Greetings. Welcome to the AudioCodes Third Quarter 2024 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, Mr. Roger Chuchen, Vice President of Investor Relations. You may begin.

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 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 impacts of competitive products and pricing on AudioCodes and as 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 result of operations. The effects of the current terrorist attacks by Hamas and the war in hostilities between Israel and Hamas and Israel and Hezbollah, as well as the possibility that this could develop into a broader regional conflict involving Israel with other parties may affect our operations and may limit our ability to produce and sell our solutions. Any disruption in our operations by the obligations of our personnel to perform military service as a result of current or future military actions involving Israel and other factors detailed in 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 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'd like to remind everyone that this call is being recorded and archived webcasts 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 third quarter 2024 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. Before I start my formal remarks, I would like to remind everyone that in conjunction with our earnings release this morning, we will post shortly on our Investor Relations website an earnings supplemental deck. On today's call, we will be referring to both GAAP and non-GAAP financial results. The earnings press release that we issued earlier this morning contains a reconciliation of the supplemental non-GAAP financial information that I will be discussing on this call. We will be comparing our third quarter 2024 results to the prior quarter as we believe it provides a better gauge of our financial performance. Revenues for the third quarter were $60.2 million, a decrease of 0.1% over the $60.3 million reported in the second quarter of the current year. Services revenues for the third quarter were $32.5 million, an increase of 1.7% over the $32 million reported in the second quarter of the current year. Services revenues in the third quarter accounted for 54% of total revenues. The amount of deferred revenues as of September 30, 2024, was $78.6 million compared to $80 million as of June 30, 2024. Revenues by geographical region for the quarter were split as follows: North America 47%, EMEA 33%, Asia-Pacific 13%, and Central and Latin America 7%. Our top 15 customers represented an aggregate of 56% of our revenues in the third quarter, of which 39% was attributed to our 10 largest distributors. GAAP results are as follows: Gross margin for the quarter was 65.2% compared to 65.5% in Q2 2024. Operating income for the third quarter was $4.9 million or 8.1% of revenues compared to operating income of $4.9 million or 8.2% of revenues in Q2 2024. EBITDA for the quarter was $5.9 million compared to EBITDA of $6.2 million for Q2 2024. Net income for the quarter was $2.7 million or $0.09 per diluted share compared to net income of $3.8 million or $0.12 per diluted share for Q2 2024. Non-GAAP results are as follows: Non-GAAP gross margin for the quarter was 65.6% compared to 65.8% in Q2 2024. Non-GAAP operating income for the third quarter was $7 million or 11.7% of revenues compared to $7.2 million or 11.9% of revenues in Q2 2024. Non-GAAP EBITDA for the quarter was $7.9 million compared to non-GAAP EBITDA of $8.3 million for Q2 2024. Non-GAAP net income for the third quarter was $4.9 million or $0.16 per diluted share compared to $5.5 million or $0.18 per diluted share in Q2 2024. At the end of September 2024, Cash, cash equivalents, bank deposits, marketable securities, and financial investments totaled $88.4 million. Net cash provided by operating activities was $7.9 million for the third quarter of 2024. Days sales outstanding as of September 30, 2024, were 112 days. In July 2024, we received court approval in Israel to purchase up to an aggregate amount of $20 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 January 1, 2025. On July 30, 2024, we declared a cash dividend of $0.18 per share. The aggregate amount of the dividend was approximately $5.4 million. The dividend was paid on August 29, 2024, to our shareholders of record at the close of trading on August 15, 2024. During the quarter, we acquired 333,000 of our ordinary shares for a total consideration of approximately $3.6 million. We reiterate our guidance for revenues for 2024 to be in the range of $240 million to $250 million and non-GAAP EBITDA in the range of $33 million to $39 million. I will now turn the call back over to Shabtai.

