Cisco Tries Reinvention in Tough Time

Updated May 12, 2013, 7:58 p.m. ET

Cisco Tries Reinvention in Tough Time

By DREW FITZGERALD

Cisco Systems Inc. CSCO +1.30% shares tumbled this time last year after executives warned their biggest corporate customers were ordering less equipment. If history repeats itself this week, the networking giant will join a dreary but growing club.

A wide range of companies—from Cisco rival Juniper Networks Inc. JNPR +0.12% to tech juggernaut International Business Machines Corp. IBM +0.61% —have caught investors off guard in recent weeks as corporate belt-tightening saps their growth.“A lot of the challenge stems from weak public-sector spending, in particular U.S. federal, along with softness in financial services,” Juniper Chief Executive Kevin Johnson said last month after delivering a weaker-than-expected view of future revenue. “We have communicated steadily over the last several quarters about expected weakness in federal. We do not expect this pattern to improve in the near term.”

Cisco, the world’s largest supplier of Internet routers and switches, has struggled particularly over the past year as slowing product sales and sliding data-center equipment prices hurt performance in its core business. The San Jose, Calif., company has responded by diversifying its revenue base with more profitable software and services—yet tight corporate budgets and government cutbacks have made the transition harder to accomplish.

“When the economy fluctuates, one of the first things people cut back on is Cisco boxes,” J.P. Morgan JPM -0.16% analyst Rod Hall said, because a large part of Cisco’s sales aren’t subject to a recurring contract. “That’s why it’s such a good bellwether.”

Cisco’s results, expected Wednesday, also will provide investors with a look into how business conditions were in April because the company’s fiscal third quarter ended a month later than those that already reported. Demand in the latest period still appeared “somewhat sluggish,” Mr. Hall said.

Chief Financial Officer Frank Calderoni in February urged Wall Street analysts to hedge their expectations through the end of Cisco’s fiscal year in July, warning that weak demand from Europe and cash-strapped federal government customers could hurt sales.

Cisco said it expects revenue to improve between 4% and 6% during the quarter ended April 27, tugging at the 5%-7% growth average executives still target for the year. Revenue projections from the company used to run in the double digits as recently as 2010.

The slowdown in sales of routing and switching gear reflects many companies’ decisions to hold onto equipment longer, according to ISI Group analyst Brian Marshall.

“Cisco is making the best of a difficult situation,” Mr. Marshall said. “They’ve got a big chunk of their business coming from an area that’s a single-digit growth market.”

Investors have shared that pessimism so far this year by nudging shares about 7% higher, well behind the S&P 500 index’s 15% rally. The stock went as low as $15 last summer and only recovered after the company raised its quarterly dividend by 75%. Last month’s dividend rose another 21%, to 17 cents a share.

Spending on dividends and stock buybacks typically accounts for more than half of Cisco’s cash flow, and the company returned $1.2 billion to shareholders last quarter. The company’s dividend yield recently stood around 3.2%, a high level compared with other large tech peers.

Cisco has taken steps to shuffle its product portfolio. It recently sold the Linksys home-router business to Belkin International Inc., soon after acquiring wireless-carrier software developer Intucell Ltd. for $475 million and Meraki Inc., a provider of wireless gear for midsize businesses, for $1.2 billion.

The acquisitions fit with Chief Executive John Chambers‘s effort to recast Cisco as more of an IT company than just a seller of network equipment. The company has pledged to double its software revenue over the next few years as it diversifies its customer base beyond machines that shuttle data between computers.

Cisco has performed better than many observers expected, Wunderlich Securities analyst Matthew Robison said, thanks to support from more profitable businesses like software for providers of cable TV and mobile-phone networks. Its line of data-center servers are typically less profitable than high-end routers, yet they helped support its revenue over the past year when router sales sputtered.

Many of the steps Cisco took happened years ago, “but they have all been important in enabling Cisco to perform better than many would have expected in a challenging environment,” Mr. Robison said.