Audiocodes Ltd Q1 FY2021 Earnings Call

Hello and welcome to the AudioCodes's First Quarter 2021 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder this conference is being recorded. It’s now my pleasure to turn the call over to Roger Chuchen. Please go ahead sir.

Thank you. 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 would 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 Laws. 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 demand for existing products, the impact of competitive products and pricing on AudioCodes and its customers' products and markets, the timing of product and technology developments, upgrades, and the ability to manage changes in the 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 from the COVID-19 pandemic on our business and results of operations and other factors detailed in AudioCodes' filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information. In addition, during the call, AudioCodes will refer to non-GAAP net income and net income per share. AudioCodes has provided a full reconciliation of the non-GAAP net income and net income per share to its net income and net income per share according to GAAP in the press release that is posted on its website. Before I turn the call over to management, I would 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 would 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 first quarter 2021 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance at 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 then 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. 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 first quarter were $58.8 million, an increase of 13.1% over the $52 million reported in the first quarter of last year. Services revenues for the first quarter were $21.8 million, up 23.3% over the year-ago period. Services revenues in the first quarter accounted for 37.1% of total revenues. The amount of deferred revenues as of March 31 2021 was $71.6 million, up from $64.2 million as of March 31 2020. Revenues by geographical region for the quarter were split as follows: North America 39%, EMEA 39%, Asia Pacific 18% and Central and Latin America 4%. Our top 15 customers represented an aggregate of 61% of our revenues in the first quarter, of which 49% was attributed to our 11 largest distributors. GAAP results are as follows: gross margin for the quarter was 68.4%, compared to 65.9% in Q1 2020. Operating income for the first quarter was $10.1 million or 17.2% of revenues compared to $6.2 million or 11.8% of revenues in Q1 2020. Net income for the quarter was $10 million or $0.29 per diluted share, compared to $5.3 million or $0.17 per diluted share for Q1 2020. Non-GAAP results are as follows: non-GAAP gross margin for the quarter was 68.7%, compared to 66.1% in Q1 2020. Non-GAAP operating income for the first quarter was $13.2 million or 22.5% of revenues, compared to $7.9 million or 15.2% of revenues in Q1 2020, an increase of 66.9%. Non-GAAP net income for the first quarter was $12.7 million, or $0.37 per diluted share, compared to $7.8 million or $0.25 per diluted share in Q1 2020. At the end of March 2021 cash, cash equivalents, bank deposits and marketable securities totaled $182.5 million. Net cash provided by operating activities was $13 million for the first quarter of 2021. Days' sales outstanding as of March 31 2021 were 56 days. During the quarter, we acquired 350,000 of our ordinary shares for a total consideration of approximately $10.3 million. We reiterate our guidance for 2021 as follows: we expect revenues in the range of $240 million to $250 million and non-GAAP diluted net income per share of $1.45 to $1.65. I will now turn the call back over to Shabtai.

