Cisco Set to Report a Weak Quarter

Cisco guided for an 8%-10% decline in revenue for the second quarter, with weakness in emerging markets the main culprit behind the decline. Earnings are expected to decline, and the company has lowered its long-term growth estimates. The second quarter will not be a pretty one.

Feb 11, 2014 at 10:00PM

Networking giant Cisco Systems (NASDAQ:CSCO) is scheduled to report its second-quarter earnings on Feb. 12, and both analysts and investors have low expectations. With guidance for the quarter pointing toward a large revenue decline, the result of emerging market weakness, earnings are likely to fall considerably compared to the same quarter last year. Better-than-expected performance in mature markets may help Cisco beat the estimates, but the quarter will almost certainly be a very weak one. Here's what to expect from Cisco's earnings report.

What analysts are expecting
While Cisco's first quarter was decent, the company's guidance for the second quarter was downright awful. Revenue was predicted to decline by 8%-10% year over year, driven by extreme weakness in emerging markets, and little detail as to the cause or expected duration of these problems was given. Revenue from China, Brazil, Mexico, India, and Russia all fell by between 18%-30%, and given the guidance, these markets could perform even worse for Cisco in the second quarter. Analysts expect earnings per share to fall to $0.46, down from $0.51 in the same quarter last year.

What to look for
The announcement of expected revenue declines came as a shock last quarter, and the most important thing to observe is what management says about next quarter and beyond. As CEO John Chambers talked about during the Q1 conference call, Cisco is dealing with three distinct issues. First, emerging markets are proving to be incredibly weak. Second, the ramping up of new switching and routing platforms is causing some short-term revenue losses. And third, orders from service providers have declined.

In the first quarter, emerging market orders declined by 12%, while service provider orders declined by 13%. Cisco's set-top box business, which accounts for about 20% of service provider revenue, declined by 20% during the quarter, and some analysts are calling for the company to sell the set-top business. Cisco has stated that it has no plans to do so, and service provider revenue will likely be dragged down in the short term due to this issue.

How long this weakness will last is the big question, and guidance for the third quarter should give some indication. At the company's analyst day in December, Cisco lowered its three- to five-year revenue growth target from 5%-7% to 3%-6%, suggesting that these issues may drag on for quite some time.

The current transition in Cisco's routing and switching platforms may be helping rival Juniper Networks (NYSE:JNPR). Juniper beat analyst estimates for both EPS and revenue when the company reported earnings on Jan. 23, with an increase in operating margin driving earnings higher. As Cisco's new platforms ramp up, Juniper could continue to benefit going forward.

Possible dividend increase
Cisco first began paying a dividend in 2011, and since then the company has boosted the dividend payment three times. Currently at $0.17 per share, the quarterly dividend gives shares of Cisco a yield of about 3%. The most recent dividend marks four straight quarters without a dividend increase, so Cisco may be planning to raise the dividend along with its earnings announcement.

Even though earnings will likely take a hit from continued emerging market weakness, Cisco still has plenty of room to increase the dividend. In fiscal 2013, Cisco paid out about 28% of the free cash flow as dividends, so even a significant dividend hike wouldn't pressure the company's cash flow situation. The $50 billion of cash on the balance sheet helps support the dividend as well, although a large portion of this cash is held abroad.

The bottom line
Cisco is facing a few distinct challenges, and the lowered long-term revenue guidance points to these issues persisting for certainly the next few quarters...and possibly the next few years. But Cisco's dominant position in the industry is unlikely to change any time soon, and these short-term problems should eventually subside. The next few quarters probably won't be pretty, but for long-term investors, quarterly results are less important than the long-term story. And the long-term story still looks fine for Cisco, despite the current weakness.

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Timothy Green owns shares of Cisco Systems. The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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