Good Quarter, Guidance from Cisco - Analyst Blog

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Cisco Systems' ( CSCO ) second quarter 2012 earnings (excluding one-time items and including stock based compensation) beat the Zacks Consensus estimate by 5 cents, or 13.2%. Revenue was more or less in line, beating the consensus by 1.8%.

As in the past, estimate revisions were minimal prior to the announcement of earnings, raising the Zacks Consensus estimate for the quarter by a penny, flattish compared to the year-ago quarter and easily exceeded by Cisco.

Revenue

Revenue of $11.53 billion was up 2.4% sequentially, 10.8% year over year and better than management's expectations of a 4-6% sequential decline.

Products, which generated 79% of revenue, did slightly worse than services, growing 1.9% sequentially and 10.7% year over year. Services accounted for the remaining 21%, up 4.6% sequentially and 11.0% year over year.

Cisco is seeing relatively stronger demand in the international market. The EMEA region was the strongest in the last quarter, growing 17.5% sequentially. The Asia/Pacific region was next, growing 7.5%. However, Americas was soft, declining 5.5%. The Asia Pacific saw the strongest growth from the year-ago quarter (14%). The EMEA region grew 5%. The net increase in the Americas was a mere 5%, indicating continued sluggishness in the doestic market.

Product Revenue by Category

Switching revenue accounted for a 31% revenue share, declining 1.6% sequentially and increasing 8.3% year over year. Cisco stated that the Nexus 2000 and 5000 lines saw over 100% growth over the copmparable prior-year quarter.

The Nexus product line is largely dependent on the UCS platform, which was up 91% year over year. Moreover, Cisco added 1,786 new UCS customers during the quarter. Cisco's partnerships with EMC Corp ( EMC ) and VMWare Inc ( VMW ) are also helping results here.

Routers were 18% of total revenue, representing a sequential decline of 1.5% and a year-over-year increase of 8.2%. The ASR edge routers had another very strong quarter, as a result of UCS deployments and greater adoption of cloud computing. Overall, high-end routers grew 11% year over year, while mid-to-low-end routers grew 6%. Cisco appears optimistic about market share gains in this area.

Advanced Technologies (now christened New Products) generated 27% of revenue, up 8.0% sequentially and 23.0% year over year. All the product lines within this category were up double-digits from the year-ago quarter, with data center up the strongest (88.1%), followed by wireless (24.8%), security (23.7%), service provider video (23.0%) and collaboration (10.0%). All except collaboration increased sequentially although data center was again the strongest, growing 88.1%.

Other products brought in a little less than 3% of revenue, up 12.1% sequentially and down 31.2% year over year.

Orders

Cisco saw strong order growth in the last quarter, although growth rates were slower than in the previous quarter. Global orders increased 7% from the year-ago quarter. The Asia/Pacific was the strongest with 14% growth, followed by the EMEA, which grew around 7% and the Americas, which was up around 5%. However, adjusting for the consumer video line of business, Americas revenue would have been up 8%.

The emerging markets were a mixed bag in the last quarter, with Russia, Brazil, Mexico and China growing 19%, 15%, 16% and 13%, respectively. India remained weak, with continued issues in the public sector, dragging revenue down 13%.

Cisco also saw strong growth in the U.K. and Canada, which grew 13% and 29%, respectively. Germany and France remained soft however, declining 2% and 3%, respectively.

Despite pockets of weakness in some areas, orders were up across most market segments. Enterprise and commercial were up 7% each, followed by service provider, which was up 12%. Public sector remained the weakest (down 1%).

Gross Margin

Cisco generated a gross margin of 61.9% in the last quarter, flat sequentially but up 20 bps on a year-over-year basis. The gross margin was negatively impacted by mix, pricing and discounts, as offset by higher volumes and lower manufacturing costs.

The product gross margin of 60.0% was down 23 bps sequentially and up 103 bps year over year. Competition has stiffened over the past few months, increasing pricing pressure and forcing management to offer heavy discounts. However, cost savings helped to offset the impact.

