Cisco’s Q1 Revenue Beats Estimates On Switching Turnaround

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Cisco (NASDAQ:CSCO) reported modest Q1 FY2015 results on Wednesday, as adjusted net income dropped over 2% year-over-year (y-o-y) to $1.8 billion, while non-GAAP earnings per share (EPS) grew at about the same rate to $0.54, slightly beating analyst expectations compiled by Reuters. The networking giant saw its revenues grow by just over 1% y-o-y to $12.2 billion, as growth in switches, wireless and security products offset sustained weakness in emerging markets and sluggish spending by service providers in the U.S. The revenue increase was above the higher end of the company’s guidance of 0-1% and marginally better than consensus expectations. [1]

Although emerging market orders fell by 6%, with China, Russia, Brazil and South Africa contributing to a bulk of the weakness, the company was able to offset some of the pressure with a strong showing in the U.S., where commercial orders grew by 7% y-o-y. Cisco’s new high-end routers and switches continued their strong momentum from the previous fiscal year, as orders for the NCS and CRS-X continued to ramp up. The Nexus 9000 and Cisco’s SDN strategy also seems to have resonated well with customers, as the number of clients jumped from 580 at the end of Q4 to 900 at the end of Q1 FY2015. [2]

The routing and switching transition seems to be going well, and the company expects these business divisions to contribute meaningfully to top line and bottom line growth in the next few quarters. Cisco expects its overall revenue to grow by 4-7% in the next quarter, slightly below market expectations of 8%. On the cost side, the company expects non-GAAP gross margins to be around 62% in Q2, slightly below those reported in the first quarter (62.5%). Gross margins are impacted by sales growth, product pricing, product mix as well as cost savings. In addition to seasonality benefits, the first quarter saw better than expected switching sales, which helped improve margins, but the company expects the current quarter to have a higher mix of UCS (Unified Computing Systems) sales, which is likely to impact gross margins negatively.

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In the coming years, we expect Cisco to be able to defend its overall operating margins better as the new high-end products start gaining traction and the company’s cost-cutting measures take hold. The company continues to generate strong cash flows and has been opportunistic in deploying the cash to buy back shares at low valuations. It repurchased 41 million shares of common stock for an aggregate price of $1 billion in the three month period ending October 25.

We have a $26.50 price estimate for Cisco, which is about 5% ahead of the current market price.

See our full analysis of Cisco

Switching Sales Growth Turns Positive

Cisco is facing a tough business environment in regions such as Asia-Pacific, Japan, China and Russia, where customers are cutting their network spending in response to intense currency fluctuations and geopolitical factors. The company saw orders in Asia-Pacific, Japan and China decline 12% over the same period last fiscal year. China has especially been a pain point given the volatile political conditions in the aftermath of the NSA spying scandal. Orders in China declined by 33% over the prior year quarter.

In developed markets such as the U.S., where the macroeconomic situation has become less uncertain, Cisco is performing comparatively much better. However, product transitions in routing and switching have delayed orders as customers review and test out the new equipment before deploying them. The slump has been more evident in the service provider market, where the lag in sales is typically greater than the enterprise market, and the company is shifting its video focus from traditional set-top boxes to the cloud. Last quarter, Cisco saw its service provider orders decline by 10% over the same period last year.

It is therefore a good sign for Cisco that its new routers and switches are seeing a good number of orders flow in, which should bolster revenue growth in the coming quarters. Cisco’s SDN strategy backed by the recently launched Nexus 9000 is gaining significant traction with customers, which was evident from the fact that its client base grew over 50% from the previous quarter. This helped the company in registering positive growth in switching division sales in Q1 FY15, after three quarters of continuous declines. Cisco seems well positioned to reclaim some of its lost market share as the strong order flow translates into revenues, possibly towards the starting of the third fiscal quarter.

Cisco Optimistic On Collaboration Despite Sales Decline

Cisco has slowly but steadily transformed its Collaboration business from a provider of telecom-based services to an integrated architecture combining mobility, software, video and cloud. The highlight of this transition has been its cost-effectiveness and focus on the new dynamics of accessibility and security, enabling people to collaborate and work together from any place using any device. The company offers products under two main categories- TelePresence Systems and Unified Communications. While TelePresence Systems includes products designed to provide high definition video and audio facilities for advanced conference room functionalities, Unified Communications is a collective term for various products such as IP phones, call center and messaging equipment as well as web-based collaborative services.

The Collaboration business sales have declined in the last couple of years owing to a decline in public sector spending in the U.S. as well as in Europe. The company’s gradual shift towards recurring revenue channels driven by software-as-a-service (SaaS) offerings also contributed to the decline, since revenue in such cases is deferred and realized over the term of the agreement.

Overall sales in the Collaboration business declined by 10% y-o-y to $1.82 billion in the fiscal first quarter, with Collaboration sales declining 8% and Service Provider Video sales declining 12%. Although demand for new video products DX70 and DX80 was strong, management stated that there were a lot of pricing pressures which impacted revenues. Cisco remains optimistic on this business and expects it to return to positive sales growth in the near future as it develops more innovative, converged and secure collaboration products.

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Notes:
  1. Cisco Press Release Q1 FY2015 []
  2. Cisco Q1 FY2015 Earnings Transcript, Seeking Alpha, Nov 12 2014 []