AudioCodes Ltd (AUDC) 2007 Q3 法說會逐字稿

Greetings, and welcome to the AudioCodes third quarter 2007 earnings conference call.

At this time all participants are in a listen-only mode.

A brief question and answer session will follow the formal presentation.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr.

Erik Knettle, Investor Relations for AudioCodes.

Thank you, you may begin.

Thank you.

I'd like to welcome everyone to the AudioCodes third quarter 2007 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 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 risk, uncertainties and factors include, but are not limited to, the effect the global economic conditions in general and conditions at AudioCodes' industry and target markets in particular, shifts in supply and demand, market acceptance of new products, 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 businesses into AudioCodes' business and other factors detailed in AudioCodes' filings with the Securities and Exchange Commission.

AudioCodes assumes no obligation to update that information.

In addition, during the call we will refer to non-GAAP net income.

We have provided a reconciliation of non-GAAP net income to our net income according to GAAP in our Press Release and on our website.

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 everybody to our third quarter 2007 conference call.

With me this morning are Nachum Falek, Vice President, Finance and Chief Financial Officer and Ben Rabinowitz, Vice President, North America Carrier Sales and Session Border Controllers.

Nachum will start off by presenting a financial overview of the quarter, I will then review the business highlights for the third quarter and turn it over to Ben to cover developments in our business.

We will then turn it into the Q&A session.

Nachum?

Thank you, Shabtai, and good morning everyone.

Before beginning the financial overview of the quarter I would like to note that the following discussion will include GAAP numbers and pro forma numbers.

Our third quarter pro forma results reflect adjustments for the following two non-cash items, stock based compensation expenses which totaled $2.1m in the third quarter of 2007 and amortization expenses relating to the acquisitions of Nuera, Netrake and CTI which totaled $500,000 net of taxes in the reported quarter.

Full reconciliation of the pro form result discussed on this call to GAAP results is currently available for all of you on our website and in the Press Release issued yesterday.

Getting to our quarterly results.

In the third quarter revenues were $40.4m which represents 5% increase from the last quarter.

As a percentage of our revenues, sales in America accounted for 62%, Europe 21%, Asia Pacific 11% and Israel 6%.

We had one customer above 10%.

Our top 15 customers accounted for 51% of our revenues compared to 42% in the previous quarter.

In terms of revenues by business group, in the third quarter our Technology business group accounted for 35% of revenues compared to 36% in the previous quarter and our Networking business group accounted for 65% of revenues compared to 64% in the previous quarter.

In the third quarter of 2007, pro forma gross margin of 58.1% compared to last quarter pro forma gross margin of 58.3%.

On a GAAP basis, gross margin was 56%.

Our total pro forma operating expenses decreased from the second quarter levels by $650,000 to approximately $20.9m in the third quarter of 2007.

The decrease in operating expenses was in line with our expectations and relates mainly to the cost reduction activities we did in the first half of this year.

On a GAAP basis, operating expenses for the third quarter were $23m.

Headcount decreased this quarter by 18 employees, which brings us to a total of 677 employees.

Pro forma net income for the third quarter was $2.8m or $0.06 per share.

GAAP net income for the third quarter was $200,000 or $0.01 per share.

Short-term and long-term cash balances were $134m compared to $131m last quarter.

The increase in cash balances is attributed mainly to a positive cash flow from operations and financing activities which were offset by a negative cash flow related to investment activities.

DSO came in at 68 days compared to last quarter's DSO of 61 days.

At this time, we are updating our earnings guidance for 2007 which we now estimate a non-GAAP earnings per share of $0.16 to $0.17 compared to our previous guidance of $0.12 to $0.15.

We also estimate our GAAP loss per share to be in the range of $0.07 to $0.06.

I will now transfer the call to Shabtai.

Thank you, Nachum.

Let me touch shortly on some of the third quarter financial highlights.

All in all we have been very successful in reaching [again], basically, above our targets with the revenues and earnings this quarter.

Our core Networking business, which now represents about 65% of our overall business, grew nicely by 5%.

If you would add in shipments that we have not counted in, growth in Networking was above 10% in the quarter.

We are very pleased to report that the operating income is almost triple this quarter.

We report now $2.6m versus $900,000 in the second quarter of 2007.

That represents 6.4% of sales versus 2.3% in the previous quarter.

