. We also work with leading service providers here. The target to sell call routing solution to their business customers here in Israel. In addition, we have been investing in entering new markets in Europe and the U.S. for our Voice. AI applications.

Now let me touch on some of the key financial highlights of the quarter. We've mentioned revenue growth of 12.3% year-over-year. We've seen continued growth in deferred revenues, which will keep feeding the next quarter. Product revenue was very strong. We grew more than 10% year-over-year. This is very encouraging phenomenon as this will basically dictate the rate of growth in services in coming years. Service revenues rose to $13.5 million, basically delivering 14.1% year-over-year. OpEx declined. Happy to inform that since the U.S. dollar and new Israeli shekel conversion rate has improved dramatically over the past 4, 5 months. So now we are sitting at a much more comfortable position. So OpEx in second quarter '18 declined 2.7% compared to the first quarter of 2018.

On the net income, we grew 60% year-over-year, delivering $4.1 million versus $2.5 million in the year-ago quarter.

To touch a bit on the sales side. Generally, sales performed very well to and above the target in almost all territories. We had remarkable performance in North America on the service providers side of the business. We have seen good business in West Europe, in India and few more countries. Like to relate to one important geographical aspect. In the first half of 2018, we saw continuation of the trend of growing significantly in EMEA as compared to other regions. Revenues in EMEA were about 35% of the company overall revenues in first half compared to 31% in 2017.

Let me touch on some key business line in our company. First and foremost, Microsoft. Second quarter 2018 revenue in the Microsoft environment were in line with planning. This year, we plan to grow more than 15% year-over-year and get the business size to about $65 million for the full year. We've seen nice growth in the second quarter, 23% over the year-ago quarter. And again, the portion of products versus services was higher, which means good momentum in products.

The most important aspect of our business in the Microsoft environment this quarter was the nearing deployment of voice services in Teams. In May, Microsoft announced direct routing GA, and basically that was an opening of the door for collaboration with service providers that can now use "Bring your own trunk and connect" teams implementation to the SIP trunks of their choices. We are a supplier of Session Border Controller technology to this service and so much interest developing in the second half of the second quarter. We've been part of the early adapted firm for Direct Routing with several enterprises, very large enterprises. At the same time, we were engaged with a list of between 5 and 10 different service provider working with us on delivering Direct Routing for Microsoft Teams.

We expect Teams to open new market segments in the future. So far, our traditional investments in the Microsoft Skype for Business market was focused much more on the large enterprise segment. We now believe that with the simplification of the solution in the Teams environment, more so Office 365 environment, we will see penetration of those solution also into 2 new segments, the mid-market and the SMB. So we believe that, that will give a push to the business. We believe that will happen somewhere either first half or second half 2019.

In other areas of our work in the Microsoft environment, we have enjoyed success with deployment of our phones, IP phones. We have generated a lot of demand and sold accordingly. We also are engaged in coming up with one of the first few phones for Teams, and that is getting a lot of interest by lot of customers in some of the field results of Microsoft technology.

One bright spot that's really in the very first early innings is the development of a new market segment that seems to be evolving, talking about mainly room solutions and meeting technology, which we believe will become much more important in the Teams environment in coming years. So here is another new market segment for us to grow.

We continue to sell appliances to the Microsoft environment, and sales were fairly well.

I'll touch also a bit on the Session Border Controller part of the business. We grew very nice, 21% year-over-year. We are very much in line with achieving our annual targets that's above 20%. In terms of a geo split, we saw nice revenues coming from North America, 38%; EMEA, 34%; Asia Pacific, 10%; and Latin America, 9%. In our top SBC customers, we have seen a mix of both Microsoft and Genesys [honors] , and we have seen some very large expansion projects of hundreds of thousands of dollars of SBC equipment. Some of them are software only. We have engaged with our SBC technology in several large contact centers, projects, among them proof-of-concepts, new technologies where we focus on are the WebRTC gateway, which is now accessed by several players, same for virtualized solution for the SBC. All in all, we also have seen an expansion of a very large access SBC project in Asia Pacific with a large mobile operator. All in all, we feel very confident that our SBC technology and solution are at the forefront of the market.

Touching on the services side of the business. This year, we intend to grow services more than 10% and reach a level of $54.5 million compared to $49.3 million last year. Achievements in this quarter were quite in line. Company services grew year-over-year 26%, and we've seen much higher growth in our professional and managed services.

