t65872_20f.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
20–F
|
|
o
|
REGISTRATION
STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
OR
|
|
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
|
|
For
the fiscal year ended December 31, 2008
|
|
OR
|
|
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
OR
|
|
o
|
SHELL
COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
|
|
|
Date
of event requiring this shell company report
__________________________
|
|
|
|
For
the transition period
from to
|
|
|
|
Commission
file number 0-30070
|
AUDIOCODES
LTD.
|
(Exact
name of Registrant as specified in its charter
|
and
translation of Registrant’s name into English)
|
|
ISRAEL
|
(Jurisdiction
of incorporation or organization)
|
|
1
Hayarden Street, Airport City Lod 70151, Israel
|
(Address
of principal executive offices)
|
|
Nachum
Falek, CFO, 972-3-976-4061, 1 Hayarden Street, Airport City, Lod 70151
Israel
|
(Name,
Telephone, E-mail and/or Facsimile number and Address of Company Contact
Person)
|
|
Securities
registered or to be registered pursuant to Section 12(b) of the
Act:
|
Title
of each class
Ordinary
Shares, nominal value NIS 0.01 per share
|
Name
of each exchange on which registered
NASDAQ
Global Select Market
|
|
|
Securities
registered or to be registered pursuant to Section 12(g) of the
Act:
|
|
|
None
|
(Title
of Class)
|
|
|
Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act:
|
|
None
|
(Title
of Class)
|
Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual
report.
As
of December 31, 2008, the Registrant had outstanding 40,182,444 Ordinary Shares,
nominal value NIS 0.01 per share.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act:
Yes o No x
If
this report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934:
Yes o No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes x No o
Indicate
by check mark whether registrant has submitted electronically and posted omits
corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files)
Yes o No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
|
|
|
|
|
Large Accelerated
filer o
|
Accelerated filer
x
|
Non-accelerated
filer o
|
Indicate
by check mark which basis of accounting the registrant has used to prepare the
financial statements included in this filing:
|
|
|
|
|
U.S. GAAP x
|
International
Financial Reporting Standards as issued by
the
International
Accounting Standards Board o
|
Other o
|
If “Other” has been checked in response to the previous question, indicate
by check mark which financial statement item the registrant has elected to
follow.
o Item
17 o Item
18
If
this is an annual report, indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act):
Yes o No x
PART
I
Unless
the context otherwise requires, “AudioCodes,” “us,” “we” and “our” refer to
AudioCodes Ltd. and its subsidiaries.
|
|
|
|
ITEM
1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND
ADVISERS
|
Not
applicable.
|
|
|
|
ITEM
2. OFFER STATISTICS AND EXPECTED
TIMETABLE
|
Not
applicable.
A.
|
SELECTED
FINANCIAL DATA
|
The
selected financial data, set forth in the table below, have been derived from
our audited historical financial statements for each of the years from 2004
through 2008. The selected consolidated statement of operations data for the
years ended December 31, 2006, 2007, and 2008, and the selected consolidated
balance sheet data as of December 31, 2007 and 2008, have been derived from our
audited consolidated financial statements set forth elsewhere in this Annual
Report. The selected consolidated statement of operations data for the years
ended December 31, 2004 and 2005, and the selected consolidated balance sheet
data as of December 31, 2004, 2005 and 2006, have been derived from our
previously published audited consolidated financial statements, which are not
included in this Annual Report. The selected financial data should be read in
conjunction with our consolidated financial statements, and are qualified
entirely by reference to these consolidated financial
statements.
|
|
Year
Ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
|
2005
|
|
|
2006(*)
|
|
|
2007(*)
|
|
|
2008(*)
(**) |
|
|
|
|
|
|
|
(In
thousands, except per share data)
|
|
|
|
|
|
Statement
of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
82,756 |
|
|
$ |
115,827 |
|
|
$ |
147,353 |
|
|
$ |
158,235 |
|
|
$ |
174,744 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of revenues
|
|
|
34,375 |
|
|
|
46,993 |
|
|
|
61,242 |
|
|
|
69,185 |
|
|
|
77,455 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
48,381 |
|
|
|
68,834 |
|
|
|
86,111 |
|
|
|
89,050 |
|
|
|
97,289 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development, net
|
|
|
20,009 |
|
|
|
24,415 |
|
|
|
35,416 |
|
|
|
40,706 |
|
|
|
37,833 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
19,891 |
|
|
|
25,944 |
|
|
|
37,664 |
|
|
|
42,900 |
|
|
|
44,657 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative
|
|
|
4,851 |
|
|
|
6,004 |
|
|
|
8,766 |
|
|
|
9,637 |
|
|
|
9,219 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment
of goodwill and intangible assets
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
85,015 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
44,751 |
|
|
|
56,363 |
|
|
|
81,846 |
|
|
|
93,243 |
|
|
|
176,724 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income (loss)
|
|
|
3,630 |
|
|
|
12,471 |
|
|
|
4,265 |
|
|
|
(4,193
|
) |
|
|
(79,435
|
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
income, net
|
|
|
2,165 |
|
|
|
2,457 |
|
|
|
3,817 |
|
|
|
2,670 |
|
|
|
1,182 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) before taxes on income (tax benefit)
|
|
|
5,795 |
|
|
|
14,928 |
|
|
|
8,082 |
|
|
|
(1,523
|
) |
|
|
(73,253
|
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxes
on income, net
|
|
|
273 |
|
|
|
799 |
|
|
|
289 |
|
|
|
1,265 |
|
|
|
505 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
in losses of affiliated companies
|
|
|
516 |
|
|
|
693 |
|
|
|
916 |
|
|
|
1,097 |
|
|
|
2,582 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$ |
5,006 |
|
|
$ |
13,436 |
|
|
$ |
6,877 |
|
|
$ |
(3,885 |
) |
|
$ |
(81,340 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
net earnings (loss) per share
|
|
$ |
0.13 |
|
|
$ |
0.33 |
|
|
$ |
0.16 |
|
|
$ |
(0.09 |
) |
|
$ |
(1.97 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
net earnings (loss) per share
|
|
$ |
0.12 |
|
|
$ |
0.31 |
|
|
$ |
0.16 |
|
|
$ |
(0.09 |
) |
|
$ |
(1.97 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of ordinary shares used in computing basic net earnings
(loss) per share
|
|
|
38,614 |
|
|
|
40,296 |
|
|
|
41,717 |
|
|
|
42,699 |
|
|
|
41,201 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of ordinary shares used in computing diluted net earnings
per share
|
|
|
42,607 |
|
|
|
43,086 |
|
|
|
43,689 |
|
|
|
42,699 |
|
|
|
41,201 |
|
(*)
|
Including
stock-based compensation expenses related to options granted to employees
and others as a result of the adoption of SFAS 123R as of January 1,
2006.
|
|
|
(**)
|
Including
impairment charge to goodwill, intangible assets and investment in an
affiliate.
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
|
2005
|
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
166,832 |
|
|
$ |
70,957 |
|
|
$ |
25,171 |
|
|
$ |
75,063 |
|
|
$ |
36,779 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
bank deposits, structured notes, marketable securities and accrued
interest
|
|
|
— |
|
|
|
71,792 |
|
|
|
58,080 |
|
|
|
35,309 |
|
|
|
78,351 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working
capital
|
|
|
171,447 |
|
|
|
152,047 |
|
|
|
97,454 |
|
|
|
124,676 |
|
|
|
56,438 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
bank deposits, structured notes and marketable securities
|
|
|
50,195 |
|
|
|
77,572 |
|
|
|
50,377 |
|
|
|
32,670 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
272,145 |
|
|
|
292,223 |
|
|
|
337,056 |
|
|
|
344,487 |
|
|
|
230,482 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank
loans
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
27,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior
convertible notes
|
|
|
120,660 |
|
|
|
120,836 |
|
|
|
121,015 |
|
|
|
121,198 |
|
|
|
71,374 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
shareholders’ equity
|
|
|
121,985 |
|
|
|
139,106 |
|
|
|
164,685 |
|
|
|
174,492 |
|
|
|
83,334 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
stock
|
|
|
126,826 |
|
|
|
130,744 |
|
|
|
149,336 |
|
|
|
162,103 |
|
|
|
167,981 |
|
B.
|
CAPITALIZATION
AND INDEBTEDNESS
|
Not
applicable.
|
|
C.
|
REASONS
FOR THE OFFER AND USE OF
PROCEEDS
|
Not
applicable.
We
are subject to various risks and uncertainties relating to or arising out of the
nature of our business and general business, economic, financing, legal and
other factors or conditions that may affect us. We believe that the occurrence
of any one or some combination of the following factors could have a material
adverse effect on our business, financial condition, cash flows and results of
operations.
Risks
Related to Our Business and Industry
We
reported losses in 2007 and 2008. We may experience additional losses in the
future.
We
reported a net loss of $3.9 million in 2007 and $81.3 million in 2008. We also
reported a loss of $3.1 million in the first quarter of 2009. The loss in 2008
included a non-cash impairment charge of $86.1 million taken in the fourth
quarter of 2008 with respect to goodwill, intangible assets and investment in an
affiliate. The majority of our expenses are directly and indirectly related to
the number of people we employ. We may increase our expenses based on
projections of revenue growth. If at any given time we do not meet our
expectations for growth in revenues our expenses incurred in anticipation of
projected revenues may cause us to incur a loss. We may not be able to
anticipate a loss in advance and adjust our variable costs accordingly. We will
need to increase revenues and reduce expenses in order to return to
profitability.
We
have depended, and expect to continue to depend, on a small number of large
customers. Our largest customer, Nortel Networks, filed for bankruptcy
protection in January 2009. The loss of Nortel or one of our other large
customers or the reduction in purchases by a significant customer or failure of
such customer to pay for the products it purchases from us could have a material
adverse effect on our revenues.
Historically,
a substantial portion of our revenue has been derived from large purchases by a
small number of original equipment manufacturers, or OEMs, and network equipment
providers, or NEPs, systems integrators and distributors. For example, our top
three customers accounted for approximately 24.9% of our revenues in 2006, 26.1%
of our revenues in 2007 and 20.9% of our revenues in 2008. Based on our
experience, we expect that our customer base may change from period to period.
If we lose a large customer and fail to add new customers, or if purchases made
by such customers are significantly reduced, there could be a material adverse
effect on our results of operations.
Sales
to Nortel Networks, our largest customer, accounted for 14.4% of our revenues in
2008 compared to 17.0% of our revenues in 2007 and 15.2% of our revenues in
2006. Nortel filed for bankruptcy protection in January 2009. As a result of
this bankruptcy filing, $1.7 million of sales to Nortel in the fourth quarter of
2008 were recorded as unpaid deferred revenues which also reduced trade
receivables on our balance sheet. The effect of this bankruptcy filing by Nortel
on the business of Nortel and, in turn, the impact on the purchase of our
products by Nortel cannot be determined at this time. Any significant reduction
in sales to Nortel or the inability to collect a significant portion of amounts
owed to us by Nortel could have a material adverse effect on our results of
operations.
Recent
and future economic conditions, including turmoil in the financial and credit
markets, may adversely affect our business.
The
current economic and credit crisis is having a significant negative impact on
business around the world. The impact of this crisis on the technology industry
and our major customers has been severe. Conditions may continue to be depressed
or may be subject to further deterioration which could lead to a further
reduction in consumer and customer spending overall, which could have an adverse
impact on sales of our products. A disruption in the ability of our significant
customers to access liquidity could cause serious disruptions or an overall
deterioration of their businesses which could lead to a significant reduction in
their orders of our products and the inability or failure on their part to meet
their payment obligations to us, any of which could have a material adverse
effect on our results of operations and liquidity. A significant adverse change
in a customer’s financial and/or credit position could also require us to assume
greater credit risk relating to that customer’s receivables or could limit our
ability to collect receivables related to previous purchases by that customer.
As a result, our reserves for doubtful accounts and write-offs of accounts
receivable may increase.
We
may not be able to raise additional financing for our capital needs on favorable
terms, or at all, which could limit our ability to grow and to continue our
longer term expansion plans.
The
conversion price of our senior convertible notes is significantly higher than
the market price of our ordinary shares and these notes are trading at a
discount to their principal amount. As a result, in November 2009, we may be
required to repay all or a portion of the $73.5 million in principal amount of
our outstanding senior convertible notes when the holders of these notes can
require us to repurchase the notes. We may need to raise additional capital to
continue our longer term expansion plans. To the extent that we cannot fund our
activities and acquisition program through our existing cash resources and any
cash we generate from operations, we may need to raise equity or debt funds
through additional public or private financings. We borrowed $30 million in 2008
that is repayable in 20 equal quarterly payments of $1.5 million from August,
2008 through July 2013. We will need to pay these installments and could also be
required to repay all or portion of these bank loans if we do not comply with
covenants in our loan agreements with respect to maintaining shareholders’
equity at specified levels or achieving certain levels of operating income. We
cannot be certain that we will be able to obtain additional financing on
commercially reasonable terms, or at all. This could inhibit our growth,
increase our financing costs or cause us severe financial
difficulties.
We
have entered into an agreement for the construction and long term lease of a new
building in Israel. If we are unable to sublease the property under reasonable
commercial terms, we may incur increased operating expenses which could
adversely affect our results of operations.
In
May, 2007, we entered into an agreement with respect to property adjacent to our
headquarters in Israel, pursuant to which a building of approximately 145,000
square feet will be erected and leased to us for period of eleven years. This
new building is expected to be completed in 2010. We estimate the annual lease
payments (including management fees) to be in the range of $2.0 million to $3.2
million, depending on the amount expended on improvements made to the building.
The leased property was intended to serve our expanding needs. However, in view
of current economic conditions and our reduction in personnel undertaken in
2008, we may not need to occupy the entire building and may seek to sublease all
or a portion of the new building to third parties. If we are unable to enter
into a sublease or enter into a sublease for an amount that is less than our
obligations under the lease, we may incur significant additional operating
expenses which could adversely affect our results of operations.
We
are dependent on the development of the VoIP market to increase our
sales.
We
are dependent on the development of the Voice over Internet Protocol, or VoIP,
market to increase our sales. Most existing networks are still not based on
Voice over Packet technology which we use in our products designed for the VoIP
market. We cannot be sure that the delivery of telephone and other
communications services over packet networks will expand or that there will be a
need to interconnect to other networks utilizing the type of technology
contained in our products. For example, the need for our Media Gateway products
depends on the need to inter connect VoIP networks with traditional non-packet
based networks. Our session border control products depend on growth in the need
to inter connect Voice over Packet networks with each other. The adaptation
process of connecting packet networks and telephone networks can be time
consuming and costly. Sales of our VoIP products will depend on the development
of packet networks and the commercialization of VoIP services. If this market
develops more slowly than we expect, we may not be able to sell our products in
a significant enough volume to be profitable.
We
intend to expand our business through acquisitions that could result in
diversion of resources and extra expenses. This could disrupt our business and
affect our results of operations.
Part
of our strategy is to pursue acquisitions of, or investments in, businesses and
technologies or to establish joint ventures to expand our business. For example,
in April 2003, we purchased a product group from Nortel Networks and in May 2004
we purchased Ai-Logix Inc., now known as AudioCodes Inc. In 2005, we invested in
two Israeli-based companies, MailVision Ltd. and CTI Squared Ltd., and continued
investing in Natural Speech Communication Ltd. We have recognized losses from
our equity investment in Natural Speech Communication in our results of
operations in each of the past three years. In December 2008, we began
consolidating the financial results of Natural Speech Communication in our
financial results since we became the primary beneficiary in accordance with
FASB Interpretation No. 46 (Revised), or FASB Interpretation (“FIN”) 46R,
“Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51”.
In July 2006, we acquired Nuera Communications, Inc. (which merged into
AudioCodes Inc.), in August 2006, we acquired Netrake Corporation (which merged
into AudioCodes Inc.), and in April 2007, we completed our acquisition of CTI
Squared Ltd.
The
negotiation of acquisitions, investments or joint ventures, as well as the
integration of acquired or jointly developed businesses or technologies, could
divert our management’s time and resources. Nuera is significantly larger than
any other acquisition we have made. As a result, we have experienced a diversion
of our management’s time and resources in connection with the integration and
operation of Nuera’s business.
Acquired
businesses, technologies or joint ventures may not be successfully integrated
with our products and operations. The markets for the products produced by the
companies we acquire may take longer than we anticipated to develop and to
result in increased sales and profits for us. We may not realize the intended
benefits of any acquisition, investment or joint venture and we may incur losses
from any acquisition, investment or joint venture. The future valuation of
acquired businesses may be less than the purchase price we paid and result in
impairment charges related to goodwill or intangible assets. During the fourth
quarter of 2008, we recognized non-cash impairment charges of $86.1 million with
respect to goodwill and intangible assets related to our acquisitions and an
investment in an affiliated company. These charges were identified in connection
with our annual impairment tests and reflect market conditions.
In
addition, acquisitions could result in:
|
|
|
|
●
|
substantial
cash expenditures;
|
|
|
|
|
●
|
potentially
dilutive issuances of equity securities;
|
|
|
|
|
●
|
the
incurrence of debt and contingent
liabilities;
|
|
●
|
a
decrease in our profit margins;
|
|
|
|
|
●
|
amortization
of intangibles and potential impairment of goodwill and intangible assets,
such as occurred during 2008;
|
|
|
|
|
●
|
reduction
of management attention to other parts of the business;
|
|
|
|
|
●
|
failure
to invest in different areas or alternative
investments;
|
|
|
|
|
●
|
failure
to generate expected financial results or reach business goals;
and
|
|
|
|
|
●
|
increased
expenditures on human resources and related
costs.
|
If
acquisitions disrupt our sales or marketing efforts or operations, our business
may suffer.
We
recorded significant charges during the fourth quarter of 2008 which caused us
to report a net loss for 2008. If our goodwill and other intangibles become
further impaired, we may be required to record additional charges to
earnings.
We
recorded aggregate charges of $86.1 million in the fourth quarter of 2008 for
impairment charges with respect to goodwill and intangible assets related to our
acquisitions and an investment in an affiliated company. As a result, we
reported a net loss for 2008. As of December 31, 2008, we had goodwill and other
intangibles in an aggregate amount of $32.1 million, or approximately 13.9% of
our total assets and 38.5% of our shareholders’ equity. Under accounting
principles generally accepted in the United States, we review our goodwill and
other intangibles for impairment annually during the fourth quarter of each
fiscal year and when events or changes in circumstances indicate the carrying
value may not be recoverable. The carrying value of our goodwill and other
intangibles may not be recoverable due to factors such as a decline in our stock
price and market capitalization, reduced estimates of future cash flows and
profitability and slower growth rates in our industry. Our impairment charges in
2008 were primarily the result of a decrease in our market capitalization.
Estimates of future cash flows and profitability are based on an updated
long-term financial outlook of our operations. However, actual performance in
the near-term or long-term could be materially different from these forecasts,
which could impact future estimates. A further significant decline in our market
capitalization or deterioration in our projected results could result in
additional impairment of goodwill and/or intangibles. We may be required to
record a significant charge to earnings in our financial statements during a
period in which an impairment of our goodwill is determined to exist, as
happened in 2008, which would negatively impact our results of operations and
could negatively impact our stock price.
If
new products we recently introduced or expect to introduce in the future fail to
generate the level of demand we anticipated, we will realize a lower than
expected return from our investment in research and development with respect to
those products, and our results of operations may suffer.
Our
success is dependent, in part, on the willingness of our customers to transition
or migrate to new products, such as our expanded offering of Mediant and IPmedia
products, the session border controller products that we now offer as a result
of our acquisition of Netrake, the Multi Service Business Gateways (MSBGs) we
recently introduced, the software application products that we now offer as a
result of our acquisition of CTI Squared, or expected future products. We are
involved in a continuous process of evaluating changing market demands and
customer requirements in order to develop and introduce new products, features
and applications to meet changing demands and requirements. We need to be able
to interpret market trends and the advancement of technology in order to
successfully develop and introduce new products, features and applications. If
potential customers defer transition or migration to new products, our return on
our investment in research and development with respect to products recently
introduced or expected to be introduced in the near future will be lower than we
originally anticipated and our results of our operations may
suffer.
Because
of the rapid technological development in the communications equipment market
and the intense competition we face, our products can become outmoded or
obsolete in a relatively short period of time, which requires us to provide
frequent updates and/or replacements to existing products. If we do not
successfully manage the transition process to the next generation of our
products, our operating results may be harmed.
The
communications equipment market is characterized by rapid technological
innovation and intense competition. Accordingly, our success depends in part on
our ability to develop next generation products in a timely and cost-effective
manner. The development of new products is expensive, complex and time
consuming. If we do not rapidly develop our next generation products ahead of
our competitors, we may lose both existing and potential customers to our
competitors. Further, if a competitor develops a new, less expensive product
using a different technological approach to delivering informational services
over existing networks, our products would no longer be competitive. Conversely,
even if we are successful in rapidly developing new products ahead of our
competitors and we do not cost-effectively manage our inventory levels of
existing products when making the transition to the new products, our financial
results could be negatively affected by high levels of obsolete inventory. If
any of the foregoing were to occur, then our operating results would be
harmed.
