First call estimate is now 12c for 3rd quarter. Some analysts have faith in Bay...
Pdt Transition, Competition Mean 3Q
Shortfall For Bay
By Joelle Tessler
NEW YORK (Dow Jones)--A slow ramp-up in getting its new Accelar
routing switches to market and competition in the low-end workgroup
switch business will cause Bay Networks Inc.'s (BAY) fiscal third-quarter
earnings to fall short of expectations.
But several analysts said company-specific issues cannot account for the
entire shortfall and maintained Bay's disappointing outlook signals that the
entire networking industry faces sluggish demand and a competitive pricing
environment right now.
"This is a product transition issue compounded by across-the-board
weakness," said Adams Harkness & Hill Inc. analyst Peter Lieu.
Although growth rates in the networking industry were solid in 1997, they
came in well below the robust levels seen in preceding years. And while
many analysts believe business did begin to pick up in second half 1997,
quite a few are now saying growth levels are not returning to the stellar rates
of several years ago.
"We are seeing lower-than-expected industry demand," said Sanford C.
Bernstein & Co. analyst Paul Sagawa.
Sagawa projects the entire data networking industry will show revenue
growth of 20% in 1998, compared with 17% in 1997 and 48% in 1996.
As a result, said Nutmeg Securities Ltd. analyst Andy Schopick, "there just
isn't good earnings visibility" in the networking industry right now. Bay
Networks' disappointing outlook could be a sign of things to come, he
added, noting preannouncements are coming earlier than usual this quarter.
After the market closed Tuesday, Bay said it expects revenue, operating
earnings and gross margins for its third quarter ending in March to be below
second-quarter levels.
The company said it expects third-quarter revenue to be about 10% below
the second-quarter figure of $645 million, but "meaningfully higher" than the
year-ago level of $513 million. In recent years, Bay said, third-quarter
revenue has come in below second-quarter levels.
The company also said it will take a charge of 67 cents a share for
in-process research and development related to recent acquisitions, but
added that it still expects to be profitable on an operating basis for the
period.
Bay earned 27 cents a share before items and reported gross margins of
51.5% in the second quarter. It earned 10 cents a share, excluding charges,
in fiscal third quarter 1997.
Based on updates from 18 of the 27 analysts who follow Bay Networks,
the third-quarter consensus earnings estimate has fallen to 12 cents a share
from 28 cents, said First Call Corp. research director Chuck Hill.
Looking at the fourth quarter, which has historically been a strong one for
the company, Bay said it is optimistic that revenue will be above
second-quarter levels.
Consensus estimates have fallen to 21 cents a share from 32 cents for the
fourth quarter, to 81 cents from $1.10 for the full fiscal 1998 year, and to
$1.28 from $1.60 for fiscal 1999, according to Hill.
Excluding charges, Bay Networks earned 15 cents a share on $543 million
in revenue for fourth quarter 1997 ended in June and 59 cents a share on
$2.1 billion in revenue for the full year.
According to Credit Suisse First Boston Corp. analyst Peter Rubicam, Bay
Networks' troubles are in large part the result of timing and product
transition issues.
For one thing, said Lieu of Adams Harkness, Bay Networks had hoped
that new products would help offset the weakness that typically occurs at
this time of year.
But the company's new line of Accelar routing switches, which it began
shipping late last year, did not ramp up quickly enough to offset weakness
in older products like shared media hubs, Rubicam said.
The analyst said this was largely due to production constraints and because
Bay shipped many products on an evaluation basis.
At the same time, Lieu said, industry giant Cisco Systems Inc. (CSCO) has
persuaded some customers to hold off on buying high-end gigabit Ethernet
switches from Bay Networks by indicating that it plans to introduce its own
products this summer.
Bay Networks has also found itself facing competition from Cisco and
3Com Corp. (COMS) in low-end workgroup switches, a market that Bay
had to itself until recently, Lieu said.
Cisco and 3Com are both introducing products that compete with Bay's
BayStack 350 Ethernet switches, which has put pricing pressure on this
product line.
Bay Networks has responded to this competition by introducing a
high-density product, which is just beginning to ramp, Lieu said.
But this has prompted Bay to cut prices on older BayStack 350 products
to move them through the channel and to protect dealers as the company
introduces the new BayStack 350T-HD.
Despite the difficulties facing Bay Networks, Rubicam believes "the
long-term story is still intact" since the company has a strong product cycle
and the opportunity for margin expansion ahead.
Lieu stressed that he still believes in the company's credibility, its product
efficacy and ability to recover from its current troubles. He said he believes
Bay's revenue should grow by more than 20% in the second half of fiscal
1999.
Several analysts maintained that Bay Networks' disappointing fiscal
third-quarter earnings outlook contains warnings for the broader networking
industry.
For one thing, Lieu of Adams Harkness pointed out that since Bay overlaps
with Cisco and 3Com in some product categories, the same issues of
competition are bound to affect those companies.
Sagawa of Sanford Bernstein believes the entire industry is facing
"lower-than-expected demand" due perhaps to a slowdown after a strong
December and pressure on information technology budgets - particularly in
the enterprise market.
He added that spending to fix the Year 2000 problem also could divert
resources from networking capital expenditures.
In addition, Lieu said, slowing PC sales and capital spending - issues that
were highlighted when Compaq Computer Corp. (CPQ) and Intel Corp.
(INTC) both released their own disappointing earnings outlooks about two
weeks ago - could have a spillover effect on the networking business.
"We are seeing shifting technology trends and growing competitive
pressures exacerbated by a slowdown in the industry," said Schopick of
Nutmeg Securities, who believes earnings estimates on many in the
networking group are too high.
And, of course, "the ripple effects of what's happening in Asia are just
catching up with these companies," Schopick added.
Despite these concerns, most networking stocks are not down too much on
Bay's outlook.
Bay Network's shares closed at 26 3/4 on the NYSE on Tuesday. Bay's
shares fell to 24 in after-hours trading but gained back 2 1/4, or 9.4%, at
26 1/4 Wednesday afternoon on volume of 10 million, compared with
average daily volume of 3.3 million.
Cisco's shares were recently down 1, or 1.5%, at 63 9/16 on Nasdaq
volume of nearly 7.9 million, compared with average daily volume of 11.3
million.
3Com was down 11/16, or 2%, at 33 5/16.
Cabletron Systems Inc. (CS), which itself recently warned that its fiscal
fourth-quarter results would fall short of expectations, is bucking the trend.
The NYSE-listed stock was up 1 1/8, or 8.1%, at 15 1/16. - Joelle
Tessler; 201-938-5285 |
