Networking equipment and software provider Cisco Systems (CSCO – Free Cisco Systems Stock Report) reported largely in-line results for the fiscal fourth quarter ended July 28, 2018. First-quarter guidance was also as expected. The company notched its third-consecutive quarter of year-over-year revenue growth and investors are rewarding the consistency.
Adjusted earnings per share of $0.70 matched our estimate and increased 15% compared to the 2017 quarter. The growth was considerably higher than the 10% rate experienced in the first period.
Record revenue of $12.8 billion was slightly better than our $12.7 billion call, and 5.9% higher year over year. Strength was broad based across geographies, product categories, and customer segments, and acquisitions contributed 90 basis points of the advance. Total product sales increased 7%, and service revenue rose 3%. Product orders were up 7% and the product backlog grew 38% year over year.
Total gross margin was down 80 basis points, with product gross margin declining at half that rate, driven by some specific Asian service providers. The company indicated memory pricing continues to increase product costs. We are optimistic this will reverse course soon, considering many industry experts are forecasting DRAM and flash supply constraints to ease and prices to normalize over the intermediate term.
Meanwhile, Cisco continues to make progress transitioning to a more software-centric company, as the recurring-revenue-to-total-revenue ratio increased one point from a year ago, to 32%. Deferred revenue grew 6% and deferred plus unbilled deferred grew 28%. The latter comes mostly from collaboration and application businesses with substantial periodic month-to-month billings that Cisco has booked, but not recognized on its balance sheet. Subscription-based products were responsible for 56% of total software sales, up 5% year over year. The company will focus on implementing the model for its enterprise networking hardware/software offerings in the coming quarters but, the strategy of bundling software subscriptions with physical equipment should eventually be adopted across categories.
Taking a look at the performance of the various customer segments, Enterprise grew 11%, Commercial was up 9%, and Public Sector rose 1%. Revenue from the Service Provider group was up 6%, well above the negative 4% result in the April quarter. Management tempered our initial exuberance by revealing that deal timing was a primary driver. The business' revenue cadence is erratic by nature, and multiple tier-1 customers happened to be spending on infrastructure around the same time. It was also made clear that Cisco doesn't expect 5G capital expenditure at telcos to become meaningful until 2020.
As for individual businesses, Infrastructure Platforms grew 7%, with all categories contributing to the advance, excluding routing. Widespread adoption of hybrid public/private cloud environments and an ongoing transition to software-defined wide area networks were key drivers. Enterprise switching was once again supported by Catalyst 9000, the fastest growing device in company history. Meanwhile, data center offerings had ``very strong double-digit growth'' owing to strength in servers and HyperFlex. Routing was down slightly, due to continued weak demand from service providers. The Applications unit's sales were up 10%, thanks to healthy demand for Unified Communications, TelePresence, Conferencing, and AppDynamics. The important Security division grew revenue 12% as many corporations and institutions ramp up spending in response to more serious threats.
We were happy to learn that Cisco recently announced its intent to buy Michigan-based cybersecurity outfit Duo Security for $2.35 billion in cash and CSCO stock. That investment is roughly double the average size of the last 10 large acquisitions. Duo offers several methods of two-factor authentication, i.e., push notifications, passcodes, and phone calls sent to smartphones to gain access to applications. Management claims Duo's cloud-based software-as-a-service solutions will enable ``any user on any device to securely connect to any application on any network.'' Other notable technology allows devices to act as physical key fobs, but still in a secure way.
We like how Cisco has been executing and growing its business around the world despite the threat of trade wars and general macroeconomic uncertainty. We think the company is uniquely positioned in the space, but recent price appreciation leaves these high-quality share with limited near-term upside potential, in our view.
About The Company: Cisco Systems Incorporated is a leading provider of Internet Protocol-based networking and other products for transporting data, voice, and video across geographically dispersed local-area networks, metropolitan-area networks, and wide-area networks. Devices are primarily integrated by Cisco IOS Software and include Routers, Switches, New Products, and Other. Provides services associated with these products.
- Kevin Downing
