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Cisco beats diminished sales targets in Q2

But profits get a big ol' haircut

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Cisco Systems CEO John Chambers insisted that the networking giant's second quarter of fiscal 2011 played out as expected when he announced that quarter's financial numbers on Wednesday. Revenues were a little better than anticipated, rising 6 per cent to $10.4bn, but net income was slammed 17.9 per cent compared to the year-ago period, dropping to $1.52bn.

Wall Street will decide tomorrow morning if it was expecting that or not when the company's shares start trading, but after-hours trading points to a bad morning for Chambers and his brain trust, with shares down as much as 9 per cent.

On a non-GAAP basis, per-share earnings during the quarter were 37 cents – two pennies better than expected and only off by 7.5 per cent, which was the other good news in addition to a slight revenue beat. Back in November 2010, when it reported a sales slump in the first quarter of fiscal 2011, Cisco said that it expected revenue to grow between 3 and 5 per cent in Q2.

In the current quarter, Cisco's product sales rose by 3.3 per cent to $8.24bn, while services revenues were up a healthy 18.1 per cent to $2.17bn. Gross margin was down 1.1 per cent, to $6.26bn. R&D, sales, and marketing costs were all up, and the company also amortized $203m in intangible assets during the quarter, all of which weighed on net income.

Chambers was as upbeat as he normally is during a conference call with Wall Street analysts. "Our timing on market transitions appears to be pretty solid," he said. "I think we will look back on this period of time and wish that we could avoid it. But in the end it will make us stronger."

One of the problems with the latest Cisco products – particularly in switching and routing – is that the newest products have more capacity and bandwidth and better price/performance, and that means the sales force has to make it up in volume. That's always the case in the IT business, of course, but the transitions are bigger this time and the volume that needs to be made up is a bit larger, Chambers explained.

In Q2, Cisco's revenues from routers rose by 4 per cent to $1.67bn, but switching sales (where the transitions are a bit rougher) fell 7 per cent to $3.15bn. Chambers said that high-end ASR router products had 68 per cent revenue growth in the quarter and are now at a $1.5bn annual run rate. Nexus 7000 switches were the shining star in the switching area, almost doubling and at an annualized run rate approaching $1bn.

So how did Cisco get surprised by the switching transition? Chambers said that never in the company's history had the entire switching product lineup been announced in such a short timeframe.

The cornucopia New Products category at Cisco accounted for $3.2bn in revenues in Q2, and included the data center/cloud products such as the Nexus 2000 top-of-rack converged switches (up over 160 per cent), the end-of-row Nexus 5000 switches (up nearly 60 per cent).

These two products are moving at a $450m annual run rate now, and the California Unified Computing System blade and rack servers (which include their own variants of the Nexus converged switches embedded in them) had over 700 per cent revenue growth in fiscal Q2, according to Chambers, and are now at a $650m annual run rate and well on the way of meeting Cisco's goal of pushing $1bn in revenues as the company exits fiscal 2011. Overall, the data center products had a combined 59 per cent revenue spike in Q2.

"We don't have an installed base to protect, and we are moving very aggressively on that," Chambers said, referring to the data center server and converged switching opportunity.

Other bright spots within New Products are the collaboration products (including Tandberg video conferencing), which had a 37 per cent jump in sales in Q2 and are at a run rate approaching $3bn a year. Wireless networking product sales were also up 34 per cent in the quarter within this New Products grouping, but video connected home products had a 4 per cent drop and security products dropped 9 per cent.

Walking through the geographies, Cisco had 7 per cent revenue growth in the United States and Canada in Q2 (to $5.55bn), with Europe up 2 per cent (to $2bn), Asia/Pacific up 8 per cent ($1.56bn), and emerging markets up 27 per cent ($1.19bn).

Of the top fifteen markets where Cisco sells stuff, all were up except for Italy. By industry sector, large enterprise revenues for Cisco rose 10 per cent, but the public sector, facing budgetary slashing and burning, was up only 7 per cent. Service providers were up 9 per cent, other commercial enterprises were up 11 per cent, and consumer sales fell 15 per cent. Chambers said that the Flip video camera line, which is in its consumer lineup, grew 15 per cent, but Cisco had been hoping for 30 per cent growth there.

Cisco generated $2.6bn in cash during the quarter and now has a cash hoard of $40.2bn. Aside from paying what is presumed to be a small dividend sometime this fiscal year, the company seems inclined to keep that cash because it gives them options and safety. Don't expect a big-bang acquisition.

Looking ahead, Cisco said that in its third quarter ending in April, which will have 13 weeks instead of the 14 it had last year, revenues will grow between 4 and 6 per cent. That extra week might account for somewhere between 3 and 5 per cent of growth if it were in fiscal 2011, according to Frank Calderoni, Cisco's chief financial officer. In the fourth quarter ending in July, Cisco expects to see 8 to 11 per cent revenue growth. ®

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