ADC sees cost-cutting, cross-selling in Krone

In reporting its earnings for its fiscal third quarter (which ended July 31), broadband equipment vendor ADC detailed its efforts to integrate Krone Group, the cabling equipment vendor it acquired in May.

In general, analysts were impressed by ADC’s outlook for cost-cutting opportunities in the integration of Krone. With Krone and ADC combined for about 80% of the quarter, fiscal third-quarter operating expenses were $85 million, up from $58 million in the previous quarter. But ADC’s vice president and chief financial officer Gokul Hemmady vowed to end fiscal 2005 with a quarterly opex of $70 million.

"What we liked most of all about yesterday's earnings call was management's longer term guidance to reduce operating expenses noticeably more than we and most on the street modeled or expected," said Lehman Brothers in a research note issued today. "To us this is a nice, positive development, especially since it is still early days, and ADC management has just begun to explore how it can cut costs as it integrates the recent acquisition of Krone."

Plans to identify synergies and redundancies between the two firms will be implemented starting in the company’s fiscal fourth quarter and continuing through fiscal 2005, Hemmady said. ADC will begin by leveraging the new company’s combined purchasing power to save money with its suppliers. The vendor will also combine its manufacturing efforts and consolidate offices; for example, ADC will close Krone’s manufacturing facility in Mexico this year and combine those functions with ADC’s own existing production plant in Mexico.

Krone did pose some immediate drawbacks for its acquirer. Due to its high percentage of international customers (generally considered a boon for ADC for giving the company global reach), Krone raised ADC’s "days sales outstanding" to 59 from 55 in the previous quarter and 49 in the quarter before that. Hemmady vowed to reduce the number to 50 days.

"There is more work for us to do in reducing our cost," he said. ADC is also simultaneously trying to divest its money-losing Metrica software business.

Since ADC and Krone have little overlap in their customer bases and product offerings, Hemmady described a "tremendous potential" to cross-sell each company’s products to the other’s base, which president and CEO Robert Switz said began to appear late in the last quarter.

"We experienced [cross-selling] in the U.S. and saw some evidence in Europe," Switz said. "Taking products as they exist today with no modification and pulling them into accounts that were foreign, in one way or another, to either one of the parties in the various markets involved or bringing those into existing relationships or pulling together combinations of the products to add to [requests for proposals]. We expect to see more of that as we move into 2005, as the sales teams come together and focus their energies around some of these cross-selling opportunities."

In March, when ADC announced its intent to acquire Krone, Switz said he didn’t anticipate canceling any product lines of either company. But on yesterday’s call, Hemmady said reviewing ADC’s product portfolio will be an "ongoing process."

ADC’s relatively new fiber-to-the-premises (FTTP) equipment business is putting a dent in the margins of its connectivity business, a problem that could grow worse in the near term as customers such as Verizon Communications buy more of ADC’s low-margin OmniReach access platforms. But ADC predicts those margins will rise gradually as the volume of its FTTP business increases.

ADC’s overall net loss for the quarter--$14.3 million, or 2 cents per share--though an improvement both sequentially and year-over-year, fell short of analyst expectations. And Switz did not offer analysts much encouragement that sales would improve much during the second half of the year. "Other companies in the industry were more bullish about an uptic in spending in the second half," Switz said. "We never adopted that position." Instead, Switz expects customer spending to flatten or decrease slightly in the second half of the year.