AudioCodes Ltd (AUDC) 2007 Q1 法說會逐字稿

Good morning.

My name is April and I will be your conference operator today.

At this time I would like to welcome everyone to the AudioCodes first quarter 2007 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session.

[OPERATOR INSTRUCTIONS].

Thank you.

Mr.

Eric Knettel, you may begin your conference.

Thank you, April.

I'd like to welcome everyone to the AudioCodes first quarter 2007 earnings conference call.

Let me begin the call today with a brief Safe Harbor statement concerning AudioCodes' business outlook or 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 as that 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 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 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, possible disruption from acquisitions, the ability of AudioCodes to successfully integrate the products and operations of acquired companies into AudioCodes' business, 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, Nachum Falek, Vice President Finance and Chief Financial Officer, and Ben Rabinowitz, Vice President and General Manager of Session Border Controllers and Media Server Business Lines.

I would now like to turn the call over to Shabtai Adlersberg.

Mr.

Adlersberg, please go ahead.

Thank you, Erik.

Good morning and good afternoon, everybody.

I would like to welcome all to our first quarter 2007 conference call.

With me this morning are Nachum Falek, our Vice President of Finance and Chief Financial Officer, and Ben Rabinowitz, Vice President of [carrier] Sales, North America.

Nachum will start by presenting a financial overview of the quarter.

I will then review the highlights for the first quarter, and focus mainly on the key reasons that led to the earning warning that we have issued earlier on March 15 this year.

We will then discuss changes in our OpEx plan for the year and new guidance for the 2007 financials.

We will then turn into the Q&A session.

Nachum?

Thank you, Shabtai, and good morning, everyone.

Before beginning, I would like to announce the following discussion will include GAAP numbers and pro forma numbers.

Our first quarter pro forma results reflect adjustment for the following two non-cash items.

Stock-based compensation expenses, which totaled $2.3m in the first quarter of 2007, and amortization expenses relating to the acquisition of Nuera and Netrake, which total $550,000 net of taxes in the reported quarter.

Conciliation of the pro forma results discussed on this call to GAAP results is currently available for review on our website and in the press release issued yesterday.

Getting to our quarterly result, in the first quarter revenues were $36.5m, which represents 14% decrease from the last quarter.

As a percentage of our revenues, sales in America accounted for 59%, Europe 28%, Asia Pacific 7% and Israel 6%.

We had one customer above 10%.

Our top 15 customers accounted for 48% of our revenues, compared to 46% in the previous quarter.

In terms of revenues by business group in the first quarter, our technology business group accounted for 41% of revenues, compared to 42% in the previous quarter.

And our networking business group accounted for 59% of revenues, compared to 58% in the previous quarter.

In the first quarter of 2007, pro forma gross margin was 58.6%, compared to last quarter pro forma gross margin of 59.5%.

On a GAAP basis, gross margin was 56.3%.

Our total pro forma operating expenses decreased from $22m in the fourth quarter of 2006 to approximately $21m in the first quarter of 2007.

On a GAAP basis, operating expenses for the first quarter were $23.4m.

Headcount decreased this quarter by four employees, which brings us to a total of 697 employees.

Pro forma net income for the first quarter was $500,000 or $0.01 per share.

The GAAP net loss for the first quarter was $2.4m or $0.06 per share.

Short-term and long-term cash balances were $133m, compared to $134m last quarter.

DSO came in at 68 days, compared to last quarter's DSO of 65 days.

Our revised guidance for 2007 is as follows.

Based on our visibility at this time, we forecast revenues on an annual basis for 2007 to be in the range of $155m to $160m.

We estimate our non-GAAP earnings per share of $0.12 to $0.15.

We also estimate our GAAP loss per share to be in the range of $0.14 to $0.11.

I will now turn the call to Shabtai.

Thank you, Nachum.

Yesterday we announced our financial result for the first quarter of 2007.

For the first time, after more than five consecutive years of growth in our business, or 21 quarters of revenue growth in a row, we reported a decline in revenues of 14.2% compared to the fourth quarter of 2006 and an increase of 16.6% compared to the first quarter of 2006.

Obviously, we are disappointed with this result.

Since our earlier announcement of profit warning, we took the time to analyze the causes for the missing revenue.

We derived preliminary conclusions and we've planned our next step to recover from this event, which we believe is a one-time event.

And, when handled properly, we should be able to really move into a growth mode.

The good news, though, or that we believe that the missing revenue does not represent and/or reflect a broad-based phenomena across all our businesses.

Actually, when compared to the [fourth] quarter of 2006, the majority of this can be traced down to a finite number of customers.

And we believe that our core networking business is good and we will -- I'll touch on the numbers in a moment.

In my discussion today, I would like to refer to the following areas.

One, identify the source of decline of -- in the revenues, [represent] progress made before in our core business, the networking business, discuss the mission steps that have been taken to adjust 2007 expense levels to reflect the new revenue plan for 2007.

Finally, I will shortly present the new financial plan and guidance and I'll give some explanation as to why we took that conservative approach.

As noted in our press release of yesterday, the key impact of this decline in the revenues is [basically] mainly a shortfall in sales in two regions, mainly the Asia Pacific region and then sales in Israel.

I'd like to mention, though, that all those numbers and comparisons have been done compared to the fourth quarter, which is the only source available to us for comparison, [with the hard] comparison against our plans for the fourth quarter.

Other regions such as North America, Europe and Latin America were lower than the fourth quarter 2006, but all have been in the range of 2% to 3% below Q4 of 2006.

