AudioCodes(AUDC) - 2019 Q4 - Annual Report

PART I ITEM 3. KEY INFORMATION Selected financial data highlights 2019 revenue growth, a $32.2 million royalty buyout impact on profitability, and key business risks Selected Consolidated Statement of Operations Data (2017-2019) | Financial Metric | 2017 (in thousands) | 2018 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | :--- | | Total Revenues | $156,739 | $176,223 | $200,287 | | Gross Profit | $97,845 | $110,606 | $94,958 | | Operating Income (Loss) | $9,650 | $16,359 | $(9,554) | | Net Income | $4,030 | $13,493 | $3,977 | | Diluted EPS | $0.13 | $0.45 | $0.13 | - In 2019, the company incurred a one-time expense of $32.178 million related to a royalty buyout agreement with the Israel National Authority for Technology and Innovation (IIA), which significantly impacted its cost of revenues and profitability for the year[13] Selected Consolidated Balance Sheet Data (As of Dec 31) | Financial Metric | 2017 (in thousands) | 2018 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | :--- | | Cash and cash equivalents | $24,235 | $31,503 | $64,773 | | Working Capital | $32,015 | $59,327 | $45,931 | | Total Assets | $170,938 | $179,372 | $243,886 | | Total Equity | $92,381 | $94,548 | $92,474 | | Dividends | $0 | $5,761 | $6,720 | ITEM 3. KEY INFORMATION Selected financial data highlights 2019 revenue growth, a $32.2 million royalty buyout impact on profitability, and key business risks Selected Financial Data Total revenues grew to $200.3 million in 2019, but a one-time royalty buyout expense led to a $9.6 million operating loss Risk Factors The company faces risks from partner reliance, intense competition, rapid technological change, operational dependencies, and Israeli geopolitical instability - The company has invested significant resources in developing products compatible with Microsoft Skype for Business and Teams. A change in Microsoft's strategy, promotion of competitors, or failure of these platforms to grow as expected would adversely affect AudioCodes' results[18][19] - The communications equipment market is highly competitive and subject to rapid technological change. The company's products can become obsolete quickly, and the rise of Communication Platform as a Service (CPaaS) may negatively impact the Unified Communications as a Service (UCaaS) market, a key revenue source[32][34] - The company depends on a small number of large customers. In 2019, ScanSource Communications Group and Westcon Group accounted for 16.0% and 13.5% of total revenues, respectively. The loss of or a significant reduction in purchases from a major customer could materially harm revenues[78][79] - Operations in Israel expose the company to political, economic, and military instability in the region, which could disrupt operations. Additionally, a significant portion of operating costs are in New Israeli Shekels (NIS), creating exposure to foreign exchange fluctuations against the U.S. dollar[141][142][147] - The company warns U.S. shareholders of the risk of being classified as a Passive Foreign Investment Company (PFIC), which could result in adverse U.S. federal income tax consequences. While management does not believe it was a PFIC from 2004-2019, there is no assurance it will not become one in the future[180][181] ITEM 4. INFORMATION ON THE COMPANY This section details AudioCodes' history, business, and operations, highlighting 2019 product advancements, strategic shifts, and competitive landscape History and Development of the Company AudioCodes evolved into a VoIP solutions provider, with 2019 advancements in cloud SBCs, AI gateways, and IP phones, alongside $1.95 million in capital expenditures - In 2019, the company continued to invest in cloud and virtualization by enhancing its software session border controller (SBC) product line with increased scale, high availability for public/private clouds, and integration with cloud automation tools[192] - The company launched 'Meeting Insights', an enterprise application that captures and analyzes meeting information, and the 'Voice.AI Gateway', a solution enabling the connection of voice calls to text-based chatbots using cloud speech recognition[193][199] - AudioCodes expanded its IP Phone offerings for Microsoft Teams with the new C448 model and added features to the C450. It also certified its 400HD series for the generic SIP market, allowing future migration to Microsoft Teams[200][201][202] Principal Capital Expenditures (in thousands) | Category | 2017 (in thousands) | 2018 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | :--- | | Computers and peripheral equipment | $1,024 | $1,111 | $1,064 | | Office furniture and equipment | $392 | $160 | $687 | | Leasehold improvements | $158 | $69 | $198 | | Total | $1,574 | $1,340 | $1,949 | Business Overview AudioCodes provides VoIP and data networking solutions, focusing on UC and CC markets, driven by cloud trends, strategic partnerships, and facing intense competition - AudioCodes is a VoIP technology market leader focused