AudioCodes Ltd.

Q1 2023 Earnings Conference Call

5/9/2023

spk03: as customers continue to consolidate to primary vendor platforms to drive cost-effectiveness while doing more with less. However, we believe there are three potential reasons for the disconnect in our results. The first one, potential lag in activation of phone licenses as customers optimize networking budgets. Second, headwinds from the ongoing ad count regionalizations. And third, migration from historical license and maintenance model, which is CAPEX, to recurring or amended services model. All in all, I will point out that any CAPEX deal in the past is now transformed into roughly 20% of value on an OPEX basis, which means that we do miss some of those recurring revenues due to the fact that the overall sale is now extended over several years. Leading growth in UCAS and CX areas were services, which have demonstrated growth of 10.8% year-over-year, with professional and managed services growing 11.8% year-over-year. Service revenues or service business now represents 51.5% of our quarterly sales. With increased focus on moving to recurring business sales, our managed services business, Live and Live Cloud, entered the quarter at $35 million annual recurring revenues, up over 60% year-over-year, with total contract value now at above $110 million. We now expect live managed services to continue to grow at above 50% growth rate throughout 2023, and we target annual revenues recurring revenues to reach between $46 and $50 million by the end of this year. We don't see any reason for that growth rate to not continue in the following years. So we're talking about a really growing business, very large. In the customer experience market, we saw healthy customer activity during the quarter. These are direct enterprise customer experience business, roughly flat year over year. Now to the reduction in force and updated operating expenses budget for 2023. Given customer spending remains pressured by macroeconomic uncertainty new term, we have taken steps to adjust our cost structure and reduce our ad count and operating expenses. We plan for a reduction in force by approximately 8 to 10 percent over the next 6 to 12 months. with 6% of that effective immediately, roughly talking about 60-plus positions in our workforce worldwide. This reduction in force should provide OPEX relief starting in the beginning of the third quarter of 2023. The reduction in force was concentrated in R&D and sales functions globally, yielding $8 million of annualized OPEX savings. with full run rate expected to be realized in the beginning of third quarter. This step will allow us to stabilize our operation and financials for the rest of 2023 as it helps to balance our need to maintain investment in strategic areas of our business while meaningfully improving new profitability. We do expect that this reduction in force plan will help substantially improve 2024 financial results where we plan to see a return to revenue growth coupled with reduced OPEX to improve earnings for 2024 by more than 50% as compared to this year. We will continue to evaluate additional cost-cutting initiatives based on changes in our business environment. Now to some of our key business lines. Let's talk about Microsoft. Microsoft business declined 3% year-over-year in the quarter, with teams up 5%, while Skype for Business down over 50%. Skype for Business is now to a very not meaningful level of between 1 to 1.5 million a quarter. The same factors that influenced our total revenue impacted our Microsoft business, namely cautious enterprise customer spending behavior leading to other push-outs, and downsizing of scope and contracts are signed, with the weakness particularly acute in the EMEA region. Importantly, we have not seen any project cancellations as existing projects already in motion or continuing as planned. I should also mention that we really do not see any competitive pressure in this area, which is our key business area. We added above 250 new Teams accounts in the core, up from 256 added in the year-ago period, which is an indication that despite difficult macro conditions, customers continue to migrate from legacy telephony systems to next-generation Teams platform, albeit at a more rigid pace. Our long-term opportunity with Microsoft Teams remains unchanged. Teams remains the leading collaboration platform with Microsoft, having recently disclosed over 300 million monthly active users, up from over 280 million plus square. Teams, phone, PST, and attach rate at the low single-digit percentage of overall monthly active users provide us ample multi-year runway to drive ongoing penetration gains. While live annual recurring revenue primarily consists of managed services sold to large enterprises and customers, I would like to call out increasing momentum from our live cloud on white-labeled voice connectivity and application platform. This self-service SaaS platform is available for multi-vendor UC and CX environments such as Teams, WebEx, Zoom, and target service providers and system integrators worldwide. We have scored some notable wins globally. We now have over 50 customers on the platform. highlighting by a number of tier one carriers. This ramp up is continuing and we believe as we add on functions to live cloud, this platform automated solution for connecting businesses to teams and other UK solutions will pick steam and will drive much of our revenues in the future. Overall, we expect strong momentum in live services to continue in 2023. Now to the global services