EMC's Ball Keeps Rolling Downhill -- and Its Stock Follows Suit

Updated from 5:35 p.m. EDT

How far the mightiest technology stocks continue to fall.

Shares of EMC (EMC Quote) were tanking Friday morning after the storage systems maker released preliminary results showing second-quarter sales and earnings would fall well short of Wall Street's expectations. The stock had lately fallen $7.33, or 24%, to $22.70.

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At EMC, Ball Keeps Rolling -- Downhill

EMC forecast second-quarter earnings of 4 cents to 6 cents a share, far below the Thomson Financial/First Call consensus estimate of 17 cents and the 19 cents EMC earned in the year-ago period. Sales, meanwhile, would come in around $2 billion, the company said, more than $400 million below expectations. This is the second consecutive quarter the company has sent its rancid results out across the wires ahead of schedule. The stock, which returned a buoyant 21% in 2000 when the rest of tech was collapsing, if off 65% so far this year.

Shakespeare in the Dark

What happened? The sheer magnitude of the shortfall forced the company to resort to simile. "The earnings results for EMC's major customers -- the bulk of the S&P 500, for example -- have been like a ball rolling down a hill for each of the past three quarters," said Joe Tucci, EMC's CEO and president. "When our customers earn less money, most of them have less to spend on IT, and they take a longer time to spend what they do have."

Something else happens when customers have less money to spend. Equipment manufacturers slash prices as they fight among themselves for the business that's left, and everybody's profits plummet. Gross profit margins had already plunged nearly 4 percentage points in EMC's first quarter, when they came in at 55.4%. But that's nothing compared to what's happening now. CFO Bill Teuber said that second-quarter gross margins will be in the mid-40% range, citing low sales volumes, customer incentive programs and, most ominously for EMC's competitors, "competitive pricing actions."

EMC's competitors include traditional enterprise hardware manufacturers like IBM (IBM Quote), Hewlett-Packard (HWP Quote) and Compaq (CPQ Quote), Unix systems king Sun Microsystems (SUNW Quote) and niche network-storage firm Network Appliance (NTAP Quote).

Of that group, NetApp was getting hit hardest, lately falling $1.45, or 11.4%, to $11.22. Sun was down $1.30, or 9.6%, to $13.87. IBM was down $5.35, or 4.8%, to $106.75. Big Blue was also coming under pressure from Thursday's warning by BMC Software (BMC Quote), about half of whose sales are tied to IBM's mainframe computers.

Strong Dollar

EMC made the standard citation of the global nature of the current slowdown, adding that its weakness overseas was further damaged by the strong U.S. dollar -- as it happens, a phenomenon that goes back to the middle of the last decade.

EMC's target growth rate has already sunk to 20% from 35% so far this year, while the company's earnings-per-share forecast has fallen to mere "modest" growth from 2000. EMC set plans in April to fire about 1,100 workers in an effort to get its cost structure in line with reduced expectations for 2001 sales. Now those expectations are headed lower still.

Though EMC won't be giving any details about its outlook until it announces its official results on July 18, analysts are already adjusting their estimates for the storage group. Most notable was Thomas Weisel Partners' move to reduce its estimate for NetApp's 2002 earnings from 20 cents a share to a mere 2 cents a share.

Think of a ball, rolling down a hill.