Success is calling: AudioCodes closes a circle

Most people downsize during a recession, but management at voice-over-packet equipment company AudioCodes decided to invest. Annual revenues were dropping alarmingly, but the company nevertheless concluded that instead of following the herd, it would invest heavily in R&D, introduce new products, and bump up the head count. "It was a brave decision," admits CFO Nachum Falek, "but management was convinced that the market would change, and that when it did, voice-over-packet technology would be the technology." It turned out they were right. After three bad years during which AudioCodes saw revenues plunge from $71.7 million in 2000, to $35.7m. the following year, and just $27.1m. in 2002, this year the company expects to see sales leap to $81.7m. The company is back in the black, and also has $220m. in cash – courtesy of a recent round of fund-raising. Suddenly, AudioCodes is attracting a great deal of interest from analysts, and in the new flurry of activity surrounding VoIP (Voice over Internet Protocol), it's feeling good about the future. AudioCodes has specialized in VoIP since it was founded by Shabtai Adlersberg and Leon Bialik in 1993. The company, which is based in smart new offices in Lod, provides VoIP technology and voice network products to OEMs and network equipment providers such as Nortel Networks, 3Com, Alcatel and Siemens. When the company was founded it focused on projects in the voice area. Gradually, however, it began to move up the food chain, introducing chips, then circuit boards and modules for packet-based applications in the wireline, wireless, broadband access, and enhanced voice services markets. In the past three years, the company has also introduced a range of media gateways, and media processing technologies. "Our unique point is that we still maintain the whole product line," says Lior Aldema, VP of marketing. "Each of our products is a good business line for AudioCodes. Together they are all building blocks of a complete vertical solution. We can offer the customer a complete product, allowing them to trade off in time to market and cost."
"It gives you a great advantage with the customer," adds Falek. "We sell them a complete solution, which the customer knows he can control right to the chip level." For the first few years of AudioCodes' life it operated very much as a start-up. Seed funding of $500,000 came from the DSP Group, and until 1999, it received just $5.5m. in investment from venture capital funds such as Genesis and Polaris. By the end of 1998, sales had reached $9.1m.; the following year, they leapt to $31.2m. AudioCodes took advantage of its growing sales to go public on Nasdaq in May 1999, and followed it with a secondary offering in October. The company raised more than $100m. in the two offerings. At this point there was still great uncertainty about whether VoIP would become the main way to carry voice, but AudioCodes was one of the first on the scene, and it sold well to pioneers, including Israeli companies VocalTec, Clarent, and Cisco. The main product offered by these companies at the time was toll bypass, which VocalTec first demonstrated in 1997. Toll bypass enabled users to route phone calls through the Internet, and make international calls for the price of local calls. Through 1999 and 2000, AudioCodes was highly profitable, making over $10m. in profits in 1999, and $26.7m. in 2000. At one time, the company's value rose to over $2 billion. THE CRASH came in the middle of 2001, when sales plunged drastically in the last two quarters, and the company unexpectedly plunged into the red as the telecom market began to downsize dramatically. In 2001, the company reported losses of $13.3m., which rose to $14.2m. in 2002, and fell to $8.4m. in 2003. Despite this, AudioCodes still had a security blanket of cash. Aside from the two years of profit, it also had over $100m. in cash left over from the offerings. Using this as a buffer, the company began investing in the future. At the end of 2000, it employed 180 people. Today it employs 440, of which 330 are in Israel, and 100 or so at the company's US headquarters in California. It also invested heavily in R&D. In 2002 – the company's worst year in terms of annual income – it ploughed 47.9% of its earnings back into R&D. "The profits in the good years helped us through the lean years," says Falek. "We had no idea when the market might change, but we were lucky with our fund-raising in 1999; it allowed us to continue investing." Already in the third quarter of 2001, the company began to see revenues start to pick up once more. Falek pulls out a graph showing steady quarter-by-quarter growth for the past 12 quarters. It is a nice graph, and Falek points to the rising blue blocks with great pride. In the third quarter of this year, the company saw revenues of $23m., compared to $11.8m., in the third quarter of 2003. By the end of the year, analysts predict fourth-quarter sales will have risen to $24.2m. At the start of this year, the company also returned to profitability. "When you look at the numbers it appears that we have closed the circle in terms of company revenues," says Falek. "We are not the same company, however. In 2000, we were selling chips and boards, but now we sell systems, and even our customer base has changed."
