Greetings and welcome to AudioCodes’ Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host, Elizabeth Parker, Director of Investor Relations at KCSA Strategic Communications. Thank you, you may begin.

Thank you Melissa. I would like to welcome everyone to the AudioCodes fourth 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 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 effects of current global economic conditions and conditions in general and in AudioCodes’ industry and target markets, in particular, shifts in supply and demand, market acceptance of new products and the demand for existing products, the impact of competitive products and pricing on AudioCodes and its customers’ products and markets, timely product and technology developments, upgrade 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 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 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, operator. Good morning and good afternoon, everybody. I would like to welcome all to our fourth quarter and full year 2016 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance for AudioCodes. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the fourth quarter and the full-year 2016. Discuss trends and developments in our industry. And that could be about the outlook for 2017. 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 fourth quarter were $37.8 million, up 1.5% from the prior quarter. Full year 2016 revenues totalled $145.6 million, compared to $139.8 million in 2016. During the fourth quarter of 2016, we made sales to Avaya of $645,000 which remained unpaid. On January 19, 2017, Avaya Inc. announced that it had filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. As a result, the revenues related to these sales were included in revenue reported for the fourth quarter. Services revenues for the fourth quarter were $11.4 million, accounting for 30.2% of total revenues. On an annual basis services revenues increased by 14.7% from the previous year. The sales revenues balance as of December 31, 2016 was $31.8 million, compared to $26.3 million as of December 31, 2015. Revenues by geographical region for the quarter were split as follows: North America, 43%; Central and Latin America, 9%; EMEA, 31%; and Asia Pacific, 17%. Our top 15 customers in aggregate represented 59% of revenues in the quarter, of which 49% are attributed to our 11 largest distributors. Gross margin for the quarter was 60.9%, compared to 61% in Q3 2016. Non-GAAP gross margin for the quarter was 61.5%, compared to 61.7% in Q3 2016. Operating income for the quarter was $3.6 million, compared to an operating income of $2 million in Q3 2016. Full-year 2016 operating income was $7.8 million. On a non-GAAP basis quarterly operating income was $2.9 million or 7.7% of revenues, compared to an operating income of $3.1 million in Q3 2016. Full…

Thank you Niran. We are very pleased to report strong financial results and continued business momentum for fourth quarter and the full-year 2016. As reported, fourth quarter revenues and earnings came within the range of our guidance for growth over the previous and the year-ago quarter. Reality though is that we had a better quarter to report until January 19. We ended the fourth quarter with record results with revenues above $38 million though the target and earnings that had beaten the Street consensus of $0.08. As stated on our press release earlier today, on January 19 Avaya filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code and about $650,000 of revenues related to Avaya as customers were moved to deferred revenues. That belongs to the past looking at we have good reason to believe that business with Avaya will continue on the yields of the first nine months of 2016 and we understand that their business is profitable and thus we assume the business will continue going forward except for may be a slight decline in revenues. So on a bigger picture level we continue the past two years momentum of turning the boat and steering the company into sustained annual revenue and earnings growth. Now this the direct result of successful execution or strategic initiative for the past five years of growing the UC-SIP business in areas relatively Unified Communications, contact centers and SIP trunking, all of which keep expanding on a multi-year basis. Growth in these areas has picked up recently as a result of the growing pace of transition to All-IP networks. This acceleration is clearly evident in revenues related to the North American market where we experience good growth in 2016, compared to previous years. The U.S. is leading the All-IP migration…

Thank you. At this time we will be conduction a question-and-answer session. [Operator Instructions] Our first question comes from the line of Rich Valera with Needham & Company. Please proceed with your question.

Thank you. Good morning Shabtai. Why don’t just talk about Avaya, it sounds like you’re pretty optimistic about business with them picking up as you move into 2017 here. Can you say what you’ve actually heard from them and do you have actually started paying their vendors at this point or do you believe that’s going to happen shortly? Just wanted to get more color there? Thank you.

Sure, we cannot talk but I can tell you that we have been talking to them. We received sign from them and I think you have seen them also in the price. So a letter that was presented in the press that Avaya is really if you go to their website and look upon their financial results for the end of September 2016, you’ll see that they are in good shape selling and profitable. I think they are at least from what we heard they intent to continue on with business. And I think they would probably look to further their relationship with their vendors. So except for changes in the market I think we will see continued relationship and that is based on communication that took place already.

Got it. And then just wanting a little more color on Microsoft’s Cloud PBX, you singed a pretty optimistic that that business – their business would accelerate in that area. It sounds like mid this year may be into 2018. Just wanted to remind us sort of what you sell into Microsoft’s Cloud PBX and then could you guys provide a little color on what makes you think that’s going to kind of accelerate as we move into the second half of this year? Thanks.