We attribute this to a typical telecom Q1 shortfall, which we believe is a current market phenomenon and we have seen similar such results with other telecom companies reporting results for the quarter.

Specifically in Asia Pacific, we have seen weakness in sales in the northern part of Asia Pacific, mainly in China.

We already took steps to enhance management and our sales resources are now such that, afterwards, we had a very bad quarter in the Southeast Asia region, with customers mainly connected with some really newer sides of the business.

We have seen similar fall in Israel, [non-typical] known before, but [driven] revenues was especially higher.

From a customer's perspective, we witnessed substantial decline in revenues from one large customer.

This decline is attributed mainly to a product that was end-of-life in the end of last year, and therefore a large inventory was built in Q4 '06.

Based on the customer's input, we believe that we should return to normal usage and higher levels in the second half of 2007.

Overall, that decline has been more than $2m in value.

We have also witnessed in APAC, in Asia Pacific, delayed acceptance on a large product in one country that has been close to $1m.

We believe that acceptance to that product should appear later this year with some reasonable [inaudible] the revenues in Q2.

Also, we know that purchases made in fourth quarter of 2006 which would not repeat in Q1 may be attributed to typical telecom end-of-the-year budget flush.

So that's from the customer's perspective.

But not on that perspective relates to the phenomenon of consolidation in this space.

We believe that we have been affected by the [Quiblin/Vinner] consolidation.

There are two non-subsequent consolidations in our space and we believe that we have been affected by those.

From a business plan perspective, almost all of the decline is attributed to three specific business lines.

First one is the Blades business line, which exhibited substantial decline.

That is connected with that one specific customer that has dropped in a large volume.

One major part of it is related to that customer, which represents more than 60% of the decline in the Blades business.

Also, we still have some weakness in the formerly Ai-Logix business.

This is the first such decline.

We still need to track and understand the trend in that part of the business.

We need also to keep in mind that, on a longer-term basis, the shift from a solutions architecture that uses Blades' embedded server is now shifting towards a gateway solution.

That means that, going forward, we will see lower Blades sales versus an increase in the gateway sales.

As we cannot correlate directly between the two, I think that on a longer term we will see lower growth or even decreasing Blades sales versus increasing networking here.

The other part of the decline in [inaudible] attributed to the acquired businesses in 2006.

In the former business of Nuera, we enjoyed good North American sales.

On the other hand, we incurred delays in a big project in Asia Pacific which, as mentioned before, based on our experience in the previous three quarters with the Nuera forecast, where we saw a large difference between the original forecasts given to us and the actual level of sales, we took steps to adjust the expense and product development investment level at the San Diego facility to adjust and reflect the new [OpEx] plan for 2007.

But, all in all, in that part of the business we suffered a lot of decline in revenues, more than $1.5m.

At Netrake, while we were planning to see revenue picking up four or five months after the acquisition made mid of last August and see that [write-off] starting at the beginning of 2007, we now realize that we will not see that pattern of growth where we have merged our pipeline [inaudible] generating for us, we believe that there will be two or three quarters towards the second half of 2007 before we will see ramp-up at Netrake.

This quarter, we intend to introduce two new products at Netrake.

Those products represent much better and competitive cost structure.

We believe that based on those new products we will see the expected ramp-up in sales in the last part of 2007.

On a brighter note, the networking business has progressed very well in the quarter.

We have executed very well on our service provider initiative in all regions and we have made great new steps in the enterprise area.

The CPE business line revenues actually topped our plan for the quarter, and specifically incurred historic [inaudible] with three large enterprise markets there.

You have heard some of the names.

Now we are working with Microsoft on their initiatives and two more unidentified partners.

We also announced a project with Telefonica in Spain, using [Voice IP] devices.

We enjoyed an important design win with a large European service provider and a large Asian service provider.

And we have since seen an interest [inaudible] competitiveness for our products in this market segment.

We have also witnessed good progress with our mid-density media gateway sales activity and nice design wins and progress in the media server space, where we are involved in four new projects which should translate into strong revenues in the second half of 2007.

Now to some of the steps that we took in order to adjust our expense level to the new [rev] plan.

Basically, I should say that in the past, [if you dig] five years ago in 2001, we take always prices [quarter-on-quarter] change.

Prices for us is [inaudible] for a change, for reevaluation, for fixing our plans and growth going forward.

So what have we done in order to do that?

Today, we have invested in a cost-reduction plan earlier this year, actually prior to the announcement.

We believe that we will be able to reduce our cost of business materials substantially in 2007 to improve gross margin.

Second, we have implemented a reduction in [forward] plan of about 5% across all the Company.

Approximately half of that was done in Israel, half of that was done in other parts of the world, mainly in North America.

We will start to see a partial effect of that reduction in the fourth -- in the end of second quarter and third quarter, but we will see the full effect of it in fourth quarter.

So we should expect at least 5% OpEx reduction in Q4.

Take a note, please, that our OpEx for the first quarter of 2007 was substantially lower than our OpEx for Q4 2006, which already reflects better control on those expenses.

We have done some reorganization steps in the Asia Pacific sales team.

We have replaced the Vice President [inaudible] East Asia with an experienced Vice President who has handled so far all our East Europe sales progression, plus experience in sales of networking gear to providers.

And we have added sales support staff in India.

For our new budget for 2007, our key assumptions are - Nachum has just put up the revenue target.

Based on that new rev plan, the steps we took on OpEx control and the reductions should bring us to a net income above 7% in the fourth quarter of 2007.

We have already started reevaluation of several businesses internally.

