AudioCodes' (AUDC) CEO Shabtai Adlersberg on Q2 2018 Results - Earnings Call Transcript

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About: AudioCodes Ltd. (AUDC)
by: SA Transcripts

AudioCodes Ltd. (NASDAQ:AUDC) Q2 2018 Earnings Conference Call July 24, 2018 8:00 AM ET

Executives

Allison Soss - KCSA

Shabtai Adlersberg - President and Chief Executive Officer

Niran Baruch - Vice President, Finance and Chief Financial Officer

Analysts

Rich Valera - Needham & Company

Dmitry Netis - William Blair

Operator

Greetings and welcome to AudioCodes Second Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Miss Allison Soss with KCSA. Thank you, you may begin.

Allison Soss

Thank you, Melissa. I would like to welcome everyone to the AudioCodes second quarter 2018 earnings call. Hosting the call today is Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President, Finance and Chief Financial Officer.

Before beginning, we’d like to remind you that the information provided during this call may contain forward-looking statements relating to AudioCodes business outlook, future economic performance, product introductions and plans and objectives related thereto and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters are forward-looking statements as the term is defined under U.S. Federal Securities Law.

Forward-looking statements are subject to various risks, 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 current global economic conditions and conditions in general and in AudioCodes industry and target markets. In particular, shifts in supply and demand, market acceptance of new products and the demand for existing products, the impact of competitive pricing and products on AudioCodes and its customers, products and markets, timely product and technology developments, upgrade and the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in the company’s loan agreements, possible disruptions from acquisitions, the ability of AudioCodes to successfully integrate the products and operations from acquired companies into AudioCodes business and other factors detailed in AudioCodes filings with the SEC, the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update such information.

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

Before I turn the call over to management, I’d like to remind everyone that this call is being recorded and an archived webcast will be made available on the Investor Relations section of the company’s website at the conclusion of this call. The call will also be archived on our Investor Relations app, which is available for free from the iTunes App Store and the Google Play market.

With that said, I would now like to turn the call over to Shabtai Adlersberg. Shabtai, please go ahead.

Shabtai Adlersberg

Thank you, operator. Good morning, and good afternoon, everybody. I would like to welcome all to our second quarter conference call. With me this morning is Niran Baruch, our Chief Financial Officer and Vice President of Finance. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the quarter, discuss trends and developments in our business and industry, and the outlook for the second half of 2018. We will then turn it into the Q&A session. Niran?

Niran Baruch

Thank you, Shabtai, and hello, everyone. As usual, we will be referring to both GAAP and non-GAAP number from the call. The non-GAAP P&L metrics exclude recurring non-cash items. Today’s earning press release contains a reconciliation of supplemental non-GAAP financial information.

Revenues for the second quarter were 43.5 million, up 2.5% from the prior quarter and up 12.3% compared to the second quarter in 2017.

Services revenues for the second quarter were 13.5 million, accounting for 31% of total revenues. Deferred revenues balance as of June 30, 2018, was 42.6 million compared to 42.4 million as of March 31, 2018.

Revenues by geographical region for the quarter were split as follows: North America, 45%; Central and Latin America, 5%; EMEA, 35%; and Asia Pacific, 15%. Our top 15 customers in aggregate represented 56% of revenues in the quarter, of which 47% are attributed to our 12 largest distributors.

Gross margin for the quarter was 62.3% compared to 61.4% in Q2 2017. Non-GAAP gross margin for the quarter was 62.8% compared to 61.9% in Q2 2017. Operating income for the quarter was 3.3 million compared to an operating income of 1.9 million in Q2 2017.

On a non-GAAP basis, quarterly operating income was 4.4 million or 10.2% of revenues, compared to an operating income of 2.7 million in Q2 2017. Net income for the quarter was 2.4 million or $0.08 per share compared to net income of 1 million or $0.03 per share in Q2 2017.

