AudioCodes Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

There are 8 speakers on the call.

Operator

Greetings. Welcome to AudioCode's Third Quarter 2023 Earnings Conference Call. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Roger Chuchen, VP of Investor Relations at Call.

Operator

Roger, over to you.

Speaker 1

Thank you, Jenny. Hosting the call today are Shabtai Alisberg, President and Chief Executive Sir, Anuram Baruch, Vice President of Finance and Chief Financial Officer. Before we begin, I would like to remind you that the information provided during this call may contain forward looking statements Relating to AudioCode's business outlook, future economic performance, product introductions, plans and objectives related thereto And statements concerning assumptions made or expectations 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 could differ materially from those stated in such statements.

Speaker 1

These risks, uncertainties and factors include, but are not limited to, The effect of global economic conditions in general and conditions in AudioCode's 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 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 AudioCode to successfully integrate the products and operations of acquired companies into AudioCode's business, possible adverse impact of the COVID-nineteen pandemic on our business and results of operations, The effects of the current terrorist attacks by Hamas and the war and 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 AudioCode's filings with the U.

Speaker 1

S. Securities and Exchange Commission. AudioCode 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 I'd like to remind everyone that this call is being recorded.

Speaker 1

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.

Speaker 2

Thank you, Roger. Good morning and good afternoon, everybody. I would like to welcome all to our Q3 2020 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance of AudioCode. Niran will start off by presenting a financial overview of the core.

Speaker 2

I will then review the business highlights and summary for the core and discuss trends and developments in our business and industry. We will then turn it into the Q and A session. Niran?

Speaker 3

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 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. Non GAAP net income excludes share based compensation expenses, Amortization expenses related to intangible assets, expenses related to deferred payment in connection with the acquisition of Colverso, Other income related to a payment made by the landlord of AudioCodes Inc, a subsidiary of the company in connection with the termination of lease agreement For its offices in New Jersey, financial income related to exchange rate differences in connection with Revaluation of assets and liability in non dollar denominated currencies, non cash deferred tax expenses or income And non cash lease expense, which is required to be recorded during the quarter even though This is a free rent period under the lease for the company new headquarters.

Speaker 3

To provide investors with a more accurate view Of our current operating performance, we are adjusting lease expenses in our non GAAP presentation. We calculate the non GAAP adjustment By subtracting the non cash lease expenses during the quarter for our new offices, which are currently under construction from our total lease expense. The exclusion of These non cash lease expenses reflect the fact that we are not required to pay rent with respect to the new office During the quarter, and we are not yet occupying the new offices. After this adjustment, lease expenses In the non GAAP presentation for the quarter will be equal to the lease expense for our current occupied office. In the future, Our non GAAP presentation will reflect an upward adjustment for lease expenses over the life of the lease for the amount of lease expenses excluded in our non GAAP presentation during the free rent period.

Speaker 3

We will be comparing our Q3 2023 results to the prior quarter as we believe it provides a better gauge of our financial performance. Revenues for the Q3 were $61,600,000 an increase of 2.6% Over the $60,000,000 reported in the 2nd quarter. Services revenues for the 3rd quarter were $30,600,000 accounting for 49.6 percent of total revenues. The amount of deferred revenues as of September 30, 2023 was $77,800,000 compared to $77,700,000 as of June 30, 2023. Revenues by geographical region for the quarter were split as follows: North America, 48% EMEA, 33% Asia Pacific, 14% and Central and Latin America, 5%.

Speaker 3

Our top 15 customers represented an aggregate of 59% of our revenues in the 3rd quarter, of which 48% was attributed to our 12 largest distributors. GAAP results are as follows: Gross margin for the quarter was 66.5 percent compared to 64.1% in Q2 2023. Operating income for the Q3 was $5,800,000 or 9.4 percent of revenues compared to $2,300,000 or 3.8 percent of revenues in Q2 2023. Net income for the quarter was $4,300,000 or $0.14 per diluted share compared to $1,100,000 or $0.03 per diluted share for Q2 2023. Non GAAP results are as follows.

