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Cisco surges on outlook

Shares of the networking company jump after better-than-expected third-quarter earnings results, which were dubbed a "home run" by the company's CEO.

Shares of Cisco Systems jumped Wednesday following better-than-expected third-quarter earnings results, which were dubbed a "home run" by CEO John Chambers.

The company on Tuesday reported a net profit of $729 million, or 10 cents a share, in the quarter that ended April 27, compared with a net loss of $2.7 billion, or 37 cents a share, in the same quarter a year ago.

Excluding special charges, Cisco's pro forma profit was $838 million, or 11 cents a share. That was better than Wall Street analysts' expectations of a third-quarter profit of 9 cents a share. Last year, the networking company reported pro forma profits of $230 million, or 3 cents a share.

Cisco generated revenue of $4.8 billion in the third quarter, up 2 percent from $4.73 billion last year. Analysts had forecast revenue of $4.87 billion, according to First Call.

Cisco shares gained $3.19, or 24 percent, to $16.27 and helped fuel Nasdaq gains. The CNET Networking index surged as did shares of companies such as PMC-Sierra and Applied Micro Circuits, which supply components to Cisco.

What had Wall Street so enthusiastic was Cisco's outlook. Cisco Chief Executive Chambers sounded an optimistic note in a conference call after the earnings were announced. Chambers also noted that there was some improvement in technology spending, but stopped short of predicting a turnaround.

"I expect a 5 percent increase in orders in the fourth quarter, which is normal seasonality over the third quarter," he said. "And although we expect a 5 percent increase, I would not be satisfied with single-digit growth. If we get a 10 percent increase, then I'd get pretty excited."

"From an operational perspective, this quarter was a home run," Chambers said. "We continue to take market share from our top 10 competitors, with revenue growth of 2 percent year over year versus a drop of 43 percent for these competitors."

That outlook wasn't exactly euphoric, but did provide some psychological balm for a sector that has struggled. "The third-quarter conference call was easily the most bullish call of the post-bubble era," said Gerard Klauer Mattison analyst Michael Cristinziano. "We believe management is effectively managing through an unprecedented industry downturn."

The networking giant also posted gross margins of 63.1 percent, cash flow of $1.6 billion, and inventory turns of 7.5 times, exceeding the company's goals, said Chambers.

Some of the issues that helped push profits included cost savings from lower component costs, focusing on products that carried a higher profit margin and tightening up the steep discounts offered by the company's sales staff, Chambers added.

Although many analysts noted that Cisco is far from repeating the its performance in 1999 and 2000, they said the company was by far the best of a bad lot.

Cisco, which saw revenue grow 2 percent in the third quarter from the same period last year, managed to show an increase, while many competitors posted declines. Companies that faced or are facing difficulty in their most recent quarter include Juniper Networks and Sycamore Networks.

"We believe that working in Cisco's favor is the virtual complete self-immolation of its primary competitors for the service provider market. Nortel and Lucent are the walking wounded, Marconi is on the ropes, and Alcatel appears to have a full set of challenges," said Needham analyst Tad LaFountain in a research note.

"In a perverse way, the decimation of the service provider market is probably the single best thing that could have happened to Cisco," he said.

Other analysts echoed those comments, adding that Cisco's success is partly attributed to the fact it gets the majority of its revenue from enterprise customers, not from ailing telecommunications providers as its rivals do. Routers accounted for 30 percent of Cisco's sales in the quarter, switches represented 40 percent and services were 17 percent, with access products and other categories making up the remainder.

Cisco's balance sheet is also in better shape than its peers. Cisco's ended the third quarter with $21 billion of cash, short-term investments, and investments with no short- or long-term debt.

Really a home run?
Cisco's quarter provided some relief to Wall Street, but many analysts said that it's too early to predict a rebound in telecom and IT spending in general.

"While the company matched sales expectations and exceeded earnings consensus, we are not convinced that next quarter will mark the turnaround for IT spending," said Bernstein analyst Paul Sagawa.

Cisco apparently isn't convinced either. The company predicted fourth-quarter revenue to be flat to up slightly, but neglected to provide an outlook beyond the fourth quarter.

Meanwhile, the company's performance by market provided a mixed picture of the tech sector. U.S. enterprise orders were flat, which analysts took as a positive sign.

By industry, federal government orders topped 10 percent, which made up for ?challenging? business at the state and local level.

Growth was also reported from retail, education, health care and retail banking, with small gains in the manufacturing sector. Sales to energy, high-tech and investment banking customers fell. The telecom service provider market remains weak, with Cisco orders falling more than 10 percent, and optical products declining the most.

When the economy turns around, Chambers said he expects the company's commercial business, which includes small to medium-sized businesses, to pick up first, followed by its large corporate customer base. Last, he anticipates that its service provider segment will recover. Given those results, Cisco plans to keep its costs in check by cutting 1 percent to 2 percent of its positions via attrition per quarter, he noted. The company employs 35,935 workers.

Despite these efforts and an anticipated increase in revenue for the fourth quarter, Chambers maintains a cautious outlook for the future.

"I remain cautious about the economy and service provider spending," Chambers said. "CEOs remain in a show-me stage in terms of capital spending. Until they are able to grow their own revenues and profits, they are cautious in their spending."