On a non-GAAP basis, quarterly net income was 4.1 million or $0.14 per share, compared to net income of 2.5 million or $0.08 per share in Q2 2017.

Our balance sheet remained strong. At the end of June 2018 cash, cash equivalents, and marketable securities totaled 58.1 million. Day sales outstanding as of June 30, 2018 were 52 days compared to 47 days in the prior quarter. Operating cash flow generated during the quarter was 2.2 million.

During the quarter, we acquired 452,000 shares for a total configuration of 3.3 million. As of June 30, 2018, and since we began to repurchase our shares in August 2014, we had acquired an aggregate of 17.2 million shares for an aggregate configuration of approximately 90.3 million.

In June 2018, we received court approval in Israel to purchase up to an aggregate of $20 million of additional ordinary shares, pursuant to our share repurchase program. The current court approval will expire on December 14, 2018.

The board of directors today declared an annual cash dividend in the amount of $0.20 per share and in the aggregate amount of approximately $5.7 million. We expect to continue declaring annual dividends in the coming years.

Now to provide an update on our guidance, we now expect revenues for 2018 to be in the range of 171 million to 175 million, compared to an original range of 166 million to 172 million. We anticipate non-GAAP diluted earnings per share to be in the range of $0.5 1 to $0.55, compared to the original range of $0.41 to $0.46.

I will now turn the call back over to Shabtai.

Shabtai Adlersberg

Thank you, Niran. We’re very pleased to report record financial results for the second quarter of 2018. It is now the fourth quarter in a row where we exhibit accelerated growths relative to previous years. Let me touch on some of the highlights of the quarter. We’ve seen very strong revenue growth in the first half of 2018. We grew 12.3% compared to the first half of 2017. We’re now focused about 10% growth for the full year, which represents acceleration in revenues growth over previous years where we compare to 7.7% growth in 2017 and 4.2% growth in 2016.

Growth in revenues translates well into profits. Assuming normal income change in our business in second half 2018, we now target to grow profits this year about 30% compared to 2017, on the heels of profit growths of close to 30% in 2017 and about 60% in 2016. All in all we now exhibit great business momentum and continued growth in profits since 2015. This progression, which we believe will continue in 2018 and beyond, is well supported by two key trends. First, steady evolution and strength in the underlying markets we participate in and second, our strong position and leadership in the market segments we serve.

Another highlight of the quarter is the substantial improvement in operating margin. We’ve reached 10.2% of operating margin in the second quarter of 2018. We anticipate further growth in the second half. That is a combination of the operating margin in our networking business with the new investment in Voice.AI. We estimate our investment in Voice.AI to be between 3 million and 4 million this year. As such, the main business, the networking business, runs now at about 12% operating margin.

Another highlight for the quarter is the acceleration in our UC-SIP business, previously recorded annual growth rates of 15% to 20%. We’re glad to say that this year we see accelerated growth. As reported second quarter 2018 provided more than 30% growth year-over-year, similar to what we’ve seen in the first quarter of 2018. All key business line including the Session Border Controllers, the IP phones, our One Voice Management Suite, the MSBR and Services demonstrated very solid growth and strength.

Another important highlight is our continued strong cash flow from operation. In the first half of 2018, we generated 10.2 million. 2018 turns to become the fourth year in a row where we generate cash in excess of 17 million, 18 million a year. We expect to generate similar level of cash flow in the second half of the year, which will translate approximately to about $0.65 of cash flow per outstanding share.

As stated many times in the past this is now a recurring statement for the past five years underlying the solid performance is our continued close collaboration as market leaders in these segments namely Microsoft and Genesis. On top of that investment in maintaining strong relationships with large and global system integrators which proves to be essential and effective pillar in our strategy.

In parallel to our success in the enterprise phase, we continue to enjoy improved business momentum our service provider side of the business, but we see continued growth of SIFT tracking and continuation of the transition to an all IP world.

