Warnings week less ugly than expected

The first couple of weeks after the end of a quarter is the time when companies take an early look at sales and earnings, so with September just concluded, Wall Street spent last week anxiously waiting to see which technology stars would report profit warnings.

And investors may have decided the earnings picture wasn't as bad as feared. The Nasdaq composite index closed the week up 7.1 percent, despite worse-than-expected jobless figures that were released Friday.

To be sure, more than a few major tech companies dismantled earnings models.

The computer hardware industry heard of lower-than-forecast results from three of its largest vendors, Compaq Computer, Gateway and Sun Microsystems.

Chipmaker Advanced Micro Devices joined the parade. Corning, the biggest provider of optical fiber, told Wall Street to reduce its expectations. Two of the biggest software names for managing mainframes and client-server systems, BMC Software and Compuware, added to the list of warnings. Storage vendor EMC, in an industry widely expected to get a post-terrorist lift, preannounced weak results.

And after several months of insisting its relatively aggressive financial targets were achievable, media giant and Internet service provider AOL-Time Warner last week issued a note of caution for the year.

But at least some of those can blame their shortfalls partly on specific problems of their own, rather than industrywide trends.

Compaq admitted its planned merger with Hewlett-Packard caused a hiccup in business. EMC until recently was slow to respond to aggressive price cuts from competitors. Market research indicates Sun lost server market share to IBM, though Sun executives and many analysts insist competition has had little or no impact on the bottom line.

Knock on wood
More telling about the overall state of the tech economy wasn't the companies that warned, but the ones that didn't. Plenty of companies unexpectedly dodged earnings bullets.

"Preannouncement season could have been far worse," said SoundView Technology chief strategist Arnold Berman, adding that there have been "substantially" fewer misses this time than at the same point in each of the last two quarters.

Silence about quarterly results from Motorola and Yahoo, slated to report earnings Tuesday and Wednesday respectively, suggests they will at least meet profit estimates. Ditto for Microsoft, Apple Computer, IBM and Texas Instruments.

Cisco Systems and Dell Computer went out of their way to say that quarterly results appeared on track. Even the enterprise applications segment--which sees more sales near the end of a quarter than almost any other market, tech or otherwise--escaped without warnings from major players.

(Note that Oracle, the largest seller of databases and second-largest software vendor overall, has fiscal periods that don't match calendar quarters. Oracle's next fiscal report won't come until after its quarter ends in November; executives already told analysts to expect steeper revenue declines in the wake of the terrorist attacks.)

Despite the list of apparent survivors, investors might not want to exhale yet, because analysts were cutting earnings estimates for technology companies throughout the September quarter. Many companies that haven't warned could meet the current First Call estimates but fall short of their original goals set at the end of June.

"It says in a pretty big way that expectations over time, as you would expect, are really getting beaten down," Berman said. "Analysts used to try and figure out how big a company can get. Now they're trying to figure out how little they can be."

Earnings veneer
Consensus forecasts for profit can be met even in the face of declining revenue.

Companies can cut costs to hit bottom-line goals if sales fall short of targets. For instance, security software stalwart Check Point Software expects to hit consensus earnings estimates even though revenue will be less than forecast.

Another earnings veneer can be created by aggressive accounting methods such as recognizing revenue early.

And companies could polish their income statements through the widespread practice of highlighting "pro forma" earnings news, rather than results reported under the Generally Accepted Accounting Principles (GAAP) required for quarterly filings with the Securities and Exchange Commission.

Pro forma results are supposed to illustrate the strength of a company's core business by leaving out the impact of goodwill write-downs and one-time events such as charges related to acquisitions or layoffs.

Although accounting regulators said terrorist-related effects could not be excluded from GAAP results, they can't prevent companies from doing so when pro forma earnings are broken out in press releases. Some government officials have already said they expect corporations' earnings news releases to cite last month's terrorist attacks as "nonrecurring" events.

Testing the market
Finally, even if companies do report quarterly results in line with expectations, the real question will be: What will happen in the future?

"Earnings forecasts are going down," Merrill Lynch tech strategist Steven Milunovich wrote last week. "Might we have a stronger second half of 2002 recovery? Possibly, but since we don't expect tech to lead the way out, we might have to wait for 2003 to see robust demand."

Waiting is a key point. Last week's gains could have been nothing more than a temporary surge that didn't truly change the market's bearish mood.

Several analysts suggested the increase could have been caused by nothing more than short sellers who make money when stocks fall. Shorts borrow stock to sell it immediately, then buy shares later to repay the loan; if the stock falls in the interim, the short seller makes money. A long decline in a stock's price may pause temporarily as short sellers buy back shares--thus driving up prices--as they cover their shorts.

Or it could simply be a temporary rally of a few months. Investors have seen those "bear market rallies" before, as recently as this spring. The Nasdaq composite index gained roughly 41 percent between the first week of April and late May, before giving it all back and more; by Sept. 10, the Nasdaq had reached a new low of the year, and it fell further in the first week of trading after the World Trade Center and Pentagon attacks.

The market may try to test new low points for stocks again, Berman said. "Investors that can't stand to stomach the retests should stay away," he said.

But whether it's nothing more than short-covering or a bear market rally, investors who can afford to hang onto stocks for multiyear periods might want to consider jumping in now because earnings predictions have fallen so low that they hardly can get worse, Berman said.

"Right now, anemic earnings prospects are being discounted at a high rate given the large level of uncertainty," he said. "Any injection of certainty in this picture would be a big catalyst for the stocks."

In other words, it wouldn't take much to make people happy.