Cisco’s third quarter earnings announcement was anticipated not just as a sign of the company’s success or failure, but as a symbol for the state of the telecom market’s recovery as a whole. And Cisco’s revenues demonstrated that while an immediate turnaround in that industry is not yet in the cards, a slow climb back may have already started.
For the third quarter, fiscal year 2002, Cisco posted a 264 percent increase in profits year-to-year, and a 26 percent increase over last quarter. Revenues were flat, remaining at $4.8 billion as reported in the second quarter, but earnings per share increased one cent quarter-to-quarter to reach $.10, due, Cisco says, to the company’s stringent cost management programs. This was a significant increase over third quarter earnings in 2001, which showed revenues of $4.7 billion and earnings per share showing a loss of $.37. Because April is traditionally Cisco’s slowest month, earnings were in line with what financial analysts had predicted.
In short, the company did not lose any ground, which accounted for the flat revenue, while its aggressive resource management and expense cutting resulted in an increase in earnings per share. This seems to be the story for the telecom market in general.
“The economy is keeping the revenues flat, while smart cost-cutting and managing of expenses allowed for increasing earnings per share,” says Zeus Kerravala, analyst with the Yankee Group. “I don’t know if you could have expected more than that right now. This is across the board.”
Salomon Smith Barney analysts also hesitate to declare the telecom market is in recovery, but appear positive that the pieces are in place to begin moving forward. “We believe the erosion at least has stopped and we think the seeds of a recovery are being sown, but the conditions do not appear ripe for those seeds to germinate yet,” they say.
With a hearty, “What a difference a year makes!,” Cisco Chief Executive Officer John Chambers attributed the positive earnings announcement to the company’s breakaway strategy, as well as increased gross margins and decreased operational expenses, rather than to any big gains in sales.
“You usually get surprised by the downturn,” he told investors and analysts on a conference call, “but then you make adjustments and prepare for the upturn. After first quarter 2001 we adjusted and realigned our resources to deal with that challenge.”
According to Chief Financial Officer Larry Chambers, Cisco reached gross margins of 63.1 percent, cash flows of $1.6 billion and inventory turns of 7.5 times, which exceeded the company’s goals. Chambers is calling operations numbers for the third quarter a home run.
Cisco continued to focus on what it could control, says Chambers, containing hiring and controlling expenses, which it plans to do for some time in the future. “We are pleased with the results. We are pleased with the order growth rate and that we continue to bring down lead times.”
Sluggish, but not ‘getting worse’
Following an industry-wide trend, Cisco’s service provider sector remained sluggish, as those customers continued to focus on decreasing operating expenses and increasing revenue. “We are working to become the Number 1 or Number 2 provider and strategic partner (for service providers). Our service provider strategy will position this company well as the economy turns,” says Chambers.
The CEO predicts that commercial customers will see a recovery first, with service providers following a few quarters later. “No one can see when the economy will pick up, but when it does, so will networking spending.”
According to Lissa Bogaty of Credit Suisse, however, the enterprise market has yet to enter any rebound stage itself.
“Our recent channel checks in the enterprise market suggest a continued challenging environment, with few hints of second-half upturn,” she says. “However, we have not heard that business is getting worse.”
Cisco’s performance in the third quarter met the expectations of financial analysts. Lehman Brothers, Credit Suisse and Salomon Smith Barney all forecasted the flat sales numbers, and all continue to recommend Cisco’s stock as a good buy.
Chambers predicts flat to up five percent revenue growth in the fourth quarter, and says he will be disappointed if Cisco doesn’t show a five to 10 percent product revenue growth.
Kerravala expects results similar to the third quarter for the fourth quarter, as investors continue to play the waiting game, watching Enron, Arthur Andersen and other SEC investigations for cues on the market’s strength. While the telecom industry may no longer be in free fall, it is still not actively regaining ground.
“The stage is set for improvement. However, the pace of improvement is a critical concern,” say Salomon analysts. “As we move into the seasonally stronger July quarter, which include three of Cisco’s strongest months…May, June and July…it’s important for Cisco to build some backlog and sales momentum which can help sustain it through the slow late summer period.”
The company’s stock closed Wednesday afternoon at $16.27 today, up $3.19. In the last year, Cisco’s stock price has ranged from a high of $24.13 to a low of $11.04 per share.