Yehud Aug 12, 2020 (Thomson StreetEvents) — Edited Transcript of AudioCodes Ltd earnings conference call or presentation Tuesday, July 28, 2020 at 12:30:00pm GMT

AudioCodes Ltd. – CFO & VP of Finance

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

Greetings. Welcome to AudioCodes Second Quarter 2020 Earnings Conference Call. (Operator Instructions)

I will now turn the conference over to Brett Maas with Hayden IR. Brett, you may begin.

Thank you. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President of Finance and Chief Financial Officer.

Before we begin, I’d like to remind you that the information provided during this call may contain forward-looking statements related to AudioCodes’ business outlook, future economic performance, product introductions, plans and objectives related thereto, 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 law.

Forward-looking statements are subject to various risks and uncertainties and other factors that could cause actual results to differ materially from those stated in such statements. These risks, uncertainties and factors include, but are not limited to, the effect of global economic conditions in general and conditions in AudioCodes’ industry and target markets, in particular; shifts in supply and demand; market acceptance of new products and the demand for existing products; the impact of competitive products and pricing on AudioCodes’ and its customers’ products and markets; timely product and technology development upgrades and the ability to manage changes in the market conditions as needed; possible need for additional financing; the ability to satisfy covenants in the company’s loan agreements; possible disruptions from acquisitions; the ability of AudioCodes to successfully integrate the products and operations of acquired companies into AudioCodes’ business; possible adverse impact of the COVID-19 pandemic on our business and results of operations; and other factors detailed in AudioCodes’ filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information.

In addition, during the call, AudioCodes will refer to non-GAAP net income and net income per share. AudioCodes has provided a full reconciliation of non-GAAP net income and net income per share to its net income and net income per share according to GAAP in the press release and is posted on this website.

Before I turn the call over to management, I’d like to remind everyone that this call is being recorded. An archived webcast will be made available on the Investor Relations section of the company’s website at the conclusion of the call.

With all that said, I’d like to turn the call over to Shabtai. Shabtai, please go ahead.

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

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Thank you, Brett. 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, Chief Financial Officer and Vice President of Finance of AudioCodes.

Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the quarter and then discuss trends and developments in our business and industry. We will then turn it to the Q&A session. Niran?

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Niran Baruch, AudioCodes Ltd. – CFO & VP of Finance [4]

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Thank you, Shabtai, and hello, everyone. As usual, on today’s call, we will be referring to both GAAP and non-GAAP financial results. The earnings press release that we issued earlier this morning contains a reconciliation of the supplemental non-GAAP financial information that I will be discussing on this call.

Revenues for the second quarter were $53.5 million, an increase of 8.1% compared to the second quarter last year. Services revenues for the second quarter were $17.1 million, accounting for 32.1% of total revenues. The amount of deferred revenues as of June 30, 2020, was $65.1 million compared to $55.8 million as of June 30, 2019.

Revenues by geographical region for the quarter were split as follows: North America, 41%; Central and Latin America, 7%; EMEA, 40%; and Asia Pacific, 12%. Our top 15 customers in aggregate represented 60% of revenues in the second quarter, of which 42% are attributed to our 9 largest distributors.

Gross margin for the quarter was 66.7% compared to 63.3% in Q2 2019. Non-GAAP gross margin for the quarter was 66.9% compared to 63.5% in Q2 2019. Operating income for the quarter was $8.8 million compared to an operating income of $5.9 million in Q2 2019.

On a non-GAAP basis, quarterly operating income was $10.7 million or 20.1% of revenues compared to an operating income of $7 million in Q2 2019.

Net income for the quarter was $6.6 million or $0.21 per share compared to net income of $4.8 million or $0.16 per share in Q2 2019. On a non-GAAP basis, quarterly net income was $10.5 million or $0.32 per share compared to net income of $6.8 million or $0.22 per share in Q2 2019.

During the quarter, the company raised $85.4 million in net proceeds from the public offering of 2.6 million ordinary shares at a purchase price of $35 per share.

At the end of June 2020, cash, cash equivalents, and bank deposits totaled $170.4 million. Day sales outstanding as of June 30, 2020, were 51 days. Operating cash flow generated during the quarter was $10.7 million.

Now to providing an update on our guidance. We reiterate our guidance for revenues for 2020 to be in the range of $214 million to $222 million. We’re now raising our guidance for non-GAAP diluted earnings per share to be in the range of $1.18 to $1.24 compared to the previous range of $1.09 to $1.13 that we updated following the close of the first quarter 2020.

