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3Com earnings grow threefold

Even as 3Com reports a threefold rise in fourth-quarter earnings, analysts say a substantial rebound for the networking sector may be a ways off.

Networking industry leader 3Com (COMS) today reported a threefold rise in fourth-quarter earnings, but warned that kind of growth is increasingly harder to maintain.

3Com's numbers came as some analysts are predicting that a substantial rebound in the networking sector won't arrive until the end of the year.

3Com reported net profits of $89.2 million, or 48 cents a share, for the period ending May 31, compared with $29.5 million a year ago. The networking company's performance was in line with analysts' expectations.

Revenues jumped to $829.9 million for the quarter, up 26 percent from the previous year. But the rate of revenue growth has slowed on a percentage basis, year-over-year. 3Com reported sales growth of nearly 30 percent in the third quarter over figures for the previous year. In its fiscal 1996 fourth quarter sales grew a whopping 71.5 percent compared with the previous year.

"The sector is kind of treading water," said Martin Pyykkonen, senior analyst at Furman Selz.

Some of his colleagues disagree, citing growth rates of 30 to 50 percent, but Pyykkonen said those figures are skewed by small companies that tend to report rapid growth. Most larger companies' revenue growth rates fall below the 30 to 50 percent range, he noted.

3Com's year-end profits of $374 million, or $2.01 a share, compared with $177.9 million, or $1.01 a share, a year earlier. Revenues climbed to $3.1 billion for the year, up 35 percent from the previous year. All figures are exclusive of 3Com's recently completed merger with U.S. Robotics.

3Com's main challenge this year was Intel's (INTC) price reductions in its network interface cards, or NICs. 3Com's stock plummeted on the news of Intel's move, but 3Com managed to increase its market share by trimming its prices as well, according to a study by IDC.

Networking sector analysts' earnings estimates
CompaniesQuarterEarnings estimateReporting date
Q4 199748 centsJune 24
Q4 199755 centsAugust 5
Bay Networks
Q4 199711 centsJuly 23
Fore Systems
Q1 19989 centsJuly 14
Ascend Communications*
Q2 199737 centsJuly 9
*Reporting combined earnings for its acquisition of Cascade Communications.
Source: First Call

Although the price cuts decreased 3Com's profit margins, the networking giant was able to weather the Intel storm, analysts agree. (Intel is an investor in CNET: The Computer Network)

Pyykkonen, who predicted 3Com's quarterly revenues would rise 27 percent over the year-ago period, presaged the company's concerns about maintain that rate of growth. 3Com's channel inventories currently are backed up, posing a risk for the current quarter.

"If [that growth] proved to be sustainable, it would be a phenomenal accomplishment," Pyykkonen said, pointing out that 3Com's rate of growth has decreased for each of the past four quarters.

Meanwhile, 3Com's acquisition of U.S. Robotics is expected have little effect on Wall Street's expectations for the networking company. 3Com had said the merger would not put a damper on Wall Street's current earnings estimates for the quarter or the coming year, and that the company may slightly beat them. Pyykkonen predicted the merger will result in layoffs of about 5 to 10 percent during the next six to nine months.

3Com's problems with NIC pricing correspond to a wider issue for the sector: price erosion. 3Com and Bay Networks (BAY) have born the brunt, as price erosion has primarily hit the hubs-and-switches market. This pricing pressure comes as networking players increasingly step into each other's market segment.

Wall Street is expecting Bay to report fourth-quarter earnings of 11 cents per share, down from 28 cents a year ago.

Another problem for the sector has been that spending decisions are on hold as many large carriers and corporations weigh their technological options. But companies are far enough along in their decision-making processes that analysts expect the last quarter of the year to bring renewed spending. If these spending decisions do not get made, a year-end rebound for the sector could be in doubt, Pyykkonen said.

Some analysts downplayed the seriousness of flatter carrier spending. Farrohk Billimoria, senior technology analyst at Hambrecht and Quist, said the longer sales cycles of the networking sector are nothing out of the ordinary and the market is in the process of correcting itself.

"Budgets are still growing," he said. "No major projects have been canceled. Fundamentally the sector is still healthy," he said.

He cited Fore Systems (FORE) as a victim of longer sales cycles, but one that has fought back with aggressive price reductions to speed up sales. Wall Street is expecting Fore to report first-quarter earnings of 9 cents per share, down from 12 cents a year ago, according to First Call.

Ascend Communications (ASND) ran into trouble this quarter when integration of 56-kbps modems into its MAX TNT access coordination product line hit a snag. The MAX remote access boxes are designed to work with networking infrastructure management gear.

But according to a report by Smith Barney, the modem snafu is a temporary problem and demand for Ascend's products remains strong. First Call reports a consensus estimate for second-quarter earnings of 37 cents per share, up from earnings of 24 cents per share for the same quarter last year.

Ascend is expected to report combined earnings this quarter to include its acquisition of Cascade Communications. The deal is expected to close before June 30.

Cascade, however, will report separately for the quarter ended in June. The company is expected to earn 19 cents per share for the second quarter, up from 17 cents per share a year ago.

Cisco Systems (CSCO) is weathering adverse market conditions better than its competitors thanks to its broad-based product mix and its majority share of the routers market. The company is expected to report fourth-quarter earnings of 55 cents per share, up from 42 cents a year ago, according to First Call.

Cisco had a weak February and March, but April brought a recovery that appears to be continuing, according to a report by Dain Bosworth. Sales of Cisco's high-end routers were down because of weak carrier spending, the report said, while sales of LAN switches continued to grow.