Good day ladies and gentlemen and welcome to AudioCodes' Third Quarter 2021 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host Roger Chuchen, VP of Investor Relations. Sir, the floor is yours.

Thank you, operator. 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 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 of AudioCodes and its customers' products and marketing, timely product and technology development, upgrades and the ability to manage changes in market conditions, as needed, possible need for additional financing, the ability just asked by covenants 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 and other factors detailed in AudioCodes' filing 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 would 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 the Shabtai. Shabtai, please go ahead.

Thank you, Roger. Good morning and good afternoon everybody. I would like to welcome all to our third quarter 2021 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 in the industry. I 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 $63.4 million, an increase of 12.1% over the $56.6 million reported in the third quarter of last year. Services revenues for the third quarter were $24.8 million, up 26.7% over the year ago period. Services revenues in the third quarter accounted for 39.1% of total revenues. The amount of deferred revenues as of September 30, 2021 was $72.1 million, up from $64 million as of September 30, 2020. Revenues by geographical region for the quarter were split as follows: North America 41%, EMEA 38%, Asia Pacific 16% and Central and Latin America 5%. Our top 15 customers represented an aggregate of 57% of our revenues in the third quarter of which 47% was attributed to our 10 largest distributors. GAAP results are as follows. Gross margin for the quarter was 69.6% compared to 67.1% in Q3 2020. Operating income for the third quarter was $10 million or 15.8% of revenues compared to $11.2 million or 19.8% of revenues in Q3 2020. Net income for the quarter was $8.3 million or $0.24 per diluted share compared to $7 million or $0.20 per diluted share for Q3 2020. Non-GAAP results are as follows. Non-GAAP gross margin for the quarter was 69.9% compared to 67.4% in Q3 2020. Non-GAAP operating income for the third quarter was $13.5 million or 21.4% of revenues compared to $13.4 million or 23.7% of revenues in Q3 2020, an increase of 1%. Non-GAAP net income for the third quarter was $12.9 million or…

Thank you, Niran. We're very pleased to report strong financial results and continued progress in our business in the third quarter of 2021. As in previous quarters, our enterprise business, now 85% of the quarterly revenue, kept growing and demonstrated growth of about 20% year-over-year. At the core of this success was the UCaaS business, which grew about 18% year over year and our contact center business which grew more than 20% year-over-year. The growth of these two key business lines for several quarters now in a row, clearly points to the potential of continued annual growth rate for revenue in coming years. Just to remind this all, our stated objective announced earlier in the year, we planned to achieve annual growth rate of 15% by the end of 2023. During the quarter, we continue to execute in all of our three strategic business areas in the enterprise space. The first one, Microsoft Teams business grew nicely above 20% year-over-year with Live services or Team's voice-as-a-Service leading charge. Contact center and customer experience operations grew nicely year-over-year. We have signed a new vendor partnership agreement and we're able to drive new advanced technological solutions with end users, mainly for call automation. And in the conversational AI space, we saw nice progress in this in several business lines growing year-over-year, above 50% in revenue and above 100% in bookings. Now products made in both the UCaaS and Contact Center in the markets in several past quarters further emphasizes the fact, the Team collaboration, hybrid work and work from home remain key industry trends, not only in 2021, but also for coming years. As such both markets over a long-term grow potential for us for several years going forward. Contributing to this fast pace of growth and success is our decision made…

Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] Your first question for today is coming from Greg Burns [Sidoti and Company]. Please announce your affiliation then pose your question.

Good morning. I'm with Sidoti and Company. So I just wanted to touch on the increase in OpEx and what your view is on that, the ranges you kind of set in terms of operating expenses as a percent of revenue and the operating margin targets. At what point do you expect to kind of slow down the investments and start to gain a little bit of leverage on some of the revenue growth that you're projecting? Thank you.

