"Sorry, we can't pay"
Hadass Geyfman
18.06.2001 14:26
p>The summer of 2001 will be remembered in the history of Israel’s high-tech sector as the season when the industry's payments ethic collapsed. One of the first hints of the revolution came this week, from a small item in the press: " Israeli start-up ComBox, owned by Terayon (Nasdaq: TERN), has sued Gilat Satellite Networks (Nasdaq: GILTF) for not paying for satellite cards it ordered. ComBox claims it cannot sell the satellite cards to other companies, because they were manufactured according to Gilat Satellite Networks' specifications.”
It turns out that ComBox’s predicament is indicative of the entire sector, and its situation is just the tip of the iceberg. The courts have not yet been flooded with suits by suppliers, but we may very well see a wave of these claims in the months ahead. Industry veterans cannot remember a crisis of trust on this scale. Global communications infrastructure equipment manufacturers are canceling orders for systems daily, and Israeli high-tech companies are panicking. The result is that all Israeli systems manufacturers who sell their products to the communications market have unilaterally decided not to pay their debts to their suppliers, which total an average of tens of millions of dollars per company, or to postpone orders and payments by several months.
The reason for the decision is the inventories gathering dust on the shelves in the companies' warehouses. These components are causing trouble. First, there is the well-known fact that the capital market does not like large inventories. Second, the inventories were bought at much higher prices than the current market prices of components. For example, the price of memory chips have fallen 80-90%, and the price of tantalum capacitors have dropped by a similar amount. This means that most of the money spent by companies in the past year has gone down the drain. Third, the components in the inventories are designed for current generation technologies, but technology doesn't wait for anybody and the next generations are just around the corner. This means that a considerable proportion of the components bought and paid for, or on order, will have to be trashed.
The result is that suppliers are caught between a rock and a hard place - the stock exchange and overflowing warehouses. Under these circumstances, even the most righteous managers become ravenous wolves trying to save their own skins. ECI Telecom (Nasdaq: ECIL), Gilat Satellite Networks, RAD Computer Communications, BreezeCOM (Nasdaq: BRZE), Orckit Communications (Nasdaq: ORCT), Ceragon Networks (Nasdaq: CRNT), Terayon, and many others are telling their suppliers: "Don't send us components. Components delivered to our plants will be returned at your expense." The problem is that the suppliers paid for some of these components in advance.
"No company has escaped damage, and no one can meet their obligations now," says an industry source. "Until now, RAD Computer Communications was always considered to be a bastion of stability. Their inability to pay indicates the scale of the catastrophe."
Although no company has refused to pay for components it has already received, the companies are refusing to accept components from orders that they had cancelled just days before the scheduled delivery date, even though the suppliers had already paid for the components.
A components importer said, "It has happened more than once that the day after we have confirmed delivery details, and the goods are already on the 'plane on their way to Israel, we get a call saying 'They just cancelled, stop everything'. Even if I can cancel 60% of the order, I can't do anything about what's already on its way, and on that part I expect to reach some kind of compromise." "More seriously, in many cases the companies cancelled orders for components to exploit the market panic," says another component supplier." A year ago, demand for components was greater than the supply, and prices were extremely high due to the scarcity. In order to avoid being stuck without inventory, companies ordered huge quantities of components at the high prices the market was demanding at the time."
”The supply process is spread throughout the year. Components arriving today were ordered when they were expensive, leaving companies stuck with orders for high-cost components. Many companies are exploiting the situation to cancel the expensive orders in order to use up their current inventories as much as possible before they re-order at the lower prices. The suppliers' problem is that no-one dares to object, because the companies are making implied threats to cease using suppliers who insist on charging them for the components. This is the type of threat than can be applied to each supplier individually. If suppliers could agree not to concede, they might very well be able to force the companies to accept and pay for their orders. Instead, each supplier caves in and tries to save his own skin."
"We're not talking about beggars. These companies have billions in sales, while companies like mine have sales of a few million dollars a year, maybe a few tens of millions under the best circumstances. I must provide a living for my employees here. My suppliers overseas don't care that no-one is prepared to buy the components I bought from them. It's one thing if the postponements were for a couple of months, but they’re unilaterally canceling all their orders, and saying they won't pay for them."