We have shown very good execution on the OpEx control side.

We have been able to reduce operating expenses by $600,000, going down from $21.5m in the previous quarter to $20.9m this quarter.

I would like to emphasize the fact, despite our OpEx reduction, we are continuing to invest what we define for ourselves as growth for the future.

We have been investing substantially in the session border controller area and we will definitely benefit from that investment in the coming quarter.

We have been able to show positive cash flow, $3.7m in Q307 and, as Nachum mentioned before, we have been able to reduce headcount to 677 employees, still keeping the investments and growing developments in our R&D Group.

So all in all, we're very pleased with a very good quarter.

We have sustained momentum and we feel we have a growing strength in the core Networking business.

We now have better visibility into the core.

We see continuation of this trend from the third quarter into the beginning of this fourth quarter, current quarter.

With the growing views of Voice over IP business communications and the growth of Broadband networks and emerging fixed mobile convergence, we believe that the Voice over IP market represents a fast-growing telecom market segment.

Capitalizing on our growing network of partners and customers, and the expansions of their networks and solutions, we believe in our ability to exhibit the same growth in coming years.

Coupling these trends with the success we enjoyed in the cost reduction initiative and the restructuring process amortizing the recorded operational income, we feel confident in our ability to return to growth trends that we have enjoyed in previous years since 2003.

Let me touch now on some of the business line activities in the third quarter 2007.

We remain focused on the best operating strategy.

We have now very good CPE momentum selling both through OEMs and selling direct to service providers and true [some of our] partnership with independent service vendors.

All in all, we see the CPE product client a very strategic sales line for us.

Mid density media gateway sales have reached a very high level this quarter, especially record levels and we believe that this business line is going to exhibit consistent growth going forward, based on the ability to deliver into niche applications.

Our go-to-market strategy remains to sell directly to service providers and the SMB markets and, at the same time, go to market through our OEMs, especially more in the Enterprise than the Carrier market.

In the Carrier market we've seen good momentum in selling to second tier and third tier service providers.

We've seen a ramp-up in sales of media gateways.

We have a very successful core in terms of selling media service both through our OEMs.

We have completed a very important project for us on the media tool from this core and we believe that that will contribute substantially in 2008 to growing our revenues there.

Activities on the Enterprise front was even more active, with very strong channels of activity.

We have seen expansion of our base.

Relationship and cooperation with Microsoft are putting their initiative on the open communications server 2007 was very successful.

We will start to see revenues from that in this fourth quarter 2007.

We have two large OEMs in the Enterprise space with which we work to embed our product.

Our mid-density gateways started to sell through one of these North American OEMs and we believe we will see sales from the other one in the beginning of 2008.

At the same time, we had another large OEM adopting our whole CPE product line and this line will start to sell this quarter.

We've also been successful in selling our CPE devices with another strong independent [service] vendor just [served] to the market.

All in all, we believe we have good condition on the Voice over IP, with our [in] consolidation taking place.

We have seen less players -- less capable players.

We believe that our diverse set of technologies and abilities, ranging from straight media gateways to session border controllers, to security in Voice IP and through more technologies, will allow us to be much more competitive compared to other players in that market.

We also believe that the value of the accumulated investment we have done so far in that market will start to pay in coming years.

Most I would say that we have a very strong brand that allows us to sell very nicely into both the Enterprise and the Carrier markets.

Other developments in the quarter, we have been investing substantially in trying to reduce costs.

We have been downsizing and basically restructuring all our manufacturing operations in North America, basically, collapsing three different sites into one site, allowing cost reductions.

We've invested substantially in improving our sales coverage worldwide and we are now unifying our sales force in coming weeks.

All in all, in terms of where we're going to invest going forward, we would like to focus on Voice IP Centric CPE sales, sold both in the Carrier and Enterprise markets.

We would add to those possibilities market service functionalities, such as session border controls and switching and routing of IP and few more functions.

We want to integrate the session border technology and the security gateway technology we have into our media gateway line.

[We've] unified media gateway capabilities and we would try to win select key accounts in the mid-density area.

All in all, the Voice over IP market seems to be very healthy.

Research firms forecast 30% annual growth.

We see new applications coming to be very substantial.

SIP trunking among them, growth of user Voice over IP in classified environments and a few more applications in the Enterprise space.

We see Voice over IP security in session border control evolving and integrating with the other technologies.