Thank you, Niran. I'm pleased to report successful execution against our strategic priorities in the quarter as we continue our journey to transform the company to a UCaaS and CCaaS cloud software and services company. We performed as expected on our key business operations related to VoIP networking and connectivity, and we're able to make substantial progress on our efforts to advance our main growth engine, the conversational AI business. In our key business area, third quarter Microsoft business grew 8% sequentially, highlighted by steady growth in North America and in the DACH region. Microsoft Teams business in the third quarter was up 9.2% sequentially. Our services business kept evolving in the third quarter. Third quarter services revenue grew 6.4% year-over-year and accounted for 54% of revenues, the highest on record for us. Fueling the strength of our services revenue stream is our primary growth engine: live managed services and conversational AI. Specifically, Live Teams business grew 21% year-over-year and accounted for 44% of total Microsoft business compared to just 37% a year ago. Also, our success in building live managed services and recurring revenue stream has translated to strong year-over-year annual recurring revenue growth of 40%, ending the third quarter at $60 million annual recurring revenue, up from $48 million exiting 2023. This success is owed to the trust we have built throughout the years with partners and enterprise customers in the voice services space. There's no better proof than our long-term standing multiyear partnership with AT&T in North America, leveraging our expertise in providing secure voice connectivity to help their business customers onboard to Microsoft Teams. This fruitful partnership has contributed multimillions of annual recurring revenues over the last several years. And then, underscoring growth in our live business is the growth of backlog of the contracts signed. We ended the third quarter of '24 with a live and managed services backlog at $67 million as compared to just $27 million in the year-ago quarter. This represents close to 150% year-over-year growth, which bodes well for a strong stream of revenues in coming years. As such, once we combine the growth in backlog of live services with the reported recognized revenue for the third quarter, we get a very positive result for the quarter and outlook going forward. On conversational AI, the third quarter dollar value of contracts signed increased roughly 50% versus the year-ago period. Speaking of conversational AI, strong operational momentum continues, driven by long-term tailwind of infusing AI into UC and CX workflows in customers' growing demand to drive ongoing productivity gains. Accordingly, we have seen significant pickup in pipeline activities across our entire conversational AI suite, including Voca CIC, our AI-first CX solution for Microsoft Teams, SaaS recording solutions such as Meeting Insights, interaction recording, and Voice AI Connect. Just as we did in 2023, we are investing in 2024 in this new growth engine for us. This year, revenue will grow above 30%, 40% and will cross for the first time the $10 million level. As we are in an investment mode in this conversational AI business, we are incurring losses in that specific line, about $9 million in 2023 and around the same figure in 2024. Glad to say that the investments are already showing good potential and results and substantial growth of the number of business voice projects and application for the UCaaS and CCaaS markets emerge. Overall, we delivered on our business priorities in the quarter with the strength in our live business reinforcing the healthy overall pipeline for our major practice, such as Microsoft Business, CX, and conversational AI. We believe that this bodes well for seeing improved top line growth performance as we head into 2025 and beyond. Let me discuss some of the notable wins in the quarter. The first one relates to a multinational bank that had both our connectivity gear over the last several years to deliver UC and CX to their over 30 country operations. Operating with a tight budget, and managing complex IT infrastructure, coupled with the need to meet service level expectations, the company preferred to move with us to a shared subscription service model in lieu of capital spending. We were one of the many RFP respondents issued 12 months ago. Among these were several of the world's largest global system integrators. We won mainly due to our longstanding relationship and goodwill built with the customer as well as the trust in the quality of our solutions. The master contract signed had a total contract value in the low seven figures range over multiple years for voice infrastructure management. This win demonstrates our success in transitioning from point product solution player to a trusted vendor of mission-critical services on the UCCX connectivity and leveraging that to successfully cross-sell our conversational AI portfolio. In another opportunity, we signed a 36-month contract with a multinational industrial equipment dealer, providing Live Pro managed gateway and device as a service in North America and the UK as an initial phase of a broader multi-core global Teams voice rollout. Third win, we signed a contract with a foreign government, putting Voca CIC to be in the pole position to be the de-facto Teams-based CCaaS platform as the legacy CX contracts of various government agencies came up for renewal. These examples are a testimonial to the success of our land and expand strategy, where we follow suit on our connectivity services business with our new growing portfolio of business voice applications powered by Gen AI and AI capabilities. The potential for upselling the same account has big potential for further business growth. Before turning to detailed business line discussion, let's quickly shift to the third quarter profitability metrics. Our non-GAAP gross margin in the quarter came at 65.6%, within the 65% to 68% long-term range planned for the business and compared to last quarter levels of 65.8%. Third quarter non-GAAP OpEx was $32.5 million, in line with second quarter levels and higher than our initial budget planning for the year. A key factor in maintaining a larger budget relates to the initial success we enjoy in our evolving conversational AI business and the need to support larger investment and growing number of projects in this space. On top of our current conversational AI activity, which I'll cover in the following, we intend to announce two new solutions in the coming weeks and months. Regarding headcount, we ended the second quarter with a headcount of 935 full-time employees, down from 940 employees in the second quarter and compared to 938 employees in the third quarter of 2023. Third quarter adjusted EBITDA of $7.9 million or 13.1% margin compares to last quarter levels of $8.3 million or 13.8%. Again, all as a result of higher investment in growing our conversational AI business, which should present nice return on investment already in 2025. Net cash provided by operating activities was $7.9 million, which alludes to the healthy nature of the business. Now to our Microsoft