AudioCodes Ltd. (NASDAQ:AUDC) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good morning everybody, and welcome to the AudioCodes' Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal the presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Roger Chuchen, Vice President of Investor Relations. Sir, you may begin.

Roger Chuchen: Thank you, Jenny. 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 or forward-looking statements as the term is defined under US 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 of existing products, the impact of competitive products and pricing on AudioCodes and its customers, products and markets; timely product and technology developments, 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 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.

Shabtai Adlersberg: Thank you, Roger. Good morning and good afternoon, everybody. I would like to welcome all to our fourth quarter 2022 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 the year and discuss strengths and developments in our industry and business. We will then turn it into the Q&A session. Niran?

Niran Baruch: 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 fourth quarter were $17.7 million, an increase of 6.9% over the $66.1 million reported in the fourth quarter of last year. Full year 2022 revenues were $275.1 million, an increase of 10.5% over the $248.9 million reported in 2021. Services revenues for the fourth quarter were $28.6 million, up 17.2% over the year ago period. Service revenues in the fourth quarter accounted for 40.5% of total revenues.

On an annual basis, service revenues increased by 18.1% compared to the previous year. The amount of deferred revenues as of December 31st, 2022 was $79.4 million, up from $76.5 million as of December 31st, 2021. Revenues by geographical region for the quarter were split as follows; North America 47%; EMEA 35%; Asia-Pacific 14%; and Central and Latin America 4%. Our top 15 customers represented an aggregate of 57% of our revenues in the fourth quarter, of which 42%was attributed to our 10 largest distributors. GAAP results are as follows; hross margin for the quarter was 65.3% compared to 67.2% in Q4 2021. Operating income for the quarter was $8.3 million or 11.8% of revenues compared to $9.3 million or 14% of revenues in Q4 2021. Full year 2022 operating income was $31.3 million compared to operating income of $39.5 million in 2021.

Net income for the quarter was $7.5 million or $0.23 per diluted shares compared to $7.3 million or $0.22 per diluted share for Q4 2021. Full year 2022 net income was $28.5 million or $0.88 per diluted share compared to $33.8 million or $1 per diluted share in 2021. Non-GAAP results are as follows; non-GAAP gross margin for the quarter was 65.8% compared to 67.6% in Q4 2021. Non-GAAP operating income for the fourth quarter was $12.5 million or17.7% of revenues compared to $13.5 million or 20.4% of revenues in Q4 2021. Full year 2022 non-GAAP operating income was $47.2 million compared to operating income of $53.8 million in 2021. Non-GAAP net income for the fourth quarter was $11.9 million or $0.36 per diluted shares compared to $13.4 million or $0.39 per diluted share in Q4 2021.

Full year 2022 non-GAAP net income was $45 million or $1.35 per diluted share compared to $51.8 million or $1.50 per diluted share in 2021. At the end of December 2022 cash, cash equivalents, bank deposits, financial investments, and marketable securities totaled $124.3 million. Net cash provided by operating activity was $0.4 million for the fourth quarter of 2022 and $8.3 million for the full year of 2022. Days sale outstanding as of December 31st, 2022 were 90 days. During the quarter, we acquired 145,000 of our ordinary shares for a total consideration of approximately $2.9 million. In January 2023, we received court approval in Israel to purchase up to an aggregate amount of $25 million of additional ordinary shares. The court approval also permits us to declare a dividend of any part of this amount.

The approval is valid through July 4th, 2023. Earlier this morning, we also declared a cash dividend of $0.18 per share. The aggregate amount of the dividend is approximately $5.7 million. The dividend will be paid on March 7th, 2023 to all of our shareholders of record at the close of the trading of February 21st, 2023. Regarding headcount, on the heels of the addition of 112 position in 2021, 84 in the nine months ended September 30th, 2022, there was no increase of full-time employees in the fourth quarter of 2022. We ended 2022 with 966 employees. Our guidance for the full year 2023 is as follows; we expect revenues in the range of $286 million to $300 million and non-GAAP diluted net income per share of $1.35 to $1.50. I will now turn the call back over to Shabtai.

