Greetings ladies and gentlemen and welcome to the AudioCodes' Second Quarter 2021 Earnings Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Mr. Roger Chuchen, VP of Investor Relations. Roger, 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; and Dmitry Netis, Chief Strategy Officer and Head of Corporate Development. Before we begin, I would 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 US Federal Securities Laws. 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 demand for existing products, the impact of competitive products and pricing on AudioCodes' and its customers' products and markets, the timing of product, and technology developments, upgrades, and the ability to manage changes in the 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 of acquired companies into AudioCodes' business, possible adverse impact from the COVID-19 pandemic on our business, and results of operations, and other factors detailed in AudioCodes' filings with the US 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 Shabtai. Shabtai, please go ahead.

Thank you, Roger. Good morning and good afternoon everybody. I would like to welcome all to our second quarter 2022 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance for 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 second quarter were $68.4 million, an increase of 12.9% over the $60.6 million reported in the second quarter of last year. Services revenues for the second quarter were $27.8 million, up 21.9% over the year ago period. Services revenues in the second quarter accounted for 40.6% of total revenues. The amount of deferred revenues as of June 30, 2022, was $75.2 million, up from $73.4 million as of June 30, 2021. Revenues by geographical region for the quarter were split as follows, North America, 43%; EMEA, 32%; Asia Pacific, 19%; and Central and Latin America, 6%. Our top 15 customers represented an aggregate of 53% of our revenues in the second quarter, of which 44% was attributed to our 12th largest distributors. GAAP results are as follows. Gross margin for the quarter was 65.1% compared to 69.4% in the second quarter of 2021. Operating income for the second quarter was $7.9 million or 11.6% of revenues, compared to $10.1 million or 16.7% of revenues in Q2 2021. Net income for the quarter was $6.9 million or $0.21 per diluted share, compared to $8.2 million or $0.24 per diluted share for Q2 2021. Non-GAAP results are as follows. Non-GAAP gross margin for the quarter was 65.6% compared to 69.7% in Q2 2021. Non-GAAP operating income for the second quarter was $11.9 million or 17.4% of revenues, compared to $13.6 million or 22.4% of revenues in Q2 2021. Non-GAAP net income for the second quarter was $11.3 million or $0.34…

Thank you, Niran. I would like to remind everyone that in conjunction with our earnings release, we have posted on our Investor Relations website and earnings supplement deck. I would like to start by providing an agenda for today's discussion. First, I would like to discuss our strategy and business characteristics that differentiate us in the market. Then I will discuss our financial highlights and outlook for second half of 2022. Finally, I will provide detailed discussions of our core business segments. On the first topic, I would like to address the macroeconomic uncertainties and remind investors why the strong business foundation we have built so far should enable us to outperform during the uncertain environment. We are leveraged to multiyear secular growth trends in the unified communications market, notably Microsoft Teams and Zoom Phone and in the customer experience space. Customers deploy our software and services to drive greater productivity, which is particularly relevant in the tight labor and inflationary environment. We have a consistent track record of strong profitability and cash flow generation. On a trailing 12 months basis, despite short-term elevated supply chain costs, our non-GAAP operating margin was 19.2%, which is amongst the highest in our industry. Over the same period, we also generated $33.9 million non-GAAP free cash flow. Our strong financial profile enables us to continue to make prudent investments in our business to further strengthen our competitive mode and differentiate us from competition. We have a rock solid balance sheet, ending the second quarter with $138.5 million of net cash. We are in a great position to capitalize on any dislocations in the market, and we are actively looking for unique assets to add to our portfolio that can accelerate our long-term growth and transition to recurring revenues. Throughout our history, each time…

Thank you very much, Shabtai. [Operator Instructions]. Your first question is coming from Greg Burns of Sidoti & Company. Go ahead. Please ask your question.

Good morning. So just first on the revised guidance. In terms of the EPS, the decrease in EPS guidance, what are your assumptions in terms of margins for the back half of the year? Are you expecting any improvement from the second quarter or should we expect the gross margins to remain under pressure?