business. Our third quarter Microsoft business grew 8% sequentially, highlighted by steady growth in North America and the DACH region. In terms of our strategic business line, Microsoft Teams business in the third quarter was up 9.2% sequentially, well in line with our planning. Recurring Teams Live business grew 21.4% year-over-year, accounting now to 45% of the Teams business compared to just 37% in the year-ago quarter. Live managed services and recurring revenue stream has translated to strong year-over-year annual recurring revenue growth of 40%, ending the third quarter at $60 million ARR, up from $48 million exiting 2023. At the same time, CapEx-based Teams business was down 12.7% in the quarter, accounting now for 56% of Teams business, again, as compared to over 63% in the year-ago quarter. So, with the continued focus on Live Teams recurring business and declining CapEx Teams business, we expect to see a return to growth of double-digit Microsoft business in the coming years. Importantly, our pipeline of creator opportunities remains robust, up 12% sequentially and 90% year-over-year, which bodes well for continued growth in this Microsoft ecosystem. With just over 20 million Teams Phone PSTN users, a fraction of over 320 million Teams monthly active users today, we believe there is a long runway for Teams voice adoption in our Live business ahead of us. What could further spur adoption of Teams Phone in the coming years is the recent incorporation of Microsoft Copilot and Gen AI features supporting the Microsoft Teams Phone system and as a result, a rising demand for the live business. Another important trend in the UCaaS market and in the Microsoft Teams Phone space is the emerging search for a business voice application that may provide added value. These applications include, among others, contact center applications, recording applications, analytics applications, and CRM integration, all representing upsell opportunities for us. According to a study published by a research firm, the demand for value-added services is bound to grow substantially in the coming years, which will further support our land and expand strategy for the Microsoft Teams segment. Now moving to CX. Third quarter 2024 CX business grew 4.4%, helped by continued steady growth in North America and ongoing strength in Live CX. In terms of booking for Live CX, we grew above 100% from 2022 to 2023, and now we expect to grow another 30% to 40% in '24 compared to '23. The strong momentum in Live CX is driven by a secular trend of large enterprises embarking on their cloud migration journey. Given the complexity associated with migrating from a legacy system and the mission-critical nature of the contact center infrastructure, these enterprises are increasingly turning to trusted managed service providers like AudioCodes to support them in this endeavor. Historically, a large majority of our Live CX contract wins arose from direct sales contribution. We have been working diligently to develop this channel to help us better scale in Live CX. I'm glad to report that these efforts are paying off. For example, over the past several years, we have been working closely with a partner in the CALA region on multiple projects totaling over $1 million in contract signing. We're now in the process to add additional partners in the near future. Now to conversational AI. Conversational AI third quarter dollar value of contract signings increased roughly 50% versus the year-ago period. The strong operational momentum is attributable to the long-term tailwind of infusing AI into UCCX workflows and customers' rising demand to drive ongoing productivity gains as enterprises increasingly look to do more with a finite amount of resources. As disclosed last quarter, we expect conversational AI to be our second major long-term growth pillar, meriting the disproportionate amount of R&D resources we are now investing into this business line. Let me walk you through some highlights of the individual business line with the conversational AI portfolio. First, to Voca CIC, representing the fruits of this R&D investment is Voca CIC, our AI-first TIM-certified contact center platform, leveraging our Teams voice dominance in the UC world, amidst the secular trend of UCCX convergence. Just to give you some idea about the growth we are experiencing, when looking at the combined revenue for the first three quarters in the year, we grew above 50% in 2024 compared to 2023, growing substantially in the number of bookings. With regards to our activities in the Voca CIC, we won a contract with a government office in Western Europe, replacing a leading legacy on-prem vendor. Voca CIC was selected as the go-to CCaaS solution for the entire group of the government offices of the country. Following the onboarding of the University of Central Florida, the second largest university in the U.S., in 2023, we continue to show good momentum in the education North America space with six universities signed in total, out of which four signed during 2024 so far. So, we see a very nice growing pipeline. We see growth of north of 130% year-over-year in the number of created opportunities, and we saw close to 200% growth in the total dollar amount of the pipeline. With the release of the callback capability for that product, Voca CIC has reached full feature parity with virtually any fully fledged contact center solution that is centered around voice. We believe that with the feature parity around voice, combined with our capability in conversational AI and omnichannel situation, that places us in the leading pack of the Team CCaaS space in the Microsoft environment. Moving on to Meeting Insights. We now have a mature and stable product that was launched in March of this year. The product is currently deployed in seven countries, with plans to add three more in the fourth quarter. Sales operations are active in Israel, the U.S., and the U.K., and we launched Mia in Europe in September with four countries: Germany, France, Italy, and the Netherlands. In October, we added support for Zoom meetings alongside Microsoft Teams meetings. Our goal is to make the application UCaaS agnostic, supporting all major UCaaS applications, including Cisco Webex and Google Meet. We are running over 100 proof-of-concepts, with about a third already becoming paying customers and more accounts expected to onboard in the fourth quarter of '24. In the third quarter, we saw a 50% sequential growth in the number of meetings, primarily driven by our use of generative AI to provide value to our customers. Our active user growth also exceeded 40%. In summary, we made significant progress this quarter towards our long-term goal of becoming a cloud software and services company with an increasing share of recurring revenues. This progress is underpinned by the growth of our two primary engines: our Live family of managed services and conversational AI. With our recurring revenue growth and Live approaching half of Microsoft Teams bookings, we believe we have established a solid foundation for sustainable and healthy top-line and margin expansion in the long run. I will now turn the call back to the operator. Thank you.

