Greetings. Welcome to the AudioCodes First Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Roger Chuchen. You may begin.

Thank you, Holly. Hosting the call today are Shabtai Adlersberg, President and Chief Executive Officer; Niran Baruch, Vice President of Finance and Chief Financial Officer; and Dmitry Netis, Chief Strategy Officer and Head of Corporate Development. Before we begin, I'd like to remind you that the information provided during this call may contain forward-looking statements relating to AudioCodes' business outlook, future economic performance, product introductions, plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters 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 to differ materially from those stated in such statements. These risks, uncertainties and factors include, but are not limited to, the effect of global economic conditions in general and conditions in AudioCodes' industry and target markets, in particular, shifts in supply and demand, market acceptance of new products and the demand 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 the ability to manage changes in market conditions as needed, possible need for additional financing, the ability to satisfy covenants in the company's loan agreements; possible disruptions from acquisitions; the ability of AudioCodes to successfully integrate the products and operations of acquired companies into AudioCodes' business; possible adverse impact of the COVID-19 pandemic on our business and results of operations; and other factors detailed in AudioCodes' filings with the U.S. Securities and Exchange Commission. AudioCodes assumes no obligation to update this information. In addition, during the call, AudioCodes will refer to non-GAAP net income and income per share. AudioCodes has provided a full reconciliation of the non-GAAP net income and income per share to its net income and net income per share according to GAAP in the press release stated – in the press release that is posted on its website. Before I turn the call over to management, I'd like to remind everyone that this call is being recorded. An archived webcast will be made available on the Investor Relations section of the company's website at the conclusion of the call. With all that said, I'd like to turn the call over to Shabtai. Shabtai, please go ahead.

Thank you, Roger. Good morning and good afternoon, everybody. I would like to welcome all to our first quarter 2023 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 industry and business. We will then turn it into the Q&A session. Niran?

Thank you, Shabtai, and hello, everyone. Before I start my formal remarks, I would like to remind everyone that we will make available shortly a supplemental earnings deck on our Investor Relations website. 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 $59.2 million, a decrease of 10.8% over the $66.4 million reported in the first quarter of last year. Services revenues for the first quarter were $13.5 million, up 10.8% over the year-ago period. Services revenues in the first quarter accounted for 51.5% of total revenues. The amount of deferred revenues as of March 31, 2023, was $77.6 million compared to $76.8 million as of March 31, 2022. Revenues by geographical region for the quarter were split as follows: North America, 46%; EMEA, 31%; Asia-Pacific, 17%; and Central and Latin America, 6%. Our top 15 customers represented an aggregate of 54% of our revenues in the first quarter, of which 40% was attributed to our 11 largest distributors. GAAP results are as follows: Gross margin for the quarter was 61.7% compared to 66.9% in Q1 2022. Operating loss for the first quarter was $0.8 million compared to operating income of $8.1 million in Q1 2022. Net loss for the quarter was $0.2 million or $0.01 per diluted share compared to operating income of $8.6 million or $0.26 per diluted share for Q1 2022. Non-GAAP results are as follows: Non-GAAP gross margin for the quarter was 62.1% compared to 67.2% in Q1 2022. Non-GAAP operating income for the first quarter was $2.9 million or 4.9% of revenues compared to $11.9 million or 18% of revenues in Q1 2022. Non-GAAP net income for the first quarter was $2.7 million or $0.08 per diluted share compared to $11.2 million or $0.33 per diluted shares in Q1 2022. At the end of March 2023, cash, cash equivalents, bank deposits, marketable securities and financial investments totaled $121.5 million. Net cash provided by operating activities was $3.2 million for the first quarter of 2023. Day sales outstanding as of March 31, 2023, were 97 days. In January 2023, we received court approval in Israel to purchase up to an aggregate amount of $25 million of additional ordinary shares. The court approval also permits us to declare a dividend of any part of this amount. The approval is valid through July 4, 2023. On February 7, 2023, we declared a cash dividend of $0.18 per share. The dividend in aggregate amount of approximately $5.7 million was paid on March 7, 2023. Regarding headcount, on the heels of the addition of 112 positions in 2021 and 81 positions in 2022, we added 12 full-time employees in the first quarter of 2023. We ended the first quarter 2023 with 978 employees. To better align our cost structure to the current business environment, we recently undertook actions to reduce headcount by 6%, which should yield $8 million annualized savings with full run rate expected to be realized at the beginning of the third quarter. We plan to evaluate additional cost-saving measures over the next six to 12 months. We adjust our guidance for 2023 as follows: We now expect revenues in the range of $240 million to $250 million, down from $286 million to $300 million, and we now guide for non-GAAP diluted net income per share in the range of $0.50 to $0.70, down from our prior outlook of $1.35 to $1.50.

