Chambers: Cisco Hit 'Air Pocket' In Subdued Q1

Cisco on Wednesday reported healthy profit and sales gains for its fiscal first quarter, in line with Wall Street expectations. But a host of challenges -- including losses in public sector accounts and in specific product areas like set-top boxes -- coupled with a less-than-invigorating sales forecast for the current quarter, were enough to send Cisco's shares tumbling.

Cisco CEO John Chambers, on Cisco's Q1 conference call, described the challenges as hitting an "air pocket," and was bullish on many of the areas in which Cisco excelled. But he set a subdued tone for the call, especially with the forecast that second quarter revenues would increase only about 3 to 5 percent, and a forecast that revenue growth for fiscal 2011 overall would be 9 to 12 percent, well below both the 13 percent for Q2 and the 13.1 percent for FY11 predicted by analysts.

Specifically, said Chambers, orders came in over $500 million below Cisco's initial Q1 sales forecast.

The result sent Cisco's shares falling, and they were off as much as 13.5 percent in after-hours trading.

For the first quarter of its fiscal 2011, ended Oct. 30, Cisco posted a profit of $1.93 billion, or 34 cents per share, up 8 percent from $1.79 billion, or 30 cents per share, in the year-ago quarter. Revenue grew 19 percent to $10.75 billion, up from $9.02 billion last year, and in line with Cisco's projection in the last quarter that revenue would grow 18 percent to 20 percent.

The earnings were slightly ahead of Wall Street expectations, which were 40 cents a share on revenue of $10.74 billion, and it was a "solid quarter" that "evolved pretty much as we expected," Chambers said on the company's Q1 conference call Wednesday afternoon.

Gross margin was 62.8 percent, down from 65.3 percent. Overall, Cisco's product revenue grew 22 percent, and its services revenue grew 13 percent.

Data center, collaboration and video are three of Cisco's fastest growing areas. Data center revenues grew 59 percent year over year, Chambers said, and collaboration grew 45 percent. According to Chambers, the industry saw a "tipping point" in the last six months whereby global CIOs are finally focused on video adoption.

In terms of specific products, Chambers called out the ASR edge routers, which grew 200 percent year over year in sales, and the Unified Computing System (UCS), which grew 550 percent year over year, has an annualized run rate of $500 million, and whose customers now number more than 2,800, up from 1,700 in 2010 Q4 and 900 in 2010 Q3.

Next: More Gains, More Challenges

All of Cisco's major sales theaters -- including Asia-Pacific, which now includes Japan under Cisco's new reporting policies -- were up in global product orders, which were up 10 percent year-over-year overall. Non-public sector enterprise sales grew 16 percent, and commercial, or midmarket and SMB sales, grew 13 percent. Consumer sales were flat.

Cisco's public sector accounts -- which account for 22 percent of its global orders -- were a challenge, Chambers noted, and grew a paltry 6 percent, with orders from U.S. state governments down roughly 25 percent. European government business was also down, and Chambers predicted that public sector difficulty would continue in the next few quarters.

There were pockets of its service provider business -- up 8 percent overall, down 2 percent in the U.S. -- and also in Cisco's cable business that also faltered, and Cisco's North American traditional cable set-top business was down 40 percent year-over-year. Growth in European markets was also sluggish, at about 10 percent year-over-year.

Chambers said that Cisco gained market share in many of its market adjacencies, and video, collaboration, data center, virtualization, cloud, emerging countries and smart connected communities. Long-term opportunities that Chambers expects to bear fruit for Cisco three-to-five years down the line include smart grid, sports and entertainment, virtual health care and virtual education.

From a headcount perspective, Cisco added about 1,900 employees during the quarter, including 150 from acquisition. Chambers noted that Cisco added 600 incremental sales representatives over the past two quarters, and said Cisco's intent is to continue to hire.

When pressed during the question-and-answer section of the call about losing market share in areas like security, wireless LAN and application delivery networking, Chambers acknowledged that rivals like Juniper and F5 Networks had gained on Cisco in some areas, but downplayed the share shifts in those areas as smaller than other Cisco market segments.

On the supply chain issue, which has been a sore spot for Cisco throughout the past year, Cisco has continued to improve. According to Frank Calderoni, executive vice president and chief financial officer, Cisco's supply chain is reaching "normal levels" on "almost all products."

Cisco said in September that it would in 2011 initiate its first dividend, but Chambers on Wednesday offered no indication of the size or timing of that payout. During the conference call, Chambers reiterated that he'd like to bring $30 billion in Cisco cash that's currently overseas back into the U.S., and that U.S. tax laws make that too expensive. Chambers has been vocal in calling for tax repatriation breaks and urged the U.S. government to create a "favorable environment."

"It's one of the few levers they could hit that doesn't cost the taxpayer," Chambers noted.