Audiocodes Ltd Q4 FY2021 Earnings Call

Good day everyone, and welcome to AudioCodes' Fourth Quarter and Full Year 2021 Earnings Conference Call. It is now my pleasure to hand it over to your host, Roger Chuchen, VP of Investor Relations. Roger, you have the floor.

Thank you, operator. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; and Niran Baruch, Vice President of Finance and Chief Financial Officer. Before we begin, I'd like to remind you that the information provided during this call may contain forward-looking statements relating to AudioCodes' business outlook, future economic performance, product introductions, plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future events, conditions, performance, or other matters, which are forward-looking statements as the term is defined under U.S. Federal Securities Law. Forward-looking statements are subject to various risks, 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, shifts in supply and demand, market acceptance of new products and the demand for existing products, the impact of competitive products and pricing of AudioCodes and its customers' products and marketing, timely product and technology development, upgrades and the ability to manage changes in market conditions, as needed, possible need for additional financing, the ability to satisfy covenants in the company's loan agreements, and possible disruptions from acquisitions. The ability of AudioCodes to successfully integrate the products and operations of acquired companies into AudioCodes business, possible adverse impact of the COVID-19 pandemic on our business and results of operations, and other factors detailed in AudioCodes' filing 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 fourth quarter and year-end 2021 conference call. With me this morning is Niran Baruch, Chief Financial Officer and Vice President of Finance of AudioCodes. Niran will start off by presenting a financial overview of the quarter. I will then review the business highlights and summary for the quarter and 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 fourth quarter were $66.1 million, an increase of 12.7% over the $58.7 million reported in the fourth quarter of last year. Full year 2021 revenues were $248.9 million, an increase of 12.7% over the $220.8 million reported in 2020. Services revenues for the fourth quarter accounted for $24.4 million, up 16.2% over the year ago period. Services revenues in the fourth quarter accounted for 37% of total revenues. On an annual basis, services revenues increased by 24.4% compared to the previous year. The amount of deferred revenues as of December 31, 2021, was $76.5 million, up from $69.2 million as of December 31, 2020. Revenues by geographical region for the quarter were split as follows: North America 44%, EMEA 40%, Asia Pacific 12%, and Central and Latin America 4%. Our top 15 customers represented an aggregate of 63% of our revenues in the fourth quarter, of which 51% was attributed to our 12 largest distributors. GAAP results are as follows: Gross margin for the quarter was 67.2% compared to 71.4% in Q4 2020. Operating income for the fourth quarter was $9.3 million or 14% of revenues compared to $12.1 million or 20.7% of revenues in Q4 2020. Full year 2021 operating income was $39.5 million compared to operating income of $38.4 million in 2020. Net income for the quarter was $7.3 million or $0.22 per diluted share compared to $8.4 million or $0.24 per diluted share for Q4 2020. Full year 2021 net income was $33.8 million or $1 per diluted share compared to $27.2 million or $0.83 per diluted share in 2020. Non-GAAP results are as follows: Non-GAAP gross margin for the quarter was 67.6% compared to 71.5% in Q4 2020. Non-GAAP operating income for the fourth quarter was $13.5 million or 20.4% of revenues compared to $15.4 million or 26.2% of revenues in Q4 2020. Full year 2021 non-GAAP operating income was $53.8 million compared to operating income of $47.5 million in 2020. Non-GAAP net income for the fourth quarter was $13.4 million or $0.39 per diluted share compared to $15.2 million or $0.44 per diluted share in Q4 2020. Full year 2021 non-GAAP net income was $51.8 million or $1.50 per diluted share compared to $46.7 million or $1.41 per diluted share in 2020. At the end of December 2021, cash, cash equivalents, bank deposits, and marketable securities totaled $174.8 million. Net cash provided by operating activities was $4.3 million for the fourth quarter of 2021 and $47.3 million for 2021. Net cash provided by operating activities in both periods were impacted by the $12.2 million payment made in December 2021, which was the third and last installment pursuant to the royalty buyout agreement. Days sales outstanding as of December 31, 2021, were 68 days. During the quarter, we acquired 314,000 of our ordinary shares for a total consideration of approximately $10.7 million. In December 2021, we received court approval in Israel to purchase up to an aggregate amount of $35 million of additional ordinary shares. The court approval also permitted us to declare a dividend of any part of this amount. The approval is valid through June 19, 2022. Earlier this morning, we declared a cash dividend of $0.18 per share. The aggregate amount of the dividend is approximately $5.8 million. The dividend will be paid on March 1, 2022, to all of our shareholders of record at the close of trading on February 15, 2022. Our guidance for the full year of 2022 is as follows: We expect revenues in the range of $277 million to $285 million and non-GAAP diluted earnings per share of $1.40 to $1.60.