Thank you, Niran. As we pre-announced earlier this quarter, our first quarter 2023 financial results were impacted materially by the slowing global economy and rising uncertainties worldwide. These macro trends have manifested in enterprise and service provider customers and partners, slowing decision cycles on product purchases, primarily in EMEA. We have also seen North American service providers manage their inventories more tightly as they focus on cash flow optimization and cost reduction. Among the business lines that are mostly hurt is the service provider CPE line, which accounts for roughly 10% to 15% of our revenues annually. This line has declined roughly 20% in the quarter year-over-year. To provide some context around this, one of our North American carrier customers placed orders at the beginning of the quarter until the carrier has utilized much of the existing inventory in its warehouses. Towards the end of the first quarter, product shipments to this customer have resumed. While the macroeconomic conditions as seen today seem to persist for the rest of the year, we do not expect further decline beyond the first quarter of 2023. We thus expect the service provider segment to decline roughly 20% in 2023 as the impact from inventory rationalization efforts from North American carriers slowly subsides over the course of the year. The other business line that has suffered decline was the IP phone line, which was mostly affected in Europe. We have seen channel partners holding purchasing for their inventories as a result of customers delaying product purchase decisions for a second quarter in a row now. We saw similar trends in North America. On a brighter note, the backlog that has been pushed forward is very high at this stage and represents tens of millions of value that we could materialize when this crisis is over. One important point to make is that none of these lines discussed so far are strategic to our business. And as such, the overall impact on our business going forward is of lesser importance. Now that we have discussed what went wrong in the first quarter, let me draw the call to progress made in the quarter and what went well. All in all, activity in our main lines of business remained intact and went well as planned in the UCaaS and CCaaS market, though marginally affected by the overall deceleration of the UCaaS space in the first quarter of 2023. It is important to emphasize that our results do not reflect the change in enterprise customers' appetite to migrate to next-generation UC platforms, such as Microsoft Teams and Zoom Phone, nor a change in the competitive dynamics. The competitive mode that we've built with our voice technology and expertise in the UC and CX business remains strong and intact. Rather, we attribute the softness to enterprise's cautious buying behavior, and so our customers are economizing in a tight budget environment. Following Microsoft's recent earnings results discussing the continued strength of E5 banners in number of monthly active users to over 300 million, we believe our secular drivers remain strong 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 is potential lag in activation of home licenses as customers optimize networking budgets; second, headwinds from the ongoing headcount rationalizations; and third, migration from historical license and maintenance model, which is CapEx to recurring managed services model. All in all, I will point out that any CapEx done 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. We see growth in UCaaS and CCaaS areas where services have demonstrated growth of 10.8% year-over-year, with professional and managed services growing 7.8% year-over-year. Service revenues now represent 51.5% of our quarterly sales. With increased focus on moving to recurring business sales, our managed services business, Live and Live Cloud ended 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 recurring revenues to reach between $46 million and $50 million by the end of this year. We don't see any reason for that growth rate to not continue in following years. So we're talking about a real growing business very large. And in the customer experience market, we saw healthy customer activity during the quarter. This is our direct enterprise customer experience business, which is roughly flat year-over-year. Now to the reduction in force and updated operating expense budget for 2023. Given customer spending remains pressured by macroeconomic uncertainty in the near term, we have taken steps to adjust our cost structure and reduce our headcount and operating expenses. We plan for a reduction in force by approximately 8% to 10% 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 a full run rate expected to be realized in the beginning of the third quarter. This step will allow us to stabilize our operations 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 near-term profitability. We do expect that this reduction in force plan will help substantially improve 2024 financial results, while 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 is down over 50%. Skype for Business is now at a very not meaningful level – level of between $1 million to $1.5 million in the quarter. The same factors that influence our total revenue impacted our Microsoft business, namely, cautious enterprise customer spending behavior leading to push-outs and downsizing of scope and contracts are seen with weakness, particularly acute in the EMEA region. Importantly, we have not seen