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Operator
Good morning.
My name is Meredith, and I will be your conference facilitator.
At this time, I would like to welcome everyone to the AudioCodes third quarter Earnings conference call.
[Operator Instructions]
I would now like to turn the conference over to Erik Knettel on behalf of AudioCodes.
Please go ahead, sir.
Erik Knettel - IR
Thank you.
I would like to welcome everyone to the AudioCodes third quarter 2005 earnings conference call.
Let me begin the call today with a brief Safe Harbor statement concerning AudioCodes' business outlook for future economic performance, product introductions and plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters.
These are forward-looking statements.
That term is defined under US Federal Securities law.
Forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results to differ materially from those stated in such statements.
These risks, uncertainties and factors include, but are not limited to, the effect of global economic conditions in general; conditions in AudioCodes' industry; target markets, in particular; shifts in supply and demand; market acceptance of new products and continuing product demand; 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; and other factors detailed in AudioCodes' filings with the Securities and Exchange Commission.
AudioCodes assumes no obligation to update that information.
Joining us today from AudioCodes, we have Shabtai Adlersberg, Chairman, President and Chief Executive Officer, and we have Nachum Falek, Vice President, Finance and Chief Financial Officer.
I would now like to turn the call over to Shabtai Adlersberg.
Mr. Adlersberg, please go ahead.
Shabtai Adlersberg - Chairman, President & CEO
Thank you, Erik.
Good morning and good afternoon, everybody.
I would like to welcome everybody to our third quarter 2005 conference call.
With me this morning is Nachum Falek, our Chief Financial Officer.
Nachum will start by presenting a financial overview of the quarter.
I will then take the lead and focus on the business highlights, key developments in the quarter, market trends as we see them from our business, key achievements in this quarter, and I will then expand on some of the progress that we have made in the networking business.
We will then turn into the Q&A session and we'll take questions.
Nachum?
Nachum Falek - VP of Finance & CFO
Thank you, Shabtai.
In the third quarter revenues were 29.7 million, which represents 4% increase over the last quarter.
Getting into geographical and product mix the America accounts were 56%, Europe 21%, Asia Pacific 12%, and Israel 11%.
We had one customer above 10%.
Our top 15 customer accounts to 56% of revenues compared to last quarter 54%.
In terms of revenues by business groups, then in the third quarter of 2005, the technology business group revenues consisted 54% of sales and the networking business group revenues accounted to 46%.
Gross margin was 59.2%, which is similar to the gross margin we had in the second quarter.
Operating expenses increased from the second quarter level to approximately 14.4 million.
This increase relates mainly to growth in R&D and sales and marketing expenses, and was inline with our expectations.
Headcount increased this quarter by 35 employees, which brings us to a total of 512 employees.
AudioCodes reported a net income of 3.5 million, or $0.08 per share.
Short-term and long-term cash balances were 270 million, compared to 250 million last quarter.
The increase in cash balances is attributed mainly to a positive cash flow from operations and financing, which were offset by a negative cash flow related to investment activities.
DSO came in at 53 days, compared to last quarter DSO of 57 days.
Our guidance for the fourth quarter is as follows.
Based on our visibility at this time, we forecast revenue for the third quarter to continue to grow modestly, up to a level of 5% compared to the third quarter revenues level.
We forecast earnings per share of $0.08 to $0.09 based on approximately 44 million shares.
This guidance is based on an initial backlog that is about 50%.
I will now transfer the call to Shabtai.
Shabtai Adlersberg - Chairman, President & CEO
Thank you, Nachum.
We are very pleased to report yet another growth quarter.
This is our 16th consecutive quarter of growing revenues and profits.
This marks four years of our increasing quarterly revenues.
More than so, it really demonstrates our ability to build a very strong position in our marketplace and a growing reputation for us in the gateway market.
To improve this quarter actually we continue to execute on our strategic objective of becoming an industry leader in the Voice over IP media gateway and media server world.
