AudioCodes Ltd (AUDC) 2022 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the AudioCodes' Third Quarter 2022 Earnings Conference Call. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, Mr. Roger Chuchen, VP of Investor Relations. Roger, over to you.

Thank you, operator. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; Niran Baruch, Vice President of Finance and Chief Financial Officer; and Dmitry Netis, Chief Strategy Officer and Head of Corporate Development.

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 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 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 products and technology development, upgrades 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 own 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; 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 plus 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, please go ahead.

Thank you, Roger. Good morning and good afternoon, everybody. I would like to welcome all to our third quarter 2022 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?

Thank you Shabtai and hello, everyone. As usual, 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.

Revenues for the third quarter were $69.7 million, an increase of 10% over the $63.4 million reported in the third quarter of last year. Services revenues for the third quarter were $26.8 million, up 8.2% over the year ago period. Services revenues in the third quarter accounted for 38.5% of total revenues. The amount of deferred revenues as of September 30, 2022 was $75.8 million, up from $72.1 million as of September 30, 2021.

Revenues by geographical region for the quarter were split as follows: North America, 46%; EMEA, 33%; Asia Pacific, 15%; and Central and Latin America, 6%. Our top 15 customers represented an aggregate of 59% of our revenues in the second quarter, of which 45% was attributed to our 11 largest distributors.

GAAP results are as follows: Gross margin for the quarter was 62.8%, compared to 69.6% in Q3 2021. Operating income for the third quarter was $7 million or 10.1% of revenues, compared to $10 million or 15.8% of revenues in Q3 2021. Net income for the quarter was $5.4 million or $0.17 per diluted share, compared to $8.3 million or $0.24 per diluted shares for Q3 2021.

Non-GAAP results are as follows: Non-GAAP gross margin for the quarter was 63.2%, compared to 69.9% in Q3 2021. Non-GAAP operating income for the third quarter was $10.8 million or 15.5% of revenue, compared to $13.5 million or 21.4% of revenues in Q3 2021. Non-GAAP net income for the third quarter was $10.5 million or $0.32 per diluted share, compared to $12.9 million or $0.38 per diluted share in Q3 2021.

At the end of September 2022, cash, cash equivalents, bank deposits, financial investments and marketable securities totaled $126.7 million. Net cash provided by operating activities was $2.1 million for the third quarter of 2022. Day sales outstanding as of September 30, 2022 were 80 days.

During the quarter, we acquired 273,000 of our ordinary shares for a total consideration of approximately $6.1 million. On August 2, 2022, we declared a cash dividend of $0.18 per share, the dividend in aggregate amount of approximately $5.7 million was paid on August 31, 2022

Regarding headcount, on the heels of 112 position in 2021 and 55 position in the first half 2022, we added 29 full-time employees in the third quarter 2022.

We reiterate our guidance for 2022 as follows: We expect revenues in the range of $275 million to $282.5 million, and non-GAAP diluted net income per share of $1.35 to $1.45.

I will now turn the call back over to Shabtai.

Thank you Niran. Before I started my phone remarks, I would like to remind everyone that in conjunction with our earnings release this morning, we've posted on our Investor Relations website, in earnings supplement deck.

So getting to the results, I'm pleased to report solid financial results for the third quarter of 2022 growing revenues 10% year-over-year. As stated in our press release earlier this morning, we see good continued business momentum in the UCaaS and the customer experience markets despite some macro uncertainty, key drivers of our growth in the third quarter '22 came from UCaaS or a Microsoft Teams related business grew nearly 20% year-over-year. AudioCodes Live from Microsoft Teams, Managed Services continued to grow and reached a level of $28 million ARR. Nearly, 100% growth of the year ago period, putting us well on track to achieve our 2022 target up over $30 million.