Our
industry is rapidly evolving and we may not be able to keep pace with
technological changes, which could adversely affect our business.
The
transmission of multimedia over data networks is rapidly evolving. Short product
life cycles place a premium on our ability to manage the transition from current
products to new products. Our future success in generating revenues will depend
on our ability to enhance our existing products and to develop and introduce new
products and product features. These products and features must keep pace with
technological developments and address the increasingly sophisticated needs of
our customers. The development of new technologies and products is increasingly
complex and uncertain. This increases the difficulty in coordinating the
planning and production process and can result in delay in the introduction of
new technologies and products.
The
increase in the number of IP networks may adversely affect the demand for media
gateway products.
Media
gateway products are primarily intended to transcode voice from traditional
telephony networks to IP networks and vise versa. Along with the growth in the
number of IP networks, there has been an increase in the amount of information
that is sent directly from one IP network to another IP network. This direct
network communication potentially obviates the need to use a media gateway or
transcoding. A reduction in the demand for media gateways may adversely affect
the demand for our media gateway products and, in turn, adversely affect our
results of operations.
New
industry standards, the modification of our products to meet additional existing
standards or the addition of features to our products may delay the introduction
of our products or increase our costs.
The
industry standards that apply to our products are continually evolving. In
addition, since our products are integrated into networks consisting of elements
manufactured by various companies, they must comply with a number of industry
standards and practices established by various international bodies and industry
forums. Should new standards gain broad acceptance, we will be required to adopt
those standards in our products. We may also decide to modify our products to
meet additional existing standards or add features to our products. Standards
may be adopted by various industry interest groups or may be proprietary and
nonetheless accepted broadly in the industry. It may take us a significant
amount of time to develop and design products incorporating these new standards.
We may also have to pay additional fees to the developers of the technologies
which constitute the newly adopted standards.
Our
OEM customers or potential customers may develop or prefer to develop their own
technical solutions, and as a result, would not buy our products.
Our
products are sold also as components or building blocks to large OEMs and NEPs.
These customers incorporate our products into their product offerings, usually
in conjunction with value-added services of their own or of third parties. OEM
or NEP customers or potential customers may prefer to develop their own
technology or purchase third party technology. They could also manufacture their
own components or building blocks that are similar to the ones we offer. Large
customers have already committed significant resources in developing integrated
product offerings. Customers may decide that this gives them better
profitability and/or greater control over supplies, specifications and
performance. Customers may therefore not buy components or products from an
external manufacturer such as us. This could have an adverse impact on our
ability to sell our products and our revenues.
We
have a limited order backlog. If revenue levels for any quarter fall below our
expectations, our results of operations will be adversely affected.
We
have a limited order backlog, which makes revenues in any quarter substantially
dependent on orders received and delivered in that quarter. A delay in the
recognition of revenue, even from one customer, may have a significant negative
impact on our results of operations for a given period. We base our decisions
regarding our operating expenses on anticipated revenue trends, and our expense
levels are relatively fixed, or require some time for adjustment. Because only a
small portion of our expenses varies with our revenues, if revenue levels fall
below our expectations, our results of operations will be adversely
affected.
Generally,
we sell to original equipment manufacturers, or OEMs, network equipment
providers or system integrator customers, as well as to distributors. As a
result, we have less information with respect to the actual requirements of end
users and their utilization of equipment. We also have less influence over the
choice of equipment by these end users.
We
typically sell to OEM customers, network equipment providers, and system
integrators, as well as to distributors. Our customers usually purchase
equipment from several suppliers and may be trying to fulfill one of their
customers’ specific technical specifications. We rely heavily on our customers
for sales of our products and to inform us about market trends and the needs of
their customers. We cannot be certain that this information is accurate. If the
information we receive is not accurate, we may be manufacturing products that do
not have a customer or fail to manufacture products that end users want. Because
we are selling products to OEMs, system integrators and distributors rather than
directly to end users, we have less control over the ultimate selection of
products by end users.
The
markets we serve are highly competitive and many of our competitors have much
greater resources, which may make it difficult for us to maintain
profitability.
Competition
in our industry is intense and we expect competition to increase in the future.
Our competitors currently sell products that provide similar benefits to those
that we sell. There has been a significant amount of merger and acquisition
activity and strategic alliances frequently involving major telecommunications
equipment manufacturers acquiring smaller companies, and we expect that this
will result in an increasing concentration of market share among these
companies, many of whom are our customers.
Our
principal competitors in the sale of signal processing chips are Texas
Instruments, Broadcom, Infineon, Centillium, Surf and Mindspeed. Several large
manufacturers of generic signal processors, such as Motorola, Agere Systems,
which merged with LSI Corporation in April 2007, and Intel have begun, or are
expected to begin, marketing competing processors. Our principal competitors in
the communications board market are NMS Communications, Intel, Motorola, Cantata
Technology, Aculab and PIKA Technologies, Inc.
Our
principal competitors in the area of analog media gateways (2 to 24 ports) for
access and enterprise are Cisco Systems Inc., Mediatrix Telecom, Inc., Vega
Stream Limited, Samsung, Innovaphone AG, Net.com/Quintum Technologies, Tainet
Communication System Corp., Welltech, Ascii Corp., D-Link Systems, Inc.,
Multitech Inc., Inomedia, OKI and LG. In addition we face competition in low,
mid and high density gateways from internal development at companies such as
Nortel, Alcatel-Lucent, Nokia-Siemens, Huawei, Ericsson, UTstarcom, ZTE and from
Cisco Systems, Inc., Veraz Networks, Sonus Networks, General Bandwidth,
Dialogic/Cantat Technologies and Commatch (Telrad).
Our
principal competitors in the media server market segment are Dialogic/Cantata
Technology, NMS Communications, Convedia/Radisys, IP Unity Glenayre,
Cognitronics and Aculab. In addition, we face competition in software-based and
hardware-based media servers from internal development at companies such as
Hewlett-Packard, Comverse-NetCentrex, Nortel, Alcatel - Lucent, Nokia – Siemens
and Ericsson.
With
respect to session border controllers, we compete against Acme Packets,
Nextone/Nexpoint, Juniper and Sonus Networks. In the security gateway market, we
compete against private companies such as GenBand, ACME Packets, Clavister and
NEC.
We
also face significant and increasing competition in the market for products
utilized in the VoIP market. Our competitors in the market for VolP products
include telecommunications companies, data communication companies and companies
specializing in voice over IP products, some of which have greater name
recognition, larger installed customer bases and significantly greater
financial, technical, sales and marketing resources than we do.
Many
of our competitors have the ability to offer complete network solutions and
vendor-sponsored financing programs to prospective customers. Some of our
competitors with broad product portfolios may also be able to offer lower prices
on products that compete with ours because of their ability to recoup a loss of
margin through sales of other products or services. Additionally, voice, audio
and other communications alternatives that compete with our products are being
continually introduced.
In
the future, we may also develop and introduce other products with new or
additional telecommunications capabilities or services. As a result, we may
compete directly with our customers with respect to sales to telephone companies
and other telecommunications infrastructure providers. Additional competitors
may include companies that currently provide computer software products and
services, such as telephone, media, publishing and cable television. The ability
of some of our competitors to bundle other enhanced services or complete
solutions with VoIP products could give these competitors an advantage over
us.
Offering
to sell system level products that compete with the products manufactured by our
customers could negatively affect our business.
Our
product offerings range from media gateway building blocks, such as chips and
boards, to media gateways, media servers and session border control products
(systems). These products could compete with products offered by our customers.
These customers could decide to decrease purchases from us because of this
competition. This could result in a material adverse effect on our results of
operations.
Offering
to sell directly to carriers or service providers may expose us to requirements
for service which we may not be able to meet.
We
also sell our products directly to telecommunications carriers, service
providers or other end-users. We have traditionally relied on third party
distributors and OEMs to test and or sell our products and inform us about the
requirements of end-users. We have limited experience selling our products
directly to end-user customers. Telecommunications carriers and other service
providers have great bargaining power in negotiating contracts. Generally,
contracts with end-users tend to be more complex and impose more obligations on
us than contracts with third party distributors. Contracts with end-users may
also require extensive support teams in the country where the end-user is
deploying its network. We may be unable to meet the requirements of these
contracts. If we are unable to meet the conditions of a contract with an
end-user customer, we may be subject to liquidated damages or liabilities that
could result in a material adverse effect on our results of
operations.
Selling
directly to end-users may adversely affect our relationship with our current
third party distributors upon whom we will continue to rely for a significant
portion of our sales. Loss of third party distributors and OEMs, or a decreased
commitment by them to sell our products as a result of direct sales by us, could
adversely affect our sales and results of operations.
We
rely on third-party subcontractors to assemble our products and therefore do not
directly control manufacturing costs, product delivery schedules or
manufacturing quality.
Our
products are assembled and tested by third-party subcontractors. As a result of
our reliance on third-party subcontractors, we cannot directly control product
delivery schedules. We have in the past experienced delays in delivery
schedules. Any problems that occur and persist in connection with the delivery,
quality or cost of the assembly and testing of our products could have a
material adverse effect on our business, financial condition and results of
operations. This reliance could also lead to product shortages or quality
assurance problems, which, in turn, could lead to an increase in the costs of
manufacturing or assembling our products.
We
may not be able to deliver our products to our customers, and substantial
reengineering costs may be incurred if a small number of third-party suppliers
do not provide us with key components on a timely basis.
Texas
Instruments Incorporated supplies all of the chips for our signal processor
product line. Our signal processor line is used both as a product line in its
own right and as a key component in our other product lines. Motorola
manufactures all of the communications processors currently used on our
communications boards.
We
have not entered into any long-term supply agreements or alternate source
agreements with our suppliers and, while we maintain an inventory of critical
components, our inventory of chips would likely not be sufficient in the event
that we had to engage an alternate supplier for these components.
Texas
Instruments is also one of our major competitors in providing signal processing
solutions. An unexpected termination of the supply of the chips provided by
Texas Instruments or Motorola or disruption in their timely delivery, would
require us to make a large investment in capital and manpower resources to shift
to using signal processors manufactured by other companies and may cause a delay
in introducing replacement products. Customers may not accept an alternative
product design. Supporting old products or redesigning products may make it more
difficult for us to support our products.
We
utilize other sole source suppliers upon whom we depend without having long term
supply agreements.
Some
of our sole source suppliers custom produce components for us based upon our
specifications and designs while other of our sole source suppliers are the only
manufacturers of certain components required by our products. We have not
entered into any long-term supply agreements or alternative source agreements
with our suppliers and while we maintain an inventory of components from single
source providers, our inventory would likely not be sufficient in the event that
we had to engage an alternate supplier of these single source components. In the
event of any interruption in the supply of components from any of our sole
source suppliers, we may have to expend significant time, effort and other
resources in order to locate a suitable alternative manufacturer and secure
replacement components. If no replacement components are available, we may be
forced to redesign certain of our products. Any such new design may not be
accepted by our customers. A prolonged disruption in supply may force us to
redesign and retest our products. Any interruption in supply from any of these
sources or an unexpected technical failure or termination of the manufacture of
components could disrupt production, thereby adversely affecting our ability to
deliver products and to support products previously sold to our
customers.
In
addition, if demand for telecommunications equipment increases, we may face a
shortage of components from our suppliers. This could result in longer lead
times, increases in the price of components and a reduction in our margins, all
of which could adversely affect the results of our operations.
Our
customers may require us to produce products or systems to hold in inventory in
order to meet their “just in time”, or short lead time, delivery requirements.
If we are unable to sell this inventory on a timely basis, we could incur
charges for excess and obsolete inventory which would adversely affect our
results of operations.
Our
customers expect us to maintain an inventory of products available for purchase
off the shelf subsequent to the initial sales cycle for these products. This may
require us to incur the costs of manufacturing inventory without having a
purchase order for the products. The VoIP industry is subject to rapid
technological change and volatile customer demands, which result in a short
product commercial life before a product becomes obsolete. If we are unable to
sell products that are produced to hold in inventory, we may incur write offs as
a result of slow moving items, technological obsolescence, excess inventories,
discontinued products and products with market prices lower than cost. Write
offs could adversely affect our operating results and financial condition. We
wrote-off inventory in a total amount of $1.9 million in 2006, $700,000 in 2007
and $1.2 million in 2008.
The
right of our customers to return products and their right to exchange products
may affect our ability to recognize revenues which could adversely affect the
results of our operations.
Some
of our customers expect us to permit them to return some or all of the products
they purchased from us. If we contractually agree to allow a customer to return
products, the customer may be entitled to a refund for the returned products or
to receive a credit for the purchase of replacement products. If we agree to
this type of contractual obligations, it could affect our ability to recognize
revenues. In addition, if we are not able to resell any products that are
returned and we would have to write off this inventory. This could adversely
affect our results of operations.
Our
products generally have long sales cycles and implementation periods, which
increase our costs in obtaining orders and reduce the predictability of our
revenues.
Our
products are technologically complex and are typically intended for use in
applications that may be critical to the business of our customers. Prospective
customers generally must make a significant commitment of resources to test and
evaluate our products and to integrate them into larger systems. As a result,
our sales process is often subject to delays associated with lengthy approval
processes that typically accompany the design and testing of new communications
equipment. The sales cycles of our products to new customers are approximately
six to twelve months after a design win, depending on the type of customer and
complexity of the product. This time may be further extended because of internal
testing, field trials and requests for the addition or customization of
features. This delays the time until we realize revenue and results in
significant investment of resources in attempting to make sales.
Long
sales cycles also subject us to risks not usually encountered in a short sales
span, including customers’ budgetary constraints, internal acceptance reviews
and cancellation. In addition, orders expected in one quarter could shift to
another because of the timing of customers’ procurement decisions. The time
required to implement our products can vary significantly with the needs of our
customers and generally exceeds several months; larger implementations can take
multiple calendar quarters. This complicates our planning processes and reduces
the predictability of our revenues.
Our
proprietary technology is difficult to protect, and our products may infringe on
the intellectual property rights of third parties. Our business may suffer if we
are unable to protect our intellectual property or if we are sued for infringing
the intellectual property rights of third parties.
Our
success and ability to compete depend in part upon protecting our proprietary
technology. We rely on a combination of patent, trade secret, copyright and
trademark laws, nondisclosure and other contractual agreements and technical
measures to protect our proprietary rights. These agreements and measures may
not be sufficient to protect our technology from third-party infringement, or to
protect us from the claims of others.
Enforcement
of intellectual property rights may be expensive and may divert attention of
management and of research and development personnel away from our business.
Intellectual property litigation could also call into question the ownership or
scope of rights owned by us. We believe that at least one of our patents may
cover technology related to the ITU G.723.1 standard. Because of our involvement
in the standard setting process, we may be required to license certain of our
patents on a reasonable and non-discriminatory basis to a current or future
competitor, to the extent required to carry out the G.723.1 standard.
Additionally, our products may be manufactured, sold, or used in countries that
provide less protection to intellectual property than that provided under U.S.
or Israeli laws or where we do not hold relevant intellectual property
rights.
We
believe that the frequency of third party intellectual claims is increasing, as
patent holders, including entities that are not in our industry and that
purchase patents as an investment or to monetize such rights by obtaining
royalties, use infringement assertions as a competitive tactic and a source of
additional revenue. Any intellectual property claims against us, even without
merit, could cost us a significant amount of money to defend and divert
management’s attention away from our business. We may not be able to secure a
license for technology that is used in our products and we may face injunctive
proceedings that prevent distribution and sale of our products even prior to any
dispute being concluded. These proceedings may also have a deterrent effect on
purchases by customers, who may be unsure about our ability to continue to
supply their requirements. We may be forced to repurchase our products and
compensate customers that have purchased such infringing products. We may be
forced to redesign the product so that it becomes non-infringing, which may have
an adverse impact on the results of our operations.
In
addition, claims alleging that the development, use, or sale of our products
infringes third parties’ intellectual property rights may be directed either at
us or at our direct or indirect customers. We may be required to indemnify such
customers against claims made against them. We may be required to indemnify them
even if we believe that the claim of infringement is without merit.
Multiple
patent holders in our industry may result in increased licensing
costs.
There
are a number of companies besides us that hold patents for various aspects of
the technology incorporated in our industry’s standards and our products. We
expect that patent enforcement will be given high priority by companies seeking
to gain competitive advantages or additional revenues. The holders of patents
from which we have not obtained licenses may take the position that we are
required to obtain a license from them. We cannot be certain that we would be
able to negotiate a license agreement at an acceptable price or at all. Our
results of operations could be adversely affected by the payment of any
additional licensing costs or if we are prevented from manufacturing or selling
a product.
Changes
in governmental regulations in the United States or other countries could slow
the growth of the VoIP telephony market and reduce the demand for our customers’
products, which, in turn, could reduce the demand for our products.
VoIP
and other services are not currently subject to all of the same regulations that
apply to traditional telephony. Nevertheless, it is possible that foreign or
U.S. federal or state legislatures may seek to impose increased fees and
administrative burdens on VoIP, data, and video providers. The FCC has already
required VoIP service providers to meet various emergency service requirements
relating to delivery of 911 calls, known as E911, and to accommodate law
enforcement interception or wiretapping requirements, such as the Communications
Assistance for Law Enforcement Act, or CALEA. In addition, the FCC may seek to
impose other traditional telephony requirements such as disability access
requirements, consumer protection requirements, number assignment and
portability requirements, and other obligations, including additional
obligations regarding E911 and CALEA.
The
cost of complying with FCC regulations could increase the cost of providing
Internet phone service which could result in slower growth and decreased
profitability for this industry, which would adversely affect our
business.
The
enactment of any additional regulation or taxation of communications over the
public Internet in the United States or elsewhere in the world could have a
material adverse effect on our customers’ (and their customers’) businesses and
could therefore adversely affect sales of our products. We do not know what
effect, if any, possible legislation or regulatory actions in the United States
or elsewhere in the world may have on private telecommunication networks, the
provision of VoIP services and purchases of our products.
Use
of encryption technology in our products is regulated by governmental
authorities and may require special development, export or import licenses.
Delays in the issuance of required licenses, or the inability to secure these
licenses, could adversely affect our revenues and results of
operations.
Growth
in the demand for security features may increase the use of encryption
technology in our products. The use of encryption technology is generally
regulated by governmental authorities and may require specific development,
export or import licenses. Encryption standards may be based on proprietary
technologies. We may be unable to incorporate encryption standards into our
products in a manner that will insure interoperability. We also may be unable to
secure licenses for proprietary technology on reasonable terms. If we cannot
meet encryption standards, or secure required licenses for proprietary
encryption technology, our revenues and results of operations could be adversely
affected.
We
are subject to regulations that will require us to use components based on
environmentally friendly materials, and we may be subject to various regulations
relating to management and disposal of waste with respect to electronic
equipment. Compliance with these regulations may increase our costs and
adversely affect our results of operations.
We
are subject to telecommunications industry regulations requiring the use of
environmentally-friendly materials in telecommunications equipment. For example,
pursuant to a European Community directive, telecom equipment suppliers were
required to stop using specified materials that are not “environmentally
friendly” by July 1, 2006. In addition, telecom equipment suppliers that take
advantage of an exemption with respect to the use of lead in solders are
required by this directive to eliminate the lead in solders from their products
by 2010. Some of our customers may also require products that meet higher
standards than those required by the directive, such as complete removal of
additional harmful substances from our products. We will be dependent on our
suppliers for components and sub-system modules, such as semiconductors and
purchased assemblies and goods, to comply with these requirements. This may harm
our ability to sell our products in regions or to customers that may adopt such
directives.
Compliance
with these directives, especially with respect to the requirement that products
eliminate lead solders, will require us to undertake significant expenses with
respect to the re-design of our products. In addition, we may be required to pay
higher prices for components that comply with this directive. We may not be able
to pass these higher component costs on to our customers. We cannot at this
point estimate the expense that will be required to redesign our products in
order to include “environmentally friendly” components. We cannot be sure that
we will be able to timely comply with these regulations, that we will be able to
comply on a cost effective basis or that a sufficient supply of compliant
components will be available to us. Compliance with these regulations could
increase our product design costs. New designs may also require qualification
testing with both customers and government certification boards. We cannot be
certain of the reliability of any new designs that utilize non-lead components,
in part, due to the lack of experience with the replacement materials and
assembly technologies. In addition, the incorporation of new components may
adversely affect equipment reliability and durability.
Some
of our operations use substances regulated under various federal, state, local
and international laws governing the environment, including laws governing the
management and disposal of waste with respect to electronic equipment. We could
incur substantial costs, including fines and civil or criminal sanctions, if we
were to violate or become liable under environmental laws or if our products
become non-compliant with environmental laws. We also face increasing complexity
in our product design and procurement operations as we adjust to new and future
requirements relating to the materials that compose our products. The EU has
enacted the Waste Electrical and Electronic Equipment Directive, which makes
producers of electrical goods financially responsible for specified collection,
recycling, treatment and disposal of past and future covered products. Producers
participating in the market became financially responsible for implementing
their responsibilities under the WEEE Legislation beginning in August 2005.
