AudioCodes Ltd. — Fiscal 2017 Form 20-F Summary
Reporting period: Fiscal year ended December 31, 2017. The requested period is identified as “2017 Q4,” but this filing is an annual Form 20-F and provides full-year results rather than standalone fourth-quarter results. Financial statements are prepared under U.S. GAAP and reported in U.S. dollars.
Business context
AudioCodes designs and sells Voice-over-IP, unified communications, contact-center, session border controller, media gateway, IP phone, networking, cloud, virtualization and related professional-services solutions. Its principal markets include enterprise communications, service providers, Microsoft Skype for Business-related deployments, contact centers and hosted business services.
Networking products generated approximately 60% of 2017 revenue, technology products approximately 8%, and services approximately 31%. Revenue outside the Americas and Israel represented approximately 47% of total revenue. ScanSource accounted for 17.5% of revenue, Westcon accounted for 12.7%, and the five largest customers accounted for 37.5%.
Financial performance and liquidity
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $156.7 million | $145.6 million | 7.6% increase |
| Product revenue | $107.5 million | $102.3 million | 5.1% increase |
| Services revenue | $49.3 million | $43.3 million | 13.6% increase |
| Gross profit | $97.8 million | $88.3 million | 10.8% increase |
| Gross margin | 62.4% | 60.7% | 170 basis-point increase |
| Operating income | $9.7 million | $7.8 million | 24.4% increase |
| Net income | $4.0 million | $16.2 million | 75.2% decrease |
| Diluted EPS | $0.13 | $0.45 | Decrease |
| Cash flow from operations | $17.8 million | $18.3 million | Decrease |
| Capital expenditures | $1.6 million | $1.5 million | Increase |
Operating expenses were $88.2 million, compared with $80.6 million in 2016. Research and development expense increased to $30.3 million, selling and marketing expense to $49.0 million, and general and administrative expense to $8.9 million.
The 2017 net income decline primarily reflected a $5.6 million income-tax expense, compared with an $8.6 million tax benefit in 2016. The 2016 benefit included recognition of deferred tax assets; 2017 tax expense reflected utilization of deferred tax assets and the impact of U.S. tax legislation enacted in December 2017.
At December 31, 2017, cash and cash equivalents were $24.2 million. Cash, marketable securities and bank deposits totaled $58.7 million, down from $69.5 million at year-end 2016. Approximately $6.9 million was restricted. Working capital was $32.0 million, compared with $35.0 million in 2016.
Total bank loans were $8.8 million, including $2.5 million due within one year. The loans bear interest based primarily on LIBOR and are subject to covenants concerning equity, cash, bank liabilities and operating income. The company stated that it was in compliance with all covenants at year-end.
Material changes versus the prior comparable period
- Revenue growth was led by services, technical support and professional services, as well as increased adoption of SIP trunking and unified communications solutions.
- Product mix shifted toward higher-margin unified communications and collaboration products, while the migration from traditional TDM networks supported UC-SIP demand but moderated media-gateway demand.
- Gross margin expanded from 60.7% to 62.4%, benefiting from increased services revenue, favorable product mix and absorption of fixed overhead.
- Operating income improved despite higher operating expenses, particularly selling and marketing costs and the effect of appreciation of the New Israeli Shekel against the dollar.
- Net income declined sharply because the prior-year tax benefit did not recur.
- Cash used for share repurchases was $25.6 million. AudioCodes repurchased 3,749,462 shares during 2017 at an average price of $6.79 per share.
- Shareholders’ equity declined from $108.7 million to $92.4 million, primarily reflecting share repurchases.
- The 2017 year-end share count was 29.443 million outstanding shares, compared with 32.411 million at year-end 2016.
Cash flow, commitments and unusual items
- Operating cash flow of $17.8 million was supported by net income, a $4.9 million decrease in deferred tax assets, a $3.4 million reduction in trade receivables and non-cash charges.