Importantly, total contract value for our Live subscription exceeded 90 million providing us with including level of revenues ability. We've also witnessed good momentum in the customer experience market, were our business was down 5% year-over-year, after being up over 20% in the prior quarter. The decline was driven mainly by seasonal and the softness in Europe. We expect this business to return to growth in the first quarter as we continue to see a strong pipeline of opportunities for the quarter. I would like to emphasize that we have not seen any evidence of competitive pressure or environment changes.

Another positive developments third quarter was stronger than anticipated activity in the service provider CPE business related to carry all-IP transformation and PSTN shutdown projects, which remerged post pandemic. Our service provider business grew for the second consecutive quarter and up over 40% this quarter and contributed to a strong pipeline for the next year. Another growth driver of our business is conversation of AI, which grew over 30% in the quarter. We saw increased activity in enterprise voice recording, in compliance recording and in the meeting space. Additionally, we had record bookings in the conversation of IVR and continue growth in our Voice AI Connect platform and enabling voice capability for the growing world of chatbots.

Lastly, I'm glad to report that despite evidence of slowing macro activity leading in few cases through longer sales cycles. We are pleased to have maintained LC top line growth and profitability relative to our UCC X peers, which speaks to the growth strength in our strong market position.

The operations front, we saw lower than anticipated gross margin and operating margin as compared to previous course. Our non-GAAP gross margin came in at 63.2% influenced by 2 primary factors. First higher supply chain costs, we incurred $1.2 million of higher component costs in the third quarter versus the year ago period. I'm glad to report that we now forecast the extra components cost to be around 500,000 only for the first score, which is a major relief compared to the third quarter just ended. Actually it's a relief also against each of the previous quarters of 2022, which were all in the range of $1.5 million to $1.2 million if that's gross margin is expected to be higher in the full score by about 100 basis points just from that category.

Product mix accounted for the balance of the gross margin difference. Trends in the service provide CPE an increase in sales associated with IP phone and meeting rooms collectively accounted for greater percentage of our sales this quarter. This products on hardware base and typically carry lower than corporate average margin. Non-GAAP operating margin was 15.5% and was largely impacted by lower gross margins and by higher operating expenses. Referring to FX, third quarter 2022, represents our lowest hedged rate of the U.S. dollar to Israeli shekels, which contributed roughly a 100 basis points to the non-GAAP margin decline on a year-by-year basis. Headcount grew year-by-year by 13.5% as a result of our increase investments, we'll talk more about it in a minute. These 2 factors were offset by tightening of discretionary expenses that lead to our non-GAAP OpEx growing 8.1% year-over-year while our revenues grew 10% year-over-year. On the yields of this development, our non-GAAP earnings per share came in at $0.32, which compressed to $0.38 in the third quarter of 2021.

In early 2021, we announced the plan 2 year increase investment cycle in R&D, sales and marketing, and services in order to better capitalize on secular growth opportunities in our end markets. Attending much of these objectives for the increased spending. We are now determined to balance our expenses for the balance of this year and into 2023.

Over the coming quarters, we expect to show improve operating leverage in the following areas: 1, tightening of spending as we approach the end of the planned investment cycle in 2023. 2, reduction of above 80% of the 2022 cost associated with component supply chain related purchases. We estimate 2022 extra costs to be around $4.4 million and so we're talking here about a savings of more than $3.5 million in 2023 bottom line. And then more favorable FX hedging in 2023 as those rates were fixed now when we do expect, again in 2023.

Now, let's dive into some of our most important our core business engine which is the Microsoft business. As discussed previously, Microsoft business grew nearly 20% year-over-year and makes up over 50% of our business. Teams grew 30% year-over-year with Skype for Business declined roughly 40% year-over-year and accounted for less than 10% of the quarterly Microsoft business.

Since newly created opportunities total amount have grown consistently over the last 3 quarters and up over 25% year-over-year in the third quarter, which provides a strong basis for further growth in coming quarters. We had another strong quarter for Microsoft Teams, account additions we added 298 accounts versus 248 in the year ago period, which speaks to the ongoing healthy adoption of teams in our growing pipeline.

