Tellium Shares Sink After Earnings

Street reacts to news of a pro forma profit skeptically; investors continue to await new contracts UPDATED 2/1/02 2:55 PM

February 1, 2002

4 Min Read
Tellium Shares Sink After Earnings

Core optical switch maker Tellium Inc. (Nasdaq: TELM) didn't announce any new customers on Thursday, as some on had hoped, but it did offer a pleasant surprise by reporting rising revenues and a pro forma profit during its fourth-quarter 2001 earnings conference call.

But pro forma numbers only tell one side of a story -- and investors may have been looking at the other side. Indeed, Tellium shares were down $0.61 (11.25%) to $4.81 in late morning trading on Friday, largely due to some concerns related to Tellium's overall business and whether it really has accomplished something other than creative accounting.

Excluding one-time charges, Tellium reported a fourth-quarter profit of $1.7 million, or a penny a share, compared to a pro forma net loss of $7.4 million, or six cents a share, for the previous quarter.

Analysts were expecting Tellium to report a loss of 4 cents a share for the quarter, so the pro forma profit came as a surprise.

Its gross margins rose to $23.1 million, or 46 percent of revenues, in the fourth quarter, compared to $17.7 million, or 44 percent of revenues, in the third quarter of 2001.

Tellium's revenues rose to $50.2 million during the quarter, an increase of 25 percent over the company's third-quarter 2001 revenues of $40.1 million. For the year, Tellium's revenues totaled $136.4 million, versus $15.6 million in 2000.

One issue with some investors, however, is the treatment of numerous special charges in Tellium's results, some of which relate to special stock warrants that Tellium has issued to its customers. Several hedge-fund managers, declining to be named for this article, said the accounting treatment has raised some eyebrows on Wall Street.

With all one-time charges added in, Tellium's net loss for the quarter was $61.5 million. That included a one-time non-cash charge of $19.2 million because of the cancellation of warrants for 1.375 million shares in connection with its amended contract with Qwest Communications International Inc. (NYSE: Q) (see Qwest and Tellium Revise Contract).

Some analysts are choosing to take a conservative approach to the numbers by discounting the value of the stock warrants that Tellium had given his customers.

But taking into account charges related to those warrants, the company only had $15 million in revenues, according to Optical Oracle research analyst Chris Bulkey. "If you figure these charges into cost of goods sold, their gross profit is a negative $15.6 million, which means they had a negative gross margin, not the 46 percent reported."

Tellium officials argued that the charges for the stock warrants issued to customers are inconsequential.

"The reality is that we're going to collect $50.2 million real dollars," says Tellium CEO Harry Carr, who was not amused with Bulkey's analysis. "The warrants charges is a creation of accountants that only accountants can understand... Not only does [backing out warrant-related revenue] misrepresent the revenue picture, but when customers exercise their warrants we'll collect even more cash from that transaction."

Tellium also cut research and development spending by about 26 percent in Q4. "Had R&D expenses even been kept flat quarter to quarter, this would have cost Tellium at least 3 to 4 cents a share," Bulkey says.Carr says the R&D cuts reflected a change in the technology demand for the upcoming full-spectrum, all-optical switch. He says a more efficient use of staff and not having to spend as much money "in non-people costs" to build future products is what led to the current quarter numbers.

During the Thursday conference call, Carr said the company would not give guidance as to when it plans to announce new customers. This comes after rumors of a new customer in Deutsche Telekom AG (NYSE: DT) and past promises by Carr that Tellium would announce a new customer by the end of 2001 (see Tellium Looks to Make Its Marks).

"We do not discuss where we are with potential customers, nor do we think it is wise to announce customer test activity," he says. "In the meantime, I intend to stay out of the prediction business of the specific timing of those opportunities."

Carr says that during the fourth quarter, Qwest and Dynegy Inc. (NYSE: DYN) each made up more than 10 percent of Tellium's revenues. For 2002, Carr says he expects about two-thirds of Tellium's revenues to come from those carriers, with the remainder -- $96 million -- coming from new customers.

"In order to recognize revenue from a new customer by the third quarter 2002, we believe Tellium would most likely have to finalize customer agreements in the next 8 weeks," writes Morgan Stanley Dean Witter & Co. analyst David Jackson, in a report sent to clients on Friday.

Tellium said it expects revenues to be in the range of $52 million to $55 million for the first quarter of 2002. In addition, the company continues to believe revenues in 2002 will be approximately $288 million.

Tellium's managers can sell their shares beginning in February, ending an extended lockup period that followed the company's May 2001 initial public offering (see Tellium Execs Lengthen Their Locks). The management team holds roughly 14.7 million shares of Tellium stock. "I am confident that we will not see much activity [in management stock sales] and certainly nothing significant," says Carr.

— Phil Harvey, Senior Editor, Light Reading

Editor's Note: Light Reading is not affiliated with Oracle Corporation.

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