Similar legislation has been or may be enacted in other jurisdictions, including
the United States, Canada, Mexico, China and Japan.
Our
inability or failure to comply with these regulations could have a material
adverse effect on our results of operations. In addition, manufacturers of
components that use lead solders may decide to stop manufacturing those
components prior to the 2010 compliance date. These actions by manufacturers of
components could result in a shortage of components that could adversely affect
our business and results of operations.
A
significant portion of our revenues is generated outside of the U.S. and Israel.
We intend to continue to expand our operations internationally and, as a result,
our results of operations could suffer if we are unable to manage our
international operations effectively.
We
generated 35% of our revenues in 2006, 37% of our revenues in 2007 and 40% of
our revenues in 2008, outside of the United States and Israel. Part of our
strategy is to expand our penetration in existing foreign markets and to enter
new foreign markets. Our ability to penetrate some international markets may be
limited due to different technical standards, protocols or product requirements
in different markets. Expansion of our international business will require
significant management attention and financial resources. Our international
sales and operations are subject to numerous risks inherent in international
business activities, including:
|
|
|
|
●
|
economic
and political instability in foreign countries;
|
|
|
|
|
●
|
compliance
with foreign laws and regulations;
|
|
|
|
|
●
|
different
technical standards or product requirements;
|
|
|
|
|
●
|
staffing
and managing foreign operations;
|
|
|
|
|
●
|
foreign
currency fluctuations;
|
|
|
|
|
●
|
export
control issues;
|
|
|
|
|
●
|
governmental
controls;
|
|
●
|
import
or currency control restrictions;
|
|
|
|
|
●
|
local
taxation;
|
|
|
|
|
●
|
increased
risk of collection; and
|
|
|
|
|
●
|
burdens
that may be imposed by tariffs and other trade
barriers.
|
If
we are unable to address these risks, our foreign operations may be unprofitable
or the value of our investment in our foreign operations may
decrease.
Currently,
our international sales are denominated primarily in dollars. Therefore, any
devaluation in the local currencies of our customers relative to the dollar
could cause customers to decrease or cancel orders or default on
payment.
The
prices of our products may become less competitive due to foreign exchange
fluctuations.
Although
we have operations throughout the world, the majority of our revenues and our
operating costs in 2008 were denominated in, or linked to, the U.S. dollar.
Accordingly, we consider the U.S. dollar to be our functional currency. However,
approximately 38% of our operating costs in 2008 were incurred in New Israeli
Shekels (NIS). During 2007 and first half of 2008, the NIS appreciated against
the U.S. dollar, which resulted in an increase in the U.S. dollar cost of our
operations in Israel. As a result of this differential, from time to time we may
experience increases in the costs of our operations outside the United States,
as expressed in dollars. If there is a significant increase in our expenses, we
may be required to increase the prices of our products and may be less
competitive. We cannot be sure that our international customers will continue to
place orders denominated in dollars.
Our
sales to European customers denominated in Euros are increasing. Sales
denominated in Euros could make our revenues subject to fluctuation in the
Euro/dollar exchange rate. If the U.S. dollar appreciates against the Euro, we
may be required to increase the prices of our products that are denominated in
Euros.
We
may be unable to attract sales representatives who will market our products
effectively.
A
significant portion of our marketing and sales involves the aid of independent
sales representatives that are not under our direct control. We cannot be
certain that our current independent sales representatives will continue to
distribute our products or that, even if they continue to distribute our
products, they will do so successfully. These representatives are not subject to
any minimum purchase requirements and can discontinue marketing our products at
any time. In addition, these representatives often market products of our
competitors. Accordingly, we must compete for the attention and sales efforts of
our independent sales representatives.
Our
products could contain defects, which would reduce sales of those products or
result in claims against us.
We
develop complex and evolving products. Despite testing by us and our customers,
undetected errors or defects may be found in existing or new products. The
introduction of products with reliability, quality or compatibility problems
could result in reduced revenues, additional costs, increased product returns
and difficulty or delays in collecting accounts receivable. The risk is higher
with products still in the development stage, where full testing or
certification is not yet completed. This could result in, among other things, a
delay in recognition or loss of revenues, loss of market share or failure to
achieve market acceptance. We could also be subject to material claims by
customers that are not covered by our insurance.
Obtaining
certification of our products by national regulators may be time-consuming and
expensive. We may be unable to sell our products in markets in which we are
unable to obtain certification.
Our
customers may expect us to obtain certificates of compliance with safety and
technical standards set by national regulators, especially standards set by U.S.
or European regulators. There is no uniform set of standards, and each national
regulator may impose and change its own standards. National regulators may also
prohibit us from importing products that do not conform to their standards. If
we make any change in the design of a product, we are usually required to obtain
recertification of the product. The process of certification may be
time-consuming and expensive and may affect the length of the sales cycle for a
product. If we are unable to obtain certification of a product in a market, we
may be unable to sell the product in that market.
We
depend on a limited number of key personnel who would be difficult to
replace.
Because
our products are complex and our market is evolving, the success of our business
depends in large part upon the continuing contributions of our management and
key personnel. Specifically, we rely heavily on the services of Shabtai
Adlersberg, our Chief Executive Officer and Chairman of our Board of Directors.
If Shabtai Adlersberg is unable or unwilling to continue with us, our results of
operations could be materially and adversely affected. We do not carry key
person insurance for Mr. Adlersberg.
The
success of our business also depends upon our continuing ability to attract and
retain other highly-qualified management, technical, sales and marketing
personnel. We need highly-qualified technical personnel who are capable of
developing technologies and products and providing the technical support
required by our customers. We experience competitive pressure with respect to
retaining and hiring employees in the high technology sector in Israel. If we
fail to hire and retain skilled employees, our business may be adversely
affected.
If
we do not manage our operations effectively, our results of operations could be
adversely affected.
We
have actively expanded our operations in the past and may continue to expand
them in the future. This expansion has required, and may continue to require,
the application of managerial, operational and financial resources. We cannot be
sure that we will continue to expand, or that we will be able to expand our
operations successfully. In particular, our business requires us to focus on
multiple markets, including the VoIP, wireline, cable and wireless markets. In
addition, we work simultaneously with a number of large OEMs and network
equipment providers each of which may have different requirements for the
products that we sell to them. We may not have sufficient manpower, or may be
unable to devote this manpower when needed, to address the requirements of these
markets and customers. If we are unable to manage our operations effectively,
our revenues may not increase, our cost of operations may rise and our results
of operations may be adversely affected.
As
we grow we may need new or enhanced systems, procedures or controls. The
transition to such systems, procedures or controls, as well as any delay in
transitioning to new or enhanced systems, procedures or controls, may seriously
harm our ability to accurately forecast sales demand, manage our product
inventory and record and report financial and management information on a timely
and accurate basis.
Our
gross profit percentage could be negatively impacted by amortization expenses in
connection with acquisitions, increased manufacturing costs and other factors.
This could adversely affect our results of operations.
Our gross
profit percentage decreased in 2006, 2007 and 2008. The decrease in our gross
profit percentage was primarily attributable to amortization expenses related to
the acquisitions of Nuera and Netrake beginning in the third quarter of 2006 and
CTI Squared beginning in the second quarter of 2007, as well as expenses related
to equity-based compensation resulting from the adoption of SFAS 123(R)
beginning in 2006. During the fourth quarter of 2008, we recognized non-cash
impairment charges of $86.1 million with respect to goodwill, intangible assets
and investment in an affiliate. As a result of these impairment charges,
non-cash amortization expense included in cost of revenues is expected to
decline in 2009.
Our
gross profit percentage has also been negatively affected in the past and could
continue to be negatively affected by an increase in manufacturing costs, a
shift in our sales mix towards our less profitable products, increased customer
demand for longer product warranties and increased cost pressures as a result of
increased competition. Acquisitions of new businesses could also negatively
affect our gross profit percentage, which could cause an adverse effect on our
results of operations.
The
growth in our product portfolio means that we have to service and support more
products. This may result in an increase in our expenses and an adverse effect
on our results of operations.
The
size of our product portfolio has increased and continues to increase. As a
result, we are required to provide to our customers sales support. Customers
have requested that we provide a contractual commitment to support a product for
a specified period of time. This period of time may exceed the working life of
the product or extend past the period of time that we may intend to manufacture
or support a product. We are dependent on our suppliers for the components
(hardware and software) needed to provide support and may be unable to secure
the components necessary to satisfy our service commitments. We do not have long
term contracts with our suppliers, and they may not be obligated to provide us
with products or services for any specified period of time. We may need to
purchase an inventory of replacement components and parts in advance in order to
try to provide for their availability when needed. This could result in
increased risk of write offs with respect to our replacement component inventory
to the extent that we cannot accurately predict our future requirements under
our customer service contracts. If any of our component suppliers cease
production, cease operations or refuse or fail to make timely delivery of
orders, we may not be able to meet our contractual commitments for product
support. We may be required to supply enhanced components or parts as
substitutes if the original versions are no longer available. Product support
may be costly and any extra service revenues may not cover the hardware and
software costs associated with providing long-term support.
We
are subject to ongoing costs and risks associated with complying with extensive
corporate governance and disclosure requirements.
As
a foreign private issuer subject to U.S. federal securities laws, we spend a
significant amount of management time and resources to comply with laws,
regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, SEC regulations and Nasdaq
rules. Section 404 of the Sarbanes-Oxley Act requires management’s annual review
and evaluation of our internal control over financial reporting and attestations
of the effectiveness of these controls by our management and by our independent
registered public accounting firm. There is no guarantee that these efforts will
result in management assurance or an attestation by our independent registered
public accounting firm that our internal control over financial reporting is
adequate in future periods. In connection with our compliance with Section 404
and the other applicable provisions of the Sarbanes-Oxley Act, our management
and other personnel devote a substantial amount of time, and may need to hire
additional accounting and financial staff, to assure that we comply with these
requirements. The additional management attention and costs relating to
compliance with the Sarbanes-Oxley Act and other corporate governance
requirements could materially and adversely affect our financial
results.
Terrorist
attacks, or the threat of such attacks, may negatively impact the global economy
which may materially adversely affect our business, financial condition and
results of operation and may cause our share price to decline.
The
financial, political, economic and other uncertainties following terrorist
attacks throughout the world have led to a worsening of the global economy. As a
result, many of our customers and potential customers have become much more
cautious in setting their capital expenditure budgets, thereby restricting their
telecommunications procurement. Uncertainties related to the threat of terrorism
have had a negative effect on global economy, causing businesses to continue
slowing spending on telecommunications products and services and further
lengthen already long sales cycles. Any escalation of these threats or similar
future events may disrupt our operations or those of our customers, distributors
and suppliers, which could adversely affect our business, financial condition
and results of operations.
We
are subject to risks from our financial investments. A continuing decline in
interest rates and worsening of the credit crisis affecting capital markets
could reduce our interest-income, decrease the value of financial assets held by
us and adversely affect our profitability.
Our
investment portfolio consists of held-to-maturity marketable securities. Our
investments are exposed to market risk due to fluctuation in interest rates,
which may affect our interest income. In addition, our funds are deposited and
invested with various financial institutions. The global economic crisis has led
to the collapse of some major international financial institutions and the
weakening of others. If the financial institutions with which we invest
collapse, this may result in a loss of our deposits or investments and a
resulting material adverse effect on our financial condition and results of
operations.
Additionally,
the performance of the capital markets affects the values of funds that are held
in marketable securities. These assets are subject to market fluctuations and
the credit worthiness of the institutions issuing the securities. This could
result in uncertain returns for these securities, which may fall below our
projected return rates and could affect the fair market value of our investment
portfolio. Due to the recent credit crisis and other market developments,
including a series of rating agency downgrades, the fair value of these
marketable securities may decline on an other than temporary basis which may
adversely affect our profitability.
We
are subject to taxation in several countries.
Because
we operate in several countries, mainly in the U.S., Israel, U.K. and Singapore,
we are subject to taxation in multiple jurisdictions. We are required to report
to and are subject to local tax authorities in the countries in which we
operate. In addition, our income that is derived from sales to customers in one
country might also be subject to taxation in other countries. We cannot be sure
of the amount of tax we may become obligated to pay in the countries in which we
operate. The tax authorities in the countries in which we operate may not agree
with our tax position. Our tax benefits from carry forward losses and other tax
planning benefits such as Israeli approved enterprise programs, may prove to be
insufficient due to Israeli tax limitations, or may prove to be insufficient to
offset tax liabilities from foreign tax authorities. Foreign tax authorities may
also use our gross profit or our revenues in each territory as the basis for
determining our income tax, and our operating expenses might not be considered
for related tax calculations adversely affect our results of
operations.
Risks
Relating to Operations in Israel
Conditions
in Israel affect our operations and may limit our ability to produce and sell
our products.
We
are incorporated under the laws of the State of Israel, and our principal
executive offices and principal research and development facilities are located
in the State of Israel. Political, economic and military conditions in Israel
directly affect our operations. There has been an increase in unrest and
terrorist activity in Israel, which began in September 2000 and which has
continued with varying levels of severity through the current period of time.
This has led to ongoing hostilities between Israel, the Palestinian Authority
and other groups in the West Bank and Gaza Strip. The future effect of this
deterioration and violence on the Israeli economy and our operations is unclear.
Recently, there has been an escalation in violence among Israel, Hamas, the
Palestinian Authority and other groups, as well as a military confrontation in
December 2008 and January 2009 along Israel’s border with the Gaza Strip, which
resulted in missiles being fired from the Gaza Strip into Southern Israel. There
were also extensive hostilities along Israel’s northern border with Lebanon in
the summer of 2006. The Israeli-Palestinian conflict may also lead to political
instability between Israel and its neighboring countries. Ongoing violence
between Israel and the Palestinians, as well as tension between Israel and the
neighboring countries, may have a material adverse effect on our business,
financial conditions and results of operations.
We
cannot predict the effect on us of an increase in these hostilities or any
future armed conflict, political instability or violence in the region.
Additionally, some of our officers and employees in Israel are obligated to
perform annual military reserve duty and are subject to being called for
additional active duty under emergency circumstances, such as the recent
military confrontation in the Gaza Strip. Some of our employees live within
conflict area territories and may be forced to stay at home instead of reporting
to work. We cannot predict the full impact of these conditions on us in the
future, particularly if emergency circumstances or an escalation in the
political situation occur. If many of our employees are called for active duty,
or forced to stay at home, our operations in Israel and our business may be
adversely affected. Additionally, a number of countries continue to restrict or
ban business with Israel or Israeli companies, which may limit our ability to
make sales in those countries.
We
are adversely affected by the devaluation of the dollar against the New Israeli
Shekel and could be adversely affected by the rate of inflation in
Israel.
We
generate substantially all of our revenues in U.S. dollars and, in 2008, 38% of
our expenses, primarily salaries, related personnel expenses and the leases of
our buildings in Israel, were incurred in NIS. We anticipate that a significant
portion of our expenses will continue to be denominated in NIS.
Our
NIS related costs, as expressed in U.S. dollars, are influenced by the exchange
rate between the U.S. dollar and the NIS. During 2007 and the first half of
2008, the NIS appreciated against the U.S. dollar, which resulted in a
significant increase in the U.S. dollar cost of our operations in Israel. During
the second half of 2008 and the first half of 2009, the NIS weakened against the
U.S. dollar. To the extent the U.S. dollar weakens against the NIS, we could
experience an increase in the cost of our operations, which are measured in U.S.
dollars in our financial statements, which could adversely affect our results of
operations. In addition, in periods in which the U.S. dollar appreciates against
the NIS, we bear the risk that the rate of inflation in Israel will exceed the
rate of such devaluation of the NIS in relation to the U.S. dollar or that the
timing of such devaluations were to lag considerably behind inflation, which
will increase our costs as expressed in U.S. dollars.
The
devaluation of the U.S. dollar in relation to the NIS in 2007 and the first half
of 2008 increased the cost in U.S. dollars of our expenses. As a result, our
dollar-measured results of operations were adversely affected. This could happen
again if the U.S. dollar were to devalue against the NIS. In order to manage the
risks imposed by foreign currency exchange rate fluctuations, from time to time,
we enter into currency forward contracts and put and call options to hedge some
of our foreign currency exposure. We can provide no assurance that our hedging
arrangements will be effective. In addition, if we wish to maintain the
dollar-denominated value of our products in non-U.S. markets, devaluation in the
local currencies of our customers relative to the U.S. dollar may cause our
customers to cancel or decrease orders or default on payment.
Because
exchange rates between the NIS and the U.S. dollar fluctuate continuously,
exchange rate fluctuations have an impact on our profitability and
period-to-period comparisons of our results of operations. In 2008, the value of
the dollar decreased in relation to the NIS by 1.1%, and the inflation rate in
Israel was 3.8% and, as a result, adversely affected our results of operations
in 2008. If this trend continues, it will continue to adversely affect our
result of operations.
The
Israeli government programs in which we currently participate, and the tax
benefits we currently receive require us to meet several conditions and may be
terminated or reduced in the future, which would increase our
costs.
We
benefit from certain government programs and tax benefits, particularly as a
result of exemptions and reductions resulting from the “approved enterprise”
status of our existing production facilities and programs in Israel. In the
past, the designation required advance approval from the Investment Center of
the Israel Ministry of Industry, Trade and Labor (the Investment Center). To be
eligible for these programs and tax benefits, we must continue to meet
conditions relating principally to adherence to the approved programs and to
periodic reporting obligations. We believe that we are currently in compliance
with these requirements. However, if we fail to meet these conditions, we will
be subject to corporate tax at the rate then in effect under Israeli law for
such tax year.
In
April 2005, an amendment to the law came into effect (the “Amendment”) which
significantly changed the provisions of the law. The Amendment limited the scope
of enterprises which may be approved by the Investment Center by setting
criteria for the approval of a facility as a Privileged Enterprise, such as
provisions generally requiring that at least 25% of the Privileged Enterprise’s
income be derived from export. Additionally, the Amendment enacted major changes
in the manner in which tax benefits are awarded under the law so that companies
no longer require Investment Center approval in order to qualify for tax
benefits.
The
law provides that terms and benefits included in any certificate of approval
granted prior to December 31, 2004 remain subject to the provisions of the law
as they were on the date of such approval. Therefore, our existing “Approved
Enterprises” are generally not subject to the provisions of the Amendment. As a
result of the Amendment, tax-exempt income generated under the provisions of the
law as amended, will subject us to taxes upon distribution or liquidation and we
may be required to record a deferred tax liability with respect to such
tax-exempt income. None of our facilities are currently approved as an Approved
Enterprise under the amended law.
In
2008, we recognized a grant of $2,053,000 from the Government of Israel, through
the Office of the Chief Scientist, or the OCS, for the financing of a portion of
our research and development expenditures in Israel. The OCS budget has been
subject to reductions, which may affect the availability of funds for these
prospective grants and other grants in the future. As a result, we cannot be
certain that we will continue to receive grants at the same rate, or at all. In
addition, the terms of any future OCS grants may be less favorable than our past
grant.
The
government grants we have received for research and development expenditures
limit our ability to manufacture products and transfer technologies outside of
Israel and require us to satisfy specified conditions. If we fail to satisfy
these conditions, we may be required to refund grants previously received
together with interest and penalties.
In
connection with research and development grants we received from the OCS, we
must pay royalties to the OCS on the revenue derived from the sale of products,
technologies and services developed with the grants from the OCS. The terms of
the OCS grants and the law pursuant to which grants are made restrict our
ability to manufacture products or transfer technologies developed outside of
Israel if OCS grants funded the development of the products or technology. An
amendment to the relevant law facilitates the transfer of technology or know-how
developed with the funding of the OCS to third parties outside of Israel, but
any future transfer would still require the approval of the OCS, which may not
be granted, and is likely to involve a material payment to the OCS. This
restriction may limit our ability to enter into agreements for those products or
technologies without OCS approval. We cannot be certain that any approval of the
OCS will be obtained on terms that are acceptable to us, or at all.
In
order to meet specified conditions in connection with the grants and programs of
the OCS, we have made representations to the Government of Israel concerning our
Israeli operations. From time to time the conduct of our Israeli operations has
deviated from our representations. If we fail to meet the conditions related to
the grants, including the maintenance of a material presence in Israel, or if
there is any material deviation from the representations made by us to the
Israeli government, we could be required to refund the grants previously
received (together with an adjustment based on the Israeli consumer price index
and an interest factor) and would likely be ineligible to receive OCS grants in
the future. Any inability to receive these grants would result in an increase in
our research and development expenses.
It
may be difficult to enforce a U.S. judgment against us, our officers and
directors, assert U.S. securities law claims in Israel or serve process on
substantially all of our officers and directors.
We
are incorporated in Israel. Substantially all of our executive officers and
directors are nonresidents of the United States, and a majority of our assets
and the assets of these persons are located outside the United States.
Therefore, it may be difficult to enforce a judgment obtained in the United
States against us or any such persons or to effect service of process upon these
persons in the United States. Israeli courts may refuse to hear a claim based on
a violation of U.S. securities laws because Israel is not the most appropriate
forum to bring such a claim. In addition, even if an Israeli court agrees to
hear a claim, it may determine that Israeli law and not U.S. law is applicable
to the claim. If U.S. law is found to be applicable, the content of applicable
U.S. law must be proved as a fact which can be a time-consuming and costly
process. Certain matters of procedure will also be governed by Israeli law.
