AudioCodes Ltd. (NASDAQ:AUDC) Q3 2023 Earnings Call Transcript

AudioCodes Ltd. (NASDAQ:AUDC) Q3 2023 Earnings Call Transcript November 2, 2023

AudioCodes Ltd. beats earnings expectations. Reported EPS is $0.25, expectations were $0.18.

Operator: Greetings. Welcome to AudioCodes Third Quarter 2023 Earnings Conference Call. [Operator Instructions] I will now turn the conference over to your host, Mr. Roger Chuchen, VP of Investor Relations at AudioCodes.

Roger Chuchen : Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President of Finance and Chief Financial Officer. Before we begin, I’d like to remind you that the information provided during this call may contain forward-looking statements relating to AudioCodes business outlook, future economic performance, product introductions, plans and objectives related thereto, and statements concerning assumptions made or expectations to any future events, conditions, performance or other matters are forward-looking statements as the term is defined under U.S. Federal Securities Law. Forward-looking statements are subject to various risks and uncertainties and other factors that could cause actual results to differ materially from those stated in such statements.

These risks, uncertainties and factors include, but are not limited to, the effect of global economic conditions in general and conditions in AudioCodes’ industry and target markets, in particular, shifts in supply and demand, market acceptance of new products and the demand for existing products; the impact of competitive products and pricing on AudioCodes and its customers, products and markets; timely product and technology development, upgrades and the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy confidence in the company’s loan agreements, possible disruptions from acquisitions, the ability of AudioCodes to successfully integrate the products and operations of acquired companies into AudioCodes business; possible adverse impact of the COVID-19 pandemic on our business and results of operations.

The effects of the current terrorists attacks by Hamas and the warrent hostilities between Israel Hamas and Israel Hezbollah as well as the possibility that this could develop into a broader regional conflict involving Israel with other parties may affect our operations and may limit our ability to produce and sell our solutions. Any disruption in our operations by the obligations of our personnel to perform military service as a result of current or future military actions involving Israel and other factors detailed in AudioCodes’ filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information. In addition, during the call, AudioCodes will refer to non-GAAP net income and net income per share.

AudioCodes has provided a full reconciliation of the non-GAAP net income and net income per share to its net income and net income per share according to GAAP in the press release that is posted on its website. Before I turn the call over to management, I’d like to remind everyone that this call is being recorded. An archived webcast will be made available on the Investor Relations section of the company’s website at the conclusion of the call. With all that said, I would like to turn the call over to Shabtai.

Shabtai Adlersberg : I would like to welcome all to our third quarter 2023 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance of AudioCodes. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the quarter and discuss trends and developments in our business and industry. We will then turn it into the Q&A session. Niran.

Niran Baruch : Before I start my formal remarks, I would like to remind everyone that in conjunction with our earnings release this morning, we will post shortly on our Investor Relations website and earnings supplemental deck. On today’s call, we will be referring to both GAAP and non-GAAP financial results. The earnings press release that we issued earlier this morning contains a reconciliation of the supplemental non-GAAP financial information that I will be discussing on this call. Non-GAAP net income exclude share-based compensation expenses, amortization expenses related to intangible assets, expenses related to deferred payment in connection with the acquisition of Callverso, other income related to a payment made by the landlord of AudioCodes Inc., a subsidiary of the company in connection with the termination of lease agreement for its offices in New Jersey, financial income related to exchange rate differences in connection with revaluation of assets and liability in non-dollar-denominated currencies.

Noncash deferred expenses or income and noncash lease expense, which is required to be recorded during the quarter even though this is a free-rent period under the lease for the company new headquarters. To provide investors with a more accurate view of our current operating performance, we are adjusting lease expenses in our non-GAAP presentation. We calculate the non-GAAP adjustment by subtracting the noncash lease expenses during the quarter for our new offices, which are currently under construction from our total lease expense. The exclusion of these noncash lease expenses reflect the fact that we are not required to pay rent with respect to the new office during the quarter, and we are not yet occupying the new offices. After this adjustment, lease expenses in the non-GAAP presentation for the quarter will be equal to the lease expense for our current occupied office.

