Cisco (CSCO) announced the earnings for the first quarter of fiscal year 2014 in the after-hours of Wednesday. While the results were roughly in line with the estimates, the company's guidance shocked the investors, initiating a sell-off. So, how should investors take the company's results as well as its guidance?
Results of the last quarter
Cisco earned 53 cents per share whereas the analysts were looking for 51 cents per share. The company generated $12.1 billion in revenues while the analysts were looking for $12.35 billion. Basically, Cisco beat the estimates slightly on earnings but missed slightly on revenues.
Compared to the first quarter of last year, Cisco posted a revenue growth of 1.8%, but it also posted a net income decline of 4.6%. On non-GAAP metrics (reporting earnings on these metrics is getting more popular each day) Cisco's revenues grew by 11.6% and its net earnings grew by 10.4% since the same period last year. The difference between the GAAP reporting and non-GAAP reporting stemmed from some charges related to Cisco's recent acquisition of Insieme Networks, Inc.
In the quarter, Cisco generated $2.6 billion in cash flow from operations, which compares poorly with last year's $4.0 billion in the same quarter. The company's cash reserves shrank slightly from $50.6 billion to $48.2 billion between the previous quarter and this quarter. This change includes the $914 million Cisco spent on dividends and the $2 billion it spent on stock buybacks in the quarter. In terms of returning cash to investors, Cisco spent aggressively in the quarter. Furthermore, the company decided to increase its repurchase program by another $15 billion which will be put to use in the following quarters. Now, the company has a total of $16.1 billion authorized to be spent on share buybacks.
Cisco performed particularly badly in the emerging markets. Of the 10 identified emerging markets, the company didn't meet its expectations in one. In fact, the company's CEO John Chambers acknowledged that things went from bad to worse in the last couple of weeks of the quarter in these markets. In Russia, orders fell by 30% and in Brazil, the fall in orders was as much as 25%. In the remaining emerging markets such as Mexico and China, orders dropped by 18%.
While Cisco's gross margin improved nicely from last year, the company's operating margin fell moderately. The company's gross margin in the quarter was 61.29%, up from last year's 60.95%. On the other hand, the company's operating margin was 20.31%, down from 22.32% in the same quarter a year ago. This was mostly accounted by a sharp increase in research and development costs (up from $1.43 billion to $1.72 billion, an increase of 20.47%). The company's other operating costs such as sales and marketing and administrative were roughly flat compared to the same quarter of last year. Cisco also took $237 million in restructuring charges in the quarter.
Cisco's Future guidance
Cisco's future guidance wasn't pleasant at all. Moving forward, the company expects its revenues to fall by 8 to 10 percent. Most of the blame was put on the emerging markets where Cisco doesn't see a reversal for the next couple of quarters. Mr. Chambers sees effects of the government shutdown to continue in the short term and hurt the business confidence. Furthermore, there is a lot of uncertainty in the emerging markets where companies take a longer time to decide on their technology vendors. Reportedly, some Chinese customers are concerned about the rumors regarding US government's intelligence collecting activities in other countries.
It looks like Cisco's management sees a lot of inconsistencies in the emerging markets and the company is having trouble with generating an accurate forecast regarding these markets. This was one of the main themes during the conference call. In fact, this has been a main theme for the last few conference calls. While the company is working hard on innovating and building new products, it will have to work even harder on convincing its customers to invest in its products and services. Because most of the growth should come from emerging markets, Cisco needs to pay extra attention to these markets in the long term, even though things look very challenging in the short term.
There are several areas where Cisco is particularly strong and the company could also work on capitalizing on those strengths in the long term. For example, Cisco is currently the top cloud infrastructure provider in the world and it is seeing a lot of demand for its security and wireless portfolios. In the next few quarters, Cisco can expect a lot from its newly launched core routing and core switching platforms.
As the company recently completed acquisition of Sourcefire, its security business has gained several strong products both in software and hardware. Security is becoming one of the most important themes in the future as cloud becomes more widely used. In the next few quarters, Cisco will be investing heavily into Sourcefire's FirePOWER platform in order to adopt this platform as quickly and efficiently as possible. This will make Cisco one of the major players in the field of security.
Data center will be another line of business where Cisco can expect a lot from. Last quarter, Cisco's data center business grew by 44%, which was one of the nice parts of the company's earnings report. Several of Cisco's solutions such as SAP Hana, NetApp, FlexPod and EMC, VMware and Vblock are seeing strong demand and each product has the potential to become a blockbuster with a run rate of $1 billion in annual revenues. In the market, SAP Hana is seen as a major disruptor, which is great for Cisco.
What to do with the stock now?
As analyst Tal Liani pointed out, Cisco's guidance for the next quarter is the lowest ever since 2000 with the exception of January of 2009 which was the peak of the global recession. Cisco's management seems very pessimistic in the short term. This is probably why the company approved a massive buyback of $15 billion so that its EPS can be boosted artificially. Last time Cisco gave guidance as weak as today's guidance, the company's share price was $14 as opposed to $24 which was observed right before the announcement. In the after-hours, the share price fell to $21 but there might be weakness for several months if the company can't turn things around in the emerging markets.
Prior to the earnings, Cisco's market cap was $129 billion. As of the after-hours of Wednesday, the company's market value fell to $115 billion. If we add the $15 billion of share buybacks to this model, Cisco might be presenting an attractive opportunity for the long-term investors. Again, this assumes that things will improve in the long run and the company's troubles are only temporary. If Cisco's problems turn out to be structural and they last longer than a couple of quarters, the company will find itself in a loop where it has to keep buying back its shares in order to keep its value attractive to investors.
Cisco can't keep blaming the macro economy forever and it can't keep going through restructuring after restructuring. These kinds of things keep investors away from companies. Cisco is one of those stocks that take forever to recover once it falls. If you look at the company's stock price movements in the last 13-14 years, whenever the stock price fell sharply, it took years for it to recover. Many times, the stock would fall sharply after some bad announcement, then it would go sideways for several quarters even if the company's business improves significantly, and it would not move upwards for a long time until investor confidence comes back. Cisco's stock chart between 2001 and 2013 looks a lot like mountains with a lot of ups and downs.
The company's buyback and decent dividend rate may keep a lot of long-term investors interested. If you buy this stock, it might take a while before you see any significant returns; however, the downside might also be limited after the recent sell-off. As a result of this sell-off, Cisco's dividend yield will move above 3.00% again.
For the time being, I would wait until the dust settles before investing in this company. In the long term, it may be a good investment, but you want the dust to settle before jumping in.