Right, so currently we have two key products sold into that market. We have the CloudBond 365 which is started to selling almost two years ago that has grown but this isn’t staged when Microsoft announced the CCE, the Cloud Connect Edition. I think that was February 2016 we’ve seen Microsoft putting more emphasis going forward on that. And we have reacted accordingly, we have completely fairly fast we invested in completed all developments necessary to come up with a Cloud Connect Edition appliance. I can tell you that we started to sell the appliance in the third quarter, revenues and sales in the fourth quarter substantially increased, we see increased pace already in the first month. So the – and I know for a fact that certain meaningful incentives that are being put to the market to help push Cloud PBX. And we’ve seen – and we’ve seen demand and some lead that tell us that there’s very strong interest in the market in Cloud PBX and how soon – and we have sold this, I told you quite a large number of appliances that will be help connect initial adopters to the Cloud PBX service. And we know that Microsoft appliance by mid-2017 to try and fill in all of the gap that they’ve currently between the server edition and the online edition. So all in all, we see increased activity from customers, we see increased sales of appliances on our side and we see less demand and push from Microsoft. So that gives us that tells us that’s – the environment is improving and it’s growing going forward.

Got it. And you expect your primary – to primarily benefit from the sales of your Cloud Connect appliance into that market, is that correct going forward?

Well, Microsoft has key interest in pushing Cloud Connect Edition and we follow their plans. So yes, we are working closely trying to help them enough to get faster market.

Great. And one more from me just with the EPS guidance, you’ve given, can you say if there’s any more stock buyback embedded in that guidance or is that assume the flat share count?

No, actually current production assumes completing the current plan by the end of the first quarter of 2017 and assumes no other buyback. That is necessary that once we completed, we will look into the situation and we will make an assessment, it doesn’t say that we do not plan but we simply will make a decision only once we completed and we have better understanding of what we needs to be done going forward.

Got it. And do you have convenient, how much is left on that plan?

Yes, so we announced that we purchased about $1.2 million, $1.25 million in first quarter, we continued the same pace in the first quarter. So in January I think we purchased between $550,000 to $600,000 and I believe that similar amount is last for the end of the quarter but we all need to assume that there are certain price pressures there, so about out of – about $2.5 million that could be purchased up to now we have purchased close to 1.9, so we’re very close to completing the forum.

Very good, thanks very much, Shabtai.

Sure, you’re most welcome.

Thank you. Our next question comes from the line of Dmitry Netis with William Blair. Please proceed with your question.

Okay, thank you very much. Shabtai, I want to follow up the Rich’s question on Avaya. I know there may not be a lot you can talk about, but if I do the math, this quarter represented – Avaya represented roughly actually less than 2% of your revenue. I wonder if that is the going rate or that’s what you have seen in the past in terms of Avaya revenue or this abnormality. Give me a comment on that. And how much potentially Avaya would be baked in into the 2017 guidance or have you not baked that into 2017 guidance, so I am just wondering if you could comment on that.

So, as you have mentioned at this stage fourth quarter was around $650,000 that was a normal quarter, so you can build from that some assumption as to the level of sales in 2016. We have no reason to believe that that will declining in abrupt way in 2017, so it will be a business that continues. We do know that Avaya and that is what they have stated. We will try to continue growth on the Chapter 11 and turning the company to be much more software and services based. We have a good track record with other companies who have got a software and services business. So I do not preclude that assuming Avaya continues to function as a company that we will either continuing or even gain more business there. So all is up and I don’t think fourth quarter is “bad news”, but I think that is a one-time thing and we have no reason to see abrupt changes going forward.

Yes, well, the thing is the – they may continue to operate in a normal environment they thing they are in. The problem is that their destiny is in the hands of the courts and nobody knows what really will happen whether the company gets played or sold or continue as a going concern.

Right.

In that vein do you assume a revenue for 2017 from Avaya or did you really take a hard look and said hey maybe we shouldn’t be putting that revenue guidance from? I am just trying to ask ascertain how conservative you are in this Avaya’s revenue in that 2017 guide?

So, yes, I mean…

Just, I mean, in a different way…

Again, the tolerance on our changing potential in the business in 2017 given the numbers we discussed could be about a million or a million and a half give or take that is a level when we’re talking about 150 somewhat that is a level that we should be able to either compensate for – from other customers and activity. So we have not paid any attention to that. We don’t think that is that material in terms of planning.

Okay, that’s helpful. And then if I look at the guide for Q1, are we expecting services revenue to continue to grow. And on a kind of seasonal basis, I think, you have shown growth in services for, I could see, seven consecutive quarters now. So should that trend continue or should we baking some seasonality there in Q1 and should product be kind of in that seasonal trend in Q1 as well as we have seen in the last few years?

Right, so usually we do not. In terms of planning or guidance, we have never made a split differentiated between product and services. As a whole, we normally have – we have guided usually for relative weakness in the first quarter of the year compared to the fourth quarter in the range of 2% to 3% that might be the case or may not, but I think we should plan for around the same level of Q4 give or take a percent or two, but that’s roughly it should be kind of a flat or a little down a quarter…

Okay, great, helpful, very helpful. And then, I guess, my last question would be just looking at the business, I mean, you have done a good job on gross margin side of the things that’s a 61.5% exiting the year, so pretty good expansion there. Your Session Border Controllers presumed higher margin product is growing, services are growing. Just I guess supposedly wanted to touch on the competitive environment as a result of your margin improvement. Is that something you are seeing that’s easing out there in terms of competition, you know, are they’re getting less aggressive from kind of the key members of the – as we see pack or gateways pack, you know, the Oracle, Sonus came into the world. You could discuss that competitive. I mean, enterprise business again you notice North America was also pretty decent growth there over 10%. So just in Broadvox as if you could discuss the competitive environment, I guess, that would be great. Thanks.

