Tags: Cisco Systems (Nasdaq: CSCO)

The Biggest Threats Cisco Systems (Nasdaq: CSCO) Needs to Overcome

By , Contributing Writer, Money Morning •

There was nothing to scoff at in Cisco Systems Inc.'s (Nasdaq: CSCO) third quarter earnings - but the company's disappointing outlook put Wall Street on alert.

Cisco, the world's leading maker of networking devices that support Internet traffic, reported healthy fiscal third-quarter numbers after the close yesterday (Wednesday). Cisco posted a profit of $2.2 billion, or 40 cents a share for the quarter that ended April 28, up from $1.8 billion or 33 cents a share in the same period a year earlier.

Per-share earnings rose from 42 cents to 48 cents, and revenue jumped 6.6% to $11.59 billion. The company's product segment, its biggest top-line contributor, enjoyed a 5% increase, while its service segment's revenue swelled by 13%.

But the company's outlook fell short of expectations, sending shares sliding lower by more than 8% in after-hours trading to $17.18. And that decline could continue if Cisco doesn't address some key areas of concern.

"While Cisco seems to be making considerable headway on improving gross margins, we expect a number of uncertainties could continue to weigh on the stock," Scott Thompson of FBR Capital told Barron's. Thompson cut his CSCO price target to $20 from $22.50.

Cisco Systems (Nasdaq: CSCO) "Lost Its Way"

The latest quarter is Cisco's second-consecutive earnings gain. These results followed a year-long string of year-over year diminishing profits, and hinted at a recovery for the tech giant.

The Silicon Valley company is in the midst of a turnaround after restructuring in 2011, when CEO John Chambers admitted the company "had lost its way." Since then, it shifted its focus on core product areas such as routing and switching gear that ferries data between computers.

Cisco is reaping the rewards of servicing telecommunications and other companies in need of more vigorous networks to support the swelling mobile and cloud computing markets.

CEO Chambers was upbeat, but subdued, following the earnings report.

"We are successfully executing against our long-term strategic plan of growing profit faster than revenue, and in a cautious IT spending environment, we continue to outperform our competitors," Chambers said.

While Cisco's last quarter performance was devoid of drama, its staid and disappointing guidance for next quarter scared investors out of the stock.

Cisco's Biggest Threats

Cisco said it anticipates fiscal fourth quarter earnings of between 44 and 46 cents a share, and revenue growth of 2.5%. That was shy of what analysts polled by Thomson Reuters expected: 49 cents a share on revenue growth of 7%.

"It's not too shabby, considering the choppy environments we are in," RBC Capital Markets' analyst Mark Sue told CNBC of third-quarter results. "Still, the global macro storm clouds are gathering and it remains to be seen if Cisco can use its newfound execution prowess to navigate this difficult environment."

Indeed, limited tech spending in the United States and Europe will weigh on Cisco's profit and stock next quarter. That's on top of increased competition that Cisco does not seem ready to fight.

"There is definitely some macro impact," Global Equities Research analyst Trip Chowdhry told Reuters. "But Cisco is also facing tougher competition from rival [Hewlett-Packard]. HP hit bottom and they are on their way up. They have become smarter. On the other hand, Cisco is suffering from stagnation. They are laying people off. How are you going to innovate and win if you are laying people off? Their remaining employees are not motivated to win."

Where Cisco Should Focus

Hope is not lost on Cisco - but only if the company can refocus its weakest areas and continue performing in its best business segments.

"It appears to be executing well on what it can control, as demonstrated by share gains (e.g., routers) and a better-than-expected gross margin," Simon Leopold of Raymond James told Barron's.

In order to regain footing, Cisco needs to plot a unique course by taking advantage of some promising acquisitions. The company has a history of making frequent and numerous purchases.

Of late, Cisco has had its sights on attaining gifted start-ups and exciting small companies to fuel growth and expansion.

Just last week, Cisco announced a deal to acquire Truviso Inc., a real-time network data analysis and reporting software maker. In March, it agreed to buy Clear Access, a maker of customer-premise-equipment management software. In early 2012, Cisco made its biggest deal in more than two years when it snapped up video software maker NDS Group LTD for $4 billion, underscoring its spotlight on video.

More strategic action this quarter could bring back the investor confidence rattled by yesterday's outlook. While Cisco still has a promising long-term outlook, its uncertain short-term success has slammed the share price.

Thursday morning, as investors reacted to CSCO numbers, shares dropped to a five-month low, gapping down another 9% to $17.05.

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