Among them are the Nuera operation.

We want to invest more in the network operation, pushing the products into the market, and in some other business lines.

We have adjusted the investments in product development, actually lowered them in order to match our revenues and earnings growth curve.

We already started a very detailed 2007 OpEx review for possible cost reductions.

We believe we will complete preparing that plan in the second quarter.

Some areas that we will look into would be materials, G&A expenses [inaudible] structure.

So we believe there's enough [meat in] those figures that would allow us to further increase the OpEx reduction.

We have already put in place a plan to merge our North American manufacturing operation.

Right now we have three such operations.

We have Ai-Logix in New Jersey networking [factories] and Nuera in San Diego.

All three facilities will coordinate manufacturing with one facility.

That would allow us substantial cost reductions.

We plan further savings in operations in 2008 as a result of the more mature product cycle.

And we believe that we will generally put a target to reduce R&D expenses from -- we usually have invested huge amounts in R&D, usually towards in the range of 22% to 23% of sales.

We put a target for 2008 to reach a level of 18%.

We will also look carefully into some of the [acceleration] of our products.

And by merging and controlling the investments to reflect and be more in line with revenues, we believe that we will -- should be able to improve profit.

A few more expenses we took in the quarter.

We have reorganized our North American sales.

We have basically structured them into two sales teams - the enterprise sales team, which is very effective, basically based on the formerly Ai-Logix operation that was selling Blades to enterprise customers.

We have added all of our CPE devices and enterprise sales plan into that team.

The other team is our service provider sales team that is basically driving on a direct sale to the service providers.

We already have such customers in the U.S., and we're going to invest substantially more into it.

In the Company itself, we're going to restructure our operations.

We're going -- instead of having a product process, we had five different business lines, just structured around Blades, media gateways, media servers, chips.

We are going to structure them into two groups, business groups.

One would be the enterprise group.

The other one would be the service provider group.

We have introduced a business operation new function at management level.

That function that will allow more bandwidth and more total control, as better control of operations will focus on the sales plan on top accounts, on customer projects, on refining processes that are taking place internally between sale requests to product management and R&D investment.

And, finally, we did some stuff on our planning control.

All in all, I think we're very encouraged by the market itself.

We see good activity in the market in the Voice over IP market segment.

We see that on a daily basis.

And [for our market budget], we believe that assuming 25% annual growth on an average basis for the next [seven] years will be a very reasonable assumption.

We believe we have good competitive position.

In Synergy reports we have been mentioned that capturing about 10% of the low to mid-density media gateways.

We believe that the size of the market [is contained] at $2b a year would allow us to much more focus on some of the larger players that probably would find that market segment to be a bit too small for them [to talk about].

Just in terms of the market opportunity, to repeat the numbers that we have from Infonetic Research from a report issued earlier 2007, the gateway business should grow from $1.5b in 2006 to $2b in 2010.

The media server marketplace should grow from $100m to $500m in four years.

And the session border controller should grow from $150m to $600m.

All in all, nice growth, not too many scares.

I think we are relatively strong and integrated well in that space.

And I think the market offers us very good opportunities.

Also, the sales of our new technology [plan is] developing in the market, which requires a lot of expertise, a lot of investment in the areas like building security applications, wideband high-quality voice and video applications.

We believe that our continued investment in R&D forces that, today, [inaudible] more 300 engineers would allow us to create momentum and advantage in the market.

Finally, I'd like to get to our financial plan for 2007.

First, we have decided to move to providing an annual guidance versus providing quarterly guidance previously.

With the shift in our business from an OEM model to selling projects to service providers who are associated with projects [inaudible] sometimes delayed, that creates difficulties.

Some of the decline in revenue in this quarter was related directly to that.

Also, we believe that our relative short experience with the ways of developing the newly acquired businesses at Netrake and Nuera really do not allow us to have a steadily growing forecast.

And we would have to live in the next coming quarters with fluctuations in the level of revenues in each of these businesses.

Therefore, we believe that with those fluctuations it would be much more prudent on our side, being conservative, to provide an annual guidance rather than quarterly guidance.

Now, to the revenue plan.

Obviously, with lower revenues and earnings for the first quarter, we need to adjust the full year.

Generally, we believe that we should be able to return to growth of up to 5% on a quarterly basis in coming quarters, with two exceptions.

For the second quarter, some of the cycles that led to our first quarter decline could proceed to continue into the second quarter, such as the decline in Blades sales and lower Netrake and lower Nuera sales.

We plan for slower growth.

We still plan for growth in Q2 over Q1, but we're not sure that we will attain the 5% growth.

On the other hand, regarding fourth quarter of the year, we believe that the fourth quarter should be much stronger.

Networking should start to ramp up and we will see our networking business basically implementing some of the large OEM projects that we are right now engaged in, and that should translate into more meaningful revenue.

So, taking into account the above, at this time we plan our revenues to be in the range of $155m, $160m for the year.

While we believe that there could be potential upside going forward, we do not want to plan on that.

We want to plan according to the worst case.

We then can enjoy the upside.

Regarding earnings, with our revenues in the second half of '07 and expense and cost control, cost reductions implemented partially in Q3 and into full effect in Q4, we can see growing curve of earnings that should lead to earnings range of $0.12 to $0.15 or even higher.

And, with that, I have finished my introduction to the call.

Operator?

Yes.

Are you ready to begin with questions?

Yes.

[OPERATOR INSTRUCTIONS].

And your first question comes from the line of Ittai Kidron.

Yes.

Hi, guys.