There is little binding case law in Israel addressing these matters.
Additionally, there is doubt as to the enforceability of civil liabilities under
the Securities Act and the Securities Exchange Act in original actions
instituted in Israel.
Israeli
law may delay, prevent or make difficult a merger with or an acquisition of us,
which could prevent a change of control and therefore depress the price of our
shares.
Provisions
of Israeli law may delay, prevent or make undesirable a merger or an acquisition
of all or a significant portion of our shares or assets. Israeli corporate law
regulates acquisitions of shares through tender offers and mergers, requires
special approvals for transactions involving significant shareholders and
regulates other matters that may be relevant to these types of transactions.
These provisions of Israeli law could have the effect of delaying or preventing
a change in control and may make it more difficult for a third party to acquire
us, even if doing so would be beneficial to our shareholders. These provisions
may limit the price that investors may be willing to pay in the future for our
ordinary shares. In addition, our articles of association contain certain
provisions that may make it more difficult to acquire us, such as a staggered
board and the ability of our board of directors to issue preferred stock.
Furthermore, Israel tax considerations may make potential transactions
undesirable to us or to some of our shareholders.
Risks
Relating to the Ownership of our Ordinary Shares and our Notes
The
price of our ordinary shares may fluctuate significantly.
The
market price for our ordinary shares, as well as the prices of shares of other
technology companies, has been volatile. Between January 1, 2007 and June 15,
2009, our share price has fluctuated from a high of $10.40 to a low of $0.92.
The following factors may cause significant fluctuations in the market price of
our ordinary shares:
|
|
|
|
●
|
fluctuations
in our quarterly revenues and earnings or those of our
competitors;
|
|
|
|
|
●
|
shortfalls
in our operating results compared to levels forecast by securities
analysts;
|
|
|
|
|
●
|
announcements
concerning us, our competitors or telephone companies;
|
|
|
|
|
●
|
announcements
of technological innovations;
|
|
|
|
|
●
|
the
introduction of new products;
|
|
|
|
|
●
|
changes
in product price policies involving us or our
competitors;
|
|
|
|
|
●
|
market
conditions in the industry;
|
|
|
|
|
●
|
integration
of acquired businesses, technologies or joint ventures with our products
and operations;
|
|
|
|
|
●
|
the
conditions of the securities markets, particularly in the technology and
Israeli sectors; and
|
|
|
|
|
●
|
political,
economic and other developments in the State of Israel and
worldwide.
|
In
addition, stock prices of many technology companies fluctuate significantly for
reasons that may be unrelated or disproportionate to operating results. The
factors discussed above may depress or cause volatility of our share price,
regardless of our actual operating results.
Our
quarterly results of operations have fluctuated in the past and we expect these
fluctuations to continue. Fluctuations in our results of operations may
disappoint investors and result in a decline in our share price.
We
have experienced and expect to continue to experience significant fluctuations
in our quarterly results of operations. In some periods, our operating results
may be below public expectations or below revenue levels and operating results
reached in prior quarters or in the corresponding quarters of the previous year.
If this occurs, the market price of our ordinary shares could
decline.
The
following factors have affected our quarterly results of operations in the past
and are likely to affect our quarterly results of operations in the
future:
|
|
|
|
●
|
size,
timing and pricing of orders, including order deferrals and delayed
shipments;
|
|
|
|
|
●
|
launching
of new product generations;
|
|
|
|
|
●
|
length
of approval processes or market testing;
|
|
|
|
|
●
|
technological
changes in the telecommunications industry;
|
|
|
|
|
●
|
competitive
pricing pressures;
|
|
|
|
|
●
|
the
timing and approval of government research and development
grants;
|
|
|
|
|
●
|
accuracy
of telecommunication company, distributor and original equipment
manufacturer forecasts of their customers’ demands;
|
|
|
|
|
●
|
changes
in our operating expenses;
|
|
|
|
|
●
|
disruption
in our sources of supply; and
|
|
|
|
|
●
|
general
economic conditions.
|
Therefore,
the results of any past periods may not be relied upon as an indication of our
future performance.
Our
actual financial results might vary from our publicly disclosed financial
forecasts.
From
time to time, we publicly disclose financial forecasts. Our forecasts reflect
numerous assumptions concerning our expected performance, as well as other
factors which are beyond our control and which might not turn out to be correct.
As a result, variations from our forecasts could be material. Our financial
results are subject to numerous risks and uncertainties, including those
identified throughout this “Risk Factors” section and elsewhere in this Annual
Report. If our actual financial results are worse than our financial forecasts,
the price of our ordinary shares may decline.
It
is our policy that we will not provide quarterly forecasts of the results of our
operations. This policy could affect the willingness of analysts to provide
research with respect to our ordinary shares which could affect the trading
market for our ordinary shares.
It
is our policy that we will not provide quarterly forecasts of the results of our
operations. This could result in the reduction of research analysts who cover
our ordinary shares. Any reduction in research coverage could affect the
willingness of investors, particularly institutional investors, to invest in our
shares which could affect the trading market for our ordinary shares and the
price at which our ordinary shares are traded.
As
a foreign private issuer whose shares are listed on the Nasdaq Global Select
Market, we may follow certain home country corporate governance practices
instead of certain Nasdaq requirements.
As
a foreign private issuer whose shares are listed on the Nasdaq Global Select
Market, we are permitted to follow certain home country corporate governance
practices instead of certain requirements of the Nasdaq Marketplace
Rules.
We
do not intend to comply with the Nasdaq requirement that we obtain shareholder
approval for certain dilutive events, such as for the establishment or amendment
of certain equity based compensation plans. Instead, we follow Israeli law and
practice which permits the establishment or amendment of certain equity based
compensation plans to be approved by our board of directors without the need for
a shareholder vote, unless such arrangements are for the compensation of
directors, in which case they also require audit committee and shareholder
approval. We also post our Annual Report on Form 20-F on our web site (www.
audiocodes.com) rather than distribute it to our shareholders pursuant to the
relevant Nasdaq requirements.
We
may also follow home country practice with regard to, among other things,
executive officer compensation, director nomination, composition of the board of
directors and quorum at shareholders’ meetings. In addition, we may follow
Israeli law, instead of the Nasdaq Marketplace Rules, which require that we
obtain shareholder approval for an issuance that will result in a change of
control of the company, certain transactions other than a public offering
involving issuances of a 20% or more interest in the company and certain
acquisitions of the stock or assets of another company.
Accordingly,
our shareholders may not be afforded the same protection as provided under
Nasdaq’s corporate governance rules.
Our
ordinary shares are listed for trading in more than one market and this may
result in price variations.
Our
ordinary shares are listed for trading on the Nasdaq Global Select Market, or
Nasdaq, and on The Tel-Aviv Stock Exchange, or TASE. Trading in our ordinary
shares on these markets is made in different currencies (U.S. dollars on Nasdaq
and New Israeli Shekels on TASE), and at different times (resulting from
different time zones, different trading days and different public holidays in
the United States and Israel). Actual trading volume on the TASE is generally
lower than trading volume on Nasdaq, and as such could be subject to higher
volatility. The trading prices of our ordinary shares on these two markets often
differ resulting from the factors described above, as well as differences in
exchange rates. Any decrease in the trading price of our ordinary shares on one
of these markets could cause a decrease in the trading price of our ordinary
shares on the other market.
We
do not anticipate declaring any cash dividends on our ordinary
shares.
We
have never declared or paid cash dividends on our ordinary shares and do not
plan to pay any cash dividends in the near future. Our current policy is to
retain all funds and earnings for use in the operation and expansion of our
business.
U.S.
shareholders face certain income tax risks in connection with their acquisition,
ownership and disposition of our ordinary shares. In any tax year, we could be
deemed a passive foreign investment company, which could result in adverse U.S.
federal income tax consequences for U.S. shareholders.
Based
on the composition of our gross income and the composition and value of our
gross assets during 2004, 2005, 2006, 2007 and 2008, we do not believe that we
were a passive foreign investment company, or PFIC, for U.S. federal income tax
purposes during any of such tax years. It is likely, however, that we would be
deemed to have been a PFIC in 2001, 2002 and 2003. In addition, there can be no
assurance that we will not be deemed a PFIC for any future tax year in which,
for example, the value of our assets, as measured by the public market valuation
of our ordinary shares, declines in relation to the value of our passive assets
(generally, cash, cash equivalents and marketable securities). If we are a PFIC
for any tax year, U.S. shareholders who own our ordinary shares during such year
may be subject to increased U.S. federal income tax liabilities and reporting
requirements for such year and succeeding years, even if we are no longer a PFIC
in such succeeding years.
We
urge U.S. holders of our ordinary shares to carefully review Item 10E. –
“Taxation – United States Tax Considerations – United States Federal Income
Taxes” in this Annual Report and to consult their own tax advisors with respect
to the U.S. federal income tax risks related to owning and disposing of our
ordinary shares and the consequences of PFIC status.
We
may not have the ability to purchase our notes for cash if required to do so by
holders on November 9, 2009, November 9, 2014 or November 9, 2019, or upon the
occurrence of a fundamental change.
During
the fourth quarter of 2008, we repurchased approximately $51.5 million in
principal amount of our senior convertible notes. As of June 15, 2009,
approximately $73.5 million principal amount of our notes was outstanding. On
November 9, 2009, November 9, 2014 or November 9, 2019, or upon specified
fundamental changes relating to us, each holder of the outstanding notes may
require us to purchase for cash all or a portion of such holder’s notes at a
price equal to 100% of the principal amount, plus accrued and unpaid interest,
if any, on such notes to but excluding the date of purchase. In addition, in the
case of certain fundamental changes occurring before November 9, 2009, we may be
required to pay a make-whole premium to holders of outstanding
notes.
As
the conversion price of the senior convertible notes is significantly higher
than the market price of our ordinary shares and the notes are trading at a
discount to their principal amount, it is likely that the holders of all or a
significant portion of the outstanding notes will require that we repurchase the
notes when they are able to do so in November 2009. We cannot be sure that we
will have sufficient financial resources to purchase these notes for cash, or
will be able to raise the financing needed to purchase these notes if required
to do so in November 2009 or at any other time as required by the terms of the
notes.
The
trading prices of our notes could be significantly affected by the market price
of our ordinary shares.
We
believe that the trading price of our notes could be significantly affected by
the market price of our ordinary shares, which may be affected by a variety of
factors as set forth in these risk factors. This relationship may result in
greater volatility in the trading prices of our notes than would be expected for
non-convertible debt securities.
Our
notes are effectively subordinated to our existing and future secured
indebtedness and structurally subordinated to existing and future indebtedness
and other liabilities of our subsidiaries.
Our
notes are general, unsecured obligations and are effectively subordinated to any
existing and future secured indebtedness we may have. In addition, our notes are
not guaranteed by our subsidiaries or any future subsidiaries and, accordingly,
our notes are effectively subordinated to the existing and future indebtedness
and other liabilities of our subsidiaries. These liabilities may include
indebtedness, trade payables, guarantees, lease obligations and letter of credit
obligations. Therefore, our rights and the rights of our creditors, including
the holders of the notes, to participate in the assets of any subsidiary upon
that subsidiary’s liquidation or reorganization will be subject to the prior
claims of the subsidiary’s creditors, except to the extent that we may ourselves
be a creditor with recognized claims against the subsidiary. However, even if we
are a creditor of one of our subsidiaries, our claims would still be effectively
subordinated to any security interests in, or mortgages or other liens on, the
assets of that subsidiary and would be subordinate to any indebtedness of the
subsidiary senior to that held by us. As of June 15, 2009, our existing
subsidiaries had no outstanding indebtedness (excluding intercompany debt and
other liabilities).
There
are no restrictive covenants in the indenture for the notes relating to our
ability to incur future indebtedness or complete other
transactions.
The
indenture governing our notes does not contain any financial covenants or
restrictions on the payment of dividends. The indenture does not restrict the
issuance or repurchase of securities by us or our subsidiaries. The indenture
contains no covenants or other provisions to afford holders of our notes
protection in the event of a highly leveraged transaction, such as a leveraged
recapitalization, that would increase the level of our indebtedness, or a change
in control except for the ability of the holders to require us to redeem the
notes under certain circumstances. The indenture governing our notes does not
restrict us from incurring senior secured debt in the future or from
guaranteeing our indebtedness, nor does it limit the amount of indebtedness that
we can issue that is equal to our notes in right of payment. In 2008, we
borrowed $30 million from Israeli banks and we may borrow additional amounts
from financial institutions without violating the terms of the
indenture.
Our
indebtedness and debt service obligations increased upon the issuance of our
notes and loans, which may adversely affect our cash flow, cash position and
stock price.
If
we do not have sufficient available cash or are unable to generate cash or raise
additional financing sufficient to meet our obligations under our notes and need
to use existing cash or liquidate investments in order to fund these
obligations, we may have to delay or curtail research, development and
commercialization programs.
Our
indebtedness could have significant additional negative consequences, including,
without limitation:
|
|
|
|
●
|
requiring
the dedication of a portion of our expected cash flow to service our
indebtedness, thereby reducing the amount of our expected cash flow
available for other purposes, including funding our research and
development programs and other capital expenditures;
|
|
|
|
|
●
|
increasing
our vulnerability to general adverse economic
conditions;
|
|
|
|
|
●
|
limiting
our ability to obtain additional financing; and
|
|
|
|
|
●
|
placing
us at a possible competitive disadvantage to less leveraged competitors
and competitors that have better access to capital
resources.
|
Holders
of our notes are not entitled to any rights with respect to our ordinary shares,
but they are subject to all changes made with respect to our ordinary
shares.
Holders
of our notes are not entitled to any rights with respect to our ordinary shares
(including, without limitation, voting rights and rights to receive dividends,
if any, or other distributions on our ordinary shares), but such holders are
subject to all changes affecting our ordinary shares. Holders of our notes are
entitled to rights on the ordinary shares if and when we deliver ordinary shares
to such holders in exchange for their notes. For example, in the event that an
amendment is proposed to our articles of association requiring shareholder
approval and the record date for determining the shareholders of record entitled
to vote on the amendment occurs prior to delivery to a converting holder of our
notes of our ordinary shares, such holders will not be entitled to vote on the
amendment, although that holder will nevertheless be subject to any changes in
the powers, preferences or special rights of our ordinary
shares.
Our
ability to fulfill our obligations under our notes and loans is dependent upon
our financial and operating performance.
Our
ability to make interest and principal payments on our notes when due depends,
in part, upon our financial performance and our ability to refinance this debt
obligation or to raise additional equity or debt. We may be required to pay all
or a portion of our notes in November 2009. Prevailing economic conditions and
financial, business and other factors, many of which are beyond our control,
will affect our ability to make these payments.
If
we are unable to generate sufficient cash flow to meet our debt service
obligations or to repay the principal of our notes and/or loans, we will have to
pursue one or more alternatives, such as:
|
|
|
|
●
|
reducing
our operating expenses;
|
|
|
|
|
●
|
reducing
or delaying capital expenditures;
|
|
|
|
|
●
|
selling
assets; or
|
|
|
|
|
●
|
raising
additional debt or equity
capital.
|
We
cannot be sure that any of these alternatives could be accomplished on
satisfactory terms, if at all, or that those actions would provide sufficient
funds to retire our notes and/or repay our loans.
|
|
|
|
ITEM
4 INFORMATION
ON THE COMPANY |
|
|
|
A.
|
HISTORY
AND DEVELOPMENT OF THE
COMPANY
|
AudioCodes
Ltd. was incorporated in 1992 under the laws of the State of Israel. Our
principal executive offices are located at 1 Hayarden Street, Airport City, Lod,
70151 Israel. Our telephone number is 972-3-976-4000. Our agent in the United
States is AudioCodes Inc., 2099 Gateway Plaza, San Jose, California
95134.
Major
Developments since January 1, 2008
In
January 2008, we merged most of our U.S. subsidiaries into AudioCodes Inc. We
did this to simplify operational and financial procedures and to save costs. As
a result, most of our activities in the United States are conducted through
AudioCodes Inc.
We
have introduced the following families of products and
technologies:
High
Definition VoIP- the adoption of VoIP and broadband networks has given us the
opportunity to offer high-quality voice coding algorithms which make
communication more efficient, effective and natural and to generate the High
Definition VoIP, or HD VoIP.
High
Definition IP Phones - suitable to be integrated with third party IP-PBX
platforms for the enterprise IP telephony market, as well as into IP-Centrex
service provider solutions.
Multi-Service
Business Gateways – a product integrating multiple data, telephony and security
services into a single device. Building on our media gateway CPE line, we have
added the support of new functions such as a LAN switch, a data router, a
firewall and a session border controller, providing service providers with an
integrated demarcation point and the enterprise with an all-in-one solution for
its communications needs.
Increased
use of Open Source codes for Enterprise Telephony - Similar to the trend
experienced with respect to Linux in the IT world, open source has started to
gain momentum in the VoIP space as well. Open source based IP telephony
solutions, led by Asterisk, a well known IP-PBX implementation, is starting to
penetrate the enterprise space as a low cost alternative to the proprietary
IP-PBX solutions from the large vendors. The adoption of open source IP
telephony solutions is gaining momentum mainly in the SMB/SME space, as well as
with service providers and developers that add their own code on top of the open
source basic code to enable special services and features.
Investments
in Other Companies
Through
December 31, 2008, we had invested an aggregate of $7.2 million in Natural
Speech Communication Ltd., a privately-held development stage company engaged in
speech recognition. This investment is intended to assist that company in
achieving substantive technological milestones. As of December 1, 2008, we began
consolidating the financial results of NSC into AudioCodes’ financial results
since we became the primary beneficiary in accordance with “FIN” 46R. As of
December 31, 2008, we owned 56.6% of the outstanding share capital of NSC
and 51.0% of the share capital of NSC on a fully diluted basis.
In
July, 2005, we invested $707,000 in MailVision Ltd., a privately-held company
engaged in developing and marketing enhanced services platforms for wireless
service providers. During 2006, 2007 and 2008, we made convertible loans in the
aggregate principal amount of $403,000 to MailVision. The loans bear interest at
the rate of 9% per annum and may be converted into shares of MailVision. As of
December 31, 2008, we owned 20.2% of the outstanding share capital of this
company and 17.4% of the share capital of this company on a diluted basis
without taking into account shares that may be issued upon conversion of the
loans.
In
December 2006, we made a convertible loan in the amount of $1,000,000 to Kayote
Networks Inc., a privately-held company engaged in VoIP interconnectivity and
interoperability services. This loan bears interest at the rate of LIBOR+2% per
annum and was due and payable in December 2007. In December 2007, we requested
repayment of the loan. We received payment of $870,000 of the principal amount
of the loan in cash and the remaining balance of the loan in the amount of
$130,000 was written off.
Principal
Capital Expenditures
We
have made and expect to continue to make capital expenditures in connection with
expansion of our production capacity. The table below sets forth our principal
capital expenditures incurred for the periods indicated.
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
Computers
and peripheral equipment
|
|
$ |
2,310 |
|
|
$ |
2,023 |
|
|
$ |
2,466 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
furniture and equipment
|
|
|
677 |
|
|
|
436 |
|
|
|
166 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leasehold
improvements
|
|
|
80 |
|
|
|
170 |
|
|
|
526 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
3,067 |
|
|
$ |
2,629 |
|
|
$ |
3,158 |
|
Introduction
We
design, develop and sell products for voice, data and video over IP networks. In
broad terms, VoP networks consist of key network elements such as software
switches, Internet protocol, or IP, phones and media gateways. Our network and
technology products primarily provide voice the media gateway element in the
network. Media gateways connect legacy and IP networks. They essentially receive
the legacy format of communication and convert it to an IP communication and
vice versa. Typically, media gateways utilize compression algorithms to compress
the amount of information and reduce the amount of bandwidth required to convey
the information (for example, a voice communication).
Gateway
equipment for Internet protocol-based packet networks has continued to
experience significant development and growth. Gateway equipment can generally
be divided into two key categories: open telecommunications architecture
systems, built around industry standard platforms (e.g., personal computers,
compact personal computer interface, or PCI, advanced telecommunications
computing architecture, or ATCA, and IBM BladeCenter) and workstation platforms
for which components are available from a number of suppliers, and proprietary
architecture-based gateways which are built around a custom design of a
telecommunications equipment manufacturer. Voice over IP gateway equipment can
be generally segmented into three classes: carrier class gateways for use in
central office facilities; enterprise gateways for use by corporations and in
small offices; and residential gateways for use in homes.
The
need to re-route voice and fax traffic from the traditional circuit-switched
networks onto the new packet networks has led to the development of interface
equipment between the two networks, generally referred to as media gateways. The
processing of voice and fax signals in gateway and access equipment is done
according to industry-wide standards. These standards are needed to ensure that
all traditional telephony traffic is seamlessly switched and routed over the
packet network and vice versa.
