Cisco Earnings Preview: Strong Results Expected Following Sustained Revenue Slowdown

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Cisco (NASDAQ:CSCO) is scheduled to report its Q2 fiscal year 2018 earnings on February 14. In recent quarters, the company has reported stagnation in revenue growth, driven primarily by low product sales. Like most IT hardware vendors, Cisco is facing pricing pressure for standalone hardware, resulting in low product revenues and compressing gross margins for the product segment.

The company has given positive guidance for Q2 FY’18, with revenues expected to increase 2% on a y-o-y basis. If Cisco reports revenues in line with guidance, it would be the first quarter in two years with an increase in revenue. The positive guidance for the quarter led Cisco’s stock price to surge by 10% after the company reported earnings in the last quarter. We have created an interactive analysis where we have summarized our Q2 FY’18 expectations for Cisco. You can change expected revenue, gross margin and income margin figures for Cisco to gauge how it will impact expected EPS.

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Improved Guidance For Second Quarter

Cisco’s management gave improved guidance for the fiscal second quarter, with revenues expected to rise by around 2% to $11.8 billion. Cisco expects its non-GAAP gross margin to be around 63% for the quarter, which is a percentage point lower than the second quarter of FY 2017. However, disciplined expense management could help improve the operating profit margin. Cisco expects its operating profit margin to be flat over the year-ago period at 30%. Resulting non-GAAP diluted earnings per share are expected to increase by around 4% on a y-o-y basis to 59 cents a share.  

Key Trends

Cisco has reported little or no growth in core product revenues in recent years, driven by pricing pressure on hardware and a shift of consumer preferences from standalone hardware products. This trend has been evident this year, with low single digit revenue declines across most product streams. Infrastructure Platforms (comprising of routers, switches and wireless equipment) revenue fell 4% y-o-y to just under $7 billion for the quarter. The decline in revenues was attributable to weakness across product segments, particularly the core switching and routing revenue streams.

On the other hand, Cisco’s collaboration segment (renamed Applications) and security segment continued to perform well. The company added around 6,000 new customers in the network security space in the most recent quarter, which was over three times its nearest competitor. Cisco now has over 80,000 customers for its network security solutions. Cisco’s management expects this trend to continue through 2018 as well.

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.

Furthermore, the company reported an improvement in its services gross profit margin in recent quarters. The services gross margin was up by 70 basis points to 66.3% through the three quarter of 2017, 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%.

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