EARNINGS SHOW SECTOR HAS BOTTOMED OUT

The bleeding in telecom has all but stopped, if the initial results from the second quarter earnings season are any indication. Now it's time to wait for the wounds to heal and hope that not too much scar tissue has developed.

Most companies that reported earnings last week showed flat revenues compared with the previous quarter. That they didn't decline has industry observers believing telecom has hit bottom — finally. Barring another WorldCom-like shock to the system, most expect the telecom sector to remain in its current flat state for the rest of 2002.

“I'd say this quarter is very similar to the last quarter — maybe slightly better,” said Tom Morabito, senior telecom analyst for McDonald Investments. “We're bouncing along the bottom. It's going to be a steady, slow comeback.”

Equipment vendor Tellabs reported earnings per share — excluding one-time items — that were 1¢ lower than expected, and sales that were down sequentially, dropping to $344.6 million from $371.5 million.

Tellingly, though, neither analysts nor the stock market reacted negatively to the news.

With almost every major carrier having announced capital expenditure cuts last quarter, it was no surprise that Tellabs' bottom line was affected, even with the 1200 jobs it cut in April. And the company is prepared to cut costs further, according to CEO Michael Birck, who said current carrier attitudes toward spending could make further steps necessary in the coming months.

“Virtually all [Tellabs' customers] are purchasing on a day-to-day basis,” Birck said in the company's earnings call. “This means we have to adjust our own spending and our own planning, and as you know, we've been doing that for some time.”

SECOND QUARTER EARNINGS BREAKDOWNS
COMPANY EPS	Q2 REVENUE	Q1 REVENUE	EPS*	EXPECTED
Tellabs	$344.6 million	$371.5 million	$0.0	$0.1
Sprint	$3.97 billion	$4.03 billion	$0.36	$0.33
Sprint PCS	$3.02 billion	$2.85 billion	$-0.17	$-0.8
Nortel	$2.27 billion	$2.91 billion	$-0.09	$-0.09
TDS	$723.8 million	$665.2 million	$1.25	$1.02
Nextel	$2.2 billion	$2.2 billion	$0.37	$-0.24
* Pro forma earnings per share
Source: Companies, First Call

Nortel Networks' cost reductions paid off in the last quarter. The company reported a 40% decline in year-over-year revenue but narrowed its bottom-line loss significantly. On a sequential basis, the vendor's revenue dropped about $600 million. Nortel CEO Frank Dunn said in an earnings call that he expects revenue to remain flat in the third quarter.

“Looking forward, we are seeing stability in the market,” he said. “I'm not saying we are seeing growth, but we are seeing the business activity starting to stabilize.”

But pressure stemming from reduced carrier capex budgets likely will remain, Dunn said, with 2003 budgets falling from 2002 levels. In response, Nortel will look to reduce costs further in coming months, he said.

Sprint, the only major carrier that announced earnings last week, cut its capex budget by $100 million. The good news, however, is that the cut was minor compared with the company's original capex budget of $5.9 billion. Ongoing weakness in the data market contributed to Sprint's capex cut.

“Data sales bookings early in the quarter were below our expectations,” said Len Lauer, president of Sprint's Global Markets Group. “We also had some disconnects in the data business due to customer bankruptcies.” Revenues for enterprise data were down 4%, Lauer said, but pricing is showing early signs of stabilization.

The stabilization of the enterprise market would be a huge step toward a recovery in a telecom sector that depends heavily on business customers and their high-dollar contracts. “[Earnings] have been more or less on target with tempered expectations,” said McDonald Investments' Morabito. “You're not going to see any blowout quarters for telecom until enterprise spending picks up, and we're just not seeing that.”

But not all the news coming from Sprint was bad. The carrier beat the consensus analyst EPS estimate by 3¢ per share and upped its guidance for EPS and EBITDA for the rest of the year.

TDS also showed some improvements this quarter. Unlike many others, the company actually grew its top line 13% sequentially, with revenues of $723.8 million.

The company attributed much of the improvement to better-than-expected line growth on the incumbent side of its wireline business, which Dave Whitworth, executive vice president and CFO of TDS Telecom, said was an indicator that the economic downturn is ending. “In tough economic times, customers will accept disconnects for a longer period of time, so the line pickups we experienced in the quarter, particularly in the past month, might be a signal that things are coming back a bit,” he said.

But growth at TDS had a hitch because too much of the revenue for the quarter was generated as a result of acquisitions made in the quarter, said Michael Balhoff, an analyst with Legg Mason. “Strip away those acquisitions, and the growth was only about 1%,” he said.

Reports from wireless carriers were mixed. Nextel reported higher net adds than expected, which contributed to the company's first profitable quarter ever. The carrier kept churn flat as well, reporting only 2.1% customer loss.

Similarly, Sprint PCS held churn to the low level of 2.9%, but much of the other news was disappointing. Net adds for the quarter were weak, and the company missed badly on EPS, reporting 17¢ per share loss, compared with the analyst estimate of 8¢ per share.

Vic Grover, director of equity research at Kaufman Bros., offered an ugly outlook for Sprint PCS. “We predict competition will lead to higher churn, higher customer acquisition costs, lower returns, higher bad debt and other issues,” he said.

With flat growth, stabilizing pricing and cost-cutting measures in place, analysts are lukewarm on the quarter in general. While that may not seem like a ringing endorsement of the telecom sector, it actually is a marked improvement over where the industry has been for the past 18 months.

“Our advice to investors is to have relatively modest expectations and they won't be disappointed,” said Morabito. “Given how brutal it's been the last couple of years, our expectations are pretty low. I don't think you're going to see any blowups on the positive or negative side.”

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With additional reporting by Glenn Bischoff, Kevin Fitchard and Tim McElligott in Chicago.