ADC Dips on Weak Outlook

Yesterday, ADC Telecommunications Inc. (ADCT) declared third-quarter results after market close. Total revenue rose 3% sequentially to $283.4 million but was down 25.8% year over year. Quarterly revenue was also 1.2% better than the Zacks Consensus Estimate. The significant drop in year-over-year sales was a weak performance of all three business segments whereas sequential improvement primarily came from higher sales of Global Connectivity Solutions in the U.S. and Asia-Pacific regions.

On a GAAP basis, net earnings in the third quarter was $5.6 million, or 6 cents per share, compared to $13.4 million, or 11 cents, in the prior-year period and a net loss of $9.6 million, or 10 cents per share, in the previous quarter. However, ADC’s quarterly adjusted profit of $16.5 million, or 17 cents a share, beat the Zacks Consensus Estimate of 13 cents.

Quarterly gross margin was 34.8%, up from 34.2% a year ago and 32.8% in the previous quarter. This reflects aggressive cost-cutting measures taken by management during the past one year. Operating expenses were $85.6 million compared to $104.8 million in the prior-year quarter and $92.5 million in the second quarter. Management has streamlined the cost structure to improve productive efficiency.

At the end of the third quarter, ADC had $562.9 million of cash and marketable securities on its balance sheet compared to $656.7 million at the end of the prior-year quarter and $513.6 million at the end of the previous quarter. Total debt was $651.6 million, lower than $654.3 million at the end of the year-ago quarter and $651.4 million in the previous quarter.

The company generated cash from operation of $47.5 million compared to $56 million in the prior-year quarter and $24.4 million in the previous quarter. Quarterly free cash flow was $40.3 million compared to $45.2 million in the year-ago quarter and $13.7 million in the previous quarter.

Global Connectivity Solutions Segment

Quarterly revenue was $226.5 million, down 25.6% year over year but up 3.4% sequentially. This segment continues to generate the bulk of total sales. Fiber Connectivity accounted for 33%, Copper Connectivity 29%, Enterprise Connectivity 15% and the rest 3% was provided by Wireline Connectivity products.

Network Solutions Segment

Quarterly revenue was $19.3 million, down 39.9% year over year and down 4.5% sequentially. This segment generated 7% of total revenue. Decline in sales came from continued delay in capital spending from both telecom carriers and large enterprises for wireless network upgrade.

Professional Services Segment

Quarterly revenue was $37.6 million, down 17.2% year over year but up 5% sequentially. This segment generated 13% of total revenue. Sales rose sequentially in the US region.

Financial Outlook

In 2008, ADC’s Board of Directors decided to change its fiscal year from Oct. 31 to Sept. 30. As a result, fiscal year 2009 will end on Sept. 30, indicating that the company will get only two months as its fourth quarter this year.

ADC sees fourth-quarter sales in the range of $160 million - $175 million, significantly below the Zacks Consensus Estimate of $277 million. GAAP EPS is expected to range between a loss of 6 cents and earnings of 2 cents, including non-cash amortization expense of 3 cents per share and excludes potential non-cash or restructuring charges. This is also well below the Zacks Consensus Estimate of a profit of 10 cents per share.

Our View

The ongoing economic recession has resulted in extremely tight budgetary control by telecom carriers. Although ADC’s current cash position is sufficient to execute its business plan, we remain concerned about its leveraged balance sheet. Competition in the communications equipment industry remains intense as vendors compete for business from fewer customers. Verizon Wireless (VZ - Analyst Report) and AT&T (T - Analyst Report) jointly constituted more than 35% of quarterly revenue.

Nevertheless, the emerging Fiber-to-the-Premise market continues to remain the leading catalyst for the company’s long-term growth. To boost carrier spending, governments in the U.S., China, India and other countries have earmarked stimulus packages to advance telecommunications infrastructure. In the U.S., for instance, rural telecom subsidies may foster improved opportunities for original equipment manufactures, including ADC, that provide advanced broadband and wireless solutions. We have a Neutral recommendation on ADC.

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