Thanks for -- Shabtai, for the detailed plan.

I think it's a smart move moving toward annual guidance but I was hoping that you could help us reconcile your annual guidance.

With your revenue intact, could you give us a little bit more color on the weakness in the gross margin?

And how do you expect the gross margin to be this year?

Ittai, it's Nachum.

Obviously, the weakness in the first quarter was partially due to the lower volume of revenues and our fixed costs.

Moving forwards to the end of 2007, we expect to maintain the gross margin we had in the first quarter.

But, obviously, there are other factors that might affect it, such as price pressure, etc., on one hand.

But, on the other hand, with the different mix in the products, we might even improve the margin; volume will go up.

That's fair.

And can you talk about the operating expenses?

So you're reducing headcount for the year by 5%, correct me if I'm wrong.

Any color you can give us, then, how should we think about operating expenses in absolute dollar terms?

Is March quarter that you've reported right now basically the peak of operating expenses and it should decline going forward?

Or should there still be an increase quarter over quarter?

Yes.

So, as Shabtai mentioned, the full impact of the cost saving will be in the second half of the year and it should be very similar to the reduction in force, meaning around 5%.

That's fair.

But, in that case, how do you get to your bottom line pro forma EPS guidance of $0.12 to $0.15?

Assuming the midpoint of your revenue range, and assuming flat gross margins and slightly increasing operating expenses, you get to higher than the high end of that range.

So, what are we missing?

Is interest income going to drop significantly for you guys?

Not significantly.

But, as Shabtai mentioned, we are trying to be conservative.

As you said, it will keep the OpEx relatively flat in the first half of the year, then the reduction that we'll get the full impact over the fourth quarter.

You are getting to be within the guidance or the range that we gave for the EPS.

Okay.

Lastly, Shabtai, with regard to you provided detail on what were the specific issues in the quarter, but it seemed to me, and maybe I'm wrong in this and if you can clarify this, some of the points of weakness seem to be a question of timings, like delayed acceptance and one large customer in Israel that shifted.

It seems like you commented that you expect that business to come back in the second half of the year to normal levels.

Does that mean that the big, significant drop that we've seen in revenue now, we're not going to move to your typical pattern of low-single-digit sequential increases from quarter to quarter, there will be quarters where we'll have significant vertical jumps right back up in revenue?

Again, we do plan on growing on a quarter-by-quarter basis.

And I've said that, roughly speaking, we're planning on a rough 20% annual growth and we'll plan on a typical 5% quarter over quarter.

We need to remember, though, that since we are engaged no more in network deployment, recognition of revenues has been not always related directly to shipment of products but to approval by the end user.

Sometimes the network approval is dependent on our suppliers on the same network.

We may find ourselves in a more fluctuating mode of revenue growth.

But, other than that, we believe that the average trend would continue.

We feel very strong.

We felt that we're not having [technical difficulty] to our customers.

Okay.

Good luck, guys.

Thanks.

And your next question comes from the line of Vivek Arya.

Shabtai, a couple of questions.

First, when I look at your technology segment, that is starting to be a real drag on your overall growth.

Even the visibility seems limited.

So, my question is, is that just a near-term phenomenon?

Does it really make strategic sense to still remain in that business?

Is it possible to get the advantages of that business without actually owning it outright?

If you could just discuss what are the synergies between your technology and networking business, because they do seem to be exposed to slightly different types of customers.

Right.

So when we talk about technology, basically we talk about two different lines of businesses.

One is the chips business, the other one is the Blades.

Actually, the chip business was very good this quarter.

We have seen growth over the fourth quarter of 2006.

The chip business is growing roughly 20%, 30% per year.

The [inaudible] is small.

I think this year we're planning for roughly $15m to $16m, which is about 10% of our revenue.

Regarding Blades, the decline this quarter was substantially attached to two customers that altogether did consist like 75% of the overall decline.

I have mentioned one customer that has had an inventory build through end-of-life-type issues, therefore was buying products end of last year, anticipating the need to use them going forward.

We have -- I have also mentioned the fact that there's some consolidation that would affect one of our biggest customers in that area.

There's one more area that I would tell you that - and I've mentioned that - is the old Ai-Logix operation, which has performed perfectly and in an excellent way in the last three years.

We have seen a drop this first quarter.

We're really not sure whether that's a trend or anything like that, but we will watch it.

All in all, we are merging the Blades with CPE business to form our enterprise group.

And we believe that there is much synergy between the two, simply because the technology and the base product for the CPE play and the enterprise play is substantially similar to the Blades.

So, it's true that one might see that the Blades business put a drag on the networking.

It's true that the growth rate would be substantially higher in the networking business.

But, all in all, there's a correlation.

We should be able simply to fine-tune our analysis, understand exactly what type of investment should be made and what should not be made.

And once we adapt in our matched investments in the Blades business to match the revenue behavior, I believe that we can control that.

I see.

And when you look at, within your networking business, as you go directly to carriers rather than go to OEMs, can you please discuss how your visibility changes as that customer profile changes?

And, obviously, sales are probably going to be lumpier because of this change in customers, but can you discuss how you see the visibility as you change that customer profile?

Yes.

We have rather good visibility on -- well, actually I should say we have two types of sales into service providers.

One, which is direct sales products.

In that regard, we usually gain some very good visibility as to the schedule, the cycle and the period over which the product is being sold.

So we should not be surprised in that area.

The one type of sale where we really have no control is where we are involved in deploying a more complete network solution.

