Cisco Shortfall Shows Broader Risks in Government Spending Cuts

Thursday, 11 Nov 2010 03:03 PM

 

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Disappointing sales and profit forecasts from Cisco Systems Inc. show cutbacks in government spending that pose risks for companies that rely on the sector for growth.

Governments in Europe, Japan and some U.S. states reduced orders as their budgets came under pressure, said John Chambers, chief executive officer of the world’s largest computer networking-equipment maker. State government orders fell 48 percent in the last quarter from the previous period, he said.

“We believe the public sector business will continue to be challenging for at least several quarters,” said Chambers on a conference call yesterday. Demand from U.S. cable operators also declined, though spending by large and mid-sized companies remained solid, he said.

The challenges for Cisco, which gets about 22 percent of its business from the public sector, may signal broader risks for businesses that depend on government spending. Companies in technology, construction and health care draw revenue from state and local governments, which reduced their spending in the third quarter and cut into U.S. economic growth.

Cisco, based in San Jose, California, said revenue in the fiscal second quarter will be about $10.1 billion to $10.3 billion and earnings, excluding some costs, will be at most 35 cents a share. Analysts projected sales of $11.1 billion and profit of 42 cents on average, according to estimates compiled by Bloomberg.

The stock plunged $3.94, or 16 percent, to $20.56 at 2:44 p.m. New York time in Nasdaq Stock Market trading, after falling 17 percent for the biggest intraday drop since October 1998. The shares had gained 2.3 percent this year before today.

Misread Demand

Cisco misread demand from some customers, Chambers said on the conference call yesterday. Still, the majority of its business remains in good shape, he said. Chambers said that the slump doesn’t affect the company’s long-term growth prospects.

“I never want to let down our shareholders, even if I believe it’s a short-term bump,” he said in an interview after the call yesterday. “I like for the stock to go up all the time. Obviously, we’ve got to get confidence back.”

Cisco’s first-quarter earnings, excluding some costs, were 42 cents a share, while sales climbed 19 percent to $10.8 billion. Analysts surveyed by Bloomberg predicted profit of 40 cents a share on sales of $10.7 billion.

Net income rose 8 percent to $1.93 billion, or 34 cents, in the period, which ended on Oct. 30. That compared with $1.79 billion, or 30 cents, a year earlier.

The report caps a quarter of earnings among corporate- technology companies that suggest the economy is struggling to recover quickly. Juniper Networks Inc. and International Business Machines Corp. both slid after earnings reports.

Government Challenge

Cutbacks at the state and local level are starting to weigh on companies doing business with those governments. The slowdown in municipal and state expenditures is putting a bigger burden on private industries and consumers to spend at a pace that maintains the economic recovery.

Third-quarter growth got a lift from business investment on equipment and software and federal government outlays, according to Commerce Department figures last month. Still, the U.S. economy may not be able to count on government spending much longer as about 70 percent of President Barack Obama’s estimated $814 billion stimulus package has been used, according to a September White House report.

Local governments have reduced payrolls the last seven months, the longest streak since 1980 to 1981, to balance their budgets as tax revenue shrinks. State and local tax revenue won’t rebound to pre-financial crisis levels for another five years, according to about half of the public-finance professionals surveyed by RBC Capital Markets in a report released Oct. 29.

Cisco Bellwether

Investors look to Cisco as a bellwether for the technology industry because the company dominates the market for routers and switches, products that direct the flow of Internet traffic. Companies buy its switches for corporate networks, while phone and Internet-service providers typically buy Cisco’s more- expensive routers.

Chambers, 61, is expanding into more than 30 businesses in a bid to reach a long-term goal of 12 percent to 17 percent in annual sales increases. He’s pushing the company into markets such as smart grids, videoconferencing and home networking. By promoting the TelePresence conferencing system and video cameras such as the Flip, Cisco is trying to generate more Internet traffic, increasing demand for its routers and switches.

Chambers said government demand varies by region. Spending by the U.S. federal government and public agencies in emerging markets remained buoyant, even as other entities held back.

“We’re trying to get ahead in terms of our projections” for government spending, he said. “We were surprised at how quickly that dropped off.”

© Copyright 2014 Bloomberg News. All rights reserved.

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