Cisco Beats on Q3 Earnings - Analyst Blog

Cisco Systems CSCO reported third-quarter fiscal 2014 earnings of 46 cents, which were above the Zacks Consensus Estimate of 43 cents. The adjusted earnings per share exclude one-time items but include stock-based compensation expenses.

Shares surged 7.2% in after-hours trading driven by better-than-expected earnings, improving markets for the company's products in the United States and Europe, and strong growth prospects in areas like cloud computing, mobile and data center.

Revenues

Revenues decreased 7.7% year over year but increased 4.8% sequentially to $8.8 billion. However, revenues were below the Zacks Consensus Estimate of $11.3 billion.

Products (75.5% of total revenue) were down 7.7% year over year to $8.8 billion, while Services (24.5% of total revenue) rose 2.6% year over year to $2.7 billion. Product book-to-bill ratio was greater than 1 in the reported quarter.

Revenues increased sequentially across all geographies, except Asia-Pacific, Japan and China (collectively known as APJC) region. On a sequential basis, the Americas, and Europe, Middle East and Africa increased 3.5% and 5.9%, respectively, while APJC declined 0.6%.

Product Revenues by Category

Switching (29.0% of total revenue), NGN Routing (17.0% of total revenue), Service Provider Video (8.0% of total revenue), Collaboration (8.0% of total revenue), Data Center (6.0% of total revenue), Wireless (5.0% of total revenue) and Other Products (1.0% of total revenue) increased 3.4%, 11.1%, 0.4%, 1.2%, 9.4%, 8.2% and 17.2% year over year, respectively.

However, this increase was partially offset by weak performance by Security (3.0% of total revenue) and Service (24.0% of total revenue) segments, which decreased 8.1% and 0.3%, respectively.

Orders

Cisco's total product orders in the quarter were flat year over year.

On a geographical basis, total U.S. product orders grew 7% with commercial and enterprise increasing above 10%. Also, the company witnessed continued stabilization across Europe, with orders increasing 7% in the U.K., 5% in Germany and 4% in Northern Europe.

However, orders in the emerging markets declined 7% with Brazil, Russia, India and China decreasing 27%, 28%, 1% and 8%, respectively, while Mexico declined 3%.

Gross Margin

Reported gross margin for the quarter was 60.7%, up 740 basis points (bps) sequentially but down 80 bps from 61.5% in the comparable year-ago quarter. The sequential increase was due to favorable product mix and higher volumes.

Cisco's operating expenses of $4.5 billion decreased 2.3% year over year. Research & development and sales & marketing expenses increased as a percentage of sales from the year-ago quarter, while general & administrative expenses declined. The net result was an operating margin of 22.0%, up 710 bps sequentially but down 210 bps from 24.1% in the year-ago quarter.

Net Income

On a GAAP basis, Cisco recorded a net profit of $2.2 billion or 42 cents per share compared with $2.5 billion or 46 cents in the year-ago quarter. On a pro-forma basis, Cisco generated adjusted net profit of $2.76 billion compared with $2.87 billion in the year-ago quarter.

Our pro-forma figure excludes certain one-time items but includes stock-based compensation expenses.

Balance Sheet

Cisco ended the third quarter with cash and investments balance of $50.5 billion, up $3.4 billion during the quarter. Trade receivables were $4.44 billion, up from $4.38 billion in the prior quarter. Total debt (short-term and long-term) was $20.89 billion versus $17.15 billion in the prior quarter. Including other long-term liabilities, the debt to total capital ratio was 27.2%.

The company generated operating cash flow of $3.2 billion and spent $0.37 billion on capital expenditure.

Share Repurchase & Dividend

During the quarter, Cisco repurchased shares worth $2 billion and paid a total dividend of $974 million.

Guidance

For the fourth quarter of fiscal 2014, Cisco expects revenues to increase in the range of 4% to 6% on a sequential basis. Non-GAAP gross margin is expected to be within 61–62% and non-GAAP operating margin is expected to be 27.5–28.5% of revenues. The company expects a GAAP tax rate of 21%, yielding non-GAAP earnings per share of 51 to 53 cents.

For fiscal 2014, non-GAAP earnings are expected in the range of $1.95 to $2.05 per share.

Our Take

Despite growing competition from several smaller players, Cisco appears to be strong in its domain. The company reported decent third-quarter results with bottom line exceeding the Zacks Consensus Estimate, reflecting Cisco's superior strategy and innovation.

Order growth and book-to-bill ratio improved in the last quarter, indicating better growth environment in the near future. However, the weakness in few of its product segments, emerging markets weakness and product transition challenges contained growth in the last quarter.

Nevertheless, the continuous dividend payment and share buyback activity indicates that the company is heading toward strong future growth. Though the company's margins have been suffering, areas like cloud computing, mobile, data center and others are witnessing strong growth, which will likely mitigate the margin slowdown, going forward.

Cisco shares carry a Zacks Rank #3 (Hold). Other stocks that are performing well at current levels include NetScout Systems, Inc. NTCT, Infinera Corp. INFN and QLogic Corp. QLGC. All these stocks sport a Zacks Rank #2 (Buy).