Thank you, Niran. We are very pleased to report strong financial results for the fourth quarter and full year 2021. 2021 capped an exceptional performance for the company, with revenue growth year-over-year, accelerating to 12.7% for both the fourth quarter and for the full year. This is a nice achievement when compared to the annual revenue growth achieved in 2020, which was 10.2%. More importantly, beyond the success on the financial front, in 2021, we successfully executed on our strategic priorities in our markets. We built a more dominant position in our industry as a leading unified communication collaboration voice company. We kept making progress in our key areas of focus: namely UCaaS contact center and CCaaS, and in the Voice AI world, and we continued to pivot our business towards cloud communications, and greater contribution from managed services and recurring revenues. On the net income side, we grew 10.8% compared to 67% in 2020. This is mainly due to our calculated and conscious decision to increase investments in sales and marketing and R&D to capture the significant opportunity available for UC Voice in the coming years in the UCaaS and contact center markets. Just to provide some data, in the recent two market studies targeting UCaaS and the contact center market, a Piper Sandler note, which discusses the global TAM of about 440 million endpoints shows that UCaaS, in the next five years, should see a significant increase. Essentially, we're talking about only 26 million endpoints at the end of 2021, and the report projects 150 million at the end of 2026, which is significantly lower than the TAM. This forecast presents a 34% five-year compound aggregate growth rate. Therefore, for us, this is a time to invest. This is a time to take some of our profits from our ability to generate net income and operating margins that are above 20% a year and reinvest them in the business to create high annual growth. Another report that was released about two weeks ago from Baird, noted that several channel partners, some of whom sell more than $10 million in UC revenue annually, expect their business to grow by 30%. Moreover, 53% of them indicated that when comparing this to what was quoted in December 2020, only 38% had expected similar growth. This indicates a strong conviction among channels and an increasing number of vendors that this market is growing rapidly and represents substantial opportunity. Consequently, this is why we made the decision to invest more in growing annual revenues and maintaining profitability at 20%. As a result, we developed some financial models not only for 2022 but also for '23 and beyond. Just based on organic growth, as stated in our guidance, we expect to grow this year at about mid-range, approximately 13%. Personally, I believe we can exceed that. If we effectively execute on our M&A strategy, we could see growth further into the 15% to 20% range annually. Therefore, expect growth and capturing market share in our markets. This is the strategy, and this is why we invest in sales, marketing, and R&D. Additionally, as we grow revenues, we capture more market share against competition, which is evident in the performance we presented in 2021. Simultaneously, we achieved an operating margin in 2021 of 21.6%, which is within the 20% to 23% range defined in our long-term financial models that we've presented to our analysts a long time ago. This is a similar level of operating margin to what we achieved in 2020. Other key achievements for 2021 include gross margin expansion from 68.1% in 2020 to 69% in 2021, and substantial expansion of our core services offering. In many ways, our performance in 2021 underscores the migration from our traditional gateway and SBC connectivity business, which was primarily hardware-based, towards a software and services offering, which carries substantially larger gross margins and innovative approaches to communication and collaboration. Central to this success was our partnership with Microsoft, contributing to a growth of about 20% year-over-year in 2021, driven primarily by the continued success of Microsoft Teams Solutions. Sales of Microsoft Teams Solutions experienced growth of over 70% year-over-year, significantly reducing the clients from Skype for Business, which now represents only about 10% of the total Microsoft UC contribution. Additionally, our quarterly contact center business grew 12% year-over-year, and over 15% for the full year. As a result, enterprise contributed nearly 85% of our revenue during the year, growing by over 15% in 2021. Our AudioCodes Live managed services exceeded our internal expectations, with annual recurring revenues (ARR) exiting this year well above our target of $15 million, more than doubling from last year's figure of about $7 million. Services grew at an annual rate of 24.4% and now account for 37.7% of our revenue, up from 34.2% in 2020. Additionally, our pipeline continues to expand across core areas of our business, supported by long-term secular trends that include the migration of voice infrastructure to the cloud, video-enabled collaboration, hybrid work, and enhanced customer engagement and experience solutions powered by AI. I would also like to address another focus area, which has been impacted by the pandemic for the past two years—the service provider CPE activity. I'm glad to report that in the fourth quarter, we saw an improvement in our salesforce CPE business with sales increasing by about 50% year-over-year, suggesting demand is rebounding as we move into 2022. However, in 2021, we observed a decline of approximately 13% in revenue compared to 2020 notably due to component shortages which limited our ability to deliver products, and this disruption in the supply chain is expected to continue well into 2022. This has limited our delivery capability and raised costs that negatively impact our gross margins. In summary, while this area contributes about 13% to 14% of our business, our focus remains on enterprise which is growing over 15%, and that is where our investments are directed. Regarding Voice AI, although it currently represents a small percentage of our revenue, Voice AI bookings and revenues grew over 100% during the year, surpassing our projection of $5 million. We anticipate this business line to nearly double again in 2022. In fact, I foresee that in about two years, with our recent acquisition of Callverso, we could see this line achieving between $20 million and $25 million in revenue, reflecting strong growth. In the first quarter of 2021, we announced the acquisition of Callverso, a small Israeli private company specializing in developing and deploying state-of-the-art virtual agent solutions for the contact center market. This acquisition further strengthens AudioCodes' ability to help contact centers improve their customer experience while reducing operational costs. Moreover, in terms of financial performance, I would like to discuss a few additional points regarding operating expenses (OpEx). OpEx has increased substantially by 1.5% sequentially, and 17.6% year-over-year, primarily due to the lower U.S. dollar to Israeli shekel exchange rate compared to 2020 rates, necessitating an increase in headcount. Over the past year, we have added more than 110 new positions, maintaining a pace of about 30 new positions every quarter. Additionally, rising salaries in Israel due to the booming high-tech industry have created shortages in skilled manpower, contributing to higher salaries. Therefore, we are committed to our business planning in a way that enables us to continue generating operating margins above 20% annually.

