3Com sees lower earnings in next quarter

Shortly after the opening bell, 3Com's shares were hard hit, tumbling more than 15 percent. In afternoon trading, shares of the company lost 6 points at 47.13, on heavy volume of 29 million shares.

The Santa Clara, Calif.-based networking company generated revenue of $1.48 billion for the quarter ended Nov. 26, a 4 percent drop from last year's $1.5 billion. Separately, the company warned that sales would slow in the third quarter as well.

While sales for Palm devices skyrocketed and sales of high-speed modems and Internet telephony products increased, revenue from network systems products--including switches, hubs and routers--dropped 12 percent to $593.2 million.

3Com earned $130.9 million, or 37 cents a share, in its fiscal second quarter, down from $133.4 million, or 36 cents a share, a year ago. The company beat analysts' expectations of 34 cents a share, marking the third straight quarter 3Com has beat Wall Street consensus estimates.

But the company warned that third-quarter earnings would fall around its year-ago pro forma figure of 24 cents a share. Analysts had been expecting the company to earn 32 cents in the third quarter, according to First Call.

Analysts say the drop in network systems product sales is alarming as the company will need to count on those sales to grow when it spins off its Palm Computing division.

Second-quarter sales of Palm devices increased 50 percent from last quarter to $260.9 million, while revenue for personal connectivity products, such as network adapter cards and modems, reached $620.9 million, a 15 percent increase from last quarter.

In a conference call with analysts, 3Com chief executive Eric Benhamou blamed the decrease in network systems product sales to equipment shipment delays, firms working to fix the Year 2000 bug, and competition from other networking firms.

"Internally, while Y2K was a factor…it was related to execution and under our direct control," said Benhamou, who added that the company has increased its focus on marketing and improving product delivery. The technologies that shipped late were its high-speed switches, called the CoreBuilder 9000.

Benhamou added that the company also saved money by cutting costs during the second quarter.

3Com has struggled over the past year as it refocused its business on more profitable networking areas. The company decided to move away from network adapter cards and analog modems to newer technology areas like Internet telephony, home and wireless networking, and high-speed cable and digital subscriber line (DSL) modems.

3Com executives said revenue for products in the emerging areas grew 50 percent sequentially and represent 3 percent of overall revenue, a sign that the company's strategy is beginning to work. During the conference call, Benhamou said 3Com will boost its revenue numbers if product sales in emerging areas continue to grow.

"Those businesses have been and continue to have high levels of investment in research and engineering and marketing, and it's a rapidly increasing revenue stream," 3Com president Bruce Claflin said.

Hambrecht & Quist analyst Erik Suppiger said he will continue to rate 3Com stock as a "market perform."

"We'll see estimates for [earnings per share] come down for the next quarter, which will not be received positively by investors," he said. "They did great for this quarter, but I think the revisions will suggest that the outlook is less positive."

Including $77.2 million from savings related to a corporate realignment and the sale of certain investments, 3Com earned $177.3 million, or 51 cents a share, in the second quarter.

Before the earnings announcement yesterday, 3Com's stock closed at 53.13, having risen 4.25. The stock price has nearly doubled since the company two months ago announced plans to spin off its Palm Computing business. Analysts believe 3Com's stock price has risen because 3Com shareholders get a majority stake in the new Palm company.

"It will do well for 3Com in the short term, but the real challenge for them is in the networking business. The growth they've had has been in Palm Pilots," Pita Group analyst Craig Johnson said in a recent interview.

3Com this past quarter launched its "e-networks" initiative, hawking its networking equipment as the technology large businesses need to connect customers, partners and workers to the Web.

As part of the strategy, the company made a series of recent announcements regarding Internet consulting firms. It invested $100 million in USWeb/CKS, announced a partnership with Unisys, and bought a 40-employee consulting firm called Interactive Web Concepts.

Separately, 3Com chief financial officer Chris Paisley said he will retire next summer to pursue a teaching career and spend more time with his family.