After Wednesday's close of trading, Cisco Systems (CSCO) reported its fiscal second quarter earnings. There were some questions about Cisco's quarter coming in after several firms in the space had warned. In early January, Acme Packet (APKT) warned that its quarter would be weak, and just a week later, Juniper Networks (JNPR) also announced numbers would be below expectations. We also have heard disappointing results out of Riverbed Technologies (RVBD). The song remained the same between the firms, blaming North American service provider weakness.
Obviously, Cisco is the largest name in the space, and it was able to shake off any weakness that existed. The company reported a very strong quarter, and announced it would be raising its dividend, which was expected with this quarter. Let's get into the numbers.
Cisco divides its reporting into two segments, one for product sales and one for service sales. We'll start with product sales first. The following table (and one for services later) show the second quarter results for the segment, in the quarter ending during that year. Their fiscal second quarter (this one) ended in January 2012.
|Gross Margin %||62.75%||64.71%||58.94%||59.97%|
Year over year, product sales were up 10.7%. Even better, the cost of those products was only up by 7.9%. That allowed gross margin dollars to increase by 12.65%, bumping up gross margins for the segment by an entire percentage point. The products segment did well, but the services segment did even better.
|Gross Margin %||63.89%||63.68%||64.81%||66.29%|
Sales of services were up almost 11% year over year. Again, Cisco was able to keep costs in check for the segment, which only rose 6.3% over last year's period. That helped gross margin dollars to increase by 13.5%, and margins to increase by almost 150 basis points, a huge increase. Service sales have become a larger part of Cisco's revenue stream, increasing from 18.74% in fiscal 2010's second quarter to 20.9% in this recent period. While the two plus percent doesn't seem like a major jump, in percentage terms, it is an 11.54% increase.
Here is Cisco's key financial data for the quarter:
I've already detailed the segment revenue numbers, so let's look at the total numbers now. Revenues increased by 10.76% to $11.527 billion, handily beating analyst estimates of $11.23 billion. Thanks to the gross margin increases in each segment, total gross margin dollars increased by more than $800 million, or 12.84%.
But the real difference came between the gross margin and operating income areas. Cisco cut back on some if its spending, giving a huge boost to operating income. Now remember, total revenues increased by almost 11% for the quarter. Cisco, however, cut R&D spending by more than 9%, a decrease of $150 million. The company also lowered sales and marketing expenses by 2%, a decrease of nearly $50 million. Amortization expense for the quarter also decreased by $106 million, which was a drop of more than 52 percent.
While gross margin dollars were up by a little less than 13%, operating income jumped by more than 62% thanks to the above mentioned cuts. However, Cisco's "other income" (including interest income, expense, etc.) dropped by $30 million, and their effective tax rate for the quarter jumped from 12.08% to 20.63%.
The tax rate increase and other income decline led to net income only being up 43.46% to the quarter, which equated to $2.182 billion. Cisco reported GAAP net income of $0.40 per share. Non-GAAP earnings per share came in at $0.47, beating analyst expectations by four cents.
To summarize, Cisco did well in the quarter. They kept costs in check, and lowered some of their expenses. A higher tax rate hurt the bottom line a little, but they still beat on both the top and bottom line.
The following quote from CEO John Chambers summarizes how Cisco is doing at present:
We are executing well on our three year plan to drive earnings faster than revenue...we hit our billion dollar expense reduction a quarter early.
Margins & Financial Guidance:
The following chart shows their quarterly margins over the past four fiscal second quarters.
Margins took a hit for the company in 2011 but have come back strong this year. Cisco's profit margin for the second quarter was higher than any of the past three. If Cisco can keep their costs in check, they may be able to hit 20% profit margins for this quarter next year.
During the conference call, Cisco gave the following guidance:
- Revenue growth for the fiscal third quarter to be 5% to 7% over prior year's period, which is in-line to above the current expectations for 5.5% growth.
- Earnings per share guidance of $0.45 to $0.47, which is in-line to above expectations of $0.45.
Dividend Increase, Share Buyback, Financial Flexibility:
Cisco announced it was increasing its quarterly dividend to 8 cents a share, up 2 cents from prior payments. At $0.32 per year, Cisco is now yielding approximately 1.6%. Remember, the company only started its dividend plan last year. It is worth noting that the mentioned above names in the space, Acme Packet, Riverbed Technologies, and Juniper Networks do not pay any dividends.
During the quarter, Cisco re-purchased 26 million shares of its stock for an average price of $17.84, a total buyback of $466 million. Since the start of their buyback program, Cisco has retired 3.6 billion shares at an average cost of $20.47, basically even to where the stock closed on Wednesday. Cisco has been criticized heavily for its buyback program, which has been called extremely ineffective. Cisco has spent $73.8 billion on buybacks so far, and still has $8.2 billion remaining on the current program.
Cisco's financial flexibility has improved through the first six months of their fiscal year. They have increased their current ratio from 3.27 to 3.37, resulting in a working capital increase of $1.975 billion. Their liabilities to assets ratio has also improved over that time, from 45.74% to 44.81%. The increased financial flexibility will allow buybacks to continue over time and dividends to increase in future years.
Overall Opinion - Wait For a Pullback:
Cisco's stock is at multi-month highs currently, which reflects the improvements they've made over the past year. The dividend increase will encourage more value investors into the name, and buybacks should add some of a cushion to share price. Cisco has done quite well over the past few months, and has done much better than its peers over the past year, as you can see below.
Cisco has done extremely well recently with this earnings report being the third good one in a row. Investors have called Cisco dead money for some time now, but I wouldn't call a big name that's up nearly 50% in just six months dead money.
However, with Cisco up so much lately, I would wait for a pullback before entering. Last time I recommended Cisco, at $18, I said wait till it pulled back to $17. It did. This time, I would wait until we get back below $20 at least, although I would prefer the $18 to $19 range if we get there. Cisco is doing better and the increasing dividend makes it more attractive, but get in at a price that makes sense.