- Investing activities provided $8.4 million, principally from marketable-security maturities and reductions in bank deposits, partially offset by $1.6 million of capital expenditures.
- Financing activities used $26.3 million, primarily for share repurchases and bank-loan repayments.
- Inventory write-offs were $1.9 million in 2017, compared with $2.2 million in 2016.
- The company recorded $8.3 million of royalty-bearing Israeli government R&D grants in 2017. Its contingent royalty obligation to the National Authority for Technology and Innovation was approximately $58.2 million at year-end.
- Non-cancelable inventory purchase commitments were approximately $18.5 million. Net non-cancelable lease commitments were approximately $36.8 million.
- The company recorded $118,000 of income in 2017 from a reduction in the estimated acquisition earn-out liability related to Active Communications Europe. The remaining earn-out liability was $378,000 at year-end.
- The filing reports no off-balance-sheet arrangements and no material legal proceedings, although a former employee brought a Brazil employment claim in February 2018 for approximately $100,000; the company disputes the claim and cannot predict its outcome.
Outlook, management commentary and risks
Management expects operating expenses to remain a material use of cash but stated that existing working capital should fund operations and scheduled debt payments for at least the next twelve months. The company generally does not provide quarterly forecasts, and the filing does not provide specific 2018 revenue or earnings guidance.
Strategic priorities include expanding unified communications, cloud and network-function-virtualization offerings; strengthening relationships with Microsoft, Genesys, BroadSoft and other partners; growing professional services; increasing direct enterprise engagement; and developing complementary products and technologies.
- AudioCodes remains exposed to rapid technology changes, intense competition, pricing pressure and declining demand for legacy media gateways and technology products.
- The transition from on-premises Skype for Business and other systems toward cloud and hybrid deployments could adversely affect demand for existing products or reduce near-term revenue recognition.
- The company is materially dependent on strategic partners, particularly Microsoft and other unified communications and contact-center platforms. Changes in partner strategy, certification or product direction could reduce demand.
- Customer concentration, limited backlog and lengthy six- to twelve-month sales cycles reduce revenue visibility.
- Key components are sourced from sole or limited suppliers, including Texas Instruments, Motorola and Cavium-related suppliers. Disruptions could affect production, margins and delivery schedules.
- The company has significant Israeli shekel-denominated expenses. Management estimated that, without hedging, a 10% decrease in the dollar exchange rate against relevant currencies for 2018 would reduce net income by approximately $5 million.
- Debt agreements contain financial covenants and require approximately $4.2 million of compensating bank deposits at year-end 2017. A covenant breach could accelerate repayment.
- Israeli R&D grants impose royalty, manufacturing and technology-transfer conditions. Failure to comply could require repayment of grants, interest and penalties.
- Other risks include intellectual-property litigation, cybersecurity and privacy breaches, international regulation, tax assessments, geopolitical conditions in Israel, and potential PFIC treatment for U.S. investors.
Investor verification checklist
- Verify that the intended analysis is full-year 2017 rather than standalone fourth-quarter 2017, because this Form 20-F does not clearly provide Q4-only financial results.
- Reconcile the $58.7 million liquidity figure with cash, marketable securities, deposits and restricted amounts, and assess liquidity after debt, lease and inventory commitments.
- Evaluate the sustainability of the 62.4% gross margin and the contribution of higher-margin services revenue.
- Separate recurring operating performance from the unusually large 2016 tax benefit and the 2017 tax expense.
- Review customer concentration, partner dependence and exposure to Microsoft’s migration from Skype for Business toward cloud and hybrid offerings.
- Assess the $58.2 million contingent NATI royalty obligation, including the unresolved royalty underpayment matter.
- Monitor foreign-exchange exposure to the New Israeli Shekel and the effectiveness of hedging arrangements.
- Review share repurchase activity, treasury shares and the effect of repurchases on equity, liquidity and per-share results.
- Confirm the status of the 2018 revenue-recognition adoption, including the expected $180,000 cumulative-effect adjustment, and other pending accounting standards.