Thank you, Niran. We are very pleased to report strong first quarter 2021 financial results ahead of our internal budget and continued progress in our business. Most importantly, we have been strong in the markets. We have seen a strong market for three main growth engines namely, Microsoft business, Contact Centers and Conversational AI. In the Microsoft business, Teams and Skype for Business, business grew above 20%. However, most notably, our U.S. market is showing increased activity in view of the decline in the pandemic. We saw a better environment for new creative accounts and businesses. A very strong book-to-bill trend points to growth ahead. In the Contact Center, we have seen a strong pickup in activity. Conversational AI growth of more than 100% year-over-year in total. Importantly, first quarter industry dynamics further underline the notion that collaboration to work from home remains central stage in 2021 and beyond, even post-pandemic, and presents long-term growth prospects for us echoing strong performance in our North America services operations. Continued business strength indicates that the outlook for 2021 and onward is positive. Talking about the growth in services, AudioCodes Live continues on track with the initial plan and we’ll talk more about it later on. Also, the return throughout the strength continues in several countries for our devices. IT phones, desktop phones, and video conference devices showed meaningful improvement from 2020, though magnitudes of recovery could be capped going forward by the ongoing chip supply constraints and shortages. Touching on the key highlights of the first quarter, total revenue grew 15.1% year-over-year, an improvement compared to the 11.7% growth in the first quarter 2020. Growth was driven mainly by a secured growth opportunity within the Unified Communication-as-a-Service in Contact Center markets. Service revenues grew 23.3% year-over-year. Service revenues were driven by strength in professional managed services offering. Most importantly, we made ongoing progress in pivoting to recurring revenues with strong traction experienced with our AudioCodes Live offering. In terms of first quarter 2021 revenue, let me go by segments. Referring to the 13.1 overall company year-on-year revenue growth, it is important to note that growth in our key markets UCaaS and Contact Center was substantially higher. UCaaS accounted for over 65% of revenue and grew above 15% year-over-year. Contact Center accounted for over 12% of revenue and grew above 20% year-over-year. Combined, we now see more than 80% of our revenues growing at a rate of 15% year-over-year, which is substantial growth above the overall company growth. Two more segments, Voice AI I've mentioned, grew over 100% still less than 2% of revenue at this stage. The decline was seen in the service provider and technology, which finally make up the balance of revenues down in the quarter. To reiterate our three-year financial model targets, growth, which was 15% in enterprise revenues in the first quarter provides strong support for our rate targets and 2021 outlook, along with our long-term financial model. The model calls for 13% to 15% growth of revenues; we achieved 13.1%. Non-GAAP gross margin, we define it in the range of 67% to 70%; we ended up doing 68.7%. Operating expenses as a percentage of revenue, we said we would cap it at 47%, which came to 46.3%. When talking about the non-GAAP operating margin, we said the range would be between 20% and 23%; we ended up at 22.4%. Now let’s focus on two more key developments in the quarter. This is the focus on real-time cloud communication and the transition to recurring revenue. A recurring theme in our operation for the past several years has been increased focus and rapid transition for our solutions and services to real-time cloud communications. We continue to invest in cloud services automation and in Software-as-a-Service solution development, seeing further growth in this space. Much was achieved in 2020. In the first quarter of 2021, we have increased and accelerated investment in this area, driving momentum in 2021 and beyond. On top of this, we have substantially moved our focus in sales towards a recurring revenue model, and an increasing percentage of revenue now comes from recurring revenue sources versus the historical model of CapEx sales in our network year's operations. To further highlight this, let us now transition to recurring revenues. In March 2020, we announced AudioCodes Live initiative, which offers AudioCodes voice expertise product and solution to enterprises via a flexible subscription-based managed services model. We have made good progress through the second half of 2020 and into the first quarter of 2021, now seeing the momentum growing and expanding. By mid-2021, we expect this line to cross the $10 million ARR mark and reach $15 million ARR by the end of the year, more than doubling 2020 levels. Our booking or total contract value of this business is already several tens of millions of dollars and is signed with a large number of enterprises who have already started or are about to start UCaaS deployments with us. This fast-growing business is tangible proof of our superior technology in the areas of connectivity, management, automation tools, services, and adjacent applications to user solutions. I am confident that this business will keep growing and represent a very significant portion of AudioCodes value in the coming years on a recurring revenue basis. Now to Microsoft operations in the quarter. First quarter 2021 business grew over 20% year-over-year. Microsoft business now constitutes 45% of overall business. We target $120 million by the end of the year, growing above 20% on top of 2020. We’ve seen accelerating opportunities in the market, some of which focus more on the mid-market. We have seen a lot of activity around Direct Routing-as-a-Service and we have seen dozens of opportunities in booking and in the pipeline. We also enjoy a lot of success in our business development efforts in the field, identifying new large enterprise opportunities. By now, we are getting several qualified deals every week. The average size is a few thousand. Similar success is now picking up in certain countries of Europe where