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 strong financial results for the second quarter 2020. As stated earlier in our financial release, we enjoyed good business momentum in the quarter, both in the enterprise space and the service provider space.

There’s no question in our markets these days that team collaboration is where the action is when it comes to enterprise communication platforms, primarily because of the fact that the pandemic forced enterprises to move employees to work from home and roll out collaboration systems like Microsoft Teams, which end-users found to be no longer just interesting but clearly indispensable: a must tool if you want to preserve business continuity and recover fast from this corona crisis. And so UCaaS as a cloud service and collaboration became key to business resilience and have taken center stage in the newly evolving digital workplace.

Now let me touch on some recent team collaboration market data that reinforces this statement. According to Nemertes, a global research-based advisory and consulting firm, team collaboration use is dramatically growing in the past few months. It says that 42% of enterprises currently have more than one team collaboration application in use. Obviously, this number is growing on an ongoing basis. According to Nemertes, Microsoft Teams is the clear leader at 14.3% followed by Cisco Webex Teams at 27%, Slack at 9%, Google Chat at 8.5%.

In another example, data from Aternity, an application-monitoring company, shows that between February 17 to June 14 this year, Microsoft Teams’ use grew almost 900% while Zoom has grown 680%.

More data points from a global study of more than 525 organizations found that 91% of the organization now support work-from-home, up from 63% prior to this pandemic. And of the total workforce, 72% are now home-based compared with just 34% before the pandemic. Obviously, video conferencing has emerged as a core technology to ensure work-from-home. And nowadays, more than 91% of companies use it to support it, and nearly 30% says that they will use video for all of their meetings.

As a result, we have experienced in the second quarter growth in most of the major market segments we participate in, including the UCaaS market, the contact center market and the service providers all-IP migration market.

Underlying our success in the second quarter of 2020 is the financial performance. Let me refer to specific financial parameters. Revenue growth. We continue to deliver on our stated guidance to grow revenue this year by 9%. Delivering 8.1% growth in the second quarter brought our first half 2020 growth to 9.9% growth over the same period in 2019. Growth was very strong in UC-SIP, which grew well above 20%, however, decline of about — above 15% in gateway revenues and decline of close to $1 million in technology revenue have limited the overall quarterly revenue to 8.1%, as stated.

Service revenues. Growth of the year ago quarter was 3%. However, taking into account seasonality in quarterly services revenue and the fact that we have reported growth of 25% year-over-year for the first quarter of this year, this basically puts us in an average services revenue growth of 13.2% in the first half of 2020.

Gross margin expansion. We keep focusing on growing our software products and solutions versus hardware offering, turning the company to increasingly become a communications software company. Software products and attached services grew to about 35% of total revenue in the quarter compared to just 25% in the year ago quarter. Specifically, in the second quarter, we grew 50% above the year ago quarter. This better mix of software products this quarter allowed us to improve gross margin to 66.9% as compared to 66.1% in the previous quarter and 63.5% in the year ago quarter.

Operating margin. Operating expenses were substantially lower than planned in the second quarter, mainly due to the decrease in expenses in travel, HR-related expenses and better FX rate. As a result, OpEx has decreased to a level of $25.1 million versus $26.5 million in the first quarter. And operating margin ended at 20.1%, a record quarter compared with just 15.2% in the previous quarter and 14.1% in the year ago quarter.

Net income growth. Increase in sales year-over-year coupled with lower operating expenses has driven a meaningful increase in earnings to a level of $10.5 million compared with $7.8 million in the previous quarter and $6.8 million in the year ago quarter. That’s an increase of 54.4% year-over-year. Cash flow was strong. We kept producing cash from operating activities, delivering $10.7 million, in line with our plan for the overall year.

Head count. Growth in head count year-over-year for full-time employees was 4.4%. Adding to its growth in outsourced head count, we grew overall 5.2% year-over-year. Obviously, adding more than 40 position over the year ago quarter clearly demonstrate our confidence in continuous expansion of our business and success in coming years. Finally, deferred revenues continued to grow and amounted to $65.1 million, an increase of 16.7% over the second quarter 2019.

