Good morning, everyone, and welcome to the AudioCodes Second Quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode, and we will be opening for questions following the presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Roger Chuchen, Investor Relations at AudioCodes. 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. 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 impacts of competitive products and pricing on AudioCodes and as 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 result of operations. The effects of the current terrorist attacks by Hamas and the war in hostilities between Israel and Hamas and Israel and Hezbollah, as well as the possibility that this could develop into a broader regional conflict involving Israel with other parties may affect our operations and may limit our ability to produce and sell our solutions. Any disruption in our operations by the obligations of our personnel to perform military service as a result of current or future military actions involving Israel 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 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 and archived webcasts will be made available on the Invest 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 2024 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. Before I start my formal 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 an earning supplemental deck. On today's call, we will be referring to both GAAP and non-GAAP financial results. The earning 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 $60.3 million, an increase of 0.5% over the $60 million reported in the second quarter of last year. Services revenues for the second quarter were $32 million, up 12.3% over the year-ago period. Services revenues in the second quarter accounted for 53% of total revenues. The amount of deferred revenues as of June 30, 2024, was $80.3 million, compared to $77.7 million as of June 30, 2023. Revenues by geographical regions for the quarter were split as follows, North America, 47%, EMEA, 35%, Asia-Pacific, 13%, and Central and Latin America, 5%. Our top 15 customers represented an aggregate of 56% of our revenues in the second quarter, of which 38% was attributed to our nine largest distributors. GAAP results are as follows. Gross margin for the quarter was 65.5% compared to 64.1% in Q2, 2023. Operating income for the quarter was $4.9 million, or 8.2% of revenues, compared to operating income of $2.3 million, or 3.8% of revenues in Q2, 2023. EBITDA for the quarter was $6.2 million, compared to EBITDA of $2.9 million, for Q2, 2023. Net income for the quarter was $3.8 million, or $0.12 per diluted share, compared to net income of $1.1 million, or $0.03 per diluted share, for Q2, 2023. Non-GAAP results are as follows, Non-GAAP gross margin…

Thank you, Niran. I am pleased to report the solid second quarter 2024 results marked by the second consecutive quarter of positive top-line growth and ongoing momentum in our Microsoft and conversational AI business with sequential uptick in the legacy gateway business. Within enterprise business, which represents about 90% of our revenue, our UCaaS business continued to perform well, highlighted by Microsoft Teams business up 3.3% year-over-year for the quarter and Microsoft Teams live minute services annual recurring revenues growing 35% year-over-year. In the CX business, Customer Experience business, we made progress as planned and our healthy pipeline continues to support a positive outlook for the second half of the full year 2024. Conversational AI business revenue was up 10.5% year-over-year. Bookings grew over 50% year-over-year. Judging by the success we enjoyed in the development of emerging conversational AI business in the second quarter and the first half of 2024, provides us with strong conviction with regards to the potential of future success in this area and positions conversational AI as a second strong leg and growth engine for the company next to our Microsoft live Teams business. Our managed services business continues to evolve to become our key go-to market. Services business grew 12.7% and accounted to 53% of revenue in the second quarter compared to 47% in the year-go quarter. What has fueled ongoing momentum in services is our live managed services which grew about 35% year-over-year and ended second quarter at $56 million annual recurring revenue, putting us on track to achieve our guidance of $64 million to $70 million exit 2024. Our focus on investment made in recent years are paving our growth for a strong recurring business with strong legs deeply rooted in growing markets such as UCaaS, CCaaS, and conversational AI. The growth of…

Thank you very much. We will now be conducting our question-and-answer session. [Operator Instructions] Please wait a moment while we poll for questions. Thank you. Your first question is coming from Ryan McWilliams of Barclays. Ryan, your line is live.

Hey guys, this is Eamon Coughlin on from Ryan McWilliams. Thanks for taking my question. Great to see improved service business growth year-over-year in the quarter. Can you help us understand what the key drivers of growth were in the quarter and how we should think about growth in the product versus service business lines in the back half of the year?