we see cooperation with the local teams of Microsoft. In terms of mix revenue, Microsoft Teams witnessed growth of 170% year-over-year, whilst the traditional Skype for Business declined moderately, less than 10% sequentially and about 50% year-over-year. Overall, we see considerable success and growth in the Microsoft business. When usually talking about revenues, I think it’s more important to discuss what’s evolving regarding what I would call a book-to-bill ratio. We have seen an acceleration of overall Teams business opportunities in the first quarter, having increased over 100% on a year-over-year basis and over 30% relative to the prior quarter. This metric is a good leading indicator pointing to ongoing momentum in our Microsoft business. All in all, substantial new Teams opportunities are developing for us going forward. As for the mix of accounts, where do they come from? Around 100 opportunities per quarter are coming from our old Skype for Business installed base but the growing number is on Teams. Comparing first quarter 2021 to first quarter 2020, we have seen an increase of more than 50% year-over-year in the number of accounts moving to Teams. To highlight some top wins in the first quarter in the Microsoft space, we had a large private company from the food industry that started with us with Skype for Business. We had a huge purchase order for replacing competitor presence. Also, we are providing Direct Routing-as-a-Service through the Live Essential Service. Another large account in the U.S., a company well-known in the financial space is also on track with their Teams migration project from Skype for Business. We executed a large professional services project for augmenting their in-house capabilities. We also brought a project in Asia Pacific, working with a bank in that region, providing a mixture of products and services including gateways, Session Border Controllers, management, central management, routing capabilities, management capability for subscribers, and professional services. This was a competitive win the against a rival from this space, and we partnered with a local large service provider. So how do we grow from here? We have a clear plan. We are going to increase the number of AudioCodes Live users. We are going to scale up in revenue from AudioCodes Live professional and premium services. We will introduce new business application services and upselling, including recording services, contact center services, analytics, meeting space services, and Conversational AI services. Now, regarding the second large market, the Contact Center, that is a rapidly growing market accounting for about 15% of our business. We target growth of above 15% year-over-year. This market goes through several disruptions, primarily the transition to cloud, as work-from-home evolves as a main trend. WebRTC is becoming the mainstream method to maintain quality of service when communications are over Internet lines. We are engaged in investing in the new emerging intelligent contact center, where we have a greater role in Conversational AI. Overall, this breadth of different technologies allows us to expand our business. Previously, we were more focused on working closely with Genesis. These days, we are expanding our efforts to work with more contact center vendors and also directly with end-users. This change in direction is assisting us a lot in growing our business. Overall, Conversational AI is receiving a significant boost for automating customer efforts and providing self-service engagements. We have seen revenues for the Contact Center grow by more than 20% year-over-year. We have expanded beyond the Genesis environment and are now selling to other large contact center vendors in a meaningful way. EMEA was exceptionally strong this quarter and we expect the same development in the current quarter. We are also engaged with innovative Voice AI technologies. As you recall, Voice AI Connect helps integrate voice with chatbots, and that activity is becoming quite successful. Let me take a moment to discuss our SBC operation, which is our most important product. Last year, sales were just short of $100 million. We plan to grow this year by another 20%. The quarter was very successful, with a 30% increase compared to the same quarter last year. We have seen a strong growth in bookings of more than 40% year-over-year across various projects and technologies, representing significant opportunity for us. Microsoft revenues in this space continue to grow at 70% year-over-year. The geographic breakdown shows the majority of revenues coming from Europe (about 40%), approximately 25% and above from North America, and 13% from APAC, with the remaining revenue coming from CALA and Israel. Now, let me address the smallest but exciting growth engine I am talking about, which is Conversational AI. Our Conversational AI business includes several product lines such as our recording services, Smartapp for Teams, and insights, along with the Voice AI Connect that connects voice to chatbots, and Voca for Conversational IVR. We’ve seen strong growth in this area, with revenue increasing by over 100% year-over-year. The rise in this sector stems from our technology's reliance on a combination of cognitive services technologies, including speech-to-text, text-to-speech, machine learning, NLU, NLP, and cloud cognitive services in SBC networking telephony expertise, which gives us a competitive edge. Long-term growth potential indicates that this business line ended 2020 at approximately $3.6 million. Our goal is to grow it by over 50% this year and reach $10 million by the end of 2022. Growth is driven by trends in the UCaaS and Contact Center space and the trends towards self-service and customer call automation in these markets. Our Smartapp solution for complex recording achieved success after obtaining certification for Teams about three months ago, being one of the few that secured it. We have observed a significant increase in our pipeline driven by increased compliance recording needs from the expanding number of Teams users in enterprise settings. So, in summary, this operation has performed extraordinarily well. Having concluded my presentation, I would now like to move to the Q&A session. Operator, please go ahead.

