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ONI Meets Estimates, Boosts Guidance

Light Reading
News Analysis
Light Reading
7/23/2001

ONI Systems Inc. (Nasdaq: ONIS) showed it is still expanding its presence in the metropolitan optical networking market, reporting second-quarter sales of $68.2 million, compared to revenues of $9.5 million during the year-ago period and $45 million in the first quarter (see ONI Posts Up ).

The company met Wall Street's expectations of a 5 cent per diluted share loss for the quarter. Its pro forma net loss -- ignoring items such as deferred stock compensation and goodwill -- was $6.7 million for the quarter ended June 30, 2001. The company's pro forma net loss from the year-ago period was $20 million, or 18 cents a share.

ONI's actual net loss for the second quarter was $18.6 million, or 14 cents per share, compared to a net loss of $39.4 million, or 40 cents a share, during the year-ago quarter.

ONI's gross margins were a source of worry for analysts on the conference call. Specifically, analysts fret that as more long-haul equipment companies begin to focus on the metro market, ONI will face tougher pricing pressures from these larger companies.

ONI's gross margin as a percentage of revenue for the quarter was 38.9 percent, compared with 27.6 percent in the second quarter of 2000. The increase in gross margins shows that ONI has more left over after the costs of making its product, but the company still needs to boost its margins substantially in order to reach net profitability.

ONI expects gross margin as a percentage of revenues to fall between 38 percent and 40 percent during the next two quarters.

The worrisome thing is that analysts were expecting ONI's gross margins to hit the 40 to 41 percent range in this quarter. The reported numbers were only a fraction of a percentage point better than the first quarter's gross margin of 38.5 percent.

Tightening gross margins are usually a sign of price wars, and many industry experts have been expecting pricing pressure now that the market for metro networking has narrowed remarkably, with the same number of suppliers present.

ONI CEO Hugh Martin explained that equipment deployments for new customers means lower gross margins at first. Because ONI had an increase in new customers, he reasons, this means lower gross margins. But as product upgrades such as line cards and software are added, its margins will improve, he says.

Martin urged analysts to consider that ONI is building a large customer base for future business, rather than concentrating on its short-term margin concerns. "Every one of these systems that are going in are just waiting for upgrades," he says. "No one else's equipment is going in there."

Martin did, however, acknowledge that ONI's competitors were applying price pressure overseas. "We've seen some irrational behavior from competitors who have equipment that they can't sell," he says. Martin noted that ONI walked away from two overseas deals because prices dropped too low.

The competitors ONI most often sees in the field, according to Martin, are Nortel Networks Corp. (NYSE/Toronto: NT) and Ciena Corp. (Nasdaq: CIEN).

During the call, Martin again upped the ante on ONI's expected results for the next few months. The company is now projecting revenues of $75 to $80 million for its third quarter, compared to its previous range of $60 to $70 million (see ONI Beats Numbers, Boosts Guidance).

Martin said fourth-quarter revenues would be between $85 and $90 million. ONI expects yearly revenues to be between $275 and $285 million, up from its previous estimate of $245 to $255 million.

ONI had seven customers a year ago, 21 customers last quarter, and 24 customers this quarter, Martin says. The company now says it expects to have between 32 and 34 customers by year-end -- up from previous estimates of 28 to 30 customers. Most of ONI's customers (10) are CLECs (competitive local exchange carriers). It also gets business from six inter-exchange carriers (IXCs), three Internet Service Providers or Application Service Providers, two utility companies, and three ILECS (incumbent local exchange carriers).

There are no RBOCs (regional Bell operating companies) on ONI's customer list now, but Martin expects that to change after the end of this year, when ONI's products complete OSMINE (Operations Systems Modification of Intelligent Network Elements) certification. OSMINE certification means that a product works with operating systems from Telcordia Technologies Inc., the firm that makes 80 percent of the operating systems used by RBOCs.

ONI's stock rose 1.07 (4.98%) to 22.54 in trading Monday. In after-hours trading on the Island ECN after earnings were announced, the stock had risen another 1.50 to 24. The company's shares hit their 52-week high a year ago this week when the stock soared to $124.75 a share.

- Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com

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