The highlights -- the key highlights of this quarter, and I will get to them back later in the call.
We saw increase and intensified work and collaboration with Tier 1 OEM from building solution and integrating our media gateways into their product solutions and portfolios.
We have seen increased footprints for first few service providers who are using our media gateways.
We have seen very thorough ad success in several media gateway product utilization done throughout the quarter.
And then we have been including a lot of work on responding to many of our space issued (ph) on Voice over IP by service providers all over the globe.
The last point is that, contrary to the trend that we saw in the previous two quarters, we have gained new design wins for our Voice over IP communication blades, which signifies returning to growth of the technology business side.
All of those occurrences and developments should lead to building a very healthy pipeline for us to develop in 2006.
Highlighting some key achievements on the financial side.
We grew revenues 29% year- over-year in the quarter and 6% sequentially.
On the income line, the results are much more impressive.
We had a very strong net income of 11.7%, and when we look on the operating income and net income, we grew more than 10% sequentially.
But more than that, we've been able to double those numbers compared to the third quarter in 2004 a year-ago, so doubling our profit while increasing.
We have increased investments, all that is happening with our increase in manpower of 7% this quarter, and 20% in 2005 compared to 2004.
We believe that that impressive growth in profits, as I said, with our ability to increase investments in manpower, best reflects management's beliefs in our infrastructure and in our ability basically to grow and continue to be successful in coming years.
Market trends, we have not seen any major change from the hurdles that we have observed in the second quarter 2005.
As I mentioned before, we have seen in terms of our activity, we have seen RFPs issued mainly in South America, in Europe.
We have seen product evaluation of media gateway, testing in lapse by a service provider, but we have not seen yet any meaningful network deployments starting in 2005.
In that regard, we do reiterate our stand that we do expect larger network deployments to occur no sooner than the second half of 2006.
However, with that being said, we do see clear indications that the market in media gateways and media servers in late 2006 and 2007 is going to be a very big market.
That is based substantially on increased OEM developing, testing, integration, and responding to our key activity and also by product testing by service providers.
So all that, do layout a brighter future for 2006 and 2007.
All in all, we are looking into a very healthy growing market that, according to market reports from Synergy and Informatics, is going to be around 1 billion in 2006.
And we are prepared to go to market with a very advanced, cost-effective and state-of-the-art products volume.
Market reports do indicate the market should grow 40% in 2006.
We believe this is a bit on the high side.
From where we sit in the market, we believe that 30, 40% growth is more consistent is what we see in the market.
And much of that will depend indeed on the pace of new network deployments, which we believe, again, will happen more towards the second half of 2006.
In any event, when we look on our prospects in 2006, we do believe that we're becoming much stronger and in much better situation than we entered 2005.
Just taking the customer base prospective, while we entered 2005 with one large OEM networking customer, we do enter 2006 in about 2 months from today with more 3 or 4 large OEM's that will use our mid and high-density gateways.
And we believe that combination of new OEM's and increased pace design wins with (ph) such OEM's will lead to higher sales of media gateways in 2006.
Now, a bit on the key application that are active in the market where we see multiple areas of activity.
In the last few months, we have seen the cable market very active, both our accounts and in accounts that we see from competing companies.
We saw increased MSO activities in deploying VoIP services, and we see this companies competing with wireline and wireless service providers.
A lot of design activities are around IMS, next-gen architecture for converged wireline and wireless network.
And we have seen a lot of activity in integrating media server products into those IMS network designs.
And we do see continued intense activity in developing fixed mobile convergence solutions and some activity in trying to take Voice over IP over Wi-Fi.
All those applications will drive -- keep driving the Voice over IP market going forward.
Going back to our business, our networking business was 46% in the quarter, down from 50% in the second quarter, and compared to 45% in the third quarter.
The decrease is mainly attributed to lower sales of our low-density media gateways, both analog and digital.
On the bright side of the business, we saw increased sales of media servers and mid and high-density gateways.