That relates to our business outlook. Let me touch on 2 other items that we have announced. First, our annual cash dividend announcement of this morning. This morning, we announced an annual cash dividend of $0.20 per share. The announcement comes on the heels of sales fee and continued growth for a fourth year in a row. In these years, we have been able to generate steady cash flow of about $18 million a year throughout the past 3.5 years and expect this trend to continue in coming years. Based on current business momentum, we expect this growing revenues, earnings and cash flow to continue. As such, we decided that we would like to increase and enhance returns to our shareholders by providing an annual fixed income in the form of annual cash dividend payment.

Coming to the last point, update on our guidance and outlook for the second half of 2018. Outlook remains very positive for the second half. As Niran has mentioned, we have upped our revenue guidance. We now target a range of $171 million to $175 million, that's about 10% over 2016. On the earnings side, based on much more comfortable FX rate and strong business, we now guide for a higher range of earnings this year to be between $0.51 and $0.56 compared to $0.37 that we achieved in 2017. So that's another very strong growth.

With that, I've given my introduction for this call, and I'll turn the call now to the Q&A session. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Rich Valera with Needham & Company.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [2]

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Just wanted to clarify on the UC-SIP business. I think in the press release, you said that was up 30% year-over-year for the quarter, and I think on your prepared remarks, you might have said for the first half. So I just wanted to clarify, was that 30% for the quarter or for the first half or for both? And then it didn't sound like you actually changed your prior expectations for that business to be up 15% to 20% for the year. Just wanted to clarify if in fact you saw that growing maybe a little faster than you did before, given the strong results?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [3]

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Right. Thank you, Rich. Well, as provided, in the second quarter, we grew above 30%. When I look back into what we reported in first quarter, it was apparent that we reported then also that the first quarter of 2018 grew by more than 30% compared to same quarter in '17, meaning that first half as a whole, we grew more than 30% compared to the first half of 2017. So that's on that. Yes, we see acceleration. I think that has to do with the fact that in some of the lines, namely, Session Border Controllers, the phones, the management suite, there's maturity that evolve throughout the years. And I believe that right now we are in a better position to deliver more product and win more opportunities in the market. So at least this year, as I've mentioned, we will grow from above 65% to almost 85%. So that tells you that this year, we plan to grow more than 20%.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [4]

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Got it. And just wanted to try to understand sort of what's driving that. I guess, our thought, based on your product comments, was that the deployment of voice within Teams would really be second half kind of event for you guys. You didn't expect to see much incremental business from the Teams-related voice deployment in 2Q. It sounds like you still expect to see that incremental Teams activity in second half. But what sort of drove the second quarter strength in the UC-SIP business?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [5]

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So yes, well second quarter, still we need to remember that put aside the new Teams deployment and projected growth in -- going forward, we have installed projects. We have -- generally, the way Skype for Business projects were deployed is that in most of the implementation, not more than 15%, 20% or maybe 30% of the total deployment occurred in a single company, meaning that along the years, we are enjoying repeatable business that's meant to expand the deployment that happens in past years. So second quarter, most of the transaction and opportunities were related to Skype for Business project, which are in midst of deployment.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [6]

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Got it. That's helpful. And then can you just give a little bit color around the Gateway business. I think you said that was down slightly in the quarter. If you could give any more color on sort of what's driving that over the near term and what your expectations are for the Gateway business for the full year, that would be helpful.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [7]

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Right. So yes, as we have mentioned in the past, the Gateway business is very profitable. It's -- annually, I would say, we do expect a decline of roughly 5%, 7% or maybe 8% or 9%, which actually this is what we saw in the second quarter. Now basically, the -- if one would invest more time into understanding this market, there are certain divisions that one might do in order to get a better understanding. So first and foremost, the enterprise will gradually stop deploying gateways simply because people will move to IP and UC-based solution. On the service providers side, there are a lot of activities I mentioned in the all-IP migration. And to migrate a large base of small businesses requires the deployment of gateways in many places. So when -- in analogue gateways. So all in all, we do see all-IP driving much of the endurance of that market. Also, you need to take into account that we have a large portion of the revenues coming from services and maintenance basically, because people need to maintain those networks and make sure that they work properly. So while product may be declining, services gateways sometimes increase. So all in all I think to summarize all these long sentence, annually, we expect gateways to decline between 5% and 9%, and I think this quarter was just in line with that projection.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [8]

