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Hiccup or flu at Aladdin?

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midastouch017   Monday, 07/17/06 01:54:27 PM
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Hiccup or flu at Aladdin?
The stock has plunged since a revenue warning. CEO Margalit: We’re not alone.

Gitit Pincas 17 Jul 06 17:20

These days, when Israeli shares are sinking on international bourses, it’s hard to say for certain what the cause is. The mix includes suffered by all technology shares, as the Nasdaq’s index struggle to keep its head above water shows. It includes pressure before the publication of financial reports for the second quarter. There is also includes a new ingredient: the escalation in the security situation in Israel, with Katyushas falling all over the north, and US investors worried that some Israeli companies are halting production and heading to the bomb shelters. The weekend and the start of the new week show that anything is possible.
One Israeli share added to this recipe a special ingredient all of its own. Six days after the end of the second quarter of 2006, Aladdin Knowledge Systems Ltd. (Nasdaq: ALDN; TASE: ALDN) published a revenue warning. Since then, the share has fallen 30%. Aladdin makes USB-based verification and content security management solutions for enterprises. Its market cap is $210 million.

Aladdin’s failure to meet its guidance apparently came as a surprise. Two weeks before the end of the quarter, the company’s managers, including those based abroad, told foreign investors that all was well. Three weeks later, the company was forced to announce that revenue for the second quarter would be $20.8 million, $2 million less than market forecasts and less than its previous guidance of $21.7-23.7 million. The company added that it now expected earnings per share for the second quarter to be $0.22-0.26, down from its previous guidance of $0.26-0.29 (representing a profit of $3.9-4.4 million).

Why is Aladdin missing its guidance? The company left investors in the dark. In the press release, Aladdin chairman, president and CEO Yanki Margalit said, “We encountered softness in select geographic markets during the quarter. As a result, we have undertaken a global restructuring of our sales organization to ensure we capture every sales opportunity and continue to grow our business. To achieve these goals, we have promoted Elinor Nissensohn to the position of global VP of sales and marketing.” He did not mention digital rights management (DRM) or other product lines, nor gave specifics about the source of the problem.

CIBC Capital Markets analysts Shaul Eyal, Yair Reiner, and Manish Hemrajani believe that Aladdin’s problem is in Germany. His hypothesis is that the 2006 World Cup caused the problem. Oscar Gruss analyst Ehud Eisenstein blames the US market. By the way, Margalit has said more than once that he felt too many analysts were covering the company. Jeffries & Co., one of the underwriters for Aladdin’s secondary offering, no longer covers the company, while UBS, which led the offering in early 2005, has not yet begun covering it.

Margalit and Aladdin CFO Efrat Makov spoke with investors recently, but not with the media. In his first interview since the revenue warning, Margalit told “Globes” by phone from the US, “Our sales will be slightly less than forecast, but not our profit.”

“Globes”: What does your analysis show?

Margalit: “We cannot talk about one problematic product during the quarter, but there were a number of territories that were weaker than expected. My research of the industry indicates that we’re not alone in this battle. We may have been the first to announce that our second quarter results will be lower, but we won’t be the only company with lower sales than it expected.”

There won’t be profit warnings at this stage, two weeks after the end of the quarter. Do you mean that companies in your field are likely to miss the numbers?

“It’s possible. We’re seeing difficulties at companies like EMC Corp. (NYSE:EMC), IBM Corp. (NYSE:IBM), and Secure Computing Corp. (Nasdaq:SCUR). I don’t like doing less than I planned and then blaming the market, and I don’t intend to do so. But I see a lot of companies in the industry facing difficulties, some of them back in the previous quarter, the first quarter of 2006, which was full of profit warnings.”

Which geographical areas are your source of weakness? Capital market sources say your biggest problem was the US, and that your sales restructuring is meant to solve it.

“We cannot provide further details.”

What about the hypothesis that the World Cup caused the weakness?

“It’s amusing and interesting. I heard this hypothesis. It seems that people are looking for reasons and excuses in all kinds of places, and not always where they really lie. What is certain is that the entire industry is struggling with growth, more than it originally thought.”

An uncomfortable situation

Is it possible that a large part of the fall in Aladdin’s share is related to a loss of confidence in the company, a problem that is worsening?

“I don’t know how to answer that. It’s hard to distinguish. When a share falls, you always look for the reasons, but I can’t tell you which part our announcement is responsible for, and which part the market as a whole is responsible for. I prefer not to specifically discuss the results, but to propose looking at us in a broader context as an IT company and as an Israeli company. In both respects, we are in an uncomfortable situation. I can say that in general, and not only at Aladdin, we’re facing a more difficult period.”

How much of the quarter did you close during the final month? Was it over 50%. Is it still possible to talk about linearity during a quarter or not?

“We cannot say what the proportion is, but non-linearity is intensifying. Quarters have become increasingly back-end for a long time now. I can say that Aladdin continues to be an excellent company, and we should be analyzed in a broader perspective in terms of time and industry. Aladdin’s general position in terms of products and market is excellent. Unquestionably, the share falls in a period like this with events like these, and that’s OK. I hope that it will respond with equal speed when we supply good news.”

What should we understand from the appointment of Nissensohn? After all, until now, global sales were directly under your authority.

”This is a necessary step and a continuation of a process begun at Aladdin several years ago, in three stages. First was the construction of business units that enabled us to grow and expand. This step meant I had a smaller, but still large, management. The second step was the appointment of CFO Efrat Makov, who basically manages Aladdin’s backbone. Besides this, we had territory managers, and Elinor Nessensohn one of them. This structure was not yet flexible enough, and did not let me see things only from above, as it should be. Therefore, the third step was to take all the global sales organizations and consolidate them under Elinor. Her performance exceeded expectations during the past six quarters, and she’ll build a new sales structure.”

A general question. You’re in the US. What do you hear from Americans about the situation in Israel?

“On one hand, there’s a kind of empathy and sympathy. On the other hand, they’re tired of the situation. They’re sick of it.”

When Aladdin published its warning for the third quarter of 2005, most investment houses subscribed to the theory that it was a hiccup; a one-time crisis that would pass. The company presented very good financial results for the subsequent quarter. On the basis of an analysis of forecasts and recommendations, it now seems that analysts are not so sure that this was a one-time incident. It may be an attack of hiccups. We’re talking about reorganization at a company, something that indicates a performance problem. It is now harder to believe that the second half of 2006 will be better than the market expects, because the problems won’t be solved overnight.

Aladdin will publish its financial report on July 24, at which point it will be possible to see exactly what happened to the forecasts for the second quarter are, what really caused the weakness (Ronaldinho? Zidane? Or maybe simply bad performance), and what can be expected for the year. This happens to be a good opportunity to mention that Retalix Ltd. (Nasdaq: RTLX; TASE: RTLX), another Israeli company that published a profit warning, went even further, and will publish its financial report for the second quarter on August 29. This is not very early, definitely not for a company that wants to send a message of business as usual.

Published by Globes [online], Israel business news - www.globes.co.il - on July 17, 2006


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