Once we need to integrate into the sale not only media gateway sales, but integrate a session border controller and/or a media server, and/or some other company's products, low enforcement and call managers and IP phones, those would be the projects in which visibility and ability to understand the schedule is, to some extent, much less.

So, right now, the majority of our business to service providers, I would throw a number here.

About 80% of it is pretty visible and trackable.

Right now, it's only about 10% to 20% of the business that is connected with that more complete solution sale and/or small network sale, and this is where visibility is really hard.

All right.

And when you look at the acquisitions you made last year, Nuera and Netrake, do you see now that you have a good handle on -- because there were some execution issues there.

Perhaps there were some expectations disconnect.

Do you now see yourself having a good understanding of where the upside and downside risks are with those opportunities?

And do you see actually being able to grow sales going forward with these two acquisitions?

Okay.

So there's a difference between those two businesses.

Relating to the Nuera business, we now are in a better position to assess our expectation for the level of sales.

We still see [it] low compared to what, [through the all moves], how that is very much connected with the evolution of the cable market segment in North America.

We believe that when cable companies will start to adapt Voice over IP in a major way, converging maybe with wireless networks, this is when we should see fruit from that acquisition.

So, to a certain extent on the Nuera side, once we know the revenue, the expected revenue level, we have adjusted our expense rates on that business.

And we now simply are waiting for evolution in the cable market to take place.

At Netrake the picture is completely different.

I think here it's really connected with the fact that A, that company has not been investing in the last two years in the space, because it was drained out of funds and therefore not investing.

So we had to start a whole new cycle of investment.

Then the current product line there was really not competitive in terms of costs versus the leading incumbent in that market.

We are -- it's likely that we are completing actually this quarter the introduction of two new products to the market that will substantially lower cost structure of the product mix, and much more competitive.

And we believe that with our large global sales force and our large [experiences] with service providers from other products, we should see Netrake coming to higher revenues already in the second half of this year.

And we are quite confident that we should do good on that part, so this is good.

And just the final question, Shabtai, what do you expect in terms of revenues from Nuera and Netrake this year?

Thanks.

Okay.

So, on the Nuera side, as you know, originally we were planning for more than $20m this year.

I think we are scaling down our expectation to be less than 50% of that.

Then, on the Netrake business, again, we anticipate a slow start in the first half of 2007, maybe a couple of million.

We do expect to grow to close to about $4m or $5m in the second half of 2007.

But, again, I think Netrake really is a story more for year 2000 -- end of 2007 and then 2008.

I think by that time the story will be completely different and quite in correlation with other successes we have with our media gateway and media server in the market.

Great.

Thank you.

Sure.

And your next question comes from the line of Eric Kainer with ThinkEquity.

Thank you very much for taking my call.

My first question is about the business that, it looks like it's gone away.

It sounds like we were expecting about $44m in first quarter sales.

We came in about $8m short of that.

Sounds like maybe $3m or $4m of it has been pushed out in a couple of projects that you told us about.

Can we assume that the other half of that, the other $4m or so, has effectively gone away?

Or has some meaningful percentage of that also been delayed?

I don't think we should talk about the business that went away.

We've done $42.5m in the fourth quarter.

My belief is that at least $1m or so, or even more than that, was part of the end-of-the-year budget flush.

For all comparison purposes, maybe you should look on the fourth quarter as representing a true revenue level of about $41m, $41m to $42m.

Then the first quarter of each year in the telecom space nobody should plan for more than a 1% or 2% increase.

Actually, you will find many companies reporting lower revenues in the first part of the year.

So, all in all, I think since we reported $36.5m you have -- I count kind of a difference of $4m or $5m.

I think I've -- we have provided explanations for about $3m or $4m.

Again, it's a myth.

It's a myth that's coming after [21] first quarter.

I don't think you should look at $4m or $5m that went away.

Okay.

The next thing that I'd like to talk about is really the win that you had with Telefonica, if we could.

I assume that those are enterprise sales through Telefonica, and I wonder if those might be extensible to other Telefonica markets and whether your deal there might be exclusive, or who you are sharing that market with.

Well, the deal is not exclusive, but you are right that we are trying to extend that success into other companies that are part of the Telefonica family.

I will tell you that that success of selling CPE devices to service providers in active application and enterprise applications is really a growing phenomenon.

As I mentioned before in my introduction, there are two large Tier 1 service providers, one in Europe, West Europe actually, one in Asia that also decided to use our gear.

I think competitively we are becoming probably second to Cisco in our ability to provide products in that area and we are being perceived as a good supplier for that type of product.

Okay.

That's very interesting.

And obviously that's something that could be exciting over time.

I am wondering if there was any R&D required on your part as far as building interfaces, or integrating with specific network elements, that you needed to do in order to seal that agreement.

Yes.

I will tell you that actually any new network deployment with any new service provider there is always some interop and feature addition work that needs to be done in order to comply with the [top region] and with other management elements in the network.

So, there is always customization, interop and [enhancing] work.

But luckily we are now at five or six years of investment in that product line, so the amount of work usually does not amount to a large volume.

Okay, great.

The last question -- last area I'd like to touch on, really, is about the benefit that maybe that you get on an R&D basis, or even on a product management basis, between SBC products and media gateway products.

Are there any transferable assets between those product lines?

Or is that more really theoretical at this point than actual?

Hi, Eric, it's Ben.

I'll take it.

Over the long run there's a lot of similarities and benefits.

If you look at how we are differentiating our media gateway with TLS and SRTP and ITSEC and all these types of security functionality being put in the gateway, obviously there's a lot of knowledge, both on the SBC side and on the media gateway side, to share there.

