Foolish Forecast: 3Com

Networking equipment maker 3Com (Nasdaq: COMS  ) reports its fiscal Q4 and full-year 2006 earnings after close of market tomorrow. Want to know what Wall Street expects to see? Read on. Want to know what really matters? Read on a bit more.

What analysts say:

  • Buy, sell, or waffle? 10 analysts follow 3Com. The stock gets one buy rating and one sell, with all the rest saying hold.
  • Revenues. Sales are expected to shoot up 59% in tomorrow's news, to $280 million.
  • Earnings. And the firm's net loss per share is supposed to narrow to $0.04.

What management says:
Continued lack of profitability aside, just look at that revenue gain! Something must certainly be going right at 3Com if Wall Street is expecting sales to grow more than 50%, right? Well, not necessarily. Reviewing 3Com's earnings report from last quarter, you'll find a one-line mention that 3Com purchased an additional 2% interest in its joint venture with China's Huawei. Since 3Com already owned a 49% interest, the extra 2% gives 3Com majority control over the JV, and as a result, 3Com will now be consolidating the JV's revenues with its own. Hence, the apparent jump in revenues.

The real story at 3Com, therefore, is not one of rocketing sales, but of the steady chipping away at costs. Said CEO Scott Murray: "3Com continues to lower its on-going operating costs, but we still have a way to go in these efforts. We are committed to building a profitable business as quickly as we can. We believe that our strong balance sheet and global operations will allow us to achieve this goal."

What management does:
The saying goes, "Slow and steady wins the race." Well, as Murray pointed out, 3Com remains far from winning, but it's got the slow and steady part down pat. Rolling gross margins have been rising steadily for the whole last year, and rolling operating and net losses have been narrowing for three quarters running now.

Margins %

11/04

2/05

5/05

9/05

12/05

3/06

Gross

37.7

37.9

36

36.4

37.7

39

Op.

(21)

(20.5)

(27.4)

(28.3)

(25.6)

(22.4)

Net

(28.2)

(23.7)

(30)

(30.3)

(23.4)

(20.1)

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Thanks to the firm's acquisition of TippingPoint (announced in late 2004) and soon-to-be thanks to the consolidation of its JV with Huawei, it's not easy to get a good feel for which way 3Com's business is heading. Comparing sequential quarterly results is inherently dodgy, and comparing recent results to results from pre-acquisition quarters isn't much better.

That said, 3Com's new CEO seems to think that the strongest growth potential at 3Com exists within its TippingPoint-boosted Security division, where sales grew 22% quarter over quarter in Q3 2006. The Connectivity Products division didn't do too shabbily last quarter either, growing 38%. The bad news is that the firm's flagship Networking unit saw revenues decline both sequentially and year over year last quarter.

Monitoring 3Com's progress in reducing costs should be easier. But there, the picture is mixed. Over the last six months, 3Com held its selling, general, and administrative expenses to a slower rate of increase than for sales (14% vs. 16%). But what's really been helping the firm slim down its losses was the fact that cost of goods sold grew only 6% during this period. That's what boosted the gross margin, and what helped to cover the operating costs. Working in as competitive a sphere as 3Com does, however, I doubt the firm will be able to maintain this kind of pricing power for long. It's also going to need to cut operating costs further in order to return to profitability.

Competitors:

  • Avaya (NYSE: AV  )
  • Cisco (Nasdaq: CSCO  )
  • Hewlett-Packard (NYSE: HPQ  )
  • Internet Security (Nasdaq: ISSX  )
  • Juniper Networks (Nasdaq: JNPR  )
  • McAfee (NYSE: MFE  )

McAfee is a Motley Fool Stock Advisorrecommendation. Take the newsletter for a 30-day free trial.

Fool contributorRich Smithdoes not own shares of any company named above.


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