Cisco Needs Solid Quarterly Numbers From Software, Services

NEW YORK ( TheStreet) -- Cisco ( CSCO) reports its fiscal third-quarter results after market close on Wednesday with investors keen to see whether CEO John Chambers can maintain the networker's momentum.

The tech giant beat Wall Street's top and bottom line estimates with record fiscal second-quarter results earlier this year, allaying concerns about enterprise IT spending.

Cisco shares have trailed the Nasdaq Composite Index in 2013 as the San Jose, Calif.-based company's stock has gained 7.9% compared to 15% for the technology benchmark. Cisco was 0.3% to $21.20 heading into the earnings announcement.

Speaking during a post-earnings interview with TheStreet, Cisco CFO Frank Calderoni described an improving spending environment, particularly in the U.S.

Nonetheless, there are lingering concerns that customers are less willing to part with their money.

"Given the muted demand environment that we continue to pick up across the IT world, we believe Cisco will need to deliver another strong quarter of execution to report acceptable profit performance," wrote Brian White, an analyst at Topeka Capital Markets, in a note published Wednesday. "Given the soft March quarter earnings cycle in April and our visit to IT shows in Las Vegas last week, we would not bet on the tailwind of strong end-market demand to drive upside for Cisco in 3QFY13 or 4QFY13."

Despite those misgiving, White has a 'buy' rating on Cisco and predicts the switch maker will at least meet Topeka Capital's earnings forecast of 49 cents a share. As for the topline, White predicts Cisco will meet or slightly miss his revenue estimate of $12.13 billion.

Analysts surveyed by Thomson Reuters are looking for revenue of $12.18 billion and earnings of 49 cents a share.

Those with a strong buy rating cite Cisco's ability to drive growth outside its traditional networking hardware.

Last quarter Calderoni highlighted the importance of software and services in driving recurring revenue, something which could feature prominently in this afternoon's Cisco conference call.

The company's profit margins will also be in the spotlight. Last quarter, Cisco's total non-GAAP gross margin was 62.3%, while non-GAAP operating margin came in at 28.2%. "We believe Cisco has the potential to deliver margin upside in 3QFY13 given the Company's strong execution in this department, along with the conservative margin outlook provided," White wrote. The Topeka Capital analyst expects Cisco's operating margin to dip to 27.4%.

ISI Group Analyst Brian Marshall will also be paying close attention to Cisco's margins. "While CSCO's execution has improved over a prolonged industry downturn (e.g., streamlining costs, divestitures, product refreshes, etc.), the sustainability of gross margins in the low-60% range (e.g., within 61-62% target range) remains uncertain," he wrote, in a note released earlier this week.

Software-Defined Networking (SDN) also poses a threat to Cisco's margin model, according to Marshall, although he feels that the company's efforts in the space will reap dividends.

SDN refers to a set of techniques for managing network traffic flows through software. Cisco is one of a number of companies, including rival HP ( HPQ), who are touting SDN technologies.

Cisco's guidance will also prove critical. "We expect roughly in-line results for Apr-13, but wouldn't be surprised to see a more cautious outlook for Jul-13," wrote Marshall, who has a 'cautious' rating on the stock. "While CSCO is trying to create a more stable, software/service-oriented business model, we believe gross margins in its core routing/switching businesses (~50% of revenue) remain under pressure."

Analysts surveyed by Thomson Reuters are looking for fourth-quarter revenue of $12.48 billion and earnings of 51 cents a share.

Cisco shares, which have crept up 1.24% during the last 3 months, dipped 0.09% to $21.25 during Wednesday's trading.

--Written by James Rogers in New York.

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