As mentioned on our previous quarter investors call, I’d like to stress again that with revenue growing steadily in past several quarters and deferred revenues growing in a similar trend all along, our ability to meet the top line target of every new quarter we are stepping in is improved. Hence, the momentum, hence, the confidence in achieving the revenue target in coming quarters.

Now to review the networking business line. Networking business line kept growing 10.5% year-over-year and has reached a level of $51.9 million, accounting now to 97% of our business in the second quarter of 2020.

With networking being the core of our business, it is important to note that in the first quarter of this year, networking business grew 12% over the first quarter in 2019. And so on first half revenue — our first half revenue in 2020 compared to the first half revenue in 2019, overall, networking business is growing nicely. It has basically grown 11%.

At this stage, I believe that we — anybody who wants to monitor the progress of the company, it makes sense to put aside the technology line, and I think we should focus from now on, on networking, which is 97% of the business. Now the networking business comprises of 2 key business lines: UC-SIP and gateways.

The UC-SIP business line grew nicely in the quarter versus a decline in our gateway business. UC-SIP business line grew substantially well above 20% in second quarter 2020 and provides now to close to 70% of our business revenue in the quarter. Key to this growth were substantially increased year-over-year sales in our SBC and MSBR product lines. Revenue grew also in our central network management, software business line and our advanced routing management solutions. The IP phone business line remained about flat compared with the revenue level of the year ago quarter. We attribute this less favorable performance to the stay-at-home new normal, which is practically hurting sales of on-prem devices, a trend which we believe will persist in the near future as work habits of organization will become more hybrid and will basically share between on-prem presence and remote work practice in the new emerging digital workplace.

Noteworthy is the fact that revenue in the UC business line grew substantially above what we used to know in previous year of 15% to 20%, meaning that, that large business line — and bear in mind, we did last year about $110 million. We target this year to do between $135 million and $140 million. This is a line that carries a gross margin of close to 70% and grosses well above 20%. All in all, I think that is the key business line of the company. This is where we invest our resources, efforts and energy. And I believe that continuing that momentum will bring the company substantially further in the future.

So please bear in mind that gross margin for this business line increased. And now that it is closer to 70%, this has provided, definitely, for the overall company growth of the gross margin to 66.9%. And this is mainly due to the increased sales of software products and related services and the transition to cloud communications.

Now to gateways. In the gateway business, we saw a second quarter in a row of declining revenue. Gateway business line revenue declined more than 15% compared to the year ago quarter. The gateway business line now provides for less than 30% of the second quarter revenue and carries a gross margin of close to 70%. The decline is mainly related to products — to the products components, which declined above 20% year-over-year. Decline of gateway services was milder at less than 15%.

Now to the Microsoft ecosystem. All in all, the business in the Microsoft ecosystem was good. Growth in revenues was close to 20%, just on the heels of the first quarter. In terms of highlights of our performance in Microsoft ecosystem, we saw a very strong uptake in Teams opportunities closure and very strong growth in new opportunities created. On the other hand, we’ve seen meaningful decline in the Skype for Business-related revenues. I’ll refer to more numbers in sequel. Also, a slowdown in IP phone sales due to the stay-at-home new practice of organization, this is the result of the pandemic and the move to work-from-home. And we believe that — as I have mentioned before, we believe that, that trend will persist. All in all, Microsoft continued to report growth and demand for its cloud services and Teams.

To quote some data points on that, according to Microsoft investor call of last week, they’ve stated that 69 organizations now have — that have more than 100,000 users have moved to use Teams. Also, over 1,800 organizations which have more than 10,000 users have been — moved to use Teams. So all that tells you that on the enterprise level, on the large enterprise companies, Microsoft Teams is a winner, and this is where we sell. So that gives part of the explanation to why we are that successful in that range.

I’ll give you more data points. There was a survey done between the middle of February and June. And basically, the survey was about to check the market share of the different team collaboration application. Basically it showed that in that environment, Microsoft Teams grew from 11.4% to 34.3%. This was an increase of 300%. On the contrary, Skype for Business declined, and that we’ll explain later on what we also see in our revenues. It has declined from 75% to 44%.

Also successful in that period was Zoom, growing 127%. Webex, Cisco Webex was less successful, growing about 50%, and then Slack showed 33% growth. All in all, Teams stands at the top of the table with more than 300% growth.