Yes. Generally, I think generally, I believe that we will see the additional cost for components going down. We've seen it going down a bit in second quarter. We expect higher decline in the third quarter. So, all in all, I think we hope to return as I have mentioned to a cross-margin that's about 67%.

Okay. I think about our operational margin A – Shabtai Adlersberg: Yes. right.

Okay. And Microsoft had mentioned they had 12 million PSTN users on Teams. So is that what -- are those the users that are -- where you're your services are touching, -- like if they're reporting to that number, is that a good number to kind of gauge the voice adoption in teams? And what are you seeing in terms of their efforts to increase that rate of adoption? A – Shabtai Adlersberg: Okay. Good point. So yes, teams-- I'll quote some of Microsoft in our statement. So A we announced €270 million of Teams uses right? Teams users does not include phone. So if you want to understand how many Teams phone users are, they stayed 80 million. Now out of those 80 million people who use Teams phone, not all are communicated with the outside world. So we have announced, and this is indeed an important announcement, they have mentioned in the last call a week ago that now they have 12 million of PSTN users compared with just 6 million a year ago. So growth on what's been -- we point here to the SBC acquired [ph]functionality, okay? Every organization that has embarked on using Teams can work internally without any specific solution. However, in order to communicate with the PSTN either to receive code in or to dial outside you need to add the SBC acquired functionality. As we just heard right now, the state 12 million such sets using that. I can tell you that we saying and we see it in the field that we control north of 50% of these sets and we see big growth in that. So yes, that is an important data point to base our future estimation as to the potential that we see ahead of us.

Okay. Great. Thank you. A – Shabtai Adlersberg: Sure.

Thank you. Your next question is coming from Samad Samana of Jefferies, Samad, please ask your question.

Hi. Great. Good morning. I wanted to follow up on the guidance question, but on the top line. I guess just as I think about the implied numbers, it kind of suggested back half deceleration to, let's call it, about from 13% in the first half of the year. And the comps are easier in the back half of 2020 versus the back half of 2021. So I guess I'm just trying to maybe understand what you're seeing specifically that led to the guidance reduction? I know you said macro, but are you seeing deal cycles get longer? Are you seeing people do smaller scale projects? What is driving the top line dollar revision? A – Shabtai Adlersberg: Right. So I'll just say initially that -- the update really was done due to our update on the earnings side, okay? If we would have not target to update that, I probably would have not changed my update on the revenue. As we provide an update, we said, okay, we're going to take down growth from -- we've guided initially to 13% a year. Now, it's going to be 12% a year. So we don't see that as a major uptick, right? To your question, yeah, we do see some of the projects taking a bit longer time. It's either a delay in decisions. I think the world has been in the previous months, questioning how this crisis is developing worldwide. I know that in the last months, estimate is more positive. But just to be prudent and not just take the guidance, we gave initially and say, okay, everything runs as before. No. There are some headwinds. We see longer projects, we see some delays, but the impact is in income is about 1% that's all.

Okay. That's helpful. And then maybe just in terms of what you're seeing with – when you're doing Microsoft conversions from Skype for Business to Teams, or as customers move over to Zoom Phone – are you seeing any change in behavior in terms of the footprint? Like are they moving over the entire base at once? Are they being more methodical about how quickly they're moving over to the cloud environment? I guess, what are you seeing as customers that you're helping convert over to the cloud? Like, how are you seeing in terms of trends there?

Yeah. We definitely see a very strong trend of all Skype of Business and Skype of Business online accounts moving to Teams. That just to talk numbers, right, a year ago or Sky for Business at 10 million, 8 million quarter – in the second quarter, I think it was down to about 2.7% versus the quarter ago, was about 4%. So the decline is fairly rapid. I know that, we know that, it's kind of costly. You can assume that, it's costly for Microsoft to maintain three different, I would say, infrastructure, application solutions, such as Skype for Business, Skype for Business Online and then Teams. So it is with Microsoft interest to speed up that process. And we are aware of that fact, customers aware of that fact – and I think it will not take more than a year, before the amount of scatter business really goes to almost nothing. But again, as I've mentioned because it's that low this time, $2.7 million a quarter, less than even 5%. And – the growth expected in Teams will substantially dwarf that decline of Skype for Business.

