Despite significant volatility in geopolitics that rattled much of the technology sector in the fourth quarter of 2018, Cisco reported stable growth and company executives described a positive environment despite a government shutdown and trade war with China. Cisco shares this morning vaulted $2.03 (4%) to a new 52-week high on the back of a positive earnings report.
On the conference call, Cisco executives gushed positively about revenue growth, earnings and stellar results from Cisco's campus networking and security business. Another notable positive development is the progress in Cisco's move to a software subscription model and security services. The company reported that subscription revenue rose to 65% of all software sales, up 10% year-over-year.
In reporting its second fiscal quarter results for the period ended Jan. 26, 2019, Cisco had revenue of $12.4 billion, compared with $11.89 billion in the year-ago quarter, representing 4% growth. Net income on a generally accepted accounting principles (GAAP) basis was $2.8 billion or $0.63 per share, and non-GAAP net income was $3.3 billion or $0.73 per share. Wall Street analysts had expected revenue of $12.42, according to polls by FactSet.
Acquisitions boost growth
A big part of the growth is coming from acquisitions. Cisco reported infrastructure platform revenue of $7.13 billion, a 6% increase. Product orders were up 8%. Applications revenue grew 24% to $1.47 billion and security revenue grew 18% to $658 million. The security revenue was boosted by the acquisition of Duo Security.
"That's the fastest growth rate we've seen in many years," said Cisco CEO Chuck Robbins.
Some of the other major acquisitions that Cisco has completed in the past few years include AppDynamics, Meraki and Viptela. All three were mentioned on the call as drivers of growth as well as key to the strategy to integrate the many pieces of Cisco's offerings into a coherent networking portfolio that drives software subscriptions. Robbins made clear that Viptela and SD-WAN technology are a key part of the company's strategy to integrate security across networking platforms using software.
"There's one common element to cloud—that's networks," said Robbins in a Q&A with analysts after the call.
Despite the advances in subscription sales, Cisco’s hardware unit still supplies 57% of total revenue, according to company reports. Sales of the company’s Catalyst 9000 switches grew 6% in the quarter.
Strong government quarter
In a development that surprised many analysts, Cisco was relatively unscathed by the government shutdown, which took place during the last month of the quarter. Trade tensions with China, including technology tariffs, were also a non-issue. Robbins pointed out that many of the divisions affected by the shutdown weren't necessarily those buying Cisco gear, and that many orders were even placed before the shutdown in its anticipation.
Public sector orders were very strong, coming in at +18% on a year-over-year basis.
"To be honest, from the first day of the quarter to the last day of the quarter, we saw zero difference," said Robbins.
This may have been one of the biggest surprises on Wall Street.
"This is especially surprising given the U.S. Government shutdown in parts of December and January," wrote Michael Genovese with MKM partners, in a note to investors.
Service provider revenues continue to be a weak spot for Cisco, down 1%.
Then there is the trade tension and tariffs with China. Cisco is not a big player in China, which is dominated by Chinese rival Huawei, the company that is now subject to the U.S. government's recent actions to discourage purchases of Huawei equipment as well as criminal charges against Huawei officials for alleged financial fraud and technology theft. The Chinese trade tensions did not appear to play any meaningful role in Cisco's business during the quarter.
Looking beneath the numbers, much of Cisco's growth was driven by acquisition—which may make sustaining the revenue growth difficult. MKM's Genovese wrote that after backing out acquisition-driven revenue, Cisco showed "very low single digit organic growth when adjusted for accounting changes and acquisitions." He pegs that number at 3%. "Cisco has solid Ethernet Switching and Security product cycles underway, but we believe the current multiple at 15x-16x earnings fully reflects this."
In the meantime, Cisco continues its strategy of putting cash flow into dividends and share buybacks to draw investor interest. The company generated $3.8 billion in cash for first quarter of fiscal 2019, which was a decrease of 7% compared with $4.1 billion for prior year's quarter. But that included a payment of $800 million for transition taxes applicable to the Tax Cuts and Jobs Act. The company said that cash flow increased 12% after being normalized for this payment.
Cisco is raising its quarterly dividend by 2 cents to 35 cents a share. It is also adding $15 billion to its share-repurchase program, making the total available $24 billion.