on converged VoIP and data communications for Enterprise Unified Communications, contact centers, and service provider business services. Its products include IP phones, session border controllers (SBC), media gateways, and management solutions[220][221] - The business strategy emphasizes maintaining technological leadership, strengthening relationships with key partners like Microsoft and Genesys, expanding its solution offerings, and growing its professional services business[251][252][260] Revenue Breakdown by Product/Service Type | Category | 2017 (%) | 2018 (%) | 2019 (%) | | :--- | :--- | :--- | :--- | | Networking Products | 60% | 61% | 64% | | Network Services | 31% | 32% | 32% | | Technology Products | 8% | 7% | 4% | | Technology Services | <1% | <1% | <1% | - The company faces intense competition from numerous players across its product segments, including Ribbon Communications, Oracle, Cisco, Poly, and Yealink in the SBC, gateway, and IP phone markets[362][363][364] Organizational Structure AudioCodes Ltd. is the parent company of over 20 global subsidiaries, including its key U.S. entity, AudioCodes Inc - AudioCodes Ltd. is the parent company of a group with over 20 subsidiaries globally[379] - A key subsidiary is AudioCodes Inc., a wholly-owned U.S. entity based in Somerset, New Jersey[379] Property, Plants and Equipment The company leases all facilities, including its main Israeli office and U.S. locations, with annual lease payments of approximately $5.7 million and $480,000 respectively - The main office and warehouse facility is leased in Airport City, Lod, Israel, covering 274,000 sq. ft. for an annual cost of approximately $5.7 million. The lease extends until January 31, 2024[380] - The U.S. subsidiary, AudioCodes Inc., leases facilities in New Jersey and North Carolina, with total annual lease payments of about $480,000 in 2019[381] ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS This section analyzes AudioCodes' 2019 financial performance, highlighting 13.7% revenue growth to $200.3 million, a $32.2 million royalty buyout impact, and key business trends Operating Results In 2019, revenues grew 13.7% to $200.3 million, but a $32.2 million royalty buyout expense led to a $9.6 million operating loss, offset by a $15.3 million tax benefit Comparison of Operations (Year Ended Dec 31) | Metric | 2018 ($M) | 2019 ($M) | % Change (%) | | :--- | :--- | :--- | :--- | | Total Revenues | $176.2M | $200.3M | 13.7% | | Product Revenues | $119.9M | $135.6M | 13.1% | | Service Revenues | $56.3M | $64.6M | 14.7% | | Gross Profit | $110.6M | $95.0M | (14.1)% | | Gross Margin | 62.8% | 47.4% | (15.4)pp | | Operating Income (Loss) | $16.4M | $(9.6)M | N/A | | Net Income | $13.5M | $4.0M | (70.4)% | - The decrease in gross profit and the shift to an operating loss in 2019 were primarily caused by a one-time expense of $32.2 million related to a royalty buyout agreement with the Israel National Authority for Technology and Innovation (IIA)[432] - The company recorded a net income tax benefit of $15.3 million in 2019, compared to a $3.1 million expense in 2018. This was mainly due to recording a new deferred tax asset of $20.5 million based on expected future operating results[441] Liquidity and Capital Resources As of December 31, 2019, the company held $71.9 million in cash, with $23.2 million from operations, $29.6 million from investing, and $14.5 million used in financing activities - Cash and cash equivalents and bank deposits increased to $71.9 million as of December 31, 2019, up from $65.4 million at the end of 2018[447] - Net cash provided by operating activities was $23.2 million in 2019, compared to $25.6 million in 2018[454][456] - During 2019, the company used $8.0 million to repurchase 559,848 of its ordinary shares and paid $6.7 million in cash dividends[449][459] - As of December 31, 2019, the company had outstanding bank loans totaling $3.7 million, down from $6.2 million at the end of 2018[14][451][452] Research and Development, Patents and Licenses, etc. R&D expenses reached $41.2 million in 2019, and the company paid $32.2 million to buy out $49 million in contingent royalty liabilities, with $16.5 million remaining - Net R&D expenses were $41.2 million in 2019, an increase from $34.7 million in 2018 and $30.3 million in 2017[465] - In November 2019, the company agreed to pay the IIA $32.2 million to buy out a contingent royalty liability of approximately $49 million, eliminating future royalty obligations for those specific grants[466] - As of December 31, 2019, a contingent obligation to pay royalties of approximately $16.5 million remains for grants not covered by the buyout agreement[468] Trend Information Business trends include the shift to VoIP and cloud-based services, increasing demand for software solutions, and decreasing demand for older hardware products - The accelerated demand for VoIP technology and the shift from traditional to packet-switched networks continue to be major business drivers[470] - The emergence of private and