Just to demonstrate our leadership in the market, I'm pleased to report that Infonetics Research issued a report for the second quarter 2007.

In that report AudioCodes has been ranked number one in that report for the mid-density gateways and a market share of 23%.

We were ranked number three in revenues in that category.

On the low-density media gateways markets AudioCodes has been ranked number three worldwide and number four in revenues.

With that, I've concluded by presentation.

Ben?

Thanks.

Thanks, Shabtai.

And good morning and good afternoon to everyone on the call.

As Shabtai mentioned, we've seen momentum and growth in the Voice over IP market and in particular for AudioCodes.

One of the market segments with the most momentum for Voice over IP is the unified communications market.

And with our CPE, media gateways and session border controller products, AudioCodes is well positioned to grow within this market segment.

In terms of SIP trunking and other SIP applications our OEMs and service providers are also supplying AudioCodes low and mid-density media gateways and session border controllers to call centers, large enterprises and government institutions.

We've also seen progress in providing our CPE media servers, security and media gateway products for fixed mobile conversions and wireless markets.

In terms of unified communication opportunities, as many of you know, we have been working together with Microsoft for the past three years to enable office communications server, OCS, and Microsoft Exchange Server to context into legacy PBX's and the PSTN.

We are starting to show tangible progress and have been selected and deployed by a number of companies, including transportation and logistics companies, such as FedEx, as well as projects with other key verticals, such as oil and gas companies, global accounting firms, pharmaceutical companies among others.

In addition, we are working with a network equipment provider, partners and channels in specific verticals.

And this helps us to expand our differentiators in the marketplace.

For an example, in the past year our NEP customers brought our mid-density media gateways into the financial services and government institutions that pushed us to enhance our security functionality within our products.

And we now believe we have among the strongest security feature sets in Voice over IP.

This builds on what we believe are our many other best-of-breed advantages, including voice quality, transcoding, rich SIP and Megaco call control implementations, inter-operability, PSTN signaling, among others.

In addition, our channels and service provider customers are seeing that SIP trunking is growing rapidly and appreciate how we help their Enterprise customers evolve the Voice over IP.

Enterprises are using our media gateways to migrate to SIP applications by using PDMs to connect to service providers.

Many others do the opposite; use our media gateways to connect SIP trunk to legacy PBX application.

We also are just starting to see enterprises and call centers using our session border controllers to integrate end-to-end SIP solutions by connecting our SIP applications to SIP trunking carrier networks.

This fuller product portfolio enables AudioCodes to expand its NEP and channel relationships and push then more products into then multi-peer distribution model.

Indeed, in the U.S.

this year already we have increased the number of active VARs from 52 to 335 that are serving enterprises and tier three service providers.

Voice over IP is also in its very early stages of being implemented as a fixed mobile convergence and mobile local networks.

And we see tangible process.

One customer worth noting is T-Mobile.

Via our Alcatel Lucent relationship, we've successfully launched their hot-bedded at home service in June and made nice progress in subscriber adoption in the third quarter.

Perhaps even more exciting is that we are also working with one of the leading wireless network equipment providers to enable enterprises to deploy fixed mobile convergence.

While the market is still very much in the early stages of deployment in both of these consumer and enterprise examples, AudioCodes is generating revenue and expects continued FMC and wireless opportunities in the marketplace.

Indeed, via our NEP customers AudioCodes are selling media servers for wireless transcoding, security gateways for secure FMC, media gateways that enable FMC networks to connect to 2G and 3G MSCs and PPE devices, such as the Mediant 1000, that is hosting FMC applications and providing connectivity to PBXs over the PSTN.

In conclusion, with our technologies, PPE, media gateway, media servers, SBCs and security gateway products we are progressing with customers and securing key design wins in emerging market segments to ensure a bright future for AudioCodes and our partner channels customers.

And now I'll turn the call back to the operator for Q&A.

Thank you.

(OPERATOR INSTRUCTIONS).

Our first question comes from Ittai Kidron with CIBC.

Please state your question.

Hello, guys.

Nachum, with regards to the guidance, can you give us a little bit of color on how we should think about revenue growth sequentially from September to December?

Yes.

With the guidance in related to the revenues, we are maintaining the same guidance we gave on the previous quarter, meaning, on an annual basis we will do 155, 160.