Shabtai Adlersberg: Thank you, Niran. Before I start my formal remarks, I would like to remind everyone that in conjunction with our earnings release this morning, we have posted on our Investor Relations website an earnings supplement deck. I would like to start off by providing a recap of 2022. We entered the year with cautious optimism as we continue to leverage the multiyear secular growth trends within the UC and CX segments that have fueled our business for several years now. We successfully executed according to plan, having delivered a 10.5% revenue growth in 2022 within the range of our guidance. I would like also to note that with the late increased focus on enterprise AI and in view of our investment in the VoiceAI business since early 2018, we see another major growth driver for our business in coming years.

Our primary growth engines during the year were Microsoft business, which ended up growing 18% year-over-year, with Microsoft Teams up 30% year-over-year. Zoom business grew above 50% year-over-year. CX business up 3% year-over-year. Excluding lumpy OEM revenue, where we have lowered priority already a year ago on the OEM segment. CX direct enterprise customers grew 13% year-over-year. VoiceAI opportunities and activities grew over 15% year-over-year. Despite the macro uncertainty we faced in the second half of the year, we believe long-term secular growth drivers remain intact. AudioCodes is well-positioned to capitalize on the defense technology such as digital transformation to the cloud within our core UC and CX markets and vendor consolidation favoring our primary partners namely Microsoft, Genesis, and Zoom.

We further believe that our unique blend of strong profitability and balance sheet relative to our UC/CX peers afford us the flexibility to continue investment in core strategic areas for our business, enabling us to leap-frog competition when the macro storm subsides. On the operations front, we are pleased to have delivered improved non-GAAP gross and operating margins in the first quarter, helped by easing supply chain pressures. Based on current trend of floor pressuring the supply chain, operating margin should continue improving entering2023. This trend, coupled with better FX hedging throughout 2023 and continued prudent allocation of investments, gives us increasing confidence to deliver on our commitment to drive improved operating leverage and profitability in 2023.

Now, shifting into some of the fourth quarter first quarter results. Stated in our press release earlier this morning, we saw continued momentum in both the UC and the CX market. Key driver of fourth quarter 2022 came from Microsoft-related business, which was up quarterly 12% year-over-year, a deceleration from prior quarters, as we saw longer sales cycles. Same Zoom on the other hand, grew about 50% year-over-year and in the quarter, although albeit from a lower base. As it relates to Live for Teams managed services, we ended the year with $31 million in ARR, achieved the target that we have laid out at the beginning of the year to reach over $30 million growth. Our execution of our strategic priority of migrating traditional CapEx to OpEx is working well with total contract value growing above 25% quarter-over-quarter.

We ended the year with sort of contract value for our live subscription exceeding 100 million, up from 90 million in last quarter, providing us with increased level of revenues and visibility. We expect strong momentum to continue in the live services in 2023. Our CX segment grew sequentially as expected, which was still down 7% for prior year period, owing largely to the lumpiness from our OEM customer. As stated earlier, we have shifted our focus away from the OEM business and now focus largely on direct enterprise accounts. Direct enterprise CX business grew 13% in the quarter. Importantly, we continue to see a strong pipeline of opportunities in live CX, which couples to our advanced SBC solutions is our strong managed services delivery.

We now enjoy close alignment with contact center accounts, planning migration from on-prem implementation to cloud solution deployments. Additive to a growth in the quarter in this area was the ongoing strength in our service provider CPE market, which is related to the carrier all-IP transformation and PSN shutdown projects. Our service provider business CPE grew for the third consecutive quarter and was up 12% year-over-year, and we continue to see a healthy pipeline in this segment in 2023. Shifting gears to margins and EPS discussion. We are pleased to see a snapback in non-GAAP gross margins to 65.8% in the quarter, up from 63.2% in the previous quarter. The increase was influenced by two primary factors. First, easing supply chain costs.