any project cancellations as existing projects are already in motion or continuously planned. I should also mention that we do not see any competitive pressure in this area, which is our key business area. Weighted above 250 new Teams accounts in the quarter, up from 256 added in the year-ago period, which indicates that despite the difficult macro conditions, customers continue to migrate from legacy telephonic systems to the 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 recently disclosing over 300 million monthly active users, up from over 280 million last quarter. Teams Phone, with a PSTN attach rate at a low single-digit percentage of overall monthly active users, provides us ample multiyear 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, our white-label 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 targets service providers and system integrators worldwide. We have scored some notable wins globally. We now have over 50 customers on the platform, highlighted by a number of Tier 1 carriers. This ramp-up is continuing, and we believe as we add functions to Live Cloud, this platform, an automated solution for connecting businesses to Teams and other UCaaS solutions, will gain traction and 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 created worldwide while total invoicing for the first quarter for total services was about 8.4% growth year-over-year. We sold 12.5% growth in the professional services year-over-year. AudioCodes Live and managed services backlog at the end of the first quarter 2023 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 managed services with Teams customers. Now let me move to the Voice.AI business. This is becoming a more important business in our overall future. Actually, I would say that while we keep strong in 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 Voca CIC products. We are projecting strong growth in this business over the long haul. Among leading solutions and products in this 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 from some of our major customers. And then newly created opportunities grew above 30% in the quarter. So all in all, a very successful product, and we don't see any competition to it. The product allows SIP Telephony to be connected to cognitive services and, if you will, ChatGPT-type solutions. So a very successful product. Then let's move to Voca CIC. Voca CIC is our entry-level Microsoft Teams-native AI-first contact center application for the CX market. It has generated growing interest over 2022, and we plan to ramp up our efforts in this area. Voca is a modern lightweight contact center solution designed to provide integration with Microsoft Teams Voice, allowing companies to effectively deliver a top-notch service experience for caller service through their existing teams infrastructure. Using powerful automation capability, Voca allows easy no-code configuration of self-service, IVR flows, combined with built-in conversational AI with CRM and database dips, together with smart routing to queues, agents, departments and company contracts, empowering employee experience using CX capabilities. The Voca solution integrates Microsoft Teams using the Power model, the latest and U.S. integration method powered by Azure Communication Services. Q1 2023 marked another peak performance period for the Voca solution with bookings of above $0.5 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 3x as big when compared to the first quarter 2022 creation of opportunities. As of today, Voca CIC 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. AudioCodes' Meeting Insights is an enterprise meeting management solution designed to unlock this mountain of information treasure, summarize and analyze the information related in these meetings and shared across the organization to substantially improve productivity and information sharing among managers and employees. Leveraging AudioCodes' vast voice expertise, state-of-the-art voice AI technology, together with integration with LLM technologies, large language models and technologies such as ChatGPT and other advanced cognitive services, Meeting Insights easily captures and organizes all meeting generating content from team collaboration and training sessions to sales and recruitment calls. It generates automatic meeting summaries and insights, creates an organizational data repository and makes important organizational information searchable and accessible like never before, using notification and mobile-client technology. We have already taken steps to adopt ChatGPT and AI models to our Meeting Insights solutions to enable advanced AI summarization and speech analytics. We plan to deploy the first such implementation in the coming weeks. We expect Voice.AI to now actually be 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 2023 and beyond to further expand our success in the UCaaS and CX market. And with that, I'm coming to the end of my introduction. While results were impacted in the quarter by difficult macro conditions causing changes in customer spending decisions and behaviors and expanded sales cycles, we are confident that our secular growth drivers and competitive position remain intact. We continue to see ample opportunity for innovation in the conversational AI business and transition to live services, with customers undergoing digital transformation to the cloud with our core UC and CX segments. And with that, I would like to turn the call back to the operator for the Q&A session.