Right, thanks. Yeah, I’ll try to touch it briefly and I will divide that based on business areas. Session Border Controllers, we feel we are becoming more competitive relatively on Session Border Controllers mainly in the enterprise space. The solution approach are our ability to provide a solution that comprises combination of Session Border Controllers and routing, session routing engines and few more elements allows us to be much more effective on the enterprise. We also – I should say that we have been able to hire some, some strong people in the sales area that once work with other companies. So we feel we are growing key activities these days in the U.S. and Germany, but we do see more Western Europe countries and other places. So we believe that what we call international market will try to become the best player on as this is. Same for phones, we believe we have invested a lot in 2016 in adding resources and coming up with development and certification that will allow us to sell better in the phone area. And I will just mention that I haven’t touched at it, but you all know that Genesys that’s now became probably one of the largest, if not the largest contact center players has initiated a commercialization program in 2016 whereby they will aim all of our products, all of our gateways as this is IT phone scenarios are sold by Genesys. So, we have – you may call it “excessive Genesys environment”. So we are picking up on phones. We definitely see Polycom as a strongest player, but we feel that we can continue to climb up the yield. That strategy – we relatively feel fairly good in the Skype for Business. I think we’re competing mainly with Sonus and we feel we are in good shape there. So all in all I think competitive wise we are in good shape.

I guess a quick follow up, my apologize for Microsoft Skype for Business that grows 20% year-over-year to $45 million. Do you – I think in the past you have said the business will grow 25-ish percent. Would you expect it to continue to grow at that rate in 2017?

My expectation is that we will not see huge difference in 2017, but I believe that as Cloud PBX gets in a full way to market that from beginning of 2019 we will definitely see higher growth. I think that the Cloud PBX has got great potential of substantially improving our growth rates from 2019 and going forward.

Okay, great, thank you very much.

Sure.

Thank you. [Operator Instructions] Our next question comes from the line of Mike Latimore with Northland Capital Markets. Please proceed with your question.

Hi, great, thanks. Just on the Skype for Business topic one more time, I guess when you talk about your CCE Appliance; I believe that’s a hybrid deployment implied there. I guess is your view that the growth that you will see will be from sort of the hybrid deployment over time?

Hi, Mike. No, not really. CCE Cloud Connect Edition is meant for pure Cloud deployment. It simply allows the business on one end to connect to Cloud PBX in the cloud and then do is PSTN Migration [ph] using the service providers is used to work with. But that has got nothing to do with hybrid, the hybrids implementation we have today is CloudBond 365. And I know that our plans of Microsoft to offer a similar search capability in less than a year from today.

Got it. So, I know you just said that you think Skype for Business were roughly – you’ll see kind of flat in 2017, but tick up back to normal growth rates in 2018 or something like that. Is that way to think about it?

For us, yes.

Yes, okay, got it. And so most of the growth in Skype over time will be coming from the pure Cloud deployments or from hybrid I guess for AudioCodes?

So, I think well initially the start was that businesses will adopt pure Cloud operation faster, I think now realization is that a lot of the businesses will probably choose a hybrid approach. So CCE will probably evolve to support not only pure Cloud environment, but also hybrid ones. So that’s going to happen.

Yes, so that is a majority of your revenue would be tied that to hybrid over time.

Yes, because that would be probably the mostly used configuration I would assume.

Well, that’s good. And then just on the tax rate, what should we think about in terms of cash tax rate or cash tax payments in fiscal 2017 and in fiscal 2018 as you kind of have a general ideas right here?

Hi, this is Niran. With regards to the tax expenses in 2017, you can assume the same level as you in see 2016 at the non-GAAP P&L range.

Right. I mean any reason that that would go up materially in 2018 or not at this point?

Also at 2018 you can assume the same level. I remind you that we have NOLs, net operating losses, both in Israel and in the U.S., which we have the majority operation there. And that will allow us to remain at the same level of 2016 and 2017.

Okay. And just last on foreign exchange rates changes, any notable impact on the fourth quarter revenue or earnings year-over-year?

With regard to the foreign exchange, we actually already hedged major part of 2017 exposures, so we already took it into account in our guidance.

Okay, great. Thanks a lot.

Thank you. Ladies and gentlemen, we have come to the end of our time allowed for questions. I’ll now turn the floor back to Mr. Adlersberg for any final remarks.

Thank you, operator. I would like to thank everyone, who attended our conference call today. Relying some good business momentum and execution on our plans in 2016, we believe we are on track to achieving 2017 another year of growth and progress, and continue to build a growing profitable business for coming years. We look forward to your participation in our next quarterly conference call. Thank you very much and have a good day.