Audiocodes: We’re like a sailboat waiting for a breeze

AudioCodes VP finance and CFO Mike Lilo: Our operating loss is mostly due to a loss of revenue. The main cause is that fact that AudioCodes decided to sacrifice the short term for the long term.

The communications market is currently trying to navigate between thick clouds of uncertainty, and AudioCodes (Nasdaq: AUDC) is one of the companies affected. Its degree of vulnerability is currently clearly reflected in AudiCodes’s financial results for the second quarter and first half of the year. Although the share posted a decline in trading, it should be kept in mind that the company’s financial situation has been reflected in its share price for quite some time. Although the reports are not encouraging, it would be hard to say that the financial results should cause a further substantial decline in the share price. The share fell 8.43% to $6.30 on Thursday, reflecting a company value of $252 million, apparently as a direct result of the severe profit warning by Clarent (Nasdaq: CLRN), AudioCodes’ largest customer.

The financial reports published for the second quarter and first half of 2001 showed quarterly revenue of $11.6 million, a 30% decrease, compared with $16.5 million in the corresponding quarter in 2000. AudioCodes had a $306,000 profit, compared with a $6.2 million profit in Q2 2000. EPS totaled $0.01, compared with $0.14 in the second quarter of last year.

As of web posting, the company had not yet conducted its conference call with the analysts, so for the time being it is unclear whether it announced lower revenue and profit forecasts for the coming quarters.

At the same time, as “Globes” reported yesterday, if the company does publish forecasts, its low visibility will probably lead it to announce that it expects third quarter revenue to be at least 30-35% lower than in the second quarter. The company will probably also lower its profit forecast for the next quarter to a loss of $0.09 per share, apparently because of Clarent’s sharp downward revision of its third quarter revenue forecast.

In any event, in view of the cloudy situation of AudioCodes’s customers, it can be assumed that even if the company does not publish explicit guidance, the analysts will lower their revenue and profit forecasts for AudioCodes for the rest of the year. It should be kept in mind that the obstructed visibility over the entire length and breadth of the market prevent many communications companies from publishing forecasts for more than one quarter ahead.

AudioCodes posted an operating loss of $1.5 million in the second quarter, compared with an operating profit of $4.4 million in the corresponding quarter last year. The company’s $135 million cash balance provided it with $1.8 million in financing revenue, a slight drop compared with the corresponding quarter in 2000, when the company had $1.9 million in financing revenue. This means that the company’s profit in the current quarter is due to financing revenue, which may indicate the company will lose money in the coming quarters.

”Considering the state of the market,” said AudioCodes president, chairman, and CEO Shabtai Adlersberg after the company financial reports were published, “we’re satisfied that we met our forecasts. At the same time, we’re feeling the effects of the slowdown, which is affecting the entire telecommunications industry. We therefore expect company revenue to fall in the short term. We’ll continue to invest in developing the company and strengthening its product lines and technology. We want to position the company well for the emergence from the slowdown and an increase in demand.”

In accordance with its buy-back plan, in the second quarter AudioCodes bought 500,000 shares at a total cost of $3.24 million. The company announced several new deals and launched a new suite of products during the quarter.

All in all, even though AudioCodes’ revenue totaled only $11.6 million in the quarter, it could be said the company exceeded the lower limit of its revenue forecast for the second quarter, although it just barely did so. The EPS forecast was $0.01-0.04, so here, too, the company was at the lower limit. At the moment, the big question is what happens next, since the future is covered by an impenetrable fog. The main problem impeding the company’s visibility lies in the fact that AudioCodes relies on a small number of customers and on big deals. Any change in one of these customers significantly affects AudioCodes’s financial results.

At a time in which major communications infrastructure companies are becoming unstable and publishing profit warnings at the drop of a hat, while many companies are vanishing completely due to consolidation, AudioCodes’s foundations are becoming rocky. Any change among its customers causes an earthquake at AudioCodes.

The most conspicuous example of this is the severe profit warning published at the end of last week by Clarent, AudioCodes’s biggest customer. Together with its profit warning, Clarent announced layoffs and management changes. As reported in “Globes”, the effect of these events on AudioCodes is liable to be severe, at least in the short term. Not only is Clarent liable to reduce procurement, it will probably also delay its decisions to allow the new management time to get organized.

In spite of all that, when you look at AudioCodes’s more distant future, several bright points can be seen. The most positive development is the closing of the internal development departments of its largest customers. One after another, the major US communications equipment companies are shutting down their internal development departments, which developed products that competed with those of AudioCodes.

