Greetings. Welcome to the AudioCodes Second 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, VP of Investor Relations. You may begin.

Thank you, Holly. 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 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 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'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 second 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?

Thank you, Shabtai, and hello everyone. Before I start my former 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. We will be comparing our second quarter 2023 results to the prior quarter as we believe it provides a better gauge of our financial performance. Revenue for the second quarter were $60 million, an increase of 1.4% over the $59.2 million reported in the first quarter of the current year. Services revenues for the second quarter were $28.5 million, accounted for 47.4% of total revenues. The amount of the deferred revenues as of June 30, 2023 was $77.7 million compared to $77.6 million as of March 31, 2023. Revenue by geographic region for the quarter was split as follows: North America 47%, EMEA 34%, Asia Pacific 13% and Central and Latin America 6%. Our top 15 customers represented an aggregate of 55% of our revenues in the second quarter of which 43% was attributed to our 11 largest distributor. GAAP results are as follows: Gross margin for the quarter was 64.1% compared to 61.7% in Q1 2023. Operating income for the second quarter was $2.3 million or 3.8% of revenues compared to an operating loss of $0.8 million or 1.4% of revenues in Q1 2023. Net income for the quarter was $1.1 million or $0.03 per diluted share compared to an operating loss of $0.2 million or $0.01 per diluted share for Q1, 2023. Non-GAAP results are as…

Thank you, Niran. I'm pleased to report second quarter 2023 results with meaningful business activity improvement relative to the prior quarter in our key strategic areas. We executed well in a challenging macro environment, with key growth engines, namely Microsoft, customer experience and voice AI growing nicely. We have also seen bookings experiencing measurable improvements relative to the last quarter. Importantly, core business leading indicators such as pipeline remain robust and we saw relative stabilization in non-core lines such as the service provider and IP phones, which was the line contributing the most the drop in revenue in the first quarter of 2023. These factors, coupled with incremental OpEx savings from cost-cutting actions announced last quarter provide us with increasing confidence to deliver on our commitment of delivering significant improvements in operating leverage over the rest of 2023 and beyond. We made good progress in our enterprise business, now reaching 88% of our company revenue. Microsoft related business in the quarter grew 12% year-over-year and 16% sequentially. Core to this growth was Microsoft Teams business, which grew 18% year-over-year. Strong ongoing momentum for AudioCodes live managed services continued with annual recurring revenue exiting the quarter at $40 million and growing over 60% year-over-year. Live total contract value generated in the second quarter grew 75% over the previous quarter. Strong life performance to date puts us on track to achieve our target of $46 million to $50 million objective for 2023, representing approximately 50% year-over-year growth. Zoom related business grew over 20% year-over-year. We also executed well in our customer experience in a conversational AI business with CX delivering 7% growth year-over-year. Overall, we executed well this quarter in our burgeoning success particularly in live puts us on an accelerated path in our long-term transformation to software and services. Talking about…

Hi. Thanks for taking the questions. So, I want to start on product revenues. Can you further elaborate what's driving the continued declines here? And then how are your inventory levels within the channels? And how does that inventory dynamic look for the back half of the year?

Yeah. First, with regards to product, indeed, year-over-year, there was a decline, a double-digit decline. But what's encouraging is that sequentially, we had 10% growth in product in the second quarter compared to the first quarter. With regards to inventory, it mainly related -- the increase in inventory mainly relates to one business line or product line, which is the IP phone and also relates to the weakness at the service provider CPE business. We believe effective next quarter, we will start to see a decrease in the inventory level.

Okay. That's good to hear. And for my second one, I want to -- I'm interested in the Voca contact center solution with Teams. Can you just tell us more about this product? What's the size of this opportunity that you believe you're attacking? And then what kind of customers is this targeted towards? You're focusing on SMBs, mid-market enterprises.

Right. So, basically, the Voca CIC targets entry-level CCaaS solution. We basically target both customer experience and enterprise experience agents. If you think about desks that would be using IT environments, HR desk, sales, travel desk, legal, et cetera. It would be very useful. Usually, we target in the initial phase, a level of tens of agents. However, the product is designed at this stage to be able to answer with customers that have up to, let's say, 500 agencies.