On other fronts, we have, early, a few wins in the AudioCodes Live initiative we announced in March 2020. This is primarily about applying professional services to the Microsoft Teams environment. Also, we keep investing in advanced networking solution for Microsoft Teams in order to allow faster growth of Teams users. We anticipate greater support from Microsoft field sales in the new fiscal year of Microsoft in pushing for an elevated use of voice services as related to Teams. We believe that, that should be a positive catalyst to our efforts in the coming year.

Now to some fully dramatic development in Microsoft revenues in the quarter. You all remember that we reported that we have sold more than $80 million of product and services in 2019. That was primarily attributed, about, I would say, 99% of Skype for Business, only about 10% to Teams. What we saw in the second quarter is a complete revolution. Skype for Business came down dramatically, Teams grew up dramatically. Skype for Business was down 28% from second quarter a year ago and 20% down from the first quarter. So 20% decline in the first quarter. However, Teams grew more than 336% year-over-year. And that basically tells you — and almost doubled quarter-to-quarter. So that tells you that growth of Teams have surpassed the decline of Skype for Business. And all in all, as we have managed to show, growing Microsoft sales it means that we have — we are doing the transition from Skype for Business to Teams in a very determined, assured way.

On another front, I mean, each quarter — we measure each quarter by 2 key KPIs. One, which is just reported, the closure of opportunities and sales level, but the other one is really not less important and it relates to the future, and that is the amount of new opportunities created in that quarter. So with regard to creation of new opportunities in the Microsoft space, I would like to know that while we saw a dramatic decline in new Skype for Business opportunities, just like in the revenue side of the business, we saw Teams-related opportunities doubling in creation year-over-year. To give you some sense for it, Skype for Business’ new created opportunities have declined more than 50% in the quarter, meaning less and less new opportunities created every quarter. On the other hand, Teams is growing substantially, almost double, in terms of the number of — or amount of opportunities in financial extent over the year ago quarter.

Now let me bring you — get you some 3 examples to important projects we have done in the second quarter. I’ll talk first about one of the largest food manufacturer companies in the world in North America. They employ 150,000 employees. They are an AudioCodes customer for the past 7 years, and they have deployed Skype for Business with our products, be it gateways, session border controllers, management software, recording software, et cetera.

Our overall revenue with them to date exceeds many millions of dollars. And recently — I’m glad to say that recently they started rolling out to Teams. For Teams, we have secured in the second quarter, $0.5 million deal for session border controllers for direct route. This is delivered through a partnership with another big value-added reseller, and we sell this as a service, a managed service. Additionally, we have secured a $700,000 support-renewal contract with their current Skype for Business solution.

Another example is a Fortune 500 global manufacturer and marketer of packaging products. We’re talking about thousands of SIPs using Teams’ fully managed service. It’s a 5 years contract. In second quarter, we have secured more than $0.5 million in professional services.

Third example is a giant Brazilian bank. This is a customer of ours for many years now. Using our gear in Genesys contact center environment. This is — by the way, it shows you AudioCodes’ strong position in the enterprise, where we are able to provide solution and equipment not only for UCaaS, but also for the contact center. So they started to roll out Teams with AudioCodes using our SBC, routing manager and One Voice Operations Center to help them build the foundation of Teams’ voice network. Again, it’s $0.5 million contract in the second quarter.

Last, let me mention a large pharma enterprise with several — 10,000 employees around the world. We have a long-standing relationship. They have evolved their digital transformation from legacy IP-PBX to Skype for Business, and now ultimately moving to Microsoft Teams. To date, we have generated about $3 million with this account, including session border controllers, gateways, One Voice Operations Center and more services. In this quarter, we have secured a virtual SBC project with them. We’re basically moving with them to the next stage in Teams.

Now let me move over to the SBC business line. I’m glad to say that 2020 is a very strong year for the line. We ended 2019 with more than $60 million in revenues. We now anticipate that in 2020, we will reach above $80 million. So all in all, we predict for more than 30% growth on SBC. We are a clear leader in SBC.

On June 24, we have issued a press release where Omdia has released a report that says that AudioCodes has experienced a 24% year-over-year growth in SBC revenues in first quarter of 2020, more than any of the other vendors covered in the report during the quarter. AudioCodes is ranked second among enterprise SBC vendors in the report, with 17% overall revenue market share. So all in all, very strong position in the SBC market. As we all know, the key application of SBC is around SIP trunking and also using transition to all-IP. We’ve seen dramatic growth in Teams direct route using our SBC. We now see few more new applications, namely, if you think about WebRTC that will be used for work-from-home; if you think about a new voice-network defined, think about virtualizing cloud migration, think about the telephony engagement for virtual agents. So all in all, SBC is a very key network element in every new solution that’s being deployed, and we know that we’re sitting among the leaders in that market.

