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56-kbps modem makers hurting

Confusion over 56-kbps modems caused consumers to delay purchases last quarter, hurting the bottom line for manufacturers once again.

Confusion over 56-kbps modems caused consumers to delay purchases last quarter, hurting the bottom line for manufacturers once again as this quarter winds down.

Rockwell International (ROK) and Bay Networks (BAY) warned this week that they expects revenue shortfalls for the current quarter. Both cited confusion in the modem market as part of the reason.

The struggle over which modem technology would prevail stalled sales, created excess channel inventories, and delayed product roll-outs, confusing customers. Now that the industry has settled on a standard, some products have started to appear on shelves, but companies still are not seeing the boon they had anticipated.

While the standard should equalize the various products on the market, there have been reports that 56-kbps modems from different manufacturers produce different connection speeds. That variance, coupled with some delays, has hurt business.

"It appears that Rockwell's customers (modem manufacturers), and their customers (distributors and retailers), are taking longer than expected to implement the new 56-kbps standard into their products," Jack Blackstock, an analyst at JP Morgan, said in a report released this week. "While shipments have reportedly begun to accelerate in early March, we view this to be too little too late and are reducing our estimates accordingly."

Blackstock added that modem chip shipments remained at disappointingly low levels in February, despite previous expectations that the new standard for the 56-kbps product, known as v.90, would spur sales.

Brian Eisenbarth, an analyst with Collins & Company in San Francisco, said the standard has made the modem business increasingly commoditized, which in turn has made it difficult for companies to differentiate their products to consumers.

"Now companies have to compete on price vs. product," Eisenbarth said. "All we see on the horizon is continued pricing pressure, and that is a real problem. PC makers and chip giant Intel are looking for volume to offset price weakness, and we just hope consumers will run after sub-$1,000 PCs."

"Prices are dropping, and there is a lot of pricing pressure, which will continue to hurt earnings," he added, noting that the price drops should stimulate shipments.

Eisenbarth explained that, as prices for personal computers fall, component price declines follow.

"It is all the way up the channel," Eisenbarth said. "Prices on everything are falling, including modems."

Rockwell warned yesterday that second-quarter earnings would be about 25 percent below the figures reported for the like period last year. The company blamed the downturn on customers who held off from buying older products in anticipation of the new standards-based 56-kbps modems.

In light of Rockwell's rivalry with 3Com (COMS), delay in growth will continue to pressure modem chip prices, Blackstock said, noting his 12-month target price of $58 a share. He also reduced the fiscal second-quarter earnings estimate for Rockwell to a range of between 71 and 72 cents per share, down from a range of 77 to 79 cents.

3Com saw soft demand even before the 56-kbps standard, Stephen Koffler, an analyst with Donaldson Lufkin & Jenrette, said in a research report. But the company started shipping v.90 modems two weeks before the standard was adopted, making it the "first company out of the box" and putting it in an advantageous position, he added.

3Com released its v.90 product within two weeks of the finalization of the standard and has completed interoperability testing with Rockwell. 3Com's earnings will be released March 24 and should provide further indication of how the market is accepting the 56-kbps modems.

Bay also said earlier this week that it expects third-quarter revenues to fall 10 percent from the previous quarter, below analysts' estimates. Bay said confusion over the new modem standard contributed to customers' decisions to postpone purchases.

However, Christopher Stix, an analyst with Cowen & Company, said Bay gets only 6 percent of its revenue from modems, so the standards issue isn't as big of a problem for the company. Bay also cited other reasons for falling short of expectations, including weakness in overseas markets and longer sales cycles.