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What to Expect When Cisco Systems Inc. Reports Earnings

By Timothy Green - Feb 8, 2016 at 2:21PM

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The networking company expects weak revenue growth during the second quarter, driven by economic uncertainty and currency issues.

Networking giant Cisco Systems (CSCO -0.09%) is set to report its fiscal-second-quarter results after the market close on Wednesday, Feb 10. The company has posted a string of solid quarters, with revenue returning to growth after a difficult fiscal 2014, and while the core businesses are growing slowly, Cisco's data center, collaboration, and security segments are growing much faster than the company as a whole.

Expectations are low going into Cisco's report, and the stock has slumped nearly 20% over the past three months. Cisco's guidance for the second quarter is light, with the company expecting year-over-year revenue growth of just 0% to 2%, compared with the low- to mid-single-digit growth the company has been reporting in recent quarters. Cisco blamed macroeconomic uncertainty for the guidance, an excuse that countless technology companies have used to justify cautious outlooks.

Source: Cisco.

What analysts are expecting
Analysts are a bit more pessimistic about Cisco's second quarter than the company itself. The average analyst estimate calls for a year-over-year revenue decline of 1.5%, bringing the total quarterly revenue to $11.76 billion. For the full fiscal year, which ends in July, analysts expect flat revenue, with growth returning in fiscal 2017.

Cisco's guidance for non-GAAP EPS for the second quarter is a range of $0.53 to $0.55, and the average analyst estimate splits the difference at $0.54. This estimate represents slight earnings growth over the $0.53 per share that Cisco reported during the prior-year period. Even without much revenue growth, the effect of share buybacks could push Cisco's per-share numbers higher. During the first quarter alone, Cisco spent over $1.2 billion on share buybacks.

Following Cisco's first-quarter report, some analysts suggested that Cisco's problems run deeper than economic uncertainty. Ryan Hutchinson of Guggenheim Securities believes that Cisco's weak enterprise outlook is due in part to uncertainty around future network architectures. As an increasing number of organizations move to the cloud, Cisco will need to adapt to maintain its dominant market share.

Another analyst, Rajesh Ghai of Macquarie, is concerned that network function virtualization, or NFV, will put pressure on Cisco's networking hardware business by causing price deflation. Cisco enjoys gross margins of around 60%, and while new networking technologies such as software-defined networking and NFV have so far not had much of an effect on Cisco's business, that may not remain true in the long run.

Key things to look for
Cisco managed to grow sales in all of its geographic regions during the first quarter, and in emerging markets, where Cisco has had trouble in the past, sales grew by 11% year over year. Sales to service providers, another recent problem area for Cisco, grew by 6% during the first quarter, while enterprise sales slumped 3% due to macroeconomic uncertainty.

Investors should keep a close eye on sales to emerging markets during the second quarter. The strong growth during the first quarter represented quite a turnaround. During the first fiscal quarter of the previous year, sales to emerging markets slumped 6%, with China down 33% and the BRICs plus Mexico down 12%. During the first quarter of this year, BRICs plus Mexico posted 21% growth, and while Cisco didn't report China sales growth, the company did state that orders grew by 40%. Both currency and economic uncertainty could undo the progress Cisco has made in these markets.

Investors should also keep an eye on Cisco's major growth businesses, namely data center and security. The data center segment, which grew by 24% year over year during the first quarter, contains the company's UCS server business. Cisco has been gaining market share for years, and currently the company is the no. 5 server vendor in the world.

In the security business, Cisco's recent growth has been slow, with revenue growing by just 7% year over year during the first quarter. But Cisco expects sales growth to pick up during the second half of this year, accelerating to a mid-teens percentage. The company has made a slew of acquisitions in the area, including OpenDNS and Lancope, and with the average large enterprise having over 50 security vendors, further consolidation is inevitable. Cisco aims to emerge from this round of consolidation as a leading provider of security solutions.

If Cisco matches its guidance, the second quarter will be the weakest quarter for the company in some time. Guidance for the third quarter should shed some additional light on whether the problems facing Cisco are truly transitory, or if the company is up against the serious long-term issues that some analysts are predicting.

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