That's obviously where steps can be done in terms of from a management perspective, an EMS perspective, on how to collaborate.

And we also expect over the long term that the convergence of products, SBC with media server and media gateway functionality, that there will be a place for those types of products in the long run.

So we do see synergies.

We also see the products acting as standalone, so we see lots of ways that we will play in the market.

But obviously there is a lot of knowledge that can be transferred and shared both ways.

So ultimately, then, what you wind up with instead of today's point products, if you will, you wind up with more of a spectrum of products over time here?

Yes.

There will be a spectrum in terms of point products, and we will see convergence over time as well.

Okay, great.

Thank you and good luck.

And your next question comes from the line of [Katherine Trevnik], FTN Midwest.

Morning.

Can you hear me?

Morning.

My question is back to you made some comments about your OEM channel into the service provider.

Could we go back and revisit that again, because I always was under the understanding that you had a direct -- you had an indirect OEM channel into the service providers?

But you said there was some shift, and I might have missed some of it with the audio going in and out on the call.

So, basically, our go-to-market strategy until two years ago was to sell through OEMs, meaning large companies such as Mosel would have selected our products to be included in their network solutions.

They would specify to us a complete specification.

We would develop to it.

That's with the other network elements that they have.

And then Mosel would go to market and sell that product.

Actually, we have until today such products, which is the media server.

So all of our media servers, well not all but a large percentage, about 80% or 85%, is sold through Mosel as an OEM product, and we never basically see the service provider itself.

Since about two years ago, we have changed our go to market.

When the market grows, we see a large pressure on margins.

This for the old route really is not a real option for us.

So right now we go direct to the service provider.

Still, in many of these cases, we do work with systems integrators.

And in many cases those system integrators are the large OEMs themselves.

So rather than taking the product into a full cycle of development and integration and so forth, in the second mode of operation we simply work with a system integrator on deploying, making final touches of interop adjustments and that would be it.

So we do maintain relationships with the large OEMs but now not on an OEM basis but more on a reseller or NOR system integrator basis.

Okay.

And then my follow up is with Vonage and Verizon this last quarter, and you talking about how when the Voice over IP market picks up in the cable space, now, what do you think the residual impact is on that for you in the near term?

My question is because I think is there a residual impact with consumer Voice over IP, and that seems to be a major target or focus for the Nuera acquisition.

Yes, Katherine.

This is Ben.

Yes.

Overall, we are not expecting to see a major negative impact.

We see Voice over IP getting embraced by more and more of the leading wireline carriers.

We see wireless carriers starting to move forward with their plans to begin to put in Voice over IP into their networks.

And we see other consumer voice players all around the world that are going forward.

So, I can't say that it's a positive, but we haven't -- we don't expect that it will have a negative impact on the growth of the Voice over IP market.

All right.

And then I will leave it be at that.

Thank you and good luck this quarter.

Thank you.

And your next question comes from the line of Carter Driscoll with Stanford Group.

Hello.

Good afternoon, gentlemen.

Previously you used to give a number, and I realized you've moved to an annual figure in terms of providing guidance, but previously you used to at least talk about backlog entering the quarter.

If we assumed kind of flat sales Q/Q for 2Q, could you estimate where your backlog might stand?

Yes.

So if I am looking at the second quarter to be in line with growth in terms of the revenues versus the first quarter, we have 50% of the backlog right now.

Okay, so your typical figure.

Can you also address the jump in inventories - is it mostly a Blade product, is it work in process, is it finished goods - and whether you may have to take some type of adjustment or write down for any of the products there?

We already took all the measurements and we took everything -- we did any write off that needs to be done.

I can say that it's been up a little bit, but it's obviously due to the lower revenue than planned level that we had in the first quarter.

Okay.

And then, finally, if you could perhaps give a little bit more timing in terms of the consolidation in your manufacturing base and the impact as it spreads out over the next two quarters, when or which quarter may see the greatest amount, or whether you are going to try to do it in an orderly fashion?

Yes.

This is Ben.

In North America we have -- as we've done these acquisitions AI-Logix, Netrake and Nuera and, as Shabtai has mentioned, they all had their own operation facilities and their own contract manufacturers.

And there is a lot of synergy now, bringing that and unifying of the operation, and also the contract manufacturers that we will deal with and where we actually do the contract manufacturing.

So we expect some significant savings.

Just to give one example, as these companies are joining a larger company, and we look at Netrake as an example, their cost of goods sold were quite significant.

And we are able to find a lot of savings by doing a better job negotiating and consolidating under one contract manufacturer.

So, we expect to see some good benefits from that.

Would that be reflected in maintaining a flat gross margin already, those benefits, for the balance of 2007?

Yes.

Previously I mentioned that we are hoping to maintain at least the gross margin that we have on the first quarter.

Obviously, with some more cost reduction, etc., it might even get higher a little bit.

But, then again, it's too soon for us to really get an accurate number at this point.

Okay.

And then, actually, one final question.

If you could possibly give us some idea of how you anticipate Nuera sales to track, whether you are going to see net additions at the cable MSOs as a whole and whether you will see a lag, or whether you should track net sub additions in some type of orderly fashion, or whether you see them build ahead of the actual -- their actual forecast for sub additions?

Yes.

So I guess there was a couple of parts to your question.

So in terms of how we see the CMSOs building up, it has been the model that has been good for a while, we've talked about it in the past, which is they build up capacity, they consume it and then they place more orders.

So, in other words, it's not that every quarter we would see the same MSO.

