Greetings. Welcome to the AudioCodes First Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Roger Chuchen. You may begin.

Thank you, Holly. 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 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 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' 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 income per share. AudioCodes has provided a full reconciliation of the non-GAAP net income and income per share to its net income and net income per share according to GAAP in the press release stated – 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'd 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 first 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 industry and business. We will then turn it into the Q&A session. Niran?

Thank you, Shabtai, and hello, everyone. Before I start my formal remarks, I would like to remind everyone that we will make available shortly an earning supplemental deck on our Investor Relations website. 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 first quarter were $59.2 million, a decrease of 10.8% over the $66.4 million reported in the first quarter of last year. Services revenues for the first quarter were $13.5 million, up 10.8% over the year-ago period. Services revenues in the first quarter accounted for 51.5% of total revenues. The amount of deferred revenues as of March 31, 2023, was $77.6 million compared to $76.8 million as of March 31, 2022. Revenues by geographical region for the quarter were split as follows: North America, 46%; EMEA, 31%; Asia-Pacific, 17%; and Central and Latin America, 6%. Our top 15 customers represented an aggregate of 54% of our revenues in the first quarter, of which 40% was attributed to our 11 largest distributors. GAAP results are as follows: Gross margin for the quarter was 61.7% compared to 66.9% in Q1 2022. Operating loss for the first quarter was $0.8 million compared to operating income of $8.1 million in Q1 2022. Net loss for the quarter was $0.2 million or $0.01 per diluted share compared to operating income of $8.6 million or $0.26 per diluted share for Q1 2022. Non-GAAP results are as follows: Non-GAAP gross margin for the quarter was 62.1% compared to 67.2% in Q1 2022. Non-GAAP operating income for the first quarter was $2.9 million or 4.9% of revenues compared to $11.9…

Thank you, Niran. As we pre-announced earlier this quarter, our first quarter 2023 financial results were impacted materially by the slowing global economy and rising uncertainties worldwide. These macro trends have manifested in enterprise and service provider customers and partners, slowing decision cycles on product purchases, primarily in EMEA. We have also seen North America service providers manage their inventories more tightly as they focus on cash flow optimization and [indiscernible] reduction. Among the business lines that are mostly hurt is the service provider CPE line according – accounting for roughly 10% to 15% of our revenues annually. This line has declined roughly 20% in the quarter year-over-year. To provide some context around this, one of our North American carrier customers post orders at the beginning of the quarter until the carrier has utilized much of the existing inventory in its warehouses. Towards the end of the first quarter, product shipments to this customer have resumed. While the macroeconomic terms as seen today seem to persist for the rest of the year, we do not expect further decline beyond the first quarter of 2023. We, thus, expect service provider segment to decline roughly 20% in 2023 as the impact from inventory rationalization efforts from North American carriers to slowly subside over the course of the year. The other business line that has suffered decline was the IP phone line, which was mostly affected in Europe. We have seen channel partners holding purchasing for their inventories as a result of customers delaying product purchase decision for a second quarter in a row now. We saw similar such trends in North America. On a brighter note, the backlog that has been pushed forward is very high at this stage and represents 10s of minutes of value that we could materialize when this…

At this time we will be conducting a question-and-answer session. [Operator Instructions] Your first question for today is coming from Greg Burns at Sidoti & Company.

Good morning. Can you just walk us through the $50 million decline in the full-year revenue outlook, the buckets of revenue driving those declines? What parts of the business are accounting for that?

Okay. So basically, we really took a cautious position. Basically saying that due to the fact that the macro trends are not changing, as we step into the second quarter, and we did roughly $60 million in the first quarter. It was natural for us to basically plan for a year that would be either flat or slowly growing. The lines that went down primarily, as I've mentioned in the call, or CPEs mainly sold to service providers and also products sold in the IP phone product line. Also, we had to took some of the growth we expected for other areas. Let's mention the meeting rooms in the Microsoft Team space, where we prior to January 2023, we envisioned substantially larger growth, and that has not happened. Also, if we watch the trends in the Microsoft camp, while we were growing 10% to 15% year-over-year in the prior years. In the first quarter, we were about 3% down. So we need to take all these factors into account when we plan for the full annual forecast, and that was the result

Okay. Thank you. And then – how big is your – the IP phone business? What percent of your revenue is IP phones and other hardware like that, I guess, that would also include your meeting room applications?

Right. So IP phone business was roughly above 10% last year. And we believe that this year, it will not reach more than 60% to 70% of that. Unfortunately, just to tell you that, as I've mentioned, we have a huge backlog of opportunities to supply. We are in a stage where it's already the second quarter in a row where purchases are being pushed to the next one. March was really very clear in that trend, things looked rather okay in January and February. In March, we saw several deals being pushed. That is the second quarter in a row. So that's what's happening. I think all-in-all, if you – both phones and CPE are CapEx type of sales, well, you could see that the recurring business sales really did not suffer as much as the CapEx. And I think this is part of what we saw in the first quarter.

Okay. Thank you.

Your next question for today is coming from Samad Samana at Jefferies.

Hi. This is Mason Marion on for Samad. Thanks for taking our questions. So if I look at your EPS guidance, how should we think about your product gross margins going forward? Is it – should we assume that your 1Q level is a fair range?

Yes. So with regard to gross margin, this quarter, we ended 62.1%, which is a major decline compared to last year. Part of it relates to product mix and the other relates to the reduction in total revenues because part of the COGS is actually a fixed cost. So all-in-all, we believe gross margin should improve slightly in the next few quarters, mainly at the second half of the year.