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Perfect. And I'm sorry, one more for me, if I could. You've been talking about the increased marketing of your voice recognition products in the Voice. AI business. I think you'd initially marketed it in Israel, you expanded that to Germany, and then you are looking to go to other countries. Can you give us any update on where you are in the marketing of those voice recognition products?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [9]

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Yes. We started increasing our investments earlier this year. We are fairly satisfied with the rate and the quality for our solution. I think here in Israel, we are becoming a de facto solution choice. And there's a lot of demand. It's amazing that with the benefit of reducing operation costs at the enterprises by removing some of the personnel that has to do with answering calls and routing calls. The technology is mature enough. I think using machine learning and natural language understanding at the top of our speech recognition technology allows us to provide more natural language like solution. We definitely see a very high rate of success, and we are simply fine-tuning. The strategy has always been develop, go to customers, deploy, test, fine-tune, do all that in Israel. Once you are at a level that you feel confident, you can go visit to other markets in a better shape to do that. And I think this is where we are today.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [10]

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So you're still kind of working on Germany at this point and other markets to come in the future?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [11]

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Yes, we do plan (inaudible).

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Operator [12]

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(Operator Instructions) Our next question comes from the line of Dmitry Netis with William Blair.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [13]

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Great. Nice quarter, guys, and good to see you express confidence in the business here by raising your numbers for the year. I would like to -- clearly, there's acceleration here. EMEA demonstrated some strong sales motion, I suppose. You'd mentioned it was 35% versus 31% a year ago. What is some of the kind of ebbs and flows in Europe? Can you walk us through it? Is it a weaker competitive backdrop? Is it something in your sales motion that's working? Maybe if you can add some specificity about some all-IP projects you're involved with, would be really helpful.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [14]

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Sure. So yes, let me divide my answer into splitting between service providers and enterprise. We do gain a lot of momentum in the service provider part of the market. Definitely, all-IP is kicking in. Germany is very strong. We've got many service providers in this -- customers in this country. We've seen similar such new beginnings in other parts of Western Europe. So all in all, we see very strong trend there. We keep developing new product that will support that. And we find a relatively easy market to compete in as we see not too many other companies racing for that segment. So that's on the service providers side. In the enterprise, I think it goes to the maturity of some of our sales operations in certain countries. So take the DACH region, which is Germany, Switzerland and Austria. This is a very strong region for us, grows steadily, and now we start to really know the benefit of being a large player in that market. We have also gave a push to our sales operation in countries such as the U.K., France, Benelux, the Nordics. Also, we have seen some comeback, very nice comeback in Russia. So all in all, that is the growth, and we feel very good about our operations in the enterprise business at this stage.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [15]

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Have you been hiring more sales people as you kind of go into all these geographies? I mean, what's your hiring levels been kind of on the sales side over the last, I don't know, year or so?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [16]

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Yes. Actually, this is indeed a trend in our country -- sorry, in our company. We basically are, if you will, putting much more effort on hiring in the sales and marketing area. We grew our personnel actually in the second quarter of 2018. We grew almost 7% in our sales staff. So yes, a lot of investment goes into increasing sales.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [17]

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Okay. That's very helpful. And you mentioned at least on the service providers side there aren't that many competitors you're competing with. Can you walk us through some of the more obvious ones, guys like Ribbon and Oracle. What are you seeing out of them? Are they chasing those deals as well? Or is it sort of an open field there for you? And if you could also comment in that same vein, what you think will happen? This has to do with more of an enterprise, obviously, side of the business. What you think the impact may be with Ribbon acquiring Edgewater?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [18]

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Yes. So yes, well, the usual suspect, as you have mentioned, are indeed Ribbon and Oracle. We do meet them in the market, and we compete with them. We do feel fairly comfortable with our technology and products. So we compete with them, but we gain our share of the market. That is much more on the Session Border Controller side of the business. When we go more for the gateways and the integrated access devices, the competition turns to be easier. We compete with some small companies, among them one access of France. The latest acquisition of Ribbon and Edgewater, we know Edgewater is very strong in the U.S., and we basically know them from many years. We've not seen them yet outside of the U.S. We may see them, but I think we'll be ready to compete in that area. So we do not believe we will see major change in that regard.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [19]

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Okay. And then also maybe just comment on your BroadSoft relationship now that it's part of Cisco. I always ask that question every quarter and wondering if there's any impact whatsoever, if you're seeing them kind of getting more aggressive with deploying their own Session Border Controllers tied to BroadSoft ecosystem or not. So a little bit of color there as well.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [20]

