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Cisco Systems (CSCO - Analyst Report) reported second quarter 2013 earnings of 47 cents share, beating the Zacks Consensus Estimate of 43 cents on higher revenues and lower-than-expected operating expenses. The adjusted earnings per share exclude one-time items, but include stock-based compensation expense.

Revenues

Revenues increased 5.2% year over year and 1.7% sequentially to $12.1 billion. Products (78.0% of total revenue) were up 3.3% year over year to $9.4 billion. Services (22.0% of total revenue) jumped 12.5% year over year to $2.7 billion.

Revenues grew year over year across most of the geographies. The Americas region increased 9% year over year, while Asia-Pacific, Japan and China collectively known as APJC surged 8.0% from the year-ago quarter. Europe, Middle East and Africa (EMEA) declined 5% on a year over year basis due to continued macroeconomic challenges in Europe.

Product Revenues by Category

NGN Routing (16.1% of total revenue), Collaboration (7.8% of total revenue) and Other Product (1.6% of total revenue) segment revenues declined 6.0%, 11.0% and 29.0% year over year, respectively.

However, this decline was fully offset by strong performances from Switching (30.8% of total revenues), Service Provider Video (10.0% of total revenue), Data Center (4.5% to total revenue), Wireless (4.3% of total revenue), Security (2.8% of total revenue), and Service (22.0% of total revenue) segments, which increased 3.0%, 20.0%, 65.0%, 27.0%, 1.0% and 10.0%, respectively.

Orders

Cisco’s total product orders in the quarter remained flat year over year. The APJC region saw the strongest growth at 3%, with the Americas growing 2% and EMEA declining 6% from the year-ago quarter (consistent with broad market trends).

In the APJC region, India again witnessed a growth of over 50%, Japan was up in the mid-single digits, while China was down approximately 4% from the year-ago quarter.

Gross Margin

Reported gross margin for the quarter was 60.7%, down 80 basis points (bps) from 61.5% in the comparable year-ago quarter due to an unfavorable product mix.

Cisco’s operating expenses of $4.4 billion were 4.0% higher than $4.2 billion incurred in the year-ago quarter. Research and development and general and administrative costs were both up as a percentage of sales from the year-ago quarters, while sales and marketing expense declined. The net result was an operating margin of 23.0%, down 70 bps year over year from 23.7% in the year-ago quarter.

Net Income

On a fully diluted GAAP basis, Cisco recorded a net profit of $3.14 billion or 59 cents per share compared with $2.18 million or 40 cents per share in the year-ago quarter. On a pro forma basis, Cisco generated adjusted net profit of $2.51 billion or earnings per share of 47 cents per share in the last quarter compared with $2.31 billion or 43 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 with cash and investments balance of $46.4 billion, down $2.3 billion during the quarter. Trade receivables were$4.46 billion, up from $3.94 billion in the prior quarter.

The company generated operating cash flow of over $3 billion and spent $1.2 billion on share repurchases and dividends.

Guidance

For third quarter of fiscal 2013, Cisco expects revenues to increase in the range of 4% to 6% on a year-over-year basis. 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 of 48 to 50 cents per share.

Our Take

Cisco reported strong second quarter results and its outlook remains positive. However, a sluggish macro-environment is the primary headwind going forward.

It is apparent that Cisco’s focus on various growth businesses including cloud computing, mobile, data center, and others is paying off. Additionally, Cisco’s strategy of pursuing growth opportunities in international markets has helped to deliver positive results. Cisco is already the best entrenched company across the world and despite growing competition from several smaller players, the company appears to be holding its own.

Additionally, the focus on new products and various acquisitions resulted in continued market share gains in the last quarter. Order growth in the last quarter was quite encouraging and the trend is reflective of Cisco’s superior strategy and innovation. 

Of course, competitors like Hewlett Packard Company (HPQ - Analyst Report) and the Chinese company Huawei have manufacturing operations in low-cost countries, which make them more competitive. They are also interested in sacrificing margins for market share gains. This remains a major concern for Cisco in the near term.

Currently, Cisco shares carry a Zacks Rank #2 (Buy). Other stocks in the sector that have been performing well and are worth a look include Autodesk Inc. (ADSK - Analyst Report) and Netflix Inc. (NFLX - Analyst Report), both with a Zacks Rank #2 (Buy).

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