Speaker 3

Non GAAP gross margin for the quarter was 67.3% compared to 64.5 percent in Q2 2023. Non GAAP operating income for the 3rd quarter was $9,600,000 or 15.5 percent of revenues compared to $5,700,000 or 9.5 percent of revenues in Q2 2023. Non GAAP net income for the 3rd quarter was $8,300,000 or $0.25 Per diluted share compared to $5,100,000 or $0.16 per diluted share in Q2 2023. At the end of September 2023, cash, cash equivalents, bank deposits, marketable securities and financial investment Total $102,500,000 Net cash provided by operating activities Was $200,000 for the Q3 of 2023. Day sales outstanding as of September 30, 2023 was 96 days.

Speaker 3

In June 2023, we received court approval in Israel To purchase up to an aggregate amount of $25,000,000 of additional ordinary shares. The court approval also permits call. To declare a dividend of any part of this amount. The approval is valid through December 27, 2023. On August 1, 2023, we declared a cash dividend of $0.18 per share.

Speaker 3

The aggregate amount Of the dividend was approximately $5,700,000 The dividend was paid on August 31, 2023 to our shareholders. During the quarter, we acquired 880,000 of our ordinary shares for call. Consideration of approximately $9,000,000 As of September 30, 2023, we had $10,000,000 available under the approval for the repurchase of shares under and or declaration of cash dividends. Regarding headcount, as discussed last quarter, we undertook actions to reduce headcount to better align our are reflected in our Q3 results. We ended the Q3 with 9 38 employees, down from 946 employees at the end of the second quarter.

Speaker 3

Now to provide an update on our guidance. We reiterate our guidance for revenue for 2023 to be in the range of $240,000,000 to 250,000,000 We are raising our guidance for non GAAP diluted earnings per share to be in the range of $0.65 to 0 point 7 $5 compared to the previously updated range of $0.55 to $0.70 I will now turn the call back over to Saptay.

Speaker 2

Thank you, Niran. I'm pleased to report solid Q3 2023 results Against the difficult macro backdrop with ongoing strength in our core enterprise business overall, partially offset by softness in our non core service provider segment. We continue to perform well in our enterprise business, Now reaching a record 90% of company revenues. Within enterprise, our U. K.

Speaker 2

S. Business continued to perform well With Microsoft Business up 13% year over year, Microsoft Teams Business grew 20% year over year And Live Teams annual recurring revenues grew north of 50% year over year, ending the quarter at EUR 43,000,000 We thus expect TIMSS Live annual recurring revenue to grow approximately 50% in 2023 as planned earlier in the year. Customer Experience Business grew 13% year over year And Conversational AI Business bookings grew over 50% year over year. Importantly, Leading indicators such as total amount of newly created opportunities remained robust and new business booking had grown substantially above 2022, giving us increasing conviction about our business prospects for the rest of 20 23 and into 2024. As referenced earlier, our non core service provider segment remains challenged, down about 50% year over year.

Speaker 2

This is primarily attributable to customers adjusting CapEx plans, delayed projects and tightened inventory investment amid the challenging macro environment. Important to note, however, that we have won several new projects with leading service provider that can provide incremental revenue contribution in 2024. Another positive development in the Q3 is the continued evolution in our conversational AI space It emerges a key growth engine for the next years. Our investment in the conversational AI product innovation are paying off And have successfully positioned our UCaaS and CX segments for faster sustainable top line growth. Conversational AI bookings grew over 50% year over year.

Speaker 2

Since our announcement of the Microsoft Teams certification Of Voca CAC in July 2023, our lightweight AI First Team CCaaS platform, We have seen a step up in customers' interest and engagement. The success with our CKS offering It's having a pull through effect on our on the rest of our conversational AI portfolio, in particular, in our generative AI powered Recording services. We are stepping up our efforts in the cognitive services space with key investments in speech to text and generative AI And LLM Technologies. In that regard, we believe that we own unique advantage in maintaining a very comprehensive knowledge in several key vital technologies, which are really vital to create efficient systems. We own technologies such as telephony, VoIP networking and variety of cognitive services technologies.