Okay. Well, most of the investment in growing headcounts really is related more to the sales and marketing side of the business to grow or Team's voice-as-a-service as the market grows and we need to be able to attract more customers and grow the business. We need to add personnel to provide good service. So our investment is less intense in the R&D space still going on and adding more automation and a few more solution to it, but the majority of the expense goes to the deployment in the market. So I think we've seen the most of the worst I would say part of the increase simply because from that pointing on, I think the behavior of the U.S. and new Israeli Shekel will moderate, substantially we will not face in anytime soon, another decline of 10% in that ratio. And then, again, coming back to the average salary issue in R&D the, I think this is a phenomena that you'll hear of many companies in Israel were due to the very attractive – I would say attractiveness of Israeli R&D, just give you an example. A month ago, we've heard Microsoft is planning to add 2,500 new positions in Israel in five new developments areas. And as you can imagine, there are tens of such companies increasing. Yesterday, we heard about AT&T opening a design center in Israel. So I would tell you that there is kind of, I would say, not call it a fight, but there is a big, big effort to be able to recruit the right talent to be able to grow the business. Luckily for us, again, most of the additions would be abroad in marketing and sales. So we do expect continued investment, but not as big job as we have faced current quarter.

Okay. And then in terms of the service provide space, do you – can you just give us a little bit more color on what is driving the declines there? Do you expect that business to kind of remain at these levels, like level off here? Or is there a reason to believe maybe that that business might potentially rebound from these current levels? Thank you.

Sure. Now I'm a bit more optimistic than I was about three months ago, because we definitely have seen in the third quarter some new demand and I would expect some level off. However, due to the shortage of components, we are kind of stuck here for, I would say, for this quarter, the fourth quarter, and maybe the first one too. So I expect I will – I do not think that we will see any further decline. Actually, I think we've reached the bottom and could see some up growth from here, but more growth should be expected in the second half of 2022. So all in all, it's an area that's not helping to drive revenues upward these days, but we believe it will make a comeback around mid next year.

Okay. Thank you.

Sure.

Your next question is coming from Ryan MacWilliams [Barclays Bank PLC]. Please announce your affiliation, then pose your question.

Sure from Barclays Bank PLC. Shabtai continued strong growth with enterprise customers. So as these larger customers are looking to adopt cloud solutions, are you seeing your average deal size increase? And are the companies by number of employees getting larger in your pipeline? Thanks.

Thank you, Ryan. Yes. Well, our focus, as I've mentioned, is really was – when we develop our solution for Microsoft's first Skype for Business and later on Team's, we're targeting usually the large enterprise companies with a number of employees ranging from, I would say, 3,000, 5,000 and upward. Lately with Team's voice-as-a-service, we also target smaller companies. We could go as low as 500 employees. So, we're working with the large global system integrator on the large enterprises. We're acting much more independently in the mid market. So this is where the focus is going to be. The typical business for us would be few thousands of employees, whereas they will start trialing and do proof-of-concept with first with a hundred or few hundreds of employees and then after a period of three to nine months will probably add more. So that's the trend you you'll see in that space.

Perfect. And then you mentioned Operator Connect last quarter along with this quarter. Would you mind just digging a little deeper on what you think that could mean for AudioCodes? And how do you think Operator Connect impacts the Direct Routing landscape? Thanks.

Sure. Okay. So, great question. As I mentioned in a moment ago, Microsoft focus was entirely in the beginning in the large enterprise space. There's no focused target effort in the mid-market. However, it's obvious that going to the SMB market and going to small businesses, usually that's not where Microsoft is having direct full efforts. In that space, obviously, RingCentral is the leading player. And as we could have seen Zoom, Zoom has entered the space. And actually now, according to that report from Piper Sandler, you can see RingCentral and Zoom in fight for this segment. Now Operator Connect, which will connect between Microsoft and service provider will allow Microsoft for the first time to target that smaller segments – smaller size business market, because, traditionally businesses of that size are being served by service providers and, you know take AT&T and Verizon, and operators anywhere in the world. So that was definitely open for us completely new segment that has not been served by us before. Once that program goes into full motion, the cooperation between Microsoft and service provider will allow us to turn our Voice Teams as a service into that small businesses market. So it's, it's a very important addition towards our future.

