Novell gains on internal options probe; ADC slips on lowered forecast; Costco down on poor outlook

By Kenneth Lim

Boston, Aug. 30 - The convertible bond market suffered another slow session on Wednesday, with Novell Inc.'s slight gain easily dominating early trading after the company reported a higher quarterly profit and began an internal inquiry into its stock options dating practices.

Meanwhile, ADC Telecommunications Inc. was lower on an outright basis in line with the stock after the company cut its full-year sales forecast again.

Costco Wholesale Corp. was lower on an outright basis in light volume after the retailer also reduced its fourth-quarter outlook.

Outside of that handful of names activity continued to be whisper thin in the convertible market.

"It was a very quiet day," a hedge fund convertible trader said. "It's a holiday week, the end of summer, a lot of people aren't at work. Plus the equity market was up today."

Novell rises on probe, results

Novell's 0.5% convertible due 2024 was higher by about half a point outright on Wednesday after the company announced higher third-quarter earnings and said it was conducting an internal probe into the way it dated stock options.

The convertible was quoted at 92.25 bid, 92.75 offered against a stock price of $6.75 on Wednesday. Novell stock (Nasdaq: NOVL) closed at $6.64, down by 2.06% or 14 cents.

Waltham, Mass.-based Novell on said late Tuesday that net profit for the fiscal third-quarter was $11.6 million, or 3 cents per share, against the year-ago profit of $1.9 million, or zero cent per share. The developer of open-source enterprise software guided for a fiscal fourth-quarter profit of 4 cents per share, which fell a penny short of analysts' estimates.

Novell also said its audit committee had started an investigation into its stock option granting practices in light of irregularities recently uncovered at other companies. Novell said the inquiry could lead to adjustments in its accounting, and the company will not file its 10-Q financial report until the investigation is complete. Novell warned that may not be able to file its report by the Sept. 11 deadline.

A sellside convertible bond trader said the possibility of Novell being late in its financial reporting may have fueled the modest gain in the note on Wednesday.

"These options issues have forced companies to look back at their accounts and some have had to file and then refile their numbers," the trader said.

"In some of these [convertible] prospectuses, the issuer has to pay par for bonds for missing 10-Q filings. A lot of the hedge funds have been buying these issues that have been trading below par, thinking that if the company is late the hedge fund can then put the bond back to they company for instant returns. Novell has suggested that they may have some problems filing their 10-Q on time...the bonds were bid up right away."

But the trader said the chances of Novell having to make a deal with convertible holders to avoid a technical default were slim.

"In my own personal opinion, this trade doesn't make sense," the trader said. "I have yet to see a company that actually misses its filing because of this. You can get an extension, and then extend that again, the company has a lot of time to make its filing. It's just not realistic, I think, that a company will not be able to do that."

ADC falls on dimmed outlook

ADC Telecommunications' 1% convertible due 2008 retreated on Wednesday with the stock after the company reported lower third-quarter profits and lowered its full-year sales forecast for the second time in two months.

The convertible traded at 92.25 versus a $13.50 stock price, lower by about three-quarters of a point outright but unchanged to slightly better on a dollar-neutral basis. ADC stock (Nasdaq: ADCT) dropped 7.25% or 1.07 on Wednesday to a $13.68 stock price.

Eden Prairie, Minn.-based ADC late Tuesday reported that profit in the quarter ended July 28 fell to $11.3 million, or 10 cents per share, from $23.9 million, or 20 cents per share, in the year-ago period. The telecommunications equipment maker also cut its full-year sales forecast to between $1.27 billion and $1.29 billion, from the previous guidance of between $1.28 billion and $1.3 billion, the second time in as many months that ADC has lowered its sales outlook. The full-year earnings forecast is between 51 and 56 cents per share.

"It's not good whenever someone lowers their forecast," a buysider said. "In this case it doesn't look like it's a very big cut, but it's coming after they already cut last month, so I would think investors aren't too happy."

Credit Suisse equity analyst Paul Silverstein on Wednesday reinstated coverage of ADC with a neutral recommendation, one notch below the previous outperform rating, and cut its 12-month stock target to $13 from $34 previously.

"Our lower multiple...reflects the deteriorating outlook for ADCT's business and the multiple contraction for ADCT's peers over the past quarter," Silverstein wrote in a note.

Because ADC has a relatively weak gross margin structure, it needs strong revenue growth to drive "meaningful earnings growth," Silverstein wrote. With the poor outlook, ADC stock lacks an upside catalyst, the analyst said.

Costco slips as forecast cut

Costco's zero-coupon convertible due 2017 was about 5 points lower on an outright basis on Wednesday after the discount retailer announced a disappointing fourth-quarter outlook.

The lightly-traded convertible was marked at 106 against a stock price of $46.95 on Wednesday. Costco stock (Nasdaq: COST) closed at $47.18, a 4.2% or $2.07 retreat.

"I haven't seen those bonds in like forever," a sellsider said.

Issaquah, Wash.-based Costco on Wednesday said fiscal fourth-quarter earnings are now expected to be between 68 to 71 cents per share, below Street estimates of around 77 cents. The company said it saw signs of slower spending on higher-end, non-essential items, and explained that it has had to lower prices and take slimmer margins in that segment.

Costco said it remains "positive" on the prospects for the next fiscal year, but did not provide details.

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