Speaker 2

Integrating these technologies with the vast experience we have in delivering full end to end solution and services creates for us clear unique Advantage and capability to emerge a strong player in the emerging voice AI space. As an example to the advantage, we have Developed with our conversational AI in the UK space, we are now seeing rising interest and progress made with our meeting insights, Workflow productivity application for meetings in the enterprise space. Coupling meeting insights with The line of devices we have developed for the meeting rooms position us with a unique leading solution for the emerging meeting space. Few more notable developments in the Q3 are the following. We saw professional and managed services And grew 13.8% year over year compared to mere 2.4% in the previous quarter, With an acceleration in growth rate primarily related to timing of professional services completion.

Speaker 2

What has fueled our ongoing momentum in services is primarily our live subscription business, which ended the 3rd quarter at 43,000,000 Annual recurring revenues, up from $40,000,000 last quarter. Additionally, we ended the quarter with Total contract value for our live subscription, growing close to 10%, up From over $120,000,000 in the 2nd quarter and providing us with increasing level of revenue visibility. We expect strong momentum in Life Services to continue for the balance of 2023 beyond And reiterate our annual recurring revenue target of $46,000,000 to $50,000,000 by the end of this year. Few more notable developments in the Q3 are the following. We see a shift in our product mix To software and services, non core hardware related product percentage of our revenues are now down to around 20%, Contributing to increasing gross margin in our revenue, non core hardware relates to business lines such as the service provider CPE, IP phones and technology legacy.

Speaker 2

As we continue to add new value add voice software application and services, We expect hardware related percentage in our product mix to decrease below 20% and to contribute to the continued increase in gross margin in coming years. Another major trend in our sales operation is the shift from CapEx selling to recurring revenue sales, a trend that will affect our long term financial model and relating mainly to both the top line and the bottom line results. On the top line or the revenue line, we expect annual revenue growth to moderate To the range of 6% to 12% compared to the previous years, our annual growth rate Range was between 10% 13%. This decline is a direct result of moving to recurring revenue where Cognition is spread over 36 to 60 months rather than recognizing in a single quarter. However, the bright side of it is that On the earnings side, the trend of this trend contributes to key results.

Speaker 2

A, better visibility in Future Core's revenue base is being built up sequentially, quarter over quarter. And then higher profitability It's a result of the ability to add managed services on top of selling products. This in return will contribute to higher annual earning growth rate, which we estimate to settle at the 25% to 50% range annually. As an example to the overall strong operational progress and execution, I would like to provide some details of a We're talking about the federal agency that issued an RFQ for IP phone associated services as part of its long term migration plan from Cisco to Microsoft Teams platform. After 18 months of extensive testing, We recently received an initial award of TIM certified Epiphone and NovoC TO, our infrastructure device management software, And wrapped up with our professional services support.

Speaker 2

This contract covers the option to purchase over 25,000 IP phones and associated software and services over the period of 5 years. While long term dollar value of this contract could be significant, I would like to emphasize The strategic nature of this win. 1st, the deal establishes direct relationship with the end customer and establishes a Beachhead from which we can pull through other products in our portfolio. In furtherance of our Lend and expense strategy that we have successfully executed upon over the past several years. 2nd, After completing additional accreditation and certification steps, which are expected in the next couple of months, This solution will be available for purchase to the broader federal agency audience, expanding our market reach by many multiples.

Speaker 2

In addition to our direct sales efforts in the federal vertical, we recently won $1,200,000 contract Over 36 months with a Tier 1 system integrator providing white glove live premium services to another federal agency. In support of its migration of 4,000 users to Microsoft Teams phone from legacy suppliers. The decision is driven by desire to upgrade from TDM to IT based voice services and to create an end to end Teams UC experience, which in the process enables the customer to terminate its high cost maintenance contracts with legacy PBX vendors. For background, this is a large federal agency with over 50,000 employees, with many bureaus spread across the U. S.

Speaker 2

The recent win includes the headquarter of this agency and we are working on several similar opportunities at the bureau level concurrently. Before turning to detailed business segment discussion, let's quickly shift to profitability metrics and guidance. Our Q3 2023 non GAAP EPS was $0.25 significantly exceeding our internal budget On the back of our then expected non GAAP gross margin and lower OpEx. 3rd quarter non GAAP gross margin was 67.3% versus previous quarter of 64.5%. The improvement is primarily attributable to higher utilization of service resources And more favorable service product mix.