In the future, our non-GAAP presentation will reflect an upward adjustment for lease expenses over the life of the lease for the amount of lease expenses excluded in our non-GAAP presentation during the free rent period. We will be comparing our third quarter 2023 results to the prior quarter as we believe it provides a better gauge of our financial performance. Revenues for the third quarter were $61.6 million, an increase of 2.6% over the $60 million reported in the second quarter. Services revenues for the third quarter were $30.6 million, accounting for 49.6% of total revenues. The amount of deferred revenues as of September 30, 2023, was $77.8 million compared to $77.7 million as of June 30, 2023. Revenues by geographical region for the quarter were split as follows: North America, 48%; EMEA, 33%; Asia Pacific, 14%; and Central and Latin America, 5%.

Our top 15 customers represented an aggregate of 59% of our revenues in the third quarter, of which 48% was attributed to our 12th largest distributors. GAAP results are as follows: Gross margin for the quarter was 66.5% compared to 64.1% in Q2 2023. Operating income for the third quarter was $5.8 million or 9.4% of revenues compared to $2.3 million or 3.8% of revenues in Q2 2023. Net income for the quarter was $4.3 million or $0.14 per diluted share compared to $1.1 million or $0.03 per diluted share for Q2 2023. Non-GAAP results are as follows: Non-GAAP gross margin for the quarter was 67.3% compared to 64.5% in Q2 2023. Non-GAAP operating income for the third quarter was $9.6 million or 15.5% of revenues compared to $5.7 million or 9.5% of revenues in Q2 2023.

Non-GAAP net income for the third quarter was $8.3 million or $0.25 per diluted share compared to $5.1 million or $0.16 per diluted shares in Q2 2023. At the end of September 2023, cash, cash equivalents, bank deposits, marketable securities and financial investment totaled $102.5 million. Net cash provided by operating activities was $0.2 million for the third quarter of 2023. Days sales outstanding as of September 30, 2023, was 96 days. In June 2023, we received court approval in Israel to purchase up to an aggregate amount of $25 million of additional ordinary shares. The court approval also permits us to declare a dividend of any part of this amount. The approval is valid through December 27, 2023. On August 1st, 2023, we declared a cash dividend of $0.18 per share.

The aggregate amount of the dividend was approximately $5.7 million. The dividend was paid on August 31st, 2023, to our shareholders. During the quarter, we acquired 880,000 of our ordinary shares for a total consideration of approximately $9 million. As of September 30, 2023, we had $10 million available under the approval for the repurchase of shares under and all declaration of cash dividends. Regarding headcount, as discussed last quarter, we undertook actions to reduce headcount to better align our cost structure to the current business environment. The full amount of previously announced headcount reduction and associated cost savings are reflected in our third quarter results. We ended the third quarter with 938 employees, down from 946 employees at the end of the second quarter.

Now to provide an update to our guidance. We reiterate our guidance for revenue for 2023 to be in the range of $240 million to $250 million. We are raising our guidance for non-GAAP diluted earnings per share to be in the range of $0.65 to $0.75 compared to the previously updated range of $0.55 to $0.70. I will now turn the call back over to Shabtai.

Shabtai Adlersberg : I’m pleased to report solid third quarter 2023 results against a difficult macro backdrop with ongoing strength in our core enterprise business overall, partially offset by softness in our noncore service provider segment. We continue to perform well in our enterprise business, now reaching a record 90% of company revenues. Within enterprise, our UCaaS business continued to perform well, with Microsoft business up 13% year-over-year. Microsoft Teams business grew 20% year-over-year. LiveTeams annual recurring revenues grew north of 50% year-over-year, ending the quarter at $43 million, we expect Teams Live annual recurring revenue to grow approximately 50% in 2023 as planned earlier in the year. Customer Experience business grew 13% year-over-year, and conversational AI business bookings grew over 50% year-over-year.

Importantly, leading indicators such as stable amount of newly created opportunities remains robust and new business bookings had grown substantially above 2022, giving us increasing conviction about our business prospects for the rest of 2023 and into 2024. As referenced earlier, our noncore service provider segment remains challenged, down about 50% year-over-year. This is primarily attributable to customers adjusting CapEx plans, delayed projects and tightened inventory investment amid the challenging macro environment. Important to note, however, that we have won several new projects with leading service provider that can provide incremental revenue contribution in 2024. Now the positive development in the third quarter is the continued evolution in our conversational AI space merges a key growth engine for the next years.

