"Despite Drop In Estimates, 3Com Outlook Seen Brightening"
Dow Jones Newswires -- March 25, 1998 (From WSJ online)
By Joelle Tessler
NEW YORK (Dow Jones)--Earnings estimates on 3Com Corp. (COMS)
have fallen substantially following the company's third-quarter earnings
report late Tuesday, but at least analysts appear to have more confidence in
their new numbers.
3Com's outlook is brightening, analysts said, because the networking
equipment maker has reduced excess channel inventories and because it is
introducing several new products. The company also has put in place a new
business plan that calls for lower gross margins and lower expenses.
As a result, there is much more visibility to the company's earnings, said
Lazard Freres analyst Michael Duran.
Still, analysts cautioned that a sequential decline in sales out of the
distribution channel to end users in the third quarter could raise a warning
flag about growth rates in the networking industry.
3Com late Tuesday reported operating earnings of 2 cents a share on
$1.25 billion in revenue for its fiscal third quarter, ended February,
compared with 50 cents on $1.46 billion in revenue a year earlier.
The results were well below the First Call consensus estimate of 14 cents a
share. Analysts, however, agreed it was far more important that the
company reduce its inventory to meet new targets and hold down expenses
than that it meet earnings estimates.
Duran estimates 3Com's focus on cutting inventories in the distribution
channel - the company's top priority - depressed revenue by roughly $150
million in the quarter.
The company, which recognizes revenue when it ships products into the
distribution channel, not when they sell through, has been coping for some
time with bloated channel inventories.
3Com brought modem inventories down by three weeks to seven weeks as
of the end of the third quarter, and inventories of systems products down by
two weeks to seven weeks. Adapter card inventories rose by one week to
six weeks. The company also improved computerized inventory
management systems to work more closely with its channel partners.
"They had some very severe channel inventory issues," said Adams
Harkness & Hill Inc. analyst Peter Lieu. "They dealt with them. That's like
cleaning out a huge mess."
As a result, Lieu said, 3Com's reported revenue and earnings will much
more closely match product sell-through going forward.
Still, on a cautionary note, Duran pointed out that sales of products out of
the distribution channel were down roughly 10% in the third quarter from
second-quarter levels. Duran attributed this to tough pricing, weakness in
Asia and seasonality as information technology budgets became final in the
beginning part of the year.
Duran believes seasonality should be more pronounced in the years ahead
as 3Com's business becomes more upscale and as networking expenses
become more important and are scrutinized at higher levels.
3Com's Nasdaq-listed shares were recently down 7/8, or 2.3%, at 36 3/8
on volume of 14.3 million, compared with average daily volume of 7.2
million.
3Com also delivered on its promise to contain expenses in the third quarter,
said Duran of Lazard Freres.
He said sales and marketing expenses fell to $315 million in the third
quarter from $338 million in the second quarter, while general and
administrative expenses fell to $68 million from $71 million.
According to Lieu of Adams Harkness & Hill, 3Com revised its business
plan, saying it expects lower operating expenses and lower gross margins
over the next few years.
The new plan calls for expenses to decline to 27.5% to 29% of revenue,
down from the company's previous plan of 30% to 32% of revenue.
It calls for gross margins between 45.5% and 47.5%. Duran noted that
although this is below the previous target of 48% to 50%, it is above the
43.4% gross margins that 3Com reported for the third quarter.
Lieu said this sets the target for operating margins at 16% to 20%.
Better sales volume as business ramps up, driven by new products, will help
margins over the coming years, Duran said.
The new 56K modem standard, v.90, will help drive demand for modems,
as well as corporate demand for remote access products, Duran said.
These two product catagories account for about half of 3Com's business,
he said.
The company's two new layer 3 switches, the CoreBuilder 3500, which
started shipping in the latter part of 1997, and the CoreBuilder 9000, which
will start shipping this spring, also should help sales, Duran said.
According to First Call Inc., the consensus estimate on 3Com has fallen to
20 cents a share from 31 cents for the fourth quarter, which ends in May.
The consensus estimate for the fiscal 1998 year has fallen to 71 cents a
share from 96 cents, and the consensus view for fiscal 1999 has dropped to
$1.50 a share from $1.84.
These numbers compare with earnings of 12 cents a share in the fourth
quarter of last year and $1.41 for the full year, both adjusted and restated
for 3Com's purchase of U.S. Robotics Corp.
-Joelle Tessler; 201-938-5285
Mang |