In terms of the quarter specifically, this was a record quarter. Revenues reached well above $20 million. We basically saw an increase of more than 10% quarter-over-quarter and more than 50% year-over-year. The business line carries a very high gross margin, above 85%. We’ve seen good activity, both in the service provider SBC, CPE and in the enterprise.

In terms of geo split, 36% of revenues were in North America, 38% in Western Europe, the rest in Asia Pacific and CALA. We have seen strong bookings, almost 50% year-over-year. We also saw an increase in new created opportunities. So all in all, a very strong established line.

One key new development that’s important, and I keep talking about our transition to being a communications software company, is that we try to increase the software content in every business line that we involve in. So just looking at the SBC line, where we started a year ago with software being — providing about 26.8% of the overall SBC line, now a year after that, the software SBC accounts to almost 40%. So very strong increase, above 50% in the software content of session border controllers. Obviously, that relates to more deployments of virtual SBC in public cloud and in private data centers.

To give you 2 examples for wins, just as we did with Microsoft. So we won a very lucrative contracting, an interconnect SBC, with a very world-known leading communication vendor in the space. Basically, they were looking to expand service and operation in specific countries in Asia Pacific and CALA. And there was a need for a high-capacity resilient SBC platform that will meet certain regulatory requirements. We were selected out of basically 7 SBC containers, all of the known names in the industry. Thanks to our flexible SBC capabilities alongside the One Voice Operations Center life cycle management suite and primarily due to real-time voice quality monitoring. This win joins previous session border controllers and WebRTC wins with leading contact center as service providers in North America and Europe. It demonstrate that real-life constraint and need for faster deployment cycles create business opportunity for high-scale SBC with pure-play cloud providers as they scale up their service.

In another example, we’re talking about a world-leading e-commerce vendor. Due to the COVID-19 needs and due to regulatory requirements in a country, the company now has to move more than 10,000 of its customer support agents to work-from-home. This customer is already a multimillion-dollar account for AudioCodes, which has purchased and deployed VoIP gateways and session border controllers. This opportunity is around our integrated WebRTC gateway that is a key differentiator versus main session border controllers competition. The customer, like other mega enterprises, has very strong internal development teams and develop their own WebRTC clients based on their own WebRTC and Client SDK. The WebRTC gateway is needed for termination of the calls.

I’ll talk a bit also on the work-from-home opportunities. As mentioned in our previous call, we see a very fast ramp-up in the need to provide good quality of service solution for contact center agents moving to work-from-home. And thus, I can tell you that in previous months, in the second quarter, we have seen an uptake in the number of new opportunities created and we work to come up with a solution that will far exceed the capabilities of any other work-from-home quality monitoring and delivery solution.

I’ll mention more, one very promising product for us. Let me talk about the Voice. AI Gateway. We’re talking here about a session border-related development, which adds on top of it the various components, and allows basically to connect existing chatbots to voice and telephony channels. Now it’s obvious that with COVID-19 pandemic, the need for chatbots is increasing. We are all locked into situation where we need to approach certain organizations and our suppliers, and our ability to — and since we’re all calling them by phone, we have 2 key problems: a, not all of us are accustomed to using chatbots, so that’s a problem. On the other hand, when you have too many phone calls coming into a contact center, you need to use more agents and then you get a substantially longer wait times. So we have developed the Voice. AI Gateway to allow connection of our voice calls to chatbots. And thus, we can, a, improve substantially the response time; and b, also provide a lot of saving for the cost of those agents. That product is already in use with several customers. I just mentioned that, so far, we have more than 50 opportunities created, out of which 20 were created in the second quarter. We have more than 10 opportunities that were closed one. We have a few already in production, less than 10. Partner’s picture is very encouraging. There’s no such comparable capability these days at the level and performance we provide. And so we are able to get to work with many chat developers in both framework vendors in the space and also with some of the big names that you all know from the public networks. So all in all, a very successful product, very successful activity.