Okay. Understood. And then if we think about the channel partners kind of destocking, are you seeing any signs that, that's going to normalize? How should we think about kind of the seasonality throughout the year or should we just assume kind of 1Q levels or a fair way to think about it?

Okay. Well, unfortunately, is the outlook going forward on the economic side is not changing. We don't see any change to the behavior. I think it's all – we all know that it's all tied to the inflation rate and the interest rate. And as long as those are in the same level and we don't see a change in those. I would not expect – and especially when the cost of money is that high, I would not expect that stocking will resume sooner than changing the overall economy.

Thank you.

Sure.

Your next question for today is coming from Tal Liani at Bank of America.

Hi guys. I want to take – maybe a step back and think about the macro. We're seeing other companies dealing with channel inventory and inventory in the hands of the customers, and that's why orders are coming down. And we're also seeing companies dealing with high backlogs, and that's why also orders are coming down. And the question is when you look at your weakness, what's the source of it? Is it coming because projects are getting canceled or is it coming because there is channel inventory and backlog, but the deployments continue to be at the same rate? I'm trying to understand if the weakness – how temporary – how much visibility you have to recovery, meaning how temporary is the weakness?

So, we do believe that we have not seen that phenomenon in previous quarters up until the end of 2022. I think the worsening conditions earlier in the year really caused service providers and channels to basically hold purchases and do better inventory control. Now as we have mentioned earlier, we gave one example in the call of one big service provider customer that halted all purchasing in January. But as soon as it has used a lot of its backlog in its warehouses in the month of March, we saw him coming back to purchasing. So it's really – I think the amount of backlog that was sitting in warehouses are fully diminished to a level where, from now on, we will not see any impact from that side. However, there's still the impact of customers rationalizing their expenses and pushing products and/or making them smaller as they lay off employees. So these are the two factors. So as long as the economic situation is not changed. We do not see any abrupt changes to what's already happened in Q1. But on the other side, we can't see yet any improvement in that respect.

But when you – I don't know how much visibility you have to end projects when you look at your big customers, do they continue to deploy at the same rate? So if they have inventory and it's just inventory adjustment, it means that they continue to deploy the same rate. So do they continue to deploy the same rate or do you see a slowdown in the rollout of projects that projects are being slowed down or canceled or pushed out? And I'm talking about the end customers, end-to-end customers kind of.

Right. So yes, primary customers, those who we target usually, and we're talking roughly on either Microsoft and/or contact center customers, we're talking about large companies. So large companies may slow down a bit projects, but all-in-all, we have not seen major pushouts of complete project or delays by more than a year. What we are seeing is a delayed decision on the expense. So when you're talking about Live projects, we gave you a number. I mean, we grew 60% year-over-year, meaning that as long as the project is of a managed services side, there's a little chance that it will be canceled and push out completely. However, when you say a CapEx deal, where you need to spend $0.5 million or more than $1 million in an opportunity, then maybe due to financial conditions, you may decide you want to push it. So that gives you kind of an idea. Overall, we see good customer behavior. Yes, on the tail, we've seen some projects being – but that's not a phenomenon. The strong companies, the large companies keep deploying and readjust – if you – we have mentioned on our website, we have one big company in Japan that has signed with us to deploy a global project. We have another U.S.-based retail company, large retail companies also started, well, signed with us and then started to deploy. So the projects are there. It's only maybe a slower deployment cycle or whatever, but that's the whole difference.

And sorry last question, is there a change in the pricing environment as a result? Is there a change in the competitive environment? Do you see competitors – other competitors getting more aggressive because of the slowdown?

None. We do not see any competition in our markets. Some people sometimes make a mistake and compare us to another company that's active in the SBC space. But I will tell you that we do not see any competition in the Microsoft space. So there's no pressure at all. It's really more our ability to add more services and more application. As I have mentioned, if you think about us being able to deploy IVR solution and our contact center solution in our Meeting Insight solution in that environment, we just improve our ability to get increased ARPU from those customers. But we have not seen pressure on the competitive effect.

Thank you.

Sure.

Your next question is coming from Ryan MacWilliams at Barclays.

Hi. Thanks for taking the question. This is Pete Newton on for Ryan MacWilliams. Just the first question is, are you seeing any slowing on planned phone deployments at the enterprise level due to macro? And then also, what does your outlook look like for contact center? It sounds like something of that business is pretty healthy?

Right. So yes, as I mentioned, I think the bottom line is that while last year, we grew above 15% year-over-year on the large enterprises in the Microsoft space, we will see this year a lower rate of growth. In the first quarter, it was 3% down, but we do expect that it will keep up going on. Also the fact that Skype for Business really went almost to 0% and Teams grew 5%. So we bring that we will see in the Microsoft space growth, maybe 5% to 10%, as compared to 50% last year, but that's all a result of the economic situation.

Okay. Perfect. And then just any thoughts on your teams versus zoom in your product portfolio? And any differences you're seeing?

We haven't mentioned Zoom in this call. But yes, we do have a good business with Zoom. We worked with them on several projects. Yes, we have not seen any major change in the behavior of our ability to win project with Zoom in the first quarter.

Okay. Thanks for taking the question.

Sure.

[Operator Instructions] We have reached the end of the question-and-answer session, and I will now turn the call over to management for closing remarks.

Thank you, operator. I would like to thank everyone who attended our conference call today with more focused planning for the rest of 2023, better control of our expenses to be aligned with revenues this year and strong underlying market trends in our industry in the coming years, we have high confidence in our ability to expand our business in coming years. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.