Packet
networks differ fundamentally from circuit-switched networks in that the packet
network’s resources and infrastructure can be shared simultaneously by several
users and bandwidth can be flexibly allocated. Packet-based communications
systems format the information to be transmitted, such as e-mail, voice, fax and
data, into a series of smaller digital packages of information called “packets.”
Each of these packets is then transmitted over the network and is reassembled as
a complete communication at the receiving end. The various packet networks
employ different network protocols for different applications, priority schemes
and addressing formats to ensure reliable communication.
Packet
networks offer a number of advantages over circuit-switched networks. Rather
than requiring a dedicated circuit for each individual call, packet networks
commingle packets of voice, fax and data from several communications sources on
a single physical link. This provides superior utilization of network resources,
especially in dealing with information sources with bursts of information
followed by periods of silence. This superior utilization means that more
traffic can be carried over the same amount of network resources.
The
integration of voice and data communications makes possible an enrichment of
services and an entire range of new, value-added applications, such as unified
messaging and voice enabled web sites. In addition, voice traffic over packet
networks is usually compressed to provide a further reduction in the use of or
demand for bandwidth. For example, the rate at which information is transmitted
over packet networks is generally between 6.3 and 8 kilobits per second as
compared to 64 kilobits per second over circuit-switched telephone
networks.
Another
recent trend in the voice over IP environment, referred to as High Definition
VoIP, or HD VoIP, now enables the improvement of voice quality,. The adoption of
both VoIP technology and broadband networks has enabled the development and
deployment of high-quality voice coding algorithms that make communication more
efficient, effective and natural. HD VoIP allows carriers to differentiate their
services with an improved audio experience, with the goal of creating customer
loyalty and affinity.
We
typically categorize our products into two main business lines: network and
technology. Sales of network products accounted for approximately 65% of our
revenues in 2007 and approximately 67% of our revenues in 2008 and sales of
technology products accounted for approximately 35% of our revenues in 2007 and
approximately 33% of our revenues in 2008. In 2008, sales of our network
products increased by 14.2% and sales of our technology products increased by
3.6%.
Network
products consist of customer premises equipment (CPE) media gateways for the
enterprise and service provider (or carrier) markets and of carrier grade
oriented low and mid density media gateways for service providers. Complementing
our media gateways as Network products are our media server, session border
controller, security gateway and value added application products.
Technology
products are enabling in nature and consist of our chips and boards business
products. These are sold primarily to original equipment manufacturers, or OEMs
through distribution channels. Our chips and boards serve as building blocks
that our customers incorporate in their products. In contrast, our networking
products are used by our customers as part of a broader technological solution
and are a box level product that interacts directly with other third party
products.
Our
Products
Our
products consist of:
|
|
|
|
●
|
Networking
products include media servers, security gateways, session border
controllers and media gateways. Media gateways are deployed in residential
and access networks, trunking applications in carrier networks, and
enterprise networks. Additional emerging applications or segments where we
believe our media gateways could be used are unified communication, hosted
services and fixed mobile convergence, or FMC. Our media gateway products
include low density analog media gateways and low, mid and high density
digital media gateways. We are part of Microsoft solution for unified
messaging and unified communications.
|
|
|
|
|
●
|
Our
media gateways enable voice, video, data and fax to be transmitted over
Internet and other protocols, and interface with third party equipment to
facilitate enhanced voice and data services. Media servers enable
conferencing, multi-language announcement functionality, and other
applications for voice over packet networks.
|
|
|
|
|
●
|
Session
border controllers enable connectivity, policies and security for
real-time sessions such as VoIP and video when traversing IP to IP
networks. In addition, security gateways enable secure real-time sessions
across WIFI, broadband and wireless networks in fixed mobile convergence
deployments.
|
|
|
|
|
●
|
Unified
communication applications offering solutions that enable the integration
of voice, data, fax and messaging.
|
|
|
|
|
●
|
Our
signal processor chips process and compresses voice, data and fax and
enable connectivity between traditional telephone networks and packet
networks.
|
|
|
|
|
●
|
Our
communications boards and modules for communication system products are
deployed on both access networks and enterprise networks. The carrier
network applications for these boards and modules include media gateways,
which terminate calls from the public switched telephone network (PSTN),
packetize and compress the call and then switch the call to the packet
network, and vice-versa. The enterprise applications for these products
include computer telephony integration, or CTI, deployments for contact
centers, providing call logging and recording utilizing either industry
standard or proprietary protocols.
|
|
|
|
|
●
|
Our
IP phones include a family of high quality, high definition IP phones,
suitable to be integrated with third party IP-PBX platforms for the
enterprise IP telephony market, as well as into IP-Centrex service
provider solutions.
|
|
|
|
|
●
|
Our
multi-service business gateways include an integration of multiple data,
telephony and security services into a single device. Building on our
media gateway CPE line, we have added the support of new functions such as
a LAN switch, a data router, a firewall and a session border controller,
providing service provider with an integrated demarcation point and the
enterprise with an all-in-one solution for its communications
needs.
|
Industry
Background
Market
Trends
The
networking and telecommunications industries have experienced rapid change over
the last few years. The primary factors driving this change include the
following:
|
|
|
|
●
|
New
technologies. The introduction of broadband access technologies
alongside related technologies, such as new voice compression algorithms,
quality of service mechanisms and security and encryption algorithms and
protocols, have enabled delivery of voice over packet to residential and
enterprise customers with more reliability, higher quality and greater
security. Examples of these broadband access technologies include: third
generation cellular, WiMax, WiFi, data over cable, digital subscriber line
technologies and fiber networks (FTTx). Packet technologies enable
delivery of real time and non-real time services by different service
providers that do not necessarily own the access network or the part of
the network through which the subscriber accesses the network. This allows
for the growth of alternative or virtual service providers that do not own
an access network.
|
|
|
|
|
●
|
Competition
by alternative service providers with incumbent and traditional service
providers. Competition by alternative service providers is causing
incumbents to deploy advanced broadband access technologies and increase
their competitiveness by offering bundled services to their subscribers,
such as voice, video and data, and online gaming. In addition, the
emergence of wide band vocoders that use a higher sampling rate than used
in legacy time domain multiplexing, or TDM, networks allows service
providers to offer higher quality voice and music over their newly
established IP network.
|
|
|
|
|
●
|
New
services enabled by broadband access. Changes in the regulatory
environment affecting service providers and the availability of new
technologies or standards allow service providers to compete with one
another in the provision of additional services over and above the
traditional telephony service of voice, fax and dial-up modem internet
connectivity. New services that could be offered include internet
connectivity over broadband access or access to rich multimedia content
such as music, video and games.
|
|
|
|
|
●
|
Increasing
need for peering between VoIP networks. Service providers and
enterprises are increasingly building out VoIP networks. As a result,
there is an increasing need to connect between two VoIP networks. In order
to interconnect between two VoIP networks, service providers and
enterprises need session border controllers to provide connectivity and
security.
|
|
|
|
|
●
|
Increased
use of open source codes for enterprise telephony. Similar to the
trend experienced with respect to Linux in the IT world, open source has
started to gain momentum in the VoIP space as well. Open source based IP
telephony solutions, led by Asterisk, a well known IP-PBX implementation,
is starting to penetrate the enterprise space as a low cost alternative to
the proprietary IP-PBX solutions from the large vendors. The adoption of
open source IP telephony solutions is gaining momentum mainly in the
SMB/SME space, as well as with service providers and developers that add
their own code on top of the open source basic code to enable special
services and
features.
|
The
Challenges
Despite
the inherent advantages and the economic attractiveness of packet voice
networking, the transmission of packet voice and fax poses a variety of
technological challenges. These challenges relate to quality of service,
reliability of equipment, functionality and features, and ability to provide a
good return on investment.
|
|
|
|
●
|
Quality
of Service. The most critical issues leading to poor quality of
service in the transmission of voice and fax over packet networks are
packet loss, packet delay and packet delay jitter. For real time signals
like voice, the slightest delay in the arrival of a packet may render that
packet unusable and, in a voice transmission, the delayed packet is
considered a lost packet. Delay is usually caused by traffic hitting
congestion or a bottleneck in the network. The ability to address delay is
compounded by the varying arrival times of packets, called packet-jitter,
which results from the different routes taken by different packets. This
“jitter” can be eliminated by holding the faster arriving packets until
the slower arriving packets can catch up, but this introduces further
delay. These idiosyncrasies of packet networks do not noticeably detract
from the quality of data transmission since data delivery is relatively
insensitive to time delay. However, even the slightest delay or packet
loss in voice and fax transmission can have severe ramifications such as
voice quality degradation or, in the case of a fax transmission, call
interruption. Therefore, the need to compensate for lost or delayed
packets without degradation of voice and fax quality is a critical
issue.
|
|
|
|
|
●
|
Gateway
Reliability. In order for a packet network to be efficient for
voice or fax transmission, the VoIP gateway equipment that is installed in
core networks must be able to deliver a higher level of performance than
existing switching equipment located at central offices. The
telecommunications providers’ central offices contain circuit-switching
equipment that typically handles tens of thousands of lines and is built
to meet severe performance criteria relating to reliability, capacity,
size, power consumption and cost.
|
|
|
|
|
●
|
Connectivity
and Security. In contrast with legacy circuit switched voice and
video communications, Internet Protocol based communications are more
susceptible to attacks, interceptions and fraud by unauthorized entities.
In addition, the complexity and relative immaturity of IP networks and
protocols pose significant quality of service and connectivity challenges
when sessions cross between separate IP
networks.
|
|
●
|
Functionality.
In order to effectively replace legacy circuit-switching equipment, packet
network equipment must be able to deliver equivalent and improved
functionality and features for the service providers and network
users.
|
|
|
|
|
●
|
Return
on Investment. With the reduction in profitability of service
providers there is an even greater need for them to achieve better returns
on investment from capital expenditures on new equipment. Given the
evolving nature of packet technologies and capabilities, there is greater
pressure to provide cost effective technological
solutions.
|
In
order to maximize the benefits of using packet networks for the transmission of
voice, data and fax, products must be able to address and solve these inherent
problems and challenges. These products must also be standards-based to support
interoperability among different equipment manufacturers and to allow operation
over various networks.
AudioCodes
Solution
Using
our proprietary voice compression algorithms and industry standards, advanced
digital signal processing techniques and voice communications system design
expertise, our products address the quality of service problems posed by packet
delay, packet delay jitter and packet loss. As a result, we enable our customers
to build packet networking equipment that provides communication quality
comparable to the traditional telephone networks. In addition, our
communications boards and modules improve gateway efficiency and provide the
building blocks for high performance, large capacity, open telecommunications
platform-based gateways. We work closely with our customers, tailor our products
to meet their specific needs, assist them in integrating our products within
their systems and help them bring their systems to market on a timely basis. We
also work with our customers in deploying their systems in various network
environments.
Utilizing
our investment in developing standards-based VoIP protocol support for our
products, customers can integrate our media gateways with a large number of
industry leading IP-PBXs and carrier soft switches. Our interoperability teams
test our products against a variety of other products for interoperability,
focusing on the leading standard VoIP protocols: SIP (Session Initiation
Protocol) and MEGACO/H.248.
We
believe that the following strengths have enabled us to develop our products and
provide services to our customers:
|
|
|
|
●
|
Leadership
in voice compression technology. We are a leader in voice
compression technology. Voice compression exploits redundancies within a
voice signal to reduce the bit rate of data required to digitally
represent the voice signal while still maintaining acceptable voice
quality. Our key development personnel have significant experience in
developing voice compression technology. We were involved in the
development of the ITU G.723.1 voice coding standard that was adopted by
the Voice over IP Forum and the International Telecommunications Union as
the recommended standard for use in voice over IP gateways. We implement
industry voice compression standards and work directly with our customers
to design state-of-the-art proprietary voice compression algorithms that
satisfy specific network requirements. We believe that our significant
knowledge of the basic technology permits us to optimize its key elements
and positions us to address further technological advances in the
industry. We also believe that our technological expertise has resulted in
us being sought out by leading equipment manufacturers to work with them
in designing their systems and provision of solutions to their
customers.
|
|
●
|
Digital
signal processing design expertise. Our extensive experience and
expertise in designing advanced digital signal processing algorithms
enables us to implement them efficiently in real time systems. Digital
signal algorithms are computerized methods used to extract information out
of signals. In designing our signal processors, we use minimal digital
signal processing memory and processing power resources. This allows us to
develop higher density solutions than our competitors. Our expertise is
comprehensive and extends to all of the functions required to perform
voice compression, fax and modem transmission over packet networks and
telephone signaling processing.
|
|
|
|
|
●
|
Compressed
voice communications systems design expertise. We have the
expertise to design and develop the various building blocks and the
complete gateways and media servers required for complete voice over
packet systems. In building these systems, we develop hardware
architectures, voice packetization software and signaling software, and
integrate them with our signal processors to develop a complete, high
performance compressed voice communications system. We assist our
customers in integrating our signal processors into their hardware and
software systems to ensure high voice quality, high completion rate of fax
and data transmissions and telephone signaling processing accuracy.
Further, we are able to customize our off-the-shelf products to meet our
customers’ specific needs, thereby providing them with a complete,
integrated solution and enabling them to market their products with a
reduced time to market.
|
|
|
|
|
●
|
Real
time embedded software design and implementation expertise. We have
the expertise to design and develop voice and data network elements using
embedded real time software to achieve more competitive pricing. The
development and integration of VoIP signaling protocols, routing
protocols, management and provisioning into a more cost effective solution
uses our expertise and investment in research and development resources.
We believe that the benefits we can deliver are better price performance,
smaller footprint, reduced power consumption and more attractive
products.
|
|
|
|
|
●
|
Media
gateway protocols design expertise. Our extensive experience in
developing media gateway standard protocols, keeping ourselves up to date
with new request for comments, or RFCs, and adjusting our features
according to customers requirements and interoperability testing allows us
to provide our customers with a single gateway that can interface with
most of the leading solution providers in the VoIP
market.
|
We
believe that our products possess the following advantages:
|
|
|
|
●
|
Voice
over Packet signal processors. Our multi-channel signal processors
enable our customers and us to create products that meet the reliability,
capacity, size, power consumption and cost requirements needed for
building high capacity gateways.
|
|
|
|
|
●
|
Multiple
and comprehensive product lines. We address both the
standards-based open telecommunications architecture market and the
proprietary system market. We can do this because we enable our customers
to offer multiple applications and address different market segments. For
example, our voice over IP communications boards target the open
telecommunications architecture market, while our signal processors,
modules and voice packetization software target the proprietary system
market. Our analog and digital media gateways target residential, hosted,
access, trunking and enterprise applications and our digital media
gateways target wireless, wire line, cable and fixed-mobile convergence
networks. Our session border controllers target access and peering
networks.
|
|
|
|
|
●
|
Extensive
feature set. Our products incorporate an extensive set of signal
processing functions and features (such as coders, fax processing and echo
cancellation), functionalities (such as H.323, media gateway control
protocol, or MGCP, trunking gateway control protocol, or TGCP, media
gateway control, or Megaco, and session initiated protocol, or SIP) and
implement a complete system. We offer the ability to manage multiple
channels of communications working independently of each other, with each
channel capable of performing all of the functions required for voice
compression, fax and modem transmission, telephone signaling processing
and other functions. These functions include voice, fax or data detection,
echo cancellation, telephone tone signal detection, generation and other
telephony signaling processing. Our Gateway products, media server and
session border controller also offer wireless/mobile features to enable
fixed mobile convergence.
|
|
|
|
|
●
|
Cost
effective solutions. We are able to address different market
segments and applications with the same hardware platforms thus providing
our customers with efficient and cost effective
solutions.
|
|
|
|
|
●
|
Open
architecture. Our voice over packet communications boards target
the open architecture gateway market segment, which enables our customers
to use hardware and software products widely available for standards-based
open telecommunications platforms. We believe that this provides our
customers with an improved time to market and the benefits of scalability,
upgradeability and enhanced functionality without the need to completely
redesign their systems for evolving applications. Our networking products
utilize industry standard control protocols that enable them to
interoperate with other vendors and easily integrate into enterprise IP
telephony systems as well as carrier IMS (IP Multimedia Subsystem)
networks.
|
|
●
|
Various
entry level products. Our wide product range (chips to media
gateways, session border controllers and media servers) provides our
customers with a range of entry level products. We believe that these
building blocks enable our customers to significantly shorten their time
to market by adding their value added
solution.
|
|
|
|
|
●
|
VoIPerfect™
architecture. Our VoIPerfect architecture serves as the underlying
technology platform common to all of our products since 1998. VoIPerfectTM
is regularly updated and upgraded with features and functionalities
required to comply with evolving standards and protocols. VoIPerfectTM
architecture comprises VoIP digital signal processing, or DSP, software
and media streaming embedded software, integrated public telephone
switched network, or PTSN, signaling protocols and VoIP standard control
protocols, provisioning and management engines. Additional features enable
carrier-grade quality and high availability. VoIPerfectTM architecture
components are available in AudioCodes’ products at various levels of
integration, from the chip level, through peripheral component
interconnect mezzanine card, or PMC, modules and PCI/compact PCI (cPCI)
blades, to high-availability and non-high-availability analog and digital
media gateway
platforms.
|
Business
Strategy
Our
goal is to be the leading provider of products and enabling technologies for the
transmission of voice, video, data and fax over packet networks. The following
are key elements of our strategy:
|
|
|
|
●
|
Maintain
and extend technological leadership. We intend to
capitalize on our expertise in voice compression technology and
proficiency in designing voice communications systems. We continually
upgrade our product lines with additional functionalities, interfaces and
densities. We have invested heavily and are committed to continued
investment in developing technologies that are key to providing high
performance voice, data and fax transmission over packet networks and to
be at the forefront of technological evolution in our
industry.
|
|
|
|
|
●
|
Strengthen
and expand strategic relationships with key customers. Our strategy
has been to sell our products to leading enterprise channels, regional
system integrators, global equipment manufacturers and value-added
resellers, or VARs, in the telecommunications and networking industries
and to establish and maintain long-term working relationships with them.
We work closely with our customers to engineer products and subsystems
that meet each customer’s particular needs. The long development cycles
usually required to build equipment incorporating our products frequently
results in close working relationships with our customers. By focusing on
leading equipment manufacturers with large volume potential, we believe
that we reach a substantial segment of our potential customer base while
minimizing the cost and complexity of our marketing
efforts.
|
|
●
|
Expand
and enhance the development of highly-integrated products. We plan
to continue designing, developing and introducing new product lines and
product features that address the increasingly sophisticated needs of our
customers. We believe that our knowledge of core technologies and system
design expertise enable us to offer better solutions that are more
complete and contain more features than competitive alternatives. We
believe that the best opportunities for our growth and profitability will
come from offering a broad range of highly- integrated network product
lines and product features, such as our continuously updated analog and
digital media gateways and products from our recently acquired companies,
including session boarder controllers, security gateways, messaging
platforms and cable telephony gateways.
|
|
|
|
|
●
|
Build
upon existing technologies to penetrate new markets. The technology
we developed in connection with the IP telephony market can be used to
serve similar product requirements in multiple emerging markets utilizing
similar packet networking technologies. These markets include those
providing telephony over digital subscriber lines, wireless networks and
the cable television infrastructure.
|
|
|
|
|
●
|
Develop
a network of strategic partners. Part of our strategy has been to
sell our products through customers that can offer our products as part of
a full-service solution to their customers. We expect to further develop
our strategic partner relationships with system integrators and other
service providers in order to increase our customer
base.
|
|
|
|
|
●
|
Acquire
complementary businesses and technologies. We expect to
pursue the acquisition of complementary businesses and technologies or the
establishment of joint ventures to broaden our product offerings, enhance
the features and functionality of our systems, increase our penetration in
targeted markets and expand our marketing and distribution capabilities.
As part of this strategy, we acquired the UAS business from Nortel in
April 2003 and Ai-Logix (now part of AudioCodes Inc.), in May 2004. We
also acquired Nuera (now part of AudioCodes Inc.) in July 2006, Netrake
(now part of AudioCodes Inc.) in August 2006 and CTI Squared in April
2007.
|
Products
Our
products facilitate the transmission of voice, video, data and fax over packet
networks. To date, we have incorporated our algorithms, technologies and systems
design expertise in product lines, which can be divided into two main product
lines:
Networking
products
This
line of products includes products that are network level products. Our
networking products include:
|
|
|
|
●
|
analog
media gateways for toll bypass, residential gateways, hosted, access and
enterprise applications;
|
|
●
|
digital
media gateways (MediantTM) with various capacities for wireless, wireline,
cable, enterprise, fixed mobile convergence, and unified
communications;
|
|
|
|
|
●
|
multi-service
business gateways for integrated voice, data and security access for
service providers connecting enterprise customers to their network and for
the enterprise branch office;
|
|
|
|
|
●
|
media
servers for enhanced voice and video services and functionalities such as
conferencing, video sharing and messaging (IPmedia™ Media
Servers);
|
|
|
|
|
●
|
session
border controllers, or SBCs (nCite), that enable connectivity, contain
protocol and connectivity policies, and provide security for real-time
sessions such as VoIP and video when traversing from a public to a private
network. In addition, security gateways enable secure real-time sessions
across wifi, broadband and wireless networks in fixed mobile convergence
deployments;
|
|
|
|
|
●
|
element
management system, or EMS; and
|
|
|
|
|
●
|
value
added applications for unified
communications.
|
In
addition, we continue to offer customers our professional services, which
usually involve customization and development projects for
customers.