Thanks for taking my questions. Thanks guys.

Your next question is coming from Samad Samana. Please announce your affiliation then pose your question.

Hi, good morning. Samad Samana from Jefferies. So maybe Shabtai first. I wanted to ask about the component side. I wanted to make sure one that I think you said it was a $2 million headwind in the quarter. One, I want to confirm if that's the case. And then how does that factor into the guidance that you've given in – given for the fourth quarter or the implied guidance for the fourth quarter, and maybe how should we think about the impact of that into 2022?

Okay. So yeah you understood correctly. We could have delivered more. IP Phone products and more service provider gear. We believe that all-in-all we kind of missed the delivery of about 2 million in the core. So we have targeted a larger growth of revenue in the quarter. That phenomena will probably continue, I would say this quarter and in the first half of 2022, we took that into account when we gave the overall guidance, meaning that, taking that shortage into account, we still target to grow in the fourth quarter, if you make quick calculation, we definitely plan on growing in the fourth quarter, although less than we could have expected earlier in the year. So all-in-all that's for the guidance. Again, next year, I believe that as we approach second half of the year all that will go away. So we should get a boost from increased phone sales and service providers gear.

Great. And then maybe a follow-up. I know we've touched on OPEX, but if I look back at sales and marketing dollars in – from 2017 to 2018, it was roughly flattish, shows up very modestly in 2019. So even, pre-COVID it was fairly limited expansion in sales and marketing dollars. And now this year we're tracking up pretty healthily. How should we think about the – just the increases there going forward and what's the right level of sales and marketing investments that we should think about maybe both short-term and intermediate ?

Hi Samad, this is Niran. So again, as Shabtai mentioned, we are planning to invest more in OpEx mainly at the sales and marketing area. I can refer to the near-term, to Q4 we are planning to invest more and the level that you see in the third quarter, which was 14.4 million, we are planning to increase it, but let's say 1% to 3% in terms of sales and marketing. With regards to other OpEx such as R&D and G&A, we are not planning to invest much more than the level that we saw in the third quarter.

Great. And then just last question for me, Shabtai you spent a lot of time today talking about the seats available in the market and the opportunity. I was wondering if you could share with us just maybe how many Microsoft Teams, voice seats you're actually enabling today, just so we can get an idea of how AudioCodes’ progress looks against this large market,

Right. We do not you know discuss in public the number of seats we have, but I'll give you some numbers if you will. And if you go back to the Piper Sandler report, you can see that Microsoft teams seem to be deploying about 4.1 million subscribers this year. This should grow, as I've mentioned to 31 million in 2026. Now we are by far the dominant player in that market. You know, you can use market share of 60% or 70% these days. So that probably can give you some idea about the number of seats we are enabling, but at the same time, give you an idea about the future, our ability to double that number next year and grow to be 60% or 70% out of the total of 30 million in 2026.

Great. Thank you for taking my questions this morning.

Thank you. Sure.

Your next question is coming from Tal Liani. Please announce your affiliation, then pose your question.

Thank you. My affiliation is Bank of America. Good morning. I have a question on Zoom and also on Microsoft. Can you share with us what's the outlook for Zoom? What is – what are they doing there that involves you? What's the potential for other types of businesses with them? Just kind of, because it's such an important company. I just want to understand the outlook even not with numbers, just the – kind of the potential opportunities there. And then on Microsoft, can you share with us your view of how they evolve from here? Is there a risk of slowdown because of COVID year-over-year comparisons and just in general, same question on Microsoft? Thanks.