Now backing the secular growth strategy in our business is the solid performance in our two key businesses, UC-SIP business and the Gateway business. In the first half UC-SIP as I mentioned before grew more than 30% compared to the first half of 2017. In fact we now predict that the UC-SIP business revenue will achieve above 85 million this year compared to above 65 million in 2017.

At this rate we’re targeting to achieve 100 million of revenue of UC-SIP products and services next year pretty much preceding our initial multi-year plan through which 100 million of business only in 2020. Growth in the UC-SIP business is driven primarily by our success in the enterprise voice business where we become top vendor [ph] for delivering voice connectivity and infrastructure for UC as a service and perfect center.

On the Gateway business side we saw good revenue stream in the second quarter of 2018, slight decline of less than 5% compared to second quarter 2017. Backing this trend is the growing pace of migration to All IP networks in leading economies such as the U.S., Germany, Australia and other countries. Key to our solid performance in these segments for several years now is the fact that we have become the partner of choice for CP products and equipment in most of the leading All IP and UC application environments. And we are building similar such position with leading service providers worldwide. We are confident that this leading position will prevail in coming years.

Now a very short and brief outlook into the first quarter, the current quarter, I'm glad to know that at this stage on July 24 the trend in both businesses continues to be along the same lines that we have seen the first and second quarters in 2018. Quick update on our activities in Voice-AI, just to remind everyone on the call that in Voice-AI business we focus primarily on delivering actionable items derived from processing voice interaction content rather than deal with the voice connectivity as we do in our main stream networking business.

In the second quarter we continue to invest and evolve technologies in the area of speech recognition, deep node [ph] network, machine learning, natural language understanding et cetera. We have had very good momentum, new projects and customer swings in Israel. We’re becoming the sector leading provider of core steering solution for enterprises. I believe that at this stage we have crossed more than 100 businesses here in Israel. We also work with leading service provider here that target to sell core browsing solution to their business customers here in Israel. In addition we have been investing in entering new markets in Europe and the U.S. for our Voice-AI application.

Now let me touch on some of the key financial highlights of the quarter. We've mentioned revenue growth of 12.3% year-over-year. We've seen continued growth in differed revenues which will keep feeding the next quarter. Product revenue was very strong. We grew more than 10% year-over-year. This is a very encouraging phenomenon as this will basically dictate the rate of growth in services in coming years. Service revenues rose to 13.5 million basically delivering 14.1% year-over-year.

OpEx declined. Happy to inform that since the US dollar and the Israel Shekel conversion rate has improved dramatically over the past four, five months, so now we are sitting at a much more comfortable position, so OpEx in second quarter ’18 declined 2.7% compared to the first quarter of 2018. On the net income, we grew 60% year-over-year delivering 4.1 million versus 2.5 million in the year ago quarter.

To touch a bit on the sales side, generally sales performed very well too and above the targets in almost all territories. We had remarkable performance in North America on the service provider side of the business. We have seen good business in West Europe, in India and few more countries.

Like to relate to one important geographical aspect, in the first half of 2018 we saw continuation of the trend of growing significantly in EMEA as compared to other regions. Revenues in EMEA were about 35% of the company overall revenues in first half compared to 31% in 2017.

Let me touch on some key business line in our company, first and foremost Microsoft. Second quarter 2018 revenues in the Microsoft environment were in line with planning. This year we plan to grow more than 15% year-over-year and get the business size to about 65 million for the full year. We have seen nice growth in second quarter, 23% over the year ago quarter and again the portion of products versus services was higher, which means good momentum in products.

The most important aspect of our business in the Microsoft environment this quarter was the nearing deployment of voice services in Teams. So in May Microsoft announced direct routing GA and basically that was an opening of the door for collaboration with service providers that can now use, bring your own trunk and connect Teams implementation to the SIP trunks of their choices. We are a supplier of Session Border Controller technology to this service and so much interest is developing in the second half of the second quarter.