So all in all, we have seen clear growth in the direction that we look for, growing densities, which is a better spot for us.
Technology revenues grew nicely, representing pickup in sales of about 5 to 10% in the Voice over IP communication board and Ai-Logix operation that was acquired.
All in all, we've refocused our aggression in that area.
We have new design wins and we have all the reason to believe that in 2006 we will see renewed growth in the technology business.
As to specific markets, in North America we saw revenue bouncing back the growth.
We've seen revenue increasing by about 10% from the second quarter.
We're happy to report that we have activity with several new (ph) wireline service providers.
We are selling currently into 2 and we do have initial work with 2 other Ilacs.
All in all, we believe that AudioCodes is developing a very good brand name for its media gateway and sort of products.
Then we have been reorganizing our sales teams in North America.
We do believe that we now stand with much better sales force that is able to take on growing sales in the area.
We have 2 new OEM's in North America that we believe we should see initial revenues kicking in in 2006.
And we do believe for all cooperation with 3com and Nortel on enterprise sales will allow that to expand that even further.
In EMEA and Latin America, we have increased revenues 5% from second quarter.
In APEC, we basically had a less good core (ph), and we went down in sales by a substantial percentage.
We believe that we should work on this and get a better result in the first two quarters in 2006.
In terms of activity in EMEA, we saw activity in East Europe, mainly with second tier, third tier utility's (ph) service provider (inaudible).
And we've seen further activity with entities (ph).
All in all, if you are looking into the specific business line (ph) the media server line enjoyed a very healthy quarter.
We've seen growing revenues, strong margins.
We've secured a design win with a leading (inaudible) North America for a small media server.
We are in the final round of (inaudible) for a larger density media server.
We believe we have good chances of winning that.
In addition to that, we had two more activities towards (ph) media server accounts with 2 leading entities.
We have signed some prior agreements with one entity, additional entity, and we do have-- we are in the final stages (inaudible) for our media server product.
All in all, we believe that in the media server markets, we have done nice steps.
In addition to that, we have announced some marketing collaboration with 2 application vendors, adding to our ability to sell a more complete product solution to the market.
In our media gateway market, as I have mentioned before, we saw increase sales of the mid to high density media gateways and lower sales of low density gateways.
We do enjoy to be recognized and be perceived to be of owning one of the best products in the field.
We went through some very thorough testing and integration with 2 or 3 customers.
We do believe that that is laying the ground for increased mid and high density in 2006.
At the same time, we have done some very nice steps in the service providers market or deployment at HOT Telecom in Israel is rapidly becoming very successful at this stage.
The network does service 50,000 subscribers, and its picking up very nicely, most of them (ph) in large gateways.
We have similar success with another MSO, a multinational level, and so we are deploying our gateways for the last 2 months and we see good performance in initial steps of using those gateways in the market.
At the same time, we are active with a large number of service providers showing interest in evaluating our products in going to market.
We do have heavy investment these days in the media gateways market.
We have increased substantially our investment in R&D and QA, mostly in order to service our customers in the service providers world (ph), and we believe that that investment again is putting us at (ph) competition with much more in not (ph) in position to put all those resources that can be fulfilled.
Now getting to our financial plan and guidance.
We entered Q4 2005 with nice backup that's about 50%.
At this stage, we do not see any changes in visibility pretty limited about a month or two into the quarter.
As in the third quarter of this year, we start seeing better flow and grow the base of project, which we believe will materialize in 2006.
As Nachum mentioned, our guidance for the quarter is continued growth topline up to 5% and earnings of 8% to 9%.
Based on that guidance, we target growing 2005 very close to 40%, which is very close to our initial target for the year on the final revenue, and grow a profit in 2005 more than 160% compared to our profit in 2004, which is a very nice achievement, again in view of the very massive investment in manpower and product development that we have done in 2005.
Looking into 2006, we believe that we will enjoy continued growth in our revenues and profits.