I’ll also mention a quarter ago, we announced a collaboration with Google on the One-Click program, which is meant to allow to connect and provide phone numbers in the U.S. and U.K. to chat developers. I’m happy to say that there’s been a lot of interest in that new service. We had more than 100 people signing in. We have more than 10 active accounts right now. And we believe that, that is a great lead-generation tool for us for the growing chatbot world.

Regarding services, I already mentioned revenues, I’ll just touch another angle, which is bookings. So in the second quarter, we grew very nicely in bookings, 6.3% compared to the second quarter a year ago. Very impressive is the growth of more than 40% in our professional services year-over-year. So all in all, a very active quarter in terms of professional services.

Finally, I’ll come to our guidance. So in terms of revenues, we estimate — Niran mentioned already, we reiterate our guidance from the beginning of the year and see no reason to change it. We feel fairly confident in achieving it. As we mentioned, the current range is targeting between $214 million to $222 million. As regards to earnings, in second quarter ’20, we were able to meaningfully beat original plan and the analyst consensus. For the rest of 2020, we believe that we will see similar patterns of revenue and operating expenses, and thus, we are confident in our ability to continue to grow earnings. As a result, we now update our earnings guidance and increase the earnings range from $1.09, $1.15 to $1.18 to $1.24.

And with that, I have completed my introduction for the quarter, and we’ll turn the call into Q&A. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Tal Liani with Bank of America.

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Tal Liani, BofA Merrill Lynch, Research Division – MD and Head of Technology Supersector [2]

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Thank you very much for the comprehensive overview of the quarter. I want to ask you — I want to go back to basics and understand, first of all, within Microsoft. What’s the current use of voice in unified communication? And what are the efforts done? What’s the outlook for increased use of voice? Because I understand that it’s about unified communication and about Microsoft meetings, but it’s more about the use of voice within the platform. So that’s number one. And number two, can you talk about your efforts with other players other than Microsoft meetings? And what can you do for other players?

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

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Yes. I’m sorry, I was on mute. Thank you, Tal. Thank you. Regarding voice, voice is definitely probably one of the most important ingredients in unified communications. Put it aside with chats, if you run statistics, statistics says that voice is the most preferred media of communication. Now Teams provide the voice capability for on-net internally. There’s no need for voice services outside it. But once you want to get a dial tone, once you want to talk with third-party organization, you want to dial them or get a call, you need to add voice services.

That is on the connectivity side, very simple functionality, sometimes very complex in terms of implementation, but essential to having a full comprehensive unified communications solution. However, now think about the new world that’s emerging. And that’s a world that knows to process content, knows to take voice content and produce results from it. So if we were talking about virtual agents and if you want to save costs, if you want to provide a service substantially faster than waiting on the line for an agent, you have today a technology that takes the voice part of that and basically can apply speech-to-text, natural language understanding, machine learning, a few more technologies that will now take advantage of the content itself. So connectivity is key to connect to other organizations. Content processing is key. So voice is primarily a key technology within every communication solution. And that’s the approach we take.

Regarding your question as to working with other organization, we definitely try to do that. We have partners. I can name a few, working for many years now with companies like 8×8 and RingCentral and Vonage. We announced certification for Zoom. We have growing opportunities with Zoom in 2020. We have announced partnership with AWS Chime. So all in all, we’re very active. We work with some legacy names like Alcatel, and we work also with companies in the contact center market. We work with Genesys and 2 more of the leading companies in the contact center market.

So all in all, we have a broad play and we try to work with more parties. But at the end of the day, right now, it seems that the majority of our growth and success will reside with Microsoft Teams, which is obviously a very dominant and successful player in the market.

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Tal Liani, BofA Merrill Lynch, Research Division – MD and Head of Technology Supersector [4]

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Great. Shabtai, if I can just have a follow-up on your first answer. So when you talk about analytics, can you discuss the reception you’re seeing from clients? Are there — what’s the competition there? I’m sure that there are other solutions that can ride on top of any voice company and provide the analytics, but what’s the benefit of customers to go with you versus others? And what’s the reception that you’re seeing from clients?

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

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Right. A, we enjoy the fact that we are a very known brand and established vendor and supplier in the enterprise world. So we have access to a lot of the large enterprises I’ve mentioned before. So selling up in an existing customer usually is easier.