Okay. I understand. Thanks for taking my questions.

Your next question is coming from Ryan MacWilliams with Barclays.

Hi. This is Damian [indiscernible] calling in for Ryan MacWilliams. What are you driving commentary around future large enterprise contact center deals? And did you see any of those deals close in the second quarter?

So, we are actually already active in this market. And we have -- as I've mentioned, on our call, we already have -- the bookings growing substantially in the first half of the year. We definitely -- look, we just delivered a deal -- well, we just signed a deal close to $1 million with a large U.S. based organization. And we are fairly competitive. We get all kind of indication that we are able to replace known and incumbent players due to the fact that the solution is very advanced native to the Microsoft Azure and Teams environment. And once we are able to consolidate UCaaS and CCaaS in a single solution, that seems to be quite attractive to the customer base that intends to use Teams as its UC platform.

Got it. Thanks. That's all from me. Back in the queue.

Sure.

Your next question for today is coming from Greg Burns with Sidoti & Company.

Good morning. The large service provider that is going to be deploying using you for Teams Live. Can you just talk about that opportunity in that channel? Is that the first large service provider using you in that capacity, and what the pipeline of maybe other opportunities look like for you there?

Yeah. So, actually, we're talking about a derivative of the live services, which we called Teams Live Cloud. Live Cloud target service providers that typically will sell the live services to their own business customers. We already have a pack of more than 50 such service provider, although some are smaller in size. We are active in that area for the past 18 months, already generating monthly recurring revenues in the order of a few hundreds of thousands of dollars. And basically, the idea if you take a name in the first tier or second tier service provider, each of them would be basically looking to empower its business customers with live services, live club services from us and it should grow. I mean, we're just in the first innings of that product, but quite advanced. The product, by the way, supports not only Teams, but also will support shortly also Zoom solution and probably also WebEx solutions. So, all in all, it's the only true multi-platform solution out there that should be able to get on board fairly quickly smaller accounts into a very powerful UC service.

Okay. And then, the improvement you saw in the Microsoft business this quarter sequentially. Have you seen that continue into this quarter? Are you seeing businesses more willing to move forward with maybe projects that were delayed? What's the market environment look like there around Microsoft? And then, looking forward, should we just expect the growth of Microsoft now just to line up with teams at this point? Thanks.

Sure. Yes. Well, the environment is really -- we saw improvement in the second quarter. I think, the question that hoover in the first quarter, whether we're going into a recession or not. I think in the second quarter that went a bit away. So, businesses are willing to invest more moving forward with their projects. So, all in all, yeah, regarding the split between Teams and Skype for Business, yes, we are glad to say that we are really at the end of the decline in Skype for Business, which hurt the Teams growth. So, yeah, going forward, the main businesses Teams and it's growing nicely. I would expect that business to continue to grow in the range of 15% to 20% year-over-year.

Okay. Thanks. And then, just lastly, how much revenue you're generating from your Voice AI suite of products now? And how much do you expect that to grow this year?

So, I think I gave some numbers in the past. Last year, we did close to $6 million. We plan this year to grow at least 50%. But as several of our applications are maturing this year, we do expect even larger growth to start next year. So, next year, I would count on a 50% to 70% growth. All in all, we have just to give you an idea. We have four different areas of activities. I've mentioned Voice AI Connect, which is already selling in several millions a year. We just started out with Meeting Insights. We do have Smartapp, which is a compliance solution. We have the Voca CIC, which again shows very strong ramp-up in bookings. And we will plan on adding interaction analytics going forward. So, as I've mentioned on the call, we believe that these many different activities in the CX, the customer experience market will definitely help us grow conversational AI rapidly over the next years.

Okay. Great. Thank you.

Sure.

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

Hi. Thanks for the question. First, a clarification on my interpretation as we think about the live subscription, $40 million ARR and new product revenue at $30 million. Is it fair to interpret that with the transition from license to subscription for new footprint going out the door right now is around 25% subscription. Is that a fair assessment?

