The Bad Gets Worse for Network Associates

Following a 25% slump in its stock, the software firm had more grim news for investors.
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SAN FRANCISCO -- Following a downgrade from a major Wall Street firm and a 25% slide in its stock, security-software maker Network Associates (NETA) announced lower-than-expected fourth-quarter results and warned of a disappointing first quarter.

Network Associates said after Tuesday's market close that it earned 40 cents per diluted share in the fourth quarter of 1998, compared with a 47-cent loss in the year-earlier quarter. The

First Call

consensus had called for a profit of 46 cents. Revenue rose 37% to $272.2 million in the quarter from the year-ago quarter.

The company also estimated first-quarter EPS between 30 and 32 cents before noncash amortization charges. Analysts surveyed by First Call had been forecasting a consensus of 48 cents a share in the quarter. Revenue for the first quarter will come in between $245 million and $250 million, compared with revenue of $188 million in the first quarter of 1998.

For all of 1998, the company earned net income of $36.4 million, or 26 cents per share. Those earnings reflect the conclusion of discussions with the

Securities and Exchange Commission

regarding in-process research and development writeoffs. As a result of new SEC guidance on in-process R&D and acquisition-related charges, Network Associates said it lowered its in-process R&D charges by $169 million in fiscal 1998 and $45 million in 1997. Amortization increased to $43 million in 1998 and $13 million in 1997. "In addition, adjustments to fiscal year 1998 and 1997 revenue and expenses occurred due to the pooling of financial statements of regional distributors and other reclassifications of certain acquisition related charges," the company said.

Morgan Stanley Dean Witter

analyst Chuck Phillips, who prompted Tuesday's selloff in Network Associates after he downgraded the stock to neutral, had forecast revenue of $283 million and earnings per share of 41 cents for the quarter. Morgan Stanley Dean Witter has not underwritten for Network Associates.

The company said first-quarter earnings were affected by "the slowdown in the enterprise software market as a whole, changes in corporate buying patterns due to Year 2000 concerns and a lengthening sales cycle." It said it expects to report final first-quarter results around April 19.

The following story ran at 5:05 p.m. EDT:

Network Associates Dives 25% on Morgan Downgrade

Shares of security software maker Network Associates lost a quarter of their value in late afternoon trading after Morgan Stanley Dean Witter analyst Chuck Phillips downgraded the company to neutral from outperform.

Network Associates closed down 7 1/2, or 25%, at 21 15/16. The stock fell as low as 20 7/8, reaching depths it hasn't seen since July 1996. More than 21 million shares were traded, making the stock the fifth most active on

Nasdaq

.

"We believe the company is about to announce a resolution to the comment letter from the

SEC

regarding in-process research and development charges," Phillips wrote in a research note. "We've recast our 1999 forecast to adjust for incremental amortization charges resulting from a lower upfront in-process R&D write-off under the new rules being enforced by the SEC. We estimate the new rules will add about $24 million in amortization charges to 1999 results." Morgan Stanley has not underwritten for Network Associates.

In the near term, Phillips expects the company to meet his first-quarter revenue forecast of $283 million, though earnings may have to come down. He predicts Network Associates will earn 41 cents for the quarter when the company releases earnings this month.

First Call's

consensus estimate is 48 cents.

But further out, Phillips lowered his fiscal year 1999 earnings estimate to $1.72, reflecting the new in-process R&D guidance, lower operating-margin assumptions of 28%, including amortization charges, and a lower revenue forecast based on a more conservative acquisition strategy. He also said the market for Network Associates' new active security products, launched on Monday, "looked interesting but may require a long period of evangelizing to take hold in the market" and that they "weren't as extensive as we had been looking for."

Officials at Network Associates weren't immediately available for comment.

After recent negative announcements from other security software makers

Axent Technologies

(AXNT)

,

Secure Computing

(SCUR)

and

Security Dynamics

(SDTI)

, Phillips expected a slower security market. He says the shortfalls "suggest the momentum in the security software market has slowed markedly."

Steve Frankel, an analyst at

Adams Harkness

who downgraded Network Associates to market perform in early January, warns that even if the company finds a way to make its first-quarter estimate, the quality of earnings may be poor. He said he was particularly concerned with days' sales outstanding, which were at 84 days in the third quarter (the company hasn't reported earnings for the fourth quarter, pending SEC review). Days' sales outstanding help analysts gauge the accounts receivable a software company has.

"The company's been talking about DSOs going into the 90s and then coming down, but the questions is, will they come down again or stay up?" asks Frankel, whose firm has not underwritten for Network Associates.