What's next? Sources in the components industry think there will be no new orders for raw materials for electronics systems in the coming year, except for a few items that are necessary to complete certain systems. Moreover, the full inventories and cancellation of orders are evidence that there will probably be huge write-offs, and that the companies expect sharp drops in their 2001 corporate sales, which are falling substantially compared with the amount of sales the companies had expected at the beginning of the year. Moreover, the systems that the companies do manage to sell to overseas customers are being sold on credit. It can therefore be assumed that ECI, Gilat Satellite Networks, and the others are being forced to lend money to pay for the financing arrangements with their customers. This means more debts to the banks and an increase in the finance expenses items in their financial reports. It can also be assumed that these companies have some problematic customers. In conclusion, sources in the sector are saying that there is now a real fear of disruption in corporate cash flows.
ECI, for example, is the market leader in both manufacturing volume and components' purchasing. Sector estimates suggest ECI's components inventory currently amounts to $160-180 million. For the sake of comparison, in normal times, ECI's inventory can support two months of operations, i.e. it has $60-70 million of inventory. ECI bought $400 million of components last year. In addition to inventories of components, ECI also has some $200 million of inventories of finished products. Industry sources estimate that ECI's purchases of components this year will not equal even 30% of this sum. Besides, ECI employees are saying they have been working for the "warehouse" for almost a year, i.e. their products are not being sold.
Another example is BreezeCOM (Nasdaq: BRZE), which is currently facing a two-front battle. "Last year, BreezeCOM sold over 100,000 systems," says an industry source. "Demand for the company's products at the time was voracious, and it could have sold many more systems than it actually did. But the components' shortage at the time meant that components were allocated to major customers, and BreezeCOM had trouble buying adequate components to meet the high demand. As a result, the company missed its high growth stage."
"No-one at BreezeCOM predicted 2001 would be catastrophic for the industry, and like everyone else they assumed there would be a shortage of components this year, as well. In order to avoid being stuck without components, the company took care to fill its inventory toward the end of last year. It was estimated that in 2001, BreezeCOM would have double to triple its sales in 2000, and the company therefore ordered triple the amount of components compared with last year."
"When the market contracted in early 2001, BreezeCOM was stuck with huge inventories. Based on current estimates, systems sales this year will be the same as in 2000, in the best case scenario. Like other companies, BreezeCOM must now begin manufacturing next generation technologies, while most of its inventories of components, as well as orders it 's now refusing to accept, are designed for previous generation technologies."
Another company affected by the market turnaround is Orckit Communications; however, it has been affected less because the company outsourced all its manufacturing to Israeli and foreign subcontractors. It is the subcontractors who now have the problem.
An industry source says, "Telrad is in a similar situation. The company subcontracted the systems it builds for Nortel (Nasdaq: NT) to SCI Systems (Nasdaq: SCI) and subcontracted the manufacture of its business systems to Flextronix International (Nasdaq: FLEX)."
"The only company that may see a glimmer of light at the end of the tunnel is Seabridge, whose main customer is Siemens (NYSE: SI; XETRA: SIE), but it's too soon to be optimistic."
As mentioned earlier, the chain does not begin with the Israeli companies, but with the global communications infrastructure and equipment manufacturers, which have been canceling orders at the last minute, forcing the Israelis to do likewise.
How is it possible that companies accumulated inventories to the point where they are forced to refuse payment for components they have ordered? Such questions are usually directed at management. The real question is whether the current situation could have been predicted.
"When the market booms, everyone is an excellent manager and a superb salesman," says a supplier. "But management is actually tested during the tough times. Managing a crisis and navigating a company to recovery are the real tests. Nevertheless, it 's hard to pass judgement on CEOs in catastrophic times like the current market climate. It should be remembered the market was in overshoot in the past few years, and has fallen proportionally.”
"All the analysts are now pointing accusing finders at the CEOs, but show me the analyst who predicted the current situation a year ago. Everyone was declaring on every stage that 2001 would be a boom year. If CEOs sinned, it was in listening to the analysts' forecasts. ECI's managers are blamed in part for splitting the company at the worst possible time. But who could foresee that this would be the worst possible time? Any analyst who predicted such a total upheaval and collapse in 2001 should stand up now. Everyone said there would a slight decline or correction in the communications market only in 2002. So who should be laid off, [ECI president and CEO] Doron Inbar and [Gilat Satellite Networks CEO] Yoel Gat, or the analysts whose forecasts they used as a basis for their actions?"
One way or the other, the components sector is taking a drubbing. Suppliers claim the companies' abrogation of the debts has created a crisis of trust that may fundamentally alter business practices in Israel and undermine the entire sector.
Published by Israel's Business Arena on 18 June 2001 |
