Nice report from Solomon SmithBarney
July 15th Salomon Smith Barney Report FYI --
ASND: Ascend Reports Solid FY 1998 Second Quarter Results
Salomon Smith Barney
July 15, 1998
--SUMMARY:--Ascend Communications--Data Networking
Key Points
Ascend reported solid FY Q2 operating results - exceeding our expectations
Raising our FY 1998 and FY 1999 estimates to $1.21 and $1.59, respectively
Raising our price target to $60-$65, based on FY 2000 EPS estimate of $2.00
--EARNINGS:-----------------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 12/97 EPS $0.31A $0.31A $0.20A $0.24A $1.07A
Previous 12/98 EPS $0.26A $0.27E $0.30E $0.35E $1.17E
Current 12/98 EPS $0.26A $0.29A $0.31E $0.35E $1.21E
Previous 12/99 EPS $0.35E $0.36E $0.37E $0.40E $1.47E
Current 12/99 EPS $0.35E $0.38E $0.41E $0.45E $1.59E
Previous 12/00 EPS $N/A $N/A $N/A $N/A $N/A
Current 12/00 EPS $N/A $N/A $N/A $N/A $2.00E
Footnotes:
--FUNDAMENTALS:-------------------------------------------------------------
Current Rank........:1-H Price 07/14/98......:$49.56
Prior Rank..........: Target Price........:$65.00
P/E 12/98...........:41.0X 52 Wk Price Range...:55.00 - 22.62
P/E 12/99...........:31.2X Proj. 5yr EPS Grth..:20.0%
Return on Equity 97.:24.00% BookValue...........:$0.00
LT Debt-to-Capital..:N/A% Dividend............:$0.00
Revenue 1998........:$1402.00 mil Yield...............:N/A%
Shares Outstanding..:189.56 mil Convertible.........:No
Mkt. Capitalization.:$9394.59 mil Hedge Clause(s).....:*
Comments............:
--OPINION:------------------------------------------------------------------
Investment Conclusion:
Ascend Communications reported strong operating results Tuesday night after
the close, exceeding Street expectations. We are raising our FY 1998 and FY
1999 estimates based on: (1) Continued strengthening fundamentals of the
carrier market; (2) Continued market share gains by Ascend in the core
switching equipment market; (3) Improved gross margin and operating expense
control; and (4) Slightly lower tax rate. Our FY 1998 EPS estimate is
$1.21, versus our prior estimate of $1.17, and our FY 1999 EPS estimate is
now $1.59, versus our prior estimate of $1.47. We are also initiating a FY
2000 EPS estimate of $2.00. We believe that there are three catalysts for
the shares in the intermediate term: (1) Announcement of new carrier wins
in the international market, including Deutsche Telecom, France Telecom and
Unisource; (2) Commercial deployment of Ascend,s emerging broadband and
advanced platforms, including xDSL, SS7 and core switch optical interfaces
- all of which expand Ascend,s available market opportunity by tenfold;
and (3) Ascend,s successful penetration of the regulated incumbent LECs.
We believe that successful execution of these opportunities over the next
six months will reinforce our confidence in our FY 1999 and FY 2000
estimates. We also would highlight that we believe that the company needs
to make strategic acquisitions in the intermediate-term in order to better
position the company for success within the three opportunities discussed
above. We reiterate our Buy (1H) rating and are initiating a new 12-month
price target of $60-$65.
Key Points:
(1) Solid quarterly performance ) exceeding our expectations. Ascend
reported revenues of $327.4 million, up 7.3% sequentially and 5.0% YoY,
versus our $326.2 million estimate. Earnings per share totaled $0.29, up
11.1% sequentially, versus our estimate of $0.27 (consensus was $0.28). We
believe there were a number of positives during the quarter, including: (1)
core switching revenue growth; (2) a slight increase in gross margins; (3)
additional reduction of customer concentration -- no 10% customer versus
one last quarter; (4) better than expected expense control and (5)continued
strong bookings growth. Ascend's balance sheet was neutral for the quarter.
DSOs were up 2 days to 74 but well within the target range of 70-75.
Inventory was up $29 million from the prior quarter, primarily due to
deferred bookings and some new product introductions during the quarter. As
a result, inventory turns was down to 3.6 times versus 4.3 times in the
March quarter. We expect to see improvement in this area going forward and
inventory turns should be approaching 5 times by the end of year.
From a product standpoint, the core switching business led the way with
revenues up 23.4% sequentially, totaling 47% of revenues for the quarter.
The strong growth was driven by the deployment of ATM backbones in the
emerging carriers (such as Williams Communications Group and Qwest
Communications) as well as network wins in the unregulated side of carriers
such as GTE. The GX 550 customer base has grown during its first full
quarter shipping, and we believe it will be a key product in winning new
business in the second half of the year. The access business grew for the
second consecutive quarter, albeit mildly at 1.3% coming in at 42% of
revenues. Consistent with historical lumpy trends in Ascend's traditional
ISP customer base, Ascend's largest North American ISPs, PSI and UUNET,
were deploying ports throughout Q2 and we expect them to return to more
normalized purchasing patterns in the second half of the year.
From a geographic standpoint, International revenues grew by 40.4%
sequentially, reflecting strong growth in Europe and Japan. Led by a big
France Telecom order, Europe was up 35% sequentially and accounted for 15%
of sales compared to 11% in the March quarter. Although we anticipate the
usual summer slow down of business in Europe, we expect the European PTTs
to begin to award contracts for Frame Relay and ATM infrastructures at the
end of Q3 and into Q4. Japan business remained strong sequentially and
accounted for 13% of revenues up from 10% in the prior quarter, with NTT
again being the major contributor. However, we do not expect the NTT
business in Japan to sustain the current levels throughout the remainder of
the year. North American revenues declined by 4.2% sequentially to total
66.3% of revenues, the decline primarily due to the lumpiness in the ISP
business.
Outlook remains positive. Huge opportunities remain ahead, execution is
critical. Ascend's target market segment (carrier / service provider)
remains one of the fastest growing markets in the data networking sector,
and three specific areas of opportunity are eminent. First, the European
carrier market is beginning to get serious about their data network
infrastructures, with most of the PTTs in the midst of issuing RFPs. We
anticipate that PTT network wins will begin being awarded towards the end
of Q3 and into Q4. Second, the focus in the North American market will be
on digital subscriber loop (dsl) deployment as the CLECs become more
aggressive and the RBOCs and ILECs are being squeezed by the CLECs and must
respond. The estimated dsl opportunity for North America is approaching
160 million access lines for the year. The third area of opportunity is in
the SS7 gateway product that Ascend started shipping in July. The gateway
could parlay nicely into increased deployment of the TNT via two direct
opportunities: (1)immediate deployment for data offload from the POTS and
(2)migration into a more cost effective version of a tandem switch. On the
GX 550, the OC-48 interface has begun shipping, providing the evolution of
the GX 550 into a core switch with SONET capability therefore entrenching
Ascend deeper into the US emerging alternative carriers such as Qwest and
Level 3. These opportunities are tempered with four challenges: (1)the
ability to continue to execute, (2)new competition in the access market,
primarily Lucent (with the acquisition of Livingston) and Northern Telecom
(with the acquisition of Aptus), (3)new competition in the core switching
market in both the US, Lucent and Cisco with new products, and in Europe,
Alcatel and Siemens with a long history of selling to the PTTs, and finally
(4)the technology must continue to out-step competitors, especially in the
dsl and SS7 arena, to penetrate the customer base in the BOCs. We still
look to Ascend to augment its products through strategic acquisitions which
will enable them to improve their positioning and drive new revenue growth.
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