Our
products are designed to build on our core technology and competence extending
them both vertically (chips inserted into boards, boards inserted into digital
media gateways) and horizontally into different applications for different
market segments, such as enterprise, call centers, wireline, cable and
wireless.
Technology
products
This
line of products serves as a building block for network level products. Our
technology products include:
|
|
|
|
●
|
voice
over packet processors;
|
|
|
|
|
●
|
VoIP
communication boards (TrunkPack®);
|
|
|
|
|
●
|
media
processing boards for enhanced services and functionalities, such as conferencing
and messaging (IPmediaTM); and
|
|
|
|
|
●
|
voice
and data logging hardware integration board
products.
|
Our
Product Families
Analog
Media Gateways for Toll Bypass Access and Enterprise Applications
MediaPackTM, our
analog and basic rate interface, or BRI, media gateways for toll bypass access
and enterprise applications, are designed to empower the next-generation network
by providing cost-effective, cutting-edge technology solutions that deliver
voice and fax services to the corporate market, small businesses and home
offices. Our analog media gateways for access and enterprise applications
provide media streaming functionality while being either controlled by a
centralized call agent or use on box VoIP control protocols (H.323, MGCP and
SIP). Convergence of data, voice and fax is achieved by a combination of the
media gateway with any IP access technology, eliminating the cost of multiple
access circuits. This product family utilizes our experience and digital signal
processing, or DSP, technology for echo cancellation, voice compression, silence
suppression and comfort noise generation. Part of this line is composed of our
analog residential gateways whose primary target market is the large volume
residential service providers or SP, market.
The
MediaPackTM family
represents a feature rich product for streaming voice quality with a powerful
analog interface supporting all major control protocols such as H323, SIP, MGCP
and is also capable of supporting some unified communication and FMC
applications.
Digital
Media Gateways and Various Capacities for Wireless, Wireline and Cable
(Mediant™)
MediantTM is our
family of converged media gateways for wireline, cable, wireless (GSM and CDMA),
fixed-mobile-convergence and enterprise networks. The MediantTM product
family offers scalability and functionality, providing a full suite of standards
compliant control protocols and public switched telephone network, or PSTN,
signaling interfaces for a variety of enterprise, wireline, cable and wireless
media gateway applications in most softswitch controlled environments. This
product family is compatible with popular wireline, cable and wireless voice
coders and protocols including code-division multiple access (CDMA), global
system for mobile communications (GSM), CDMA2000 and universal mobile
telecommunications service (UMTS). It builds on our TrunkPack® architecture,
which is installed in millions of lines worldwide. The MediantTM family
provides carriers with a comprehensive line of different sized gateways. Small
or medium-sized gateways enable cost-effective solutions for enterprise or small
points of presence, as well as entry into fast growing new and emerging markets.
The large gateway scales to central office capacities and is designed to meet
carriers’ operational requirements. The Mediant family of media gateways is
capable of supporting some of the unified communication and fixed mobile
convergence applications which may be of increased interest to enterprises and
service providers. The Mediant™ gateway family shares our same VoIP
perfect architecture, designed to provide mature, field-proven
solutions.
For
the cable market, the MediantTM gateway
family complies with packet telephony standards and is designed for either
hybrid or all IP cable network architecture. The Mediant gateway enables
deployment of advanced packet-based cable telephony at multiple service
operators own pace, without costly hardware changes. The MediantTM gateway
can be initially deployed as a V5.2 IP access terminal and then easily migrated
by software upgrade to a cable telephony media gateway with external call
management provided by a softswitch and an SS7 interface to the
PSTN.
Multi
service business gateways (MSBGs) are networking devices that combine multiple
multiservice functions such as a media gateway, session border controller, data
router and firewall, LAN switch, WAN access, and stand alone
survivability (SAS). The MSBG concept is designed to address the needs of
service providers and cable operators that offer IP-Centrex and SIP trunking
services and of distributed enterprises.
We
offer the Mediant 1000 MSBG, which is an all-in-one multi-service access
solution designed to provide converged voice and data services for business
customers at wire speed, while maintaining service level agreement, or SLA,
parameters for superior voice quality. The Mediant 1000 MSBG is based on
AudioCodes’ VoIPerfect best-of-breed media gateway technology, combined with
enterprise class session border controller, data and voice security elements,
data routing, LAN switching and WAN access.
Session
Border Controllers and Security Gateways
We
provide the nCite session border controller, or SBC, and security gateway
products that help service providers and network equipment providers enable
connectivity between different VoIP networks and provide security to deployments
of fixed mobile convergence, or FMC networks, for integrating wireline and
wireless networks.
nCite
session border controllers provide secure VoIP and multimedia traversal of
firewall, or FW, and network address translation, or NAT, systems, as well as
denial of service, or DoS, attack prevention at both the signaling and media
layers. NAT and FW traversal are necessary to allow VoIP and multimedia session
to pass from the Service Provider (“SP”) network to the residential or
enterprise networks. DoS attack prevention protects the SP network from attacks
that load the network until it crashes. The nCite SBCs also provide
comprehensive Quality of Service, or QoS, mechanisms and protocol interworking
(translation from one VoIP protocol to another, or between two variants of same
VoIP protocol to enable two softswitches to communicate with each other).
AudioCodes nCite solutions offer proven interoperability with major
softswitches, SIP servers, application servers, IP PBXs and a large number of
IP-based voice and video endpoints.
The
nCite security gateway enables secure (authenticated and encrypted) real-time
sessions across Wi-Fi, broadband and wireless networks in FMC deployments. The
nCite security gateway, or nCite SG, provides secure termination and aggregation
for IP phones, dual-mode Wi-Fi and cellular-capable VoIP handsets that are used
in converged wireline and wireless networks.
Element
Management System
Our
element management system, or EMS, is an advanced solution for centralized,
standards-based management of our VoP gateways, covering all areas vital to the
efficient operations, administration, management and provisioning of our
MediantTM and
MediaPackTM VoP
gateways.
Our
EMS offers network equipment providers and system integrators fast setup of
medium and large VoP networks with the advantage of a single centralized
management system that configures, provisions and monitors all of AudioCodes
gateways deployed, either as customer premises equipment, access or core network
platforms.
CTI2
Value Added Services Applications (InTouch)
The
InTouch platform is an enhanced value added services (VAS) platform for service
providers, such as cable, class 5, class 4, fixed-line, mobile, multiservice
virtual network operator, or MVNO, and operators. InTouch provides a
suite of next generation VAS. InTouch is an IP-based, email-centric and
telco-grade platform conforming to ultimate service providers’ requirements for
high-availability, reliability, scalability, and security. InTouch is designed
to smoothly scale from a very small system to a system with millions of
subscribers based on the same software and architecture, while enabling a rich
suite of applications at all sizes. InTouch’s open architecture is based on
industry-standard protocols, facilitating interoperability and integration with
best of breed, third-party applications. InTouch acts as a mediator between
InTouch services and a large selection of clients and devices enabling service
providers to offer attractive packages.
Voice
Over Packet Processors
Our
signal processor chips compress and decompress voice, data and fax
communications. This enables these communications to be sent from
circuit-switched telephone networks to packet networks. Our chips are digital
signal processors on which we have embedded our algorithms. These signal
processor chips are the basic building blocks used by our customers and us to
enable their products to transmit voice, fax and data over packet networks.
These chips may be incorporated into our communications boards, media gateway
modules and analog media gateways for access and enterprise applications or they
may be purchased separately and incorporated into other boards or customer
products.
VoIP
Communication Boards
Our
communications boards are designed to operate in gateways connecting the
circuit-switched telephone network to packet networks based on Internet
protocols. Our boards comply with voice over IP industry standards and allow for
interoperability with other gateways. Our boards support standards-based open
telecommunications architecture systems and combine our signal processor chips
with communications software, signaling software and proprietary hardware
architecture to provide a cost efficient interoperable solution for high
capacity gateways. We believe that using open architecture permits our customers
to bring their systems to market quickly and to integrate our products more
easily within their systems.
IPmediaTM Boards
and Servers for Enhanced Services and Functionalities such as Conferencing,
Video Sharing and Messaging (IPmediaTM
Platforms)
The
IPmediaTM product
family is designed to allow OEMs and application partners to provide
sophisticated content and services that create revenue streams and customer
loyalty through the ability to provide additional services. The IPmediaTM
platform provides voice, video and fax processing capabilities to enable,
together with our partners, an architecture for development and deployment of
enhanced services.
IPmediaTM
platforms are designed to answer the growing market demand for enhanced voice
and video services over packet networks, particularly network-based applications
like unified communications, call recording, conferencing and video sharing by
carriers and application service providers. IPmediaTM enables
our customers to develop and market applications such as: unified
communications, interactive voice response, call-centers, conferencing and
voice-activated personal assistants. IPmediaTM
products are currently offered on our PCI and cCPI boards and on the 2000, 3000,
5000 and 8000 series (IPmediaTM 2000,
IPmediaTM 3000,
IPmediaTM 5000
and IPmediaTM
8000).
Voice
and Data Logging Hardware Integration Board Products
The
SmartWORKSTM family of products is our voice and data logging hardware
integration board product line. SmartWORKSTM boards for the call recording and
voice voice/data logging industry are compatible with a multitude of private
branch exchange, or PBX, telephone system integrations.
Core
Technologies
We
believe that one of our key competitive advantages is our broad base of core
technologies ranging from advanced voice compression algorithms to complex
architecture system design. We have developed and continue to build on a number
of key technology areas. We have named our cross platform core technology
VoIPerfect™. It essentially allows us to leverage the same feature set and
interoperability with other products across our product lines.
Low
Bit Rate Voice Compression Algorithms
Voice
compression techniques are essential for the transmission of voice over limited
bandwidth packet networks. Voice compression exploits redundancies within a
voice signal to reduce the bit rate required to digitally represent the voice
signal, from 64 kilobits per second, or kbps, down to low bit rates ranging from
5.3 kbps to 8 kbps, while still maintaining acceptable voice quality. A bit is a
unit of data. Different voice compression algorithms, or coders, make certain
tradeoffs between voice quality, bit rate, delay and complexity to satisfy
various network requirements. Use of voice activity detection techniques and
silence removal techniques further reduce the transmission rate by detecting the
silence periods embedded in the voice flow and discarding the information
packets which do not contribute to voice intelligibility.
We
are one of the innovators in developing low bit rate voice compression
technologies. Our patented MP-MLQTM coder was adopted in 1995 by the ITU as the
basis for the G.723.1 voice coding standard for audio/visual applications over
the circuit-switched telephone networks. By adhering to this standard, system
manufacturers guarantee the interoperability of their equipment with the
equipment of other vendors.
Advanced
Digital Signal Processing Algorithms
To
provide a complete voice over packet communications solution, we have developed
a library of digital signal processing functions designed to complement voice
compression coders with additional functionality, including: echo cancellation;
voice activity detection; facsimile and data modem processing; and telephony
signaling processing. Our extensive experience and expertise in designing
advanced digital signal processing solutions allows us to implement algorithms
using minimal processing memory and power resources. Our algorithms
include:
Echo
cancellation. Low bit rate voice compression techniques introduce
considerable delay, necessitating the use of echo cancellation algorithms. The
key performance criterion of an echo canceller is its ability to deal with large
echo reflections, long echo delays, fast changing echo characteristics, diverse
telecommunications equipment and network effects. Our technology achieves low
residual echo and fast response time to render echo effects virtually
unnoticeable.
Fax
transmission. There are two widely used techniques for real time
transmission of fax over networks based on Internet protocols: fax relay and fax
spoofing. Fax relay takes place when a fax is sent from a fax machine through a
gateway over networks based on Internet protocols in real time to a fax machine
at the other end of the network. At the gateway, the analog fax signals are
demodulated back into digital data, converted into packets, routed over the
packet network and reassembled at the receiving end. Fax relay is used when the
round trip network delay is small (typically below one second). When the round
trip network delay increases, one of the fax machines may time out while waiting
for a response from the other fax machine to arrive.
Data
modem technology. We have developed data modem technologies that
facilitate data relay over packet networks. Our data modem relay software
algorithms support all existing data modem standards up to a bit rate of 14.4
kbps.
Telephony
signaling processing. Various telephony signaling standards and protocols
are employed to route calls over the traditional telephone network, some of
which use “in-band” methods, which means that the signaling tones are sent over
the telephone line just like the voice signal. As a result, in-band signaling
tones may have to undergo the compression process just like the voice signal.
Most low bit-rate voice coders, however, are optimized for speech signals and
exhibit poor tone transfer performance. To overcome this, our processors are
equipped with tone detection and tone generation algorithms. To provide seamless
transparency between the traditional telephone network and packet networks for
signaling, we employ various digital signal processing techniques for efficient
tone processing.
Voice
Communications Software
To
transmit the compressed voice and fax over packet networks, voice packetization
processes are required to construct and deconstruct each packet of data for
transmission. The processing involves breaking up information into packets and
adding address and control fields information according to the specifications of
the appropriate packet network protocol. In addition, the software provides the
interface with the signal processors and addresses packet delay and packet loss
issues.
Media
Processing
Our
media processing products provide the enabling technology and platforms for
developing enhanced voice and video service applications for legacy and next
generation networks. We have developed media processing technologies such as
message recording/playback, announcements, voice and video coding and mixing and
call progress tone detection that enable our customers to develop and offer
advanced revenue generating services such as conferencing, network
announcements, voice and video mail, video share and interactive voice
response.
Our
media processing technology is integrated into our enabling technology platforms
like Voice over Packet processors and VoIP blades, as well as into our network
platforms like the Mediant media gateways and the IPMedia media servers. The
same technology is also integrated into our multi-service business gateways,
enabling the use of these platforms to run third party VoIP software, offloading
media processing from the host CPU.
Digital
Cellular Communications Technology
Convergence
of wireline and wireless networks is becoming a key driver for deployment of
voice over packet networks, enabling operators to use common equipment for both
networks, thus lowering capital expenditures and operating expenses, while
offering enriched services.
Our
voice over packet products provide a cost effective solution for these
convergence needs, complying with 2G and 3G cellular standards, for GSM/UMTS,
UMA, Femtocell and CDMA/CDMA2000 networks. These include support for cellular
vocoders (concurrently with wireline vocoders), interfaces and protocols. These
interfaces and protocols are being defined by special standardization groups
(e.g., 3GPP and 3GPP2) and include capabilities such as mediation (mobile to
mobile calls with no transcoding), support for handoff and lawful intercept and
various other cellular-specific capabilities.
VoIP
for Telephony over Cable Networks
Telephony
over cable networks is characterized by technical challenges due to the
intrinsic nature of the cable system which broadcasts across the subscriber
network. The cable telephony market is divided into two main standards:
softswitch solutions and IP access terminal, or IPAT, V5.2 solutions utilizing
Class 5 switches. We have developed media gateway technology that is capable of
supporting both standards while migration from IPAT solutions to softswitch
solutions may be done by a software only upgrade, thus protecting the end
customer’s investment. Our technology complies with PacketCable standards
including security/encryption technology, support for quality of service, call
control and signaling.
Hardware
Architectures for Dense Multi-Trunk Voice over Packet Systems
Our
voice over packet product offerings include high density, multi-trunk voice over
packet systems for standards-based open telecommunications platforms in access
equipment. Multi-trunk processing is centered around a design encompassing two
key processing elements, signal processors performing voice, fax and data
processing and a communications processor. Overall system performance,
reliability, capacity, size, cost and power consumption are optimized, based on
our hardware architecture, which supports high throughput rates for multi-trunk
processing. On-board efficient network and system interfaces relieve the system
controller from extensive real time data transfer and processing of data
streams.
Carrier
Grade System Expertise
To
provide state of the art carrier grade media gateways, we have developed a wide
expertise in a number of fields essential to such a product line. We have
developed or integrated the various components required to implement a full
digital media gateway solution that behaves as a unified entity to the external
world. This required a major investment in adapting standard cPCI platforms to
our needs. Such adaptation included optimizing power supply and cooling
requirements, adding centralized shelf controllers, fabric switches and alarm
cards to the chassis. Another aspect of the expertise we developed relates to
high availability software and hardware design. High availability is a required
feature in any carrier grade media gateway platform. We have also developed a
sophisticated EMS to complete our offering. Our EMS enables the user to
provision and monitor a number of media gateways from a centralized
location.
Customers
Our
customers consist of service providers and channels (such as distributors),
OEMs, network equipment providers and systems integrators. Historically, we have
derived the majority of our revenues from sales to a small number of customers.
The identities of our principal customers have changed and we expect that they
will continue to change, from year to year. We expect that a small number of
customers will continue to account for a large percentage of our sales. Sales to
Nortel Networks accounted for 15.2% of our revenues in 2006, 17.0% of our
revenues in 2007 and 14.4% of our revenues in 2008. No other customer accounted
for more than 10.0% of our revenues in 2006, 2007 or 2008. As a result of the
bankruptcy filing by Nortel in January 2009, we cannot be sure as to the amount
of revenues we will record in 2009 from sales to Nortel.
Sales
and Marketing
Our
sales and marketing strategy is to secure the leading channels and system
integrators in each region, partner with leading application companies and
achieve design wins with network equipment providers in our targeted markets.
Prospective customers and channels generally must make a significant commitment
of resources to test and evaluate our products and to integrate them into larger
systems, networks, and applications. As a result, our sales process is often
subject to delays associated with lengthy approval processes that typically
accompany the design and testing of new communications equipment. For these
reasons, the sales cycles of our products to new customers are often lengthy,
averaging approximately six to twelve months after achieving a design win. This
time may be further extended because of internal testing, field trials and
requests for the addition or customization of features.
We
also provide our customers with reference platform designs, which enable them to
achieve easier and faster transitions from the initial prototype designs we use
in the test trials through final production releases. We believe this
significantly enhances our customers’ confidence that our products will meet
their market requirements and product introduction schedules.
We
market our products in the United States, Europe, Asia, Latin America and Israel
primarily through a direct sales force. We have invested significant resources
in setting up local sales forces giving us a presence in relevant markets. We
have given particular emphasis to emerging markets such as Latin America and
Eastern Europe in addition to continuing to sell our products in developed
countries.
Marketing
managers are dedicated to principal customers to promote close cooperation and
communication. Additionally, we market our products in these areas through
independent sales representatives and system integrators. We select these
independent entities based on their ability to provide effective field sales,
marketing communications and technical support to our customers. We have
generally entered into a combination of exclusive and non-exclusive sales
representation agreements with these representatives in each of the major
countries in which we do business. These agreements are typically for renewable
12-month terms, are terminable at will by us upon 90 days notice, and do not
commit the sales representative to any minimum sales of our products to third
parties. Some of our representatives have the ability to return some of the
products they have previously purchased and purchase more up to date
models.
Manufacturing
Texas
Instruments Incorporated supplies all of the signal processor chips used for our
signal processors. Other components are generic in nature and we believe they
can be obtained from multiple suppliers.
We
have not entered into any long-term supply agreements. However, we have worked
for years in several countries with established global manufacturing leaders
such as Flextronics and have a good experience with their level of commitment
and ability to deliver. To date, we have been able to obtain sufficient amounts
of these components to meet our needs and do not foresee any supply difficulty
in obtaining timely delivery of any parts or components. However, an
interruption in supply from any of these sources, especially with regard to
signal processors from Texas Instruments Incorporated, or an unexpected
termination of the manufacture of certain electronic components, could disrupt
production, thereby adversely affecting our results. We generally maintain an
inventory of critical components used in the manufacture and assembly of our
products although our inventory of signal processor chips would likely not be
sufficient in the event that we had to engage an alternate supplier for these
components.
We
utilize contract manufacturing for substantially all of our manufacturing
processes. Most of our manufacturing is carried out by third-party
subcontractors in Israel and China. We have extended our manufacturing
capabilities through third party subcontractors in the United States and Mexico.
Our internal manufacturing activities consist primarily of the production of
prototypes, test engineering, materials purchasing and inspection, final product
configuration and quality control and assurance.
We
are obligated under certain agreements with our suppliers to purchase goods and
under an agreement with one of our manufacturing subcontractors to purchase
excess inventory. Aggregate non-cancellable obligations under these
agreements as of December 31, 2008 were approximately $2.3 million.
Industry
Standards and Government Regulations
Our
products must comply with industry standards relating to telecommunications
equipment. Before completing sales in a country, our products must
comply with local telecommunications standards, recommendations of
quasi-regulatory authorities and recommendations of standards-setting
committees. In addition, public carriers require that equipment connected to
their networks comply with their own standards. Telecommunication-related
policies and regulations are continuously reviewed by governmental and industry
standards-setting organizations and are always subject to amendment or change.
Although we believe that our products currently meet applicable industry and
government standards, we cannot be sure that our products will comply with
future standards.