Speaker 2

3rd quarter non GAAP OpEx was 31,900,000 Down from the $33,000,000 level in the prior quarter and in line with the $2,000,000 quarterly step down in OpEx Plans from the Q1 of 2023, all in connection with our previously announced cost cutting measure. We ended the quarter with headcount of 938 employees, down from the 978 People we had in the Q1. We will continue to align our OpEx to current market environment and business line performance with the aim of executing to our commitment of delivering significant operating leverage in 2024. On the guidance front, we are reiterating our 2023 revenue guidance of $240,000,000 to 250,000,000 And adjusting non GAAP EPS guidance to $0.65 to $0.75 to reflect better than expected 3rd quarter earnings results and ongoing momentum. This outlook builds in continued conservative enterprise spending environment And cost saving impact from our previously announced cost cutting initiative.

Speaker 2

In addition, we expect our OpEx To decline the next 2 years as a result of edging the U. S. Dollar against the Israeli new Israeli shekel where steps we took in the previous will contribute nicely towards lower expenses. Getting to our main business line, let's talk first about Microsoft. Microsoft Business or bookings increased 13% year over year in Q3, within which Microsoft Teams grew 21%.

Speaker 2

At the same time, Sky for Business was down 75%. CACHA business now at less than 2% of overall Microsoft business is now at a minimum level of less than €5,000,000 annually. Starting in 2024, we will no longer break out mix of Teams versus Skyfall Business. From a geo perspective, North America was again the standout performer, while EMEA seems to have stabilized. For the 1st 9 of 2023, Microsoft Windows grew 7% year over year.

Speaker 2

Overall, we added 284 New Teams accounts in the quarter, a slight increase from 282 in the 2nd quarter. With the robust year to date growth in our pipeline For credit opportunities, we remain optimistic about the long term growth potential for Microsoft Business. As a reminder, Microsoft recently disclosed over 17,000,000 PSCN users, representing 45% growth year over year. However, still representing just a fraction of the overall 320,000,000 Teams monthly active users. We believe the low Teams phone voice penetration provide us with ample multiyear runway to drive ongoing penetration gains.

Speaker 2

We also saw recovery of our IP phone business, where demand from end users recovered significantly, although what we One key area for us in the Microsoft business is TIMSS Live Enterprise deals, which represent each a high total contract value. I'm glad to inform that in the Q3, we were able to sign and close 3 accounts valued each above 1,000,000 And 5 more accounts with an average total contract value of about $500,000 This success rate helps us to build It's a very stable growing backlog of monthly recurring revenues for the next 36 months and beyond. Moving to customer experience. 3rd quarter contact center business or bookings grew 13% year over year With strength in North America and APAC, Conversational AI bookings grew more than 50% year over year. While we are pleased with the ongoing momentum in our Customer call.

Speaker 2

What may be less apparent to investors is the underlying transformation in this business line. If we look back Past period of similar growth in customer experience in 2020202021, revenue growth Then was driven primarily by OEM operations and core SBC and connectivity solution, often sold on a CapEx basis. At that time, we had benefited mainly from increased volume of calls going into the contact centers during the pandemic. Fast forward to today, our growth vectors are multifaceted, benefiting not only from increasing customer experience call volume, But also product innovation and introduction in conversational AI, particularly our Voca CIC service offering. Clearly, The FVR and the investments we have made in these emerging areas over the past couple of years are now starting to bear fruit.

Speaker 2

WebRTC, Click2Call, VoiceAI Connect, those platforms are among the new sources of growth. This transformation of our Customer Experience business has not only improved the percentage of recurring mix, but also added additional growth drivers, which ultimately should position this segment for more sustainable long term growth. At this stage, I should mention that Microsoft Teams And Microsoft Business account for almost 2 thirds of our quarterly business, while CX now contribute About 20%. Let's move to discuss our recently introduced Voca CAC CCaaS platform for the Microsoft Teams environment. Since the announcement of Microsoft Teams certification for lightweight AI first Teams, Seacast platform, we have seen a step up in customer interest and engagements.

