AUDIOCODES LTD annual report, Q4 FY2011

AudioCodes Ltd. 2011 Form 20-F Summary

Business context and reporting period

AudioCodes designs, develops and sells voice-over-IP, voice, data and video networking products for service providers, enterprises, OEMs, distributors, network equipment providers and systems integrators. Products include media gateways, enterprise session border controllers, multi-service business gateways, IP phones, media servers, mobile VoIP solutions, software applications, chips and communications boards.

The filing is an annual report for the fiscal year ended December 31, 2011, prepared under U.S. GAAP and audited by Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global. The filing is not a quarterly report; the source does not provide separate fourth-quarter financial statements.

Financial performance and position

Metric	2011	2010	Change
Revenue	$155.8 million	$150.0 million	Up 3.9%
Gross profit	$91.7 million	$83.9 million	Up 9.3%
Gross margin	58.8%	55.9%	Up 2.9 percentage points
Operating income	$7.3 million	$10.4 million	Down 30.5%
Net income attributable to shareholders	$7.2 million	$12.1 million	Down 40.9%
Diluted earnings per share	$0.17	$0.30	Down $0.13
Operating margin	4.6%	6.9%	Down 2.3 percentage points
Net margin	4.6%	8.1%	Down 3.5 percentage points

• Networking products generated $120.8 million, or approximately 77% of revenue, compared with $104.8 million, or approximately 70%, in 2010.
• Technology products generated $35.0 million, or approximately 23% of revenue, compared with $45.3 million, or approximately 30%, in 2010.
• Research and development expense increased to $32.2 million from $30.2 million. Selling and marketing expense increased 23.4% to $43.2 million, while general and administrative expense increased to $9.0 million.
• Net financial income was $423,000, compared with net financial expense of $94,000 in 2010. Income tax expense was $238,000, compared with a $1.9 million tax benefit in 2010.
• Cash flow from operations was negative $1.3 million, compared with positive $16.4 million in 2010. Working-capital usage included increases of $4.6 million in trade receivables and $4.1 million in inventories.
• Investing activities used $35.5 million, primarily for $24.4 million of marketable securities and $9.1 million of long-term bank deposits. Capital expenditures were $1.6 million.
• Financing activities provided $14.7 million, including $24.0 million of bank borrowings, partially offset by $6.6 million of debt repayment and $4.0 million used for share repurchases.
• Cash and cash equivalents were $28.3 million at year-end, compared with $50.3 million in 2010. Cash, marketable securities and bank deposits totaled approximately $75.2 million, of which approximately $21.5 million was restricted.
• Working capital was $55.1 million. Total bank debt was $33.2 million, and $353,000 of senior convertible notes remained outstanding.
• Total assets were $192.7 million and shareholders’ equity was $106.0 million at December 31, 2011.

Material changes versus the prior comparable period

• Revenue growth was modest, but the mix shifted materially toward higher-revenue networking products and away from technology products.
• Gross margin improved because of reduced manufacturing costs and higher revenue, but operating income and net income declined as sales and marketing, research and development and administrative costs increased.
• Cash generation deteriorated from $16.4 million of operating cash inflow to $1.3 million of operating cash outflow, while debt increased following $23.8 million of 2011 loan agreements.
• The company repurchased approximately 1.2 million shares for approximately $4.0 million under a program authorizing repurchases of up to 4.0 million shares.
• Sales concentration remained significant. The top three customers represented approximately 25.5% of 2011 revenue, the top five represented 33.4%, and ScanSource Communications represented 14.4%. Nortel revenue became negligible following its bankruptcy.
• AudioCodes increased its ownership of MailVision to approximately 26.6% and recorded $277,000 of equity-method losses from affiliated companies.
• The company adopted ASU 2009-13 for multiple-deliverable arrangements prospectively; management stated that the adoption did not have a significant effect on 2011 revenue.

Guidance, outlook, commentary and risks

• Management expected research and development, selling and marketing, and general and administrative expenses to remain approximately at 2011 absolute-dollar levels in 2012. No specific revenue or earnings guidance was provided.
• Management stated that working capital was sufficient to meet operating requirements and scheduled debt payments for at least the next twelve months, while noting that acquisitions or expansion could require additional financing.
• The company continued investing in Microsoft Lync-related products, mobility solutions, session border controllers, call recording and unified communications applications. Software Enterprise SBC and Session Experience Manager launches were announced in March 2012.
• Profitability remains exposed to customer concentration, limited backlog, long sales cycles, economic weakness, competitive pricing, rapid technological change and dependence on the continued growth of VoIP and unified communications markets.
• Manufacturing relies substantially on third-party subcontractors and certain sole-source suppliers, including key signal-processing and communications processors. The company has no long-term supply agreements for these components.
• As of December 31, 2011, the company was not in compliance with a bank covenant limiting liabilities to banks but had received a waiver through June 30, 2012. The loans are secured by company assets and require approximately $16.5 million of compensating bank balances.
• Material contingencies included a Nortel preference claim for approximately $3.2 million, for which the parties had reached a settlement in principle requiring a $20,000 payment subject to documentation and court approval; an Israeli landlord arbitration with a counterclaim of approximately NIS 14 million, or about $3.7 million; and two unresolved patent-infringement actions.
• Government research and development grants create contingent royalty obligations to Israel’s Office of the Chief Scientist of approximately $24.1 million, payable from sales of funded products. Manufacturing and technology-transfer restrictions also apply.
• Foreign exchange remains material because revenues are primarily U.S.-dollar denominated while a significant portion of Israeli operating costs is denominated in NIS. Management estimated that, absent hedging, a 10% decrease in relevant U.S. dollar exchange rates would reduce net income by approximately $4 million.
• The company does not intend to pay cash dividends in the foreseeable future. Management reported effective disclosure controls and effective internal control over financial reporting, supported by an unqualified auditor opinion.

Important facts for investors to verify

• Whether the bank-covenant waiver was resolved or extended after June 30, 2012 and whether subsequent debt repayments affected liquidity.
• The final outcome and cash cost of the Nortel settlement, landlord arbitration and remaining patent litigation.
• Whether the shift toward networking products produced sustainable revenue and margin improvement.
• Customer concentration, particularly ScanSource and the top five customers, and the company’s ability to replace lost Nortel-related demand.
• Operating cash flow conversion, receivables collection and inventory levels following the 2011 working-capital outflow.
• The availability of restricted cash and bank deposits for operating purposes and the company’s future financing requirements.
• Future VoIP demand, competitive pricing, product transitions and the commercial contribution of Microsoft Lync, mobility and software products.
• The potential impact of OCS royalty obligations, Israeli tax-benefit expiration, foreign exchange movements and supply-chain concentration.