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Cisco Tanks: What Wall Street's Saying

This story has been updated from 1:25 p.m. EST with Cisco's closing share price and information on the company's free cash flow.

NEW YORK (TheStreet) - Cisco (CSCO - Get Report) beat Wall Street's estimates in its second-quarter results on Wednesday, although shares tanked on its guidance and ongoing weakness in some key markets. 

"We saw the impact of emerging markets, service provider and high-end product transitions as we discussed last quarter," said Cisco CEO John Chambers, during the company's earnings conference call. "The emerging countries were better this quarter than last quarter, but way too early to call a trend."

Cisco shares closed down 2.54% at $22.27 on Thursday.

For the third-quarter, Cisco expects revenue between $11.22 billion and $11.47 billion, a decline of 6% to 8% on the prior year's quarter, in line with consensus. Analysts surveyed by Thomson Reuters were expecting sales of $11.34 billion.

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During a post-earnings interview with TheStreet on Wednesday evening, Cisco CFO Frank Calderoni pointed to an improvement in the company's guidance. For the second quarter, he noted, Cisco had predicted a year-over-year revenue decline of 8% to 10%.

"From a quarter on quarter standpoint, the decline is less," he said. "We're going to take this one quarter at a time and continue to work through the transitions and challenges that we articulated three months ago and see improvement quarter after quarter."

Excluding items, Cisco's second-quarter gross margin came in at 61.3%, within its guidance range of 61% to 62%. "We had low volume in the past quarter," said Calderoni, in his interview with TheStreet. "When you have low volume, you have gross margin implications."

The San Jose, Calif.-based firm gave the same 61% to 62% gross margin guidance for the third quarter.

Cisco generated $2.9 billion in cash flow from operations during the second quarter, up from $2.6 billion in the first quarter, but down from $3.3 billion in the same period last year. The company repurchased $4 billion worth of shares during the second quarter and also announced a dividend hike on Wednesday, increasing its quarterly payment by 2 cents to 19 cents a share.

The company's free cash flow, crucially important for generating healthy dividends and share repurchases, was $2.6 billion, up from $2.3 billion in the fiscal first quarter, but down from $3.1 billion in the same period last year.

During the fourth quarter of Cisco's fiscal 2012, the company committed to return at least 50% of its free cash flow annually through dividends and share repurchases. In its fiscal 2013, the switchmaker returned over 50% of its free cash flow to investors. Speaking during the second-quarter conference call, Chambers noted that, during the first half of fiscal 2014, Cisco returned over 150% of its free cash flow to investors, $6 billion of which was in the form of share repurchases, and $1.8 billion in dividends.

Cisco has enjoyed cash flow growth in recent years. During fiscal 2013, the company's free cash flow was $11.7 billion, up from $10.4 billion and $8.9 billion, respectively, in the prior two fiscal years. Investors will therefore be closely monitoring this number during the coming quarters. In a note released on Thursday, Citi Research analyst Ehud Gelblum highlighted the company's "impressive" $4 billion share repurchase, a 6-quarter peak. Citi Research expects Cisco to generate $9.5 billion of free cash flow in fiscal 2014, a figure which it estimates will reach $11.1 billion and $11.7 billion in fiscal years 2015 and 2016, respectively.

During the second quarter, revenue from Cisco's switching business dipped 12% year-over-year to $3.27 billion, while Next-Generation (NGN) Routing revenue was down 11% to $1.74 billion. Service provider video revenue fell 22% to $957 million and collaboration and wireless sales dipped 7% and 4%, respectively, to $881 million and $511 million.

Cisco, however, saw revenue growth in other parts of its business, with security sales climbing 17% year over year to $393 million, and Data Center (DC) revenue growing 10% to $605 million, fueled by the Unified Computing System (UCS) server product. The services business also grew, with revenue increasing 3% to $2.73 billion.

Here's what Wall Street analysts have to say about Cisco's earnings:

Cantor Fitzgerald analyst Brian White (Buy, $27.50)

"The overall tone around the spending environment on last night's call was lackluster; however, we believe the issues in emerging markets, service provider, and new platforms appear to be in a bottoming process. In fact, product order rates in emerging markets fell by 3% YoY in 2Q:FY14 and were up from down 12% in 1Q:FY14. Overall product orders fell by 4% YoY in 2Q:FY14 (vs. down 4% in 1Q:FY14), and the product book-to-bill ratio came in greater than 1.0x (vs. <1.0x in 1Q:FY14). Product orders in the Americas were down 5% YoY, while EMEA was down 2% YoY, and APJC declined by 5%. In terms of customer segments, Service Provider product orders decreased by 12% YoY, Enterprise fell by 2%, Commercial rose by 1%, and Public grew by 1%."

 ISI Group analyst Brian White (Neutral) 

"We are impressed that CSCO has been able to preserve its high-20% operating margin model despite severe revenue headwinds. While GM stability remains a concern, we are incrementally more positive on CSCO's ability to preserve its financial model as a slower growth company. In our view, Jan-14 likely marked a bottom and we expect recent headwinds from set-top boxes, emerging markets and product transitions to become de minimis by early CY15. We are adjusting our CY14 estimates to revenue of $46.4bil (down ~3% y/y), GMs of 61.0% (down 140bps y/y), OMs of 27.5% (down ~90bps y/y) and EPS of $1.95 (down ~4% y/y). We maintain our NEUTRAL rating, but continue to "warm up" to the story and would look to get more constructive on pullbacks or increased visibility on margins and new product traction."

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