Why Redback Got Whacked

The numbers met the estimates, but Wall Street didn't like the message being sent by declining margins

January 18, 2001

2 Min Read
Why Redback Got Whacked

Redback Networks Inc. (Nasdaq: RBAK) appears to have run out of luck pleasing Wall Street, following another quarter that beat estimates but was plagued by several warning flags.

The company reported earnings per share (EPS) that came in a penny over most estimates. At the same time, however, the company indicated that gross margins had once again dropped. Investors appear to be getting weary of the caveats attached to Redback's quarterly reports (see Redback Blows Away the Numbers). As a result, the stock took a hit today in early trading, down 7.87 (16.22%) to 40.69.

Also contributing to the selloff was a downgrade by SG Cowen, which lowered Redback's rating from a Strong Buy to a Buy. Analyst Christon Armacost cited lower margins due to volume discounts on the Subsciber Management System product as a reason for the demotion. "Volume discounts on the SMS caused another shortfall in gross margins, down to 54.3 percent."

Earnings for the fourth quarter were 114.6 million, compared with 26.1 million for the period last year, an increase of 339 percent. Pro forma net income was 7.8 million or 5 cents per share, compared to 2.0 million or 2 cents per share for the same period last year, an increase of 290 percent.

Of primary concern concern to analysts and investors was the decline in margins from 76.3 percent to 54.3 percent. Gross margins are a general measure of the profitability of a product line.

Concerns about the company’s gross margins point to looming challenges for Redback. Not only is its SMS product line coming under pricing pressure, but its new product line, the SmartEdge, will be competing in a crowded marketplace, making it subject to similar competitive pressures. The SmartEdge optical networking product line will be competing with products from Cisco Systems Inc. (Nasdaq: CSCO) and Ciena Corp. (Nasdaq: CIEN), which this year plans to have a similar product on the market through its merger with Cyras. To a lesser extent, the SmartEdge series will compete with a number of other companies marketing optical networking products for the metropolitan area, including Sycamore Networks Inc. (Nasdaq: SCMR) and ONI Systems Inc. (Nasdaq: ONIS).

In addition to worries about Redback’s gross margins, there are concerns about accounts receivable growing faster than revenues in the fourth quarter. Accounts receivable grew from 59.0 million in Q3 to 96.0 million in Q4. When compared to revenue, which grew from 80.0 million to 114.6 million, flags are thrown.

According to Steve Levy, an analyst at Lehman Brothers, this has contributed to the reaction to Redback's quarterly numbers. “There has not been a consistent negative trend in Redback’s account receivables, but the numbers this quarter definitely warrant concern," says Levy.

-- Matt Malina, research associate, Light Reading http://www.lightreading.com

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