"Today VoIP is the mainstream," adds Aldema. "It's no longer a question of if, but when it will be introduced." He points to a deal that AudioCodes signed in November to provide Israel's newest cable and telecom provider, HOT Telecom, with media gateways as part of a cable telephony project.
"This is mainstream now, everyone will go to voice over packet," he says. As a result of all the hard work over the past few years, Aldema believes that AudioCodes is now in a strong position.
"Today, when customers need a solution they need it fast. Time to market is a major consideration. We already have the technology. Anyone starting now will be way behind," he explains. He points to former competitor, Brooktrout, a Massachusetts company that provides platforms that enable applications for the new networks, as an example. Originally, Brooktrout competed with AudioCodes in the field of circuit boards. Today it is a customer.
"Rather than reinvent proven technology, Brooktrout will utilize AudioCodes capabilities to achieve high-density voice-over-packet platforms," Eric Giler, president of Brooktrout said in a statement. Brooktrout still competes in the area of chips, however, as do Mindspeed Technologies, (market cap $242.8m.), which just raised $46m. in a private offering; Broadcom; and Texas Instruments. In circuit boards, AudioCodes is up against NMS Communications, while giant Cisco Systems is muscling into the media gateway sector. These are all significant competitors, and Falek admits that AudioCodes is also up against the internal R&D teams of its customers, though in recent months the trend has been to outsource production. AUDIOCODES, which has already shipped 12 million channels, has a few advantages, not least that it developed the industry standard, ITU G.723.1, for the emerging market. It also makes both higher-level VoIP components and full VoIP systems. The company cannot rest on its laurels, however. The field of VoIP is developing quickly, and AudioCodes is still a small company that must race to keep up.
"It's a question of time," says Falek. "Right now we have an advantage in the market because we have been working in this field for 11 years, and have 200 engineers working on R&D, but one slip and the competitors will be there." In November, AudioCodes completed a private offering of $125m. It announced at the time that it intends to use the money for general corporate purposes. Speculation is running high. A report from WR Hambrecht & Co. says the company is poised for an acquisition. Over the past two years, AudioCodes has made two purchases. In May, it bought Ai-Logix, a privately-held New Jersey company that specializes in advanced recording hardware for the call logging and voice recording industry, for an estimated $20m. Ai-Logix saw revenues of $13m. in 2003. In April 2003, AudioCodes purchased the Universal Audio Server division of Nortel for some $15m. There are no specific plans, Falek stresses, but he adds: "We do see consolidation in the market place, and having already made two acquisitions, it makes sense to use this strategy." However, he insists, if the company does buy, it will be looking for a good acquisition.
"For another M&A to be meaningful, the numbers would have to be larger," he hints.
Certainly consolidation is on the agenda. The market is now maturing, and companies that hope to gain a large market share need to invest heavily. Stock prices at AudioCodes have risen steadily over the past year. At the closing of trading on Wednesday the company's stock stood at $15.71, with a market cap of $593m. Analysts – with a few exceptions – seem to be positive. In November, however, business weekly Barrons opined that shares in the company were "overvalued." The report came after Merrill Lynch reinstated coverage of AudioCodes with a "buy" rating, and a 12-month price target of $18. Barrons, however, reported that much of the company's recent sales growth and profits had come from acquisitions, and that there is strong competition for all its products. "Little of AudioCodes' demonstrable growth has come from high-value VoIP products. Why, then, should investors expect the Nasdaq-listed shares to rise 20% to Merrill's price target of $18?" asked Barron's.
Aldema shakes his head in dismay.
"Our revenue growth per quarter is between 10% and 25%. Of this, internal growth is usually at least 10%, sometimes more," he says. "We have always had internal growth which has nothing to do with our M&A activity." So what's next for AudioCodes?
"We are still investing in our technology, still growing the company, and still recruiting," says Falek. "We aim to maintain the advantage we have." "Our target is to keep quarterly growth as steady and consistent as it has been," says Aldema. "If we succeed, we will probably do great."
"Right now VoIP is hot and everyone is talking about it. It is happening everywhere," adds Falek. "Industry experts say this market is growing about 45% a year. We are not giving guidance for 2005, but think we should continue growing at the same rate as the market. We have been in this market for a long time, and will continue to stay focused on it, because we know this is a revolution and we want to be part of it."