We incurred $500,000 of our accompanying cost in fourth quarter, which compares to $1.2 million spent in the third quarter. Lower supply chain costs throughout the prior quarter accounted for roughly half of the sequential improvement in our non-GAAP gross margin. Second, product mix accounted for the balance of the sequential gross margin improvement with our percentage of sales coming from product or managed services. Full year 2022 non-GAAP gross margin came in at 65.4% versus 69% in 2021 with 160 basis points of the change related to the supply chain inefficiencies and the balance of the product mix. Also, fourth quarter 2022 was the first quarter in 2022 where we enjoyed higher US dollar/Israeli shekel conversion rate compared to the year ago quarter as a result of our hedge activity.

We expect this favorable hedge ratio to persist in 2023. Higher gross margin and tight OpEx management translated to sequential improvement in non-GAAP operating margin to 17.7%, up from 15.5% in the third quarter. Compared to the year ago period, which was 20% operating margin, the margin difference can be explained primarily by change in gross margin and, to a lesser extent, higher OpEx growth rising from our hiring activity in 2022. Headcount, we ended fourth quarter with headcount of 966 employees, down slightly from 969 employees in the third quarter. OpEx ended upgrowing 9% in the fourth quarter, capping on our investment in 2003 in view of the worsening global economy, headcount is expected to grow at a very minimal -- moderate rate in 2023.

Main driver for incremental hiring is our continued investment in enterprise VoiceAI. VoiceAI will go to that topic in a few slides. Now, getting back to the outlook provided earlier. So, given the global economy business outlook for 2023, our guidance as provided earlier is as follows; our guidance for the full year would be a revenue range of $286 million to $300 million that's about 4% to 9% growth. And non-GAAP diluted net income per share, $1.35 to $1.50, which is growth from 2022. As for the first quarter, we believe we will see growth year-over-year, albeit lower than the range anticipated for the full year 2023, which is roughly 4% to 9%. Also, I would like to mention that while December 2022 was sort of weak when compared to the October and November 2022 period, January 2023 was fairly normal or even stronger and on par with the November 2022 activity.

Now, diving into our core business engines. Let's go first to Microsoft. Microsoft business delivered 12% growth in the fourth quarter, making up over 50% of our business now. Teams grew over 15% year-over-year in the quarter, while growing more than 30% for the full year. Skype for business declined roughly 10% year-over-year and is now accounting for less than 10% of our quarterly Microsoft business. We had another strong quarter for Microsoft Teams account additions. We added 279 accounts, versus 229 accounts in the year ago period, which speaks to the ongoing healthy adoption of Teams in our growing pipeline. For the full year, we achieved $145 million of revenue at the high end of our guidance. The business grew18% in the year, we expect another year of growth in 2023 from our Microsoft business, albeit at a more moderate pace than in 2022, given the macroeconomic uncertainty and longer sales cycles as we've been discussing.

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The long-term opportunity has not changed, given Microsoft's priority to shift a growing percentage of their 280 million monthly active teams users on to E5 licenses, which includes Teams' license for PSTN. Microsoft recently disclosed in July 2022 since PSTN and users reaching over 12 million and more recently in January 2023, adding 5 million more users, implying only low-digit growth penetration and suggesting a significant multiyear runway ahead. Recently , our market share within Microsoft ecosystem remains strong and is well above 50%. Then our most important activity these days in the Microsoft space is the development of Live Cloud. Live Cloud is voice platform, which provides SBC direct routing. On top of that, it adds value-add services, such as recording conversational IVR, device management, analytics and management and in all digital cloud portal.

Live Cloud facilitates the on warding of midsize and small businesses accounts into teams to service providers in a very efficient way and can be used for Microsoft Operator Connect and facilitates faster and very efficient onboarding. By the end of the fourth quarter of 2022, the three-year total contract value of Live Cloud reached a level of 10 million, more than tripling the year ago total contract value. Now to CX, we saw wealthy customer activity during the quarter in the customer experience market. On a quarterly basis, the whole activity declined 6.5%. However, more important to us, contact center direct accounts for enterprise grew 13%. This is where we focus our efforts. For the full year and excluding declining OEM revenue, which we will focus less going forward, our direct enterprise CX business grew 13%.

