It's Called Bellwether for a Reason: Cisco Shows How Tough Things Are

The conventional wisdom is that Tuesday's rare earnings miss by Cisco Systems (CSCO Quote - Cramer on CSCO - Stock Picks) was somehow expected, and now that the bad news is out in the open, the market has seen the bottom. That's why Cisco's shares "only" fell to $33.50 in after-hours trading, a decline of 6% from Tuesday's close of $35.75.

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Sorry, the argument doesn't wash. No miss by a company that beats expectations by one penny per share quarter after quarter is expected. And anyone who listened to Cisco's marathon conference call Tuesday evening would be foolish to think the tech economy -- or the U.S. economy -- is out of the woods. But you already knew Cisco was suffering because of a dramatic slowdown in spending by telecommunications carriers, young and old. CEO John Chambers says the upstarts are conserving capital to survive, and the old ones are trying to preserve their profitability.

The far more troubling element of Cisco's comments -- which included guiding Wall Street to flat or negative sequential revenue growth for two consecutive quarters -- was the impact Cisco is seeing from its manufacturer customers. Cisco says it gets 20% of its enterprise revenue (sales to big businesses as opposed to telecommunications concerns) from manufacturing companies.

One unnamed customer told Chambers it had slashed its corporate information-technology spending budget from $2.5 billion this year to $800 million. That makes word of the slowdown at dot-com customers seem like a trifle. For the record, Cisco forecasts dot-com companies will account for 4% of overall revenue for the fiscal year ending July 31, vs. the 12% it originally had forecast.

This slowdown at manufacturing companies can't be overestimated because they represent the "real" economy. They're the folks who buy the stuff Cisco makes regardless of the vagaries in the overheated and overhyped telecommunications market.

"It confirms our fears about the magnitude of IT spending cuts," says Dane Lewis, an analyst at Robertson Stephens who's been bearish since the beginning of the year on equipment makers of all kinds. "If Cisco is feeling pain in the January quarter, it is very problematic for the March quarter [for other companies] overall."

But never mind the March quarter. Cisco's comments Tuesday cut to the very assumptions of a second-half turnaround. Chambers says global business and political leaders "get it." This means he's assuming that because the prime minister of India, the CEO of General Electric and the chairman of the Federal Reserve understand the problems, they know how to fix them.

Perhaps they do. But in his cautious and sometimes defensive comments (any company with 50% market share of a giant market will be affected by an economic downturn, Chambers said repeatedly), Chambers made clear that there are two assumptions to Cisco achieving even its lowered revenue forecast of 40% year-over-year growth on significantly reduced margins. First, the downturn in the U.S. economy is a two-quarter phenomenon that began in mid-December. Second, the pain doesn't spread to Asia and Europe, which are relatively strong.

Comfortable with those assumptions? Then buy Cisco and lots of other tech stocks Wednesday morning. Think the pain will get worse? Then consider how this sort of thing rolls out.

Charles Philips, the enterprise software analyst for Morgan Stanley Dean Witter, notes that manufacturing-oriented software makers like i2 Technologies (ITWO Quote - Cramer on ITWO - Stock Picks) and Manugistics (MANU Quote - Cramer on MANU - Stock Picks) are safe because "software companies have an ability to withstand it a little longer because of the implementation time" needed for their products. Having said that, "they also come out of it more slowly."

Bottom line: Financial visibility for the rest of the year got worse, not better, Tuesday evening. It was less than two weeks ago that Cisco supplier PMC-Sierra (PMCS Quote - Cramer on PMCS - Stock Picks) suggested its near-term visibility was nil. Its stock settled around $74, from $96 before it reported earnings on Jan. 25, and even traded as high as $82.63 recently. The stock closed Tuesday at $66.56 and then fell below $64 in after-hours trading, according to Island ECN.

It's not over until Cisco says it's over. And Cisco hasn't said it's over.

Street to Xerox: Don't Photocopy Those Financial Results

The situation at Xerox (XRX Quote - Cramer on XRX - Stock Picks) worsens by the day, and yet management maintains its cool. Perhaps too much cool.

The Wall Street Journal had a fabulous story Tuesday, detailing how accounting irregularities in the copier maker's Mexican unit may be far more widespread than the Stamford, Conn., company has let on. The shares are now down 12% since Friday, when a column here disclosed that Xerox was meeting with four leveraged buyout firms to discuss possible ways to restructure the troubled company. The four big-foot buyout firms are Texas Pacific Group, Clayton Dubilier & Rice, Kohlberg Kravis Roberts and Silver Lake Partners.

A participant at the Thursday and Friday meetings says it appears that Xerox isn't all that serious about giving up control to one or all of the four firms it invited in for a chitchat. The participant says Xerox is all for some "dumb money" -- in other words, an investment without control -- but not the major change that would come with an infusion from a major financial player. That's to be expected. The situation at Xerox is grave, but not urgent. The company should be able to cover its near-term debt payments of roughly $3 billion this year with its cash and the assets it plans to sell worth between $2 billion and $4 billion.

But the business itself remains rough. Japanese copier maker Ricoh briefed financial analysts on its U.S. business Tuesday, and Credit Suisse First Boston analyst Gibboney Huske listened in for competitive information on Xerox. According to Huske, Ricoh said U.S. revenue grew 22% for the four months ended Jan. 31, and that U.S. unit shipments in the December quarter grew 32.5%. This means Ricoh is taking share from Xerox in high-end copiers and forcing Xerox to cut prices. "I just don't see how this company turns around in the second half," says Huske.

A turnaround is what Xerox needs to pay off next year's debt commitments of as much as $9 billion, when asset sales no longer will be able to plug the holes. "Xerox would appear to have limited ability to maneuver on prices," Huske told clients in a note. "With Ricoh and Canon launching new products, Xerox's operations could very reasonably get worse, not better, during the course of 2001."

As previously noted, Xerox's stock price could improve as it announces major asset sales, but now that the validity of past revenue is in question, it's safe to assume that a potential acquirer of any Xerox asset will begin anew its due diligence into the unit's accounting practices.

Maybe next time Xerox holds a gabfest with potential financial partners, the temperature will be a little hotter.