Information technology bellwether Cisco Systems (NASDAQ:CSCO) delivered a good set of first-quarter fiscal 2016 results, but by management's own admission, its second-quarter guidance was lower than market expectations. The company blamed this on a combination of adverse foreign exchange issues and macro-economic challenges. However, there is a lot more going under the surface of these results, so let's take a closer look.

Cisco Systems first-quarter results: The raw numbers
Total revenue growth of 3.6% came in near the top end of management's 2% to 4% guidance range, while non-GAAP EPS rose 9.3% to $0.59 and was ahead of the $0.55 to $0.57 forecast on the first-quarter earnings call. Non-GAAP net income rose 7.9% year over year. As you can see below, product sales growth outpaced services growth in the quarter.

 RevenueGrowthGross ProfitGross Margin

Product

$9,844

4.3%

$5,991

60.9%

Service

$2,838

1%

$1,841

64.9%

Total

$12,682

3.6%

$7,832

61.8%

Data source: Cisco presentations. Dollar figures in millions.  

Meanwhile, deferred revenue -- important because it measures advance payments for services or products that haven't been delivered yet -- continued to grow at a double-digit rate with 10.3% growth in the quarter.

Cisco

Data source: Cisco presentations. Figures in millions of dollars.

Turning to revenue growth by product line, as the graph below indicates, it was clearly a difficult quarter for its next-generation network routing business, where revenue declined 8%. Switching (up 4.6%) and NGN routing are Cisco's core product lines, representing 30% and 16% of 2015 sales, respectively. Moreover, as noted earlier, services growth of 1% was a notable slowdown from previous quarters.

This chart of yearly revenue growth by quarter shows the trends in Cisco's businesses.

Cisco

Data source: Cisco presentations. Growth figures on a year-on-year basis.

Now, the all-important second-quarter guidance:

  • Revenue growth will be in the range of 0% to 2%, compared to last year's second quarter.
  • Non-GAAP EPS forecast to be $0.53 to $0.55, compared to last year's second-quarter figure of $0.54.

The revenue guidance represents a slowdown in growth, which CEO Chuck Robbins outlined in the earnings release. "We guided to solid growth in Q2. Our guidance reflects lower than expected order growth in Q1, driven largely by the uncertainty of the macro environment and currency impacts."

What happened with Cisco Systems in the quarter

  • Weakness in service revenue growth was "largely isolated" to service providers, according to CFO Kellly Kramer on the earnings call.
  • The services segment's deferred revenue was up 7% in the quarter.
  • Robbins claimed routing weakness was a "timing issue" related to the introduction of new products due soon, and feels "pretty reasonably well about our routing performance over the coming quarters."
  • Switching revenue will pass an "inflection point" in the second half as next-generation data center switching revenue offsets declines in historical data center switching, according to Robbins.
  • Enterprise orders declined 3% in the quarter due to "macro challenges," with management signaling weakness outside the U.S. "and particularly in Asia-Pacific." Canada and Latin America were also weak.
  • Public sector orders were flat, with service provider up 6% and commercial up 7%. Total orders were up 3% in the quarter.
  • Free cash flow of $2.5 billion was up 13.5% compared to the same period last year, and represents 83% conversion from non-GAAP net income.

Looking ahead
Cisco can't do much about the macro environment, but investors should keep an eye on U.S. enterprise growth in the coming quarter. Robbins declared he was "very comfortable with the situation," but any deterioration would indicate that Cisco's issues go beyond the economic slowdown in emerging markets.

On a granular level, management expects NGN routing growth to improve as new products are sold, and services revenue should improve, given the 7% increase in deferred revenue. Like many other companies exposed to emerging markets, Cisco needs to adjust to a lower level of growth in the coming quarters.

Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.