Our investment in the conversational AI product innovation are paying off and have successfully positioned our UCaaS and CX segments for faster sustainable top line growth. Conversational AI bookings grew over 50% year-over-year. Since our announcement of the Microsoft Teams certification of Voca CIC in July 2023, our lightweight AI-first Team CCaaS platform, we have seen a step-up in customers’ interest and engagement. The success with our CCaaS offering is having a pull-through effect on our — on the rest of our conversational AI portfolio, in particular, in our generative AI-powered recording services. We are stepping up our efforts in the cognitive services space with key investments in speech to text and generative AI and LLM technologies.

In that regard, we believe that we own a unique advantage in maintaining a very comprehensive knowledge in several key vital technologies, which are really vital to create efficient systems. We own technologies such as telephony, VoIP networking and a variety of cognitive services technologies. Integrating these technologies with the vast experience we have in delivering full end-to-end solution and services creates for us clear unique advantage and capability to emerge a strong player in the emerging voice AI space. As an example to the advantage we have developed with our conversational AI in the UCaas space, we are now seeing rising interest and progress made with our meeting insights, workflow productivity application for meetings in the enterprise space.

Coupling meeting insights with the line of devices we have developed for the meeting rooms position, position us with a unique leading solution for the emerging meeting space. A few more notable developments in the third quarter are the following. We saw professional and managed services continue to evolve at a meaningful pace. Services accounted for 49.6% of revenues and grew 13.8% year-over-year compared to mere 2.4% in the previous quarter with an acceleration in growth rate primarily related to timing of professional services completion. What has fueled our ongoing momentum in services is primarily our live subscription business, which ended the third quarter at $43 million annual recurring revenues, up from $40 million last quarter. Additionally, we ended the quarter with total contract value for our live subscription, growing close to 10%, up from over $120 million in second quarter and providing us with an increasing level of revenue visibility.

We expect strong momentum in live services to continue for the balance of 2023 and beyond and reiterate our annual recurring revenue target of $46 million to $50 million by the end of this year. A few more notable developments in the third quarter are the following. We see a shift in our product mix to software and services. Noncore hardware-related product percentage of our revenues are now down to around 20%, contributing to increase in gross margin in our revenue. Noncore hardware relates to business lines such as the service provider CPE, IP phones and technology legacy. As we continue to add new value-add voice software application and services, we expect hardware-related percentage in our product mix to decrease below 20% and to contribute to the continued increase in gross margin in the coming years.

Another major trend in our sales operation is the shift from CapEx selling to recurring revenue sales, a trend that will affect our long-term financial model and relating mainly to both the top line and the bottom line results. On the top line or at the revenue line, we expect annual revenue growth to moderate to the range of 6% to 12% compared to the previous years, our annual growth rate was — range was between 10% and 13%. This decline is a direct result of moving to recurring revenue, where recognition is spread over 36 to 60 months rather than recognizing in a single quarter. However, the bright side of it is that on the earnings side, this trend contributes to key results: A, better visibility in future quarters revenue base is being built up sequentially quarter-over-quarter.

Then higher profitability is a result of the ability to add managed services on top of selling products. This, in return, will contribute to higher annual earnings growth rate, which we estimate to settle at the 25% to 50% range annually. As an example to the overall strong operational progress and execution, I would like to provide some details of a couple of major wins in the U.S. government space, which positions us to emerge as a major player in the vertical. We’re talking about a federal agency that issued an RFQ 4 IP Phone associated services as part of its long-term migration plan from Cisco to Microsoft Teams platform. After 18 months of extensive testing, we recently received an initial award of Teams certified epiphone in our work PO.

Our infrastructure device management software and wrapped up with our professional services support. This contract covers the option to purchase over 25,000 IP phones and associated software services over the period of five years. While long-term dollar value of this contract could be significant, I would like to emphasize the strategic nature of this win. First, the deal establishes direct relationship with the end customer and establishes a beachhead from which we can pull through other products in our portfolio. In furtherance of our land and expand strategy that we have successfully executed upon over the past several years. Second, after completing additional accredition and certification steps which are expected in the next couple of months.