We generated $16.5 million in cash flow during the quarter, bringing our overall cash flow for 2021 to around $59.6 million, almost $60 million this year following close to $50 million generated the previous year. Deferred revenues also grew to $76.5 million compared to $69.2 million a year ago, reflecting an increase of about 10.5%. Our long-term financial model remains unchanged: we plan for revenue growth to reach between 13% to 15%. Non-GAAP gross margin is targeted to be in the range of 67% to 70%, while OpEx is expected to be no more than 47% to 50%. Our operating margin, as I've previously mentioned, is projected to remain within the 20% to 23% range.

Recently, we have announced enhancements to our corporate development efforts, including the appointment of Mr. Dmitry Netis as Chief Strategy Officer effective immediately. Dmitry brings a wealth of experience with a 25-year career in technology and 15 years covering companies in unified communication and collaboration, customer experience, and other sectors. We expect these changes to significantly strengthen our corporate development and planning this year to facilitate non-organic growth for our company. Regarding our activities, I should emphasize that Microsoft experienced around 20% year-over-year growth, supported primarily by our Live services, which aid companies in transforming their UC and telephony services to Microsoft Teams. In 2021, we had signed contracts valued at over $50 million, and I can share that our ARR increased from $7 million to well above $16 million, reaching our planned target. In terms of Microsoft revenues, Teams has been growing steadily, while Skype for Business has seen a decline. In terms of new opportunities in the Microsoft space, we have recorded growth of over 76% year-over-year in newly created opportunities. Using a ratio of three to one when evaluating opportunity creation versus build, we expect continued growth and acceleration of revenues from our activities in the Microsoft ecosystem. Recent initiatives like Operator Connect, aimed at enabling service providers to offer Microsoft Teams to their business customers, have generated significant interest from Tier 1 providers, and we anticipate our platform will feature prominently in its launch. We've also observed impressive growth in the desktop phones segment during 2021 and into the first quarter of 2022, attributed partially to the return to the office. Our meeting room solutions, boasting conference devices introduced more than a year ago, have seen substantial growth and are expected to triple in volume in 2022. Furthermore, we successfully gained traction in the Zoom marketplace, with Zoom's strategic focus on Zoom Phone gaining importance. From our side, this has translated into a noticeable increase in our business activity. In 2021, we grew SBC revenues from $100 million to $121 million. We also witnessed promising new opportunities, with a growth of 36%. The transition to software solutions continues, now reaching 40% in 2021 from 30% the previous year. Investment in our SaaS infrastructure and managed services is a priority, and we plan to enhance our SaaS solutions for key target markets including Microsoft Teams, Zoom Phone, and other various use cases driven by conversational AI. In closing, while our services grew by 16.2% in 2021, we also noted a decline in support and maintenance services as a result of the transition from CapEx to recurring sales. However, we saw significant gains in professional and managed services, with a growth of nearly 50% in this area. The Voice AI segment alone observed bookings that surpassed our expectations, and this business is projected to escalate substantially in the near future, given the strong demand across various sectors. The acquisition made in November was of a private company focusing on virtual agents, further enhancing our capacity in the contact center sphere. This integration is progressing well, and we are deploying their technology internationally. The pandemic and the recent omicron wave resulted in increased call volume into contact centers, and our virtual agents demonstrated efficiency in managing that influx.