Second, the company is fairly established, more than 20 years public, many years in the business, very advanced, sophisticated telephony capability, quite an established organization with known functionalities. We have found ourselves several times competing with new start-ups. At the end of the day, our scale, our brand, our capabilities, I’m able to throw resources into a project because it is important to me. We find ourselves preferable with customers due to the fact that we are a very established and strong vendor.

So all in all — one more data point that is never discussed in those cases is the fact that contrary to the products we knew in the past, take a router, take a firewall, take anything that “is a standard product,” the winner takes it all. So if Cisco was leading the router market, it was very tough for other companies to play in it simply because they had reached the overall market. When you’re talking about cognitive services, when you’re talking about speech-to-text and text-to-speech, you’re talking about languages. And here, the picture is completely different. So that allows us to penetrate several markets in parallel and basically will allow us to be much more successful because we will have the scale. If AudioCodes can sell to, let’s say, the U.S., Germany, U.K., Japan and Australia, you bet that our ability to invest resources and get to results will be substantially better than an Australian-based start-up that will be maybe successful in Australia, but will find it hard to expand being a smaller platform. So all in all, I think we’re sitting in a very comfortable situation.

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Tal Liani, BofA Merrill Lynch, Research Division – MD and Head of Technology Supersector [6]

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Got it. Shabtai, I’m just going to squeeze in one little — one small additional question, and that’s for Niran. Your revenues were roughly in line for the quarter, roughly in line with expectations, but your gross margins were almost 200 basis points above. And your operating margin was a lot more, it was almost 400 basis points above. So first, what drives this great margin performance? And second, what’s the sustainability? What’s the outlook for the next few quarters? What are the puts and takes for margins?

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Niran Baruch, AudioCodes Ltd. – CFO & VP of Finance [7]

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Okay. So actually, what drives the gross margin to 66.9% was mainly the increase in software revenues that Shabtai mentioned in the call, more a professional services. And all in all, product mix was a benefit this quarter. We had more revenues from SBC, which is in high gross margin, and less revenues related to phones, which is in low gross margin. We believe it’s sustainable for the coming quarters and even may improve because we are selling more and more software revenues.

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Operator [8]

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Our next question is from the line of Samad Samana with Jefferies.

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Samad Saleem Samana, Jefferies LLC, Research Division – Equity Analyst [9]

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Maybe one to start with on — a follow-up on Teams. It’s clearly outstanding. How much of that was Skype for Business customers migrating to Teams versus maybe organic net new Teams customers using voice? And then I have a follow-up question. Hello?

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Shabtai Adlersberg, AudioCodes Ltd. – Co-Founder, President, CEO & Director [10]

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Sorry to disappoint you, Samad, on that. I really do not have the data with me now. We’ll look into it, and I will provide the answer. But we’ve seen — I can tell you that we are seeing definitely a mix between new customers and some of the customers that already used — as I’ve mentioned in some of the examples that I gave, already using Skype for Business and moving. But I don’t have the actual division with me right now.

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Samad Saleem Samana, Jefferies LLC, Research Division – Equity Analyst [11]

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Okay. That’s helpful. And then maybe just as a follow-up to that, if you think about generally the customers that are adding voice to Teams through AudioCodes, any characteristics in terms of maybe the average size of the customer or is it usually a full end-to-end deployment? Or is it a phased rollout? How should we think about maybe the ramp at individual customers of rolling out voice into Teams?

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Shabtai Adlersberg, AudioCodes Ltd. – Co-Founder, President, CEO & Director [12]

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Okay. That’s actually a very interesting question. I’ll tell you why. Because in the past, when Microsoft was selling mainly Skype for Business, large companies always took the time to do a pilot, to deploy it with several branch offices and then continue the deployment every quarter in coming years. I think this is — the situation right now with Teams is completely different. I think these days, organizations are moving out of necessity. Nobody has the time to wait for a prolonged deployment. So — and because — actually, there’s no deployment. I mean we’re not talking about deploying Microsoft service on-prem. You’re talking about using a cloud service. So actually, you can think about companies going online with Teams all across the company, unless, of course, they want to first trial it with a smaller group. So that’s regarding that.

I’m sorry, your first question was, Samad?

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Samad Saleem Samana, Jefferies LLC, Research Division – Equity Analyst [13]

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No. You got them both, just that rollout cadence. And maybe just one final financial question. Clearly, the earnings was a solid performance this quarter. How should we think about maybe the investment philosophy for the back half of the year on expenses since, if I heard the guidance correctly, there isn’t — the guidance was just reiterated. So is the upside planning on being reinvested? Or how should we think about OpEx trends maybe for the rest of 2020?