The services gross margin of 66.3% was up 115 bps sequentially and 148 bps year over year. The sequential variation in services gross margins is attributable to the mix of business (higher-cost advanced versus lower-cost technical support), as well as the timing of contract initiations.

Operating Performance

Cisco's operating expenses of $4.22 billion were 1.3% higher than the previous quarter's $4.17 billion. The operating margin was 25.3%, up 39 bps sequentially and 497 bps year over year. G&A expenses increased significantly as a percentage of sales, with both R&D and S&M declining.  

Pursuant to the company's growth plans, management increased the workforce by 400 in the last quarter, which followed an increase of 1,900 in the September quarter, 2,000 in the June quarter and 1,000 in the preceding quarter.

On a pro forma basis, Cisco generated a net income of $2.31 billion, or a 20.0% net income margin compared to $2.22 billion, or 19.7% in the previous quarter and $1.77 billion or 17.0% net income margin in the same quarter last year. Our pro forma estimate for the last quarter excludes restructuring charges, acquisition-related costs and intangibles amortization charges on a tax-adjusted basis but includes stock based compensation expenses. Our pro forma calculations may differ from management's presentation due to the inclusion/exclusion of some items that were not considered by management.

On a fully diluted GAAP basis, the company reported a net income of $2.18 billion ($0.40 per share) compared to $1.78 billion ($0.33 per share) in the previous quarter and $1.52 billion ($0.27 per share) in the prior-year quarter.

Balance Sheet

Cisco ended with a cash and investments balance of $46.7 billion, up $2.35 billion during the quarter. The company generated $3.10 billion in operating cash flow, spent $284 million on capex, $71 million on acquisitions net of cash and equivalents acquired, $474 million on share repurchases and $322 million on dividends. The net cash position at quarter-end was $29.84 billion, down from $26.71 billion at the end of the fiscal first quarter. Including short term debt and long term liabilities, the debt-cap ratio was a mere 31.8%.

Inventories dropped 2.0% to $1.59 billion, with inventory turns increasing from 10.2X to 11.0X. Days sales outstanding (DSOs) were down from 38 to around 31.

Guidance

In the third quarter, Cisco expects revenue to be down 1% to up 1% on a sequential basis, or increase 5-7% on a year-over-year basis. The non-GAAP gross margin is expected to be 61.5-62%, non-GAAP operating margin to be 27-28% of revenue, a non-GAAP tax rate of 22%, yielding a non-GAAP EPS of 45 to 47 cents. The GAAP EPS is expected to be 7-10 cents lower than the non-GAAP EPS. The Zacks Consensus estimate (includes stock based compensation) was 40 cents when the company reported, below the guided range.

Our Take

Cisco beat expectations on both the top and bottom lines and guidance was also better than expected. It is apparent that the company's strategy of pursuing opportunities in international markets and focus on new products and markets is paying off. Cisco is already the best entrenched company across the world and despite growing competition from several smaller players, the company appears to be holding its own.

What remains a slight concern is the margin side, where the company could be impacted by continued pricing pressure, as competitors like Hewlett Packard Company ( HPQ ) and Chinese company Huawei have manufacturing operations in low-cost countries, which make them more competitive.

The company is also keen on sacrificing margins for market share gains. However, we think it would not be easy to dislodge Cisco, which has already introduced more competitive switching products and has been increasing headcount in emerging countries.  

The other thing impacting margins is the mix, which is currently against the company given the growing adoption of UCS. However, there is a longer-term positive here too. The growing installed base could possible help Cisco sell higher-margin products more easily at a later date.

All things considered, we think that Cisco is a very strong company with significant market share and customer clout that would generate solid results as the economy continues to improve. Cisco shares therefore carry a Zacks Rank of #2, which translates to a Buy rating in the near term (1-3 months).


 
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Stocks

Referenced Stocks: CSCO , EMC , HPQ , VMW

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