We currently plan on growing revenues at the range of 25% to 35%.
Regarding earnings, we do plan on a higher growth rate of 30% to 40%, as we believe that the majority for our investment in the networking business is already took place in 2005.
Should the pace of new network deployment indeed pick up in the second half of 2006, we believe that earnings growth should be more towards the high end of the range of 30% to 40%.
And with that, I have completed my introduction and I will turn it to you for Q&A.
Erik?
Operator
[Operator Instructions]
The first question is from Jonathan Half with UBS.
Jonathan Half - Analyst
Thank you.
Congratulations on a solid quarter and execution.
Shabtai, you mentioned an increase in number of OEM's that you're entering '06 with compared to '05.
Do you expect any of them to become 10% customers in the first half of '06?
Shabtai Adlersberg - Chairman, President & CEO
No.
Actually you cannot expect any OEM to ramp up that fast.
And hard for me to tell you whether any of them which level of 10%.
We do believe, however, that having 4 OEM's rather than one will allow us to build our business much more in a more sound way and with less fluctuation.
Jonathan Half - Analyst
Okay.
And as far as your business segments are concerned, can you give us a sense of the growth rate that you are expecting for next year.
Can you give us a sense if there is any -- is it different between the different business segments or are you expecting similar growth rates?
Shabtai Adlersberg - Chairman, President & CEO
We haven't done yet, we haven't completed yet our planning of 2006 on a business plan basis.
But I will tell you that business (ph) and technology business we do look for growth that would be somewhere between 20% and 30%, while on the networking side we do expect higher growth, and I have just mentioned, about 30% to 40%.
That would be roughly the type of growth we look for.
Jonathan Half - Analyst
Okay.
And finally, on the headcount.
It was up quite nicely this quarter.
Can you maybe-- I think you mentioned R&D is an area you are investing in.
But can you discuss what your plans are in terms of operating expenses for Q4, and also how we should think about that in 2006?
Shabtai Adlersberg - Chairman, President & CEO
Talking about the guidance we gave to Q4, obviously we will increase the expenses and we are continuing to recruit new employees.
And I think it is hard for us to model on a quarterly basis looking at '06.
But OpEx, in general, will increase probably around 4% to 5% quarter-over-quarter.
That's the range.
I mean, it's only a rough estimate at this time.
Jonathan Half - Analyst
In Q4, 5% quarter-over-quarter?
Shabtai Adlersberg - Chairman, President & CEO
Roughly the range that we're seeing right now.
Yes.
Jonathan Half - Analyst
Great.
Thank you.
And good luck going forward.
Shabtai Adlersberg - Chairman, President & CEO
Thank you, Jonathan.
Operator
Your next question is from Troy Jensen with Piper Jaffray.
Troy Jensen - Analyst
Hi congrats also on a nice quarter, guys.
Quick question-- you mentioned two new North American OEMs?
Could you just kind of give us any incremental color?
Are these enterprise focused versus carrier ?
Any insight would be helpful.
Shabtai Adlersberg - Chairman, President & CEO
Yes.
Those OEMs do target the service providers market.
One of them is more towards IMS type application.
The other one is connected both to IMS and seek (ph) mobile conversions market.
Troy Jensen - Analyst
All right.
And then sticking to North America, could you talk on the cable side?
There has already been a lot of selections by the MSOs in North America.
Is there an opportunity to penetrate that maybe as a second source supplier?
Do you think that those kind of selections are kind of behind us?
Shabtai Adlersberg - Chairman, President & CEO
That is something that pretty much in the works now.
Although we are successful in the cable market in Europe, we have entered the North American markets place.
And some of the design wins have already been made.
However, there are a few slots through which we believe we can come in, and we due to the fact we have the ability to invest substantially in that markets, we do believe that is a true second flow (ph) in all other opportunities, we should be able to take part in that market.
Troy Jensen - Analyst
And then just a last question.