Our first question today is from Samad Samana from Jefferies. Your line is now live.

Hi. Good morning and congrats on the strong results. It’s good to see you kick off with strong numbers. So, Shabtai, maybe first, Team’s growth continues to be very exciting and I know you dug into it somewhat in your prepared remarks. When you think about the go-to-market motion, are you guys hiring more sales reps to sell into that Microsoft installed base to drive voice into Teams or maybe what’s AudioCodes doing as an organization to address that opportunity from a go-to-market perspective?

Thank you, Samad. I am really glad you brought that up. I didn’t mention headcount and headcount has really changed dramatically. We grew 6% over the last year. So we added another 45 employees to the 745 employees we had then. A majority of these positions are with our sales and services organization and as you can expect, because we see a lot of growth in the U.S., most of it is really occurring in the U.S. Therefore, yes, in just the past two weeks, we have approved between 10 and 15 new positions for the sales and services organization. There is a lot of activity and we are going to support that.

Great. And maybe on the pipeline again, your confidence in the environment definitely ran through on the prepared remarks, but when you think about how you measure it in terms of either client inbound requests or sign-ups for demos, is there anything tangible that AudioCodes measures that points to what the pipeline looks like or how healthy the pipeline for Teams related deals is?

Yes, we do track that internally. We have analytics measuring the contract’s value and how much was deployed, among others. You need to simulate that. Every organization finds it tough to move into AudioCodes Live, and our managed services typically begin with just a small portion of its operations initially. It will be natural for an organization to start with just a few hundred users. So, basically, we can tell you in terms of total contract value, we haven’t counted the thousands, but we have counted only the hundreds. So there is a lot of accumulated potential there. As we continue to deliver on our promises with the growth, as I have mentioned, we expect tens of millions of contract value to be developed throughout the year.

And great, maybe just one last one for me, for either of you, but profitability continues to exceed our expectations. I noticed that AudioCodes repurchased $10 million worth of shares in the quarter. How should we think about the rest of what’s left in terms of that $30 million buyback? Is there any appetite to expand the buyback level given the current valuation?

Right. Currently, we are in a position to relaunch a new purchasing effort every six months. The current buyback adds approximately $25 million in total, out of which we have already executed about $10 million. So, we have roughly $14 million remaining for the rest of the six months; this period will end around July. Again, based on the situation and what makes sense for us, we believe there is a lot of value in this buyback, because we want to invest where we believe the investment makes sense. That is currently what is happening.

Great. I’ll turn it over. Congrats again on the quarter, and thanks for taking my questions.

Sure. Thank you, Samad.

Thank you. Our next question today is coming from Raimo Lenschow from Barclays. Your line is now live.

Hey. Thanks for taking the question and congrats from me as well. Can you talk a little bit about the strength in the call center market? How much of that growth do you think is more on the pandemic side versus really strategic changes in the industry?

I think the pandemic really intensified the move of agents from physical facilities to working from home. There was no other choice. However, during that process, many vendors and end-users discovered that the cost of using agents at home is significantly lower than the cost of maintaining data protection on-premises in facilities. This competitive edge will remain. Additionally, the progression of cognitive services technology and industry has accelerated the shift from human agents. Two years ago, this was 100% human agents; it is now at 80%, and research indicates that in three years, only about 30% of agents will remain human. So, the evolution of technology is intertwined with the pandemic, driving this shift. The move from premises to cloud is beneficial for smaller companies, but it also provides significant efficiency for the vendor. Thus, while the pandemic's influence is notable, it is primarily the work-from-home approach, the WebRTC, and quality monitoring technologies that have evolved due to the pandemic and will continue to persist.

Okay. Okay, perfect. Then, if you think about your ongoing migration towards more software away from hardware, can you discuss any active steps you need to take as an organization to accelerate that transition, or do you feel it's just a natural evolution?