business. Invoicing was pretty strong. We saw healthy new service opportunity created worldwide. While total invoicing for the first quarter for total services was about 8.4% growth year over year, we saw 12.5% growth in the professional services year by year. Audiocode's live and managed service backlog at this at the end of the first quarter 23 was 52 million. That's compared to 26 million at the end of the first quarter 2022. This represents roughly 96% year over year growth, which tells a lot about the strength and the appeal for our live maintenance services with teams customers. Now let me move to the voice AI business. This is becoming a more important business in our future. Actually, I would say that while we keep strong on the networking business, we invest a lot in terms of budget in the voice AI business. The business was up 5% year over year on the back of ongoing momentum seen in voice AI connect and CIC products. We are projecting strong growth in this business over the long haul. Among the leading solutions and products in that business are the voice AI connect, connectivity solution, meeting insights, and our intelligent virtual agent solutions. Let me go one by one. Voice AI Connect was pretty successful in the first quarter. Invoicing grew 75% year over year. Booking was strong. Actually, we saw here more than 10% growth year over year. We could have grown further. Unfortunately, we had some delays in projects of some of our major customers. And then newly created opportunities grew above 30% in the core. So all in all, a very successful product. We don't see any competition to it. The product allows SIP telephony to be connected to cognitive services and, if you will, chat GPT type solutions. So a very successful product. Then let's move to VOCA CAC. VOCA CAC is our entry-level Microsoft Teams native AI-first contact center application for the CX market, and it has generated growing interest over 2022, and we plan to step up our efforts in this area. VOCA is a modern lightweight contact center solution designed to provide the lightest integration with Microsoft Teams Voice, allowing companies to effectively deliver a top-notch service experience for callers over their existing Teams Voice infrastructure. Using powerful automation capability, Loca allows easy no-code configuration of self-service IVR flows that combine built-in conversational AI with CRM and database dips, together with smart routing to queues, agents, departments, and company contracts, empowering employee experience. experience using CX capability. The VOCA solution integrates the Microsoft Teams using with power model, the latest and newest integration method powered by Azure communication services. Q1 2023 marked another peak of performance period for the VOCA solution with booking of above half a million, which is equivalent to the overall booking level of 2022. New opportunity creation was at 92, newly created opportunities in the first quarter. That is three times as big when compared to the first quarter 2022 creation of opportunities. As of today, VOCA CAC has 47 accounts worldwide, out of which 37 were acquired in the past year alone. Now to meeting insights. Meetings are the lifeblood of every organization, where valuable company information is shared among participants. Audicode's Meeting Insight is an enterprise meeting management solution designed to unlock this mountain of information treasure, summarize and analyze information relating to these meetings, and share it across the organization to substantially improve productivity and information sharing among managers and employees. Leveraging Audicode's vast voice capabilities a state-of-the-art voice AI technology, together with integrating it with LLM technologies, large language models, and technologies such as ChatGPT and other advanced cognitive services. Meeting Insight easily captures and organizes all meaning-generating content from team collaboration and training session to sales and recruitment calls. It generates automatic meeting summaries and insights, creates organizational data repository, and makes important organizational information searchable and accessible like never before using notification and mobile client technology. We already have taken steps to adopt ChatGPT and LLM models in our meeting insight solution to enable advanced AI summarization and speech analytics. We plan to deploy in coming weeks, the first such implementation. We expect Voice AI is now actually running in alpha, and we do plan to ship it to beta customers in less than a month from today. We expect Voice AI to achieve acceleration in the rest of 2022 and beyond to further expand our success in the U.S. and CX markets. And with that, I'm coming to the end of my introduction. While results work, impacted in the core by difficult market conditions causing a change in customers' spending decision and behavior and expanded sales cycles, we are confident that our secular growth drives and competitive position remain intact. We continue to see ample opportunity for innovation in the conversational AI business and transition to live services at customers undergoing digital transformation to cloud with our core UCSCX segment. And with that, I would like to turn the call back to the operator for the Q&A session.
spk09: At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, It may be necessary to pick up your handset before pressing the star keys.
spk08: One moment while we poll for questions. Your first question for today is coming from Greg Burns at Sidodian Company.
