With Sales Falling, Cisco Looks To Reduce Expenses
BY MIKE ANGELL/INVESTOR'S BUSINESS DAILY/April 8, 2002
With sales growth uncertain, how will Cisco pump up profits?
Spending by telecom networks has dried up. Businesses are still buying routers and switches, but not at the breakneck pace of the last decade. Cisco still needs to show profit growth to satisfy investors.
The answer is to boost earnings by getting better prices from suppliers, analysts say. Cisco's in a good position to work out more favorable deals with its vendors, they say. Still, the savings may not be enough to offset slowing sales.
"Cisco is going from being a top-line revenue growth story to a bottom-line earnings growth story," said Merrill Lynch analyst Sam Wilson.
In its fiscal second quarter, which ended in January, Cisco's sales fell 29% from the year earlier to $4.8 billion. The cost of making those products fell 20%, from $2.5 billion to $2 billion.
Analysts expect Cisco's cost of goods sold to be flat in future quarters, even as sales begin to grow a little. That should give the company more of a profit cushion.
The components that go into Cisco's routers and switches could be the main source of savings. Nearly two-thirds of the cost of building Cisco's products comes from the networking chips.
No Price War
Those chips come from a wide variety of suppliers, such as Altera Corp. (ALTR), Xilinx Inc. (XLNX), PMC-Sierra Inc. (PMCS), Applied Micro Circuits Corp. (AMCC) and Integrated Device Technology Inc. (IDTI)
For now, there's no price war in networking chips, says Erik Cleage, Altera's senior vice president of marketing. The chips that Altera makes - programmable logic devices - have a long shelf life. So there's no need for Altera to give steep discounts to get them out the door.
"Our products are less prone to obsolescence," Cleage said.
Still, Altera's newest chips are 50% cheaper than older versions. And companies like Cisco are ordering fewer chips as they bure off inventory.
When asked if Cisco and others have demanded more price cuts, Cleage said, "I wouldn't say that's never happened."
Cisco built up $2.2 billion in inventory last year. It got stuck with chips and other raw materials for switches and routers that couldn't be sold.
Cisco ordered more than it needed to ensure supply, Wilson says. In 2000 the chip market was tight. Now chips are a buyer's market.
"With the froth out of the market, Cisco is more likely to stay in the spot market for chips rather than entering into long-term supply agreements where they have to take the stuff," Wilson said.
Among the first to feel Cisco's cost cuts would be contract manufacturers. They assemble Cisco's switches and routers.
Its two biggest contract manufacturers are Solectron Corp. (SLR) and Jabil Circuit Inc. (JBL) They both made more than $3 billion from Cisco last year.
Contract manufacturers typically have fixed prices for equipment, says Brean Murray & Co. analyst Kevin Denney. But they'll be willing to strike better deals with Cisco because they need the business.
"There's excess capacity, which does force contract manufacturers to address pricing issues," Denney said. "The way they've done that is by pushing more business to lower-cost regions."
Cisco, though, isn't relying on external sources of cost cuts. It's also looking inside.
There's An Opportunity
The company's going through its operations and trimming duplications, CIBC analyst Steve Kamman says.
One sales manager may now cover several product lines, rather than one. Or Cisco might put an ad in one trade magazine, not three.
"There are tremendous opportunities to raise earnings per share through cost reductions," Kamman said.
In one big area, research and development, Cisco is still spending. It shelled out $4.7 billion in research and development last year.
That compares with Lucent Technologies Inc. (LU), which spent $3.5 billion, even with its formidable Bell Labs.
Cisco is trying to rely more on its own ideas for new products, rather than acquisitions, says ABN Amro analyst Ken Leon. That's a big break from the past.
"Can you believe it? Cisco outspent Lucent," he said.
Cisco will have to run a tight ship this fiscal quarter. Spring and early summer are the seasonal drought in networking spending.
Yet with a mere month to go until the quarter ends, it looks like Cisco will hit its sales and earnings targets.
The company appears to be gaining market share amid the downturn. More technology buyers are favoring Cisco over smaller network gear vendors.
They're afraid some of Cisco's smaller rivals might not have staying power. |