We have already introduced our entry-level Microsoft Teams native conversational AI first contact center application for the CX market and plan to significantly expand this effort in 2023. Overall, voice applications grew above 15% year-over-year. Looking out to 2023, we see growing adoption of new products and services launched during the past 12 months, and we expect them to boost revenue growth. Among them, I'll count Live CX, WebRTC, Click-to-Call application, VoiceAI Connect, Conversational IVR, and Recording Solution, among them, SmartTap and MeetingInsights. Talking about what's happening in the space. We've seen the transition from on-prem to cloud moving ahead, but with pains. Talking about some of the leading manufacturing of vendors in this field.

Looking on Genesys and Avaya both vendors, customers are nervous about the future and the new migration path from the on-prem solution they currently use to the cloud. And we know and we have seen several of them looking for a trusted partner that can execute this migration and solve their complexity. We definitely there to enjoy that opportunity, take advantage of it. Recent announcements from Genesys to discontinue Genesys Engage made a lot of their customers unhappy. And for us, that is definitely a feel for us to invest. Same goes for a certain number of Avaya customers with their on-prem solution. Now, to VoiceAI. So, we have seen lately increased focus on enterprise AI. First was the announcement in November of ChatGPT by OpenAI and then the MarketSoft investment in Open AI.

Yesterday, Google announced Bard, the latest entry into the field of advanced chatbots for search. In fact, we see increased activity on all fronts in cognitive services, including in the areas of virtual agents, intelligent assistant, conversational IVR, and more. I'm glad to say that VoiceAI was a key investment area for us in 2022, an area where we started back in January 2018. We're glad to see growing global awareness to embedding AI technologies into the CX and enterprise applications. Obviously, we intend to keep growing investment in VoiceAI this year will now start to bear fruits. In 2022, we saw an increase of more than 15% in the VoiceAI business, and we expect this activity to grow by more than 70% in 2023 and keep growing at similar rates in the years beyond.

In the VoiceAI Connect area, we grew above 70% in bookings and registered growth of more than 100% in new opportunities created. In our compliance recording business, we saw growth of about 15% in both booking and invoicing. Our Meeting Insights application for Teams was deployed earlier in 2002, has got warm reception in the market, already handling around 250 meetings a day and a few thousands meetings every month. We now have a list of new customers that are joining and see the value in recording, transcribing, and creating a vocal interaction repository for the organization. This is an area where we're going to focus in a big way going forward. Lastly, our virtual agent technology is handling close to 100,000 calls a day in our medical AI routing services.

More to come. Now I'd like to focus on one very important point, which is we believe that these days, we are among a very few. I would count less than one hand of players who can provide technology and contribution from two different fields. One is the voice over IP networking area and the other one is the conversational AI technology area. Very few companies have got two. Yes, it's great to have those very advanced cognitive services deployed in the cloud, but at the end of the day, enterprise customers need fully working solution that they take care of everything that's needed in order to implement a solution. Let me give you one such project which exemplifies exactly our advantage. We have a project that was implemented was the Red Cross in Israel and is now working more than a year.

Actually, I'll give you some details. This is a service. This is emergency 911 call to Red Cross. In 2018 -- I'm sorry, in 2019, they have handled more than 2 million calls a year. These days and basically at the end of 2020, they have handled more than 8 million, huge growth. They grew from like 50 agents to like 400 agents instead of a call coming in every 15 seconds, a call is coming in every four seconds. So, that means more than 10,000 calls a day. Now, we have implemented for them a very sophisticated solution that allows treatment of incoming calls to the contact center. And in order to implement that basically, every call this coming in is rooted to various places, including recording, including two real-time speech-to-text transcription and then operating kind of bots to basically have insight from that call.

So, to build such a system, I'll read to you the list of technological solution that we are employing in order to provide the full solution. So, we've used our SBCs and gateways for connectivity. We've used our smart app for recording. We have used our VoiceAI Connect in order to convert telephony media into cognitive services. We have developed and deployed speech to tax technology, text to speech. We have employed management of our One Voice Operations sales management, and then on top of that, we have applied analytics. Now, that gives you an idea about the complexity of those projects coming to happen and the need basically to master both voice over IP networking and conversational AI solution. And I think in that area, we'll definitely excel.

And I think that really gives you a taste for the potential we have on our end going forward. And with that, I've concluded my talk, and I'll hand over the call to the operator. Thank you.

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