Verisity (Nasdaq: VRST) has overcome another obstacle – the troubles of its customers. The third quarter of 2001 is the sixth straight quarter in which the company has posted record revenue. In other words, continuous growth in earnings. But in times like these, the latest record merely raises questions about the next quarter. On this subject too, this modest company from Rosh Ha'ayin is swimming against the current and continues to provide optimistic forecasts based on good projections for next year.
Verisity's third quarter revenue totaled $9.79 million, 8.5% above the preceding quarter. The growth in the company's operations is also expressed in management and sales costs 8% higher this quarter than last. Operating profits were $920,000, up 48% over the second quarter. Net profit was $1.3 million, a 23% improvement compared with the preceding quarter. Verisity's third quarter pro forma profits, excluding stock-based compensation expense, were $1.4 million, a 17% improvement over its pro forma profit of $1.2 million in the second quarter.
As for its fourth quarter forecasts, Verisity is keeping its high-end forecast of $11.3 million in revenue, and is raising its low-end forecast to $0.09 pro forma profit per share, or $1.7 million in total. Thanks to Verisity's business model, CEO Moshe Gavrielov has good visibility for next year as well. Gavrielov reiterated the company’s forecast from a year ago that predicted $54 million in revenue and $6 million in profits ($0.06 per share) in 2002. Gavrielov says the company's impressive orders backlog is largely responsible for this visibility. The backlog is $28 million, of which $24 million is scheduled for delivery in the next 12 months.
Despite these optimistic figures, the company's shares graph reflects the current capital market uncertainty. Verisity was the first Israeli IPO on Nasdaq after the high-tech bubble burst and the primary market issues halted. Verisity floated on 20 March 2000, raising $26.8 million at $7 per share, reflecting a company value of $130 million, The lower than originally planned pricing, forced by circumstances, made it a safe investment.
Verisity is one of the rare companies floated last year whose share has not fallen from its issue price. To be precise, only once, on 26 September, when it closed at $6.60, did it fall below issue price. Most of the time, it has been far above, peaking at $18. Yesterday, Verisity closed at $8.70, 24% above its issue price.
Verisity develops tools to compare integrated circuits' designs to their intended functional demands. The chip sector has been marching forward in accordance with Moore's Law. Chips now have 5 million transistors, compared with only 50,000 just a few years ago. This makes designing chips extremely complicated, with the most problematic part being the verification of blueprints to performance. The accepted solution is to build a prototype, but this involves numerous drawbacks: high cost and protracted verification times. Verisity uses software tools to solve these problems, in effect carrying out very strong simulations of blueprints to see whether the results are as planned.
Verisity's ability to meet its targets and grow is based on the fundamental need for its products, as well as its conservative business model. Verisity knows how to distribute revenue over time. A major part of the company's revenue – 58% in this quarter – is derived from long-term licensing. Licenses are sold for a fixed period, usually one year. The licenses are therefore renewed each year, and revenue is not recognized at the time of the order, but spread out over the license term..
"In fact," says Gavrielov, "we often get the money when we sign the contract at the start, but we spread it out, recognizing the payment over the quarters. This conservative approach in these hard times helps us sleep at night." The approach also explains how the company posted an additional $3 million in cash reserves in the present quarter (to a total of $52.4 million), when its profits were only $1.3 million.
Another component of Verisity's business model that guarantees steady sales revenue is the support and consultancy services the company offers its customers. Verisity now has over 200 customers worldwide. The target markets are systems companies (50% of revenue this quarter), chip manufacturers (26%), and IP start-ups (24%).
In the systems sector, Verisity focuses on four segments: communications, storage, computers, and electronic consumer products. Gavrielov says the company faces heavy competition, mostly from Synopsis, but he thinks Verisity has more than half the market share in the chip design verification market.
"98% of revenue in the last quarter came from repeat customers, and 81% of new new orders were from existing customers," says Gavrielov. "Naturally, orders from new customers are spread out, so if we received an order at the end of the quarter, we did not recognize it in the third quarter."
"Globes": In other words, you have reached saturation point as far as your customer base is concerned?
Gavrielov: "No. But we are not now necessarily focusing on new customers, but rahter on penetrating and spreading to existing customers, whose potential licensing needs are much greater."
How can they design chips now without your verification tools?
"They simply manage poorly. That is our strength. Now, they only buy what they need, and that barely. But our business model is based on those customers for whom our product is essential. We are looking for new customers, but in the short term, i.e. in the next two years, we will mainly focus on existing customers and their internal growth. These customers include most of the electronics companies, and it is naturally easier to sell to satisfied customers than to convince new ones."
Who are your new customers?
"There were new and even important new customers in the third quarter, but we are forbidden to reveal their names. I can inform you that we have expanded our customer base with a new Japanese customer in the chip sector. There was also expansion in the systems sector, with an emphasis on the storage field."
Can you identify growing sectors in these times?
"It is very dangerous to look at a quarter in isolation and draw conclusions. However, the last quarter was incredible in the chip sector. Sales to IP companies and start-ups also increased, in contrast to what might have been expected. We saw a fall in sales to systems companies."
In light of the situation, are you contemplating streamlining?
"We actually increased our staff to 170 in this quarter. We are growing, but very carefully. It should be remembered that there are many opportunities to hire good people now."
What about your acquisition strategy?
"We are continuing to study all kinds of acquisition possibilities, but we will be very cautious. While it is true there are many opportunities on the market, they must be checked in case they might prevent further growth and meeting financial targets."
How do your products handle the transition to photonics by communications components?
"Optical components are usually interfaces that translate optics to electronics. Even though our tools are not used to design the optical part of the components, the focus on optical communications helps us because the electronic part of the optical interfaces do need our tools."
Dain Rauscher Wessels today issued a recommendation for Verisity that confirms Gavrielov's optimism. "Verisity exceeded top-and bottom-line expectations," the investment bank said, continuing, "In our view,Verisity continues to make great progress as design teams buy verification solutions to ensure that increasingly complex chips work right." DRW reiterated its Buy- Aggressive rating and $19 price target.
Published by Israel's Business Arena on 23 October 2001