It is indeed an evolution. We initiated that journey three years ago and have made great strides. We are improving quarter-to-quarter, and I believe that today, there is no single application developed internally that does not rely on cloud communications. Everything being developed takes into account DevOps, Software-as-a-Service, automation tools, analytics, etc. Thus, I anticipate that in less than two years, we will be entirely cloud-based.

Okay, perfect. Thank you.

Sure.

Thank you. Our next question is coming from Greg Burns with Sidoti & Company. Your line is now live.

Morning. You gave the relative growth rates between Teams and Skype for Business. Can you provide us with the revenue mix? How much revenue from Microsoft is still from Skype for Business?

Yes, from the pro forma perspective, overall revenues topped $25 million or above. Out of that, Skype for Business accounted for about $8 million, while the remainder came from Teams.

Okay. Great. Thanks. And then, when you look at the Teams market in terms of voice penetration within the user base, can you provide an update on where that stands? Have you seen any change in the trajectory or pace of voice adoption within the Teams user base?

Yes, we are seeing a greater emphasis on voice in 2021. This may relate to competition from other companies making voice more important this year. If you want to succeed among the top-tier vendors of UCaaS, you need to offer all components. This drives other companies to invest heavily in voice. Additionally, we saw significant progress in selling into the Zoom environment as well. The Zoom phone, which was less visible in our operations last year, truly surged at the end of last year, and the first quarter alone more than doubled the business we saw in the fourth quarter of last year. Thus, all in all, I believe voice is gaining importance in today’s business landscape.

Okay. Great. And then, in terms of AudioCodes Live, can you share what is embedded within those ARR targets, the $10 million by mid-year and $15 million by year-end, and maybe discuss the number of seats, relative seismic counts, and ARPUs?

We are mainly targeting companies with thousands of seats, but projects typically start with hundreds. In terms of services we provide initially, we start with the most basic services, Direct Routing, and then build upon that to offer management, routing services, call recording services, and eventually more cognitive services. When deploying voice like Teams Voice-as-a-Service, you require an entire stack of technologies to ensure complete functionality. So that involves SBC, routing, management, and devices—essentially everything needed for Teams that delivers Voice-as-a-Service model.

Okay. When you examine that stack of the unlocking technology required to streamline the process and also some of these incremental applications you’re contemplating for cross-selling into that ecosystem, where do you think ARPU could get to? Or where do you see it starting?

Yes, it’s a great question. We can start as low as $1 when the service is offered at the most basic level. However, as we integrate more advanced services, the ARPU can escalate to $4, $6, $7, etc. So, I’d say the average range would be between $1 to $7.

Okay. Great. Lastly, how are you planning to go to market with AudioCodes Live? Do you have a direct sales force selling that, or are you primarily utilizing the channel?

We work with our channel partners. We haven't altered our go-to-market strategy; instead, we include our partners. They bring in knowledge and expertise. While we handle the direct interactions in some instances for very large customers, the majority of the service is mediated through indirect channels.

Okay. Thank you.

Sure.

Thank you. Our next question is coming from an unidentified analyst from Needham & Company. Your line is now live.

Thanks for the question and thanks for the color on the Microsoft ecosystem. Are you seeing any shifts in the competitive landscape? Are new vendors being approved? Secondly, on the product side, are you witnessing any shifts toward more of a SaaS model there, or does it remain more of a license approach?

Generally, very few newcomers have emerged. We have seen announcements from companies like 8x8, RingCentral, and Vonage offering similar services but nothing beyond that. In terms of providing a complete technology stack for Teams, there isn’t much competition at this stage. Regarding your second question about shifting to SaaS—yes, we are experiencing more of that. In the first quarter, we implemented new services that are part of our Live Essential or Azure, representing a completely SaaS solution that we will be offering for management. Our trend is indeed significantly moving from services and managed services into SaaS solutions.

Thanks so much.

Sure.

Thank you. We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further remarks or closing comments.

Thank you, operator. I would like to thank everyone for attending our conference call today. With continued good business momentum and execution in the first quarter of 2021 and previous quarters, we believe we are on track to achieve another strong year of growth and expansion in 2021. We look forward to your participation in our next quarterly conference call. Thank you all. Have a nice day.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.