MarketWatch First Take: Cisco earnings show turnaround success, stock zooms toward post-2000 highs

Cisco Systems Inc. has turned the corner in a painful transition, with the first quarter of revenue growth since 2016 showing success in the networking giant’s quest to become a subscription-based business.

Cisco CSCO, +2.09%  reported better-than-expected fiscal second quarter revenue and adjusted earnings Wednesday, excluding the impact of a charge related to the changes in the U.S. tax law, and its shares soared more than 6% in after-hours trading. Cisco shares jumped to levels not seen since the dot-com boom went bust, and were already up nearly 10% this year, while the Dow Jones Industrial Average DJIA, +1.03%  , which counts Cisco as a component, is up less than 1% early in 2018.

Since taking the helm of Cisco, Chief Executive Chuck Robbins has focused on subscriptions, common in the software industry but more difficult for a hardware company. That kind of transition can have a negative effect on revenue in the short term, as less of the sale is recognized up front with the rest deferred to later quarters, which Cisco has seen in the past couple of years.

For instance, Cisco introduced a new switching family called the Catalyst 9000, a software-centric switch that is delivered as a service with subscription fees and long-term contracts, last June. While previously, a sale of a switch—Cisco’s biggest business—would have been recognized in full up front, Chief Financial Officer Kelly Kramer explained that a healthy portion of that sale is now considered to be for software support and recognized over the length of the contract.

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In the quarter reported Wednesday, the company’s recurring revenue climbed 36% year-over-year and in the quarter it grew to 33% of total revenue, both services and product. Kramer, in an interview with MarketWatch, specifically pointed to the success Cisco has had with products like the Catalyst 9000 for that.

“Of total product revenue, 13% of product revenue is recurring,” Kramer said; at the beginning of Cisco’s fiscal 2015, recurring revenue was about 6% of total revenue, she said.

“The Catalyst 9000 is our fastest ramping product in our history,” Robbins crowed on a conference call.

Kramer largely echoed Robbins’s positive tone in a later interview, while avoiding any grand pronouncements. When asked whether the company’s transition was at an inflection point, she said, ‘I am always hesitant to call any inflection, but I am not surprised about the improvement. Overall, we feel very, very good about our portfolio, this is where we have been focused for a long time.”

Robbins has focused on software as a path, making big-money acquisitions like AppDynamics and BroadSoft, and analysts were curious in Wednesday’s conference call about what may be next for the acquisitive company. Company executives said they plan to bring back all of Cisco’s cash that is outside the U.S. by the end of this quarter under the new tax laws that are now taking hold.

After recognizing an $11.1 billion charge largely from repatriation in Wednesday’s report, Cisco will have many billions to play with even after adding $25 billion to its stock-repurchase authorization and increasing its dividend 14% Wednesday.

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“I will still be net cash positive position of $10 to $12 [billion] without assuming anything else for acquisitions,” Kramer told analysts. “Acquisitions have been a critical part of our overall strategy. We will continue to look for acquisitions that can drive value and drive growth.”

Cisco could look to security for a big acquisition, as that business’s revenue growth declined to 6% in the quarter after growing more than 9% in the 2017 fiscal year, missing analysts’ estimates. Security is a huge focus for the company as it looks for success in software, and is a big reason the company has been able to power through this transition.

There is still upside for Cisco if it can figure out how to move more switching and router customers to subscription-based models, and the company projects more revenue growth in the current quarter. With the possibility of more acquisitions to boost its security business or other software-focused offerings, Cisco could emerge from this effort with cleaner balance sheets than it did before Robbins took over.

“We are seeing the benefits of the strategy we started executing on 10 quarters ago,” Kramer said. “We are seeing the benefits as we shift the business model and you are seeing it translate through fantastic financials.”

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