public cloud-based services is increasing demand for the company's software-based products, which may result in lower revenues from its hardware-based session border controllers[471] - Demand for the company's enabling technology products (chips and boards) is decreasing as customers migrate to more integrated, comprehensive solutions[472] Tabular Disclosure of Contractual Obligations As of December 31, 2019, total contractual obligations were $93,951 thousand, primarily comprising lease commitments, inventory purchases, and IIA royalty buyout liabilities Contractual Obligations as of December 31, 2019 (in thousands) | Obligation | Less than 1 year (in thousands) | 1-3 years (in thousands) | 3-5 years (in thousands) | More than 5 years (in thousands) | Total (in thousands) | | :--- | :--- | :--- | :--- | :--- | :--- | | Bank loans | $2,473 | $1,200 | $0 | $0 | $3,673 | | Rent and lease commitments, net | $6,202 | $20,885 | $604 | $655 | $28,346 | | IIA – Royalty Buyout Agreement | $10,750 | $10,749 | $0 | $0 | $21,499 | | Other commitments (inventory) | $23,020 | $0 | $0 | $0 | $23,020 | ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES This section details the company's leadership, compensation, board practices, and employee base, including CEO compensation and major shareholder information Compensation In 2019, CEO Shabtai Adlersberg's total compensation was approximately $2.36 million, with aggregate remuneration for all directors and senior officers at $4.9 million 2019 Compensation for Covered Executives | Name and Principal Position | Salary ($) | Bonus ($) | Share-Based Comp. ($) | Other Comp. ($) | Total ($) | | :--- | :--- | :--- | :--- | :--- | :--- | | Shabtai Adlersberg – President and CEO | $371,282 | $785,006 | $1,004,292 | $194,790 | $2,355,370 | | Lior Aldema – CBO | $258,803 | $242,732 | $432,813 | $109,628 | $1,043,976 | | Niran Baruch – VP Finance and CFO | $218,020 | $62,780 | $333,684 | $91,179 | $705,663 | - The aggregate direct remuneration for the 15 individuals serving as directors, senior executive officers, or key employees in 2019 was approximately $4.9 million[500] - Non-employee directors receive an annual fee of $38,000, a fee of $1,140 per meeting attended, and an annual grant of 7,500 restricted share units (RSUs) that vest over three years[501][502] Employees As of December 31, 2019, AudioCodes had 728 employees, with the majority in Israel, and significant numbers in sales, marketing, and R&D departments Employees by Department (as of Dec 31) | Department | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | | Research and development | 280 | 264 | 273 | | Sales, marketing, tech service & support | 303 | 327 | 340 | | Operations | 77 | 77 | 76 | | Management and administration | 38 | 38 | 39 | | Total | 698 | 706 | 728 | Employees by Geographic Area (as of Dec 31) | Region | 2017 | 2019 | | :--- | :--- | :--- | | Israel | 403 | 398 | | United States | 130 | 134 | | Europe | 59 | 69 | | Far East | 92 | 112 | | Latin America | 14 | 15 | | Total | 698 | 728 | Share Ownership As of February 18, 2020, CEO Shabtai Adlersberg beneficially owned 15.8% of ordinary shares, with 1,878,993 shares available for future grants under the equity incentive plan - As of February 18, 2020, Shabtai Adlersberg, President and CEO, beneficially owned 4,705,116 shares, representing 15.8% of the company's ordinary shares[537] - Under the 2008 Equity Incentive Plan, as of December 31, 2019, there were 1,341,073 options and 977,169 RSUs outstanding, with 1,878,993 ordinary shares remaining available for future grants[545] ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS This section identifies major shareholders, including Shabtai Adlersberg (17.4%), Leon Bialik (10.2%), and Morgan Stanley (6.7%), with no related party transactions reported Major Shareholders (as of Feb 18, 2020) | Shareholder | Amount Owned | Percent of Class (%) | | :--- | :--- | :--- | | Shabtai Adlersberg | 5,181,198 | 17.4% | | Leon Bialik | 3,043,936 | 10.2% | | Morgan Stanley | 1,988,584 | 6.7% | | All directors and senior executive officers as a group (15 persons) | 5,493,661 | 18.5% | ITEM 8. FINANCIAL INFORMATION This section refers to consolidated financial statements, confirms no material legal proceedings, and outlines the company's dividend policy - The company reports no material legal proceedings[557] - No significant changes have occurred since December 31, 2019, other than what has been disclosed in the annual report[557] ITEM 10. ADDITIONAL INFORMATION This section details corporate information, share capital, Israeli corporate governance, material contracts like the IIA royalty buyout, and tax considerations for the company and shareholders - The company's authorized share capital consists of 100,000,000 ordinary shares and 2,500,000 preferred shares, with 29,725,156 ordinary shares outstanding as of February 18, 2020[561] - A material contract from November 2019 is the royalty buyout agreement with the IIA, where the company agreed to pay $32.2 million to settle a