Cisco Systems (Nasdaq: CSCO) has stated for the past several years that it would grow at a 30% to 50% annualized clip for as long as it cared to project. After continually beating analyst estimates by one penny every quarter, management confidently said last year, "We're the most boring, consistent company" on the market, "and, yes, we'll continue growing at least 30% annua...."
Just as management finished the sentence, the floor fell out beneath it. Cisco just took a $2.2 billion charge for excess inventory purchased last fall while the economy was slowing. In the most recent quarter, its sales actually declined 29% from the previous quarter, rather than rising, and at least the next quarter will suffer as well.
In discussing the pitiful results, both Cisco management and stock analysts pointed to Cisco's pro forma, or hypothetical, profit and coolly called the inventory charge an "unusual, one-time event." It should be called a blundering mistake for which management is entirely responsible. That's one problem with pro forma numbers: Every time a management makes a big mistake, they call it a one-time event and brush it under the rug by reporting pro forma results more prominently than actual results.
Even analyst earnings estimates for Cisco are now made on a pro forma basis, which I find hard to believe. Including $3.7 billion in charges for inventory and lay-offs, Cisco lost $0.37 per share last quarter, or $2.69 billion. On a pro forma basis, which removes any so-called "unusual charges," the company hypothetically earned net income of $0.03 per share. The average analyst estimate for the quarter: $0.03 per share. Pro forma has become the norm in estimating earnings. That is frightening!
In all but true one-time cases -- such as acquisitions or spinoffs -- it is time that investors stop giving such merit to pro forma results. An inventory debacle should not qualify as an "extraordinary event." It's a mistake, and mistakes are not extraordinary. They're fairly common. A mistake should be reported in the numbers as such and management should accept full responsibility.
Today's column is not just about the abuse of pro forma accounting. It is also about management making long-term projections. Cisco apparently hasn't learned from this mistake. Management's credibility is in question after repeatedly promising 30% to 50% growth and then suddenly shrinking. But managers are still doing it. Cisco's management recently said that eventually the industry and Cisco should again grow at least 30% to 50% annually "when the economy is strong again."
I love the qualifier: "When the economy is strong again." How strong? Like 1999 strong?
Do yourself a favor, Cisco, and zip it! Stop saying silly things about how much the industry and your company will grow in the long term, because clearly you don't know (even with your advanced inventory management system, you just blew $2.2 billion on parts); and the thing is, you shouldn't feel bad for not knowing. Nobody knows. Especially not the stock analysts who rely on Cisco to do all their work for them.
That brings us to eBay (Nasdaq: EBAY). On Wall Street, eBay is now more famous for its bold "50% annualized sales growth through 2005" projection than for its actual business. That's unfortunate. Like Cisco, eBay has put itself in a position of vulnerability. If the company doesn't meet its own projection, it will be difficult to take management at its word in the future.
So, why make an aggressive, long-term projection at all? eBay's CEO, Meg Whitman, said that the company wanted to get the word out that they are not just about collectibles anymore; eBay has great opportunities ahead; eBay is going to grow very large in the next five years due to increasing sales of larger goods.
Great, eBay. But don't tell us. Show us! And certainly don't put a specific sales number on your business five years ahead. That's like standing in front of a long, fast train and saying that it'll stop right... HERE.
Come on. eBay's management doesn't know if the business can keep growing 50% annualized through 2005. They're hoping, and they'll do everything possible to make it happen. But they don't know when growth in their customer base might slow. It could slow considerably in 2002, and then Wall Street would have just one thing to say: "eBay might miss its 2005 goal. Sell!"
Warren Buffett doesn't like any company's management to publicly make long-term projections about its business because it puts extra risk on shareholders (should the company fall short of the public projection), and because it can make management act irrationally. When a management knows that it has a public goal to reach, it often takes extra risks -- even dumb risks -- to try to make the goal. It has all the pressure in the world to do so.
Cisco Systems continued to buy inventory even as the industry slowed last year -- why? Partly because it lived and died by its "We will grow 30% to 50% each year" projection. It couldn't grow at that rate without the inventory to do so, so it continued to buy a mountain of inventory despite warning signs.
eBay is a great business with growing promise. I only wish that it didn't choose to make the next five years a public spectacle with a $3 billion 2005 revenue goal. I admire Meg Whitman and almost everything that she's done at eBay. I know she believes in the goal. Making it public was unnecessary, though. You can discuss your great potential in general, but don't put a number out there for everyone to shoot at. Show us. Don't tell us.
Jeff Fischer owns shares of eBay -- in fact, it's his favorite holding. And by the way, Jeff wants to tell you that by 2005 he projects he'll weigh 10% more. The Motley Fool has a full disclosure policy.
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