We've been part of the early adopted forum for direct routing with several enterprises, very large enterprises at the same time we were engaged with the list of between five and ten different service provider working with us on delivering direct routing for Microsoft Teams. We expect Teams open new market segments in the future. So far through additional investment in the Microsoft Skype for Business market was focused much more on the large enterprise segment.

We now believe that with the simplification of the solution in the Teams environment and more so Office 365 environment we will see penetration of those solution also into two new segments the mid market and SMB. So we believe that that will give a push to the business. We believe that will happen somewhere in the first half or second half 2019.

In other areas for work in the Microsoft environment we have enjoyed success with deployment for phones, IP phones. We have generated a lot of demand then and sold accordingly. We also are engaged in – coming up with one of the first few phones for Teams and that is getting a lot of interest by a lot of customers and some of the field reserves of Microsoft technology.

One bright spot that’s really in the very first early innings is the development of new market segment seems evolving talking about mainly ROM solutions and meeting technology which we believe will become much more important in the Teams environment in coming years. So here is another new market segment for us to grow. We continue to sell appliances to the Microsoft environment and sales were fairly well.

I’ll touch also a bit on the Session Border Controller part of the business. We grew a very nice 21% year-over-year. We are very much in line at achieving our annual target that’s about 20%. In terms of the geo split, we saw nice revenues coming from North America, 38%; EMEA, 34%; Asia Pacific, 10%; and Latin America 9%.

In our top SBC customers, we’ve seen a mix of both Microsoft and Genesis, Honors and we've seen some very large expansion projects of hundreds of thousands of dollars of SBC equipment, some of them software only. We have engaged with our SBC technology in several large contact centers, projects, among them proof of concept.

New Technologies, where we focus on the web or SCC Gateway which is now tested by several players, same for visualized solution for the SBC, all in all we also have seen an expansion of a very large access SBC project in Asia Pacific with a large mobile operator. All in all we feel very confident that our SBC technology and solution are at the forefront of the market.

Touching on the Services side of the business, this year we intend to grow services more than 10% and reach a level of 54.5 million compared to 49.3 million last year. Achievements in this quarter were quite in line. Company services grew year-over-year 26% and we've seen much higher growth in our professional and many services. That relates to our business.

Let's let me touch on two other items that we have announced. First our annual cash dividend announcement of this morning. This morning we announced an annual cash dividend of $0.20.per share. The announcement comes on the heels of healthy and continued growth for our fourth year in a row. In these years we have been able to generate steady cash flow of about 18 million a year throughout the past three and a half years and expect this trend to continue in coming years.

Based on current business momentum, we expect this grow in revenues, earnings and cash flow to continue. As such we decided that we would like to increase and enhance return to shareholders by providing an annual fixed income in the form of annual cash dividend payment.

Coming to the last point, update on our guidance and outlook for the second half of 2018. Outlook remains very positive for the second half. As Niran has mentioned, we have up our revenue guidance. We now target the range of 171 million to 175 million, that’s about 10% over 2016.

On the earnings side, based on much more comfortable FX rate and strong business, we now guide for a higher range of earnings this year to be between $0.51 and $0.56 compared to $0.37 that we achieved in 2017, so that's another very strong growth.

This is my introduction for this call and I'll turn the call now to the Q&A session. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]

Our first question comes from the line of Rich Valera with Needham & Company. Please proceed with your question.

Rich Valera

Hi, Shabtai . Congratulations on the strong results. Just wanted to clarify on the UC-SIP business, I think in the press release you said that was up 30% year-over-year for the quarter and I think on your prepared remarks you might have said for the first half. So I just wanted to clarify was that 30% for the quarter or for the first half or for both? And then it didn't sound like you actually changed your prior expectations for that business to be up 15% to 20% for the year, just wanted to clarify if in fact you saw that growing maybe little faster than you did before given the strong results.

