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Dow 30 Earnings: Cisco Systems - Fiscal Fourth Quarter 2011
Shares of Cisco Systems (CSCO - Free Cisco Stock Report), which had just reached a new 52-week low earlier this week, soared after the networking bellwether reported better-than-expected results for the fiscal fourth quarter ended July 30th. Revenues of $11.2 billion were up 3.3% year over year, compared to the company's guidance of a flat to 2.0% advance and our 1.3% estimate. Bright spots included data center, TelePresence, and emerging markets. GAAP earnings per share of $0.22 (down $0.11 year over year) were $0.02 below our call and included $0.11 worth of restructuring charges and $0.07 in non-cash stock-based compensation and amortization of intangibles expense.
The company has made progress in its restructuring initiatives. The extensive management hierarchy of boards and counsels has been scaled back significantly (17% fewer VP and above positions), which ought to speed up the technology approval process and lead to increased accountability of leadership. Too, sales teams are working closer with engineers to better relay customer needs to capture ``market transitions'', a key problem area for the last several quarters. A Mexican set-top box manufacturing facility is being sold to Taiwan-based Foxconn (but Cisco is remaining in the set-top box business), which will transfer 5,000 positions. An additional 6,500 global employees (9% of the workforce) are being let go, 2,100 of whom have elected to participate in the ''early retirement program''. These initiatives should lower expenses by $1.0 billion annually. However, they are also expected to result in GAAP cash restructuring charges in excess of $1.3 billion. Approximately $725 million of this was already realized in the July period, another $300 should come in the current quarter, and the rest throughout fiscal 2012. Lastly, Cisco has reduced its investment in certain non-core markets.
Meanwhile, Revenues from the public sector remain depressed, with nearly every nation in the developed world buying less year over year. Public-sector order growth fell 4%, and the United States was particularly weak, with a 7% decline (federal down 18%, state and local off 2%). Importantly, industry peers have also seen weakness from this customer group, which makes sense since Cisco usually experiences declines two to four quarters before the competition, as a result of the short-term nature of its orders. We believe Cisco has gotten a head start on adjusting to the new demand environment, but management expects the public market to remain challenging for the next several quarters. This is why it is aligning its selling resources to high growth areas like the data center, collaboration, and video.
The Switching unit also continues to be a weak spot for the company, due to intense competition and declining prices. To be sure, poor demand from the public sector also led to the 4% revenue decline. These trends contributed to market share declines and the overall product gross margin falling 2.4 points year over year, to 61.2% during the July period. However, management appears confident in its ability to maintain Cisco's current Switching market share of approximately 68%. In order to remedy the margin issue, the switching portfolio has undergone the largest refresh in company history, and devices now present an improved value proposition. As volumes on new products accelerate and input prices decline, we expect switching margins to bounce back.
Although Routing revenue was down 2% in the quarter, orders advanced 17%, with July performing particularly well. Overall, orders were up 11%, with strength coming from enterprises (up 25%) and service providers (up 15%). The company is doing well at selling its data center solution, the Unified Computing System, to enterprises. Around half of these customers are also buying core routing and switching products, which speaks to the company's core differentiation strategy of offering operational efficiencies and cost savings through a wide breadth of product. Further, the service provider capex environment is proving less restrictive than originally thought considering AT&T (T - Free AT&T Stock Report) is now expected to allocate additional funds during in the second half of 2011 thanks to cloud computing, video, and mobile bandwidth demand. Overall, we expect orders to continue outpacing revenue growth in the October period considering the book-to-bill ratio is well above one at present.
The company's first-quarter revenue guidance of 1%-4% was encouraging. Similar to the past three quarters, the gross margin is expected to be in the 61%-61.5% range as higher component costs related to the Japanese earthquake and increased sales of lower margined UCS devices offset a more favorable product mix, higher service margins, and limiting promotional activity to several large routing orders from China. Eventually, the company's value engineering initiative and supply chain improvements ought to push the gross margin up some, but it remains to be seen if historical levels are achievable.
October-period GAAP earnings per share are expected to range from $0.24-$0.31 which reflects macro economic weakness, the usual aforementioned differences, and $0.03-$0.05 worth of severance and other restructuring charges. In response, we have lowered our earnings per share estimate by $0.03 to $0.31.
About The Company: Cisco Systems Incorporated is the 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 45.7% of 2010 revenues. R&D was about 13% of revenues.