The Day Ahead: Sycamore allays Wall Street worries for now

But can the fibre optics company stay on a successful roll?

Commentary: Sycamore Networks did what it had to on its conference call -- give a great outlook to get investors interested again. The company succeeded, but the big question is how long the good cheer will last.

Sycamore, a fibre optic equipment vendor, reported fiscal first quarter earnings of 2 cents a share on sales topping $120m. The sales tally was well ahead of estimates, but the key line to watch was deferred revenue, which fell slightly last quarter and kicked off three months of worry. This quarter deferred revenue jumped $20m.

On a conference call with analysts, officials seemed to be well aware of Wall Street's questions about the company and systematically tried to shoot them down.

The software glitch? When a company's main pitch is "intelligent optical networking" that means software is a big part of the equation. Some folks were concerned about a software flaw that wouldn't allow Sycamore's hardware to get along with its fellow equipment vendors' gear. Chief executive Dan Smith shot those concerns down, but did acknowledge a few problems last quarter. One customer had trouble with Sycamore gear when it left the lab. Smith said it's natural and the problem is fixed.

Too reliant on one customer? Up until this quarter, Williams Communications was Sycamore's sugar daddy, accounting for about 80 percent of sales. In the first quarter, Williams was less than 60 percent of sales as Sycamore shipped to all ten customers it has. The company recently added BellSouth and counts Enron and 360Networks as key customers. International revenue accounted for 15 percent of sales.

Capital spending worries? Any company catering to competitive local exchange carriers (CLECs) and telco upstarts could be hurt by a spending slowdown. After all, many of these big spenders are mired in debt and running low on cash. Smith said service providers may cut back, but they will flock to equipment vendors that can add value. Sycamore said it thinks it falls into the value add category. Sycamore has also worked hard to broaden its product line from the core of the network to the edge of the network.

The outlook? Chief financial officer Frances Jewels said the company will top current estimates for fiscal 2001 with earnings of about 23 cents to 24 cents a share. Current projections are about 19 cents to 21 cents a share. Revenue in 2001 will also top current expectations with growth of about 200 percent to 205 percent year over year to top $500 million.

Margins will remain steady at about 47 percent for fiscal 2001. For 2002, Sycamore sees revenue up 75 percent from 2001. Simply put, Sycamore put to rest the perception that it had been "bullish without substance" in the prior quarters.

So everything should be just great with Sycamore, right? Not so fast. There are a few outstanding issues. The biggest issue is competition. Sycamore is running out of time to land a significant "incumbent" carrier. These carriers are the big telcos that aren't going anywhere. It's an elite club that counts AT&T, Baby Bells and WorldCom among its main members.

Ahead of Sycamore's results, Seth Spalding, an analyst with Epoch Partners, said the biggest knock against the company was its lack of big incumbent carriers as customers. BellSouth is a fine customer win and a good start, but it doesn't have the clout of AT&T, which has been rumored to be considering Sycamore gear.

There are two reasons why you should focus on Sycamore's attempts to land a big-name customer -- Nortel and Ciena.

Sycamore piggybacks with Nortel gear when it comes to pitching clients. Sycamore's main pitch is that its equipment is interoperable with Nortel products. The catch is that Nortel has expanded its product portfolio and is likely to pitch its own gear in the future. Nortel can consolidate vendors and billing. If Sycamore can't ride shotgun with Nortel, it'll have big problems expanding.

The other thorn is Ciena, which is entrenched with incumbent carriers. Toss in companies like ONI Systems, which is gaining significant traction, and you can see why folks were worried about Sycamore and its P/E of 550 (and that's after a big dip).

For Sycamore, it all comes down to landing a big customer. The company had a lot of answers, but the incumbent question is a biggy. Without a big telco on the customer list, Sycamore could quickly find itself in a bind. The good news is there's an easy cure -- a big contract announcement with an incumbent carrier.

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