This solution will be available for purchase to the broader federal agency audience, expanding our market reach by many multiples. In addition to our direct sales efforts in the federal vertical recently won a $1.2 million contract over 36 months with a Tier 1 system integrator, providing Live-glove, Live premium services to another federal agency. In support of its migration of 4,000 users to Microsoft Teams phone from legacy suppliers. This decision is driven by desire to upgrade from TDM to IT-based voice services and to create an end-to-end teams UC experience, which in the process enables the customer to terminate its high-cost maintenance contracts with legacy PBX vendors. For background, this is a large federal agency with over 50,000 employees with many bureau spread across the U.S. The recent win includes the headquaters of this agency, and we are working on several similar opportunities at the bureau level concurrently.

Before turning to detailed business segment discussion, let’s quickly shift to profitability metrics and guidance. Our third quarter 2023 non-GAAP EPS was $0.25, significantly exceeding our internal budget on the back of higher-than-expected non-GAAP gross margin and lower OpEx. Third quarter non-GAAP gross margin was 67.3% versus previous quarter of 64.5%. The improvement is primarily attributable to higher utilization of service resources and more favorable service product mix. Third quarter non-GAAP OpEx was $31.9 million, down from the $33 million level in the prior quarter and in line with the $2 million quarterly step down in OpEx planned from the first quarter of 2023, all in connection with our previously announced cost-cutting measure.

We ended the quarter with headcount of 938 employees, down from the 978 people we had in the first quarter. We will continue to align our OpEx to current market environment and business line performance with the aim of executing to our commitment of delivering significant operating leverage in 2024. On the guidance front, we are reiterating our 2023 revenue guidance of $240 million to $250 million and adjusting non-GAAP EPS guidance to $0.65 to $0.75 to reflect better-than-expected third quarter earnings results and ongoing momentum. This outlook builds in continued conservative enterprise spending environment and cost saving impact from our previously announced cost-cutting initiative. In addition, we expect our OpEx to decline in the next two years as a result of hedging the U.S. dollar against the new Israeli shekel, where steps we took in the previous periods will contribute nicely towards lower expenses.

Getting to more main business line, let’s talk first about Microsoft. Microsoft Business, our bookings increased 13% year-over-year in third quarter within which Microsoft Teams grew 21%. At the same time, Skype for Business was down 75%. Cafe business now at less than 2% of overall Microsoft business is now at a minimum level of less than $5 million annually. Starting in 2024, we will no longer break out mix of Teams versus Skype for business. From a geo perspective, North America was again the standout performer, while EMEA seems to have stabilized. For the first line of 2023, Microsoft business grew 7% year-over-year. Overall, we added 284 new Teams accounts in the quarter, a slight increase from $282 in the second quarter with the robust year-to-date growth in our pipeline or created opportunities.

We remain optimistic about the long-term growth potential for our Microsoft business. As a reminder, Microsoft recently disclosed over 17 million PSN users, representing 45% growth year-over-year. However, still representing just a fraction of the overall $320 million Teams monthly active users. We believe the low Teams phone voice penetration provides us with ample multiyear runway to drive ongoing penetration gains. We also saw a recovery of our IP phone business where demand from end users recovered significantly over what we experienced in first half 2023 as a result of inventory place. One key area for us in the Microsoft business is Teams Live Enterprise deals, which represent each a high total contract value. I’m glad to inform that in the third quarter, we were able to sign and close three accounts valued each above $1 million and five more accounts with an average total contract value of about $0.5 million.

This success rate helps us to build a very stable growing backlog of monthly recurring revenues for the next 36 months and beyond. Moving to customer experience. Third quarter contact center business, our bookings grew 13% year-over-year with strength in North America and APAC. Conversational AI bookings grew more than 50% year-over-year. While we are pleased with the ongoing momentum in our Customer Experience segment, what may be less apparent to investors is the underlying transformation in this business line. If we look back past period of similar growth in customer experience in 2020 and 2021 revenue growth then was driven primarily by our OEM operations and core SBC and connectivity solution, often sold on a CapEx basis. At that time, we had benefited mainly from increased volume of costs going into the contact centers during the pandemic.

