Cisco investors pessimistic on growth

By Ben Klayman

CHICAGO: Cisco Systems Inc.'s earnings report next week may signal that an industry recovery is still way off as analysts and investors expect to hear a repeat of weak sales forecasts from the networking giant.

Also of interest to investors will be whether the No. 1 maker of gear that directs Internet traffic will expense its stock options and how it plans to use its huge cash stockpile.

"My interest is clearly on the top line (revenue). People are questioning whether this is a growth story again," said Armada Funds, which holds Cisco shares in several of its mutual funds, senior portfolio manager Alex Vallecillo.

Cisco has been hit by a slowdown in spending by its large customers, but has suffered less than other suppliers because large corporate "enterprise" customers account for about 80 percent of its sales, with only 20 percent in the battered telecommunications sector.

Cisco is scheduled to report its fiscal fourth-quarter results after the stock market closes on Tuesday, as reports continued to swirl about the possible departure of Chief Financial Officer Larry Carter.

The company denied the rumors, repeating that Carter, who is turning 60, has always said he will retire "at some point in the future" and at that time there will be "a smooth and well-planned transition."

The company also repeated on Friday, it would certify its financial results in late September in its annual 10-K filing with the U.S. Securities and Exchange Commission. Because the company's fiscal year ended July 27, its deadline to file is October 25, 2002.

Cisco's stock fell more than 8 percent on Thursday on rumors Carter and Chief Executive John Chambers would resign, and they would not certify the company's financial results. Both reports were denied by the company.

First-quarter forecast key

More important than the current results is the guidance for the first quarter because that reflects the strength of a recovery. Several analysts expect Cisco to forecast flat to slightly higher revenue for the first quarter, the same as it forecast for the fourth quarter.

"At this point, they're probably nervous enough about the macro-environment to just keep it very moderate," said Vallecillo.

Analysts and investors also expect Cisco to address whether it will start expensing stock options, and some would love to hear it discuss plans for spending at least a small part of its cash, which was $21 billion at the end of last quarter.

Many investors would like to see Cisco join Coca-Cola Co., General Electric Co., Computer Associates International Inc. and Amazon.com Inc. in expensing stock options.

"It's a low chance, but the winds are blowing in the direction that might force their hand. Sooner or later, they're going to have to do it," said Columbia Management Group, which owns Cisco shares, portfolio manager Ajay Mehra.

Sanford C. Bernstein analyst Paul Sagawa does not think Cisco will go down that road, given the negative impact it would have on the company's bottom line.

Cisco's fiscal 2002 and 2003 earnings would decline 58 percent and 40 percent, respectively, with the inclusion of options charges, he estimated in a research note. That means investors now willing to pay 23 times fiscal 2003 consensus earnings would have to pay 39 times earnings including the options expenses in order to keep the stock price unchanged.

Some expect Cisco to at least start using footnotes to explain the impact of options on financial results. Everyone agreed if the bellwether technology stock starts expensing options, it would lead others to follow suit.

Show me the money

Opinions are varied on what Cisco should do with its cash, which has been growing by $1 billion a quarter. Some analysts and investors want it left untouched until spending by corporations recovers, while others would like to see Cisco boost its $3 billion stock-buyback program or initiate a dividend payment.

"They've got to do something with it at this point. Right now, people need a tangible reason to own a stock," said, Northstar Group, a New York money manager that owns a small number of Cisco shares, President Henry Asher. For the fourth quarter, analysts expect Cisco to earn 12 cents a share before one-time items, according to Thomson First Call. They estimate revenue in the quarter ended July 27 will be $4.89 billion.

The company said in May it expected fourth-quarter revenue to be flat to up in the very low single digit levels from the $4.82 billion posted in the third quarter.

(C) Reuters Ltd.