Speaker 2

The success with our CKS offering is having a pull through effect on the rest of our conversational AI portfolio, in particular In our generative AI based value add solution. Let's talk about the recent contract win that demonstrates our success in Diversifying our revenue streams beyond our traditional business of selling session border controls and connectivity. This win relates to a very large auto service firm with broad distribution of local affiliates across The United States. The customer is on a legacy platform, routing in from incoming customer calls from centralized hotline To appropriate local branch. Working closely with a Tier 1 system integrator, we were recently selected to provide our conversational IVR System in a deal worth over $1,000,000 total contract value over the next 36 months.

Speaker 2

The significance of this deal is twofold. 1, this is one of the largest data contract value contracts in our Voca CRC product to date. This year, we think very steep increase in bookings in that line. 2nd, when fully implemented, the 400 concurrent channels to be deployed demonstrates scalability of the Vocus AAC platform, which should Better position us to target progressively larger deal opportunity. And 3rd, this deal demonstrates the flexibility of the platform As customers can purchase the lightweight CCAS system, including conversational AI or IVR on a standalone basis.

Speaker 2

Now moving to our VoiceAI Connect platform. A major communication platform as a service customer Recently unveiled an innovative new service powered by our VoiceAI Connect solution, which enables its enterprise and customers To expedite rollout of virtual agents, thereby driving productivity improvement and cost savings. Our solution provides Seamless back end integration and connection to both Frameworks, contact centers and to the CPaaS customer. Separately, we recently received from a multinational healthcare company, large follow on purchase for our voice AI Connect solution, Providing connectivity services to various conversational AI platforms in support of virtual agent and virtual assist use cases. This customer now is over $1,000,000 annual recurring revenue to AudioCode is an early adopter of conversational AI.

Speaker 2

We believe that the advent of generative AI can help accelerate time to market with this technology and look forward to working with other customers in their journey to drive productivity improvements. Lastly, I'll speak about our meeting insight solution. Transcription, analytics, sharing, distribution and archiving. To date, we have tens of new accounts onboarding to the platform for Processing enterprise voice interactions in meetings and calls. In terms of wins, I'll mention that we recently scored A significant win within Israeli government branch for large number of users.

Speaker 2

Additionally, we are gearing up towards a cloud based multi tenant So far as a service application with full generative AI integration, which is expected for GA early next year. Now to the geopolitics situation. Before I conclude, I'd like to briefly address the impact of our operation From a war and recent developments in Israel. Adequate is a global organization providing sales support and maintenance spanning all major geographies. We have not seen any material impact, short term or long term disruption from this conflict.

Speaker 2

There are there have not been any delays in our logistical challenges. If our operational systems are cloud based, we are assured Solid business continuity. Around 10% of overall employees in Israel, mostly in R and D position, have been called up to the Army duty. Aside from few weeks delaying small number of projects in R and D, there's no impact to our productivity. For the rest of the employees based in Israel, Work is conducted in hybrid mode to ensure everyone's safety and security.

Speaker 2

Today, I'm heartened By the fact that all of our employees and families are safe. I would like to state that our hearts and thoughts With all who were impacted by this terrorist attack, we hope and pray for the full recovery of those who were wounded And for the safe return of those who are still missing. We wish for days of long lasting peace in the region and around the world. To wrap up my presentation, over the last 6 months, we have navigated well in an ongoing difficult macro environment, Definitely balancing the achievement of shorter milestones while maintaining laser focus on our long term transformation to a software and services company. In the short term, we have accelerated growth in key strategic areas of our business, Microsoft Teams phone comprehensive voice solution, Customer experience and conversational AI and successfully executed on cost saving program, both of which have contributed to significant call.

Speaker 2

At the same time, we achieved all of this. We did not lost sight of longer term objective of Expanding our total addressable market. Some of the accomplishments include: 1, gained Significant traction into the unified communication space with U. S. Federal agencies, a vertical that we have previously pursued only opportunistically.

Speaker 2

And second, successfully transformed our CX segment into a dynamic business with multifaceted growth drivers. These developments, backed by core business leading indicators such as pipeline remaining robust, give us increasing confidence In returning the company to top line growth with ongoing operation leverage improvements in 2024. And with that, I've concluded my presentation for the session.

