The last glimmer of a second-half rebound in networking-gear sales vanished this week.

Just two months in, telecom-equipment maker Nortel ( NT) has seen enough to know that the third quarter won't deliver even the flat performance the company had promised. The Canadian telco-gear outfit warned Tuesday evening that third-quarter revenue will fall 10% from the second quarter's $2.77 billion. Nortel also kicked off its eighth round of job cuts, making plans to slash its ranks by 7,000.

The era of great expectations for companies like Nortel and rival Lucent ( LU) is long gone, as suggested by their single-digit stock prices. Still, even as these companies' big telco customers wilt under the pressure of sagging prices and a soft economy, some analysts have predicted that pent-up demand for telecom equipment would drive a late-year bounce in orders. That Nortel isn't seeing one, could signal similar warnings from Lucent and other big gear peddlers.

Nortel's warning spurred a broad telecom-industry selloff Wednesday. Its shares dropped 22 cents, to $1.01, while Lucent slid 20 cents, to $1.69 and optical gear maker Ciena fell 46 cents, to $4.30.

Short-Lived Optimism

Can a bad year get worse? Apparently it can, according to early indications.

Just last month, Nortel was fairly optimistic about its chances of returning to profitability next year, largely through staff cuts and a shift in spending patterns by its customers.

And even the slightest signs of an advantage go a long ways in this slow-motion horse race. As recently as Monday, Deutsche Bank analyst George Notter hailed Lucent for getting its act together by building on its metro optical network win at Verizon ( VZ). Notter says early indications show Lucent is also in line for BellSouth's ( BLS) business as it seeks to upgrade the optical gear in its local networks. Though Notter didn't expect the deal to translate into any near-term revenue, it does demonstrate Lucent's momentum in an area where telcos seem willing to spend money.

Still, in citing its eighth shortfall in the past two years Tuesday, Nortel pinned the blame on slashed spending plans among the troubled U.S. telcos, nearly all of which are suffering from chronic sales declines and onerous interest payments.

Adding to the gloom, the Commerce Department reported Tuesday that communications equipment shipments dropped in July. This suggests that third-quarter industrywide orders will fall 3%, while shipments will slide 8% sequentially, concludes UBS Warburg analyst Nikos Theodosopoulos.

Some Bottom

Nortel's warning dealt a major setback to the optimists who'd predicted that the second quarter marked a bottom for sales. Lehman Brothers analyst Steve Levy has been among the most vocal proponents of the second-half rebound thesis. Levy and a small group of his peers had turned positive on outfits like Lucent earlier this year, fueled largely by the assumption that the worst of the downturn was behind us.

Levy was on vacation and unavailable for comment Wednesday. But the continued focus on cost-cutting and reaching a sustainable revenue break-even point among these companies suggests that the downturn continues to erode the telecom-gear business in grave and unpredictable ways.

Nortel's latest cutback will shrink the company's staff to 35,000, barely a third of its boom-era peak. Though Lucent has denied it has similar plans, people familiar with the company say a new series of product cancellations, manufacturing outsourcing and other cost-cutting moves will bring its total headcount down to 35,000 next year.

As a result of the slackening sales and the new job cuts, Nortel now says it will have a quarterly revenue break-even point of below $2.6 billion. Predicting new and lower break-even points has become a popular pastime for the staggering gearmakers, whose profitable pasts are but a distant memory now.

Nortel shares, which had recently climbed well above the $1 mark, fell back near a buck Wednesday. That threshold is important because NYSE-listed companies risk delisting if they trade below $1 for prolonged periods. That fact has fed speculation that Nortel might have to execute a humbling reverse stock split to keep its listing.


For Nortel, the new break-even target marks the fifth attempt to predict its own low-water mark. But analysts say these numbers still lack a true reflection of the telcos' slow-spending reality.

"Although we applaud the lower break even, it is not in-line with Nortel's current revenue run rates, indicating management is still forecasting a slight recovery in its plan, which may prove optimistic," wrote Credit Suisse First Boston analyst Jim Parmelee in a note to clients Wednesday. Indeed, a third-quarter sales drop of 10% from the second quarter's $2.77 billion would put Nortel significantly below next year's $2.6 billion break-even target.

Parmelee joined a growing cadre of industry observers who are predicting a recovery for the gearmakers sometime in 2004. But given the trends in this business lately, it's hard to take any bounceback plan without a healthy dose of salt.