contingent liability of approximately $49 million[618] - The company is subject to Israeli corporate law, which includes specific rules for fiduciary duties of officers, approval of related-party transactions, and anti-takeover measures such as tender offer requirements for acquisitions exceeding 25% or 45% ownership thresholds[583][589][605] - The company benefits from Israeli government programs, including the Law for the Encouragement of Capital Investments, which provides reduced corporate tax rates. The standard corporate tax rate in Israel was 23% for 2019[626][628] ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company faces market risks from foreign currency and interest rate fluctuations, with hedging strategies in place, and a 10% dollar decrease could impact net income by $6.3 million - The company is exposed to foreign currency risk as a portion of its expenses are denominated in NIS while revenues are primarily in USD. It uses derivative financial instruments to hedge some of this exposure[703] - A hypothetical 10% decrease in the dollar exchange rate for the year ending December 31, 2019, would have resulted in a decrease in net income of approximately $6.3 million, excluding the impact of hedging[703] - The company is subject to interest rate risk on its bank loans, which are based on LIBOR. A 100 basis point increase in borrowing rates would result in an estimated additional interest expense of $24,400 for 2020[704] PART II ITEM 15. CONTROLS AND PROCEDURES Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2019, with an unqualified attestation report from auditors - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2019[705] - Based on the COSO 2013 framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2019[709] - The company's independent registered public accounting firm provided an unqualified attestation report on the effectiveness of internal control over financial reporting[711][737] ITEM 16.A. AUDIT COMMITTEE FINANCIAL EXPERT The Board of Directors has determined that Joseph Tenne qualifies as an independent audit committee financial expert - The Board of Directors has identified Joseph Tenne as an "audit committee financial expert" and confirmed his independence[712] ITEM 16.C. PRINCIPAL ACCOUNTANT FEES AND SERVICES The company's independent accountant is Kost Forer Gabbay & Kasierer, with total fees of $515,000 in 2019, and the audit committee pre-approves all services Principal Accountant Fees (in thousands) | Fee Type | 2018 (in thousands) | 2019 (in thousands) | | :--- | :--- | :--- | | Audit Fees | $382 | $390 | | Audit Related Fees | $38 | $10 | | Tax Fees | $96 | $115 | | Total | $516 | $515 | - The audit committee has a pre-approval policy for all audit and non-audit services, and all services provided in 2019 were pre-approved in accordance with this policy[718][719][721] ITEM 16.E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS In 2019, the company repurchased 559,848 ordinary shares for approximately $8.0 million, with $8.5 million remaining available for future purchases under the program - During 2019, the company repurchased 559,848 of its ordinary shares for a total cost of approximately $8.0 million[721] Share Repurchases in 2019 | Period | Total Shares Purchased | Average Price Paid per Share ($) | | :--- | :--- | :--- | | Jan 2019 | 86,613 | 10.95 | | May 2019 | 471,799 | 14.87 | | June 2019 | 1,436 | 14.39 | | Total | 559,848 | 14.26 | ITEM 16.G. CORPORATE GOVERNANCE As a foreign private issuer, AudioCodes follows Israeli corporate governance practices, deviating from some Nasdaq rules regarding shareholder approval for compensation plans - The company follows Israeli home country practice instead of the Nasdaq rule requiring shareholder approval for certain dilutive events, such as establishing or amending share-based compensation plans[726] - Under Israeli law, board approval is sufficient for certain share-based compensation plans, whereas compensation for directors and the CEO requires compensation committee and shareholder approval[726] PART III ITEM 18. FINANCIAL STATEMENTS This section presents the audited consolidated financial statements for AudioCodes Ltd. as of December 31, 2019, prepared under U.S. GAAP, with an unqualified auditor's opinion - The independent auditor, Kost Forer Gabbay & Kasierer (a member of Ernst & Young Global), issued an unqualified opinion on the consolidated financial statements for the three years ended December 31, 2019[736] Key Financial Statement Balances (as of Dec 31, 2019) | Account | Amount (in thousands) | | :--- | :--- | | Assets | | | Total Current Assets | $132,591 | | Total Assets | $244,324 | | Liabilities & Equity | | | Total Current Liabilities | $86,660 | | Total Liabilities | $151,850 | | Total Shareholders' Equity | $92,474 | Consolidated Statement of Operations Highlights (Year ended Dec 31, 2019) | Account | Amount (in thousands) | | :--- | :--- | | Total Revenues | $200,287 | | Gross Profit | $94,958 | | Operating Loss | $(9,554) | | Net Income | $3,977 |