Tech stalwart Cisco Systems (NSDQ: CSCO) grabbed a lot of headlines this week–some good, some bad.
After reporting disappointing earnings for the fourth quarter in a row, CEO John Chambers is on the offensive.
In an internal memo to staff, Chambers declared that the company had lost its focus (it has pushed into 30 new businesses) and some credibility. That’s a refreshingly honest analysis.
Here’s my take on Cisco Systems, and whether or not it warrants any of your hard-earned investment dollars. We’ll start with the latest numbers.
Fiscal 2011 second-quarter revenue rose 6 percent year over year to $10.4 billion, which topped a consensus estimate of $10.24 billion. What caused the double-digit decline in Cisco’s stock price following the announcement? The company’s second-quarter gross profit margin slid from 64.5 percent a year ago to 60.2 percent.
In the previous fiscal year, Cisco’s non-GAAP gross profit margin slipped from 65.6 percent in the second quarter of fiscal 2010 to 62.4 percent. The firm has now reported four consecutive quarters of declining gross profit margin.
Sales to government customers, which account for approximately 20 percent of overall revenue, were weak. Cisco’s relatively small consumer business also dragged down margins, though the company continues to divest assets in this area.
Sales of switches were off by 7 percent, weighed down by a batch of new product introductions. All new products launch with smaller gross margins that improve over time. But intense competition from Hewlett-Packard (NYSE: HPQ) and Juniper Networks (NSDQ: JNPR) is also having an impact.
Management delivered an outlook for the next two quarters that disappointed analysts. Fiscal third-quarter earnings should fall between $0.35 and $0.38 per share, short of the $0.40 consensus estimate. It expects non-GAAP gross margin to be 62 to 63 percent of sales over the next two quarters, roughly in line with the second quarter.
Budget crises at the state and local levels and a new austerity at the federal level mean that this part of Cisco’s business (roughly 20 percent of overall sales) will be weak through at least the rest of the year.
On the bright side, management reaffirmed a plan to begin paying a dividend this year, with a projected yield of 1 to 2 percent. That makes for adequate compensation as investors ride out what will be a difficult transition period.
High-margin services are also becoming a bigger part of Cisco’s game. Services accounted for approximately 21 percent of the firm’s total revenue mix, up from 19 percent in the first quarter. Total service revenue was $2.17 billion, up approximately 18 percent year over year, driven by 30 percent growth in advanced services.
In the mid-1980s, Cisco Systems built its reputation by providing routers for multiple network protocols. The emergence of Internet Protocol in the 1990s forced the company to evolve, but Cisco handled the transition well enough that its products form the foundation of the Internet. Today, its ubiquitous routers and switches transmit data packets all over the world, all the time.
A combination of factors, including aggressive discounting and new products, have helped competitors chip away at Cisco’s dominant position within the industry. But what characterized Cisco in the beginning–responsive innovation–will enable it to recover its footing over the course of 2011 and into 2012.
The Cloud
Cisco’s development pipeline includes a number of products that are well-suited to accommodate the growing number of companies that are outsourcing their information-technology functions to “the cloud,” a virtual pool of complex distributed computing systems and storage resources.
Larger enterprises, Cisco’s bread and butter, are beginning to take note of the cloud’s cost-saving potential. In fact, 70 percent of Chief Information Officers say they plan to migrate to the cloud.
Cisco’s focus is providing “the essential architecture,” including the core networking gear, the unified computing systems, the security tools and the ports where computers connect to the network.
Cloud computing doesn’t work without fast connections between systems, which is something Cisco knows very well. Reliable, secure networking blocks–Cisco’s strength–are at the center of its cloud strategy.
Hardware innovations include a pre-integrated compute-store-network package. Cisco’s Unified Computing System is driven by a set of application programming interfaces (API) that are built into “every networkable device [it] sells.” These APIs enable the automation, management and provisioning of devices–in short, the customization that’s indispensible to cloud computing.
In the immediate term, Cisco is working with its existing base of customers on “collaboration services,” the integration of video and voice and calendaring and messaging. Cisco has created a collaboration product for enterprises, Quad, that’s based on Facebook’s consumer model.
As for video, the company recently rolled out a new version of its TelePresence Content Server 5.0, which allows videos to be recorded and shared easily within a company. These videos are made searchable with a network appliance–the Cisco MXE 3500–that can “tag” speakers and words.
Cisco has also launched a line of video-related hardware, including a 47-inch TelePresence endpoint, aimed at offices or small conference rooms, as well as a line of IP phones that have cameras built in.
Finally, it brought out a “digital signage” product that serves as sort of a TelePresence kiosk. Say you’re at a bank and see an ad on a display screen for a product or service that you want to know more about. Touching the screen triggers a video chat with a sales rep who will try to close the deal immediately.
Cisco, in the long run, will maintain its market dominance because it continues to improve the offerings at its one-stop shop for big companies and organizations. But this is not a stock you should buy at any price–get my specific buy instructions immediately when you start your risk-free trial to Personal Finance.
We have racked up some fantastic profits in our technology recommendations, like our 23 percent gain in anti-virus leader McAfee. I expect even bigger things from our current tech stocks.
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