Key Takeaways From Cisco’s Earnings

Networking giant Cisco (NASDAQ:CSCO) announced its Q1 fiscal year 2017 earnings on November 16, reporting a 3% decline in revenues to $12.4 billion. ^[1] The decline was attributable to the company selling off the Service Provider Video CPE (SP Video CPE) business in November of last year. Excluding the impact of the SP Video CPE revenues, Cisco’s net revenues were up by 1%. Moreover, a favorable product mix of data center and collaboration products, complemented by an increasing mix of service-based revenues, led the gross margin (non-GAAP) to improve by 2 percentage points to 65.2% for the quarter. Higher gross margins were also attributable to spinning off some low-margin businesses, particularly the SP Video CPE segment. In addition, the operating margin (non-GAAP) for the quarter stood at 31.6%, over a percentage point higher than the comparable prior year period as shown below. Improved margins for the quarter led to a better than expected diluted earnings per share of 61 cents a share.

The company derives a huge chunk of its revenues from selling networking and telecom hardware, with revenues growing at very modest rates over the last couple of years. Comparatively, software solutions and other network security solutions sold by Cisco have performed well in recent years. Moreover, service-based revenues have also grown at a steady pace to offset the stagnating revenues from hardware sales. This trend was evident in the most recent quarter, as well as for the three quarters of the current year thus far.

Network Switching revenues have fallen at around 3% for the year while NGN routing revenues have risen by around 1% for the year. In the most recent quarter, Routing revenues were up by 6% y-o-y to $2.1 billion driven by strong performance from both SPCORE and Edge routers. Data center product revenues were down 3%, primarily due to the transition in customer preferences from blade servers to rack servers. This could be a challenging area for Cisco given its strength in blade servers. Similarly, wireless revenues also fell by 2% during the quarter to $632 million due to a decline in demand for controllers during the quarter. ^[2]

Comparatively, the services division continued to drive Cisco’s net revenues, with 7% annual growth in revenues to $3.1 billion. This mirrored the trend in the year thus far, with combined services revenues in three quarters increasing by 8% y-o-y to $9.3 billion.

Weak Outlook For Q2 FY 2017

Cisco’s management gave conservative guidance for the upcoming quarters, with revenues and margins expected to decline. ^[2] Low product sales could continue to be a challenge for Cisco, with Q2’17 revenues expected to be 3% lower on a y-o-y basis to $11.6 billion. Among the product divisions, routing and switching revenues could witness limited growth while data center products and collaboration segments combined with Cisco’s strength in cloud capabilities, network security, IoT, Software-as-a-Service (SaaS) and analytics could help drive revenues. We have a $30 price estimate for Cisco, which is roughly in line with the current market price.

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1. Cisco Reports First Quarter Earnings, Cisco Press Release, November 2016 [↩]
2. Cisco Q1 2017 Earnings Call Transcript, Seeking Alpha, November 2016 [↩] [↩]