Yes, actually, again, anyone who wants to understand the prospects of our business should pay attention to two key lines, business lines. One is the live and Microsoft live Teams, which is the managed services business, which service is now about 53% growing nicely year-over-year. This is where we put most of our energy and resources. We have built -- I think the strength comes from the fact that we have developed throughout several years a platform. The platform is called Live Platform. And it's based on connectivity services for which we are known, right, both Gateway and SBC. But then throughout the years, we have added more services, first and foremost, management services. So we can manage addition, deletion of user sites. We then added on top of that, the contact center Teams application, which provides for contact center applications. We've added recording solutions. Nowadays, recording and transcription and inference become key in the evolution of both UCaaS and CCaaS solutions. So adding those services further strengthen. So our strategy here is lend and expand. So we usually lend with our connectivity services where we consider to be the dominant leader in the market. And then we simply tunnel and sell, do an upsell of voice-related business application to each such account. So using, and Coughlin, we had the last win, very important win with UCF, University of Central Florida, one of the top three universities in the U.S. They've been using our SBCs for a long time. And because they recognize us as a trusted reliable supplier, when we offer them to evaluate our contact center solution, they took on it and last year we signed the contract. So it's, again, it's lend and expand and the addition of more services. And you can expect, right, I was…

Got it. Thank you, Shabtai. Great to see the continued improvement in the conversational AI product. Can you just help us understand what kind of customers are adopting that product? And is customer appetite for adopting AI use cases better than your expectations?

Yes. So we have -- well, my strategy was always to start up here in Israel next to headquarter [ph], where we have got great access to a lot of businesses. So we have few projects running already and completely delivered, both in the financial sector, in the government sector, and in the healthcare sector. So for example, we completed a project with the Israeli Red Cross Ambulance Service back in 2021, that's working for three years now. We have delivered two projects for the government space. We are delivered already the Israeli largest medical service organization is called Clalit. It has 4.5 million subscribers. We have a solution for call Steering [ph], and now we have for setting calls it's running like 100,000 calls a day. So at this stage, I would say that we have close to 10 different applications, which are not based on the sense of products, right? It's not a Vocal CIC and it's not Meeting Insight. It's projects where you need to connect to a contact center, you need to connect to a cellular phone environment, you need to do management of elements, you need to transcribe, to extract, to infer, record, deliver reports, analytics, so a lot of areas where we can shine.

Got it. Thank you, Shabtai. I'll hop back into the queue. Appreciate it.

Sure. Thank you, Ryan.

Thank you very much. Your next question is coming from Ryan Koontz of Needham & Company. Ryan, your line is live.

Great, thanks. I wanted to take a different cut at the last question about the transition from license over subscription. And if we think about this over a multi-year view, at what point do you expect growth to re-inflect as you see this transition from product over service? Do you have an idea? Can you set any kind of goalposts out there when you think you might see this return to revenue recognition growth again, approaching high single digit or maybe double digit?

Yes, I believe that the decline of legacy is moderating. And at the same time, we see many services picking up and CAI services at the same time. Based on visibility, we should talk about two to three quarters going forward. So I expect that actually either first quarter, second quarter 2025, we are definitely going into growth. And I believe that now that our business will be primarily based on recurring business and not one time sale business, chances for decline such as happened to us back in 2023 and this year will not repeat themselves. So we expect growth to come back a second quarter of '25 and beyond.

That's really helpful, thank you for that. On the recovery and the legacy gateways, anything going on there, and it just doesn't seem like the operators are particularly investing a lot these days. So wondering what's behind your recovery and legacy gateway shipments?

Yes. When we looked into the history of gateway sales, we saw that back in '23 first quarter and this first quarter of '24, there was a sharp decline between fourth quarter to the last quarter in a year to the first quarter in the year. And then it stabilized for the rest of the year. So we do expect that gateway business will not continue to decline or it will definitely moderate its decline throughout '24. All-in-all, I believe that we already just give you a quick think all-in-all, if I'll sum up the totals, back in the end of 2022, our combined gateway business was roughly about $90 million. At the end of this quarter, I think we got somewhere to like $60 million. I don't believe we will see decline of more than another $10 or $15 million. So throughout the coming quarter, so all-in-all, I think we already experienced the largest drop and so it will moderate and will vanish.

Helpful. And just a quick housekeeping one here on the higher cash use in the quarter. You mentioned the headquarters modernization investments there that will continue in third quarter. Any other puts and takes on the cash use in the quarter? Yes, I did see that the accounts receivable was up and things like this, but anything else you'd call out on the cash flow that drove you guys to have a higher use in the quarter?

