After a year of lackluster results and falling revenue, Cisco Systems (NASDAQ:CSCO) blew the market away with its fiscal second quarter earnings. The stock rose nearly 10% the following day, reaching an eight-year high, as analyst upgrades poured in.
I highlighted some problem areas for Cisco in my earnings preview, and the company made meaningful progress turning around those parts of its business during the quarter. Growth was strong in nearly all of its markets, and CEO John Chambers sounded extremely optimistic during the earnings call. Here is what investors need to know.
Returning to robust growth
Cisco actually returned to revenue growth during the first quarter, but the 1.3% rate was far below the historical pace. During the second quarter, Cisco grew revenue 7% year-over-year, even with the currency-related issues affecting many global companies. Adjusted earnings per share jumped 12.8%, well above analyst estimates.
The switching business, which delivered 30% of the top line, grew revenue 11% year-over-year. Gross margin in the segment remained stable, and the Nexus line of products, Cisco's answer to the software-defined-networking trend, posted strong growth.
Cisco had previously struggled in emerging markets. Sales in these regions grew by 1% overall in the quarter, with areas of strength in Mexico and India. However, some countries are still performing poorly: Russia revenue was down 16%, Brazil fell 8%, and China dropped by 19% during the quarter.
Product orders were strong in both the Americas and Europe, rising by 8% and 7% year-over-year, respectively. Asia, including China and Japan, saw a 6% drop in product orders, with China a major drag on the region.
One of the primary challenges over the past year has been the service provider customer segment. The trouble continued during the second quarter, with product orders dropping by 1% year-over-year, but it is clear the situation is beginning to stabilize. During the first quarter, orders to service providers fell by 10%, so a 1% drop is a substantial improvement. Cisco does not expect growth from the segment for several more quarters.
Product orders overall were strong from all other customer groups, leading to a 5% increase year-over-year. Enterprise orders rose by 10%, public sector orders were up 7%, and commercial orders spiked by 8%, counteracting any weakness from service providers. Cisco has guided for 3% to 5% revenue growth for the third quarter.
Security hits a speed bump and server sales explode
One thing I mentioned in my earnings preview was the security business, which has been growing rapidly. Growth slowed to just 6% during the second quarter, well below the 25% Cisco enjoyed the previous quarter.
Chambers noted that this business will occasionally be bumpy. Cisco reorganized the security business, which contributed to the lower sales growth. Security orders grew by 9% during the quarter, suggesting sales will accelerate going forward. We will have to wait and see if the second quarter was truly an outlier.
The other big growth business, servers, did not disappoint. Sales in the data center segment surged 40% year-over-year, an acceleration from 15% the prior quarter. The server business is now at a $3 billion annual run rate, cementing Cisco a No. 4 spot in the global server market.
Growth in the second quarter really just reversed the declines the company suffered last year. During the second quarter of 2014, both revenue and adjusted EPS declined by 7.8% year-over-year, so Cisco is roughly back where it started.
Every company and industry goes through the occasional downturn, and Cisco has emerged from the difficulties of the past year in a strong position. The vast increase in connected devices anticipated in the near future creates a huge opportunity. And while commodity networking hardware remains a threat to the business, it seems to have had essentially no effect so far.
Cisco remains the dominant player in the switching and routing markets; it has become a major server vendor in just a few short years; and it is in prime position to become a leader in cybersecurity. The company has nearly $50 billion in cash, which it could use to make acquisitions or buy back shares. Its exceptional profitability has remained intact, despite the threats facing its core businesses.
The coming quarters will show whether this return to growth can be sustained. It appears the major problems plaguing the business have largely subsided. It is even possible, if everything goes right, that Cisco can return to the double-digit growth it achieved during most of the past decade. At the very least, the company has demonstrated that its business is far more resilient than the market gave it credit for a year ago.