THE DAY AHEAD: Cisco''s puts face on economic slowdown

Larry Dignan
4 min read

COMMENTARY -- You know Cisco Systems was having a bad earnings day when the company's Web cast for its analyst conference call didn't work and the dial-in number produced sounds that sounded like an alien life form took it over.

Perhaps that's fitting on a day when the networking giant broke its nearly seven-year string of meeting or beating Wall Street estimates. Only every investor on the planet wanted to hear Cisco CEO John Chambers' outlook because the Nasdaq follows Cisco's lead. And like Cisco's conference call, which was derailed by a non-Cisco routing problem, there were plenty of glitches to go around in the second quarter.

"Ladies and gentleman please continue to stand by. The Cisco conference call will resume shortly. Thank you for your patience."

Investors are going to need a little patience. Once Cisco (Nasdaq: CSCO) got its conference call on track, the company said it sees flat sequential growth for the next two quarters. CFO Larry Carter said Cisco sales in the third quarter will be "flat to down 5 percent" with the second quarter. Fourth-quarter sales will be flat with the third quarter "with some variability."

Cisco's flat revenue forecast is everything Wall Street didn't want to hear. Although Cisco is trading near a 52-week low, no one on Wall Street had flat revenue growth baked into their valuation models. Analysts were expecting fiscal third-quarter revenue of $7.6 billion and $8.3 billion for the April and July quarters, respectively.

Cisco's results put a face on a startling downturn in the economy. In November, Cisco -- a poster company for corporate excellence and hyper growth -- was bullish. By January, Chambers was talking down estimates and warning of a "challenging" second quarter. He noted that the economy switched off like a light switch.

He wasn't kidding.

Although Cisco's second-quarter miss wasn't a total shocker (shares slumped ahead of the report), the company did fall short of consensus estimates by a penny with earnings of 18 cents a share. The company's revenue was a big shocker. Due to an economic slowdown that appeared in the second week of December, Cisco reported revenue of $6.75 billion, up 55 percent from a year ago but a meager increase of 4 percent sequentially. According to First Call Corp., analysts were expecting sales of $7 billion to $7.2 billion, or a 10 percent sequential gain.

A few years ago, Cisco made a big push into the telecommunications space to take on Nortel (NYSE: NT) and Lucent (NYSE: LU). While that focus has boosted sales, it left Cisco vulnerable to capital spending fluctuations. The company's enterprise business is also taking a few knocks because manufacturing companies are in a recession, according to Chambers.

Meanwhile, inventory at Cisco has doubled in just six months. Profit margins are going to take a hit as the company tries to move inventory with price cuts. And accounts receivables surged, indicating that Cisco was struggling to report sales as the quarter closed.

Add it all up and it was a very un-Cisco-like quarter. Chambers said the company could grow at a 40 percent clip for the fiscal year, but it will be "more front-loaded than we would have liked." That might be putting it mildly -- Cisco's first-quarter results will carry the year.

Chambers said the economic slowdown will take roughly two quarters to get over -- assuming the U.S. malaise doesn't spread to other countries. Chambers was "cautiously optimistic" about a recovery.

Analysts cut Cisco's projections for the rest of the fiscal year and handed out downgrades. But many analysts are still touting the company's long-term prospects.

Stephen Koffler, an analyst First Union Securities, kept a "strong buy" rating on Cisco, but cut his earnings and revenue projections. Koffler said Cisco could see revenue acceleration in the October quarter, assuming the economy rebounds.

Koffler wasn't alone. Deutsche Banc analyst James Wade kept a "strong buy" rating too, but admitted that banking on an economic rebound in two quarters may be a waste of time. "The visibility into the downturn is very limited and we would view it as difficult to pick a particular point of inflection," said Wade. "Nonetheless, when the economy rebounds, Cisco should continue to be the leader in the industry."

But questions remain. Has Cisco seen the end of its glory days? Or is it a giant that'll use the downturn to gain market share as all good companies do?

One thing is for sure -- even the mighty Cisco isn't bulletproof from an economic slowdown. Cisco will be cutting back on its spending, focusing on profitability instead of revenue growth and hunkering down just like the rest of the tech sector.TDAIN

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