Shabtai Adlersberg

Right. Thank you, Rich. Well as provided in the second quarter we grew about 30%. When I look back into what's reported in the first quarter, it was apparent that we were put through then also that the first quarter of 2018 grew by more than 30% compared to the same quarter in ’17. Meaning that first half as a whole we grew more than 30% compared to the first half of 2017, so that’s on that. Yeah, we see acceleration, I think that has to do with the fact that in some of the lines namely Session Border Controllers, the phones, the management suite, the maturity that evolve throughout the years and I believe that right now we are in a better position to deliver more product and win more opportunities in the market. So at least this year as I mentioned we will grow from about 65 to almost 85, so that tells you that indeed this year we plan to grow more than 20%.

Rich Valera

Got it and just want to try to understand sort of what's driving that, I guess our thought based on your prior comments was that the deployment of voice within Teams would really be a second half kind of event for you guys. You didn't expect to see much incremental business from the Teams related voice deployment in 2Q. Sounds like you still expect to see that incremental Teams activity in second half, but what sort of drove the second quarter strength in the UC-SIP business?

Shabtai Adlersberg

So yeah, second quarter still we need to remember that puts aside the new Teams deployment and its projected growth in going forward, we have installed projects. We have – generally the way half of these projects were deployed is that in most of the implementation not more than 15%, 20% or maybe 30% of the total deployment occurred in a single company. Meaning that along the years we are enjoying repeatable business that's meant to expand the deployment that happened in past year. So second quarter most of the transaction opportunities were related to projects which are in midst of deployment.

Rich Valera

Yeah, that's helpful. And then can you just give a little more color on the Gateway business. I think you said that was down slightly in the quarter, if you can give any more color on sort of what's driving that over the near term and what your expectations are for the Gateway business for the full year that will be helpful? Thank you.

Shabtai Adlersberg

Right. So yeah, as we have mentioned in the past the Gateway business is very profitable. It’s annually I would say we do expect a decline of roughly 5%, 7% or maybe 8% or 9%, which actually this is what we saw in the second quarter. Now basically the decline – if one would invest more time into understanding the market there are certain divisions that one might do in order to get a better understanding, so first and foremost he Enterprise will gradually stop deploying Gateways simply because people will move to IP and UC based solution. On the Serviceable [indiscernible] side there are a lot of activities I’ve mentioned in the All-IP migration and to migrate a large base of small businesses requires the deployments of gateways in many places and analog gateways. So all in all we do see All-IP is driving much of the endurance of that market. Also you need to take into account the – we have a large portion of the revenues coming from services and maintenance basically because people need to maintain those networks and make sure that they work properly. So while product may be declining, services for gateways sometimes increase. So all in all I think to summarize all these long sentence, annually we expect gateways to decline between 5% and 9% and I think this quarter was just in line with that projection.

Rich Valera

Perfect. And I'm sorry one more for me if I could. You've been talking about the increase in marketing of your voice recognition products in the Voice.AI business. I think you initially marketed in Israel. You expanded that to Germany and then you are looking to go to other countries. Can you give us any update on where you are in the marketing of those voice recognition products? Thanks.

Shabtai Adlersberg

Yeah, we started increasing our investments earlier this year. We are fairly satisfied with the rates and the quality for our solution I think here in Israel we are becoming a de facto solution of choice. And there's a lot of demand. It's amazing that with the benefit of reducing operation costs at enterprises by removing some of the personnel it has to do with answering calls and routing calls.

The technology is mature enough I think using machine-learning and natural language understanding of the tough of our speech recognition technology allows us to provide more a natural language like solution. We definitely see a very high rate of success. And we are simply fine-tuning. The strategy has always been develop, go to customers, deploy, test, fine-tune, do all that in Israel. Once you are at the level that you feel confident, you can go with it to other markets in the best shape and do that and I think this is where we are today.

Rich Valera

So you're still kind of working on Germany at this point and other markets to come in the future?

Shabtai Adlersberg

Yeah, yeah.

Rich Valera

Okay. Thank you, Shabtai. I appreciate it.

Shabtai Adlersberg

Sure. Most welcome, Rich. Thank you.

