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Cisco beats, but ...
Tech bellwether's profits top forecasts but worries about sales punish the stock after-hours.
August 10, 2004: 6:18 PM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - Cisco Systems Inc. reported strong earnings Tuesday that surpassed Wall Street's estimates for the latest quarter.

But while sales rose, they didn't significantly beat analysts' forecasts and investors appeared to interpret that as another reason to worry about a slowdown in tech spending by big businesses. The company also gave tepid sales guidance for the first quarter. Shares sank after-hours on the news.

The San Jose, Calif.-based company, the world's leading maker of routers and switches used to connect computers to the Internet, posted net income of $1.4 billion, or 20 cents a share, for its fiscal fourth quarter, a 43 percent increase from $982 million, or 14 cents a share, a year earlier.

Excluding stock-based compensation expenses and other charges, Cisco's earnings were $1.5 billion, or 21 cents a share, a penny ahead of Wall Street's consensus estimate of 20 cents a share, according to earnings tracker First Call.

Sales rose 26 percent from a year ago to $5.93 billion, slightly higher than analysts' average forecast of $5.89 billion for the quarter. But some on Wall Street were hoping Cisco could report at least $6 billion in revenue.

And during a conference call with analysts Tuesday afternoon, Cisco CEO John Chambers said that the company expects sales to be flat to up 2 percent sequentially in the first quarter, which ends in October. That implies a target of about $5.93 billion to $6.04 billion. The current consensus estimate is $6.02 billion.

Shares of Cisco (CSCO: Research, Estimates), the most actively traded stock on the Nasdaq Tuesday, tumbled nearly 6 percent in after-hours trading after rising 2 percent, to $20.46, during the regular session. The after-hours losses accelerated after the company gave its sales guidance for the first quarter.

Chambers: Customers more cautious

The stock has fallen nearly 15 percent since early July due to concerns that earnings and sales growth will cool after a strong first half of the year. Rising oil prices and weaker than expected job growth during the past two months have added to these fears. And Cisco's guidance probably won't help matters.

Shares of Cisco rival Juniper Networks (JNPR: Research, Estimates) fell 5 percent after hours. Networking chip companies PMC-Sierra (PMCS: Research, Estimates) and Broadcom (BRCM: Research, Estimates) fell sharply as well, although their drop was probably influenced more by a warning from fellow chip firm National Semiconductor (NSM: Research, Estimates).

Cisco's recent slide may continue since the company gave lackluster fiscal 1Q sales guidance.  
Cisco's recent slide may continue since the company gave lackluster fiscal 1Q sales guidance.

Blaylock & Partners analyst Gabriel Lowy, speaking before Cisco reported its results, said that he wasn't even considering that Cisco's first-quarter sales could be unchanged from the fourth quarter. He said the most likely scenario was an increase from about 1 percent to 3 percent and that guidance for a 4 percent to 6 percent increase wasn't out of the question.

During the conference call, Chambers said that the economic recovery "was continuing to gain momentum on a global basis", language similar to what he used to describe the economic environment during the last quarterly conference call in May.

He added though that CEO customers that he talks to are "more cautious than they were a quarter ago."

Chambers' comments are typically dissected closely by Wall Street for the status of the overall technology sectors' health. Wall Street had held out a faint hope that he would be more optimistic than he had been in May, despite the latest round of evidence suggesting that the economy has hit a soft patch.

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But Chambers added that he was pleased with domestic order growth, which accounted for nearly half of the company's total bookings in the fourth quarter. He said that order growth from large U.S. businesses, a segment known as enterprises, rose in the mid-teens sequentially while order growth from U.S. telecom service providers increased in the high-teens from the third quarter.

And the company also announced that Chambers' annual salary had been reinstated to $350,000 due to the recovery in Cisco's business during the past few years. Chambers agreed to cut his salary to $1 in April 2001 and it had stayed there since.

Still, analysts are hoping that going forward, Cisco will be able to report higher sales from newer products such as wireless, security, Internet phone technology, or VoIP, and storage. That's because the company's bread and butter business of selling switches and routers, which accounts for nearly two-thirds of total sales, is starting to mature.

"Cisco needs to have bigger numbers from new product areas since the core business is not going to grow that fast in this economy," said Timm Bechter, an analyst with Legg Mason.

The wireless and VoIP segments both reported sequential sales increases of 15 percent while storage sales were up 41 percent. Security sales, however, dipped 2 percent from the third quarter.

Inventories keep rising

Another cause for worry was that Cisco's inventories rose nearly 8 percent from the fiscal third quarter, to $1.2 billion. While that's a smaller sequential increase than the more than 20 percent jump last quarter, it may still feed into investors' fears that the company may wind up with unsold goods on its books if demand does not materialize in the second half of this year.

But during the conference call with analysts, Cisco CFO Dennis Powell said inventories may rise further as the company tries to meet demand for products in advanced technology areas and that this should not be a cause for concern.

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Investors may have also been disappointed by the fact that Cisco's gross margins, which measure how profitable the company is after subtracting the cost of sales, dipped slightly on a sequential basis as well. Gross margins in the fourth quarter were 68.4 percent, down from 68.8 percent in the third quarter. Powell said the gross margin slip was due, in part, to the buildup in inventory.

For Cisco's full fiscal year, the company reported net income of $4.4 billion, or 62 cents a share, up from $3.6 billion, or 50 cents a share, a year ago. Excluding items, earnings came in at $5.3 billion, or 76 cents a share, compared with $4.3 billion, or 59 cents, last year. Sales for the full year were $22 billion, up 16.8 percent from a year ago.

Overall, it was certainly a strong quarter and year for Cisco, but investors were obviously still disappointed. And with that in mind, it was telling how Chambers concluded the conference call.

He stressed that the fiscal first quarter is typically a weak one for Cisco and that the sales forecast was just another example of the company's conservative nature. Chambers was criticized by some investors for being too optimistic in the immediate aftermath of the tech sector's collapse in 2000.

So it appears he doesn't want to make that mistake again, even if investors don't like this conservative nature either.

"We want to be the most predictable, boring growth company," Chambers said.

Bechter and Lowy own shares of Cisco but their firms have no investment banking ties to the company.  Top of page

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