I think the last quarter, you guys gave the breakout between OEMs and system integrators?
Just wondered if you'd be able to share that?
Shabtai Adlersberg - Chairman, President & CEO
Well, so this quarter the numbers do look at about 19% end users and 81% OEMs.
More sales did for actual OEMs.
Troy Jensen - Analyst
And that's obviously because the technology business is stronger, correct?
Shabtai Adlersberg - Chairman, President & CEO
Well I believe that the service provider market is still (inaudible) and all initial network deployments are really in their infancy and just starting.
So most of the sales are being done through OEMs, some of them through the enterprise market.
Troy Jensen - Analyst
Got it.
Keep up the good work, guys.
Shabtai Adlersberg - Chairman, President & CEO
Thank you, Troy.
Operator
The next question is from Marcus Kupferschmidt with Lehman Brothers.
Marcus Kupferschmidt - Analyst
Good morning, guys.
Shabtai Adlersberg - Chairman, President & CEO
Hi, Marcus
Marcus Kupferschmidt - Analyst
Just to clarify, you said the EPS growth for 2006-- you said 30% to 40% expected earnings growth?
Shabtai Adlersberg - Chairman, President & CEO
Yes.
Marcus Kupferschmidt - Analyst
Okay.
And within that, what would be your expectations for where the gross margin would go?
We have talked how gross margin could move back toward the mid-50s in the past.
Shabtai Adlersberg - Chairman, President & CEO
We are modeling that right now, but one should look at our business-- it's comprised of two businesses, technology business and networking business.
In our technology business, we do look for very high margins that should be above 50%.
In the networking business, if you judge by performance of other competing companies in the field, you normally do not see gross margins that are substantially higher than 50.
It's really the mix of these 2 businesses and mix of sales of the 2 businesses.
We believe that it -- we will be growing faster on the networking side than we would start to see and this is more towards the end of 2006 and 2007, more decreasing our gross margins.
But we will try to get to much more excellent planning and modeling for our gross margin going forward.
But we do not expect any decrease in gross margin in the coming quarter or even 2 or 3 quarters down the road.
Marcus Kupferschmidt - Analyst
Okay.
And -- other question, I guess, when we think about your quarterly trends, it -- would there be anything you think out of the ordinary for this upcoming first quarter to 2006, and why, you wouldn't continue to see continued revenue growth on a sequential basis even though it's the beginning of the year when things can be bit slow?
Shabtai Adlersberg - Chairman, President & CEO
Hard to say.
Again, I have mentioned that visibility at this stage is fairly limited.
So today for me to comment on Q1 is really a bit too early.
We have not seen any increase, typical Q4 activity.
So if one would rely on that, you may assume that Q1 should not deviate substantially.
But we really are a bit too early in the game now.
Marcus Kupferschmidt - Analyst
No, I understand.
That's fair.
Great.
Thanks, guys.
Shabtai Adlersberg - Chairman, President & CEO
Sure.
Operator
Your next question is from Ittai Kidron with CIBC World Markets.
Ittai Kidron - Analyst
Hi guys.
With regards to the fourth quarter, is there any reason why the growth in the fourth quarter should not be higher than the growth in the third quarter?
This does -- your business doesn't see any seasonality anymore?
Shabtai Adlersberg - Chairman, President & CEO
Hard to say.
I mean, again, we do not see any substantial different behavior in the beginning of Q4 versus Q3.
But on the other hand, we do not expect any major new accounts to develop faster (ph) than anticipated.
We are assuming that we would basically demonstrate similar growth to the one that we have seen in Q3.
Ittai Kidron - Analyst
Okay.
Now, going into your business model, it seems to me that recently you've been working more and more directly with your end customers, and you obviously increased your hiring to support that, which frankly is a concern to me.
What is your budget for next year to increase your headcount?
And how do you make sure that you do not create conflicts with your OEM customers?
And plus supporting a large and growing number of customers, to me in the long run spells nothing but trouble.