Operator

Operator? Thank you very much. We will now be conducting our question and answer Thank you. Your first question is coming from Ryan McWilliams of Barclays. Ryan, your line is live.

Speaker 4

Hey, thanks for taking my question. And in regards to you and the AudioCodes team for the strong execution during this difficult period. Shabtai, do you think products like Microsoft CoPilot for enterprise could drive more enterprise customers to put their communications on Microsoft Teams And then in turn utilize your solutions at AudioCode to help them do that for things like voice?

Speaker 2

Yes. Thank you, Ryan. Yes, indeed, that is the play. And I believe Justice Markersoff thinks that Moving from one telephony solution partner like in the past like could be Cisco, Avaya or anyone else into Teams, It will be really desirable mainly if on top of Teams, you can provide higher valued applications. This is indeed what CoPilot provides and this is indeed what we're trying to do with our value add voice of the application, right?

Speaker 2

I mean, Locustic is a contact center in our IVR on top of Tim's phone. Same goes for Meeting Insights, same goes for Smarter. So yes, I definitely believe that with CoPilot becoming useful and Contributing to gaining more insight into the phone system and voice interaction Resulting from it? Yes, that will definitely help in the future to the growth of our Microsoft Teams phone.

Speaker 4

Excellent. And you guys have pretty strong exposures in terms of facing off against the macro with Federal customers and large enterprises and the time to Microsoft are things that I think have been a little more resilient at least so far During this earnings season, as you talk to some of your largest customers or potential customers, what are they saying right now about next year? Like do they think they can Grow next year or are they still because they're on better footing being more enterprise, more comfortable continuing with large Enterprise fluffing deployments, just wanted to kind of hear how they're thinking about their budgets and their place in the macro at this point?

Speaker 2

Yes. I'm less in a direct touch. And quite frankly, we deeply Looking to make 2,003 successful, have not yet. I mean, we're entering our planning phase Normally, in November December, we can though judged by their actions and from what we can see, I think definitely Microsoft Teams is an essential platform For collaborating, both on prem and remotely. And I think It is really they'll do exactly what we just answered on the previous questions.

Speaker 2

They will simply look to enhance Their productivity, definitely generative AI will be there to drive more voice based Software application. So we've not seen a decline. I'm not aware of Substantial uptake, we see the business continuing developing. I mean, Microsoft should grow for us this year around the 10% -ish, 10%, 12%, and we expect to see that Next year. And I think that the increasing maturity and more value from applications will definitely help drive Will that definitely help drive usage of the system.

Speaker 2

So no decrease, You know, modest increase.

Speaker 4

Appreciate that.

Speaker 2

That's what

Speaker 4

I was looking for. Thanks guys.

Operator

Thank you very much. Your next question is coming from Greg Burns of Sidoti and Company. Greg, your line is live.

Speaker 5

Good morning. I appreciate the improved momentum or execution you had quarter over quarter. But can you just remind us Well, what is the primary drivers of the year over year decline, particularly around, I guess, on the product side of The business, can you just give us a little bit more color on the primary drivers of the year over year decline and I guess The outlook for getting back to revenue growth?

Speaker 2

Yes. It has to do primarily with The split of our business between enterprise and service provider. Yes, we can see and definitely in Q3, we've seen that More than before, Enterprise Business is well on its growth and we have not seen Except for a slight decrease in the Q1 in Microsoft, the rest of the year we see growth. The other side of the business, which is service provider, really suffers badly. To give you some rough numbers, we Looking on the overall 2023, take one line, the service provider CPE, We reached about EUR 40,000,000 level of revenue last year.

Speaker 2

This year, we do not expect more than EUR 30,000,000. So the major decrease in product value comes from product used by service provider, Namely, gateways and service provider and MSBR. Also, there was an issue of inventories of 51s, which Due to high interest rates, drove partners to Hold less inventories. However, let me give you one perspective that we have not mentioned so far about, You know, we say the decline in gateways and MSBR. As the world moves from PSN to IP increasingly, call.

