Cisco Systems (CSCO) Earnings Preview

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CSCO -7.3% on earnings/guidance

On the call:

The company guides Q3 revenue growth rate of 10%, which equates to approx $9.79 vs consensus of $10.19 bln. CSCO says they remain comfortable with their long-term growth rate of 12-17%, and says while it is probable that they will remain in the 13-16% growth range for FY08, they will not provide guidance past that. CSCO also sees Q3 gross margins of 65%. The company's gross margin was 65.9% in Q2, which benefited from cost savings, but was offset by pricing and discounts.

CSCO says they see economic challenges in the US and Europe, and has a cautious near-term stance. The company says they saw a sharp drop-off from Dec to Jan, and is assuming January growth rates may continue over the next several months. However, the company expects growth rates to normalize in the relatively short-term. In terms of key trends, CSCO says service providers continue to look strong, and routing looks strong, but switching will probably be more challenging. CSCO says competition remains robust, but believes it is maintaining its leadership position and believes it is gaining market share in many of its 10 product categories. In its verticals, the company said it was most surprised by strength the financial sector, which was up 21% in the qtr. CSCO says retail and transportation were softer. Geographically, CSCO says emerging markets remain very strong, and would not be surprised if its growth rate is twice CSCO's normal growth rate. The US service provider market is the area where the company continues to feel the most comfortable. The Europe service provider market is expected to be weak. Overall, CSCO remains optimistic about a majority of global economies outside the US. CSCO also states that 60% of its business in now outside the US, compared to 50% a couple years ago. In terms of growth drivers, CSCO is most excited about Phase two of the internet, and believes it has achieved a clear number one position in terms of thought leadership and implementation.


Areas of Focus on the Call:
1) Guidance: CSCO historically gives revenue guidance for the next quarter, expressed in a Y/Y growth rate. To meet consensus estimates, CSCO needs to guide Q3 rev growth rate to approx 15%. Also, the company should give FY08 growth rate guidance, currently at 13-16%, and "long-term" growth rate guidance, currently at 12-17%. Barring a significant beat and blow-out guidance, share performance will be solely driven by Chamber's commentary;

2) Macro Outlook: Chambers' commentary regarding demand and the overall enterprise spending environment in both the U.S. and Europe will be largely scrutinized by the broader markets. The main question tonight is whether or not the U.S. business segment (50% of biz) got worse. Europe (20%) could be problematic due to a deteriorating economic environment. Recall that last quarter, Chambers' tone was tempered and cautious on the conference call, which routed both the stock and the markets the next day. However, expectations are likely not as high heading into this earnings report;

3) Competition: Another potential issue for CSCO is Juniper's (JNPR) entrance into the IP switching market. On the Q1 call, CSCO stated that competition was robust, but in their 10 product families, they believe they are gaining share in all of them. We would also note that the carrier segment is strong, underscored by JNPR's strong quarterly results, which indicate robust router demand;

4) Profitabilty: This will be key, due to concerns that CSCO reduced pricing to atone for slower growth. CSCO's annual profit range is 13-16%, and the current consensus Q2 EPS estimate of $0.38 equates to 15% growth. Shares would sell off if growth came in at the lower end of the targeted range...