To that end, we expect Microsoft winds to be up nearly 20% in 2022 to a run rate of between $140 million and $145 million. We really excited about the multi year growth opportunity to up-sell voice services that Microsoft Teams environments. Say reminder there are over $270 million monthly active users and Microsoft recently disclosed only about 12 million teams PSTN users implying only low single digit percentage penetration suggesting significant multiyear runway for growth.

Importantly, our market share within Microsoft ecosystem for that grouting. Application remains strong and is well above 50%. Because life managed services subscription increased nearly 100% year-over-year and the quarter and reach a level of 28 million annual recurring revenues nearly 100% growth year-over-year and putting us well on track to achieve our 2022 target of crossing the 30 million bar. Total contract value for our Live subscription exceeded 90 million providing us with increasing level of revenue visibility.

Now to our next emerging business, which is the contact center or customer experience. Third quarter revenues were down 5% year-over-year after being up 20% in prior quarter. Decline was driven seasonally by -- I'm sorry, decline was driven mainly by seasonal softener in EMEA. We expect a return to growth in the customer experience market in the fourth quarter. Backlog for the fourth quarter suppose this expectation at this stage. On an annual basis, year-to-date customer experience business was $31 million, growth of about 6.5% compared with the same period in 2021.

Looking out to 2023, we see growing adoption of new product and services launched during the past 12 months based on the increased investment cycle in 2021 and 2022. Each product and services should help boost revenue growth among them, and I'll count the various areas in which we have growing activity. It's activity related to WebRTC solutions, applications such as click-to-call application, allowing people to call over the Internet to their target companies and contact centers, conversational IVR solution. Voice AI Connect, which enables voice connectivity to voice enabled CRM, chatbots and IVAs and finally, recording solution, which are very in need these days with the evolution and the process of UCaaS, among them, we count Smartapp recording and meeting insight for meeting space.

Now let's shift gear to another very important pillar of our business, which is the services segment. So during driving growth in services, which consists of maintenance support, professional services and recurring Live subscription is key to our success in executing a multiyear transformation to software and service revenue stream. Services revenue grew 8.2% year-over-year in the quarter and accounted for 38.5% of revenues, while service revenues growth was lower than usual, largely attributed to timing. We saw strong invoicing activity in services and invoicing activity grew close to 15% year-over-year. With regards to invoicing, I should mention too that professional and managed services were up 23% year-over-year. We had excellent execution, again, in all our subscription, as I've mentioned before. Overall, we ended third quarter at $28 million, as mentioned earlier. Importantly, we benefit from multiyear visibility from this revenue stream as Live customers often sign for 36 months-plus contracts. We ended September quarter with over $90 million total contract value. Long term, we expect services revenue growth to outpace that of product.

Now to something that's usually is not part of our presentation, but it's important. I think before I'll turn the call over to the operator for the Q&A session. I'd like to talk about our strategy of how we navigate through the current economic slowdown. This is partially based on our own past experience in the dotcom crisis of 2001 to 2003 a year ago. So we entered the 2001, 2003 dotcom crises with a rock-solid balance sheet, around $140 million on our balance sheet, 190 employees and R&D expense of $10.6 million quarterly. During that period and up to the end of 2003, during the dotcom crises, R&D headcount grew from 190 to 330 and expense -- R&D expense grew 50% as we increased investments in innovative products, which allowed us to emerge winner from this crisis. We took this position as we add the money, the power, demand power, the technology base and our customers to rely upon in a market that we were confident in return to normal growth once the crisis is over. Obviously, we started from heavy losses during that period.

