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Dow 30 Earnings: Cisco Systems - Fiscal Second Quarter 2012
Global networking bellwether Cisco Systems (CSCO - Free Cisco Stock Report) has surpassed expectations in the January quarter. The company registered year-over-year top- and bottom-line gains of 10.5% and 48%, respectively, on a GAAP basis. (Excluding non-cash stock-based compensation and amortization of intangibles expenses, earnings increased 27%.) This compared favorably to GAAP guidance of 7.5% and 27%, respectively. Nonetheless, the stock moved modestly lower following the report.
Cisco reached its goal of $1 billion, or 6%, in annualized cost savings (compared to the fourth quarter of fiscal 2011, which ended on July 30th) three months earlier than expected. A reduced headcount, more streamlined operations, and lower R&D spending helped explain why operating expenses declined 5% and the non-GAAP operating margin improved by 390 basis points, to 28.4%. Over the next three years, management believes that this rate will fall to the mid-twenties, but expects it to be approximately 27%-28% in the April quarter.
The product gross margin fell 20 basis points, year over year, in the January term, reaching a record low of 60.9%. This compares to the 64% achieved in the 2011 October period, when Cisco had yet to feel the impact of a market shift toward less expensive, more technologically efficient routers and switches. Cisco's subsequent “value engineering” initiative and product refresh in Switching has driven volumes and gross profits higher, but historically low pricing remains. This is especially true in China, where CSCO is battling low-priced rival Huawei in the routing market. John Chambers, Cisco's CEO, commented about the new market for networking gear, saying “Speed and agility is in, cost and complexity are out”. Although the low end of gross margin guidance was raised by 150 basis points, we expect aggressive pricing to continue, and a mix shift toward less profitable data center products should also keep a lid on margins.
Customers appear to be welcoming the more focused Cisco. Switching and Routing were both up 8%, and the overall book-to-bill ratio was above 1.00. Although third-party market share data have not been released, the company may be taking service provider business from rival router vendor Juniper Networks (JNPR), based on its recent weak results (routing down 20%) and softer guidance. A lack of customer diversification and unfavorable product launch timing there is probably contributing. Better value proposition in Ethernet switching is likely driving share gains, as well. Collaboration (which includes Telepresence) was up 10%, thanks to new methods of connecting workers' media devices through cloud-based networks. Service Provider Video advanced 23%. Data center products surged by 88%, to $333 million. The higher-margined Services business clocked in at 11% growth, which boosted the overall gross margin. Enterprise and commercial businesses were up 7% each, while service providers spent 12% more. Public sector revenues fell 1%, driven in part by 14% declines in United States and European government spending on information technology. This should continue to be a soft spot in the coming quarters.
Elsewhere, management said Cisco will recommence its long-time strategy for revenue growth by buying companies it believes possess market leading technologies. It also raised the quarterly dividend payment $0.02 a share, to $0.08. We view these as positive uses of the company's ample $46.7 billion in cash and equivalents.
Management expects April-quarter revenues to be up 5% to 7% and earnings per share to advance 7% to 12%. In response, we are raising our fiscal 2012 top- and bottom-line estimates to $46.25 billion and $1.52 a share, respectively.
Overall, we are impressed by the speed with which Cisco has right sized its business. More competitive pricing and technology should support revenue growth but keep product margins under some pressure. Still, evidence of further market share gains should help support the stock.
About The Company:Cisco Systems Incorporated is a leading provider of Internet Protocol-based networking and other products for transporting data, voice, and video across geographically dispersed local-area networks, metropolitan-area networks, and wide-area networks. Devices are primarily integrated by Cisco IOS Software and include Routers, Switches, New Products, and Other. Provides services associated with these products. Foreign business accounted for 46.5% of fiscal 2011 revenues. R&D, 13.5% of revenues.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.