Fast forward to today, our growth factors are benefiting not only from increasing customer experience call volume, but also product innovation and introduction in conversational AI, particularly our Voca CIC service offering. Clearly, the heavy R&D investments we have made in these emerging areas over the past couple of years are now starting to bear fruit. WebRTC, Click-to-Call, Voice.AI connect, those platforms are among the new sources of growth. This transformation of our customer experience business has not only improved the percentage of recurring mix, but also added additional growth drivers, which ultimately should position this segment for more sustainable long-term growth. At this stage, I should mention that Microsoft Teams and Microsoft business account for almost 2/3 of our quarterly business while CX now contributes about 20%.

Let’s move to discuss our recently introduced Voca CIC CCaaS platform for the Microsoft Teams environment. Since the announcement of Microsoft Teams certification for lightweight AI-first teams CCaaS platform, we have seen a step-up in customer interest and engagement. The success with our CCaas offering is having a pull-through effect on the rest of our conversational AI portfolio, in particular in our general AI based value-add solution. Let’s talk about the recent contract win that demonstrates our success in diversifying our revenue streams beyond our traditional business of selling session border controls and connectivity. This win relates to a very large auto service firm with broad distribution of local affiliates across the United States.

The customer is on a legacy platform, routing incoming customer calls from centralized outline to appropriate local branch. Working closely with a Tier 1 system integrator, we were recently selected to provide our conversational IVR system in a deal worth over $1 million total contract value over the next 36 months. The significance of this deal is twofold. One, this is one of the largest total contract value contracts in our Voca CIC product to date. This year, we’re seeing a very steep increase in bookings in that line. Second, when fully implemented, the 400 concurrent channels to be deployed demonstrates scalability of the Voca CIC platform, which should better position us to target progressively larger deal opportunity. Third, this deal demonstrates the flexibility of the platform as customers can purchase the lightweight SCaaS system, including conversational AI or IVR on a stand-alone basis.

Now moving to our Voice.AI connect platform. A major communication platform as a service customer recently unveiled an innovative new service powered by our Voice.AI connect solution, which enables its enterprise and customers to expedite rollout of virtual agents, thereby driving productivity improvement and cost savings. Our solution provides seamless back-end integration and connection to both frameworks, contact centers and to the SCaas customer. Separately, we recently received from a multinational health care company, large follow-on purchase of our Voice.AI connect solution, providing connectivity services to various conversational AI platforms in support of virtual agents and visual assist use cases. This customer now it’s over $1 million annual recurring revenue to AudioCodes is an early adopter of conversational AI.

We believe that the advance of generative AI can help accelerate time to market with this technology and look forward to working with other customers in their journey to drive productivity improvements. Lastly, I’ll speak about our Meeting Insight solution. We see ramping interest in our platform for handling meetings and calls across the organization, among those functions, recording, transcription, analytics, sharing, distribution and archiving. To date, we have tens of new accounts onboarding to the platform for processing enterprise voice interactions in meetings and calls. In terms of wins, I’ll mention that we recently scored a significant win with an Israeli government branch for a large number of users. Additionally, we are gearing up towards a cloud-based multi-tenant software as a service application with full generative AI integration, which is expected for GA early next year.

Now to the geopolitical situation. Before I conclude, I’d like to briefly address the impact of our operation from a war and recent developments in Israel. AudioCodes is a global organization, providing sales support and maintenance spanning all major geographies. We have not seen any material impact short-term or long-term disruption from this conflict. There has not been any delays in our logistical challenges. It’s our operational systems are cloud-based. We are assured solid business continuity. Around 10% of overall employees in Israel, mostly in R&D position, have been called up to the army duty. Aside from few weeks delaying a small number of projects in R&D, there’s no impact to our productivity. For the rest of the employees based in Israel, work is conducted in hybrid mode to ensure everyone’s safety and security.

