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Earnings progress "vindicates" Cisco CEO

John Chambers may have earned his stripes by boosting his company's bottom line, but how long will the honeymoon last once Wall Street asks: Fine, but where's the revenue?

Cisco Systems Chief Executive John Chambers became a technology sector star by delivering eye-popping increases in revenue. Now he's earning his stripes by cutting costs and boosting his company's bottom line.

For Chambers, Cisco's third-quarter earnings report Tuesday provided a measure of exoneration. The company's profit was better than expected, and other operational measures such as inventory turns and gross margins shined. Operationally, Cisco's quarter was a "home run," Chambers said.

"If you look at the progress Cisco made in operating income margin, it definitely vindicates him and the organization," said Timothy Slevin, an analyst for Parker/Hunter, a stock brokerage and investment banking company. "Cisco continues to cut expenses in an uneven period."

The numbers tell the tale. The networking giant 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. Those figures impressed Wall Street, sparked a market rally Wednesday, and even temporarily silenced a few critics who had questioned whether Chambers could steer his company during a tech bust.

In an interview after his keynote speech Wednesday at NetWorld+Interop in Las Vegas, Chambers was dismissive when asked whether Cisco's earnings vindicated him.

"I think you could probably argue that myself and our leadership team were better experienced in handling tough situations than any other company," Chambers said. "I think what we've showed is an ability to do that in a way that no other company in the industry did."

Chambers is under scrutiny as questions arise about whether executives accustomed to growth can manage after the go-go days disappear.

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Executives who became famous in the telecommunications boom are conspicuously absent these days. Ask former WorldCom CEO Bernie Ebbers how hard it is to manage a company when a boom turns into a bust. Ask former Nortel Networks CEO John Roth or former Lucent Technologies chief Richard McGinn. Retirement--forced or chosen--isn't so bad when the telecom bubble bursts.

Many analysts said Chambers' best feat has been the speed in which he has turned around the company.

"To Cisco's credit, it responded as rapidly as any company of its scale could have," said analyst Tad LaFountain of Needham & Company, an investment bank and brokerage. "The quarter did give him a little vindication."

Tough choices
Although many analysts give Chambers credit for delivering good operational results in a downturn, they also note that he had something to do with the problems in the first place.

In 2000, analysts say, Chambers clearly guessed wrong on inventory and market direction. His bullish outlook eventually led to a massive inventory charge and an announcement of 8,000 layoffs in 2001. In an interview earlier this year with CNET, Chambers became emotional about the layoffs, adding that the job cuts reflected his "personal failure."

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John Chambers, CEO, Cisco Systems
"It's clear he overshot in 2000, but Cisco showed a lot of nimbleness compared to other large companies," LaFountain said.

It was quite a turnabout for Chambers, a poster boy for the Internet boom. Up until the crash of 2001, Chambers could do no wrong, leading Cisco to become the world's most valuable company at one point.

Now Chambers is focused on the present, providing a cautiously optimistic outlook for the future, but not venturing beyond Cisco's current quarter. Chambers insists that he can handle the bust as well as the boom.

"First, if anyone looks at what I've done over my career--at IBM, then at Wang (Computer), then at Cisco--I usually was asked to run the most troubled operations and almost always took it from last place to first place," he said. "Cisco's been through this in 1991 when I got there, in 1994 and then 1997, so I've done this more, unfortunately, than almost any other high-tech person has."

In Chambers' latest refrain, he said technology is currently in a "show me" economy, one in which CEOs are cautious about their capital spending until they can improve their own revenue and profit.

That's why Cisco continues to cut costs. Slevin noted that Cisco is still cutting jobs through attrition, having lost about 800 positions in each of the last two quarters.

Built-in advantage
Analysts said Chambers can be more upbeat than most of his rivals largely because Cisco has a few built-in advantages.

To wit: LaFountain noted that Lucent is shooting for gross margins of 35 percent once it's done restructuring. Cisco's margins eclipse that by 28 percent. "That's got to be disheartening," he said.

"It's clear (Chambers) overshot in 2000, but Cisco showed a lot of nimbleness compared to other large companies."
--Tad LaFountain, analyst, Needham & Company
Paras Bhargava, an analyst at BMO Nesbitt Burns, like other analysts noted that Cisco gets the majority of its revenue from corporate customers. That fact has allowed Cisco to bounce back more quickly despite ongoing turmoil in the telecom sector.

"Being focused on the enterprise definitely gives them some advantages," Bhargava said.

Indeed, Cisco's third quarter showed how being focused on corporations paid off. U.S. business orders were flat, but that was still much better compared with the company's orders from telecom service providers, which fell more than 10 percent.

While Nortel and Lucent are focused on telecom service providers, Cisco's more diversified customer base has given it a cushion. By industry, federal government orders topped 10 percent. 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.

It also helps that Cisco has $21 billion in cash and equivalents, enough cash to continue to invest in new markets while other companies retrench. "The game is easier to play when you have more chips than anyone else," LaFountain said.

Short-lived celebration?
But the honeymoon may be short-lived. Most analysts agree that it won't be long until Wall Street wonders where the revenue growth is. Cisco's revenue in the third quarter was up just 2 percent.

"I still think Cisco has a ways to go before it's out of the woods."
--Marian Stasney, analyst, The Yankee Group
To grow, Cisco needs information-technology spending to rebound, but those prospects so far are iffy, analysts say. In addition, Cisco will also have to look to the telecommunications service providers to boost sales in the future.

"I still think Cisco has a ways to go before it's out of the woods," said Marian Stasney, an analyst at The Yankee Group, a research and consulting company. "Cisco has to make more inroads to the carrier market for revenue growth."

Stasney and other analysts argue that the enterprise market is about as big as it can get. Assuming the telecommunications market comes back, Cisco will have to expand into Lucent's and Nortel's territory to increase sales.

Stasney said the company has to refine its sales channel and possibly pare back its product lines to eventually win over more telecom carriers.

LaFountain said he considers Cisco to be in the third stage of its development as a company. The first stage was marked by an agnostic approach to corporate networking, the second focused on evangelizing Internet protocol, and the third will be developing the carrier business.

The catch? To focus on the telecom carrier market, Cisco will likely have to give up some of its beefy gross margins.

For now, however, those worries about future revenue growth will take a backseat.

"Chambers gets a couple days of respite and then he'll get beat up over something else," LaFountain said.'s Ben Heskett contributed to this report.