At this time we will be conducting a question-and-answer session. Your first question for today is coming from Greg Burns at Sidoti & Company.

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?

Okay. So basically, we really took a cautious position. We are saying that due to the fact that the macro 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 plan for a year that would be either flat or slowly growing. The lines that went down primarily, as I mentioned in the call, or CPEs mainly sold to service providers and also products sold in the IP phone product line. Also, we had to cut some of the growth we expected for other areas. For example, in the meeting rooms in the Microsoft Team space, where we previously envisioned substantially larger growth, that has not happened. Also, if we watch the trends in the Microsoft camp, we were growing 10% to 15% year-over-year in the prior years, but 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.

Okay. Thank you. And then – how big is your 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?

Right. So the IP phone business was roughly above 10% last year. We believe that this year, it will not reach more than 60% to 70% of that. Unfortunately, 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 quarter. March was really very clear in that trend – things looked rather okay in January and February, but 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 compare both phones and CPE as CapEx type sales, you could see that the recurring business sales really did not suffer as much as the CapEx. And I think this is part of what we saw in the first quarter.

Okay. Thank you.

Your next question for today is coming from Samad Samana at Jefferies.

Hi. This is Mason Marion on for Samad. Thanks for taking our questions. So if I look at your EPS guidance, how should we think about your product gross margins going forward? Should we assume that your Q1 level is a fair range?

Yes. So with regard to gross margin, this quarter, we ended at 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 cost of goods sold is actually a fixed cost. So all in all, we believe gross margin should improve slightly in the next few quarters, mainly in the second half of the year.

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 Q1 levels are a fair way to think about it?

Okay. Well, unfortunately, the outlook for the economic side is not changing. We don't see any change in behavior. I think we all know that it's all tied to the inflation rate and the interest rate. As long as those are at the same level and we don't see a change in those, I would not expect – and especially when the cost of money is that high, I would not expect that stocking will resume sooner than a change in the overall economy.

Thank you.

Your next question for today is coming from Tal Liani at Bank of America.

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 how temporary the weakness is and how much visibility you have to recovery.

So, we do believe that we have not seen that phenomenon in previous quarters up until the end of 2022. I think the worsening conditions earlier in the year really caused service providers and channels to hold purchases and do better inventory control. Now, as we have mentioned earlier, we gave one example in the call of one big service provider customer that halted all purchasing in January. But as soon as it used a lot of its backlog in its warehouses in the month of March, we saw him coming back to purchasing. So it really suggests that the amount of backlog that was sitting in warehouses has been sufficiently diminished to a level where, from now on, we will not see any impact from that side. However, there’s still the impact of customers rationalizing their expenses and pushing products, or making them smaller as they lay off employees. So these are the two factors. As long as the economic situation remains unchanged, we do not see any abrupt changes to what we've already experienced in Q1. But on the other side, we can't yet see any improvement in that respect.

But when you – 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 an inventory adjustment, it means that they continue to deploy at the same rate. So do they continue to deploy at the same rate, or do you see a slowdown in the rollout of projects that are being slowed down or canceled or pushed out? And I'm talking about the end customers, end-to-end customers.

Right. So yes, primary customers, those who we target usually, and we're talking roughly on either Microsoft and/or contact center customers, we've been partnering with large companies. So large companies may slow down projects a bit, but all in all, we have not seen major push-outs of complete project or delays by more than a year. What we're seeing is a delayed decision on the expense. When you're talking about live projects, we gave you a number. We mean that we grew 60% year-over-year, meaning that as long as the project is of a managed services side, there's little chance that it will be canceled or pushed out completely. However, when talking about CapEx deals, where you need to spend $0.5 million or more in an opportunity, then due to financial conditions, you might decide to push it. So that gives you an idea. Overall, we see good customer behavior; yes, on the tail, we've seen some projects being pushed, but that's not a phenomenon. The strong companies, the large companies keep deploying and readjusting – if you noted on our website, we have one big company in Japan that signed with us to deploy a global project. We have another U.S.-based retail company, a large retail company also started, well, signed with us and then started to deploy. So the projects are there. There may be a slower deployment cycle, but that's the whole difference.

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 competitors getting more aggressive because of the slowdown?

None. We do not see any competition in our markets. 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 we do not see any competition in the Microsoft space. So there's no pressure at all. It's really more about our ability to add more services and more applications. As I have mentioned, if you think about us being able to deploy IVR solutions and our contact center solutions in our Meeting Insight solutions in that environment, we just improve our ability to get increased average revenue per user from those customers. But we have not seen pressure from the competitive side.

Your next question is coming from Ryan MacWilliams at Barclays.

Hi. Thanks for taking the question. This is Pete Newton on for Ryan MacWilliams. 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 something of that business is pretty healthy?

Right. So yes, as I mentioned, I think the bottom line is that while last year, we grew above 15% year-over-year on 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 they will keep going on. Also the fact that Skype for Business is basically at almost 0%, while Teams grew 5%. So we project that we will see in the Microsoft space growth, maybe 5% to 10%, compared to 50% last year, but that's all a result of the economic situation.

Okay. Perfect. And then just any thoughts on your teams versus Zoom in your product portfolio? And any differences you're seeing?

We haven't mentioned Zoom in this call. But yes, we do have a good business with Zoom. We worked with them on several projects. Yes, we have not seen any major change in the behavior of our ability to win projects with Zoom in the first quarter.

We have reached the end of the question-and-answer session, and I will now turn the call over to management for closing remarks.

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 align with revenues this year, and strong underlying market trends in our industry in the coming years, we have high confidence in our ability to expand our business in the coming years. We look forward to your participation in our next quarterly conference call. Thank you very much. Have a nice day.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.