Great. Thank you for taking my question.

Thank you. Your next question is coming from Ryan Koontz of Needham & Company. Ryan, please ask your question.

Thanks for the question. On the strong services growth here with the AudioCodes Live $24 million ARR, what inning would you characterize Narin in terms of this transition of your new sales from product over to subscription? Where are we in that migration today on new sales? Thanks.

Okay. Yes, it's a good -- great question actually because we still keep selling products. At this stage, I think, products are above 50% of our revenue core. 50 is a very rapid transition. Already now, if I need to give an estimate, I think that approximately above 25% or maybe close to 30%, already moved from you know, bank – you know, AudioCodes live, let's say, recurring service compared with our CapEx transaction items. So it's a rapid. But again, I think, we have shown so far the ability to grow 100% year-over-year with because life move to recurring. We do not see -- actually, I would tell you that this is a very -- accepted very well in the market because the current difficulties of chronic lack of professional and talents in this space and the inability of large companies to deal with the modernization of the solution and actually, most of them are very often to is not part of their core competence. Many of them are open to using many services. This is all I think, I think managed services at this time or accepted federal simply because it alleviates a lot of the issues, one is to deal with when its deploying in the new solution in our system. So yes, we will see continued growth, if not 100% a year. I would tend to think that in the next three years, we will see between 50% and 100% growth every year.

Super helpful. And can you remind us of the gross margin difference in your managed services versus your corporate average?

Actually, the live because it's with more services and the margin there is higher than onetime CapEx deal.

Got it. And just a quick follow-up if I could. Any update on the competitive environment there, particularly as it relates to Microsoft's own internal solutions for SBCs?

Yes. I think, I mentioned before, everything we discussed so far relates to enterprise business. Microsoft acquired SBC from the Metaswitch deal is not in this space at all. They try to the operator connect. And there actually a substantial ramp-up of sales really did last for. So we do not see at this stage an impact to our business from that.

Good to hear. That’s all I had. Thank you.

Thank you.

Okay. Your next question is coming from Tal Liani of the Bank of America. Tal, over to you.

Hi. Thank you. Good morning. Good afternoon. Hi, guys. Shabtai, I didn't understand your answer on the previous, previous question. So I'll ask it again, but in a different way. You lowered the revenue guidance for the next two quarters. Is it based on concern, or is it based on a decline in orders you've seen from customers? And where -- if there was a decline, where is it? Is it specific product lines or specific customers. Can you elaborate on the revenue side? And then on margins, why now? We've seen supply constraints throughout the last at least four quarters, heavy, heavy supply constraints. Actually, most companies are saying that it has stabilized. It didn't improve, but stabilized. So why now you are flying it more than before?

Okay. So let me answer the second question first. A, we watch our costs in this market and our ability to get delivery and supply, I can tell you that towards the end of the second quarter, the two or three manufacturers, which we use, most of them solve their issues. So we believe this going forward. I'm not sure we're not using the same volume that large companies are using. So with our volume, we believe that third quarter will be a nice improvement. And actually, I'm told that in the fourth quarter, it will be minimal. So that's what we're seeing here internally at AudioCodes. Can you remind on your first question, what this is regarding the…

Yes. The revenue -- the question is, in simple terms, where do you see the weakness that drives you to lower the revenue guidance for the next two quarters. Is this coming from specific customers or specific products? Is it related to order cuts, what drives you to lower the guidance for the next two quarters?

Okay. On the revenue side, okay, no order cuts. No specific situation with specific customers. It's simply taking into account we have seen the velocity and that we had two years ago in providing products and services and getting to revenues. And the picture in the second quarter was more difficult, right? I think we all experienced headwinds anywhere in this world. So, just being more precautious. Simply, we have -- again, I've mentioned that with revenue, that's not the reason for providing an updated guidance. This is just since some updating guidance, it should -- this will take that into account. And so we lowered it by 1%. Not as specific. It's simply longer project decision being taken slower than before, et cetera.