spk05: Good morning. Can you just walk us through the $50 million decline in the full-year revenue outlook? the buckets of revenue driving those declines, what parts of the business are accounting for that?
spk03: Okay, so basically, you know, we really took a cautious position, basically saying that due to the fact that the market trends are not changing as we step into the second quarter, and we did roughly $60 million in the first quarter, it was natural for us to basically plan for a year that would be either flat or slowly growing. The lines that went down primarily, as I've mentioned in the call, are CPEs, mainly sold to service providers, and also products sold in the IP phone product line. Also, we had to take some of the growth we expected for other areas. Let's mention the meeting rooms in the Microsoft Teams space where prior to January 2023, we envisioned substantially larger growth, and that has not happened. Also, if we watch the trends in the Microsoft camp, while we were growing 10% to 15% year-on-year, over a year in the prior years. In the first quarter, we were about 3% down. So we need to take all these factors into account when we plan for the full annual forecast, and that was the result.
spk05: Okay. Thank you. And then... How big is the IP phone business? What percent of your revenue is IP phones and other hardware like that? I guess that would also include your meeting room applications.
spk03: Right. So IP phone business was roughly above 10% last year. And we believe that this year it will not reach more than 60 to 70% of that. Unfortunately, just to tell you that, as I've mentioned, we have a huge backlog of opportunities to supply. We are in a stage where it's already the second quarter in a row where purchases are being pushed to the next one. March was really very clear in that trend. Things looked rather okay in January and February. In March, we saw several deals being pushed. That is the second quarter in a row. So that's what's happening. I think all in all, if you, you know, both phones and CP or CapEx type of sales, well, you could see that, you know, the recurring business sales really did not suffer as much as the CapEx. And I think this is part of what we saw, you know, in the first quarter.
spk06: Okay, thank you.
spk09: Your next question for today is coming from Ramad Samana at Jefferies.
spk07: Hi, this is Mason Marion on for Samad. Thanks for taking our question. So if I look at your EPS guidance, how should we think about your product gross margins going forward? Is it Should we assume that your 1Q level is a fair range?
spk01: Yeah, so with regard to gross margin, this quarter we ended 62.1%, which is a major decline compared to last year. Part of it relates to product mix and the other relates to the reduction in total revenues because part of the COX is actually a fixed cost. So all in all, we believe gross margin should improve slightly in the next few quarters, mainly at the second half of the year.
spk07: Okay, understood. And then if we think about the channel partners kind of destocking, are you seeing any signs that that's going to normalize? How should we think about kind of the seasonality throughout the year? Or should we just assume kind of 1Q levels are a fair way to think about it?
spk03: Okay. Well, unfortunately, you know, the outlook going forward, you know, on the economic side is not changing. You know, we don't see any change to the behavior. You know, I think it's all, you know, we all know that it's all tied to the inflation rate and the interest rate. And as long as those, you know, are, you know, in the same level and we don't see a change in those, I would not expect, you know, and especially when the cost of money is that high, I would not expect that stocking will resume, you know, sooner than changing the overall economy. Thank you. Sure.
spk09: Your next question for today is coming from Tal Liani at Bank of America.
spk02: Hi, guys. I want to take maybe a step back and think about the macro. We're seeing other companies dealing with channel inventory and inventory in the hands of the customers, and that's why orders are coming down. And we're also seeing companies dealing with high backlogs, and that's why also orders are coming down. And the question is, when you look at your weakness, what's the source of it? Is it coming because projects are getting canceled? or is it coming because there is channel inventory and backlog, but the deployments continue to be at the same rate? I'm trying to understand if the weakness, how temporary, how much visibility you have to a recovery, meaning how temporary is the weakness?
spk03: So we do believe that we have not seen that phenomenon in previous course up until the end of 2022. I think The worsening conditions earlier in the year really caused service providers and channels to basically hold purchases and do better inventory control. Now, as we have mentioned, we gave one example in the call of one big service provider customer that halted all purchasing in January, but as soon as it has used a lot of its backlog, you know, in its warehouses in the month of March, we saw him coming back to purchasing. So it's really, I think, you know, the amount of backlog that was sitting in warehouses awfully, you know, diminished to a level where from now on we will not see any impact from that side. However, there's still the impact of, you know, customers you know, rationalizing their expenses and pushing products in or, you know, making them smaller as they, you know, lay off employees. So these are the two factors. So as long as, you know, the economic situation is not changing now, we do not see any abrupt changes to what already happened in Q1. But on the other side, we can't see yet any improvement in that respect.