Operator

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

Dmitry Netis

Great, thank you very much. Nice quarter guys and good to see you express confidence in the business here by raising your numbers for the year. I would like to – clearly there's acceleration here. EMEA demonstrated some strong sales motion I suppose. You had mentioned it was 35% versus 31% a year ago. What are some of the kind of ebbs and flows in Europe? Can you walk us through it? Is it a weaker competitive backdrop? Is it something in your sales motion that's working? Maybe if you can add some specificity about some All-IP project you're involved with would be really helpful.

Shabtai Adlersberg

Sure. So, yeah, let me divide my answer into splitting between service providers and enterprise. We do gain a lot of momentum in the service provider part of the market. Definitely All-IP is kicking gain. Germany is very strong. We have got many service providers customers in this country. We’re seeing those such new beginnings in other parts of US and Europe. So all in all we see very strong trend there.

We keep developing new product that will support that and we find a relatively easy market to compete in as we see not too many other companies rising for that segment. So that's on the service provider side. In the enterprise, I think it goes to the maturity of some of our sales operation in certain countries, so take the DACH region which is Germany, Switzerland, and Austria.

This is a very strong region for us to grow steadily and now we know the benefit of being a large player in that market. We also gave a push to our cell suppression in countries such as the UK, France, Benelux, the Nordics, also we've seen some comeback, very nice comeback in Russia. So all in all that is a broad growth and we feel very good about our operations in the enterprise at this stage.

Dmitry Netis

Have you been hiring more salespeople as you kind of go into all these geographies? I mean what's your hiring levels been kind of on the sales side over the last, I don't know, year or so?

Shabtai Adlersberg

Yeah, yeah, actually this is indeed a trend in our country – I'm sorry in a company. We basically are, if you will, putting much more effort on hiring in the sales and marketing area. We grow our personnel actually in the second quarter of 2018. We grew almost 7% in our sales staff. So, yes, a lot of investment goes into increasing sales staff.

Dmitry Netis

Very helpful. And you mentioned at least on the service provider side, there aren’t that many competitors you’re competing with. Can you walk us through some of the more obvious ones, guys like Ribbon and Oracle? What are you seeing out of them? They're chasing those deals as well or is it sort of an open field there for you? And if you could also comment in that same vein, what do you think will happen? This has to do with more of an enterprise obviously side of the business. What do you think the impact maybe with Ribbon acquiring Edgewater?

Shabtai Adlersberg

Yeah. So, yes, the usual suspects that you’ve mentioned are indeed Ribbon and Oracle. We do meet them in the market and we compete with them. We do feel fairly comfortable with our technology and products. So we compete with them. But we gain our share of the market. That is much more on the session border controller side of the business. When we go more for the gateways and the integrated access devices, the competition turns to be easier.

We compete with some small companies among them, one axis of France. The latest acquisition of Ribbon and Edgewater, we know Edgewater. It’s very strong in the US and we basically know that for many years. We have not seen them yet. Outside of the US, we may see them. But I think we'll be ready to compete in that area. So we do not believe that we will see a major change in that regard.

Dmitry Netis

Okay. And then also maybe just comment on your BroadSoft relationship now that it's part of Cisco, I always ask that question every quarter and wondering if there's any impact whatsoever, if you are seeing them kind of getting more aggressive at deploying their own session border controllers tied to BroadSoft ecosystem or not? A little color there as well.

Shabtai Adlersberg

Okay. So, yeah, all in all not too many days past since that acquisition occurred, so far all service provider accounts where we were designed in and where we sold the product, we do see continuation of our sales. So in that regard there's no change. And going forward it’s a question whether a service provider will choose to work with the suppliers front that has been deployed for so many years and another one that Cisco may bring in. But that relates to all accounts. We do believe that we will not see much business with Cisco going forward in new accounts. We know that Cisco is pretty determined to use its on solutions. We've seen that basically stated as referred to phones and headsets where Cisco announced that they will do their own.