Shabtai Adlersberg - Chairman, President & CEO
Right.
Selling media gateway needed service, at the end of the day, the end customer is the service provider.
And this is where we look.
We are working with OEM product simply to bridge the gap and fill their product portfolio.
We have been very careful.
Each time we have approached a service provider for fulfillment of media gateway deliveries that we are working (inaudible), and if requested to be working more directly in several cases, then we go through local system integrators.
In fact, there should not be a major difference between local system integrators and subsidiaries of our large OEM.
So we have not seen any conflict rising in the past, and based on the experience we have so far, we believe that we should be able to manage the situation.
You are right that working -- I'm sorry?
Ittai Kidron - Analyst
I'm sorry, go ahead.
Shabtai Adlersberg - Chairman, President & CEO
Okay.
So you are right that working more toward the service provider would require us to add more customers facing (ph) technical support and project management people, which was indeed taken into account.
The fact is, however, that we do believe that in terms of our need to continue to evolve our R&D, we do believe that the majority of investment has been done in the last 24 months.
And therefore, we believe that reduction or need to grow R&D will be compensated by adding those customer support functions.
Ittai Kidron - Analyst
And in those new relationships that you are now developing in North America, are those direct or through OEMs?
Shabtai Adlersberg - Chairman, President & CEO
In North America, we mostly work through OEMs.
We have a push pull way of work, where we do promote our products through the service provider's and then for our fulfillment, we do implement that through our OEM partners.
Ittai Kidron - Analyst
All right.
Good luck, guys.
Shabtai Adlersberg - Chairman, President & CEO
Sure.
Thanks.
Operator
The next question is from Vivek Arya with Merrill Lynch.
Vivek Arya - Analyst
Hi, Shabtai.
Shabtai, my question is when I look at the Voice over IP industry growth rate that you mentioned of 30 to 40% and then your topline growth rate that you mentioned of 25 to 35% for 2006.
If I compare that to Street estimates, for sales next year, it is only 24%.
So my question is, is there anything, any trend that the Street is underestimating?
Is there -- and why is there such a big difference between what you expect for Voice over IP growth versus what the Street expects for your sales?
Shabtai Adlersberg - Chairman, President & CEO
Well, it's hard for me to relate to the Street expectations.
I would say that we do count on two key sources.
One is market research, and second is our experience of working in the fields and in the market.
I think when we combine the two, we do see very intense activity for preparing solutions and setting deployments.
And my belief is that putting a 24% growth forecast for 2006 is a bit on the low side.
So I've mentioned that our expectation in 2006 would be to grow between 25 and 35%, and again we will have to be closer to 2006, and maybe in the second quarter, I could a better number.
But right now we believe that it is a much better portfolio and (inaudible) and more success or our design wins, designing (ph) field we should be able to maintain that growth.
Vivek Arya - Analyst
I see.
And Shabtai, what's your near term outlook on M&A?
It's been a while since you did the convertible, which was to prepare for an M&A.
What's your outlook in the near term on that?
Shabtai Adlersberg - Chairman, President & CEO
Okay.
So we've been very active.
Actually it's one year since we did our convert (ph) deal.
We've been very active in identifying good candidates for M&A.
We've been working with a few of them.
We have, on and off, engaged in discussions with some parties.
We do believe that -- my belief, personal belief is that within the next 12 to 24 months we should see at least one M&A transaction, if not more than one.
We do believe that today's world does dictate a larger presence, larger entity and economy of scale.
And we believe that the smaller, private companies will understand that, and we are seeing acceptance to the idea of acquisition, but something that needs to be worked out and need to be matching market -- public market criteria.
We believe that we should be able to do that.
So -- we do believe that indeed the deal we've made, and better than that amount of money should allow us to do that type of deal in the coming months.
Vivek Arya - Analyst
I see.
And two quick questions for Nachum.
Nachum, what's your outlook on operating margins?
I think you are close to 11% now.