Hi, Ryan. This is Niran. So we had a very nice cash flow, operating cash flow in the first quarter, it was a $15 million. So no dramatic change during this quarter, although we saw a slight increase in our accounts receivables, but there is no issues with the collection or doubtful allowance with regards to the accounts receivables. We managed to lower the inventory level. So all-in-all, we believe we will back to positive operating cash flow at the third quarter and then after. And with regards to the capital expenditures here, it relates to our new headquarter. We will have a few more millions invested at the third quarter and then we will back to the regular level that we used to have before.

Got it. Thanks, Niran. That's all I've got. Appreciate it.

Thank you very much. Your next question is coming from Samad Samana of Jefferies. Samad, your line is live.

Hey guys, this is Billy Fitzsimmons on for Samad. Maybe first question, there are a lot of conflicting narratives right now on the macro front and what this means for the UCaaS and CCaaS vendors. We'd be curious if you guys have seen any material changes in either UCaaS or CCaaS spending from a macro backdrop perspective, quarter-for-quarter, or as you look out to the third quarter? Thank you.

Okay. Well, all-in-all, I believe, and we also review information provided by analysts in the space. Contact center activity doesn't seem to stop. Actually, it continues. If you'll take Enterprise Connect back in March of this year, it was fully active and intensive on all contact center application. That's growing. No impact from the global economy. UCaaS is growing less, however, it still very strong. We've not seen -- well, there's definitely an impact of the economic situation on enterprises, investing in modernizing their networks. I believe that that will come back when that situation ends, hopefully next year. Just say that, again, as I've mentioned, that the appearance of Gen AI technology copilot and likes will definitely give a push to the UCaaS use case simply because now there's ample -- actually excellent technology that allows to provide substantially more value from analyzing meetings and calls in the enterprise. So while we have been using data, messages, email messages, and our files, digital files, to derive our intel from, nowadays there's the information exchange in meetings, which is, we sit on meetings all day, so there's a huge amount of new information that has not been captured so far, it has not been used to generate good intelligence. So, we do expect that Gen AI copilot and few more chatbots technology will definitely help to increase the use of UCaaS. So all-in-all, we are optimistic that in 2025 we'll see better behavior.

Got it. And then conversational AI grew 50% year-over-year. And Shabtai, you provided some customer examples of conversational AI adopters. Maybe digging a little deeper there, can you just relay some anecdotes from customers on kind of the sales motion and what initial feedback on the product has been like? How are customers justifying the cost increase? What are getting those deals over the finish line? Any color there would be helpful.

Yes, very simply. I mean, let's talk about a corporation that needs to be highly operational and effective in running its operation and diverse location and sites. One organization that we work with was usually recording its meetings, but however, it had a turnaround time of about three weeks before they got back the transcription and then were able to distribute it. Nowadays, if you have some time pressure to solve issues, at the end of the meeting, you're getting a full transcribed summary action items that can be distributed and sent over immediately over the communication line. So it takes an operation that was really non-efficient, very slow to an operation that's fully real-time operated. And that's a big, big plus. Think also about a contact center that was working. However, management and analysts had no idea about what was going on in all those calls. Now we have tools such as summarization and insights extraction that allows analysts and data scientists to inform managers where the focus is, what application and operation is hot and which is not, and where management should invest its resources. So many such, I can tell you that we have plenty of use cases all around. Give you an example, employee leaving your organization, knowledge retention. If you have a talent that has left your organization, you're at loss. It will take you four months to recruit replacement. All the experience and knowledge that the previous employees were gone usually, and it's a blow. Many years ago, we lost several design engineers. We made a calculation that the departure of each cost us about $70,000 in total. Now that if you use a meeting summary and insights tool for each meeting, all you need to do is you tell your employees to include that capability in each of their meetings. Now when somebody leaves, the new employee that comes and replaces him, all of a sudden he has got tens and hundreds of recordings and summarization and insight in text from this person experience. So all of a sudden it can become fully productive and effective within a matter of a week or two. So that's definitely three different examples which tells you why our organization would spend a lot of money to take advantage of the use of AI.

Super helpful. Thank you very much.

Thank you very much. [Operator Instructions]. Okay, we appear to have reached the end of our question and answer session. I will now hand back over to Shabtai for any closing remarks.

Thank you, operator. I would like to thank everyone who attended our conference call today. With continued good business momentum in our enterprise operation and good underlining market growth trends in the UCaasS, CcaaS and CAI, we believe we are transitioning the business towards growth and growing profitability in coming years. We look forward to your participation in our next quarterly conference call. Thank you all, have a nice day.

Thank you very much. This does conclude today's conference. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.