Thank you. At this time, we will be conducting a question-and-answer session. Your first question for today is from Ryan MacWilliams with Barclays.

This is Damian Cogen on for Ryan MacWilliams. Thanks for the question. Just curious how your customers are thinking about AI investments for next year? And are budgets for next year generally getting healthier in your conversations?

We have seen increasing interest and demand. We actually have two go-to-markets: one is our SaaS application, which includes Voca CIC and Meeting Insights, and we also have SmartApp, a compliance recorder. We will introduce an exciting new product in the coming weeks. On the other side, we have projects, and in the AI space, when implementing a solution, there is a growing need for customization, connectors to our project management applications, CRM, and more. We are definitely observing a significant uptick in various areas, particularly in the government sector, where there is a lot of interest in solutions tailored for that space.

Got it. Thanks, Shabtai. And then how should we think about growth of product and service revenue in 4Q and fiscal year '25? It seems like AudioCodes is making strides to become a cloud software and services company first. So, just curious how we should think about the revenue breakdown in the near term.

Right. So, I've been speaking mainly about growth in our key lines, which are live services and conversational AI. However, at the same time, we are facing two kinds of, I would say, restraining factors. One is as we grow with live services, we witnessed a drop in CapEx in perpetual sales of Teams. So that is kind of impacting or having some layer on top of our growth. So that has caused, I would say, the muted growth you're seeing right now. We believe that Live now is about 44% of revenues and CapEx is about 56%. So, as we move forward with another three or four quarters, all this picture will reverse. And therefore, Live has grown 20% in the quarter, meaning that as we cross that point in three or four quarters, you'll start to see nice growth. And actually, I expect in 2026 to see double-digit Microsoft business growth. So that's on that. The other factor that impacts revenues, but less this quarter actually is the decline of the legacy gateway and SBC business, which usually we face a drop mainly from the fourth quarter to the first one in a year. And this was the phenomenon also in the third quarter. Then during the year, we see a slight uptick in that business. So, just to give you some idea about moving from '22 to '23, we were hit by a $15 million drop. I think we will end up '24 with another, I would say, $10 million, $11 million drop. I expect this figure again to be visible in '25, but now probably somewhere between $5 million and $10 million, which means that the impact of that decline of legacy will be substantially weaker. So those are the trends. On one hand, we have a nicely growing business in Live and concessional AI, and we're still suffering from declining of some legacy business, both connectivity and Teams CapEx.

Thanks, guys.

Your next question for today is from Ryan Koontz with Needham & Company.

In light of the slowdown in revenue that you've mentioned, could you explain what key performance indicators you are monitoring internally to assess the ongoing progress of your subscription bookings? Are you focusing on bookings, and can you provide insights on those figures, or on remaining performance obligations or annual recurring revenue? Are there any other indicators you are watching that could provide more clarity on your subscription business? Thank you.

Right. So, yeah, actually, we have a few such KPIs as you have mentioned. The most important for us is the monthly recurring revenue and then the annual recurring revenue, which at the end of the day translates into the revenue we recognize and report. So that's one KPI. The other one, by the way, which is, for me, even more important, is the bookings, because obviously, if you just take an analogy from, let's say, the semiconductor business, talk about book-to-bill, our book-to-bill on booking versus recognition is substantially higher. So, we definitely track our bookings. As I've mentioned on the call, backlog now is at $67 million versus $27 million a year ago. So, we have a steady flow of bookings of about $15 million a quarter. And that's what really drives the business. I mean, all of the efforts are really pointing towards increasing bookings. And even in our compensation for our salesforce, booking is a very meaningful side by side, of course, with meeting the revenue targets.