Do you expect to see getting closer to 15% as you exit '06?
Or is that very high stretched target right now?
Nachum Falek - VP of Finance & CFO
Obviously, it is too soon to predict what we will do at the end of -- second half of '06.
Right now we're much closer to 12 actually, and I think that reaching what we're seeing in terms of revenue and profitability, obviously that we'll be much closer to 15% target on the second half of '06.
Vivek Arya - Analyst
And last question, Nachum, on stock option expensing.
In the last two quarters it was about $2 million plus, if I am correct.
What's your outlook for '06?
Nachum Falek - VP of Finance & CFO
Yes.
Again, it is a little bit too soon, and I'm planning to provide the numbers on our next conference call.
As an estimate, it should be in the range that you just mentioned.
But since you are looking into different models, different alternatives and we are exploring other alternatives such as they restricted stock etcetera, it might be even lower than the numbers that you mentioned.
And-- but I will give you a better answer on our next conference call, when I have the numbers for '06.
Vivek Arya - Analyst
Excellent.
Thank you.
Nachum Falek - VP of Finance & CFO
Thank you.
Operator
[Operator Instructions]
Your next question is from Alex Henderson with Citigroup.
Nigel Frankson - Analyst
Hi.
This is Nigel Frankson calling in for Alex.
A couple of questions.
One just housekeeping, what tax rate should we use for the fourth quarter?
Should it be 5%, or 7% like it was this quarter?
Nachum Falek - VP of Finance & CFO
It should be on that range --
Nigel Frankson - Analyst
Okay.
Nachum Falek - VP of Finance & CFO
...something between 5 to 7%.
Nigel Frankson - Analyst
Okay.
Fair enough.
Secondly, have you seen impact in the marketplace from the release of the Sonus GSX 4000 Media Gateway?
Nachum Falek - VP of Finance & CFO
No.
Actually, we are involved into launch our (inaudible) for Media Gateway, we've have not seen that gateway.
Nigel Frankson - Analyst
Okay.
And last question for you.
A lot of your competitors, if it is fair to call them that, have been making a lot of noise about the IMS space and how it's changing the game, and they're respective advantages and disadvantages regarding that.
How does IMS impact your business model?
How does it change the game for you guys?
Do a lot of these OEMs maybe start depending more on your gateway or more on their own in-house R&D developed gateway?
How does IMS impact for (ph) your growth?
Shabtai Adlersberg - Chairman, President & CEO
Okay.
In the IMS architecture, we basically target two key components, network elements.
One is the Media Gateway, a converged wireline wireless gateway, and the other one would be something that's called MRFP, which is the another name for media server.
In the media server-- I'll start with the second one-- in the media server space, we feel very confident that we have a very strong product line.
As you know, we sell to Nortel.
We just won another deal.
We are in the finalist of third deal, and we signed a VAR (ph) agreement with another company.
All of that probably should lead to a very strong position for us with the media server and/or at the MRFP in the IMS architecture.
As to Media Gateways, it is a continued basically battle, to win the attention and win some of the OEM products that will be outsourced rather then developed internally.
And right now, we are successful with one such entity.
We're in the very final stages of another entity.
And we believe that IMS indeed is going to be a very big market, but that's really down the road and we'll not be done before the beginning of 2007.
Nigel Frankson - Analyst
Okay.
Thank you.
Nachum Falek - VP of Finance & CFO
Sure.
Operator
The next question is from Rami Rosen with Oscar Gruss.
Rami Rosen - Analyst
Thank you.
Shabtai, can you give us the breakdown of Media Gateways, the system sales between fixed for wireless (ph) cables?
Shabtai Adlersberg - Chairman, President & CEO
Again, I think we commented on that in the last quarter.
At this stage, we still don't see much wireless sales -- wireless gateway sales, and that will happen more in 2006.
We've seen quite a large number of sales into the cable space.
As I've mentioned, we have two accounts that are very live and growing.
