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Cisco Systems (CSCO - Analyst Report) reported third-quarter 2013 earnings of 48 cents a share, beating the Zacks Consensus Estimate of 45 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 0.8% sequentially to $12.2 billion. Products (78.2% of total revenue) were up 5.5% year over year to $9.6 billion. Services (21.8% of total revenue) jumped 8.0% year over year to $2.7 billion.

Revenues decreased year over year across most of the geographies except Americas. The Americas region increased 10.2% year over year, while Asia-Pacific, Japan and China collectively known as APJC decreased 0.2% from the year-ago quarter. Europe, the Middle East and Africa (EMEA) also declined 0.9% on a year-over-year basis due to continued macroeconomic challenges in Europe.

Product Revenues by Category

Switching (29.5% of total revenue), Collaboration (8.3% of total revenue), Security (2.7% of total revenue), and Other Products revenues declined 2.0%,1.0%, 4.0% and 41.0% year over year, respectively. NGN Routing, which accounted for 17.5% of total revenue, was flat year over year.

However, this decline was fully offset by strong performances from Service Provider Video (10.6% of total revenue), Data Center (4.2% of total revenue), Wireless (4.3% to total revenue) and Service (21.8% of total revenue) segments, which increased 30.0%, 77.0%, 27.0%, 7.0%, respectively.

Orders

Cisco’s total product orders in the quarter were up 4% year over year. The Americas region saw the strongest growth at 7%, APJC orders increased 1% while EMEA and Russia declined 6% from the year-ago quarter (consistent with broad market trends).

In the APJC region, Japan again witnessed strong growth, while China continues to see challenges related to the business environment.

Gross Margin

Reported gross margin for the quarter was 61.5%, down 60 basis points (bps) from 62.1% in the comparable year-ago quarter due to an unfavorable product mix.

Cisco’s operating expenses of $4.5 billion were 4.7% higher than $4.3 billion incurred in the year-ago quarter. However, all three expenses, research & development, general & administrative and sales & marketing declined as a percentage of sales from the year-ago quarters. The net result was an operating margin of 23.8%, down 30 bps from 24.1% in the year-ago quarter.

Net Income

On a GAAP basis, Cisco recorded a net profit of $2.5 billion or 46 cents per share compared with $2.2 billion or 40 cents per share in the year-ago quarter. On a pro forma basis, Cisco generated adjusted net profit of $2.59 billion or earnings per share of 48 cents per share in the last quarter compared with $2.34 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 the quarter with cash and investments balance of $47.4 billion, up $1.0 billion during the quarter. Trade receivables were $4.94 billion, up from $4.46 billion in the prior quarter.

The company generated operating cash flow of over $3.1 billion and spent $1.8 billion on share repurchases and dividends.

Share Repurchase & Dividend

During the quarter, Cisco repurchased approximately 41 million shares of common stock under the stock repurchase program at an average price of $20.85 per share for an aggregate purchase price of $860 million.

The company paid a cash dividend of $0.17 per common share, or $905 million.

Guidance

For the fourth quarter of fiscal 2013, Cisco expects revenues to increase in the range of 4% to 7% 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 27.5%–28.5% of revenues. The company expects a non-GAAP tax rate of 21%, yielding non-GAAP earnings of 50 to 52 cents per share. GAAP earnings are expected in the range of 7 to 10 cents.

Our Take

Cisco reported strong third-quarter results and its outlook remains positive. Both the top and bottom-line results exceeded the prior-year figures.

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.

Order growth in the last quarter was quite encouraging and the trend is reflective of Cisco’s superior strategy and innovation. Increasing strength in data center and wireless businesses will help to maintain the company’s strength.

Additionally, the focus on new products and acquisitions resulted in continued market share gains. In this quarter, the company completed the divestiture of Linksys, continued NDS integration and announced two more acquisitions in order to deliver top-line growth and profitability.

Others 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 carries a Zacks Rank #4 (Sell). Other stocks that have been performing well and are worth a look include Hasbro Inc. (HAS - Analyst Report) and Netflix Inc. (NFLX - Analyst Report), both with a Zacks Rank #2 (Buy).

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