Cisco VP Gets Cool Reception
NEW YORK – A Cisco Systems Inc. (Nasdaq: CSCO) financial guru today left the impression that Cisco investors shouldn't be expecting a cash dividend -- and that they may want to temper their outlook for the coming months.
Dennis Powell, senior vice president of corporate finance, did not provide any new financial information on the company here at the Merrill Lynch & Co. Inc. Global Communications Investor Conference. But after his presentation, some members of the audience walked away with a less rosy outlook for Cisco in the coming quarters.
“Gross margins are at their peak,” noted Tal Liani, an analyst with Merrill Lynch, covering Cisco. “There is limited upside.”
During his talk, Powell highlighted the company’s performance over the past few quarters. While revenues have been flat to down, gross margins have improved, reaching about 70 percent for the year. The company has also controlled costs associated with headcount and inventory. On a pro forma basis, the last three quarters have been the best the company has seen in its history, said Powell. And, he continued, in terms of GAAP, Cisco’s second fiscal quarter (ended January) recorded the highest earnings the company has seen in its history (see Cisco Profits Up, Outlook Down).
But a dark cloud looms over Cisco as it searches for a bottom to the spending slump. Although he didn’t come right out and say it, Powell suggested that gross margins will likely not continue to improve. Cisco's rising gross margins, in fact, have risen some eybrows among those analysts who suspect that 70 percent is unusually high and not sustainable.
“In a weak spending environment, a hit in the gross margins will have a huge impact on the company,” said Liani. “The risk is that Cisco’s technology will become more commoditized and margins will fall.”
As a result the company will be looking to expand its business in new product areas -- including, security, storage area networking, voice over IP, and wireless. But Liani is skeptical that the new areas will be enough to sustain any meaningful growth in Cisco’s business.
“These markets are really small,” he said. “We ran the numbers and even if these areas grow 25 percent, that is only about 3 percent growth for Cisco.”
Powell said the company will also try to squeeze out more market share in its traditional markets: switching and routing. The company currently has about 68 percent and 80 percent market share, respectively, in each of these sectors.
Powell indicated that the company would not be cutting costs even if the quarter starts to look weak. Rather, he insisted, the company would continue to control headcount through natural attrition -- he said the company has been able to reduce its headcount by 5 percent on a yearly basis through this method. He noted, however, that Cisco would continue to offer substantial compensation and stock option plans to retain employees.
After the formal presentation, Powell fielded a series of questions from investors asking whether Cisco would be returning any of the cash the company generates every quarter to investors by way of a dividend.
Cisco has been aggressive about buying back its stock, spending about $4.4 billion on the buy-backs so far, according to Powell. But some investors would like to see this extra cash coming back to them in the form of dividends.
While Powell said the company is considering all options right now, it seems unlikely that it will offer dividends anytime soon, mainly because of tax issues. Cisco has managed to keep its cash balance stable, ending the previous quarter with $21.2 billion in cash and no debt.
“We believe the cash on the balance sheet has been a competitive advantage,” said Powell. “That is the reason we have been able to take market share from competitors, because we are viewed as a sustainable company.”
But he also admitted that it’s possible to have too much of a good thing and that the company is considering using some cash to make acquisitions and/or expand its customer financing program.
Liani said he did not expect Cisco to make any major moves anytime soon. In terms of acquisitions, the company will likely stick to its current strategy by focusing on early startups with fewer than 100 employees that are located near Cisco’s San Jose, Calif., headquarters.
— Marguerite Reardon, Senior Editor, Light Reading