That will hurt other players such as Polycom and Plantronics, but we’re not in there. But, yes, going forward we do not expect that we will see increased sales of session border controllers or a gateway into the Cisco environment.

Dmitry Netis

Okay. I appreciate that. Maybe moving on to Microsoft real quick and then I'll have one more financial question for you. I think I heard you say that you believe that Microsoft with their Tim’s product will start to push more into mid-market in SMB and I think you gave kind of first half of ‘19 timeframe. This is also applied to a cloud PBX or telephony systems or is it just kind of their team's environments or how are you thinking about that?

Shabtai Adlersberg

Yeah, well, I believe that Microsoft probably gives preference to grow Tim’s over a cloud PBX that has to do with their own consideration and technology evolution. So definitely while cloud PBX still keeps selling and it will keep being sold with large [indiscernible] customers would you like to use hybrid on-prem and cloud solution, I think that looking down the road a year and beyond, we will see much more emphasis, much more focus on Tim’s deployment. So we're trying to adjust our investments accordingly.

Dmitry Netis

Okay. And then Tim will have kind of cloud PBX attached to it like a pure cloud product for telephony as well. Is that that your expectation?

Shabtai Adlersberg

Well, Tim already provides voice services. Actually the announcement of direct routing means that they now – in the past they offered on-net voice services, now you can get to call PSTN numbers using the direct routing. So, yeah, voice is definitely a part – an important part of the Tim’s deployment.

Dmitry Netis

Okay. Yeah. I know there was a release back in May, but there are still some features that they're rolling out through the end of the year. There's like another major release happening at the end of this year. So I guess once that's complete, I don't know I was hoping to see if there were more aggressive selling their telephony systems or not and what you're hearing out there from Europe engagement with them?

Shabtai Adlersberg

Yeah. I will tell you I think they are and I’ll tell you why. As I’ve mentioned, up to Tim’s, there was no [indiscernible] business was not really cost-effective when selling to the mid-market and SMB. Now the go-to market, the perfect go-to market for SMB would be true service providers. And the addition of direct routing means that now Microsoft can team up with a service provider to provide voice services for the SMB. So, yeah, I think SMB will enjoy dramatic growth next year as the solution will become more mature.

Dmitry Netis

Okay. And then last question on the margin, gross margin side of things, strong performance relative to expectations for the quarter. It is down however from Q1. But I mean Q1 was sort of abnormal as you said last quarter. So what is your expectation for margin? It sounds like you are getting a lot more software products in the mix. So should that put positive pressure on the margin? And if so, where do you think that kind of a steady state margin is at the end of this year and then maybe going into ‘19 what should we be thinking kind of another 100 or 200 basis points of margin improvement or maybe just the balance kind of level set steady state, 60%, 30%, so just walk us through your thoughts there?

Shabtai Adlersberg

Yeah. So as I’ve mentioned first quarter gross margin was indeed abnormally high simply because we had large services and some credit mix that was more in favor of software that drove that higher. We believe that gross margin will generally be around 63% this year. We do expect, as I’ve mentioned, that going forward with the growing services portion of the business and the fact that some of our products such as session border controllers and management solution that are made in software, we do expect that on a year-by-year basis we’ll see step-up of that margin upwards. Yeah, we've seen about 100 basis points in past years. That would be a reasonable assumption for next year, yes.

Dmitry Netis

Okay. I appreciate that. Thank you and keep up the good work. Thank you, Shabtai.

Shabtai Adlersberg

Thank you, thank you, Dmitry, sure.

Operator

Thank you. Mr. Adlersberg, there are no further questions at this time. I’ll turn this over back to you for any final comments.

Shabtai Adlersberg

Thank you, operator. I would like to thank everyone who attended our conference call today. With good business momentum and execution on our plans in the first half of 2018, we believe we are on track to achieve another year for growth, substantial growth in our revenues and profits for the year. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.

Operator

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