Obviously, fourth quarter should be in line or even stronger than the third quarter, goes in line with the earnings guidance that we gave.

Then that implies, if you just take the mid point of that and reconciling it with your annual EPS guidance, that you're expecting operating expenses to increase significantly again September to December.

How should I think about this?

I wouldn't go into that detail, Ittai, but I would say that, again, in terms of earnings we target fourth quarter to be between $0.06 and $0.07 and, therefore, OpEx should be flat or a little bit growth versus the third quarter.

Then are we -- are you -- is it your position that you've pretty much done all it is that you planned to do as far as cost cutting is concerned?

It is not that we have done.

There are two processes that take place at the same time.

We can't reduce expenses at the same time we do increase investments into certain areas.

We do increase the sales force, we do make investments in R&D and business development and sales in the session border controller area.

So those are different processes.

One is investing.

The other one is reduction.

So, when you add them two, you see a flat performance on that.

And how should we think gross margins heading into next year?

This is fourth quarter in a row when your gross margins are declining.

I think, going forward, [for] business growth and I think that we will grow next year and in coming years.

We will probably see slight reduction decline of our gross margin.

We don't expect that to be meaningful in any respect but, all in all, I think that restoring volume and that naturally will see some decline in our gross margin, but not by a large number.

Very good.

And Shabtai, with regards to -- I'm just looking at your geographical revenues split.

It looks like every region was actually weak sequentially, with the exception of North America, was exceptionally strong.

So how much of the strength this quarter was driven by that one customer, which is probably Nortel?

Well, naturally, you will basically need to realize that third quarter includes the summer and the summer usually both in Europe and in other regions is weak.

So that is probably the reason why you see some flatness in those regions.

Indeed, we had good sales from one customer but that represents growth in media server sales, something that is natural with the evolution of Networks..

Very good.

And lastly, Ben, maybe you can just comment on the session border control activity, how is the progress?

You mentioned a few things there including call centers and, I think, enterprises.

And is the new area players are talking about with regards to the adoption of session border controllers.

Maybe you could give us a just a little bit of color, how much revenue was that line item this quarter and how's progress been to date in turning around this Netrake business and getting it on track again?

Okay.

So we're not breaking out yet our revenues for the security gateway.

We are seeing -- definitely seeing interest in terms of call centers and enterprises in terms of the rolling out of the trunking and they are looking as SBCs.

AudioCodes is well positioned in terms of with our channels and our other relationships to take advantage of that.

But we're still very much in the early stages of investing in the business, building our advantages and focusing on the right market segments, but we are seeing a momentum and some important progress in the Enterprise and Call Center space.

Very good.

Good luck, guys.

Our next question comes from Irit Jakoby with Susquehanna.

Please state your

Hello,

good morning, good afternoon.

You mention that you do continue to invest in sales and marketing, and could you go into a little bit more detail in terms of what geographies or which areas channel versus direct?

Yes, basically we are investing in all regions.

We have just added personnel in Asia Pacific to support sales in China and other places.

We are adding people in our North American operation and same is happening in Europe.

So all in all, we believe that growth [in all] geographies worldwide.

It's not tied up to a specific region and, basically, we simply see a need to support our customers who are basically networked all around the world, and this is why we are investing in this activity.

Okay, great.

And one more question.

You mentioned also that you are seeing cost reductions from cutting manufacturing facilities.

Has that all been included in Q3, or should we expect -- or do you expect more benefit from that going into Q4 and going into 2008?

Actually, for us it's a program that would last between six and nine months.

We are at the middle of that program.

So at this stage we still do not see any benefit from it, actually, even you would see a slight increase in the expenses simply because we thought to duplicate resources at other sites.

But we believe that the full effect of that transition will come into play mid 2008.

Okay, great.

Thank you.

Sure.

Our next question comes from Troy Jensen with Piper Jaffray.

Please state your question.

Hello, congrats on a nice quarter, gentlemen.

Thanks.

So, to follow up on Ittai's question, for Ben, on Netrake, if I remember correct with '06 it was believed they were going to do $6m of revenues and, '07, $9m.

First of all, is that correct?

If I think about it right and have you guys revised those expectations for Netrake?

Okay.

One is we're not trying to set expectations at this point in terms of the business.

But the important way to think about the Netrake business is AudioCodes is investing in the SBC business and the technology, but it's still very much in the investment stage.

