Fibre Channel Sinks Vitesse

Vitesse Semiconductor Corp. (Nasdaq: VTSS) said on its conference call that demand for Fibre Channel components has mysteriously dried up, forcing the company to forecast a disappointing earnings drop for September.

CEO Lou Tomasetta told analysts on yesterday's earnings call that he expects storage revenue -- which consists primarily of port adaptors for 2-Gbit/s Fibre Channel -- to drop 30 percent from its $25.8 million level reported in the June quarter.

Vitesse executives didn't point to exactly what's going on, but the few allusions they made to it were dark enough. "There's either something going on with overall demand or the way the market is absorbing the finished product," Tomasetta said. "I suspect it'll take us through most of the summer quarter to understand what's going on."

But the basic connection Vitesse made between "Fibre Channel" and "falling revenues" is probably enough to get investors running for cover, considering that earnings reports this season have been wobbly at best. Whatever Vitesse's "Fibre Channel thing" is, it seems to be affecting nearly all storage customers in every geography.

Tomasetta rules out the inventory problem that chip makers sometimes face, where customers stockpile parts until, one day, they're oversaturated and stop ordering for a while. "I don't believe it's an inventory issue, because there it would be unique to one or two customers."It's a tough blow for Vitesse, which has seen storage become 43 percent of revenues since cutting back on telecom chips two years ago (see Chip Trio Faces Post-Bubble Blues). Vitesse stock traded down 15 percent today, at $2.75.

Vitesse officials didn't guess at how long the FC lag will last. Still, the possibility of a prolonged slump led analyst Chris Dzurinko of American Technology Research to downgrade Vitesse to a Sell recommendation today.

"We believe that the softness in demand likely started at the beginning of July and that inventory issues, integration of more IC functionality, and competition are all playing a part in the weakening demand," Dzurinko writes in today's report. "In addition to the weakness in September, we think that storage revenue in the following two quarters thereafter may be flattish."

The chip vendor's results for the June quarter were not, however, that bad. For its third quarter ended June 30, Vitesse reported a pro-forma profit of $3.5 million, or 2 cents per share, on revenues of $60.4 million, compared with a loss of $8.1 million, 4 cents per share, on revenues of $39.7 million for the same quarter in 2003.

Acquisition-related charges wiped out the June profits, leaving Vitesse with a loss of $4.6 million, or 2 cents per share, when tracked by generally accepted accounting principles (GAAP).Separately, Tomasetta predicted a hard road for 4-Gbit/s Fibre Channel, as intense competition is expected to keep prices low. While the company estimates 2-Gbit/s FC will be a $75 million market at its peak, it expects only $50 million per year from the 4-Gbit/s generation.

Vitesse did have good news on the communications side of the house, where chips for metro networks have produced more than 10 percent revenue growth for four quarters straight. Metro business now represents 22 percent of Vitesse's revenues, up from 15 percent a year ago.

Vitesse's results continue a streak of bad news in this quarter's earnings batch. Previously, Agere Systems Inc. (NYSE: AGR.A) and Foundry Networks Inc. (Nasdaq: FDRY) each turned in disappointing numbers due to problems with specific customers' orders (see Agere Stung by 3G (Again) and Foundry Haunted by 'Lumpiness').

Craig Matsumoto, Senior Editor, Light Reading

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