Great. Is the backlog primarily made up of your subscription contracts, or is there a significant amount of license maintenance included in it?

The majority of our progress is tied to Microsoft Teams Managed Services, which is a strong segment for us. We're actually seeing some acceleration in this area. While the UCaaS industry has been growing rapidly in recent years, it appears to be stabilizing now. However, it's important to remember that when we report a win, particularly with large enterprises that have thousands of seats, the initial contracts typically start with hundreds or a few thousands. Currently, the pace for Teams stands at $320 million, and Teams Phone is at just $20 million, indicating significant potential for growth. I believe we have a long runway ahead, possibly spanning 10 to 20 years, though growth will be gradual. We must also consider the reduced spending expected in 2023 and 2024 due to the economic downturn. Overall, we're optimistic that the growing revenue from live services will surpass the declining capital expenditures, resulting in overall revenue growth.

That's great. One follow-up, if I could, around what you're seeing in the CX market, maybe with renewals. Are you seeing any seat pressures in these renewals in terms of more productivity from agents around AI for your SBCs there at all?

No, no. I think we see a fairly stable and steady market for us. No, we don't see any kind of pressure at this stage.

Got it. All right, thanks. That's all I've got.

Sure.

Your next question for today is from Samad Samana with Jefferies.

This is actually Billy Fitzsimmons on for Samad. Shabtai, you expressed confidence in the Microsoft business returning to double-digit growth next year. Just to double-click on that, can you expand on what gives you confidence there and kind of what you're seeing in your pipeline? It sounds like the pipeline there for kind of the biggest opportunities, if I'm understanding correctly, is up 12% sequentially and 19% year-over-year. Can you just break down who those customers are, maybe how we should think about pipeline versus maybe what occurred in the third quarter?

We focus on the largest enterprises in the U.S. in our live business, but we are unable to disclose specific names. Some are public; for instance, I've mentioned the University of Florida, which had a contract worth about $1 million. We have several similar contracts. Currently, live business accounts for 44% of our overall business and is growing at 21%, while CapEx makes up 56% and is declining by 12%. We expect these trends to continue, and as we grow the live business, it will overtake our other segments. This gives us confidence in our potential return to double-digit growth. While I am not certain that this will be evident in 2025, you will see continued improvement, and I am confident that by 2026, we will definitely experience double-digit growth in the Microsoft business.

Got it. That's helpful. And then if I can ask another one. We talked about this a little bit during the prepared remarks. But can you just give us some anecdotes of customer wins with conversational AI? What do customers like about your product? And for what reason are they purchasing your product there over competitors?

Our solution is notably unique as it serves as an organizational tool. While there are several note-taking applications available, such as Author, Avama, and Firefly, they primarily focus on personal productivity. Users typically utilize these apps for their own needs, but our product is designed for enterprises. For instance, AudioCodes employs nearly 1,000 people, with around 400 using Meeting Insights daily. This tool serves various purposes. It addresses the fear of missing out by providing access to recordings of missed meetings. Users can listen to calls and see summaries of discussions with specific speakers. Recently, I had a conversation with a significant European system integrator, and I shared the meeting details with five colleagues across sales and business departments. This allowed them to grasp the essence of my discussion quickly. Consider knowledge retention; if a top employee departs, it can be challenging to find a suitable replacement. However, if Meeting Insights has been used routinely, all the calls and meetings from the past few years are recorded, enabling a new hire to quickly catch up on essential knowledge and experience. Our product is utilized across various sectors, including municipalities, healthcare, and defense organizations. We believe that in two years, most companies will adopt it. Much like how Outlook is used for messages, where not every email is read but essential content is easily retrieved, the same will apply to our product for customer projects and products. Meetings are recorded and stored in a repository, allowing teams to search through past discussions, such as those involving a company like Siemens, using natural language processing applications. Teams can easily query this information through tools like Copilot or chatbots to get needed responses. The use cases are abundant, and we stand out as one of the best organizational solutions. This distinction sets us apart from competitors. Even when compared to Microsoft Teams, which offers basic summarization, we provide comprehensive organizational capabilities that ensure you receive the most relevant information.

Helpful. Thank you very much.

Sure.

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

Okay. Thank you, operator. I would like to thank everyone who attended our conference call today. With continued good business momentum in our enterprise operation and good underlying market growth trend in UCaaS, CCaaS, and CI, we believe we are transitioning the business towards growth and growing profitability in the coming years. We look forward to your participation in our next quarterly conference call. Thank you all. Have a nice day.

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