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Okay. So yes, all in all, there are not too many days past since that acquisition occurred. So far, in all service provider accounts, where we were designed in and where we sold product, we do see continuation of our sales. So in that regard, there's no change. And going forward, it's a question whether a service provider will choose to work with the supplier's one that has been deployed for so many years and other ones that Cisco may bring in. But that relates to all the accounts. We do believe that we will not see much business with Cisco going forward in new accounts. We know that Cisco is pretty determined to use its own solutions. We've seen that basically stated as referred to phones and headsets, where Cisco announced that will -- they will do their own. That will hurt other players, such as Polycom and/or Plantroncs, but we not in there. But yes, going forward, we do not expect that we will see increased sales of Session Border Controllers or Gateway into the Cisco environment.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [21]

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Okay. I appreciate that. Maybe moving on to Microsoft real quick and then I'll have one more financial question for you. I think I heard you say that you believe that Microsoft with their Teams product will start to push more into mid-market and SMB, and I think you gave kind of first half of '19 time frame. Does this also apply to a Cloud PBX or telephony systems? Or is this just kind of their Teams environment? Or how are you thinking about that?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [22]

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Yes. Well, I believe that Microsoft probably gives preference to grow Teams over Cloud PBX. That has to do with their own consideration and technology evolution. So definitely, while Cloud PBX still keeps selling and it will keep being sold with large Skype for Business customers who'd like to use hybrid on-prem and cloud solution, I think that looking down the road 1 year and beyond, we will see much more emphasis, much more focus on Teams deployment. So we're trying to adjust our investments accordingly.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [23]

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Okay. And Teams will have kind of Cloud PBX attached to it, like a pure cloud product for telephony as well. Is that your expectation?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [24]

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Well, Teams already provides voice services. Actually, the announcement of Direct Routing means that they now -- in the past, they offered on-net voice services, now you can get to call PSTN numbers using the Direct Routing. So yes, voice is definitely part -- an important part of the Teams deployment.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [25]

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Okay. Yes. I know there was a release back in May, but there's still some features that they're rolling out through the end of the year. There's like another major release happening at the end of this year. So I guess, once that's complete, I don't know I was hoping to see if they were more aggressive selling their telephony systems or not and what you're hearing out there from your engagement with them.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [26]

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Yes. I will tell you. I think they are, and I'll tell you why. As I've mentioned, up to Teams, there was no -- the solution -- Skype for Business was not really cost-effective when selling to the mid-market and SMB. Now the go-to-market -- the preferred go-to-market for SMB would be through service providers, and the addition of Direct Routing means that now Microsoft can team up with service provider to provide voice services for the SMB. So yes, I think SMB will enjoy dramatic growth next year as solution will become more mature.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [27]

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Okay. And then last question on the margin -- gross margin side of things. Strong performance relative to expectations for the quarter. It is down, however, from Q1. But -- I mean, Q1 was sort of abnormal, as you said, last quarter. So what is your expectation for March, and it sounds like you are getting a lot more software products in the mix. So should that put positive pressure on the margin? And if so, where do you think that kind of a steady state margin is at the end of this year? And then maybe going into '19, what -- should we be thinking kind of another 100, 200 basis points margin improvement? Or maybe just a balance kind of level set steady state?

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [28]

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Right.

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Dmitry G. Netis, William Blair & Company L.L.C., Research Division - Equity Research Analyst [29]

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63%. So walk us through your thoughts there.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [30]

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Yes. So as I've mentioned, first quarter gross margin was indeed abnormally high, simply because we had large services and some product mix that was more in favor of software that drove that higher. We believe that gross margin will generally be around 63% this year. We do expect, as you have mentioned, that going forward, with the growing services portion of the business and the fact that some of our products, such as Session Border Controllers and management, are solution that are made in software, we do expect that on a year-by-year basis, we will see step-up of that margin upward. Yes, we've seen about 100 basis points in past years that would be a reasonable assumption for next year, yes.

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Operator [31]

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Mr. Adlersberg, there are no further questions at this time. I'll turn the floor back to you for any final comments.

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Shabtai Adlersberg, AudioCodes Ltd. - Co-Founder, President, CEO & Director [32]

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Thank you, operator. I would like to thank everyone who attended our conference call today. With good business momentum and execution on our plans in the first half of 2018, we believe we are on track to achieve another year of growth -- substantial growth in our revenues and profit for the year. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.

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Operator [33]

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