It's in the same customer, but it would shift depending on the quarter.

So they tend to build then absorb customers and then build again.

In terms of additions, though, from our perspective there's many places to grow and leverage these relationships.

So obviously there's the residential play, where we use the products that we get from Nuera.

But at the same time we see these cable companies moving into business services, which play well for our CPE products as well as our session border controllers.

And we will also see cable operators start to peer with other cable operators in terms of peering, or for between Voice over IP networks, and then eventually looking at fixed/mobile convergence.

So we see lots of areas to grow the business and add value to these MSOs.

Thanks very much, gentlemen.

Good luck.

Thank you.

And your next question comes from the line of Irit Jakoby with SIG.

Hi, thank you.

So just getting back to what you had said earlier about scaling back on the Nuera operation, are you -- I'd just like a clarification on that.

Are you scaling back on the sales or on the development in the Nuera business?

Much of the assessment was really done on the product development side of the business.

At that stage we are investing in [things like] products that are being used by our current set of customers and we have abandoned old product development

Okay.

And so, when we think of the service provider sales, is that organization comprised of sales people from Nuera, from AudioCodes, is it a combination of both?

It's a combination of both.

Actually, in our North American carrier sales we have got our original sales team to go to service providers.

And we also have the Nuera sales person just selling to the North American [OEM sales].

Okay.

And my final question, again with respect to guidance, you had mentioned earlier that you believe that there is good visibility in 80% of the business and less visibility in the rest.

Does your guidance reflect only the 80% that you feel is visible?

Yes.

Okay.

Thank you.

That's it from me.

Sure.

And your next question comes from the line of Ted Jackson with Cantor Fitzgerald.

Hello.

Hi.

Okay.

So, Nachum, I have a few questions for you so I can finish my model.

They are really fun ones.

I'd like to start with how much amortization was in cost of goods, and how much amortization was in sales and marketing?

Actually, that is part of the press release and I won't get into the reasons right now.

I don't have it in front of me.

But either -- I can send it later on [multiple speakers].

Okay.

No.

It's -- actually it's just a lump sum there.

It's not broken out by line item.

So I'd kind of -- I'd like to get that from you.

And the same thing would apply to stock compensation, but I think I can back into it if I get the amortization.

Most of the information, they are in the notes of the press release, but it's not an issue.

And then, I am not sure if other people had seen this or not, but in the press release the PDF that I had gotten from you all, the last digit on a number of line items on the balance sheet was missing.

So I was curious if you could give me the number for the line items for investment in companies, long-term investments, total assets [inaudible].

Ted, I will make sure to send you a clean PDF file.

Okay, thanks.

And also, within your quarter you were actually negative cash flow on a quarterly basis.

And it looks like the largest chunk as to what made that happen was a reduction in other payables.

I was curious in terms of what was in that line item, and what caused the drop off in it.

Basically, looking at our cash flow depends on how you get into it.

But I can say that with the inventory that move up around $2m, and so, and as you mentioned, the other payables, we were negative this quarter.

Moving forward, I do believe that we will get back to cash flow that fairly is similar to the parts of the earnings that we will show on an non-GAAP basis.

But could you tell me what actually is in other payables, in terms of what made that change?

It was the biggest single movement on your cash flow statement.

It's actually -- there's a lot of line items within it.

It's payables to employees, government and stuff like that.

Okay.

And then just you danced around a bit about the second quarter, and I know you are not providing guidance.

But are you feeling more along the lines that it's going to be flat sequentially, or are you viewing it as being just modest growth that's going to be underneath, well underneath, that 5% number that was talked about?

We believe that we will have growth in the second quarter.

And then, am I correct in interpreting from your comment, Shabtai, that when you look at the sequential drop off in revenues, that roughly $1m to $2m of that was seasonal in nature and the other of it is relatively identified from your commentary?

Yes, that is correct.

Okay.

And then, relative to the weakness within your Blade business in AI-Logix, am I right in understanding that AI-Logix was weak but there was weakness within your Blades business outside of AI-Logix?

Yes.

The large customer that I've mentioned was an AudioCodes customer.

So, although we have seen some weakness in several customers at AI-Logix, so it's a combination of those two.

Okay.

And then, did I hear correctly that when you looked at the weakness within the quarter that Nuera itself was about $1.5m of that?

About.

Okay.

Okay.

And just on a more positive side, is one of the things that people have mentioned to me in the past many times is that you've showed revenue growth but you haven't been able to let it flow through to the bottom line.

So I wanted to actually congratulate you on making the moves relative to your operating structure that you are making.

I think that will be received well, particularly as we move through the year.

Thanks.

Thanks, Ted.

And your next question comes from the line of Marcus Kupferschmidt with Lehman Brothers

Hello, everybody.

Hi, Marcus.

I guess I want to clarify the numbers and some of the trends and things you are talking about.

So if I could just, I guess, clarify the numbers.

We talked about how in the networking business you had the chip sales, which I think we said are $50m for the year or something is your plan.

So I assume, then, the rest of the networking business is traditional Blade, AI-Logix and then the CPE.

Those are the basically the four components of networking now?

No, not true.

No, completely not true.

Actually, technology is chip and Blade.

Networking we do count --

Yes.

I meant to say technology, not networking.

I am sorry.

Okay.

So $50m do belong to networking.

We are not talking just technology.

Okay.

So technology, then, is the chips, the boards and the AI-Logix, that's the full amount?

Right.

And if we think about your board business today, how high is the customer concentration in there, because you said one customer brought it down by roughly $2m in the quarter?