As you know, this was a business that AudioCodes acquired for $10m last year and it's still very much a business that we're turning around, but we're definitely seeing evidence that we're pointing in the right direction.

So, this is going to be an investment and that will both from a standalone and an integrated standpoint.

And, again, like I said, we're making progress but we're certainly not breaking out the revenues at this point.

Okay, got it.

And then, Shabtai, on the TB side, it looks like that's stabilized and had a little bit of growth this quarter.

Do you think some of the declines we've seen recently are behind us now and we can grow this business?

Or is this kind of a model that flat type of business?

Well, we do believe the Technology business is somewhat flat and will be supposed at current levels.

We -- that includes Chip part of it is growing slowly, about 15% a year is growing.

The blade business is currently stabilized and we do believe that with some of our products are being sold through partnerships with ISVs, we will see a clear support for that level.

So we do not expect that the Technology will drag on growth in the Networking side.

And then one for Nachum, just to be fair.

Nachum, if we look at share count here now, if you guys reported GAAP profit here, in the December quarter, maybe March or some time soon, is the GAAP share count going to jump back up to 50m shares?

I know it's converted, right.

It was the convertible offering, but I'm just trying to get the model fixed here.

You're right, Troy, but it will happen around $0.09 per share on a quarterly basis.

$0.09, okay, thank you.

That's a rough estimate.

It's actually the interest we are paying on the convert then we will need to take into account when it will be dilluted.

You're absolutely right, once we get there we will need to add the shares from our convert.

Okay, got it guys.

Keep up the good work.

Thanks.

Thanks.

Our next question comes from Reg King with Nollenberger Capital Partners.

Please state your question.

Yes, thank you.

Shabtai, I was hoping that you comment a little bit.

It sounds like in your commentary you were explaining that you may be focused a little bit more on CPE market than in the past.

Could you just clarify that for us?

Sure.

We, actually, and you could see that through the numbers that I quoted from the Infonetics report, we've been able to achieve a leading position in the low-density media gateway market and also in the mid-density gateway market.

That plays well both into selling into the Carrier space, basically, partnering with all the large NECs and selling with them small and mid-density gateways.

At the same time, we do sell also to the enterprise space, again, either through OEMs but partly through their channels.

Our initiative with Microsoft is another good example to selling CPEs in conjunction with a service vendor and application server vendor.

And all in all, we believe that the market is much more fragmented.

We do believe that we do have a very growth portfolio.

We are enriching that portfolio with features from the joint functionality that, basically, puts a barrier to entry to other players.

So all in all, we believe that in the CPE space we do emerge as a very clear player -- one of the top three.

I know you've increased your focus on foreign directed service providers recently, during the time we've been involved with you.

That's obviously an increased focus.

Have you seen any conflict yet between your sales as service providers and your traditional OEM sales?

Well naturally, because we are perceived as a leader, as I've said, in the low and mid-density gateway markets and, therefore, we are selling either directly in/or with our partners, so there's no conflict there.

We try not to put an emphasis on selling high density gateways because that would create a conflict and we're selling those primarily more into the enterprise market and some niche applications.

So all in all, we have not seen cases lately in which we have any collisions with any of our partners.

And then Nachum, just to go back and clarify an earlier point.

I believe you indicated to an earlier question that the gross margin profile going into '08, we're likely to see some slight decline going into '08.

And if you could just give us a little clarity of why we might see a decline, as you are able to get your cost reduction program under control and you're able to bring some of the new products online.

Yes.

Obviously, it's very hard to predict the gross margin exactly for next year, as you said.

When we're doing cost reduction activities and when volume is going up, it goes in our favor.

But on the other hand, there's always some price pressure and, therefore, gross margin might went down a little bit in the near future.

Okay.

Thank you very much.

Thanks

Thank you.

Our next question comes from Marcus Kupferschmidt with Lehman Brothers.

Please state your question.

Hello.

Good morning, everybody.

Hello Marcus.

A few things.

I just want to clarify I heard you right, in terms of your outlook for the fourth quarter.

You'd expect the sequential revenue growth to be in line or stronger than what you saw in 3Q.

I wouldn't go to the growth but I would say that it should be in line with the third quarter revenues and we should expect growth as fourth quarter is usually the strongest.

Okay.

So you're expecting some sequential growth.

