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Optical/IP

Cisco Profits Up, Outlook Down

Cisco Systems Inc. (Nasdaq: CSCO) reported higher profits but lower sales for its fiscal second quarter. The company also had a subdued outlook for its next quarter, but it pointed to hopes for growth in the wireless networking and storage networking markets (see Cisco Posts Q2 Profit).

The company reported net income of $991 million, or 14 cents per share, for its fiscal 2003 second quarter, ending Jan. 25. This compared with earnings of $660 million, or 9 cents a share, in the year-ago quarter. It logged $4.7 billion in revenue in the second fiscal quarter, down from $4.8 billion a year earlier and also down from the $4.8 billion it reported in the first fiscal quarter.

Analysts expected net income of 13 cents per share and revenues of $4.73 billion, according to First Call. Excluding one-time charges and profits, it earned 15 cents a share, compared with 9 cents last year.

Cisco CEO John Chambers had a subdued outlook for the company's next fiscal quarter of 2003, saying that the company expected sales to be "flat to slightly down." The company qualified "slightly" as meaning sales could decline 2 percent to 3 percent.

"We are seeing even more conservative attitudes than a quarter ago," said Chambers on the quarterly conference call. "There was a little more weakness in the first few weeks of January than we expected."

Overall, Cisco executives are looking for growth in the wireless networking and storage networking areas, but they continue to have a conservative outlook for the wireline service provider market.

Chambers specifically said the storage networking could be the "most exciting," pointing to new reseller agreements with Hewlett-Packard Co. (NYSE: HPQ) and IBM Corp. (NYSE: IBM) to sell its MDS 9000 Series storage switches (see IBM Tells Cisco: 'Let's Go!' and HP Refills Its SAN Flask). He also referenced the new reseller deal with Lucent Technologies Inc. (NYSE: LU) for IP gear targeted at wireless networks (see Lucent & Cisco: Together at Last).

At the same time, Chambers reported little change in the service provider equipment market.

"Spending from service providers remained relatively flat, but there are some positive signs that customers are driving capital expenditure toward packet infrastructure," said Chambers.

Despite all the bad news, the company continued to preserve the cash in its bank account. At the end of the quarter, the company had $21.2 billion in cash, the same as the $21.2 billion it held at the end of the last quarter.

Regardless of its substantial cash position, the company does not appear eager to start paying a cash dividend to shareholders, but it will consider paying a dividend in the future.

"We do not have a religious position on dividends," said Chambers. The company will first look at other uses of its cash, including share repurchases, acquisitions, and investments, said Chambers.

— R. Scott Raynovich, US Editor, Light Reading
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digerato 12/5/2012 | 12:42:58 AM
re: Cisco Profits Up, Outlook Down Warning! Amateur armchair CFO alert!

The problem: there are approx 7 billion CSCO shares outstanding, so unless something you do can add $206 million in earnings (7 billion divided by the PE, 34), it doesn't justify an extra dollar on the stock price. In fact, the stock can't seem to make progress past $20, and most of your employees' stock options are under water. Beyond the odd security company and the wireless LAN BU, there really isn't much to invest in that will grow your earnings by $200 million.

The upside: you have $21.2Bn in the bank, revenue holding at approx $4Bn a quarter, and margins continue to climb (the upside of having no growth is that you can concentrate on reducing costs).

What to do?

Reverse split the stock 4-to-1. It propels the stock price up to approx $52, and by reducing the sharecount to a mere 1.75 billion shares, it only takes an incremental $51 million in earnings to move the stock up by $1 if your PE sticks at 34. In other words, your stock suddenly got a lot more interesting to investors as well as appearing to be "more valuable" since it now trades in the $50 range. Yes, I know that on paper it's just as valuable as before, Wall St trades on perceptions -- otherwise why bother with a stock split in the first place?

Then, spend some of that $21.2Bn on a stock dividend. Let's say a nice round $0.30 per share at the kick off, at a total cost of $525m (after the reverse split). Your stock price rises as investors pile in for their "fair share" of the cash.

Now your stock price is up, employees are happy, the board is happy, Wall St. is happy, shareholders are happy -- heck, even George W "thanks for the donation John" Bush is happy (another corporate dividend to be untaxed, encouraging investment, blah blah blah).

And you're still the gorilla with a huge pile of cash and a business that spins off a cool billion or so of free cash flow every quarter. You could spend just half of it on a dividend, and keep the rest for a rainy day. Or just increase the dividend -- after all, $21Bn is enough for a long rainy spell.

Digerato

(Alert ends)
BobbyMax 12/5/2012 | 12:42:57 AM
re: Cisco Profits Up, Outlook Down It is really peculiar that Cisco keeps reporting lower sales volume but higher levels of profits. How does Coico achieve this? There are no indications that the storage marketing is expanding and equally there arte no indications that Cisco is any position to take away maket share from other vendors.

Is Cico predicting lower sales volume in oreder to lower the expectations. How does Cisco manage expectations - takling it higher and lower at will?

How will Cisco resnd to the fact that Entresys routers are 7X faster than the corresponding Cisco routers? Does Cisco have any explanation to the customers?
digerato 12/5/2012 | 12:42:56 AM
re: Cisco Profits Up, Outlook Down "It is really peculiar that Cisco keeps reporting lower sales volume but higher levels of profits. How does Coico achieve this?"

Well, you did ask... to grow profit when revenues are slightly down (as is the case with Cisco), you must reduce costs. This is easier for Cisco since their margins took a huge hit when they had to write off that inventory bubble in 2001. Improving on crappy margins is easier than improving on already-great margins.

After so many years of blow-out growth at Cisco, I expect there are plenty of opportunities to trim out fat accumulated during the "good old days". Also, you can redirect large parts of your org to look for cost savings (in COGS and elsewhere) since the massive growth just isn't there to occupy them.

