Cisco Systems Slumps as Profit Margin Falls Short of Analysts' Estimates

Cisco Systems Inc., the largest provider of networking equipment, fell the most in three months in Nasdaq trading after a report showed higher spending on new products eroded its fiscal second-quarter profitability.

Gross margin, the percentage of profit left after subtracting production costs, slid to 62.4 percent in the period that ended Jan. 29, San Jose, California-based Cisco said yesterday. That fell short of 63.3 percent, the average estimate of analysts surveyed by Bloomberg.

Cisco boosted spending on research and product development by 19 percent, outpacing a 6 percent revenue gain. The company was also undercut as competitors sold comparable gear at lower prices. Chief Executive Officer John Chambers said new products may take time to become as profitable as the established lineup.

“In terms of gross margins, we are going to hit a couple bumps,” Chambers said in an interview after the results were released. “It takes a while to come up the gross margin chain with these new products.”

Cisco dropped $2.63, or 12 percent, to $19.41 at 9:41 a.m. New York time on the Nasdaq Stock Market, the biggest decline since Nov. 11, a day after the company reported its fiscal first-quarter earnings. The shares fell 15 percent last year.

Chambers said on a conference call with analysts that the company will form a working group to find ways to improve margins.

The company’s forecast for profit excluding some items this quarter also missed analysts’ estimates. Earnings will be 35 cents to 38 cents a share, compared with the 40-cent average prediction.

P&G Lookalike

Sales in the fiscal third quarter will rise 4 percent to 6 percent from a year earlier, the company said yesterday on the call. That implies revenue of $10.8 billion to $11 billion. Analysts on average estimated sales of $10.9 billion, with some projecting as much as $11.3 billion.

Investors look to Cisco as a bellwether for the technology industry because it dominates the market for routers and switches, which direct Internet traffic. Companies buy its switches for corporate networks, while phone and Web-service providers typically purchase Cisco’s more-expensive routers.

The company’s move into more than 30 new businesses, including servers and consumer video, has given rivals an opening to grab market share on its old turf, said Joanna Makris, an analyst at Mizuho Securities USA Inc.

“They’ve become the Procter & Gamble of networking,” Makris said, referring to the world’s largest consumer-products company, which has more than 70 brands. “The stocks that have outperformed them have been the more focused, nimble companies.” Makris has a “neutral” rating on the stock and doesn’t own it.

Rivals’ Inroads

The company’s broadened ambitions have let such rivals as Juniper Networks Inc., Hewlett-Packard Co. and Brocade Communications Systems Inc. make inroads in switches, said Mark McKechnie, an analyst at Gleacher & Co. in San Francisco.

Dell Inc. and Huawei Technologies Co. have also been able to undercut Cisco on prices for certain switches and routers, said Nikos Theodosopoulos, an analyst at UBS Securities LLC in New York.

Cisco may also be extending better terms to its customers, giving them longer to pay, said Mark Sue, an analyst at RBC Capital Markets in New York.

“The product gross margins declined quite meaningfully,” Sue said. “We know demand is improving, but will Cisco capitalize on that? And will it have to resort to price cuts to get its fair share?”

Cash For Deals

Second-quarter earnings excluding some costs were 37 cents a share on sales of $10.4 billion, Cisco said. They compared with analysts’ average predictions of 35 cents in profit and $10.2 billion in revenue. Net income fell to $1.52 billion, or 27 cents a share, from $1.85 billion, or 32 cents, a year ago.

The company, which has about $40 billion in cash, plans to issue its first dividend in the first half. Last week, it agreed to buy Inlet Technologies for $95 million in cash, and said last month it would purchase networking company Pari Networks for an undisclosed price.

Juniper, the second-largest U.S. maker of networking gear, said last month that profitability will improve this year as customer demand boosts sales growth at a faster rate than research and development costs. Its shares climbed 38 percent last year.

To contact the reporter on this story: Joseph Galante in San Francisco at jgalante3@bloomberg.net.

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net.

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