Speaker 2

I would tell you that in our longer term trends, we assumed that in the next 3 to 5 years, we will see a decline In sales of hardware products, mainly gateways and MSBR. But that was Primarily based on the thought that the process would be linear. Unfortunately, due to the Global crisis in 2023, this process has accelerated. And I believe that we've seen the majority of that decline Occurring already in the 1st 3 quarters of 2023. So basically, I think What we should have went through the next 3 to 5 years, part substantial part of it we went through in 2023.

Speaker 2

So That's what drove product decline. Also IP phones, I think I mentioned the high cost of inventory, But we're seeing a comeback. One area that we have not touched and mentioned just briefly is the MTR, the meeting rooms. And we do expect we have invested heavily in the last 2 years to prep it. And we believe that we will start call.

Speaker 2

The benefit of it already in 2024. This is a huge market. We know there was a big push by Microsoft Into the MTR space in 2022, which subsidized a bit because of the inflation, the high inflation and interest Straight. Which affect hardware cost. Hopefully, if we see that Changing somewhere mid-twenty 24 or towards the end of the year, I believe that already in 2025, we will see a big ramp up In that.

Speaker 2

So we will then probably go up in products.

Speaker 5

Okay. Thank you. And you mentioned, I guess, the hardware mix on the non core And I guess you just kind of discussed some of that. But in the core on the enterprise side, what's the mix of hardware versus software On that part of the business, particularly around SBCs?

Speaker 2

Yes. Good news on that, SBC is a major line call. The annual level of revenues for SBC is give or take about $120,000,000 Now We constantly move more to software, so many for new SBC solution or cloud based. And even more than that, while in small branch offices, you need to use some hardware, We're now in the process of moving from proprietary designed hardware that we engaged with in the past. We're now moving into using software that's embedded in service we purchase from other parties.

Speaker 2

So All in all, majority of our SBC is going to become sulfur based and that's the trend and therefore The very high gross margin that we will enjoy.

Speaker 4

Thank you.

Speaker 6

Thank you

Operator

very much. Your next question is coming from Ryan Coons of Needham and Company. Ryan, your line is live. Ryan, your line is live.

Speaker 6

Sorry about that. My bad. I was muted. I'm back. Nice quarter.

Speaker 6

I wanted to see if you could unpack the gross margin strength The nice job you did there. You talked about product mix and software and services. Is the shift to subscription and software Kind of the key driver there on gross margins? Or is there more to kind of understand if you could help us unpack that? Thank you.

Speaker 3

Hi, Ryan. No, it's mainly related to the improvement in our Service revenues, which is now about 50% of total revenues And also relates to more software as part of the product and high gross Margin product, as Chabtay mentioned, the SPC was very strong this quarter and it's In a better gross margin than the other products Such as the MSBR and IP phones. So it's mainly relates to the product mix.

Speaker 6

Got it. That's helpful, Niran. And With regards to that the software services revenue at 50%, is there further upside in margins In that business as you continue to scale or do you feel like you've really achieved your goals there within that mix And net margin?

Speaker 3

No. If you will look at the supplemental deck that we published With our results on our website, you will see that our long term target for gross margin is 65% to 68%. So there is More room for improvement in gross margin.

Speaker 6

Great. Thanks. And one follow-up if I could. On the AI products and your kind of strategy around pricing and Maybe your cost advantages you have from bringing that technology in house. Considering the different Commercial strategies out there.

Speaker 6

On one side, you've got Microsoft CoPilot charging a very hefty premium With their capabilities, you've got Zoom, who's essentially giving it away. What's your approach To your AI feature set with regards to costs and price and then how do your costs compare to maybe others that are dependent on Yes. Outsourced using outsourced models. Thanks.

Speaker 2

Okay. Thank you, Ryan. I think this was a very interesting question. I'll tell you, usually when you go to market, you want to penetrate the market. Cost is less important.

Speaker 2

So you drive with, let's call it, quick and dirty Using many cloud based services that may cost a bit, once you become successful And cost becomes an issue. I think you need to include in your strategy the ability to move So solution, including generative AI solution, that will owned by itself. There's a huge Fast running forward in industry that provides a lot of open source solutions for generative AI In our plans for the future and we definitely would like to decrease cost based on Our solution developed internally. I would also add that due to the issue of security, you'll find many Large corporation enterprises and entities, government entities, etcetera, that are forbidden from using You know a cloud solution and therefore, mastering those technologies and bringing them Into your development team and potentially developing on prem solution That will result both in, obviously, security, but then with substantially lower costs. So 1 is to navigate among all those options and find out the one that's best suitable for him.