spk02: I don't know how much visibility you have to end projects. When you look at your big customers, do they continue to deploy at the same rate? So if they have inventory and it's just inventory adjustment, it means that they continue to deploy at the same rate. do they continue to deploy at the same rate, or do you see slowdown in the rollout of projects, that projects are being slowed down or canceled or pushed out? And I'm talking about the end customers, end-end customers, kind of.
spk03: Right. So, yeah, primary customers, you know, those who we target usually, and we're talking roughly on either Microsoft and our contact center customers, we're talking about large companies. So large companies... you know, may slow down a bit projects, but all in all, we have not seen major pushouts of complete project or delays by more than a year. What we are seeing is, you know, delayed decision on the expense. So when you're talking about, you know, live projects, you know, we gave you a number. I mean, we grew 60% year over year, meaning that as long as the project is of a managed services type, there's little chance that it will be canceled and pushed out completely. However, when it's a CapEx deal where you need to spend half a million or more than a million in the opportunity, then maybe due to financial conditions, you may decide you want to push it. So that gives you kind of an idea. Overall, we see good customer behavior. Yes, on the we've seen some project being, but that's not a phenomenon. The strong companies, the large companies keep deploying and we're just, you know, if you, we have mentioned on our website, we have one big company in Japan that is assigned with us to deploy, you know, a global project. We have another U.S.-based retail company Large retail companies also signed with us and then started to deploy. So the projects are there. It's only maybe a slower deployment cycle or whatever, but that's the whole difference.
spk02: And sorry, last question. Is there a change in the pricing environment as a result? Is there a change in the competitive environment? Do you see other competitors getting more aggressive because of the slowdown?
spk03: None. None. We do not see any competition in our markets. You know, some people sometimes make a mistake and compare us to another company that's active in the SBC space, but I will tell you that, you know, we do not see any competition in the Microsoft space. So, you know, there's no pressure at all. It's really more our ability to add more services and more applications. As I have mentioned, you know, If you think about us being able to deploy IVR solution and our contact center solution and our meeting inside solution in that environment, we just improve our ability to get increased ARPU from those customers. But we have not seen pressure on the competitive side. Thank you. Sure.
spk09: Your next question is coming from Ryan McWilliams at Barclays.
spk04: Hi, thanks for taking the question. This is Pete Newton on for Ryan McWilliams. Just the first question is, are you seeing any slowing on planned phone deployments at the enterprise level due to macro? And then also, what does your outlook look like for contact center? It sounds like that's something that does this pretty healthy.
spk03: Right. So, yeah, as I mentioned, you know, I think the bottom line is that while last year we grew about 15% year-over-year on the large enterprises in the Microsoft space, we will see this year a lower rate of growth. In the first quarter, it was 3% down, but we do expect that it will keep up going. Also, the fact that you know, Skype for Business really went almost to zero, and Teams grew 5%. So we believe that we will see in the Microsoft space, you know, a growth, maybe 5% to 10%, you know, as compared to 50% last year. But that's all, you know, a result of the economic situation.
spk04: Okay, perfect. And then, Just any thoughts on your Teams versus Zoom and your product portfolio and any differences you're seeing?
spk03: We haven't mentioned Zoom in this call, but yes, we do have good business with Zoom. We work with them on several projects. Yeah, we have not seen any major change in the behavior of our ability to win projects with Zoom in the first quarter.
spk04: Okay, thanks for taking the question. Sure.
spk09: Once again, if there are any questions or comments, please press star 1 on your telephone keypad. We have reached the end of the question and answer session, and I will now turn the call over to management for closing remarks.
spk03: Thank you, operator. I would like to thank everyone who attended our conference call today. With more focused planning for the rest of 2023, better control of our expenses to be aligned with revenues this year, and strong underlying market trends in our industry in coming years, we have high confidence in our ability to expand our business in coming years. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.
spk09: This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.
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