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Earnings warnings pound some tech shares

As the second quarter nears a close, analysts and investors are having trouble digesting a steady diet of earnings warnings.

As the second quarter nears a close, analysts and investors are having trouble digesting a steady diet of earnings warnings.

Gadzoox Networks became the latest in a growing list of companies that have issued a warning about quarterly earnings, then watched helplessly as investors returned the favor by punishing the stock.

However, some analysts say the damage is isolated and they remain optimistic about the overall growth in earnings, particularly among technology companies. "It's going to be a great quarter," said Chuck Hill, a spokesman for First Call.

Gadzoox announced late yesterday that it expects revenue for the current first quarter to fall by as much as a third from the previous quarter's revenue of $15.1 million. The company added that fiscal second-quarter revenue also will fall short of estimates.

In late trading today, shares in the San Jose, Calif.-based company fell $6.69, or 33 percent, to $13.63 on volume of 5.3 million shares, more than seven times the stock's daily average volume. The stock also hit a new 52-week intraday trading low of $12.50, almost one-tenth its 12-month peak of $109.87.

Gadzoox, which makes software and hardware such as hubs, routers and switches used in corporate networks, is hardly alone. In the past few days, several large and small tech companies have issued warnings, including:

• Today, online drugstore warned that second-quarter revenue will be less than expected and that it expects to lose about 62 cents per share--about 4 cents less than analyst forecasts. In late trading, the shares were down 47 cents, or 23 percent, to $1.53.

• Yesterday, Emachines said it expects to post a per share loss of about 30 cents per share, far more than the 1 cent loss analysts expected. The shares fell $1.09, or about 30 percent, to $2.59.

• Also yesterday, Honeywell said it expects to earn 73 cents to 77 cents per share in the second quarter, slightly less than the 78 cents that analysts expected. Its shares were down $4.56, or 11 percent, to $35.69, extending yesterday's decline of $8.63.

• Xerox warned last Friday that second-quarter earnings will be closer to 30 cents per share than the 42 cents that Wall Street analysts expected. The shares sank 19 percent to $20.58 the day of the announcement.

Despite the recent earnings scares, First Call's Hill said analysts expect 18.2 percent earnings growth for companies in the Standard and Poor's 500 index this quarter compared to last year, and he expects growth to rise as high as 23 percent as analysts review and upgrade their estimates.

In the first quarter of this year, S&P 500 companies posted earnings growth of 23.6 percent, which Hill attributed partly to a lackluster first quarter in 1999.

As for this quarter, Hill said investors should be satisfied that the S&P 500 will turn in flat sequential growth because the second quarter is being compared to a robust period a year ago.

So far this quarter, more than 105 companies have announced that earnings will not meet Wall Street expectations. Hill expects the number of negative earnings pre-announcements for the second quarter will exceed the 225 warnings issued in the first quarter. However, he said, the bad news will fall short of the 370 warnings issued in the second quarter of last year.

Other market watchers also believe that the volatile tech sector will continue to impress investors with earnings growth.

"We expect the tech sector will see earnings growth just behind the energy and basic materials sectors," said Richard Cripps, a market strategist at Legg Mason. "But what is unique for tech is they have continued to have strong earnings growth quarter after quarter."

Strong earnings growth, however, is not expected to spark an across-the-board rally in tech stocks, he noted.

"There'll still be discriminating factors at work. Investors will still be looking at revenues, cash flow and earnings. Those companies' shares will be helped by Q2, but not those that are still burning cash."

As for Gadzoox, the recent news complicates the company's future. Salomon Smith Barney analyst John Dean lowered his first-quarter revenue estimate to $10 million from $18.3 million, and his revenue forecast for the fiscal year to $40 million from $105 million. Dean also cut his price target on the stock to $14 from $50.

The analyst left his "neutral" rating unchanged but lowered earnings estimates for the quarter to a loss of 17 cents from a loss of 12 cents per share. Dean also lowered his annual estimate to a loss of 62 cents from a loss of 10 cents.

Seven analysts surveyed by First Call expect the company to lose 12 cents a share for the quarter and 43 cents for the year, but those numbers should fall once analysts factor in today's warning.

Dean believes the earnings hit underlies product problems within the company. "Gadzoox's difficulty is company-specific and stems from its delay in developing a fabric switch," he wrote in a report.

Analyst Bill Lewis of Chase H&Q added that sales for other products have been sluggish. "Sales for the company's fibre channel loop switch have not been as strong into the (distribution) channel as the company had hoped," he said in an interview.

Lewis also was disappointed with the timing of the announcement, saying as recently as last week that they were comfortable with Chase H&Q's estimates.

Lewis cut the stock to "market perform" from "buy" and expects to revise his estimates.

Gadzoox could not immediately be reached for comment.