Speaker 6

That's great. Thanks for the insights. That's all I have. Thank you. Sure.

Operator

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

Speaker 7

Hey, guys. This is actually Billy Fitzsimmons on for Samad. You guys talked about how leading indicators are robust and new business bookings have grown substantially over the last year. Maybe double clicking and asking another in another way, you talked about last quarter how bookings experienced a measurable improvement over Q1, in terms of an update on that, how do bookings track over the course of Q3? And how did that compare to Q1 and Q2?

Speaker 7

And kind of a follow-up. Can you kind of rank order and speak to the products and offerings that are driving that bookings and pipeline activity And maybe the products and offerings that have been maybe a little less successful and potentially a headwind to that activity.

Speaker 2

Right. Yes. So in our conversational AI, I would split the discussion into 2. We have Currently, two lines, which are already up and running and generating revenues and profits, but are, I would Say, mildly in scope of and those are the Smart App and VoiceAI Connect. We do have a major focus and emphasis on 2 fast developing business lines in this conversational AI.

Speaker 2

And those will be Voca CIC, a CCaaS platform for Teams. And second one is the Meeting Insight platform for Enterprise voice interaction processing. We definitely see maturity is driving the evolution of this, Obviously, the need in the market. So booking is growing definitely due to the fact that This increase need in the market for this type of solution and we're glad to be among the front runners who can provide it.

Speaker 7

Got it. And then if I can sneak a second one in there. I want to ask Ryan's question maybe a different way. How should we think about the sustainability of gross margins over the next, call it, handful of quarters? Should we expect A lot of quarter over quarter variability?

Speaker 7

Or should we expect that the product mix will be Generally similar or potentially improving compared to the Q3, the quarter you just reported in subsequent quarters.

Speaker 2

Right. We haven't done yet a Detailed analysis, but I'll tell you that basically, I think we've seen some of the worst In the hardware side of the business, mainly the service provider, the CPE and the phones. So we do not expect Those lines to grow. And therefore, the hardware part of the mix will not Affect gross margins, we see growth coming from software and services related business, mainly In Microsoft Teams phone, in customer experience and conversational AI, all are majority, which is software. So I do expect gradual growth going forward.

Speaker 2

And in our Long term financial model, we basically try to basically target the range of 65 to Or even I would dare to say that in 2, 3 years from today, we'll reach to 70. So we will not see big Change in the trends, we I think we would see gradual increase So the 68 thereafter. So that's what we plan.

Speaker 5

Got it. Thank you very much.

Operator

Thank for any closing remarks.

Speaker 2

Thank you, operator. I would like to thank everyone who attended our conference call today. On the heels of good Q3 and solid pipeline this quarter, Q4, we have high confidence in our ability to successfully expand our business this year and in coming years. We look forward to your participation in our next quarterly conference call. Thank you all.

Speaker 2

Have a nice day.

Operator

Thank you very much. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.

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Key Takeaways

  • AudioCodes reported Q3 2023 revenue of $61.6 million (up 2.6% sequentially), with non-GAAP gross margin rising to 67.3% and non-GAAP EPS of $0.25, leading to an upgraded full-year EPS guidance of $0.65–$0.75.
  • Enterprise now drives 90% of revenue, featuring Microsoft Teams Business up 20% year-over-year and Live Teams ARR growing over 50% to €43 million, targeting €46–€50 million by year-end.
  • Conversational AI and CX bookings climbed more than 50% year-over-year, powered by new AI offerings (Voca CIC, VoiceAI Connect, Meeting Insights) and several seven-figure contract wins.
  • The non-core service provider segment fell about 50% year-over-year due to delayed CapEx and inventory pullbacks, though recent project awards are expected to contribute in 2024.
  • Software and services now account for approximately 80% of revenue (hardware under 20%), boosting margins and marking a shift toward recurring-revenue models with enhanced operating leverage.
AI Generated. May Contain Errors.
Earnings Conference Call
AudioCodes Q3 2023
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