Cisco announced its Q3 fiscal year 2017 earnings on May 17, reporting a 1% decline in revenues to $11.9 billion. The slight decline in revenues was attributable to an extra week included in the comparable prior year quarter, during which the company generated around $265 million in revenues. Moreover, weakness in switching, wireless and data center product revenues kept revenues largely flat over the year-ago period. Cisco’s gross margin (non-GAAP) for the quarter stood at 64.4%, which was around 80 basis points lower than the prior year quarter. However, a fall in operating expenses (both R&D and SG&A) led to an increase in operating income. As a result, Cisco’s operating margin (non-GAAP) for the quarter stood at 32.3%, over 2 percentage points higher on a y-o-y basis.

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Performance By Segment

The company derives a huge chunk of its revenues from selling networking and telecom hardware, with revenues growing at very modest rates over the last few years. Comparatively, software solutions and other network security solutions sold by Cisco have performed well in recent years. Moreover, service-based revenues have also grown at a steady pace to offset the stagnating revenues from hardware sales. This trend has been evident in recent quarters as well as the third fiscal quarter.

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Core routing revenues were down 2% y-o-y to $2 billion, while data center product revenues were down 5% y-o-y to $767 million. Collaboration revenues were also down 4% to just over $1 billion. Although WebEx and Cisco Spark witnessed sustained growth in product sales, weakness in Unified Communications was largely responsible for the decline in segment revenues.

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Cisco continued to witness strong growth in its security product portfolio. Network security revenues rose 9% y-o-y to $527 million for the quarter. Similarly, wireless revenues also increased by 13% during the quarter to $703 million due to strong performance of Meraki and a refreshed product line for the 11ac Wave 2 products. Wireless product revenues have grown primarily due to the transition in customer preferences from blade servers to rack servers. This could be a challenging area for Cisco given its deep investments and strength in blade servers.

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Network security revenues were down 2% y-o-y to just over $3 billion for the quarter. However, normalized for the extra week, services revenues were up 4% on a year-over-year basis. This mirrored the trend observed through the previous year, with combined services revenues in increasing by 7% y-o-y to $12.3 billion for the full year,.

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Soft Guidance For Fourth Quarter

Cisco’s management gave conservative guidance for the fourth fiscal quarter, with revenues expected to fall by around 5% to $12.2 billion. Among the product divisions, routing and switching revenues could witness limited growth while data center products and collaboration segments – combined with Cisco’s strength in cloud capabilities, network security, IoT, Software-as-a-Service (SaaS) and analytics – could help drive revenues. Cisco expects non-GAAP gross margin to be around 63.5% for the quarter, which is over a percentage point lower than the fourth quarter of FY 2016. Similarly, operating profit margin (non-GAAP) could be around 140 basis points lower than the year-ago period at 30%. Resulting non-GAAP diluted earnings per share could be around 3% lower on a y-o-y basis to 61 cents a share. We have a $33 price estimate for Cisco, which is roughly in line with the current market price.

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