Important - AFTER WEAK 1ST HALF, NETWORKING COS
3Q EARNS SEEN IMPROVING
By Joelle Tessler
NEW YORK (Dow Jones)--Although most
networking companies won't report dazzling
year-over-year earnings increases for the third
quarter, analysts don't expect a repeat of the
shortfalls that marked the first half of 1997 for
the group.
"They are showing some improvement,"
Oppenheimer & Co. analyst Randall Yuen
said. "We won't see the companies beating
estimates, but at least the days of widespread
disappointment are past. Things sound a little
better."
Cowen & Co. analyst Chris Stix expects most
network-equipment makers to report
third-quarter earnings in line with estimates and
to show improving balance sheets, improving
inventories and accelerating sales.
The better outlook is helping dispel concerns
that arose earlier this year that the sector was
seeing a slowdown.
"The market drivers are there - the rapid
growth of the Internet and the buildup of
corporate intranet networks," said Bear Stearns
& Co. analyst Eric Blachno, who expects a
steady finish to the year for the group.
A number of factors that hurt the industry's
earnings in the first half of 1997 have begun to
ease in recent months.
First, softness due to weak economic
conditions in many international markets -
notably Japan, France and Germany - hurt
first-half earnings, but those conditions have
begun to stabilize.
According to Yuen, of Oppenheimer & Co.,
while international business remains soft, it is
not getting any worse. Indeed, Cowen & Co.
analyst Stix said, there has been a partial
recovery in Europe.
Moreover, Yuen added, expectations of
international contributions have come down for
the group - which should make future
disappointments less likely.
Likewise, pricing pressure also impacted many
networking companies in the first half but has
now begun to ease. Bay Networks Inc. (BAY),
3Com Corp. (COMS) and Cisco Systems Inc.
(CSCO) were all very price aggressive in
low-end switching and hubs, while Intel Corp.
(INTC) dropped prices on Fast Ethernet
adapter cards - which impacted 3Com.
But while pricing pressure remains intense in
some segments, including chassis-based hubs,
it has stabilized overall as demand has picked
up, order pipelines have increased and channel
inventories have fallen, Yuen said.
A high number of product transitions also
resulted in some purchasing delays in the first
six months as customers awaited the release of
new products and new technologies.
According to Yuen, the transition to layer 3
switches and routers, Fast and Gigabit Ethernet
technologies, and high density switches and
remote access concentrators all contributed to
purchasing delays.
In recent months, however, equipment makers
have entered a number of new product cycles
and should therefore be able to tap into
pent-up demand that has been building up as
customers put off equipment purchases, Yuen
said.
For instance, Bay Networks introduced its new
BayStack 350 Fast Ethernet switch in the
spring. Cisco started shipping its new Catalyst
5500, a high-end switch with routing software
and hardware, at the end of April. And 3Com
started shipping its Fast Ethernet SuperStack II
Switch 3000 in July and its Total Control
HiPer Access System family of remote access
products in September.
Customers Making Buying Decisions
"There is a new product cycle in almost every
major product category," said Stix, of Cowen
& Co.
Oppenheimer & Co.'s Yuen noted, however,
that since the networking companies are still
introducing products now, "we will really see
an acceleration in the December quarter."
The final cause of the first half weakness - a
shift in information technology spending away
from network upgrades to PC and software
purchases - has also begun to ease, Yuen said,
particularly as new networking products have
hit the market.
"Customers are making buying decisions," said
Hambrecht & Quist Inc. analyst Farrokh
Billimoria. "They were evaluating different
alternatives in the first half."
Stix added that the emergence of very
high-band width, low-cost solutions for wide
area networks is also leading to upgrades at the
edges of networks.
Earnings from 3Com and Cabletron Systems
Inc. (CS), which have quarters ended in
August, reflected the better outlook for the
group and give an idea of what to expect from
others.
Although investors had been bracing for
earnings disappointments from both
companies, 3Com and Cabletron each
delivered results that were essentially in line.
"This bodes well for others," Bear Stearns'
Blachno said.
Gross margins declined a bit at both companies
due to a shift in product mix to lower-margin
products as well as ongoing pricing pressure in
some sectors, he said. But each said
international business was improving after
weakening earlier in the year, Yuen, of
Oppenheimer & Co., noted.
3Com reported earnings of 48 cents a share,
excluding charges associated with its merger
with U.S. Robotics Corp., for its first quarter.
The results were in line with views and above
the 43 cents a share that the company earned
last year.
