Why Lucent's 'Beat' Doesn't Impress the Shorts

Let's just say the quality of these earnings doesn't pass the sniff test.
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Based on its stock today, which rose 3 1/2 today to close at 62 3/4, Wall Street loves

Lucent's

(LU)

fiscal second-quarter financial performance. Not only did earnings beat analyst estimates by a penny, but revenue was well ahead of expectations.

So, what's not to like?

Plenty, according to short-sellers, who find the quality of Lucent's latest earnings leaves much to be desired. Specifically, while operating earnings rose $233 million, research and development, and selling, general and administrative expenses -- both discretionary areas -- fell by $151 million.

Perhaps more troubling is that gross margins, which analysts had been expecting to be around 46%, actually fell to 42.1%. Gross margins -- gross profit divided by sales -- is an indicator of how well a company is being run. The higher the better, generally, and it should generally be higher than analyst expectations if revenue is higher than expectations.

Lucent attributed the lower margins to higher costs of ramping up its high-growth optical networks business, which is a fine explanation. However, "It's just they didn't tell you anything about it until last night," says one longtime Lucent short-seller. "Here's a company that blows up

with an earnings warning in January and supposedly goes out of its way to tell you what's going on. And then it comes out with another quarter that has nothing to do with what people had expected it to be. It leads me to say there must be more stuff going on here, and that they're managing the bottom line number and how they get there."

The evidence of that, they believe, is the company's decision to cut sales, general and administrative expenses, and R&D. (The predecessor of

Nortel

(NT)

did that a few years ago in order to meet numbers, and wound up paying the price with earnings misses down the road.) What's more, R&D is the lifeblood of a tech company.

A Lucent spokesman says that while R&D fell, after subtracting out the part of Lucent that will be spun off later this year, the percentage of R&D to revenue is now 12.2%, which is more in line with the company's objective. Maybe so, but R&D isn't falling at Nortel, where it's about 13.5% of revs, or

Cisco

(CSCO) - Get Report

, where it actually rose to 13.7% of sales from 13.1%. "How does a tech company reduce R&D spending?" asks one short.

They just do it, and that's one reason the shorts are staying short.

P.S.: On a positive note, Lucent said that days outstanding of receivables, which had been rising, actually fell by three days last quarter, as did inventory. But skeptics like

Wasserstein Perella

analyst Eric Buck won't believe the quality of

those

numbers until they see them for themselves in the 10-Q, which probably won't be filed for another month.

Herb Greenberg writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at

herb@thestreet.com. Greenberg also writes a monthly column for Fortune.

Mark Martinez assisted with the reporting of this column.