Your first question for today is from Ryan MacWilliams. Please state your affiliation and then ask your question.

Ryan MacWilliams from Barclays. So, thanks for taking the question, guys. It looks like the midpoint of your initial revenue guidance implies similar growth this year. And the guidance going into next year is stronger than the guidance you gave when headed into fiscal 2021. So, Shabtai, given that there are investor concerns around a pull forward and cloud communications growth due to COVID, can you talk about some of the indications you are seeing of an improved market opportunity as we head into this year? Thanks.

Right. Yes, unfortunately, with COVID, we have transitioned to hybrid working models. In this hybrid environment, the necessity to work from anywhere, including both home and office, has created huge demand for UCaaS solutions. The growth we have seen, along with data we've provided, reflects this ongoing trend in UCaaS and contact centers. I can attest that our main challenge moving forward will be ensuring sufficient manpower to meet this demand. Thus, our ongoing efforts to grow headcount are critical; last year we added 110 employees, and we are hiring around 30 new employees each quarter.

Excellent. And then one for Niran. Niran, it looks like fourth quarter service revenues were slightly lower than the prior quarter. Any puts and takes to call out would be helpful. Thanks.

Yes, I wouldn't read too much into quarterly fluctuations in the service revenue growth alone. As you know, we have professional services training in the service line. There can be fluctuations that can skew the quarterly growth rate. Our 2021 service revenues grew 24%, which is an improved growth rate from 16% in 2020. So, while there are occasional fluctuations, I suggest not to focus on them on a quarterly basis.

Excellent. Then last one for me. Shabtai, congrats on bringing on Dmitry. You mentioned the potential for future inorganic acquisitions going forward. Are there any specific areas of the market that seem interesting? Or are there any software capabilities that your customers are asking for? Thanks.

Thank you. Our focus is on enhancing our strategic market direction, which we've identified as the Microsoft Teams space. Therefore, our highest priority will be to supplement and augment our capacity to deliver more services in that specific area. Of course, we are also looking into Voice AI and contact center solutions. Our strategy emphasizes increasing our market reach rather than merely pursuing individual technology advancements.

I appreciate the color. Thanks, guys.

Your next question for today is coming from Greg Burns. Please announce your affiliation, then pose your question.

Good morning. Greg Burns with Sidoti and Company. I’m following up on the service line just in terms of gross margins. What was driving the gross margin down on the service line this quarter? Is that kind of how we should expect things to be looking for '22?

Yes, the decrease was primarily due to increasing our manpower at the customer service department. Additionally, we faced ongoing supply chain disruptions that affected our gross margin. In this quarter, we had made one-time purchases of components at a higher cost in the open market to meet demand, which contributed to roughly a 100 basis point reduction in Q4 gross margin. This issue impacted both service and total gross margins.

Okay. And Shabtai, you mentioned a shift in the revenue mix, given you're moving away from hardware to more recurring service sales. Does the recurring revenue, like if you sell a Live solution, fall into the service revenue line item? Or is that considered product line revenue?

Yes, it's definitely categorized under services. It's part of our managed services, and as mentioned, it's experiencing substantial growth. For reference, our Teams revenue grew almost 70% compared to the previous year. Now Live accounts for over 20% to 25% of total Teams revenue, which means as Teams grows, Live and managed services will grow accordingly.

Okay. And lastly, you talked about Operator Connect, but Microsoft also launched Teams Essentials, targeting the SMB space. How might that impact your business? Could it accelerate growth for you in the Microsoft ecosystem?

Yes, Microsoft Teams Essentials mainly targets small organizations by reducing subscription rates, which should positively impact the Operator Connect initiative. This will make it more appealing for smaller businesses to connect to Teams.

Your next question is coming from Samad Samana. Please announce your affiliation, then pose your question.

