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A Weak Quarter Expected for Cisco Systems

By Timothy Green – Nov 13, 2016 at 3:05PM

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The company may beat expectations, but revenue is likely to decline, and earnings growth is expected to be sluggish at best.

Networking hardware giant Cisco Systems (CSCO 1.57%) has made a habit of beating analyst estimates, and the company will try to extend that streak when it reports its fiscal first-quarter results after the market close on Nov. 16. Cisco performed better than expected during the fourth quarter, but the announcement of significant layoffs balanced out that good news. Revenue has declined for three quarters in a row, and Cisco's guidance suggests that a fourth quarter of decline is likely.

Image source: Cisco Systems.

What analysts are expecting

Cisco guided for year-over-year revenue growth between -1% and 1%, excluding divestitures, during the first quarter. The average analyst estimate, which doesn't exclude that negative impact, calls for revenue of $12.34 billion, a 2.7% drop. Analysts do expect Cisco to return to revenue growth during the second quarter, but it looks likely that another revenue decline is in the cards.

Turning to earnings, analysts expect Cisco to produce non-GAAP EPS of $0.59, right in the middle of the company's guidance range. This represents flat earnings compared to the prior-year period. During the fourth quarter, non-GAAP EPS surged 9%, driven by a higher gross margin and lower operating expenses. That kind of growth is unlikely to be repeated during the first quarter.

A restructuring plan amid tepid growth

Cisco still derives the bulk of its revenue from networking switches and routers, two businesses that are no longer producing much growth. Collaboration, data center, and security are three growth areas Cisco has focused on in recent years, and the company's restructuring efforts could help accelerate growth in those businesses.

Cisco planned to eliminate 5,500 positions beginning in the first quarter -- roughly 7% of its global workforce. These layoffs are occurring in low-growth areas, with the company expecting to reinvest the cost savings in businesses that have the potential to return the company to growth. It's unlikely that there will be an immediate impact, but investors should expect to hear more about this plan from management during Cisco's earnings conference call.

Overseas cash

Cisco is one of many large technology companies that have mountains of cash sitting overseas. At the moment, bringing that cash back to the U.S. would trigger repatriation taxes of 35%. Following the election of Donald Trump, who promised to allow U.S. companies to bring back overseas cash and pay a 10% tax rate, the issue of Cisco's cash is likely to come up during the company's conference call.

Cisco has taken on debt in order to fund dividends and share buybacks, while its hoard of cash continues to grow. If a lower repatriation tax is implemented, it would allow Cisco to bring back that excess cash, potentially fueling a higher dividend payment, more share buybacks, or a greater number of acquisitions. Investors should be on the lookout for any guidance on that front.

Growth businesses

During fiscal 2016, collaboration and security were standouts for Cisco in terms of growth. The collaboration segment, which includes everything from video conferencing equipment to the company's Spark communications software, has grown into the third-largest segment. Security is much smaller, but it grew at a double-digit pace in fiscal 2016, and a slew of recent acquisitions should help drive continued growth.

One thing holding Cisco's revenue and earnings back is the company's shift toward subscription-based software and services. Both the collaboration and security businesses heavily tilt toward software, creating a situation where an increasing amount of revenue is realized over time instead of up front. During the fourth quarter, Cisco's deferred revenue from software and subscriptions grew by 33%. That growth is a good indication that Cisco's strategy is working, despite the sluggish headline numbers.

On an absolute basis, Cisco's first quarter is likely to be lackluster. A revenue decline and flat earnings are nothing to get excited about. The company's guidance will be important, as will commentary from management regarding its overseas cash, the effects of its restructuring, and how it expects the results of the election to affect its international business. With Cisco deriving a significant portion of its revenue from international markets, any backlash against American companies would be bad news for the tech giant.

Timothy Green owns shares of Cisco Systems. The Motley Fool recommends Cisco Systems. 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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