On Wednesday, networking giant Cisco (CSCO) reported mixed fiscal first-quarter results (ending in October), and the company’s order performance in the period and fiscal second-quarter guidance came up short versus expectations. Revenue in the fiscal first-quarter dropped 2% year-over-year, but non-GAAP net income and earnings per share advanced 11.6% and 10.4%, respectively, from the prior-year period. Non-GAAP diluted earnings per share of $0.53 came in a few pennies better than expected. Net cash from operations advanced to $2.65 billion from $2.47 billion in the year-ago period, while capital expenditures expanded to $315 million from $265 million. Free cash flow was $2.3 billion, or 19.3% of sales (a strong figure). Cash and investments totaled $48.2 billion and short and long-term debt totaled $16.2 billion at the end of the fiscal first quarter, resulting in a net cash position of about $32 billion (or nearly $6 per share).
Though the headline numbers weren’t bad, the conference call revealed significant underlying weakness (adapted):
Cisco is managing through several cycles in its business. First, emerging market weakness; second, the introduction of several new generation platforms in high end switching and routing; and third, its service provider of business evolution.
From a macroeconomic perspective, in the last two quarters, Cisco’s order growth rate in emerging countries, which is over 20% of its product business, has gone from a positive 13% in total in Q3 to a negative 12% in Q1 of this year…that’s a drag of between four to five percentage points on the growth for this quarter.
As the firm looks to Q2 FY’14, Cisco does not anticipate material improvement in its order growth. This is impacting its revenue guidance for Q2. Given the firm’s orders performance in Q1, its backlog is significantly lower than anticipated. As a point reference, approximately 70% of product revenue is dependent on new orders each quarter. With that in mind, the firm expects total revenue to decline in the range of 8% to 10% on a year-over-year basis.
The company’s Q2 FY ‘14, non-GAAP earnings per share is expected to range from $0.45 to $0.47 per share. Given the guidance for Q2 ‘14 and the shift in momentum in its business…the firm expects its FY ‘14 non-GAAP earnings per share to range from a $1.95 to $2.05.
Cisco’s comments regarding the significant slowdown in orders is what stood out to us, even as we acknowledge that expectations were for a revenue increase (not a decline) in the fiscal second quarter on earnings per share of more than $0.50. The full-year measure was also below expectations. With Cisco not expecting a rebound in order growth during the current quarter, we think core guidance for fiscal 2014 earnings is actually much worse than the headline range, especially since the firm announced a meaningful increase to its stock repurchase program (a key lever management will use to hit forward earnings-per-share targets).
Valuentum’s Take
Cisco is a powerful technology company with a strong dividend. However, orders are under pressure, which raises concerns about the trajectory of revenue and earnings expansion over the near- to- intermediate term. Cisco understands this heightened fundamental risk and has added $15 billion to its buyback plan (raising the overall authorization to $16.1 billion). We would expect the company to use the increased share-repurchase flexibility to help meet bottom-line targets. Cisco’s stock is under considerable pressure, and we’ll be waiting for the dust to settle before we consider the company in either of our actively-managed portfolios.
Communications Equipment: ALU, ARMH, CIEN, HRS, JDSU, PLT, QCOM, SATS, TLAB, VSAT
Communications Equipment – Networking: ARUN, CSCO, FNSR, JNPR, NOK, RVBD