Hi. Great. With Jefferies. Thanks for taking my questions. I want to unpack one of the comments you made, Shabtai, about growth expectations. I know the formal guidance, but your view was that you guys should do better than that. Historically, when you've guided, that has often correlated with achieving those targets. What gives you confidence that you can outperform the initial guidance set today? Help us understand what underpins that confidence.

Actually, yes, thank you for that question, Samad. I believe I provided some insights earlier that support our expectations. In the past, we were more cautious. For example, Microsoft’s revenue grew at about 20% year-over-year, and we always emphasized that Teams was growing while Skype for Business was on a decline. In the fourth quarter specifically, we observed a significant drop-off in Skype for Business, while Teams saw substantial growth. This dynamic means that, moving forward, decline in Skype revenue won't overshadow the successful growth of Teams. Hence, I can confidently project a growth rate for Microsoft close to 30% if we continue to invest strategically in Microsoft solutions.

Got it. And one last question for me. As for the growth versus investment philosophy, you've touched on it a bit on the call. But what is your end goal for growth level? Is it to sustain this low teens growth, or do you expect your operational expenditures to drive a growth level closer to 20%? Can you clarify how we should think about your reinvestment philosophy amidst the EPS guidance for 2022?

Right, thanks for asking. If we step back, and look at several years from 2020 to 2025, I can share that before 2020 we took a more cautious approach towards growing OpEx. For example, in 2020, our OpEx only grew around 3.5% over the previous year. Contrarily, as planned for 2021, we increased our OpEx by 14.6%. We intend to mirror that effort, if not double it, in 2022. The outcomes we anticipate from these major investments will lead to revenue growth of approximately 15% to 70%. Ultimately, this will position us for greater net income in 2023 and onward, as we will reduce growth-related investments significantly.

Your next question is coming from Ryan Koontz. Please announce your affiliation, then pose your question.

Sure. I'm with Needham & Company. The Teams ecosystem is significantly gaining momentum here globally. I wonder if you could share any insights regarding performance across various segments? Is the core of their business primarily in the U.S., and how are they performing outside the U.S. as they advance into the SMB sector?

Thank you, Ryan. Currently, while there isn't a specific vertical that stands out, it is indeed true that the U.S. leads significantly in the deployment of Teams with Western countries like the U.K., Germany, Canada, and France also showing notable growth. However, these deployments are still in their infancy, and the potential for expansion remains high across markets. According to the Piper Sandler report, a small portion of total opportunities has been utilized so far, leaving a substantial market still to capture.

Okay, that's super helpful. And just a quick follow-up, could you provide any insight on deal sizes in terms of seating? Are you noticing larger enterprises adopting UCaaS offerings more than smaller and mid-market businesses?

No, Teams is deploying significantly within the larger enterprise sector. We have seen Teams deployed in about 90% of the S&P 100, primarily focusing on larger enterprises and increasingly within the mid-market. However, the recent initiatives target smaller businesses, but currently, the emphasis remains on the larger enterprises.

Your next question is coming from Tal Liani. Please announce your affiliation, then pose your question.

Hi, Shabtai and Niran. This is Tal from Bank of America. I have two questions. First, regarding the margins. Your R&D and G&A went up 15% and 20%. Your EPS is going down while revenues are increasing. Could you explain what's driving these investments and what the outlook for expenses is? Secondly, regarding supply constraints, you mentioned some impacts on delivery, but can you elaborate further?

Yes, hi, Tal. Our OpEx increased 14% year-over-year, with R&D growing 13%, sales and marketing 17%, and G&A 6.8%. We plan to invest even more in OpEx to support revenue growth, especially in sales, marketing, and customer service. Regarding gross margin, as I've mentioned, we are facing widespread supply chain disruptions, leading to an additional 100 basis point impact from purchasing components in the open market at higher costs. We expect similar challenges in Q1 of 2022 but believe this is a temporary setback.

Got it. To clarify on your first answer about expenses, will this be a one-time phenomenon or should we expect operating margins to decrease next year?

For 2022, we plan to continue increasing OpEx, which is reflected in our flat EPS guidance midpoint. As we head into 2023, we expect to require fewer growth investments than in '21 and '22.

Great, thank you.

Thank you, operator. We would like to thank everyone who attended our conference call today. We continue to see good business momentum and accelerated growth in 2021, alongside strong underpinning market trends in our industry. We believe we are on track for another year of growth in 2022. We look forward to your participation in our next quarterly conference call. Thank you very much, and have a nice day. Bye-bye.

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