3Com said sales of systems products, including
switches, hubs, internetworking products and
remote access products, rose 34%
year-over-year in the quarter. And sales of
client access products, including network
interface cards and modems, rose 23%.
The company has several new products in its
pipeline and will roll out its CoreBuilder 3500
layer 3 switch next month.
Meanwhile, Cabletron reported earnings of 37
cents a share for its fiscal second quarter,
compared with 41 cents excluding expenses for
acquisitions a year earlier. The results were a
penny above the First Call Inc. consensus
estimate.
The company has faced some difficulties in
recent quarters getting components from one
of its suppliers for its SmartSwitch 6000 and
because it did not have enough manufacturing
capacity. Yet analysts believe the company's
problems are behind it and noted that
Cabletron has ramped up additional
manufacturing capacity for its switching
products.
Looking at others in the group, Billimoria, of
Hambrecht & Quist, projects Cisco will earn
59 cents a share for its first quarter, ending
October, versus 47 cents a share excluding
items last year.
The company's international business has
stabilized after growing just 1% in the
company's fiscal fourth quarter, Oppenheimer
& Co.'s Yuen said. And sales of Cisco's
Catalyst 5500 are ramping up.
Cisco recently started shipping its new GSR
high-end router. Although the product won't
impact Cisco's results for the current quarter, it
will contribute a bit in the second quarter and
will impact earnings after that, Yuen said.
Cowen & Co.'s Stix also expects Cisco to
introduce a number of products that integrate
voice and data solutions this year.
Ascend 3Q Earns Dn On TNT Pdt Problems
Ascend Communications Inc. (ASND) already
has said it expects third-quarter earnings to be
between 18 cents and 20 cents a share, down
from 29 cents a year ago.
The disappointing results are largely due to
problems with Ascend's MAX TNT remote
access concentrator product, which Internet
service providers use to aggregate users and
connect them to computer networks.
The company has had trouble getting 56K
modem cards to interface properly with the
product, said Amar Senan, an analyst at Volpe
Brown Whelan & Co. In addition, the TNT
has cut off dial-in users and overheated.
Ascend's troubles with the product have been
particularly pronounced in Europe - where it
faces different standards and has more new
customers. Delays in shipping the TNT to that
continent compounded these problems.
Continued weakness in the Japanese market
and pricing pressure from Cisco and U.S.
Robotics in the remote access concentrator
market also plagued Ascend in the quarter.
Cowen & Co.'s Stix expects Bay Networks to
earn 20 cents a share in its fiscal first quarter,
ended September, and believes the company
could deliver an upside surprise or a significant
buildup in its backlog for the period.
The company, which earned 25 cents
excluding charges last year, said in August that
it expected its first-quarter sales to exceed
expectations due to strong demand for its
products.
Bay Networks is seeing strong demand for its
new BayStack 350 switch, said Yuen, of
Oppenheimer & Co.
Stix added that the company has a huge
opportunity to sell switches into its stalled base
with modular products for its System 5000
hub.
Bay Networks will start shipping its Accelar
family of routing switches early next year.
Billimoria, of Hambrecht & Quist, estimates
Fore Systems Inc. (FORE) will earn 5 cents a
share in its second quarter, ended September.
This is below the company's year-ago earnings
of 14 cents a share, but flat with its results in
the prior quarter, he said.
Volpe Brown Whelan's Senan projects Digital
Link Corp. (DLNK) earned 18 cents a share in
the third quarter, up from 16 cents last year.
The company has entered a new product cycle
with its new ATM access concentrator, which
came out about two months ago.
Cowen & Co.'s Stix believes Network General
Corp. (NETG) will easily meet his estimate of
17 cents a share in its second quarter, ended
September, versus 22 cents last year. Yuen, of
Oppenheimer & Co., believes the company's
international business has stabilized after order
weakness in Europe hurt results in the first
quarter.
Yuen added that Network General will benefit
from several recently-introduced products,
including its CyberCop Intrusion Detection
security product, a new ISDN analyzer and a
new low-end software-only analyzer.
Billimoria expects Newbridge Networks Corp.
(NN) to report 30 cents a share for its second
quarter, ended October, compared with 26
cents last year.
Finally, Yuen believes Madge Networks NV
(MADGF) lost 39 cents a share in the third
quarter versus a loss of 15 cents last year.
While Madge has good technology, it has been
struggling with distribution and is restructuring
its U.S. operations and its international sales
channel, he said.
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