And where do you -- right.

Right.

And this 1% -- it's 1% for the year, but it's greater for the next two quarters just because of the math. And where do you expect -- if you think about kind of where to take it from, where do you expect the weakness to be for the next two quarters? Is it -- I'm trying to understand if certain projects or certain customers, or is it more general kind of all over the place? Is it services? Is it product? Is it shipments?

Listen, just to give you an idea, it's not tied to any specific area. I'll give you the reason for it, right? I mean, we're talking about deals. If you take a Contact Center deal, that could be $1 million in size, that could be $0.5 million in size. So, just a removal of one project or a project replanning. I mean, we feel with revenue of close to 70 million a quarter. So, the ability to be on top in such difficult environment, I assume I need to leave more space for misses here and there. It's not tied to any specific area. It's not tied to Microsoft at all, not tied to -- specifically to the contact center. It's not it to the service provider space. But all-in-all, if I want to take the overall environment into account, if I have to basically estimate, I would probably say that middle of 2022, contrary to the beginning of 2022, chances are that it's going to be harder to achieve the revenue target and that's why we made that change.

And I know you don't provide guidance for 2023, but from your discussions with your customers and the projects you're involved in, do you already see some cautiousness from customers about project pushouts or anything that could suggest that we shouldn't be cautious on the following year?

Not really. No. Actually, I can tell you that we discussed in second quarter, I'll tell you that we have already -- July behind us. I can tell you that the pickup in projects in July is very strong. We have not heard in even one case projection for 2023 is going down. Think Microsoft keeps growing. Well, if you want to take Microsoft announcement a week ago, they are taking more very cautious, right? They are limiting the hiring trends before. I need to relate to that, right? And I think there was another announcement in May, I believe, where they've mentioned that they intend to decrease the rate of hiring in certain areas, including our Phase 2. So, taking that into account makes me make estimate that we're no different than Microsoft, right?

Got it. Last question, Shabtai, about your own hiring and your own kind of workforce, what are your plans? And how do you adjust to the environment?

So, we keep hiring. I mean, we have stated that this quarter, we did 31 position, about 18 full-time employees and 13 in outsourced positions. We continue to hire. I can tell you that I'm sitting daily and weekly with new request. Our services business approach, we need to add people. We have more position. We would like to increase our business in Asia-Pacific because it's growing very nicely, and we will have 12 positions. So, all in all, we simply need to be in control of how we grow, but we will continue to hire.

Great. Thank you.

Sure.

Thank you very much. Your next question is coming from Brian McWilliams [ph] from Barclays. Brian, please ask your question.

Hi, this is Jack on for Brian. Thanks for taking the question. So, you hit a strong inflection point in the CX business coming off the first quarter's year-over-year decline. After this return to growth versus the first quarter, should we expect this momentum to continue into the third? Thanks.

Yes. Well, I can tell you that from what we see already in the third quarter, we are in a good position to continue to grow in the third quarter. And all in all, I will tell you that the disruption in that market and the whole fast growth of call automation and conversational solution, yes, we will see contact center growing up.

Great. Thanks. And then in the first quarter, you discussed bringing on covers, so virtual agent of the global market in the second half of the year. Is there any sort of update here?

So, we're talking about progress, but there's no big contracts that I can talk about. I can tell you that a new solution that we got to the market in the second quarter for conversation of IVR. We are receiving very strong reception. And we are right now -- the product is now being trialed in between five and 10 new accounts. And since the -- it seems to be a gap in the market, that we can cover with that new product.

All right. That's it for me. Thanks.

Thank you, Brian.

[Operator Instructions] Okay. We appear to have no further questions in the queue. Would you like me to hand back over for closing?

Well, thank you, operator. I would like to thank everyone who attended our conference call today. This continued good business momentum in the second quarter of 2022 and strong underlying market trends in our industry. We believe, we are on track 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.