Soft Sales Sack Cisco

Updated from 4:15 p.m.

Cisco (CSCO Quote) slipped 2% late Tuesday after disappointing investors with a soft quarter.

The company matched Wall Street's bottom-line estimates for the second quarter and offered solid third-quarter guidance, but gross margins continued to weaken. CEO John Chambers sounded characteristically cautious on the company's outlook, saying he doesn't expect a pickup in business technology spending till the second half of 2005.

For its second quarter ended last month, the San Jose, Calif., communications-gear maker earned $1.4 billion, or 21 cents a share, up from the year-ago $1.29 billion, or 18 cents a share, before the effect of an accounting change. On a pro forma basis excluding certain costs, latest-quarter earnings were 22 cents a share, in line with the Wall Street estimate.

Revenue rose to $6.06 billion from $5.4 billion a year earlier. Wall Street analysts had been expecting sales of $6.13 billion, according to Thomson Financial.

The company posted a 66.8% gross margin for the quarter, a shade below the 67.3% target that some analysts were expecting. Cisco blamed higher costs in its services business, namely high-salary employees. Cisco added 876 net new employees in the quarter, taking its headcount to 35,962.

"Gross margins were below guidance -- that's the story right there," said one analyst who rates the stock neutral.

Indeed, shareholders have been keeping an especially close eye on Cisco's profit margins. The company's quarterly gross margin hit 70.8% two years ago and has been narrowing ever since. In the fiscal first quarter ended in October, Cisco's gross margin fell to 67.2%. That's a troubling trend for a company trying to shift its focus from sales growth to a profit expansion.

On a conference call with analysts, Chambers said he expects third-quarter sales to be flat to up 2% from second-quarter levels. That's in line with Wall Street's expectations. Cisco's fiscal third quarter, which ends in April, is a week shorter than normal quarters. For the year, Chambers expects sales growth of as much as 15%.