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It’s Time to Buy the “New” Cisco Systems, Inc. (CSCO)

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If you’re a tech investor and you’re not in a state of perpetual worry, then you’re probably not paying enough attention. From VMware, Inc. (NYSE:VMW), to F5 Networks, Inc. (NASDAQ:FFIV), and Riverbed Technology, Inc. (NASDAQ:RVBD) — one right after the other — punished for either subpar results, poor guidance or both. Although there were plenty of reasons to be bullish on Cisco Systems, Inc. (NASDAQ:CSCO)‘s Q2 report, there was also doubt that it could avoid the Street’s wrath. And despite soft enterprise IT spending and prolonged weakness from Europe, Cisco did well enough.

Cisco Systems, Inc. (NASDAQ:CSCO)

Revenue was light, but consistent with sector
Year-over-year revenue growth arrived at 5% while advancing 2% sequentially. Not exactly outstanding numbers. But these days, they don’t need to be (and the Street wasn’t expecting a blowout quarter). They just need to be solid, and in that regard, Cisco Systems, Inc. (NASDAQ:CSCO) delivered. However, there was odd behavior in the company’s top two businesses, routing and switching.

Both have suffered weaknesses of late, including in Q1 as both dropped 2% sequentially and 3% year over year. However, in this quarter, both hardware units went in opposite directions. Switch revenue grew 3% year over year, while routing revenue shed more than 5%. But management didn’t sound all that concerned, nor were there any reasons to be. It’s been clear from Cisco’s recent acquisitions that the company is phasing out its focus on hardware. And it’s working.

For that matter, the routing business, which now comprises of 16.1% of Cisco’s total revenue, shed more than 1% sequentially. It’s heading into the single digits, which would not be such a bad thing considering hardware margins aren’t that impressive, not when compared to the company’s stronger growth businesses such as data center, which grew 65%. Likewise, wireless services arrived solid, growing 20% year over year.

On the hand, the 1% growth in security services was disappointing. But it shouldn’t have been a surprise considering that F5 only posted 1% sequential growth and Check Point Software Technologies Ltd. (NASDAQ:CHKP) didn’t fare any better. This means that contrary to popular belief, Cisco is not gaining share against the likes of Palo Alto Networks Inc (NYSE:PANW), which just posted 50% revenue growth .

I have said this on more than one occasion and it’s worth repeating here: Cisco can’t afford to let Palo Alto get into the wrong hands. Both Check Point and F5 are in desperate need of Palo Alto’s growth and margins. In that regard, Cisco’s gross margin could have used a little help this quarter — arriving lower sequentially and year-over-year on a non-GAAP basis. Disappointing router sales didn’t help.

However, the company’s product mix and adjustments were largely responsible. Again, there’s no cause for concern there, especially since operating income advanced 4%. That said, it will be very encouraging if Cisco Systems, Inc. (NASDAQ:CSCO) can reverse this trend in the Q3, while also strengthening operating margin. Although it arrived better than expected, it didn’t signify the sort of leverage investors have come to expect or hope.

Third-quarter outlook was not great, but in-line
Cisco’s Q2 numbers didn’t reflect any sort of strength within the tech sector as a whole. Clearly, although the company is doing well managing its business, times are still tough. So it didn’t come as a surprise that the company went the conservative route with Q3 guidance and projected 4% to 6% revenue growth. It wasn’t the level of doom presumed by VMware, but Cisco’s management didn’t offer a rosier picture, either.

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