I'm wondering, given 4Q is normally the strongest quarter, why wouldn't 4Q sales typically grow faster than what you saw in 3Q?

Marcus, we -- as Shabtai indicated, we have better visibility.

We've seen good trends entering into the fourth quarter.

And we believe that we should be able to outperform the third quarter results, at least on the revenue side.

Okay.

And a second question I'd like to understand is about the effects of the U.S.

dollar to Israeli shekel.

It looks like the shekel weakened again significantly during the third quarter.

So, a, what effect did this have on your revenues versus what you might have been expecting?

And, b, how does this affect your operating expenses, or cost of sales?

Yes.

So Marcus, in regards to the revenues, the majority of our revenues are not in shekels but they are in U.S.

dollars, so there is no effect there because we are reporting as well in U.S.

dollars.

As it relates to the expenses in Israel, you're absolutely right.

But we are doing some hedging activities from time to time.

So, so far, looking at the last quarter -- the third quarter, we didn't have any effect in regards to the exchange rates of the dollars with the Israeli shekel.

Okay.

But the way you're hedging it all, should we expect in 2008 there will be some extra expenses incurred by the Company because at some point you do feel the pain of the weaker shekel?

It's a little bit too soon for me to give you an accurate answer, but I would say that we already hedge part of next year as well.

Okay.

And then I didn't understand something Shabtai mentioned in the prepared comments.

I thought Shabtai made some comment about if you looked at the networking unit shipments, the growth would have been much stronger than the actual revenue growth that you announced.

Is that -- was that the comment?

Slightly different.

Indeed, we shipped more than we recognized for the quarter.

And would we recognize that and our growth in the quarter on the Networking side, it would be more than 5%.

We should have been above 10%.

So we have a flow of shipments.

Those projects sometimes need recognition and acceptance on the other side.

But all in all, we had stronger pipeline of shipments than we had before.

I think the point is, this is better than normal.

In some quarters I would assume you always have shipments more than what you recognize.

But the third quarter was extraordinarily strong for that kind of activity.

The quarter has been better than previous quarters on that respect, yes.

Okay.

And you assume this would be converted quickly.

There's not some reason that this would drag out beyond the fourth quarter?

Again, Marcus, we cannot say at this time when exactly and how much change it will have on the next quarter, although as Shabtai mentioned, if you look at Networking, we did ship more than the recognized revenues.

But looking at the entire picture, it's not meaningful, looking at the fourth quarter revenues completely.

Okay.

And is this one big project or a bunch of small ones?

It's not just one.

It's several.

Okay.

And anything else you would give us about your target for operating expenses as a percent of revenue or profitability levels, looking into '08?

Well, we put a target for ourselves to reach at least 10% operating income by mid 2008.

With the rate of improvements we see, we believe that this is something that is doable.

Great.

Thank you.

Yes, thanks.

Our next question comes from Eric Kainer with ThinkEquity.

Please state your question.

Thank you very much and congratulations on a solid quarter, gentlemen.

First question is really -- it sounds like the action is hottest, really, in the Enterprise side.

I can't even count the number of times you mentioned either Enterprise or CPE in your prepared remarks.

You mentioned the integration of the SBC and other technologies for Enterprise applications.

I wonder if you can talk a little bit more about that.

Well, it's very simple.

At the beginning of the Voice over IP era, one had to connect new emerging IP networks with the established [TDM] network.

That process took, for us, a good seven to 10 years.

We now have more and more IP networks and you have to interconnect IP networks between themselves.

Actually, that you do connect between the IP to the [TDM].

So any device that would -- that will have to mediate between networks, we will have basically to include internally capabilities to interconnect, not only IP and [TDM], but also IP and IP.

And we're working towards that target.

Okay.

Now, obviously, you've had historic strength in the Enterprise gateway space.

Have you seen -- and obviously, a couple weeks ago Acme made kind of a splash in the SBC side by saying that they're really looking more into Enterprise opportunities there.

Have you seen, in your business, where you've had implementations of media gateways on the Enterprise side -- transitioning some of those over to your SBC platform?

I believe that's really very early in the game.

I think we are just seeing very initial signs on that.

We are not aware of any large number of clients that need to be supported on the Enterprise.

So I think it's a process you will see that developing over the next two years and at this stage it's really not meaningful.

Okay.