Okay. Thank you, Tal. Okay. Referring first to Zoom, [indiscernible] that Zoom Phone is a strategic for Zoom. And we have been working with Zoom for more than two years now, on reading and integrating our solution into frame. Now we've done a very little business in 2020, that business is growing substantially in 2021. The amount of new business created for us in the past two quarters is really overwhelming. Now, the way we are designing to the Zoom Phone solution is in two key areas. One is devices, phones that is integrated already today. Now I'll tell you and I think this is known that Zoom success really comes from the small businesses and in SMB. Zoom has an effort to grow up the market and go into larger organization. Whenever they go into larger organization, they need for SBC good as the solutions grow. So whenever they go to sell to a larger company, our potential offering grows in importance. Also we do intend to come in next six to nine months with our new offering for Meeting Rooms and that offering would combine of conference devices or meeting room devices management and meeting insights. And we will provide a comprehensive battle. We believe we will be very successful. We believe the Zoom should be a very important partner for us. So that's on Zoom. Regarding Microsoft Teams is perceived to be a key driver in Microsoft effort to increase licensing fees from E5. I think security and teams are the two leading drivers for the increasing E5 licensing as such. We could see a pretty focused effort at Microsoft to support Teams and Teams Voice more specifically. And I've just mentioned these two programs operated connect and SIP gateway to be fairly important to them. So I think it's known that Teams should be part of Windows 365, basically integrating Teams into practically not only the business world, but also for the consumer world. So I don't think we face a trend, a potential trend of lower focus in this area. I think we will see Microsoft keep investing because this is part of a substantially larger and overall more important target for Microsoft.

Great. Thanks Shabtai for the color.

Sure.

Just last question on supply chain, how – can you discuss how supply chain impacts you? How it impacts your clients and your ability to sell, even if you have the right components in place, just in general, the environment for supply chain?

Yes, actually it's really more the shortage of components. Obviously, there is increased lead times. So, our customers really suffer from inability to get the products they want. But other than that shortage, we are capable of working out around those issue in the production and delivery. So that's something that contained within our operations. All in all, I think, we are starting to see some signs that there are ways in which the world is starting to crank out more devices, more components. I'm optimistic that in six to nine months, we will see substantially leveling off of this issue.

Got it. Thank you.

Sure.

Your next question is from Ali Yaakov. [ph] Please announce your affiliation then pose your question.

Hi, [indiscernible] Capital. Great job on another good quarter. So my question is can you elaborate and give us more color about the time that you mentioned in the Microsoft Teams area specifically for the AudioCodes Live. To my understanding your thoughts about the rest of the market from the 440 million seats is $4.2 million, and that you can assume 50% CAGR year-over-year. And from that you can take 70% market share. Is that correct?

Yes, that is about the rough of my calculation. Yes.

And how should we look at it in the next couple of years in terms of your market share, or maybe you can charge more from a user per month?

Right. So AE1 [ph] needs to make a differentiation. We haven't done that yet, but we'll probably need to do it starting from next year. Everything we discussed so far on Microsoft Teams is really in the enterprise space. Now let's not forget that 440 million TAM relates to both enterprise and service providers. Now service provider was start to play next year. We'll see their competition. We expect competition from companies like Ribbon and Metaswitch, which is now part of Microsoft. So how market share will develop in the service provider that is still yet to be seen. However, we're very confident that in the enterprise space where we are today, we will keep being the dominant player. Obviously, the only competition – real competition will face there. It's just one company and we really don't see them close to us. Also, we do intend and I have not mentioned it. But we do intend to add more services, contact center services, meeting rooms services, recording services, management services. So I think we should be able to defend fairly nicely or dominance in the enterprise teams space.

So to my understanding that expands your time it is $4.2 million is only for the enterprises. Then you can take another market share from the service providers in the last – in the upcoming years, right?

Yes, that is correct. Although, 2022 will be just the launch here. So you should expect rather mild beginning, but I would tend to think that 2023 will be a year of where that market was growing fairly fast with large service provider, no names pushing it to the market.

Okay. Thank you so much.

Sure.

There are no more questions in queue. I would now like to turn the floor back over to Shabtai.

Thank you, operator. I would like to thank everyone for attending our conference call today with continued good business momentum and execution in the first nine months of the year. We believe we are well on track to end 2021 with a strong note of confidence in growth and expansion in coming years. We look forward to your participation in our next quarterly conference call. Thank you very much. Enjoy the 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.