Cisco Still Talking a Big Game

Cisco (CSCO Quote) is really stretching it now.

The networker reported Tuesday that fourth-quarter earnings plunged 86% from a year ago on a 25% drop in sales, owing to the telecom industrywide slowdown in equipment spending.

Saying that visibility remains limited, Cisco declined to offer an earnings projection for the first quarter or fiscal year 2002, while predicting as much as a 5% sequential drop in first-quarter sales.

Fourth-quarter gross margins disappointed analysts, falling some 3 points short of expectations. Worse yet, margins will stay around those depressed levels in coming quarters, executives said on a conference call Tuesday.

But playing to character, CEO John Chambers confounded analysts who expected him to back off Cisco's long-held, ambitious target of 30%-50% annual growth. The executive said in the postclose conference call with analysts and investors that 30%-50% growth would be a "stretch goal." Still, considering that sales rose just 18% in fiscal 2001, a year that saw the company swing to a $1 billion loss from a year-ago profit of $2.67 billion, even considering growth of that magnitude seems a stretch.

Cisco shares dropped 2% in postclose trading on Island after sliding 28 cents Tuesday to finish at $19.26.

Holding Firm

"It's hilarious. The overall market is not improving at all, so every conference call they come out with another set of caveats on their growth projections," says Sanford Bernstein's Paul Sagawa, who has rates Cisco hold. "I think [Chambers] sounded a little embarrassed to bring up the 30%-to-50% thing again."

While Cisco saw some signs of stabilizing sales of computer networking equipment to businesses, revenue from phone and Internet companies declined substantially. Fourth-quarter sales to service providers were 30% lower than sales to enterprise customers, a dramatic drop from the nearly equal status the two divisions had just two quarters ago.

Notably, Cisco had sequentially fewer equipment sales to the regional Bells, the few remaining customers with money left in the till to spend on new gear. Chambers said that "pipeline" of orders wasn't increasing, putting even greater pressure on Cisco's sales to cash-starved, debt-plagued upstarts.

The Upside

But Chambers took pains on the call to highlight Cisco's ruddy financial health. Even in the wake of this year's layoffs and inventory writedowns, Cisco remains in far better financial shape than rivals like Lucent(LU Quote) and Nortel(NT Quote), Chambers pointed out, noting that Cisco has no debt and some $18.5 billion in cash in the bank. That financial strength will enable Cisco to make savvy investments in smaller tech firms while competitors are focusing desperately on their own survival, the executive said.

That said, Cisco's financial picture isn't without its blemishes. CFO Larry Carter again told investors that vendor financing, the practice in which network builders accept equipment and loans to pay for it in exchange for the implicit promise of future business, is a far greater problem at the Lucents and Nortels of the world. Cisco has reduced outstanding loans to customers to $80 million from $675 million just three months ago. But Cisco also raised its provisions for doubtful accounts to $288 million from $43 million a year ago.

And analysts on the conference call displayed some skepticism about Cisco's deferred revenues, which have ballooned to $3.2 billion from $1.4 billion a year ago. "The extraordinary rise in deferred revenues certainly gives them a cushion, but this is an artificial war chest," Sagawa says. "It should give investors comfort to know that they can use it to prevent from blowing a quarter, but they are probably not going to start dipping into it until business picks up."

Progress

Cisco also emphasized that it is making progress in winning back share in the core router market, where its primary competitor is Juniper(JNPR Quote). Chambers said Cisco swiped 3 to 5 points of market share during the quarter, reversing the recent trend that has seen Juniper making inroads quarter after quarter.

Still, signs of fourth-quarter weakness were hard to ignore. Gross margin fell to 52.3% in the fourth quarter from 54.5% in the third; some analysts had hoped to see a number as high as 57%. Clearly Cisco's gains in the router market didn't come cheap: Analysts have speculated that Cisco's financial strength would allow it to pursue a price-slashing policy that would take a heavy toll on upstart players like Juniper.

So expect Cisco to keep stretching, but don't expect to see serious growth return any time soon.