by Rob DeFrancesco

Two weeks ago, Cisco Systems (CSCO) reported fiscal Q4 (July) earnings per share (EPS) of 55 cents, two cents above the consensus estimate, on revenue of $12.4 billion (flat year over year), vs. the consensus of $12.1 billion. Gross margin was 61.8% and operating margin came in at 28%.

Product revenue declined 2% year over year, with revenue from the core switching (30% of total revenue) and routing (16% of total) segments off 4% and 7%, respectively.

On a sequential basis, service provider video revenue (9% of total) and wireless revenue (5% of total) advanced 10.7% and 19.5%, respectively. But tough comparables from a year ago resulted in service provider revenue falling 10% and wireless revenue gaining just 1% on an annual basis.

In the latest quarter, the two bright spots on the product side: datacenter revenue (6% of total) rose 30% and security revenue (4% of total) was up 29%. 

In the datacenter unit, Cisco now has 580 customers for the Nexus 9000 switch (the foundation of its Application Centric Infrastructure architecture), more than triple the number from the previous quarter.

The Nexus 9000 is where Cisco competes directly against emerging datacenter switch vendor Arista Networks (ANET), a company that has been steadily taking market share from the networking giant by winning customers in the cloud, tier-2 service provider, financial and technology enterprise verticals.

Also in the datacenter segment, Cisco’s Unified Computing System (UCS) server unit saw growth of 30%, with repeat business up 49%. UCS now has more than 36,500 customers and its annual revenue run rate tops $3 billion.

Within the security segment, networking security revenue gained 35%. On the earnings conference call, CEO John Chambers said Sourcefire is now growing more quickly than when Cisco first acquired the cybersecurity company last October. Security orders in the quarter grew faster than revenue, a positive indicator.

While there were pockets of strength in the fiscal Q4 report, Cisco remains a company in transition, evident from the announcement of 6,000 job cuts (8% of the workforce) along with a related restructuring charge of $700 million. The layoffs will come mainly from underperforming segments and geographies.

Emerging markets in the latest quarter were weak once again and are expected to stay that way for the near term, possibly getting worse before they get better. Also, the overall service provider segment, particularly on the international front, continues to be a headwind.

Strength in the quarter was most evident in the U.S. commercial and enterprise areas, which showed product order growth of 17% and 16% year over year, respectively. A promising metric: Cisco is seeing more larger deals in the U.S. enterprise pipeline (the number of fiscal Q4 deals worth more than $5 million each jumped 70% from a year ago). Enterprise and commercial product orders in the EMEA region were up 8% and 7%, respectively.

Cash flow from operations in fiscal Q4 totaled $3.6 billion. Cisco ended the quarter with $52.1 billion in cash, $4.7 billion of which is located in the U.S.

For fiscal Q1 (Oct.), Cisco offered revenue growth guidance of flat to up 1% year over year, in line with the consensus estimate. Gross margin is expected in a range of 61% to 62%, with operating margin of 27.5% to 28.5%. Per-share earnings guidance: 51 cents to 53 cents, vs. the consensus of 53 cents.

Cisco is putting in the effort to operate more efficiently (with less headcount), control costs, properly allocate capital, compete more effectively against the incursion of low-cost software-defined networking (SDN) technology and refocus its resources on areas of growth, such as the datacenter and security segments.

With a yield of 3.1%, continued share buybacks ($1.5 billion was spent on repurchases in fiscal Q4) and a low valuation (forward P/E of 11 on the fiscal 2015 consensus EPS estimate of $2.16), Cisco shares should attract buyers on any dips into the low $20s.

Cisco Systems remains a buy up to $25.00 in our Investments Portfolio.

NASDAQ Composite Index:                                                                        

Friday, August 22 = 4,538.55                                                   

Year to Date = + 9.5%                                          

Trailing 7 Days = + 1.8%                                      

Trailing 4 Weeks = + 4.5%

Portfolio Update:

by Jim Pearce

Last week we took big gains in Western Digital (NSDQ: WDC) and Seagate Technology (NSDQ: STX), as both of them had appreciate to the point that they no longer score highly enough on our STR ranking system to remain in our upper echelon of undervalued tech stocks.  

The good news is that there are other companies now with higher STR scores, one of which I am adding to our Investments Portfolio. Effective today I am initiating a position in Verizon Communications (NYSE: VZ) with a buy limit of $55. It now has an STR score of 9.8 thanks to the strong combination of high dividend (current yield is 4.5%), strong cash flow, excellent strategy execution and discounted valuation based on forward earnings.

While Verizon is hardly a secret, it has traded down slightly since peaking near $54 in the spring of 2013. We believe it is due for a breakout to the upside given its current valuation, and would hold its value relatively well in the face of a stock market correction should there be one prior to the next Presidential election.