And we have similar such activity on the wireless side.
I do not have the numbers to split between those two sectors.
I guess I'll ask Nachum to provide them later after the call.
Rami Rosen - Analyst
What -- sorry?
Shabtai Adlersberg - Chairman, President & CEO
Sorry?
Rami Rosen - Analyst
What is the timeframe for-- if you're estimating a change in the mix of sales in (ph) segments.
What is the timeframe for that?
Shabtai Adlersberg - Chairman, President & CEO
I am sorry.
Rami, can you repeat the question?
Rami Rosen - Analyst
Yes.
I mean, there is going to be a change in the mix of the sales of these different segments...
Shabtai Adlersberg - Chairman, President & CEO
Right.
Rami Rosen - Analyst
...what is the timeframe for that?
Shabtai Adlersberg - Chairman, President & CEO
We-again I think, my belief-- and again, we have not done yet planning and modeling for 2006.
I would say that I would expect networking gear to comprise above 55-- probably, somewhere between 55 to 65% of our sales next year and technology to fill the rest.
But again, I mean, we would like to do more accurate planning and come back to you with more concrete planning.
Rami Rosen - Analyst
Finally for me, the acquisition of Brooktrout by EIS, how does that change your competitive landscape?
Is that an opportunity for you or a concern?
Shabtai Adlersberg - Chairman, President & CEO
Right.
So two key aspects.
One is that is probably much the end of our OEM relationship with Brooktrout, which I don't believe has been very meaningful to us.
So-- but that's probably the end of it.
As to whether that combination will now become more of a competitor, yes, on the media server front, a bit less on the media gateway.
All in all, we have not seen the two companies very active in or successful in the business that we are participating.
So we believe that we should be able to compete well with that new entity.
Rami Rosen - Analyst
Okay, guys.
Thank you and good luck going forward.
Shabtai Adlersberg - Chairman, President & CEO
Thanks Rami.
Operator
[Operator Instructions]
Your next question is from Marcus Kupferschmidt with Lehman Brothers.
Marcus Kupferschmidt - Analyst
Hi.
Just a couple of clarifications for Nachum.
The guidance you gave for 2006, does that include expensing options or exclude?
Nachum Falek - VP of Finance & CFO
Marcus, what we mentioned is without option expense.
Marcus Kupferschmidt - Analyst
Okay.
And in terms of the margin growth of the company going forward, I guess more just the operating margins.
If I work through my model loosely here, it seems like you are not forecasting a dramatic uptick in operating margins over the course of the year within your guidance?
Or is it something with operating margin may dip before they go higher over the course of the year?
Shabtai Adlersberg - Chairman, President & CEO
It's obviously, as we mentioned, that we do think the second half of the year will be stronger than the first one in terms of revenue, and therefore, same in terms of profitability.
Marcus Kupferschmidt - Analyst
Okay.
And also just to clarify your EPS outlook for the year.
I would assume a dilutive accounting method for a convertible bond, where we would add the shares, and then add back interest expense?
Shabtai Adlersberg - Chairman, President & CEO
Yes, I mean-- we obviously took the convert into effect.
But as I mentioned, as for the option expenses too soon and we'll only have accurate numbers on the next conference call simply because we need to explore other alternatives and different models to expense the options.
Marcus Kupferschmidt - Analyst
Sure.
That's fair.
Okay.
Thank you.
Shabtai Adlersberg - Chairman, President & CEO
Okay.
Thanks Marcus.
Operator
[Operator Instructions].
At this time, there are no further questions.
I would now like to turn the call back over to Shabtai Adlersberg for closing remarks.
Shabtai Adlersberg - Chairman, President & CEO
Thank you.
I would like just to thank everybody that took part in our conference call today.
And we look forward to seeing you on next conference call in the beginning of the year.
Thank you very much.
Bye-bye.
Operator
Thank you.
This concludes the AudioCodes third quarter earnings conference call.
You may now disconnect.