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Cisco Systems (CSCO - Analyst Report) reported second-quarter fiscal 2014 earnings of 42 cents a share, beating the Zacks Consensus Estimate by a penny. The adjusted earnings per share exclude one-time items but include stock-based compensation expenses.

Revenues

Revenues decreased 7.8% year over year and 7.4% sequentially to $11.2 billion. However, revenues were slightly above the Zacks Consensus Estimate of $11.1 billion.

Products (75.5% of total revenue) were down 10.7% year over year to $8.4 billion, while Services (24.5% of total revenue) rose 2.7% year over year to $2.7 billion. Product book-to-bill ratio was greater than 1 in the last quarter.

Revenues decreased sequentially across all geographies. The Americas, Europe, Middle East and Africa (EMEA) and Asia-Pacific, Japan and China (collectively known as APJC) declined 11.7%, 1.3% and 2.0%, respectively.

Product Revenues by Category

Switching (29.0% of total revenue), NGN Routing (16.0% of total revenue), Service Provider Video (9.0% of total revenue), Collaboration (8.0% of total revenue), Wireless (5.0% of total revenue), Service (24.0% of total revenue) and Other Products (1.0% of total revenue) declined 12.9%, 14.8%, 3.0%, 14.2%, 5.4%, 1.6% and 20.0% year over year, respectively.

However, this decline was partially offset by strong performances by Security (4.0% of total revenue) and Data Center (5.0% of total revenue) segments, which increased 7.7% and 0.7%, respectively.

Orders

Cisco’s total product orders in the quarter were down 4% year over year. The U.S. enterprise and commercial sector went up 13%, which was partially offset by the 3% order decline in emerging markets and 12% in service provider.

On a geographical basis, the Americas declined 5% and EMEA and Russia decreased 2% from the year-ago quarter. Northern Europe and the U.K. continued to show positive growth, while southern Europe continued to be challenging.

APJC orders decreased 5% due to macroeconomic challenges. In the APJC region, China declined 8% as it continues to see challenges related to the business environment.

Gross Margin

Reported gross margin for the quarter was 53.3%, down 800 basis points (bps) sequentially and 740 bps from 60.7% in the comparable year-ago quarter due to unfavorable product mix and lower volumes.

Cisco’s operating expenses of $4.3 billion decreased 4.6% year over year. Research & development and sales & marketing expenses increased as a percentage of sales from the year-ago quarter, while general & administrative expenses declined. The net result was an operating margin of 14.9%, down 840 bps sequentially and 820 bps from 23.1% in the year-ago quarter.

Net Income

On a GAAP basis, Cisco recorded a net profit of $1.43 billion or 27 cents per share compared with $3.1 billion or 59 cents in the year-ago quarter. On a pro-forma basis, Cisco generated adjusted net profit of $2.26 billion or earnings per share of 42 cents in the last quarter compared with $2.93 billion or 55 cents in the year-ago quarter.

Our pro-forma figure excludes certain one-time items but includes stock-based compensation expenses.

Balance Sheet

Cisco ended the second quarter with cash and investments balance of $47.1 billion, down $1.1 billion during the quarter. Trade receivables were $4.38 billion, down from $5.19 billion in the prior quarter. Total debt (short-term and long-term debt) was $17.15 billion versus $16.23 billion in the prior quarter. Including other long-term liabilities, the debt to total capital ratio was 25.1%.

The company generated operating cash flow of $2.9 billion and spent $0.26 billion on capital expenditure.

Share Repurchase & Dividend

During the quarter, Cisco repurchased shares worth $4 billion and paid a total dividend of $896 million.

Cisco has also announced its decision to hike quarterly dividend by 2 cents to 19 cents per share. This dividend will be paid on Apr 23, 2014 to all shareholders of record as of the close of business on Apr 3, 2014

Guidance

For the third quarter of fiscal 2014, Cisco expects revenues to decrease in the range of 6% to 8% on a year-over-year basis, while Zacks Consensus revenue estimate is pegged at $11.3 billion. Non-GAAP gross margin is expected to be 61%–62% and non-GAAP operating margin is expected to be 26.5%–27.5% of revenues. The company expects a non-GAAP tax rate of 21%, yielding non-GAAP earnings per share of 47 to 49 cents. The mid-point of the company guidance is better than the Zacks Consensus Estimate of 44 cents.

For fiscal 2014, non-GAAP earnings are expected in the range of $1.95 to $2.05 per share.

Our Take

Despite growing competition from several smaller players, Cisco appears to be strong in its domain. The company reported decent second-quarter results with both the top and bottom lines exceeding the Zacks Consensus Estimate, reflecting Cisco’s superior strategy and innovation.

However, the weakness in few of its product segments, emerging markets weakness and product transition challenges contained growth in the last quarter. Also, the order growth in the last quarter was quite weak which impacted the revenue guidance for the third quarter.

However, the increase in dividend indicates that the company is heading toward strong future growth. Though the company’s margins have been suffering, areas like cloud computing, mobile, data center, and others are witnessing strong growth, which will likely mitigate the margin slowdown, going forward.

Cisco shares carry a Zacks Rank #3 (Hold). Other stocks that are performing well at current levels include Melco Crown Entertainment Limited (MPEL - Snapshot Report), Silicom Ltd. (SILC) and Brocade Communications Systems, Inc. (BRCD - Snapshot Report). All these stocks sport a Zacks Rank #1 (Strong Buy).

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