4 Things Cisco's Management Wants You to Know

By Markets Fool.com

Image source: Cisco Systems.

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Cisco Systems (NASDAQ: CSCO) beat analyst estimates when it reported its fiscal first-quarter results on Nov. 16, but there was plenty of bad news for investors to consider. Collaboration and data center, two growth segments, posted revenue declines, and switching, Cisco's core business, reported a decline, as well. Revenue during the second quarter is expected to contract by 2% to 4%, adjusted for divestitures, a disappointing outlook that sent shares of the networking hardware giant tumbling.

The details beyond the headline numbers are important. Cisco's earnings conference call was packed with valuable pieces of data that can help investors fully understand the company's results. Here are four key quotes from management that stood out, taken from the transcript provided by Thomson Reuters.

Security continues to shine

One of Cisco's major growth initiatives is security, a business that has been growing at a double-digit rate in recent quarters. Because the security business is shifting toward subscriptions, the 11% revenue growth Cisco reported during the first quarter doesn't fully reflect how much progress the company is making. CEO Chuck Robbins went into the details:

Let me review a few areas of our business where our innovation is driving momentum. First, security. Our security revenue grew 11%, marking the fourth-consecutive quarter of double-digit growth. We're driving more subscription-based recurring business, resulting in deferred revenue growth of 39%.

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That big jump in deferred revenue suggests that Cisco's security business will continue growing at a rapid pace going forward. Robbins also pointed out that Cisco is the only company with security product revenue exceeding a $2 billion annual run rate and growing at a double-digit pace. Acquisitions are driving some of this growth, but Cisco's strategy of offering integrated security solutions appears to be working.

Explaining the weak guidance

Cisco's second-quarter guidance fell well short of expectations, with analysts expecting the company to grow sales. Robbins discussed the one major factor behind the weak guidance:

I think if you just look at our guidance, let me be clear. It's predominantly the SP weakness and the overall CapEx challenges that we've seen in SP. That business is largely account driven. You can assume that we have done an account by account by account analysis in that space and understand what's going on there. Right now I think there are a unique set of characteristics, particularly in the SP space. You have the overarching macro uncertainty in the economy, which I think has led to the SP CapEx weakness that's been reported all year by the analysts, as well as you have political and regulatory environments that are somewhat uncertain, both in the U.S. and around the world.

Product orders from service providers slumped 12% year over year, while every other customer group posted flat or positive order growth. Macro-economic uncertainty, something we've heard from Cisco before, is one component, as is the uncertainty created by the U.S. election. Robbins was optimistic that President-elect Trump would enact business-friendly policies, potentially reversing some of these headwinds. But the company is not modeling any improvement, thus the weak guidance.

The shift to subscriptions

Security isn't the only segment where a shift to subscription and recurring revenue is hurting near-term results. When asked by an analyst about the exact impact of this shift, CFO Kelly Kramer laid out the details:

I'd say it's a couple points for sure impact on our growth and it's a combination of -- its largely been historically collaboration and security and Meraki, but we are continuing to add on our core platform with our Cisco ONE suite, like I mentioned last quarter, which that is now being recognized ratable where a year ago, we would have recognized that as a perpetual license sale. For example, just using Cisco ONE as an example in this quarter, it would have been a point and a half just on that if we had recognized it perpetually like we had a year ago.

Moving toward a recurring revenue model should make revenue more predictable, but for now, it's hurting Cisco's top-line numbers. Revenue that was once recognized all at once is being spread out over time. In the near term, this shift makes Cisco's results look worse than they really are. However, even adjusting for the negative impact of the subscription shift, Cisco's guidance still calls for a sales decline.

Repatriation

With President-elect Donald Trump promising to allow companies holding cash overseas to bring it back into the country at a 10% tax rate, Cisco's mountain of overseas cash may finally be put to good use. Kramer outlined the company's priorities:

Just high level, as you could imagine, we have many, many scenarios of what we would do when repatriation comes, which is a combination of obviously we would ring fence in our debt and then we would have a blend of actions we can certainly take with our dividend, as well as our share buyback, as well as leading flexibility for us to be able to do M&A and strategic investments. It'd be a combination of all those things. Obviously, we listen very closely to our shareholders and how we want to do that and we recognize it will certainly give us a lot more flexibility.

At the end of the first quarter, Cisco had about $71 billion of cash and investments on its balance sheet, along with $34.8 billion of debt. Borrowing costs are low for Cisco, with the company paying just $198 million in interest during the first quarter. But some debt reduction is likely.

I suspect a major boost to the buyback would be in the cards in the event of repatriation. Cisco may also raise its dividend more than it would have otherwise, or implement a special one-time dividend. This is all speculation at this point, but I think it's safe to say that the company would return some of that cash to shareholders.

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