Just kind of popping up a level, perhaps, it sounds like the Enterprise -- your Enterprise business maybe able to grow faster than your carrier business.

Can you kind of give us a little bit of color around that?

And then maybe is that one of the things that potentially drives the slight decrease in gross margins as we go forward?

And might that have an impact on your M&S, and specifically the new sales positions that it sounds like you're building out?

Well, I would say that if I have to comment on gross margins in the Enterprise space compared to those in the Carrier space, I would say that -- I would normally say that they would be higher on the Enterprise.

Price pressure on Carriers still are usually higher as you look on gross margin of larger players.

In the telephone space you will see gross margin as low as 40% and 30%.

So that does not have any effect.

Very simply, the Enterprise market is much more healthy in terms of spending.

It's much more fragmented in terms of the number of customers available.

It has much -- the projects are substantially smaller.

It is much more differentiating features to sell.

And our ability to develop those unique features, supporting our customers better with integrating -- supporting on a worldwide basis because you're talking about enterprises who are based -- on a global basis.

I think all of those capabilities make us much more competent in being able to deliver.

Also, I would say that you'll see much less competition in that space compared to the Carrier space.

Okay, that --

And just be careful in terms of conclusions here.

We are growing on the Carrier side and we are finding areas of momentum.

So I don't want -- I want to just be careful in terms of the emphasis on that.

Both are growing for us, but we see a lot of things in our CPE space, especially with unified communications, that makes this market very exciting for us.

Okay.

And one last question, then, and that's about the impact of your partnership with Microsoft on -- around OCS.

Is it possible -- obviously, it sounds like we've got some early traction there.

But I'm not sure that it's fair to expect meaningful volume of revenue in the near term.

But as we look out towards the end of next year, could that become a significant driver for your top line, at a maybe 10% type of level by -- again, by the end of next year?

I wouldn't build on that.

We really look upon late 2007, 2008, still those years.

I think that will come a much more visible part of our revenues in 2009 and going beyond.

2008 is simply a lot of trials, a lot of initial deployments.

I don't think the volume in 2008 will pay -- will drive us (inaudible) progress.

Okay.

Thank you very much, and good luck.

Sure, thanks.

Our next question comes from Ted Jackson with Cantor Fitzgerald.

Please state your question.

Thanks.

Hello, Shabtai, Ben, Nachum.

Hello.

First question is, Ben, I was curious if you'd give us a little color on how you feel the combination of NexTone and ReefPoint will impact the SBC and security gateway market.

Is that something you think is good for you, or totally neutral, or bad?

Okay.

I'm not expecting too much change there.

We haven't -- NexTone certainly has had its spaces or segments where it's had some success.

ReefPoint, we don't believe this has made any significant penetration and we expect that they will be working on combining their companies together.

So we expect it will be more of the same in terms of how we see both NexTone and ReefPoint in the market.

And the second thing is just on the comment relative to the growth in bars, where you've put forth that the bar growth has gone from 52 to 335 in North America.

What's the timeframe for that?

That's what we have accomplished this year.

Wow, that's pretty impressive.

Third thing is, historically you guys have made commentary relative to the amount of your next quarter revenue that you had in backlog.

And given the annual guidance, let's say, roughly speaking the midpoint is for -- it's 7m in revenue in '08.

How much of that do you have in backlog?

I would say that it's what we have usually, which is about 50%.

Okay.

And then the next question is basically CTI Squared.

I haven't heard really any commentary relative to that acquisition during the call.

So do you have some kind of update relative to progress you're seeing with that applications business and how it's impacting your Media Server business?

Yes, CTI Squared integration is really who we work with?

We still do not see any resumption of that activity.

There's a lot of reshaping and repackaging of their offering with our products.

And it's still too early for us to comment whether that would be a great success or not.

Okay.

And then just one last question.

Maybe you, Shabtai, maybe Ben.

But just the cable MSO market, it used to be something that there was a lot of promise, a lot of potential as it related to your exposure there, particularly with the Nuera acquisition.

And given the state of affairs today, could you give us an update relative to what's going on in the cable MSO market, where you stand in it, what your prospects are going forward?

And that's it.

Thanks.

Okay.

So things are continuing to move for us with the North American MSOs.

They're continuing to deploy residential Voice and the customers that we've had before, we still have and support them and help them build out the network.

We've also added some additional smaller tier MSOs since the acquisition.

