The NW200 in decline

Fraud. Scandal. Bankruptcy. The Network World 200 - the biggest names in networking - stumble through 2002

One thing you can say about 2002 is that there was nothing subtle about it.

The year was pockmarked by fraud on a grand scale, management changes at some of the leading companies and frantic refocusing. The latter wasn't all bad, as companies such as Nortel and 3Com, among others, found new religion about the enterprise market.

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Stepping back Clearer skies IT spending Systems blues Telecom's black eye Dell most productive Fast growth The NW200 alphabetically  Sector summaries

One thing you can say about 2002 is that there was nothing subtle about it.

The year was pockmarked by fraud on a grand scale, management changes at some of the leading companies and frantic refocusing. The latter wasn't all bad, as companies such as Nortel and 3Com, among others, found new religion about the enterprise market.

But the turmoil left an indelible mark on the Network World 200, our annual list of the largest domestic public network companies. WorldCom didn't make it because it is in Chapter 11, while Broadwing Communications dropped off because it is busy restructuring and waiting until the last minute to close its books (missing our deadline of March 18). That takes $38 billion right off the top of the list.

When you combine the revenue missing from companies in Chapter 11 with the whipsaw effects of the sour economy and a general retreat from IT spending, it's no surprise that revenue for the NW200 dropped 12% from $890 billion in 2001 to $785 billion in 2002. That makes 2001 and 2002 the only years in the NW200's nine-year history for which collective revenue declined.

The profit picture was just as bleak: Together the NW200 companies generated about $154 billion in losses, compared with $65 billion in losses in 2001. But that number is deceiving because 1) new accounting rules required companies to write off impaired goodwill immediately instead of over many years, and 2) almost $100 billion of that outsized loss is from a single company: AOL Time Warner.

Of AOL's loss, some $46 billion is attributed to goodwill. Companies end up with goodwill on their balance sheets if, in acquiring another company, they pay more than the market value of that company's assets.

Companies don't have to write off goodwill unless it becomes permanently impaired, meaning it no longer represents the value of the asset. For example, if a company issues a million shares at $100 to buy a company for $100 million, and after the transaction the share price tumbles to $10, the company could write $90 million of impaired goodwill off its balance sheet.

Companies that went on acquisition sprees in the bubble were left with huge impaired assets after it burst. Of Qwest's $36 billion loss in 2002, for example, $18 billion was in impaired goodwill.

Alfred King, vice chairman of Valuation Research in Milwaukee, says his best guess is that U.S. companies wrote off some $400 billion to $500 billion in goodwill last year.

The numbers are all the more dramatic because everyone took the charges at the same time to comply with regulations that went into effect in January 2002. But the write-offs are what analysts call noncash events, meaning they don't reflect the day-to-day health of an organization. The poor stockholders are the ones whose money has gone up in smoke.

So, as bad as the profit number looks, it is artificially high and not really as dire as it might seem. In fact, more NW200 companies reported profits in 2002 than in 2001: 69 vs. 62. But a few of the losses were real whoppers. Besides AOL's loss - the largest ever in U.S. corporate history - the NW200 includes eight other billion-dollar-plus losses, including AT&T, $13 billion; Qwest, $36 billion; and VeriSign, $4.9 billion.

Clearer skies

One company that did muster a profit is industry bellwether Cisco. Even as revenue dropped 15% to $18.9 billion, the company managed to reduce expenses enough to generate income of $1.9 billion. That compares with the $1 billion loss the company posted in 2001.

Cisco's 2002 fiscal year ended in July, so to get a better sense for how the company did in calendar 2002, it is interesting to string together the last two quarters of '02 with the first two quarters of '03. For that period, revenue was up 5% to $19.2 billion compared with the same four quarters spanning '01, and profits were $3.1 billion vs. a $2.3 billion loss in the earlier period.

Either way, the sky is getting brighter for this network demagogue.

The same cannot be said for some of the other network pure plays: 3Com's sales were down 48% last year, Juniper's, 38%; Extreme Networks', 10%; Enterasys Networks', 57%, Foundry Networks', 3%.

Even Avaya, sitting pretty in the hot convergence market, saw sales decline 27%.

But one bright spot was the security sector: Symantec's 26% revenue jump made it a billion-dollar-plus company for the first time; Network Associates' sales grew 16% to $942 million; Internet Security Systems' revenue was up 9% to $243 million; and NetScreen Technologies' sales leapt a whopping 62% to close at $138 million.

Check Point  is one security company that didn't fare well. Revenue dropped 19% to $427 million, and profits slid 21% to $255 million. But with a 60% profit margin, Check Point still ranks as one of the top 20 most profitable NW200 companies.

Systems blues

While you can find pockets of good news among the network-only houses, it is harder with the big systems players. Revenue trailed off in 2002 for all the big systems houses.

That is, technically speaking. While the numbers on the chart show Dell sales slipped 2% to $31 billion in fiscal 2002, Dell's year ends in February so those results are mostly for the 2001 calendar year. In Dell's fiscal 2003, which is comparable to the other systems houses' 2002, Dell did much better: Revenue was up 9% to $35 billion and profits were up 37% to $2 billion.

Growth-wise, no one else comes close.

IBM's sales were down 2% to $81 billion for roughly the same period, while profits dropped 54% to $3.6 billion, largely because of charges associated with the acquisition of PricewaterhouseCoopers Consulting.

Revenue for HP, merged with Compaq midyear, was $72 billion, down 11% compared with $81 billion in fiscal 2001 on a combined company basis. HP posted a loss of close to $1 billion.

In HP's annual report, CEO Carly Fiorina said: "Our Enterprise Systems Group and our Personal Systems Group each reduced its operating loss by more than 50% in the fourth quarter from the third quarter - while ESG's revenue grew more than 8%, and PSG's revenue increased by 6% in the same period."

If you add up IDC's total server shipment numbers for Compaq and HP and compare them in 2001 and 2002, you end up with a 6% decline year to year. Dell for the same period ratcheted server shipments up 15%. While Dell still is in the minor leagues on a server revenue basis - $3.6 billion vs. HP's $12.3 billion - Dell certainly is on a tear.