Today, I’m heartened by the fact that all of our employees and families are safe. I would like to say that our hearts and thoughts are with all who were impacted by this terrorist attack. We hope and pray for the full recovery of those who were wounded and for the safe return of those, who are still missing. We wish for days of lasting peace in the region and around the world. To wrap up my presentation of the last six months, we have navigated well in an ongoing difficult macro environment, definitely balancing the achievement of short-term milestones while maintaining laser focus on our long-term transformation to our software and services company. In the short term, we have accelerated growth in key strategic areas of our business, Microsoft Teams phone comprehensive voice solution, customer experience and conversational AI and successfully executed on cost-saving program, both of which have contributed to significant expansion in our margins in third quarter.

At the same time, we achieved all of this. We did not lose sight of longer-term objective of expanding our total addressable market. Some of the accomplishments include. One, gained significant traction into the unified communications space with US federal agencies, a vertical that we have previously pursued only opportunistically. Second, successfully transformed our CX segment into a dynamic business with multifesitive growth drivers. These developments, backed by core business leading indicators, such as pipeline remaining robust, give us increasing confidence in returning the company to top line growth with ongoing operation leverage improvements in 2024. With that, I’ve concluded my presentation for the session.

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Q&A Session

Operator: We will now be conducting our question-and-answer session. [Operator Instructions] Your first question is coming from Ryan MacWilliams of Barclays.

Ryan MacWilliams : Do you think products like Microsoft Co-Pilot for enterprise could drive more enterprise customers to put their communications following Microsoft Teams and then in turn utilize your solutions at AudioCodes to help them do that for things like voice?

Shabtai Adlersberg : Yes, that is the play. I believe just as Microsoft thinks that moving from one telephone solution partner, like in the past, could be Cisco, Avaya and anyone else into Teams, it will be really desirable mainly if on top of Teams, you can provide higher value applications. This is indeed what Co-pilot provides, and this is indeed what we’re trying to do with our value, voice of the application. Voca CIC is a contact center in our IVR on top of Teams phone. Same goes for Meeting Insights, same goes for smarter. Yes, I definitely believe that with Co-Pilot becoming useful and contributing to gaining more insight into the phone system and voice interaction resulting from it? Yes, that will definitely help in the future to the growth of Microsoft Teams phone.

Ryan MacWilliams : You guys have a pretty strong exposures in terms of facing up against the macro with federal customers and large enterprises and the time to Microsoft are things that I think have been a little more resilient at least so far during this earnings season. As you talk to some of your largest customers or potential customers, what are they saying right now about next year? Do they think they can grow next year? Or are they still — because they’re on better footing, being more enterprise, more comfortable continuing with large enterprise deployments. Just want to hear how they’re thinking about their budgets and their place in the macro at this point.

Shabtai Adlersberg : Yes. I’m less in a direct touch. Quite frankly, we’re deeply looking to make 2023 successful. Have not yet. I mean, we’re entering our planning phase normally in November and December. We can though judged by their actions and from what we can see, I think definitely Microsoft Teams is an essential platform for collaborating, both on-prem and remotely. I think it is really do exactly what we just answered on the previous questions, they will simply look to enhance their productivity. Definitely, generative AI will be there to drive more voice-based software applications. We have not seen a decline. I’m not aware of a substantial uptake. We see the business continuing developing. Microsoft should grow for us this year around 10-ish, 10%, 12%, and we expect to see that next year. I think that the increasing maturity and more value from applications will definitely help drive usage of the system. No decrease

Operator: Your next question is coming from Greg Burns of Sidoti & Company.

Gregory Burns : I appreciate the improved momentum or execution you had quarter-over-quarter. Can you just remind us what is the primary drivers of the year-over-year decline, particularly around, I guess, on the product side of the business. Can you just give us a little bit more color on the primary drivers of the year-over-year decline and I guess the outlook for getting back to revenue growth?

Shabtai Adlersberg : Yes, it has to do primarily with the split of our business between enterprise and service provider. Yes, we can see and definitely in the third quarter, we’ve seen that more than before, Enterprise business is well on its growth, and we have not seen — except for a slight decrease in the first quarter in Microsoft. The rest of the year, we see growth. The other side of the business, which is service provider really suffers badly. To give you some rough numbers, looking on the overall 2023, take one line, the service provider CPE. We reached about $40 million level of revenue last year. This year, we do not expect more than $30 million. The major decrease in product value comes from product used by service provider, namely gateways and service provider and MSBR.