Digerato
gea 12/5/2012 | 12:42:47 AM
re: Cisco Profits Up, Outlook Down "How will Cisco resnd to the fact that Entresys routers are 7X faster than the corresponding Cisco routers? Does Cisco have any explanation to the customers?"

Yes, the Entresys routers are able to boost the speed of optical signals 7 times. Cisco's optical signals are manytimes slower.

This proves the fact that Cisco routers generate fake heat. Without this fake heat, temperature near Cisco routers would drop to almost zero. This means that Cisco routers are smuggling heat inside there optical signals, which slows them down. This means that Cisco OC-48 is really OC-3 because of the slowness of Cisco photons.
Xile 12/5/2012 | 12:42:44 AM
re: Cisco Profits Up, Outlook Down They beat the livin' daylights out of their vendors.

Xile
DoTheMath 12/5/2012 | 12:42:43 AM
re: Cisco Profits Up, Outlook Down One interesting note for me is that there was no mention
of gross margins in the press release. I believe they
don't want to draw attention to that, because it is so
obscenely, ridiculously high. Just to give you a
quick illustration (full numbers at
http://newsroom.cisco.com/dlls...

Jan 2002 Quarter: $4.8 B and Cost of Sales: $1.8 B
Jan 2003 Quarter: $4.7 B and Cost of Sales: $1.4 B

Gross margin increased from 62.5% to 70%. By the way
62% is considered WAY HIGH, and 70% is considered
so OBSCENE that they don't even want to talk about it!

So sales dropped by $100 million, yet costs dropped
by $400 million. All of the drop in "Cost of Sales" is
due to what they paid their suppliers (not their
employees), in other words, all of the drop came from
"product cost of sales" not "service cost of sales".

So they are really SQUEEZING their suppliers, costs are
dropping dramatically, but they are passing almost nothing
of those dropping costs to their customers.

This is, to put it mildly, unsustainable. You can only
squeeze suppliers so far. There comes a point at which
suppliers consolidate, and gain leverage, and won't play
ball on Cisco's terms any more. So I see no upside in
their earnings/share unless they show meaningful top-line
growth. In fact, gross margins are likely to come down
in the future due to supplier exists/consolidation etc,
and that means their earnings may stagnate *even with*
top line growth.

Cisco is exploiting its last-man-standing status to do
a fair bit of price gouging. But such tactics backfire
very often (look at AOL today). They claim to offer
"differentiated value". I beg to differ - I don't see
any differentiated value in ethernet switches, even low
end routers. They are commodities, and Dell will prove
that soon. For comparison, Dell makes a very nice living
with 20% gross margins. Don't tell me Cisco does
a lot more R&D - by their own admission most of their R&D
dollars are going towards "futuristic" products like
Wi-Fi, Storage etc. and not on ethernet switches and the like
(which account of bulk of sales & gross margins).

So the outlook is clear: they will suffer signficant
margin erosion, which will likely offset any boost from
new high-margin sales coming out of Wi-Fi, storage etc.
Even the "high margin in new markets" story is questionable
because those markets are already saturated with players who
won't easily surrender market share.
gea 12/5/2012 | 12:42:41 AM
re: Cisco Profits Up, Outlook Down "Dr" Gea you must have mental disease and have no understaning of telecommunications or optical photons. Clearly you work for Alien VCs that are trying to destroy Earth economy by performing unspeakable and shameful acts of hate. Please return to your flying saucer and attend a community college (if you can get in) so you can be on par.
green 12/5/2012 | 12:42:40 AM
re: Cisco Profits Up, Outlook Down ways of increasing gross margins

1: increase price (unlikeyly in this environment)

2: lower costs (ASICS instead of FPGA, squeeze suppliers etc.)

3: accounting gimmickry
cisco could be back dipping into their 2 Billion write-off they took a while ago. essentially the cost of components is skewed b'cause they wrote off the inventory, use the inventory next quater with zero cost this quater and suddenly see margins improve dramitically.

another interesting point is that their cash (21 odd billion) stayed the same while they had a profit of 900 odd million dollars , spent 1.5 billion in share buybacks. where did they get the extra 600 million ????
DoTheMath 12/5/2012 | 12:42:29 AM
re: Cisco Profits Up, Outlook Down green>3: accounting gimmickry
cisco could be back dipping into their 2 Billion write-off they took a while ago. essentially the cost of components is skewed b'cause they wrote off the inventory, use the inventory next quater with zero cost this quater and suddenly see margins improve dramitically.

------------------------------------------------------
I am assuming Cisco would know better than draw components from written off inventory, show good profits but not disclose this fact to investors. This would be a very material fact they would have to disclose, I would think.
nelsonal 12/5/2012 | 12:42:28 AM
re: Cisco Profits Up, Outlook Down I can't say anything certain about the inventory, however, it should be written off completely, and it would be the cause of many lawsuits if they were found to be doing this.
On their cash flows, the company generated about 1.3 billion on cash from ops, cash from ops = $991 million income + $373 million depreciation (a non cash expense)-$13 other adjustments (deferred taxes, bad debt expense, working capital, options tax effects, and assets writedowns).
They spent this money on new captial goods, acquisitions, and other assets totaling $296 million (excluding about $1.6 billion of cash spent on investments, which are in the 21 billion dollar figure).
They did spend 1.475 billion on share buybacks, but got $190 million from share issuances (mostly due to stock options. I'd estimate that they issued about 40 million shares at about $4.50 per share. All this totals a small decline in cash and investments I think it was about a $250 million decrease.
If you want it in full detail check Cisco's IR page for financial statments and then get their statement of cash flows which break down what added to and subtracted from cash during the quarter. If anything wasn't clear feel free to ask further questions.
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