Foundry Meets Lowered Expectations

Good news from Foundry Networks Inc. (Nasdaq: FDRY) yesterday has boosted the company’s stock better than 20 percent today to about $13.23 at midday (see Foundry Lowers Q1 Outlook). Yesterday the company, which makes switches and routers, reported its first-quarter earnings, meeting analysts' lowered expectations for the quarter.

But analysts covering the company are skeptical whether the stock will benefit long term from this news. Seth Spalding, an analyst with Epoch Partners issued a research note his morning.

“The tone of business seems to be firming up, which will in the end have a bigger impact on the sector than on Foundry itself,” he writes. “These improvements could propel Foundry shares higher immediately following today's announcement, but our analysis indicates that FDRY is near fair value, and therefore should be avoided.”

Ironically, Spalding sees Cisco Systems Inc. (Nasdaq: CSCO), Riverstone Networks (Nasdaq: RSTN), and even new entrants Luminous Networks Inc., Force10 Networks Inc., Atrica Inc., and Lantern Communications benefitting more in the long term from Foundry’s news than Foundry itself.

The company reported $82.6 million in revenue for Q1, compared to $70 million for Q1 last year. And it reported earnings per share (EPS) of $0.04. Gross margin of 52.9 percent came in just ahead of some estimates, which were around 52 percent.

Foundry’s CEO Bobby Johnson was upbeat on yesterday’s conference call, joshing with his audience that business is a lot better now than it was in January.

“Despite the current economic conditions I am cautiously optimistic,” he said. “Foundry has several key announcements coming up as we prepare for Networld Interop in Atlanta. And we’re well positioned to build on current products.”

One potential problem for Foundry is its increasing reliance on sales to lower-margin enterprise accounts, rather than higher-value service provider customers. Of the 300 new customers added this quarter nearly 80 percent are enterprise accounts, according to Spalding. And the newly added customers, along with the downturn in carrier spending, caused an even 50-50 split between service provider and enterprise customers this quarter. Last quarter the split was about 60 percent service provider and 40 percent enterprise.

Sales into the metropolitan area network (MAN) represented 10 percent of revenue, up from 5 percent last quarter. But even though penetration in this market increased, it still doesn’t represent a significant stream of sales, says Spalding.

“Foundry's MAN products may not be differentiated enough from competitors such as Riverstone,” he writes. “Meager metro sales are also a function of the nascent metro Ethernet opportunity.”

Like Cisco, Foundry also reported issues with its inventory, reporting a $63 million backlog. But Johnson sees the inventory as a way to help the company improve its margins in future quarters.

“I’m confident that we will be able to handle the inventory,” he said. “As the economy improves, our margins could improve much more favorably.”

-- Marguerite Reardon, senior editor, Light Reading http://www.lightreading.com

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