Cisco Systems's (CSCO) latest earnings report is hardly terrible, but it's not exactly stellar either. And with the stock up 17% on the year following a strong January quarter report, markets wanted something more unequivocally positive.
Key Numbers
Cisco reported April quarter (fiscal third quarter) revenue of $12.46 billion (up 4% annually, with the help of M&A and a weak dollar) and non-GAAP EPS of $0.66, slightly beating consensus analyst estimates of $12.43 billion and $0.65. For the July quarter, the company guided for 4% to 6% revenue growth and non-GAAP EPS of $0.68 to $0.70, in-line with a consensus for 5% growth and EPS of $0.69.
Product orders (closely watched) rose 4% annually, after having grown 5% in the January quarter. It helped that orders were down 4% in the year-ago period.
Shares fell 3.6% in after-hours trading to $43.54.
Details
- Boosting EPS: Cisco spent $6 billion on buybacks, up from $4 billion in the January quarter. On the earnings call, CFO Kelly Kramer said Cisco expects to use the $25 billion it has left on its buyback authorization during the next 18 to 21 months.
- Hurting EPS: Non-GAAP operating expenses grew 6% annually, a pickup from the 2% growth. Kramer attributed 4 percentage points of the growth to the AppDynamics and BroadSoft acquisitions.
- Also hurting EPS: Gross margin fell 80 basis points to 64.4%, partly due to high DRAM prices. In comments that Micron (MU) investors won't object to, Kramer said memory prices continue to rise, albeit at a slower pace than before.
- Enterprise product order growth improved to 11% from the January quarter's 3%. But Commercial order growth (driven by small and mid-sized businesses) fell to 7% from 14% and Service Provider orders (hurt by weak capital spending) fell once again, dropping 4%. Public Sector orders grew 2%.
- Cisco is still seeing good momentum for its Catalyst 9000 switch family (launched last June) and the subscription offerings enabled by it. Catalyst 9000 customers rose by another 2,700 to over 5,800, and the company says "the vast majority" of buyers are opting for its costlier DNA Advantage subscription bundles.
- Total switching revenue grew, but Cisco doesn't say by how much. Routing revenue fell due to weak service provider demand (again, no figure is given).
- Cisco's "Data Center" business (servers and storage) improved last quarter, posting double-digit growth with the help of an Intel (INTC) CPU upgrade cycle and efforts to pass higher memory prices on to clients. Security revenue rose 11% (a little better than expected), and "solid growth" is claimed for Wi-Fi sales.
- Software momentum remained strong, though it's worth keeping in mind growth rates were boosted by acquisitions. Total "Applications" revenue rose 19% to $1.31 billion, and Cisco's deferred product revenue balance related to software and subscriptions grew 29%. Total deferred revenue -- sales that Cisco has received payment for, but hasn't yet recognized as revenue on its income statement -- grew 9% to $19 billion.
Cisco's product order trends are a mixed bag.
Analysis
On the whole, Cisco still isn't growing a lot. As the company notes, its revenue growth rates would be a little higher if not for a shift towards subscriptions and other recurring revenue streams relative to up-front product sales. On the other hand, growth would be lower if not for acquisitions, forex and a healthy IT spending environment.
Moreover, with the dollar having begun to strengthen and Cisco having lapped the 1-year anniversary of the AppDynamics acquisition in March, forex and M&A might not provide the same kind of lift going forward. And though buybacks will continue, it's unlikely that Cisco will be buying back $6 billion worth of stock each quarter to boost EPS.
CEO Chuck Robbins and the rest of Cisco's leadership deserves credit for understanding the need to grow the company's software and services exposure given the long-term competitive and secular pressures faced by core hardware franchises, and for trying to do so via both M&A and (as the recent Catalyst refresh shows) new offerings that play nice with those hardware franchises. But for now, these efforts are largely just serving to offset hardware pressures rather than produce strong growth.
The ongoing Service Provider order declines are telling, since these orders cover not only telcos and pay-TV providers, but also cloud giants (Alphabet/Google (GOOGL) , Facebook (FB) , Amazon (AMZN) , etc.) that are rapidly growing their capital spending. Though Cisco has been trying hard to grow its exposure to U.S. and Chinese cloud giants, it still looks as if they only account for a small percentage of total sales and orders (the same isn't true for fast-growing switch rival Arista Networks (ANET) ).
It was a little easier to brush off such concerns when Cisco was trading in the low-30s last summer, and its stock could credibly be called a value play. But it's harder now that the stock is in the 40s. Following its post-earnings selloff, Cisco still trades for 16 times a fiscal 2019 (ends in July 2019) EPS consensus of $2.86.
Much like the company's latest earnings report, that valuation isn't awful, but not one to get excited about either, given the mixture of positives and negatives found in Cisco's story.
