Cisco Momentum Evaporates

Shares give back earlier gains as guidance fails to impress.
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Updated from 4:20 p.m.

Cisco

(CSCO) - Get Report

whipsawed Wall Street late Tuesday, following a rock-hard third-quarter earnings report with squishy fourth-quarter guidance.

Cisco's strong third-quarter showing, in which the communications gearmaker beat earnings and revenue targets, pushed the stock up 5% in early postclose trading. CEO John Chambers crowed on the postclose conference call that while other information technology players have warned of a slowdown, "Our business momentum is actually increasing."

But momentum in Cisco shares turned around when fiscal-fourth-quarter earnings and revenue guidance failed to impress investors. Cisco shares, up 27% this year going into the report, were down 2% in late action following the unchanged outlook.

Cisco says that including a $500 million in revenue contribution from set-top box maker Scientific-Atlanta, acquired Feb. 24, total sales in the current fiscal fourth quarter will be about $7.85 billion. Analysts were looking for a topline of about $7.87 billion.

"This is good, but not great," says one hedge fund manager who has no position in Cisco. "SFA drove the growth, but the margin is dragging, taking the stock down."

Indeed, gross margins continued to be a concern for investors and analysts on the earnings conference call. SFA gross margins were about 35% in the fiscal third quarter, says JPMorgan Chase analyst Ehud Gelblum. That was below the 37% Cisco had predicted.

Cisco blamed merger-related costs for the narrower SFA margin, and executives said they expect the gross margins in their newly acquired cable-gear business to be around 37% in the current quarter.

Chambers said that for the two months that SFA was part of Cisco, it shipped 1 million set-top boxes. That was a "solid set-top box number," says the hedge fund manager, who sees it as a positive development for broadband chipmakers like

Conexant

(CNXT) - Get Report

and

Broadcom

.

Cisco says that over the long term, annual revenue growth should be in a range between 10% and 15%. "We are not in any way suggesting we are seeing a slowing in order rates," Chambers insisted on the call.

For the third quarter ended April 29, the San Jose, Calif., communications-gear giant made $1.4 billion, or 22 cents a share, compared with the year-ago $1.41 billion, or 21 cents a share. Revenue rose to $7.32 billion from $6.19 billion a year earlier.

On an adjusted basis, excluding certain costs, earnings rose to 29 cents a share from 23 cents a year earlier. Analysts were looking for a 26-cent profit on sales of $7.17 billion.

"Cisco's third quarter was marked by record revenues and strong results in orders and earnings per share," said Chambers. "We saw a number of highlights this quarter, notably the growth of our U.S. and emerging markets, the continued strength of the commercial market segment and advanced technologies, and the balanced performance across most of our key product categories."

Scientific-Atlanta contributed $407 million to net sales for the third quarter.

Cash flow from operations rose to $2.3 billion in the latest quarter from $1.9 billion a year earlier. Cash on hand rose to $18.2 billion from $15 billion the quarter before. Cisco bought back 60 million shares at an average price of $20.34 per share, for an aggregate purchase price of $1.2 billion.

One blemish on the quarter's performance was in days' sales outstanding, or DSOs, a measure of the time between orders and shipments. That number rose to 36 from 31 in the year-ago period. DSOs were 35 in the second quarter.

Cisco's strong quarter comes a day after PC giant

Dell

(DELL) - Get Report

, another longtime tech bellwether, disappointed Wall Street with a soft profit outlook.

After trading as high as $22.90 in the postclose session, Cisco shares fell 48 cents late Tuesday to $21.20.