Our competitors did the opposite, they had to either cutback on investments, exit the business or ultimately fell by the wayside. This ongoing innovation fuels new product launches that help us to gain market share and drive outsized revenue growth. To give you an idea of how we went through that crisis. So revenue numbers for the period were as follows. In year 2000, we sold $72 million. In year 2001, the first crisis, we sold 36 going down 50%, emerging back from the crisis end of 2003, we sold 44 million. And then going forward, 5 years to 2008, we then sold 175 million. So from a bottom of 36 million in 2001, we grew to 175 million in 2008. Same, by the way, for our operating income, we entered the year -- we closed 2000 with 90 million. At the end of 2001, we lost 19 million, year 2003, we lost 10 million, but then in year 2008, we earned 13 million. Obviously, these numbers tell the whole story. We do believe that similar such strategy these days will take us in 2 years to 5 years from now.

Now heading into potentially another deep potentially deep or mild recession, we are in even better positioned as we have a similarly pristine balance sheet today. But now with very strong profitability that can further fuel our innovation and help us (inaudible) the competition whenever we emerge out of this economic downturn.

And with that, I've basically completed my presentation for today. And I'd like to turn the session to Q&A. Operator?

Thank you very much, Shabtai. (Operator Instructions) Your first question is coming from Ryan MacWilliams from Barclays.

Shabtai, since I feel like you've seen it all in this industry. How do you think about how the next 12 months plays out for cloud communications? Like do you think you'll see any difference in strength between cloud voice versus customer experience during that time period? And how do you think AudioCodes can best help customers during these macro difficulties?

Right. Ryan, I'm glad to say that we haven't seen any change in terms of the trends in both the UCaaS and the CX markets. So -- and we have not seen almost any change also in the adoption of Microsoft Teams and customer experience solutions. So we believe that trends will be well. Should we suffer from longer cycles of sales and/or long project. Yes, that could be the case. But I don't think that will affect us by more than a few percentage. At least this is the experience we have.

Perfect. And then one for Niran. I like to hear about improving operating leverage from here. Maybe how should we think about the magnitude of that? Should we think about maybe EBITDA margins in like 2020 or 2021 as kind of like a target for what AudioCodes trying to get back to you here?

As Shabtai mentioned -- just a second. Sorry for that. Ryan, as Shabtai mentioned earlier, we had 2 years of investments, mainly at adding more personnel and as I mentioned, we added 112 position in 2021 and more than 80 position so far in 2022. And by that, we are planning to stop the 2 years investment in more adding personnel. We believe and due to the 2 reasons that Shabtai mentioned also during the call, the FX, which this quarter was the worst hedging rate that we had and the component extra bite that we paid, we believe that effective the fourth quarter, we will start to see an improvement in getting back to operating leverage. Of course, for 2022, we will update and, say, the guidance for 2022 when we release our fourth quarter results. 2023 moment.

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

Could you just discuss the sequential decline in services revenues. What's driving that? And maybe we could just start there.

Yes. It's mainly timing. The best way to refer to services, especially maintenance contracts is referred to a whole year, simply because there are deviations in the timing of this. Usually, those are 3-year contracts, which are signed. There's no time pressure on selling them. So it may move from one quarter to another. But that's -- on an annual basis, I think the mix is such that the contracts are usually in the range of 8% to 10% annually. However, we continue to mention professional services in many services grow most of 20%. So the combination of the 2 allies somewhere between 10 and 15.

Okay. And then maybe we could just give a little more color about the types of customers that are signing up for Live. Is that mostly SMBs? Or is it SMBs to enterprise, the size of the customers signing up? And when you look at the mix of sales to the Teams environment, can you just kind of break out what is -- what percent of that business or new business is coming from recurring services like live versus traditional CapEx sales?

Right. So yes, the optimal customer for Live will usually be the mid-market, mid-market companies. Basically, smaller companies do not have the breadth and the bid for those type of services. A company that 1000 and 3000, 7000 or so will be served optimally by Live. They would focus on their core competence, no need and actually going to be difficult to attain those talents and resources that could help them run teams smoothly. So our sweet spot is mid-market. We happen also to gain some larger enterprises. And that's a process as time goes on being the percentage of larger companies grow. Okay. Sorry, what was the second question?