We
are subject to telecom industry regulations and requirements set by
telecommunication carriers that address a wide range of areas including quality,
final testing, safety, packaging and use of environmentally friendly
components. We comply with the European Union’s Restriction of
Hazardous Substances Directive (under certain exemptions) that requires telecom
equipment suppliers to stop the usage of some materials that are not
environmentally friendly by July 1, 2006. These materials include
cadmium, hexavalent chromium, lead, mercury, polybrominated biphenyls and
polybrominatel diphenyl ethers. Under the directive, an extension for compliance
through 2010 was granted with respect to the usage of lead in solders in Network
Infrastructure equipment. We expect that other countries, including countries we
operate in, will adopt similar directives or other additional
regulations.
Competition
Competition
in our industry is intense and we expect competition to increase in the future.
Our competitors currently sell products that provide similar benefits to those
that we sell. There has been a significant amount of merger and acquisition
activity and strategic alliances frequently involving major telecommunications
equipment manufacturers acquiring smaller companies, and we expect that this
will result in an increasing concentration of market share among these
companies, many of whom are our customers.
Our
principal competitors in the area of analog media gateways (2 to 24 ports) for
access and enterprise are Cisco Systems Inc., Mediatrix Telecom, Inc., Vega
Stream Limited, Samsung, Innovaphone AG, Net.com/Quintum Technologies, Tainet
Communication System Corp., Welltech, Ascii Corp., D-Link Systems, Inc.,
Multitech Inc., Inomedia, OKI and LG. In addition we face competition in low,
mid and high density gateways from internal development at companies such as
Nortel, Alcatel-Lucent, Nokia-Siemens, Huawei, Ericsson, UTstarcom, ZTE and from
Cisco Systems, Veraz Networks, Sonus Networks, General Bandwidth,
Dialogic/Cantata Technologies and Commatch (Telrad).
Our
principal competitors in the media server market segment are Dialogic/Cantata
Technology, NMS Communications, Convedia/Radisys, IP Unity/Glenayre,
Cognitronics and Aculab. In addition, we face competition in
software-based and hardware-based media servers from internal development at
companies such as Hewlett-Packard, Comverse-NetCentrex, Nortel, Alcatel -
Lucent, Nokia-Siemens and Ericsson.
With
respect to session border controllers, we compete against Acme Packets,
Nextpoint, Covergence and Sonus. In the security gateway market, we
compete against companies such as GenBand, ACME Packets, Clavister and
NEC.
Our
principal competitors in the sale of signal processing chips are Texas
Instruments, Broadcom, Infineon, Centillium, Surf and Mindspeed. Several large
manufacturers of generic signal processors, such as Motorola, Agere Systems,
which merged with LSI Corporation in April 2007, and Intel have begun, or are
expected to begin marketing competing processors. Our principal competitors in
the communications board market are NMS Communications, Intel, Motorola, Cantata
Technology, Acculab and PIKA Technologies, Inc.
We
also face significant and increasing competition in the market for products
utilized in the VoIP market. Our competitors in the market for VolP products
include telecommunications companies, data communication companies and companies
specializing in voice over IP products, some of which have greater name
recognition, larger installed customer bases and significantly greater
financial, technical, sales and marketing resources than we do.
Many
of our competitors have the ability to offer vendor-sponsored financing programs
to prospective customers. Some of our competitors with broad product portfolios
may also be able to offer lower prices on products that compete with ours
because of their ability to recoup a loss of margin through sales of other
products or services. Additionally, voice, audio and other communications
alternatives that compete with our products are being continually
introduced.
In
the future, we may also develop and introduce other products with new or
additional telecommunications capabilities or services. As a result, we may
compete directly with telephone companies and other telecommunications
infrastructure providers. Additional competitors may include companies that
currently provide computer software products and services, such as telephone,
media, publishing and cable television. The ability of some of our competitors
to bundle other enhanced services or complete solutions with VoIP products could
give these competitors an advantage over us.
Intellectual
Property and Proprietary Rights
Our
success is dependent in part upon proprietary technology. We rely primarily on a
combination of patent, copyright and trade secret laws, as well as
confidentiality procedures and contractual provisions, to protect our
proprietary rights. We also rely on trademark protection concerning various
names and marks that serve to identify it and our products. While our ability to
compete may be affected by our ability to protect our intellectual property, we
believe that, because of the rapid pace of technological change in our industry,
maintaining our technological leadership and our comprehensive familiarity with
all aspects of the technology contained in our signal processors and
communication boards is also of primary importance.
We
own U.S. patents that relate to our voice compression and session border control
technologies. We also actively pursue patent protection in selected other
countries of interest to us. In addition to patent protection, we seek to
protect our proprietary rights through copyright protection and through
restrictions on access to our trade secrets and other proprietary information
which we impose through confidentiality agreements with our customers,
suppliers, employees and consultants.
There
are a number of companies besides us who hold or may acquire patents for various
aspects of the technology incorporated in the ITU’s standards or other industry
standards or proprietary standards, for example, in the fields of wireless and
cable. While we have obtained cross-licenses from some of the holders of these
other patents, we have not obtained a license from all of the holders. The
holders of these other patents from whom we have not obtained licenses may take
the position that we are required to obtain a license from them. Companies that
have submitted their technology to the ITU (and generally other industry
standards making bodies) for adoption as an industry standard are required by
the ITU to undertake to agree to provide licenses to that technology on
reasonable terms. Accordingly, we believe that even if we were required to
negotiate a license for the use of such technology, we would be able to do so at
an acceptable price. Similarly, however, third parties who also participate with
respect to the same standards-setting organizations as do we may be able to
negotiate a license for use of our proprietary technology at a price acceptable
to them, but which may be lower than the price we would otherwise prefer to
demand.
Under
a pooling agreement dated March 3, 1995, as amended, between AudioCodes and DSP
Group, Inc., on the one hand, and France Telecom, Université de Sherbrooke and
their agent, Sipro Lab Telecom, on the other hand, we and DSP Group, Inc.
granted to France Telecom and Université de Sherbrooke the right to use certain
of our specified patents, and any other of our and DSP Group, Inc. intellectual
property rights incorporated in the ITU G.723.1 standard. Likewise France
Telecom and Université de Sherbrooke granted AudioCodes and DSP Group, Inc. the
right to use certain of their patents and any other intellectual property rights
incorporated in the G.723.1 standard. In each case, the rights granted are to
design, make and use products developed or manufactured for joint contribution
to the G.723.1 standard without any payment by any party to the other
parties.
In
addition, each of the parties to the agreement granted to the other parties the
right to license to third parties the patents of any party included in the
intellectual property required to meet the G.723.1 standard, in accordance with
each licensing party’s standard patent licensing agreement. The agreement
provides for the fee structure for licensing to third parties. The agreement
provides that certain technical information be shared among the parties, and
each of the groups agreed not to assert any patent rights against the other with
respect of the authorized use of voice compression products based upon the
technical information transferred. Licensing by any of the parties of the
parties’ intellectual property incorporated in the G.723.1 standard to third
parties is subject to royalties that are specified under the
agreement.
Each
of the parties to the agreement is free to develop and sell products embodying
the intellectual property incorporated into the G.723.1 standard without payment
of royalties to other parties, so long as the G.723.1 standard is implemented as
is, without modification. The agreement expires upon the last expiration date of
any of the AudioCodes, DSP Group, Inc., France Telecom or Université de
Sherbrooke patents incorporated in the G.723.1 standard. The parties to the
agreement are not the only claimants to technology underlying the G.723.1
standard.
We
are aware of parties who may be infringing our technology that is part of the
G.723.1 standard. We evaluate these matters on a case by case basis, directly or
through our licensing partner. Although we have not yet determined whether to
pursue legal action, we may do so in the future. There can be no assurance that
any legal action will be successful.
Third
parties have claimed, and from time to time in the future may claim, that our
past, current or future products infringe their intellectual property rights.
Intellectual property litigation is complex and there can be no assurance of a
favorable outcome of any litigation. Any future intellectual property
litigation, regardless of outcome, could result in substantial expense to us and
significant diversion of the efforts of our technical and management personnel.
Litigation could also disrupt or otherwise severely impact our relationships
with current and potential customers as well as our manufacturing, distribution
and sales operations in countries where relevant third party rights are held and
where we may be subject to jurisdiction. An adverse determination in any
proceeding could subject us to significant liabilities to third parties, require
disputed rights to be licensed from such parties, assuming licenses to such
rights could be obtained, or require us to cease using such technology and
expend significant resources to develop non-infringing technology. We may not be
able to obtain a license at an acceptable price.
We
have entered into technology licensing fee agreements with third parties. We
expect that in the ordinary course of business we may be required to enter into
additional licensing agreements. Under one agreement, we agreed to pay a third
party royalty fees until 2008, based on 0.75% - 0.9% of our revenues. We are no
longer required to pay licensing fees under this agreement in 2009.
Legal
Proceedings
We
are not a party to any material legal proceedings, except for the proceeding
referred to below.
Prior
to the acquisition of Nuera by us in 2006, one of Nuera’s customers had been
named as a defendant in a patent infringement suit involving technology the
customer purchased from Nuera. In the suit, the plaintiff alleged that the
customer used devices to offer services that infringe upon a patent the
plaintiff owns. The customer has sought indemnification from Nuera pursuant to
the terms of a purchase agreement between Nuera and the customer relating to the
allegedly infringing technology at issue.
|
|
C.
|
ORGANIZATIONAL
STRUCTURE
|
List
of Significant Subsidiaries
AudioCodes
Inc., our wholly-owned subsidiary, is a Delaware corporation.
AudioCodes
UK Limited and AudioCodes Europe Limited, our wholly-owned subsidiaries, are
incorporated in England.
|
|
D.
|
PROPERTY,
PLANTS AND EQUIPMENT
|
We
lease our main facilities, located in Airport City, Lod, Israel, which occupy
approximately 128,000 square feet for annual lease payments (including
management fees) of approximately $2.6 million. In January 2008, we increased
the amount of space we lease by approximately 74,000 square feet for annual
lease payments (including management fees) of approximately $1.4 million. In
addition, we have entered into an agreement with Airport City, Ltd. regarding
the neighboring property pursuant to which a building of approximately 145,000
square feet will be erected and leased to us for period of eleven years. This
new building is expected to be completed in 2010. We estimate the annual lease
payments (including management fees) to be in the range of $2.0 million to $3.2
million, depending on the amount expended by the lessor on improvements to the
building. In view of current economic conditions and our reduction in personnel
undertaken in 2008, we may not need to occupy the entire building and may seek
to sublease all or a portion of the new building to third
parties.
Our
U.S. subsidiary, AudioCodes Inc., leases a 7,000 square foot facility in San
Jose, California, and has additional offices with aggregate leased space of
20,000 square feet in Raleigh, Chicago, Boston and Dallas. AudioCodes Inc. also
leases a 32,000 square foot facility in Somerset, New Jersey, a 20,000 square
foot facility in San Diego, California, and a 20,000 square foot facility in
Plano, Texas. The annual lease payments (including management fees) for all our
offices in the United States is approximately $1.5 million.
We
believe that these properties are sufficient to meet our current needs. However,
we may need to increase the size of our current facilities, seek new facilities,
close certain facilities or sublease portions of our existing facilities in
order to address our needs in the future.
|
|
|
|
ITEM
4A. UNRESOLVED
STAFF
COMMENTS
|
None.
|
|
|
|
ITEM
5. OPERATING AND FINANCIAL REVIEW AND
PROSPECTS
|
Statements
in this Annual Report concerning our business outlook or future economic
performance; anticipated revenues, expenses or other financial items; product
introductions and 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 that term is
defined under the United States Federal securities laws. Forward-looking
statements are subject to various risks, uncertainties and other factors that
could cause actual results to differ materially from those stated in such
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those set forth under “Risk Factors” in this Annual
Report, as well as those discussed elsewhere in this Annual Report and in our
other filings with the Securities and Exchange Commission.
Critical
Accounting Policies and Estimates
Our
consolidated financial statements are prepared in accordance with U.S. generally
accepted accounting principles, or U.S. GAAP. These accounting principles
require management to make certain estimates, judgments and assumptions based
upon information available at the time that they are made, historical experience
and various other factors that are believed to be reasonable under the
circumstances. These estimates, judgments and assumptions can affect the
reported amounts of assets and liabilities as of the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
periods presented.
On
an on-going basis, management evaluates its estimates and judgments, including
those related to revenue recognition and allowance for sales returns, allowance
for doubtful accounts, inventories, marketable securities, business
combinations, goodwill and intangible assets, income taxes and valuation
allowance, and stock-based compensation. Management bases its estimates and
judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources.
Our
management has reviewed these critical accounting policies and related
disclosures with our Audit Committee. See Note 2 to the Consolidated Financial
Statements, which contain additional information regarding our accounting
policies and other disclosures required by US GAAP.
Management
believes the significant accounting policies that affect its more significant
judgments and estimates used in the preparation of its consolidated financial
statements and are the most critical to aid in fully understanding and
evaluating AudioCodes’ reported financial results include the
following:
|
|
|
|
●
|
Revenue
recognition and allowance for sales returns;
|
|
|
|
|
●
|
Allowance
for doubtful accounts;
|
|
|
|
|
●
|
Inventories;
|
|
|
|
|
●
|
Marketable
securities;
|
|
|
|
|
●
|
Intangible
assets;
|
|
|
|
|
●
|
Goodwill;
|
|
|
|
|
●
|
Income
taxes and valuation allowance;
|
|
|
|
|
●
|
Stock-based
compensation; and
|
|
|
|
|
●
|
Senior
convertible notes
|
Revenue
Recognition and Allowance for Sales Returns
We
generate our revenues primarily from the sale of products. We sell our products
through a direct sales force and sales representatives. Our customers include
original equipment manufacturers (OEMs), network equipment providers, systems
integrators and distributors in the telecommunications and networking
industries, all of whom are considered end users.
Revenues
from products are recognized in accordance with Staff Accounting Bulleting
(“SAB”) No. 104, “Revenue Recognition in Financial Statements” when the
following criteria are met: (i) persuasive evidence of an arrangement exists,
(ii) delivery of the product has occurred, (iii) the fee is fixed or
determinable and (iv) collectability is probable. We have no obligation to
customers after the date on which products are delivered, other than pursuant to
warranty obligations and any applicable right of return. We grant to some of our
customers the right of return or the ability to exchange a specific percentage
of the total price paid for products they have purchased over a limited period
for other products.
We
maintain a provision for product returns and exchanges. This provision is based
on historical sales returns, analysis of credit memo data and other known
factors. This provision amounted to $636,000 in 2006, $559,000 in 2007 and
$754,000 in 2008.
Revenues
from the sale of products which were not yet determined to be final sales due to
market acceptance or technological compatibility were deferred and included in
deferred revenues. In cases where collectability is not probable, revenues are
deferred and recognized upon collection. Revenues from services are recognized
ratably over the time of the service agreement, usually one year.
Allowance
for Doubtful Accounts
Our
trade receivables are derived from sales to customers located primarily in the
Americas, the Far East, Israel and Europe. We perform ongoing credit evaluations
of our customers and to date have not experienced any material losses from
uncollected receivables. An allowance for doubtful accounts is determined with
respect to those amounts that we have recognized as revenue and determined to be
doubtful of collection. We usually do not require collateral on trade
receivables because most of our sales are to large and well-established
companies. On occasion we may purchase credit insurance to cover credit exposure
for a portion of our sales and this may mitigate the amount we need to write off
as a result of doubtful collections.
Inventories
Inventories
are stated at the lower of cost or market value. Cost is determined using the
“moving average cost” method for raw materials and on the basis of direct
manufacturing costs for finished products. We periodically evaluate the
quantities on hand relative to current and historical selling prices and
historical and projected sales volume and technological obsolescence. Based on
these evaluations, inventory write-offs are provided to cover risks arising from
slow moving items, technological obsolescence, excess inventories, discontinued
products and for market prices lower than cost. We wrote-off inventory in a
total amount of $1.9 million in 2006, $700,000 in 2007 and $1.2 million in
2008.
Marketable
Securities
We
account for investments in marketable debt securities in accordance with SFAS
No. 115, “Accounting for Certain Investments in Debt and Equity Securities”
(“SFAS 115”). Management determines the appropriate classification of its
investments in marketable debt securities at the time of purchase and
reevaluates such determinations at each balance sheet date. Debt securities are
classified as held-to-maturity since we have the intent and the ability to hold
the securities to maturity. Accordingly, debt securities are stated at amortized
cost.
The
amortized cost of held-to-maturity securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Any amortization and interest
is included in the consolidated statement of income as financial income or
expense, as appropriate. The accrued interest on short-term and long-term
marketable securities is included in the balance of short-term marketable
securities.
Intangible
assets
As
a result of our acquisitions, our balance sheet included acquired intangible
assets, in the aggregate amount of approximately $19.0 million as of December
31, 2007 and $9.1 million as of December 31, 2008.
We
allocated the purchase price of the companies we have acquired to the tangible
and intangible assets acquired and liabilities assumed, based on their estimated
fair values. These valuations require management to make significant estimations
and assumptions, especially with respect to intangible assets. Critical
estimates in valuing intangible assets include future expected cash flows from
technology acquired, trade names, backlog and customer relationships. In
addition, other factors considered are the brand awareness and market position
of the products sold by the acquired companies and assumptions about the period
of time the brand will continue to be used in the combined company’s product
portfolio. Management’s estimates of fair value are based on assumptions
believed to be reasonable, but which are inherently uncertain and
unpredictable.
If
we did not appropriately allocate these components or we incorrectly estimate
the useful lives of these components, our computation of amortization expense
may not appropriately reflect the actual impact of these costs over future
periods, which will affect our net income.
Intangible
assets are reviewed for impairment in accordance with SFAS No. 144,
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. The loss is allocated to the intangible assets on a pro rata basis
using the relative carrying amounts of those assets, except that the loss
allocated to an individual intangible asset shall not reduce the carrying amount
of that asset below its fair value whenever that fair value is
determinable.
Our
intangible assets are comprised of acquired technology, customer relations,
trade names, existing contracts for maintenance and backlog. All intangible
assets are amortized using the straight-line method over their estimated useful
life.
During
2006 and 2007, no impairment charges were identified. During 2008, we recorded
an impairment charge for intangible assets in the amount of $5.9 million
(relating to the acquisition of Nuera).
Goodwill
As
a result of our acquisitions, our balance sheet included acquired goodwill, in
the aggregate amount of approximately $111.2 million as of December 31, 2007 and
$32.1 million as of December 31, 2008.
SFAS
No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) requires that
goodwill and intangible assets with an indefinite life be tested for impairment
at least annually. Goodwill and intangible assets with an indefinite life are
required to be written down when impaired, rather than amortized as previous
accounting standards required. Goodwill and intangible assets with an indefinite
life are tested for impairment by comparing the fair value of the reporting unit
with its carrying value. Fair value is generally determined using discounted
cash flows, market multiples and market capitalization. Significant estimates
used in the fair value methodologies include estimates of future cash flows,
future short-term and long-term growth rates, weighted average cost of capital
and estimates of market multiples of the reportable unit. If these estimates or
their related assumptions change in the future, we may be required to record
impairment charges for our goodwill and intangible assets with an indefinite
life. Our annual impairment test is performed in the fourth quarter each
year.
The
process of evaluating the potential impairment of goodwill is subjective and
requires significant judgment at many points during the analysis. In estimating
the fair value of a reporting unit for the purposes of our annual or periodic
analyses, we make estimates and judgments about the future cash flows of that
reporting unit. Although our cash flow forecasts are based on assumptions that
are consistent with our plans and estimates we are using to manage the
underlying businesses, there is significant exercise of judgment involved in
determining the cash flows attributable to a reporting unit over its estimated
remaining useful life. In addition, we make certain judgments about allocating
shared assets to the estimated balance sheets of our reporting units. We also
consider our and our competitor’s market capitalizations on the date we perform
the analysis. Changes in judgment on these assumptions and estimates could
result in a goodwill impairment charge.
Goodwill
represents the excess of the purchase price and related costs over the value
assigned to net tangible and identifiable intangible assets of businesses
acquired and accounted for under the purchase method. We review and test our
goodwill for impairment at the reporting unit level at least annually, or more
frequently if events or changes in circumstances indicate that the carrying
amount of such assets may be impaired. We operate in one operating segment, and
this segment comprises our only reporting unit. We perform our test in the
fourth quarter of each year using a combination of a discounted cash flow
analysis and a market approach. The discounted cash flow approach requires that
certain assumptions and estimates be made regarding industry economic factors
and future profitability. The market approach estimates the fair value based on
comparisons with the market values and market multiples of earnings and revenues
of similar public companies. The fair value derived from these two methodologies
are then compared to the carrying value of the respective segments.
During
2006 and 2007, no impairment charges were identified. As a result of the
impairment analysis for 2008, we determined that the goodwill balance was
impaired as a result of adverse equity market conditions which caused a decline
in industry market multiples and reduced fair values from our projected cash
flows. Accordingly, we recorded non-cash impairment charges of $ 79.1
million.
