An Overview Of Cisco’s 2017 Performance

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Cisco (NASDAQ:CSCO) has reported a decline in revenues this year, driven largely by low core product sales. The networking giant is facing pricing pressure for standalone hardware, resulting in low product revenues and compressing gross margins for the product segment. In order to battle stagnating hardware sales, Cisco has made large investments in fast-growing networking domains such as software-defined networking, and has also increased its revenue dependence on its network security, data center and collaboration segments.

The company has provided strong guidance for the current quarter, with an expected 2% revenue growth after nearly two straight years of quarterly revenue declines. As a result, Cisco’s stock price surged nearly 10% after the company announced earnings last month. We maintain our $32 price estimate for Cisco, which is now around 15% lower than the current market price.  You can modify the interactive charts in this note to gauge how a change in individual drivers can have on our price estimate for Cisco.

See our full analysis of Cisco

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Product Revenues Stagnate

Cisco’s realigned its segments in the most recent quarter, with the routing, switching, wireless and data center product streams combining to form the Infrastructure Platforms segment. We have estimated the revenue split among these segments for the first half of the year based on the information provided by the company on its earnings call. Combined sales for Infrastructure Platforms fell 3% over the comparable prior year period to just under $21 billion, as shown below.

Similarly, the Applications segment (which is comprised of collaboration and unified communications) were also down 3%, according to our estimates. However, in the fiscal first quarter ended October, Cisco reported 6% growth in Applications revenues.

On the other hand, Network Security solutions revenues have continued to grow at a steady pace. Network Security revenues have increased 7% through the three quarters of the year to $1.7 billion. Over the years, it has become an increasingly important component of networks, as enterprises look to safely share data between geographically separate individuals and teams. This has benefited Cisco in recent years, with the company reporting double digit annual revenue growth in security revenues from 2014 through 2016. We forecast this trend to continue in the coming years with high single digit revenue growth in the network security domain.

Cisco’s services have grown at a consistent pace over the years due to the increasing mix of service and subscription-based solutions on offer. Post-sales services and subscription-based revenues are more beneficial to Cisco since they are annually recurring revenues, compared to the lumpy demand caused by product life cycles extending for multiple years. Despite steady growth in previous years, services revenues stagnated to around $9.2 billion through the year.

Despite low revenue growth from the services segment, the company reported an improvement in its services gross profit margin, as shown above. The services gross margin was up by 70 basis points to 66.3%, partially offsetting the negative impact of declining product gross margins. Cisco’s company-wide gross margin was down by 160 basis points over previous year levels to 62.1%.

The impact of lower gross margins was partially offset by roughly flat operating expenses this year. Cisco’s operating expenses, including R&D and SG&A expenses, through the first three quarters were lower than previous year levels. Consequently, its adjusted EBITDA margin was only around 50 basis points lower than 2016 at 29.3%. Further, Cisco’s net income and earnings per share have remained flat over the comparable prior year period.

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