Furthermore, the chips and circuits developed by AudioCodes are sold to large communications equipment manufacturers, such as Alcatel, Cisco, Lucent, and Clarent. This concentration of customers increases AudioCodes’s dependence on a limited number of customers. On the other hand, however, it also enables it to focus its marketing channels and limit its marketing expenses. In addition to the large manufacturers, it has several dozen more customers. The problem is that the large communications companies control the market and limit the number of players there.

”Globes”: How would you define AudiCodes’ current situation?

AudioCodes VP finance and CFO Mike Lilo: “We’re like a sailing ship in mid-ocean waiting for a breeze.”

What actually caused your operating loss and fall in operating and gross profit?

”Our operating loss is mostly due to a loss of revenue, rather than a rise in operating expenses. The same is true of our gross profit. You can see that operating expenses totaled $8.2 million in the current quarter, compared with $7.9 million in the previous quarter. The main cause, however, is that fact that AudioCodes deliberately decided to sacrifice the short term for the long term. This means that the company is continuing to recruit employees, mostly for R&D, in order to preserve its technological superiority over its competitors. In other words, despite the fall in revenue, we’re not reducing manpower at this stage, although we have taken a number of economizing measures, such as a wage freeze for all company employees.”

How has your cash flow changed in the current quarter and how is it expected to change in the coming quarters?

”Regardless of the operating loss, cash flow from current activity in the second quarter was positive, reaching $2.7 million. The total amount of cash fell by $2 million, since this amount was offset by $1.5 million in investments and $3.2 million spent on buying back company shares in the market. Most of our cash burning was therefore due to investments and share purchases. Regarding the coming quarters, in line with our official policy of continuing to expand the company’s infrastructure, I expect us to burn $4-5 million in the coming quarters.”

What are you doing at the moment to get through the crisis?

”First of all, we’re increasing incentives to sales people to sell larger volumes by paying higher commissions. Second of all, we’re investing in development of new infrastructure in the ERP field, which is currently serving a new function around the world. It’s becoming a integral part of an organization’s functioning, not just an auxiliary tool.”

Either way, the first indications that AudioCodes’s market will not give much satisfaction to the companies operating in it, at least in the coming quarters, were already visible just under a year ago. Despite the advantages inherent in the Voice over Internet Protocol (VoIP) market and the rapid growth that began in 2000, it has now come to a halt, and AudioCodes is feeling the result. While AudioCodes is considered one of the leading companies in the field, in which the technological entry barrier is extremely high, it now depends on communications companies’ deployment speeds, which have recently slowed from a mad race to a crawl.

AudioCodes’s financials began to be affected at the end of the fourth quarter of last year, when the company had to lower its profit and sales forecasts for 2001. In spite of that reduction, AudioCodes published a profit warning at the end of the first quarter. “At the end of the fourth quarter of 2000, when the lowered forecasts were published, we had no way of knowing revenue would continue to fall so sharply,” says a senior company source. “The main reason for the first quarter profit warning was cancellation and postponement of orders already in the pipeline. When the lowered forecasts were published, we couldn’t have known the cancellations would be so extensive.”

Capital market sources say the severe communications industry crisis has significantly slowed the adoption of new technologies, including technology relating to VoIP, AudioCodes’s market. One of the direct results of the slowdown is a dramatic drop in the procurement by communications companies, especially of new technologies.

It seems that, while before the first quarter of 2001, AudioCodes had to deal mostly with problems involving smaller customers, it subsequently began to run up against a slowdown among its larger customers.

AudioCodes develops chips and circuits for compressing voice and transmitting it on data communications networks, which run on Internet Protocol (IP) and ATM. AudioCodes’s chips are among the cornerstones of voice transmission on packet switching networks, such as IP and ATM, and are scheduled to replace the old telephone networks operating on circuit switching.

One of the main factors accelerating AudioCodes’s growth last year was the establishment of new communications networks in developing countries. Communications operators in these countries prefer to set up their networks in the most economical way, with modern technology. In developed countries, however, the decision by older companies to invest in such equipment is more complex, since they have no need to hurry to upgrade the existing networks, particularly during a recession. Furthermore, the new communications providers (CLECs) are experiencing difficulties. Many of them have vanished, while others are finding it hard to function and upgrade their networks. The desire and need of the older communications providers (ILECs) to upgrade their networks to IP as a competitive tool has consequently declined.

Published by Israel's Business Arena on July 24, 2001

Twitter Facebook Linkedin RSS Newsletters âìåáñ Israel Business Conference 2018