Income
Taxes and Valuation Allowance
As
part of the process of preparing our consolidated financial statements, we are
required to estimate our income tax expense in each of the jurisdictions in
which we operate. This process involves us estimating our actual current tax
exposure, which is accrued as taxes payable, together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets, which are included
within our consolidated balance sheet. We may record a valuation allowance to
reduce our deferred tax assets to the amount of future tax benefit that is more
likely than not to be realized.
Although
we believe that our estimates are reasonable, there is no assurance that the
final tax outcome and the valuation allowance will not be different than those
which are reflected in our historical income tax provisions and
accruals.
We
have filed or are in the process of filing federal, state and foreign tax
returns that are subject to audit by the respective tax authorities. Although
the ultimate outcome is unknown, we believe that adequate amounts have been
provided for and any adjustments that may result from tax return audits are not
likely to materially adversely affect our consolidated results of operations,
financial condition or cash flows.
In
June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income
Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48
clarifies the accounting for uncertainty in income taxes recognized under SFAS
No. 109. FIN 48 prescribes a recognition threshold and measurement
attribute for financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return and also provides guidance on
various related matters such as derecognition, interest and penalties, and
disclosure. On January 1, 2007, we adopted FIN 48. The initial application
of FIN 48 to our tax position did not have a material effect on ourshareholders’
equity. We recognize interest and penalties, if any, related to unrecognized tax
benefits in tax expenses.
Stock-based
compensation
We
account for stock-based compensation in accordance with Statement of Financial
Accounting Statements Standards No. 123R-”Share-Based Payments”. We utilize the
Black-Scholes option pricing model to estimate the fair value of stock-based
compensation at the date of grant. The Black-Scholes model requires subjective
assumptions regarding dividend yields, expected volatility, expected life of
options and risk-free interest rates. These assumptions reflect management’s
best estimates. Changes in these inputs and assumptions can materially affect
the estimate of fair value and the amount of our stock-based compensation
expenses. We recognized $8.0 million of stock-based compensation expense in 2007
and $4.3 million of stock-based compensation expense in 2008. As of December 31,
2008, there was approximately $2.9 million of total unrecognized stock-based
compensation expense related to non-vested stock-based compensation arrangements
granted by us. As of December 31, 2008, that expense is expected to be
recognized over a weighted-average period of 0.9 years.
Senior
convertible notes
We
presented the outstanding principal amount of our senior convertible notes as a
long-term liability, in accordance with APB No. 14, “Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants”. The debt is classified as a
long-term liability until the date of conversion on which it would be
reclassified to equity, or within one year of the first contractual redemption
date, on which it would be reclassified as a short-term liability. As the first
contractual redemption date is November 9, 2009, the senior convertible notes
have been classified as a current liability in our balance sheet as of December
31, 2009. Accrued interest on the senior convertible notes is included in “other
payables and accrued expenses.
The
initial purchasers discount was recorded as a discount to the debt and amortized
according to the interest method over the term of the senior convertible notes
in accordance with EITF Issue No. 00-27, “Application of Issue No. 98-5 to
Certain Convertible Industries”, which is 20 years.
You
should read this discussion with the consolidated financial statements and other
financial information included in this Annual Report.
Overview
We
design, develop and market enabling technologies and system products for the
transmission of voice, data, fax and multimedia communications over packet
networks, which we refer to as the new voice infrastructure. Our products enable
our customers to build high-quality packet networking equipment and network
solutions and provide the building blocks to connect traditional telephone
networks to the new voice infrastructure, as well as connecting and securing
multimedia communication between different packet-based networks. Our products
are sold primarily to leading original equipment manufacturers, or OEMs, system
integrators and network equipment providers in the telecommunications and
networking industries. We have continued to broaden our offerings, both from
internal development and through acquisitions, as we have expanded in the last
few years from selling chips to boards, subsystems, media gateway systems, media
servers, session border controllers and messaging platforms.
Our
headquarters and R&D facilities are located in Israel with R&D
extensions in the U.S. and in the U.K. We have other offices located in Europe,
the Far East, and Latin America.
Nortel
Networks accounted for 15.2% of our revenues in 2006, 17.0% of our revenues in
2007 and 14.4% of our revenues in 2008. Nortel filed for bankruptcy protection
in January 2009. As a result of Nortel’s bankruptcy filing, we could not
recognize $1.7 million of sales to Nortel in the fourth quarter of 2008. We
cannot determine the effect of such bankruptcy filing will have on our revenues
in 2009.
Our
top five customers accounted for 29.1% of our revenues in 2006, 32.8% of our
revenues in 2007 and 26.3% of our revenues in 2008. Based on our experience, we
expect that our largest customers may change from period to period. If we lose a
large customer and fail to add new customers to replace lost revenue our
operating results may be materially adversely affected.
Revenues
based on the location of our customers for the last three fiscal years are as
follows:
|
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
|
Americas
|
|
|
56.6
|
% |
|
|
56.6
|
% |
|
|
52.4
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Far
East
|
|
|
12.8 |
|
|
|
11.2 |
|
|
|
16.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Europe
|
|
|
22.2 |
|
|
|
25.5 |
|
|
|
23.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Israel
|
|
|
8.4 |
|
|
|
6.7 |
|
|
|
7.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
% |
|
|
100.0
|
% |
|
|
100.0
|
% |
Part
of our strategy over the past few years has involved the acquisition of
complementary businesses and technologies. We continued implementation of this
strategy with three additional acquisitions in the past three years. In July,
2006, we completed the acquisition of Nuera (merged into AudioCodes Inc. as of
December 31, 2007). Nuera provides Voice over Internet Protocol infrastructure
solutions for broadband and long distance networks.
In
August 2006, we acquired Netrake (merged into AudioCodes Inc. as of December 31,
2007), a provider of session border controller, or SBC, and security gateway
solutions. SBCs enable connectivity, policies and security for real-time media
sessions, such as VoIP, video or fax, between public or private IP networks.
Security gateways enable secure real-time sessions across wifi, broadband and
wireless networks in field mobile convergence deployments.
In
April 2007, we completed the acquisition of CTI Squared. CTI Squared is a
provider of enhanced messaging and communications platforms deployed globally by
service providers and enterprises. CTI Squared’s platforms integrate data and
voice messaging services over internet, intranet, PSTN, cellular, cable and
enterprise networks.
We
believe that prospective customers generally are required to make a significant
commitment of resources to test and evaluate our products and to integrate them
into their larger systems. As a result, our sales process is often subject to
delays associated with lengthy approval processes that typically accompany the
design and testing of new communications equipment. For these reasons, the sales
cycles of our products to new customers are often lengthy, averaging
approximately six to twelve months. As a result, we may incur significant
selling and product development expenses prior to generating revenues from
sales.
The
currency of the primary economic environment in which our operations are
conducted is the U.S. dollar, and as such, we use the dollar as our functional
currency. Transactions and balances originally denominated in dollars are
presented at their original amounts. All transaction gains and losses from the
remeasurement of monetary balance sheet items denominated in non-dollar
currencies are reflected in the statement of operations as financial income or
expenses, as appropriate.
The
demand for Voice over IP, or VoIP, technology has increased during recent years.
In recent years, the shift from traditional circuit-switched networks to next
generation packet-switched networks continued to gain momentum. As data traffic
becomes the dominant factor in communications, service providers are building
and maintaining converged networks for integrated voice and data services. In
developed countries, traditional and alternative service providers adopt bundled
triple play (voice, video and data) and quadruple play (voice, video, data and
mobile) offerings. This trend, enabled by voice and multimedia over IP, has
fueled competition among cable, wireline, ISP and mobile operators, increasing
the pressure for adopting and deploying VoIP networks. In addition,
underdeveloped markets without basic wire line service in countries such as
China and India and certain countries in Eastern Europe are adopting the use of
VoIP technology to deliver voice and data services that were previously
unavailable.
The
current economic and credit crisis is having a significant negative impact on
business around the world. The impact of this crisis on the technology industry
and our major customers has been severe. Conditions may continue to be depressed
or may be subject to further deterioration which could lead to a further
reduction in consumer and customer spending overall, which could have an adverse
impact on sales of our products. A disruption in the ability of our significant
customers to access liquidity could cause serious disruptions or an overall
deterioration of their businesses which could lead to a significant reduction in
their orders of our products and the inability or failure on their part to meet
their payment obligations to us, any of which could have a material adverse
effect on our results of operations and liquidity. In addition, any disruption
in the ability of customers to access liquidity could lead customers to request
longer payment terms from us or long-term financing of their purchases from us.
Granting extended payment terms or a significant adverse change in a customer’s
financial and/or credit position could also require us to assume greater credit
risk relating to that customer’s receivables or could limit our ability to
collect receivables related to purchases by that customer. As a result, our
reserves for doubtful accounts and write-offs of accounts receivable could
increase.
Results
of Operations
The
following table sets forth the percentage relationships of certain items from
our consolidated statements of operations, as a percentage of total revenues for
the periods indicated:
|
|
|
Year
Ended December 31,
|
|
|
|
|
|
2006
|
|
|
2007
|
|
|
2008
|
|
|
|
Statement
of Operations
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
100.0
|
% |
|
|
100.0
|
% |
|
|
100.0
|
% |
|
|
Cost
of revenues
|
|
|
41.6 |
|
|
|
43.7 |
|
|
|
44.3 |
|
|
|
Gross
profit
|
|
|
58.4 |
|
|
|
56.3 |
|
|
|
55.7 |
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development, net
|
|
|
24.0 |
|
|
|
25.7 |
|
|
|
21.6 |
|
|
|
Selling
and marketing
|
|
|
25.6 |
|
|
|
27.1 |
|
|
|
25.5 |
|
|
|
General
and administrative
|
|
|
5.9 |
|
|
|
6.1 |
|
|
|
5.3 |
|
|
|
Impairment
of goodwill and intangible assets
|
|
|
— |
|
|
|
— |
|
|
|
48.7 |
|
|
|
Total
operating expenses
|
|
|
55.5 |
|
|
|
58.9 |
|
|
|
101.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
2.9 |
|
|
|
(2.6
|
) |
|
|
(45.4
|
) |
|
|
Financial
income, net
|
|
|
2.6 |
|
|
|
1.7 |
|
|
|
0.7 |
|
|
|
Income
(loss) before taxes on income
|
|
|
5.5 |
|
|
|
(0.9
|
) |
|
|
(44.7
|
) |
|
|
Taxes
on income
|
|
|
0.2 |
|
|
|
0.8 |
|
|
|
0.3 |
|
|
|
Equity
in losses of affiliated companies, net
|
|
|
0.6 |
|
|
|
0.7 |
|
|
|
1.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
4.7
|
% |
|
|
(2.4 |
)% |
|
|
(46.5 |
)% |
|
Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007
Revenues.
Revenues increased 10.4% to $174.7 million in 2008 from $158.2 million in 2007.
The increase in revenues was primarily due to an increase in revenues from our
networking business.
Gross
Profit. Cost of revenues includes the manufacturing cost of hardware,
quality assurance, overhead related to manufacturing activity and technology
licensing fees payable to third parties. Gross profit increased to $97.3 million
in 2008 from $89.1 million in 2007. Gross profit as a percentage of revenues
decreased to 55.7% in 2008 from 56.3% in 2007. The decrease in our gross profit
percentage was primarily attributable to a less favorable product mix in 2008
and a decline in average selling prices of our products. The decrease in gross
profit percentage was partially offset by the higher sales volume that allowed
us to leverage our manufacturing overhead over a larger sales base as well as a
reduction in manufacturing costs due to a reduction in our raw material costs
and our cost reduction plan implemented in 2008.
Research
and Development Expenses, net. Research and development expenses, net
consist primarily of compensation and related costs of employees engaged in
ongoing research and development activities, development-related raw materials
and the cost of subcontractors less grants from the OCS. Research and
development expenses decreased 7.1% to $37.8 million in 2008, from $40.7 million
in 2007 and decreased as a percentage of revenues to 21.7% in 2008 from 25.7% in
2007. The decrease in net research and development expenses, both on an absolute
and a percentage basis, was primarily due to our cost reduction plans
implemented during 2007 and 2008 and due to a decrease in stock-based
compensation expense which amounted to $1.5 million in 2008 and $3.0 million in
2007. We expect that research and development expenses will decrease in an
absolute dollar basis in 2009 as a result of our continued cost reduction
plan.
Selling
and Marketing Expenses. Selling and marketing expenses consist primarily
of compensation for selling and marketing personnel, as well as exhibition,
travel and related expenses. Selling and marketing expenses increased 4.1% in
2008 to $44.7 million from $42.9 million in 2007. These expenses increased
because the effect of the higher value of the NIS compared to the U.S. dollar
increased the cost of expenses denominated in NIS and higher commissions on
sales were greater than the decrease in expenses as a result of our reduction in
personnel. As a percentage of revenues, selling and marketing expenses decreased
to 25.6% in 2008 from 27.1% in 2007. The decrease in selling and marketing
expenses on a percentage basis was primarily a result of our revenues increasing
at a faster rate than these expenses and due to a decrease in the stock-based
compensation expense included in selling and marketing expenses which was $2.0
million in 2008 compared to $3.5 million in 2007. We expect that selling and
marketing expenses will decrease on an absolute dollar basis in 2009 as a result
of our continued cost reduction plan, subject to any negative effects based on
the U.S. dollar/NIS exchange rate.
General
and Administrative Expenses. General and administrative expenses consist
primarily of compensation for finance, human resources, general management,
rent, network and bad debt reserve, as well as insurance and professional
services expenses. General and administrative expenses decreased 4.3% to $9.2
million in 2008 from $9.6 million in 2007. As a percentage of revenues, general
and administrative expenses decreased to 5.3% in 2008 from 6.1% in 2007. The
decrease in general and administrative expenses was primarily due to our cost
reduction plans implemented during 2007 and 2008. We expect that general and
administrative expenses will continue to decrease in absolute dollar terms as a
result of our continued cost reduction plan.
Impairment
of Goodwill and Intangible Assets. We review goodwill for impairment
annually during the fourth quarter of the fiscal year or more frequently if
events or circumstances indicate that an impairment loss may have occurred. In
the fourth quarter of fiscal 2008, in connection with the impact of weakening
market conditions on our forecasts and a sustained, significant decline in the
market capitalization to a level lower than our net book value, it was concluded
that triggering events existed and we were required to test intangible assets
and goodwill for impairment, in accordance with SFAS 144 “Accounting for the
Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) and SFAS 142 “Goodwill
and Other Intangible Asset” (“SFAS 142”). As a result, in the fourth quarter of
2008, we recorded a goodwill impairment charge of approximately $79.1 million
and an intangible assets impairment charge of $5.9 million. These impairment
charges do not impact our business operations, cash flows or compliance with the
financial covenants in our loan agreements. There was no impairment charge in
the prior year.
Financial
Income, Net. Financial income consists primarily of interest derived on
cash and cash equivalents, short-term and long-term marketable securities,
short-term and long-term bank deposits and structured notes, net of interest
accrued in connection with our senior convertible notes and bank loans and bank
charges. Financial income, net, in 2008 was $1.2 million compared to $2.7
million in 2007. The decrease in financial income, net in 2008 was primarily due
to lower interest rates and interest income, net, on the remaining net proceeds
from our sale of senior convertible notes in November 2004 and due to interest
expenses related to bank borrowings in the aggregate amount of $30 million
during the second and third quarters of 2008.
Taxes
on Income. Taxes on income were $505,000 in 2008 compared to $1.3 million
in 2007. The decrease is principally attributable to a reduction in the deferred
tax liability.
Equity
in Losses of Affiliated Companies, Net. Equity in losses of affiliated
companies, net was $2.6 million in 2008 compared to $1.1 million in 2007. The
increase in 2008 was primarily due to an impairment charge of $1.1 million
related to an investment in an affiliate.
Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues.
Revenues increased 7.4% to $158.2 million in 2007 from $147.4 million in 2006.
The increase in revenues was primarily due to an increase in revenues from our
networking business. Our results of operation include CTI Squared beginning in
April 2007, Nuera beginning in July 2006 and Netrake beginning in August
2006.
Gross
Profit. Cost of revenues includes the manufacturing cost of hardware,
quality assurance, overhead related to manufacturing activity and technology
licensing fees payable to third parties. Gross profit increased to $89.1 million
in 2007 from $86.1 million in 2006. Gross profit as a percentage of revenues
decreased to 56.3% in 2007 from 58.4% in 2006. The decrease in our gross profit
percentage was primarily attributable to amortization expenses in 2007 related
to the acquisitions of CTI Squared during the second quarter of 2007 and Nuera
and Netrake during the third quarter of 2006. Amortization expense allocated to
cost of revenues amounted to $2.5 million in 2007 and $1.2 million in 2006. The
decrease in gross profit percentage was partially offset by the higher sales
volume that allowed us to leverage our manufacturing overhead over a larger
sales base. The decrease in gross profit percentage was also offset by a
reduction in manufacturing costs which was primarily due to a reduction in our
raw material costs.
Research
and Development Expenses. Research and development expenses consist
primarily of compensation and related costs of employees engaged in ongoing
research and development activities, development-related raw materials and the
cost of subcontractors. Research and development expenses increased 14.9% to
$40.7 million in 2007, from $35.4 million in 2006 and increased as a percentage
of revenues to 25.7% in 2007 from 24.0% in 2006. The increase in net research
and development expenses, both on an absolute and a percentage basis, was
primarily due to our research and development personnel resulting from the
acquisitions of CTI Squared in the second quarter of 2007 and the acquisitions
of Nuera and Netrake during the third quarter of
2006.
Selling
and Marketing Expenses. Selling and marketing expenses consist primarily
of compensation for selling and marketing personnel, as well as exhibition,
travel and related expenses. Selling and marketing expenses increased 13.9% in
2007 to $42.9 million from $37.7 million in 2006. As a percentage of revenues,
selling and marketing expenses increased to 27.1% in 2007 from 25.6% in 2006.
The increase in selling and marketing expenses was due to an increase in selling
and marketing personnel and amortization expenses as a result of the
acquisitions of CTI Squared, Nuera and Netrake. Amortization expense allocated
to sales and marketing amounted to $1.0 million in 2007 and $522,000 in
2006.
General
and Administrative Expenses. General and administrative expenses consist
primarily of compensation for finance, human resources, general management,
rent, network and bad debt reserve, as well as insurance and professional
services expenses. General and administrative expenses increased 9.9% to $9.6
million in 2007 from $8.8 million in 2006. As a percentage of revenues, general
and administrative expenses increased to 6.1% in 2007 from 5.9% in 2006. The
increase in general and administrative expenses was due to consolidating the
expenses of our Nuera and Netrake subsidiaries, which were acquired in July 2006
and August 2006, and consolidating the expenses of our CTI Squared subsidiary,
which was acquired in April 2007.
Financial
Income, Net. Financial income consists primarily of interest derived on
cash and cash equivalents, short-term and long-term marketable securities,
short-term and long-term bank deposits and structured notes, net of interest
accrued in connection with our senior convertible notes and bank charges.
Financial income, net, in 2007 was $2.7 million compared to $3.8 million in
2006. The decrease in financial income, net in 2007 was primarily due to lower
interest rates and interest income, net, on the remaining net proceeds from our
sale of senior convertible notes in November 2004.
Taxes
on Income. Taxes on Income were $1.3 million in 2007 compared to
approximately $289,000 in 2006. The increase is principally attributable to a
decrease in our deferred tax asset.
Equity
in Losses of Affiliated Companies, Net. Equity in losses of affiliated
companies, net was $1.1 million in 2007 compared to $916,000 in
2006.
Impact
of Inflation, Devaluation and Fluctuation of Currencies on Results of
Operations, Liabilities and Assets
Since
the majority of our revenues are paid in or linked to the dollar, we believe
that inflation and fluctuations in the NIS/dollar exchange rate have no material
effect on our revenues. However, a majority of the cost of our Israeli
operations, mainly personnel and facility-related, is incurred in NIS. Inflation
in Israel and dollar exchange rate fluctuations have some influence on our
expenses and, as a result, on our net income. Our NIS costs, as expressed in
dollars, are influenced by the extent to which any increase in the rate of
inflation in Israel is not offset (or is offset on a lagging basis) by a
devaluation of the NIS in relation to the dollar.
To
protect against the changes in value of forecasted foreign currency cash flows
resulting from payments in NIS, we maintain a foreign currency cash flow hedging
program. We hedge portions of our forecasted expenses denominated in foreign
currencies with forward contracts. These measures may not adequately protect us
from material adverse effects due to the impact of inflation in
Israel.
The
following table presents information about the rate of inflation in Israel, the
rate of devaluation of the NIS against the dollar, and the rate of inflation in
Israel adjusted for the devaluation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended
December
31,
|
|
Israeli
inflation
rate
%
|
|
NIS
Devaluation
Rate
%
|
|
Israeli
inflation
adjusted
for
devaluation
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
(0.1
|
)
|
|
(8.2
|
)
|
|
8.1
|
|
|
|
|
2007
|
|
3.4
|
|
|
(9.0
|
)
|
|
12.4
|
|
|
|
|
2008
|
|
3.8
|
|
|
(1.1
|
)
|
|
|