Pointing to Slowdown, Cisco Slashes Revenue Forecasts

Updated from 5:49 p.m. EST:

Earnings Scorecard
Actual	Estimated*	Year-Ago
$0.18	$0.19	$0.12
*By First Call/Thomson Financial

Cisco Systems (CSCO) has been buying too much and selling too little. And now it's expecting to sell even less.

Once all but bulletproof, the longtime Wall Street darling Tuesday joined the ranks of technology's struggling giants, missing Wall Street's consensus earnings estimate for the first time in three years. In a postclose conference call, Cisco forecast that revenue growth would grind to a halt in coming periods as the industry's slowdown winds take hold of the networker's mighty sails.

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On the call, CEO John Chambers cut Cisco's revenue-growth forecasts sharply, underscoring his cautious words in recent weeks. The executive said third-quarter revenue would at best match the second quarter's disappointing $6.72 billion showing, and perhaps fall 5% short; analysts had expected third-quarter revenue of $7.6 billion. Fourth-quarter revenue is likely to be flat with third-quarter levels, Chambers said.

And the CEO said 2001 revenue growth would be around 40%, short of the company's 45% average of the past five years and in the middle of the executive's recently trimmed 30%-to-50% range. Chambers said weak buying from the nation's manufacturing sector was partly responsible for the weakness.

Changing His Spots?

For the second quarter ended Jan. 27, earnings rose 66% to 18 cents a share, from 12 cents a year earlier. But analysts surveyed by First Call/Thomson Financial had expected the networking giant to earn 19 cents a share. Cisco had beaten Wall Street earnings estimates by a penny in 12 successive quarters coming into Tuesday.

Meanwhile, second-quarter revenue growth slowed far more sharply than analysts had expected, falling 6% short of the consensus target. Gross margins plunged to 62% from 65%, and several other measures of the company's financial well-being moved in the wrong direction. Cisco stock dropped more than $2 in after-hours trading, hitting $33.67.

Echoing his comments of last month, Chambers said the second quarter was "more challenging than we anticipated" due to the declining health of the U.S. economy and the telecom industry spending slowdown. Chambers, an inveterate optimist, conceded Tuesday for the first time that restructurings and debt problems at Cisco customers are reducing customer spending, by putting some customers in "survival" mode, Chambers said.

Chambers also made a rare bearish comment on the telecom industry's near-term outlook, telling listeners on the conference call that "this capital spending trend could get worse before it improves" and that the company's visibility, or ability to forecast trends, on capital spending was poor. Accordingly, the company has effectively "stopped all hiring," a Cisco executive said on the call.

Uncharacteristic Shortfall

The second-quarter revenue shortfall came as other numbers on the income statement and balance sheet grew sickly. Second-quarter sales jumped 55% to $6.75 billion from $4.36 billion a year ago, but they rose only 3.5% from the first quarter. Inventories, on the other hand, jumped 29% to $2.53 billion, putting them at more than double the July 29 number. A rise in inventory can signal slackening demand, which can foretell further slowing in sales growth.

Cisco's allowance for doubtful accounts jumped to $89 million at the end of the latest period, from $43 million a year ago. Investors have been keeping an eye on that number as Cisco customers see their businesses deteriorate.

Notably, Cisco declined to provide a breakdown of enterprise and service provider growth. Cisco's carrier sales growth had slipped to 7% in the first quarter, the latest period for which figures are available, from 16% in the fourth quarter. Sales of data gear and the like to businesses are Cisco's emerging growth engine as its core business matures.

Growth Stocks and You

The flat third-quarter revenue guidance looms large because, shortfall aside, the real concern for Cisco and other networking concerns is the rest of the year and beyond. Cisco has some specific challenges that include a weak stock price that may stall its growth-through-acquisitions strategy, a slipping lead in its core market, and a host of weak customers that appear increasingly dependent on generous financing terms.

One analyst, who spoke on the condition of anonymity and whose firm hasn't underwritten for Cisco, wonders how long the company can hold out before offering workers a new carrot in the form of options priced at current levels. The analyst pointed out in an email that "50% of employees are new as of the last two years," giving them options priced between $50 and $60. If the company fails to offer new incentives, it "may see sales teams leave," the analyst wrote.

On the conference call, Chambers said, "Retention tends to improve during tough economic times as long as you're treating your employees well."

An industrywide spending slowdown took Cisco by surprise at the turn of the year, despite mounting evidence that customers were trimming their budgets. Chambers, no slacker when it comes to optimism, had just two months ago forecast annual sales growth in the 50% to 60% range.

Chambers has since recast that guidance and is counting on a quick reboot of the spending process. But as at least one analyst, BlueStone Capital's Susan Kalla, has pointed out, spending cycles can take a year or two to bounce back.

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