Actually, we've got good customer concentration there.

Unfortunately, that customer is one of our largest top five customers.

So, although we have not counted it as a 10% customer, it was, if you take fourth quarter 2006, it was between 5% and 10%.

So, therefore, that particular customer has witnessed such a large drop.

But, relatively speaking, I think all of the other customers really do not represent more than 2% or 3% of the figures.

Of total sales?

Yes.

Okay.

So you are saying they're the biggest one in the Group?

Yes.

Okay.

Can you help us understand, when you talked about -- I think you said a customer in Israel built up some inventory in the fourth quarter, and so therefore they didn't buy much in the beginning of the year here.

And that was, I think you said about a $2m change?

I mentioned that number, yes.

Okay.

So the point is you thought he was on a normal run rate coming out of fourth Q, and now we find out he is sitting in that [inaudible]?

No, I am not sure I said that build up of inventory was related to end-of-life planning.

Therefore, there was more accumulation in the fourth quarter.

Okay?

Okay.

But this customer comes back, even though he just finished end of life on one product is moving to a new product, I assume?

Right.

Actually, I said our business -- Blades business plan is really -- usually comprised of several products.

So on one product there was end of life.

It doesn't touch the other products being sold.

Okay.

Can you help us understand the comment about how we want to cut back R&D as a percent of revenues, because I thought you made a comment about seeing some business areas maturing?

And I want to understand, what is maturing in the Company at this point?

Okay.

So you would think about, if you go through the service provider stage, and you're selling to a central office application, usually once a set of specification has been defined for our deployment and once that set of features has been developed, that product is pretty much deployed and can be used.

Now, at least some -- when you said something about media gateway business, when you are comparing to other applications such as session border controller and media server, people in the space would tell you that the amount of new features that are needed to implement on a media gateway are relatively much lower in number than the new features that are needed to deploy the media server and session border controller.

So, when I refer to more mature products, I meant those of our media gateway products that are very much more, very competitive actually, more competitive than other products, simply due to the fact that we have invested a large amount in R&D and service here.

So we believe that in 2008 we should be able to release some of that investment.

Okay.

So that wasn't a comment about your sales outlook for some products declining or maturing?

No.

Naturally, I hope that my comment was not perceived wrongly.

We didn't talk about a product that's being matured and now declining in sales.

I was referring more to the feature set that could be close to being mature as the amount of addition on the annual basis is becoming lower compared to previous year.

Okay.

So could you help us understand, in terms of the gross margins?

I thought traditionally boards were a high-margin business.

And so it sounds like that's having -- was down here, not clear if it's growing or stable or what.

Isn't it something that goes against your gross margins, if it declines in the sales mix?

Generally it's true, but it also depends in the mix within the networking itself, whether it's low, mid, high density, and obviously the different products within.

Without getting into the specific gross margin for each product line, I can say that the gross margin that we have this quarter, most of the decline was due to the lower leveling in revenues in general, and not specific to any product line.

Okay.

And to the point gross margins you think should be stable over the year, or improving with mix?

Exactly.

Okay.

And then, if I could ask one other question.

Your accounts receivables, DSOs have gone up a lot and your sales dropped off noticeably quarter over quarter but the receivables still seem pretty high.

Can you help us understand?

Are payables just getting longer and longer from your customers or what's going on there?

Two major reasons are obviously payment terms that we are giving our customers, and working more closely to service providers.

We will probably need to give some more credit on one hand.

And obviously it also depends on the linearity within the quarter.

So both of them, I think, affect us for the both.

And right now we are between 65 and 70 days.

The target is -- I believe we will maintain this DSO, and we will try obviously to get it down if possible.

And how was the linearity of 1Q?

I don't want to get into it but it was a little bit backhanded in terms of shipments.

All right, great.

Thank you for the info.

Thanks.

And your last question comes from the line of [Kevin Statler] with KCP.

Thank you.

How would you characterize demand in North American carrier sales for Tier 1 accounts?

Can you repeat the question?

How would you characterize demand for Tier 1 North American carriers?

We are having a problem hearing the question.

Hello?

Yes.

How would you characterize demand for Tier 1 North American carriers?

I am sorry.

I wasn't able -- we weren't able to hear the question.

Operator, can you get the next question?

We are having problems hearing this one.

Hello?

Is that better?

Now we can hear it.

Okay.

I was asking about how do you characterize demand in the Tier 1 North American sale -- North American carriers.

I think the question was how would we characterize demand with the North American carriers.

And I would say it was typical, which is, and as Shabtai mentioned earlier, which is Q4 tends to be stronger, Q1 tends to be weaker as far as seasonality.

There are also a lot of M&A activity and companies being integrated that also had impact on some short-term CapEx spending, as many of you have seen in some of the announcements that have come out.

So, nothing is typical.

Though I would stress that certainly the interest and the moving forward with Voice over IP, both for service providers serving enterprises as well as for their core networks, is definitely increasing.

Do you think you are losing share, perhaps?

[Technical difficulty] answer.

But do you think that there is a share loss, or is it really end-market demand?

I am sorry.

Operator, we are not able to hear the question.

I was asking is it a share loss or is it end-market demand?

He said he was asking if it was a share loss or end-market demand.

Operator, can we get the next question?

There are no further questions.

I would like to turn the call back over to management.

Thank you.

Okay.

Thank you very much.

So, again, I'd like to thank everybody that took part in our conference call today.

We do look forward to seeing you in the next conference call.

Thank you very much.

Bye-bye.

And this concludes today's conference call.

You may all now disconnect.