Cisco's third quarter earnings: Strong results expected but Europe worries loom

Cisco Systems is expected to deliver strong third quarter results as sales of its new Nexus switches surge. The big question is how the economic turmoil in Europe, which accounts for 20 percent of Cisco's sales, will affect the networking giant.

Wall Street is expecting Cisco to report earnings of 38 cents a share on revenue of $10.24 billion. Jefferies analyst William Choi expects strong results from Cisco's Nexus switches (right)

---expected to be a $1 billion annual run rate business out of the gate---and the routing and advanced technology unit.

The wild card for Cisco remains Europe. Choi noted that Cisco's business in Europe was already lagging North America and Asia Pacific and now the economic meltdown in Greece---and its after effects---may postpone any recovery. The good news is Cisco's demand elsewhere is strong enough to pick up the slack as long as supply chain issues aren't a problem.

Meanwhile, Cisco continues to plug away with its Unified Computing System (UCS), which analysts say is gaining traction. Toss in Tandberg and Cisco's outlook should be solid. For the fiscal fourth quarter ending July 31, Cisco is expected to report earnings of 40 cents a share on revenue of $10.7 billion. For fiscal 2010, Cisco is expected to deliver earnings of $1.54 a share on revenue of $39.7 billion.

Among the key items to watch:

The state of IT demand: Morgan Keegan analyst Simon Leopold said that it's likely that demand in North America is strong. Meanwhile, the acquisition of Tandberg could provide upside in the region. "Spending patterns sound better in North America, but we’re not convinced that’s true globally; this is actually good news because it suggests that an eventual international recovery can fuel further improvement," said Leopold in a research note.

Data center reinvestment: Wedbush Securities analyst Rohit Chopra said in a research note that "we conclude that demand in the quarter was strong driven primarily by strength in the enterprise and service provider markets and as firms are beginning to reinvest in their datacenter and server virtualization initiatives."

Cisco's switch demand: Leopold said that Cisco timed an update of its enterprise switches just ahead of Hewlett-Packard closing its acquisition of 3Com. Meanwhile, Juniper's results showed stronger than expected enterprise sales. In addition, IBM has been a strong reseller of Cisco gear despite partnerships with Juniper and Brocade, said Leopold.

How are UCS servers doing? Choi writes:

Our checks suggest Cisco is starting to gain traction with its new UCS servers (right). We believe Cisco may be targeting roughly $400M in sales from UCS in CY10. We expect UCS to start ramping July qtr and are estimating roughly $600M in UCS sales in FY11. Our checks also suggest Cisco is able to garner healthy gross margins and we believe it could be higher than the 40-45% anticipated by the Street.

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