Pretty much. Yes, at this stage, I think we have gone pretty upward with our live subscription. I believe that in terms of bookings that's close to 25% of our overall Teams business.

That's great. And then, circling back to contact centers. Can you update us on any of your strategic kind of partner developments in this space be it some of the big players like Genesis and Five9 or any pure CCaaS players, including Amazon progress with there? Any updates on your kind of strategic plans with your contact center partners, would be helpful. Thank you.

Right. So, yeah, actually, we enjoy quite a success in the second quarter. We won and have described we own a multi-million deal of seven, eight years with a large system integrator moving a large logistics company from an on-prem vendor who seems to be losing steam into a cloud contact center solution. Our hall of fame is our voice capabilities. We -- well, providing a solution to a fairly complex voice network that may include 200 different sites in 100 different countries, different locations, different -- that's definitely a difficult task. And yes, I think that capability of ours has not gone discovered by some of the large contact center names that you have mentioned. So, yes, we do have a fairly close discussion with some of these partners that see us as a strong partner who can help them in solving all kind of issues. I've mentioned business continuity solution. There are some switching and first-mile solutions. So, yes, we are in a very strong discussion with players in the field.

That's great. Thanks very much. Appreciate it.

Sure.

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

Hey, I hope you can hear me.

Hi, Tal. We can hear you.

I want to ask you about the environment in the context of last quarter, Microsoft was weaker. This quarter, Microsoft is better. Does it mean that the environment is getting better, meaning the visibility has improved, or any better signed deals, did they work through inventories? Kind of when you look at last quarter that was pretty dire. And this quarter, when you look beneath surface, you can see some signs of I don't know if it's stability or even some growth. I want to understand if it means something, or it's not, just if you can tell us about spending. Thanks.

Sure. So, I've mentioned that we feel second quarter was better in terms of the overall environment and willingness, I would say, of management of cooperations to start spending more on modernizing their communication and collaboration solutions. And in that regard, I've mentioned that Teams users, we have overall worldwide 300 million. Voice have been applied to less than $20 million at this stage. I mean, Teams phone. So, there's a huge, huge runaway in front of us. And I think that once the climate is better economically, we do see the environment better. So, yeah, we see it quite stable, and we'll be able to further grow in coming quarters and years.

Now, there is expected acceleration in the second half. Is it based on contracts you already have? Or is it just normal seasonality? I'm trying to understand the risk in the acceleration.

Well, so far, we have not met any such risk. If you take our annual recurring revenue, which basically tells you that is the most important parameter for us. We're stepping fairly steadily. Just like an ARR solutions that growths, we grew 100% a year, then declined to 80%. This year, we will grow 60%. We're talking about tens of different projects. So, all in all, the statistic is there. The coverage is nice. By the way, one very important thing is that we're starting to see, as I've mentioned on the call, some very high total contract value projects, which could range from $1 million to $3 million over 36 months. All in all, very stable and promising environment for live deals in Microsoft Teams environment.

Got it. Last question. Sorry, I'm taking too much time. I think there was a question about it before me, but maybe it wasn't. One of the problems we have in the industry is two things. Number one is channel inventory that companies just bought too much. And number two is too much backlog. So, even when you see growth, it's coming from backlog, it's not coming from orders. Can you refer to these two things?

Yeah. Actually, we've been on the opposite side of defense, right? I mean, in the first quarter, we dropped simply because partners who used to buy a product and sell them to their customers stop buying due to the higher cost of money. So, we see -- we saw in the second quarter that some of them probably emptied already their inventory. So, we started to see some growth in the second half of the quarter. And going forward, we're already -- we are past July and we see that trend continuing. So, I believe that in the second half, we will see, at least for us, more orders that would use to fill up those inventories.

Got it. Thank you.

Sure.

We have reached the end of the question-and-answer session. And I will now turn the call back to Shabtai for closing remarks. End of Q&A:

Thank you, operator. I would like to thank everyone who attended our conference call today. On the heels of good second quarter and with more focused planning and better control of expenses for the rest of 2023, we have high confidence in our ability to expand our business this year and in coming years. We look forward to your participation in our next quarterly conference call. Thank you all. Have a nice day.

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