I was just asking what the percentage, the mix of like the team's revenues coming from traditional CapEx sales, new sales coming from traditional versus the live recurring?

Yes. Okay. So the way it looks now Live at this stage, is above 20% of overall team. So to break down teams into CapEx sales and Live, 80% or less than a 75% to 80% at this stage or CapEx sales and about 20% to 25% is recurring revenues Live.

Okay. And then could you just quantify the FX impact this quarter? Like how much did that impact the top line and the margins?

Yes. So basically, this was our worst quarter ever in terms of the hedge we had. And comparing to a year ago quarter, we declined almost 5%. So the impact was around 100 basis points. Going forward, we know and we have actually, we have an edge the trends well over '23 into '24. We already know that doing an annual calculation will benefit from the edge compared to '22 in a major way that will contribute. So already in Q4, we'll have a better rate, almost 1% over the third quarter, and this will continue and grow further into 2023.

Okay. And did the FX impact the top line at all this quarter?

Actually, yes, we have some revenues nominated in euros. So about, I'd say, 10% to 20% of our total quarterly revenues are in euro. And due to the weakness of the euro against the U.S. dollar this quarter we suffer also at the top line. And you can do the math.

Your next question is coming from Ryan Koontz of Needham & Company.

I wanted to double click if we could, on the Microsoft Teams environment, which obviously is a big growth driver for the company. And specifically, the phenomenon of direct routing versus Operator Connect seems to me we're starting to see these larger service provider partners begin to move to this Operator Connect model, which my understanding is that simplifies some of the onboarding for the enterprise by integrating into the administration of teams itself. So my question is, how does that change affect your business, selling it to direct routing versus Operator Connect? Are you seeing operator connects begin to happen yet? And in your current direct routing business, how is your exposure spread across traditional service provider operators versus kind of next-generation cloud voice providers?

Sure. Well, actually, one needs to make a big distinction between directing and Operator Connect. That routing usually targets enterprise companies, and that is an ongoing activity for the past 2 years already. So very active growing strongly. And Operator Connect is a new offering for service provider that has not really kicked in yet. Service provider will do and evaluate and make preparations to deploy the service, these will probably be more applicable to SMB. And so it's another area. But right now, that has not started yet. That's for us, obviously, we keep currently on working diligently on the enterprise side with Direct Routing. And we have done everything necessary to compete well on Operator Connect when it -- we'll see. I mean, we may see starting to take off second half of '23. But it's not known yet. So -- but again, we tend to be fairly competitive. We'll talk more about it that we -- one key different strategic advantage we believe, we'll have in that and all that is that we usually try to combined connectivity with business applications. And that is something that none of our competitors does. And that will become, we believe, substantially more important for it and be served by service providers. So we were waiting for that to often as well.

Okay. That's super helpful Shabtai. One quick follow-on. Discussing some of the cloud providers like 8x8 and RingCentral with their own direct routing offerings, they claim that there is an improved level of contact center integration with direct routing versus Operator Connect. Is that true from your perspective?

Yes, that is very logical. We definitely see that Direct Routing is basically a connectivity solution. However, if you talk about the needs of a business for voice services, they also need all of the different voice business application, take recording a contact center, take other areas. And in that regard, yes, it definitely makes sense that contact center will grow on the yield so far Direct Routing.

Thank you very much. There appears to be no further questions in the queue. I will now hand back over to the management for any closing remarks.

Okay. Well, thank you, operator. I would like to thank everyone who attended our conference call today. With continued good business momentum in 2022 and strong underlying market trends in our industry. We believe we are on track to another year of growth in 2022. We look forward to your participation in our next quarterly conference call. Thank you all. Have a nice day.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time. And have a wonderful day. Thank you for your participation.