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Typically, such a misstep would provide more than enough ammo for today's momentum-obsessed traders to blow away the horrible perpetrator's share price. However, Tellabs' shares only slid a couple of percentage points in early trading, suggesting that market participants assimilated the bad news as really not all that bad after all. If anything, the real bummer was that the firm's shares missed out on the run-up of equipment peers Alcatel (NYSE: ALA), Ciena (Nasdaq: CIEN), Newbridge Networks (NYSE: NN), and ADC Telecommunications (Nasdaq: ADCT), which were all sharply higher today.
Tellabs sees EPS for the quarter coming in between $0.25 and $0.27 (excluding one time items), not much of an improvement over last year's $0.24 and below the First Call mean estimate of $0.30. Even though high demand for its products will lead to quarterly revenues somewhat above plan at $630 million, component shortages are taking their toll on margins. During a conference call this morning, management indicated that gross margins will fall to 51% to 52% in Q1 from the 57% to 58% norm in previous quarters.
The earnings shortfall may end up being a one-time deal, but the lower gross margins are probably here to stay, at least for a little while. By its own account, the company was scrambling during the period to get its hands on the capacitors that go into its flagship Titan 5500 broadband digital cross connects and Cablespan cable telephony access products. After initially thinking that its suppliers might be able to catch up to its needs, management admitted today that such a notion in hindsight was "perhaps naive." The company is now on "allocation" with its capacitor suppliers for the rest of the year. Such lingo is familiar for long-time followers of the Old World, component-dependent PC market; it's a rather recent development along the telecommunications equipment new frontier.
General component shortages are not unique to Tellabs, as other companies involved in providing the necessary infrastructure for next-generation networks are running into similar problems. In the optical networking space, Nortel (NYSE: NT) in particular has alluded to the component issue both publicly and privately as an immediate concern. Even though key suppliers like JDS Uniphase (Nasdaq: JDSU), SDL (Nasdaq: SDLI), and Corning (NYSE: GLW) are busy rolling up the optical components business through acquisitions as a way to boost capacity and meet exploding demand, the shortages are persisting.
Tellabs can't point the finger at any one supplier for causing the margin pain, since the company uses many suppliers for its standard commercial components and relies on a single-source vendor for only a few items. And with components accounting for more than two-thirds of the firms' cost of sales last year, it's easy to see just how vulnerable the firm's efficient, just-in-time factory process is to the ups and downs of the components market.
Tellabs said it has learned its lesson and currently feels that it has enough parts on hand to get its products out the door without interruptions for the rest of the year.
However, such security comes at a steep price. Besides the higher component prices the firm has been forced to pay, it will also incur higher inventory carrying charges to boot. On the bright side, essentially all of the company's products -- with the lone exception being echo cancellation products -- are selling very well, which means higher unit revenues are expected to make up for the margin slide in the coming quarters. For the full-year, Tellabs is sticking to its prior guidance of EPS of $1.66, signifying 28% year-over-year earnings growth.
Unlike the PC business, Tellabs fortunately does not have to worry about constantly falling end-unit pricing, so it has more flexibility to absorb short-term component price spikes. While the firm doesn't have much in the way of pricing power either, white-hot demand for its high-capacity transmission and access products ensures a great deal of price stability and revenue visibility. For investors possibly concerned that the telecom equipment business will eventually assume more of the deflationary economic characteristics of the PC business, that day seems long off.
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