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Niran Baruch, AudioCodes Ltd. – CFO & VP of Finance [14]

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Okay. So OpEx indeed decreased from a level of $26.5 million in the first quarter to $25 million in the second quarter. It was mainly related to less expenses related to travel and to HR-related expenses. I could tell you that our planning for the second half of 2020 is to be — to still saving in these major expenses, travel and HR-related. Moreover, we have a better FX rate, Israeli shekels against the dollar. And as such, we believe the OpEx, it will be increased, but not too much compared to the second quarter of 2020.

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Operator [15]

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(Operator Instructions) Your next question is from the line of Rich Valera with Needham & Company.

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Richard Frank Valera, Needham & Company, LLC, Research Division – Senior Analyst [16]

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Shabtai, you’ve noted the conflicting dynamics in the Microsoft business with Skype for Business declining and Teams growing quite rapidly. How do you think that nets out for you kind of for the year from the year-outlook perspective for Microsoft? And then taking that a level higher, UC-SIP sounded like it saw very good growth overall. So how do you think about kind of UC-SIP outlook for the year? Do you think that’s kind of a 20% or better growth business overall for the year?

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Shabtai Adlersberg, AudioCodes Ltd. – Co-Founder, President, CEO & Director [17]

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Thank you, Rich. Yes, that is indeed a very interesting question. As I have mentioned before, take our 20-plus revenue for the second quarter, I’ll give you one more data point that Teams and Skype for Business were basically around the same level, give or take $1 million. Now the real question is how fast Skype for Business declines, purchase orders for Skype for Business-related equipment declines versus growth in Teams. We think a very strong pickup in Teams.

Actually, as we speak, this is July 28, already, the current ramp up in the third quarter is substantially better than what we have seen in April. So I’m confident that, at least based on data we have in hand right now, that growth in Teams will more than outgrow the decline in Skype for Business. Also, let’s bear in mind that every time a business line is dropping, the majority of the drop occurs in the initial phase, and then it — basically, it’s weighted out. So all in all, we’re pretty confident in our ability to keep growing the Microsoft revenues for the rest of the year. And we believe we will see continued growth next year.

Also, I’ll mention that we all — we try always to increase the new products and new services we offer in that environment. So in many ways, our offering for Skype for Business was kind of altered more than a year or 2 years ago. And on the other hand, we have, as I’ve mentioned, more investment in new offering, new opportunities for Teams. So all in all, we believe that Teams will be fully successful.

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Richard Frank Valera, Needham & Company, LLC, Research Division – Senior Analyst [18]

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Got it. Just one more, if I could, on the service revenue, which I guess was a little light from a growth perspective this quarter, but it has shown some historical lumpiness. How should we think about that going forward? Was that just kind of lumpiness? And should we expect that to kind of resume more of its historical growth trajectory?

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Shabtai Adlersberg, AudioCodes Ltd. – Co-Founder, President, CEO & Director [19]

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Yes. Definitely. I mean services basically has 2 components. One is the maintenance contracts, and the other one is the professional services. Maintenance contracts, it’s already years, 5, 6 years now that growth in a year is usually between 11% to 15%, and we believe we will see the same here. As I mentioned already, if you take into account the first half of the year, the growth was 13.2%.

However, there’s another component, and this is the professional services. And here, I think the picture is substantially rosier. We are growing substantially. There’s much need — by the way, a philosophical point, when people are staying at home, although they are productive and efficient, when it comes to new large projects that has to occur within a company, it’s always substantially more difficult to put them to work and complete them when you have people distributed all around the place. So you can assume that the need or desire to move — to use more services from a party that can provide them, you can assume that, that desire is growing. And therefore, we believe that professional services on a global basis will become a much more successful area for deployment. And this is where we focus these days.

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Operator [20]

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We’ve reached the end of the question-and-answer session. I will now turn the call over to Shabtai Adlersberg for closing remarks.

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Shabtai Adlersberg, AudioCodes Ltd. – Co-Founder, President, CEO & Director [21]

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Great. Well thank you, operator. I would like to thank everyone who attended our conference call today.

With continued good business momentum and execution in our markets in the first half of 2020, we believe we are on track to achieve another strong year of growth in our business. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day. Thank you.

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Operator [22]

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