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The Good and the Bad in Cisco Systems' Earnings Report

By Timothy Green - Feb 13, 2016 at 3:07PM

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The networking giant posted a solid quarter, but there were some weak areas that investors should keep an eye on.

With investors expecting disappointing numbers from Cisco Systems ( CSCO 2.04% ), the company surprised when it reported its fiscal second-quarter results. Cisco beat analyst estimates for both earnings and revenue, provided revenue guidance that exceeded analysts' expectations, boosted its quarterly dividend by 24%, and added $15 billion to its share buyback program. But even though its stock surged the next day, it wasn't all good news for Cisco. Here's a look at the good and the bad in Cisco's second-quarter earnings report.

Image source: Cisco.

The good
Cisco managed to post year-over-year revenue growth of 2%, adjusted for the sale of its set-top box business, hitting the high end of its previous guidance. Adjusted revenue of $11.93 billion came in $170 million higher than the average analyst estimate, driven by strength in the Asia-Pacific region. Non-GAAP EPS came in at $0.57, which was $0.03 better than analyst expectations.

During the quarter, revenue adjusted for the sale of the set-top box business rose in all three of Cisco's geographic regions, but Asia was a standout. Revenue in the Americas and the Europe, Middle East, and Africa regions rose by 1% year over year. Revenue in Asia, including China and Japan, jumped an impressive 11%, despite macroeconomic headwinds and a strong dollar. Product orders in China rose 64% during the quarter, following a 40% rise in the previous quarter.

Last year, Cisco announced a $10 billion multiyear investment in China, made in an effort to win back business from local competitors. That effort appears to be paying off, although it's too early to tell whether growth in China is here to stay.

Cisco's security business, which has been growing by single-digit percentages in recent quarters, picked up the pace during the second quarter. Security revenue was up 11% year over year, while deferred revenue related to security jumped 26%. Last quarter, Cisco stated that it expects the security business to grow by a mid-teens percentage during the second half of fiscal 2016.

Beyond Cisco's second-quarter results, the company expects third-quarter revenue to grow by 1% to 4% year over year, adjusted for the set-top box business, well above analyst expectations of a 1% decline. Non-GAAP EPS is expected between $0.54 and $0.56, in line with analyst expectations.

Cisco's dividend is also getting a boost, with the company raising its quarterly dividend payment by 24% to $0.26 per share. Cisco also added $15 billion to its share buyback program, raising its total available funds for buybacks to $16.9 billion.

The bad
Despite all of this good news, Cisco's results weren't universally positive. The core switching business suffered a 4% year-over-year decline in revenue, driven by macroeconomic uncertainty that has delayed spending decisions from customers. Growth in the collaboration business slowed dramatically, with revenue rising just 3% year over year, compared to 17% growth during the first quarter.

The biggest piece of bad news, though, was a 3% decline in data center sales. Cisco's data center business, which includes its UCS servers, has been the fastest growing segment for Cisco for quite some time, and during the first quarter, it produced 24% year-over-year growth.

This reversal is troubling, as it might be a sign of a broader slowdown in IT spending. Part of the problem was a tough comparison, with data center revenue having risen 40% during the prior-year period. But macroeconomic uncertainty is certainly a major issue, and customers may be delaying investments in new infrastructure.

A decent quarter for Cisco
Cisco managed to beat pessimistic expectations, and overall, the company's results were solid. As a Cisco shareholder, I'm happy about the dividend raise, but the drop in data center sales is concerning.

One thing to note is that Cisco doesn't disclose how much currency fluctuations affects its results. Other large technology companies are seeing major negative impacts, and the fact that Cisco is still growing revenue despite currency issues is impressive. The growth in China is also a big positive, and while the strength of the Chinese economy is a wild card going forward, Cisco's investments in that country seem to be paying off.

2016 will be a challenging year for Cisco as it navigates the current macroeconomic environment, but so far the company seems to be doing a good job growing revenue and maintaining profitability despite these issues.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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