The place where we see potential growth will be as they start to get more serious about business services, and we believe we're at the early stage of them starting to take that more seriously and have more deployments in that area.

How would you look at that market from a competitive standpoint?

Who do you see as the top two competitors for you when you look in the cable space?

Well, certainly, Cisco comes to mind.

But again I believe, given our relationship, not just with the MSOs, but also the fact that Nortel tends to be the systems integrator, we feel that we should be able to get our fair share in the market.

Okay.

Good quarter.

Thanks very much.

Thanks, Ted.

(OPERATOR INSTRUCTIONS).

Our next question comes from Carter Driscoll with Stanford Group.

Please state your question.

Good afternoon, gentlemen.

If we could just -- not to beat it to death, but to talk about the Microsoft relationship a little bit more, is it -- do you have any type of -- any sense of visibility into how they're going to ramp this product in terms of when a customer may turn on, what your lead times might be in terms of trying to satisfy that?

Will it come directly out of inventory built in a particular quarter?

Do you imagine building inventory specifically for this project as it progresses?

Yes.

So remember, Microsoft is a partner.

Then there are channels, large distance integrators and bars that actually then bundle everything together and deploy at the customer.

So we expect some inventory in the channel.

But frankly, channels are very efficient these days.

So there tends not to be too much in the system.

But -- so I wouldn't expect a blip as a result of inventory build-up.

Okay.

And then a question for you, Ben, is you've talked a lot about fixed mobile convergence and the opportunities in wireless.

If you could elaborate upon what you specifically see AudioCodes' role is versus the direction the market could potentially take that may not be favorable from your perspective.

Actually, we only see things in a positive way.

We play both with dual-mode handsets as well as in the femtocell plays.

We will be involved, whether it's residential or enterprise deployment.

So we think it plays to our advantage.

Anywhere that there is SMC there is basically trans-coding and, of course, that's our heritage and our strong competency in transcoding.

And we're also strong now in security gateway and media processing.

So, however SMC rolls out, we think we have -- we're in the right solution to take advantage of it.

I think it will be more who the systems integrator is and specific dealer opportunities and whether AudioCodes benefits or not.

And then just lastly, 3Com used to be a fairly decent customer for you in the past.

And, obviously, the partnership with Wallway may have impacted a little bit.

Do you see that changing at all now that it's essentially been swallowed by an outside investor?

It's too early for us to see.

At this stage we are not seeing anything and I believe that will take a long time for us before we realize if, indeed, there is going to be an effect.

And then lastly, for Nachum, just housekeeping.

CapEx and [D&A] in the quarter?

You ask about CapEx, right?

We do have the cash flow report, so it's in there.

I don't have this number just in front of me.

So, again, Carter, you can look it up.

Fair enough.

Thanks, gentlemen.

Okay.

Thank you.

Our next question comes from Reg King with Nollenberger Capital Partners.

Please state your question.

Yes.

Nachum, could you or Shabtai possibly update us on your recent relationship with Shortel?

Can you just give us an update on what the relationship is looking like today and have you seen any traction with the new Shortel partnership?

Hello.

This is Shabtai.

Sorry, but we're not into the details of that activity.

We know there is cooperation in the market.

We know our enterprise group in North America is working with the company but we are not aware of any further development at this stage.

Okay.

Thank you very much.

Sure.

Our next question comes from Marcus Kupferschmidt with Lehman Brothers.

Please state your question.

Hello, guys.

Just wanted to clarify, for the interest income during the third quarter, it looks like it's down a little bit sequentially at about just over $600,000.

Was there any charge you took in that, or loss you took in that?

Or is it just that the June quarter interest income was much stronger than normal?

Actually, the third quarter should be the run rate, Marcus.

Part of it was payments that we did.

And obviously, the CTI, etcetera, that took it down a little bit.

But if you ask me about the run rate, we should see the run rate we had in the third quarter.

Even though you had positive cash flow during the quarter.

Obviously, it will have an effect, but it will take time and it's not meaningful at this point.

Okay.

Thank you.

Thanks.

Thank you.

At this time there are no further questions.

I will now turn the conference back over to management for closing comments.

Thank you.

I would like to thank everybody that attended our conference call today.

And we look forward to seeing you all in our next conference call.

Thank you.

Thank you.

This concludes today's conference.

All parties may disconnect now.

Thank you.