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Routing

Wild Ride for Redback Shares

You think the Redback Networks Inc. (Nasdaq: RBAK) conference call was going to be simple? Think again.

Redback last night released third-quarter results that failed to meet analysts' expectations, which caused the stock to crater in after-hours trading. But talk of ongoing growth and the explanation that $3 million in revenue was deferred in the quarter helped pep up the firm's see-saw stock price in morning trading, where it rose nearly 10 percent. (See Redback Reports Q3.)

Complicating the picture further was the message from Redback management that sales in Asia are fueling growth, yet at the same time bringing down margins.

The edge router firm posted revenues of $36.4 million, up 73 percent from revenues of $21 million a year earlier. But that still fell short of the $37.14 million analysts had been expecting.

A net loss of $8.4 million, or 15 cents per share, was also better than last year's third-quarter net loss of $12.5 million, or 24 cents per share. Again, analysts had expected better. Even accounting for a one-time charge that reduced the loss to 8 cents per share, Wall Street had anticipated a 4 cents per share loss.

Those numbers initially sent Redback's share price down by nearly 5 percent to $8.74 in after-hours trading Wednesday, taking it even further away from the $11-plus the stock achieved in September, spurred by rumors of new customers and potential partners. (See Redback Shares Rock: What's Up? and Tellabs May 'Edge' Towards Redback.)

But the vendor's management went on the offensive during a late Wednesday afternoon conference call, and clearly gave investors renewed confidence. In early morning trading Thursday, the share price was up 79 cents, nearly 9 percent, to $9.98.

On the conference call, CFO Tom Cronan said third-quarter revenues would have been higher, but the firm played it safe by deferring recognition of $3 million in revenues from a major new European customer using the Smartedge router in its video-on-demand network.

Cronan added that gross margins were lower than anticipated at 57 percent, down from 63 percent in the second quarter, but these were set to bounce back in the fourth quarter. The dip was due to the high volume of business in China and Taiwan, which are "challenging markets for margins," said CEO Kevin DeNuccio on the conference call.

“The margin pressure could almost completely be attributed to some outstanding success of our business in China and neighboring Taiwan, two of our most challenging margin countries,” said DeNuccio.

Redback officials also noted that new deployments were weighted towards initial chassis deployments, which derived lower gross margins. Later on, the sale of additional linecards and software generated higher margins, added Cronan.

That Asia/Pacific business was driven by large deployments at Chunghwa Telecom Co. Ltd. and (NYSE: CN; Hong Kong: 0906), both of which were top five customers in the quarter, along with (NYSE: SBC), (NYSE: BLS), and (See China Netcom Picks Redback, How Redback Won BellSouth, and Chunghwa Deploys Redback Gear .)

The two RBOCs and Chunghwa each accounted for more than 10 percent of total revenues, while reseller partner Alcatel (NYSE: ALA; Paris: CGEP:PA) also weighed in with more than one tenth of revenues.

DeNuccio noted that Redback now has more than 150 service provider customers, with 47 signing up this year, and he believes there's plenty of growth ahead for the firm's Smartedge router as broadband growth continues and carriers launch IPTV and video-on-demand services.

Guidance was strong. DeNuccio said fourth-quarter revenues will be between 15 percent and 20 percent higher -- between $41.9 million and $43.7 million -- and that Redback is on course to break even during that period.

DeNuccio isn't the only one predicting increased demand for the Smartedge product. George Notter at Jefferies & Co. Inc. sees a significant ramp up in Smartedge sales in the coming year.

In a research note issued today, Notter estimates 2005 revenues of $147.2 million and a loss of 20 cents per share for the year, and revenues of $185.7 million generating earnings of 15 cents per share in 2006.

But he's cautious about Redback's ability to control its costs as business grows, and not especially bullish on the stock price. He believes the vendor might still post a small loss in the fourth quarter before breaking even in the first quarter of 2006. Notter is maintaining his Hold rating and a stock target price of $7.50.

As Redback continues to move away from deploying the older SMS platform, company officials said they expect SmartEdge technology to account for almost all new growth, and they reported 47 new customer acquisitions for the platform for the year-to-date.

One mystery yet to be unraveled is whether or not Redback has big new European customers coming. Among those new wins was a deal announced earlier this week with France’s Completel S.A.S. (Paris: CPT) to deploy SmartEdge technologies as the company expands its network from eight to 90 metropolitan areas in France. But some analysts were disappointed that it wasn't a larger provider.

On the conference call, one analyst wondered aloud whether France Telecom SA (NYSE: FTE), a former SMS customer, was now a major Redback customer.

Redback said that it had the top three of the largest networks in France. When the analyst asked if this included France Telecom, DeNuccio replied that this would be a safe assumption.

— Ray Le Maistre, International News Editor, and Joe Tuzzo, Special to Light Reading

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