3Com earnings disappoint

Stock in networking giant 3Com (COMS) was down by more than 4 percent this morning, after the company yesterday fell below Wall Street's estimates as pricing pressure deteriorated gross margins.

3Com shares were hovering at 35 9/16, down 1-11/16 in early morning trading.

On the upside, however, the company contends that channel inventory problems are under control.

3Com posted net profits of $13.9 million, or 4 cents per share, for the third fiscal quarter ended March 1. A year ago, 3Com recorded earnings of $179.1 million, or 54 cents per share.

The results for the latest quarter include a net reduction of about $9.9 million for charges related to 3Com's buyout of U.S. Robotics last June. Excluding the adjustment, net income was $7.4 million, or 2 cents a share.

The earnings are likely to disappoint many on Wall Street. According to First Call, analysts had been expected a mean estimate of 14 cents per share for 3Com's fiscal third quarter earnings. First Call's range of estimates was between 7 cents and 26 cents per share for the quarter.

Eliot Glazer, who follows 3Com for du Pasquier & Company, downgraded 3Com to a "sell" from "neutral." Trading in 3Com was halted late yesterday.

3Com's earnings shortfall comes on the heels of similar disappointments from other networking players, such as Bay Networks (BAY), which warned last week that its third-quarter revenues and profits will fall short of expectations. Bay cited weaker-than-anticipated demand for a broad range of products, as well as weakness in overseas markets and longer sales cycles, as the main factors contributing to the shortfall.

3Com recorded sales of $1.25 billion for the quarter, up 4 percent from the previous quarter but down from $1.46 billion from the like quarter a year ago.

Sales for systems products, which include switches, hubs, remote access concentrators, and internetworking platforms, amounted to $549.9 million, or 44 percent of total sales. Client access products, which include network interface cards and modems, accounted for $700.3 million, or 56 percent, of total sales.

One analyst said he didn't see much relief on the horizon for 3Com.

"They had low prices of modems, workgroup hubs and switches, and access concentrators. Those aren't things that going to go away," said Peter Rubicam, an analyst at CS First Boston. "The low prices in low-end products are taking the growth out of the industry. Unit demand is strong, but the company is not getting dollar demand."

Other analysts, however, were more optimistic about the company's outlook.

"The quarter looks pretty good, but there are some blemishes," said Stephen Koffler, an analyst at Donaldson Lufkin & Jenrette. "Gross margins are the biggest negative part of the story," he said, adding that the company appears to have cleaned up its inventory problems up a bit.

The company's gross margins fell to $543 million, down from $738 million reported for the same quarter a year ago.

The networking giant also said it completed its shift to a new channel inventory model that it expects to help increase both "the predictability and linearity of sales, in addition to simplifying the administration of inventory in global channels." 3Com said the supply of channel inventories for the company's network interface cards, modems, and systems products "all are now within the intended range."

"The sell-out at the channel fell by 10 percent. There is a lot of pricing pressure out there and a real softening in business?. Pricing pressure lowers gross margins," Rubicam said, adding that he is cautious about the industry outlook in general.

Rubicam said that, in order to offset such difficulties, 3Com needs to increase its exposure to the enterprise, where the pricing is more stable.

"Converging on our revised channel inventory model and reducing expenses were our primary objectives this quarter," 3Com chief executive Eric Benhamou said in a statement. "I am pleased we were able to meet both of these goals and still post a modest sequential increase in both sales and earnings."

3Com started shipping its 56-kbps modems around the last week of the quarter. The modem standard reached earlier this year does remove some barrier to market, but people are not rushing out to buy these products, Rubicam said.

This is partly because the infrastructure in some places doesn't yet support the faster modem speeds. For example, if a user has a 56-kbps modem, but her ISP doesn't support 56-kbps, the users will not get the faster connection.

3Com's stock closed up 2-1/8 yesterday, at 37-1/4. The earnings report came after the stock market closed.