Inventory Backlog Pulling Down Vitesse Projections

By all accounts, the upcoming fourth quarter should have been the break-even quarter for Vitesse Semiconductor Corp., a turning point the company has been working toward for years. But earlier this month, the Camarillo-based maker of components for telecommunications, data storage and other sectors, revised its guidance, saying that its revenues would be lower than initially anticipated, and the company would likely report a pro forma loss of about $0.02 per share as a result. “In the early part of the year things looked a lot rosier, so a lot of our customers may have been buying more components in terms of anticipated growth and sales, which, by the time June and July rolled out, they did not realize,” said Yatin Mody, Vitesse’s vice president of finance. “So there’s a lot of inventory out there that will take some time to bleed off.” Vitesse, which works on a fiscal year that ends Sept. 30, is due to release its fourth quarter and full year financials following press time on Oct. 26. But in the company’s revised guidance, Vitesse reduced its earnings projections from an initial $0.00 to $0.01 per share and said that revenues would be about $52 million, down from earlier guidance of $54 million to $57 million. The data storage sector that accounts for a hefty portion of Vitesse’s sales has slowed considerably, affecting many of the companies that supply the industry. “Half the companies within my coverage area pre-announced (downward) this quarter,” said Sandy Harrison, director of research at Pacific Growth Equities in San Francisco. “There seems to be a bit of an inventory adjustment taking place, and (Vitesse is) obviously not immune to it.” But the downturn is an especially bitter pill for Vitesse to swallow. Shielding itself Beginning around 2000, Vitesse ramped up its data storage efforts in an attempt to fortify the company against the vagaries of the much smaller niche business where it had concentrated, a narrow range of products for the telecommunications and test equipment markets. By the third quarter of this fiscal year, data storage had grown to account for $25.7 million of Vitesse’s $60.4 million in quarterly revenues, or about 42 percent of the company’s business. And as a result, Vitesse did not feel the full brunt of the downturn in the telecommunications sector over the past several years. But what had been a successful solution several years ago is now at the center of the company’s latest setback. Even before its October revision, Vitesse had said that its storage revenues would decline by 30 percent in the upcoming quarter. Although the company did not specify the amount, officials now say that the decline will exceed that percentage. What’s worse, the industry is not anticipating an upswing anytime soon. “We believe that we are at the early stages of a semi downturn which is likely to become intensified in Q4 and Q1,” wrote Arnab K. Chanda, a Lehman Bros. analyst in a report on the semiconductor and communications industries issued earlier this month. “While nearly every stock we downgraded has pre-announced negatively, we believe further downside is possible as Q4 guidance is worse than expected.” In addition to the industry-wide issues, Vitesse is also grappling with another problem. While the demand for data storage has continued to climb, changes in storage hardware have reduced its customers’ need for the company’s chips. “Drive capacity in the current year doubled,” said Mody. “When drive capacities go up by a large amount, what happens is the number of drives required to fulfill the need for additional storage doesn’t increase at the same rate, or it even decreases.” With technological advances in storage hardware, customers can fill their data storage needs with fewer drives, so the makers of those drives do not require as many chips from Vitesse in order to meet the demand. “Our projection is that in 2005 that will have a dampening effect on our sales in the storage market,” said Mody. “We really won’t have a spectacular 2005.” In the meantime, Vitesse is working to hold down its research and development expenses to their recent levels. At the same time, the company expects that new products currently in the pipeline will help to compensate for the changes in drive capacity.