Networking equipment veteran Cisco Systems ( CSCO 0.35% ) reported respectable results in the first quarter of fiscal year 2020. Sales rose 0.7% year over year to $13.2 billion, and adjusted earnings increased by 12% to $0.84 per diluted share. In both cases, Cisco's reported results edged out Wall Street's consensus estimates.
The company also issued second-quarter guidance far below analyst expectations, triggering a sharp sell-off of Cisco's shares. After publishing the report on Wednesday evening, the stock closed Thursday's trading session 7.3% lower.
But the numbers rarely tell the whole story. Let's take a dive into Cisco's earnings call, where management added color commentary and insights you simply won't find anywhere else.
1. The market is in worse shape than Cisco thought
Cisco CEO Chuck Robbins essentially apologized for keeping an overly positive attitude toward market conditions throughout 2019. The China-U.S. trade war and the Brexit mess really are hurting Cisco financially, after all.
"We delivered a solid quarter against a challenging macro environment," Robbins opened his prepared commentary. "Over the last year, many of you have heard me talk about the resilience of the global macro environment. However, on our last earnings call, we indicated that we had begun to see some weakness and that weakness continued throughout Q1 and was more broad-based."
Later, he added more detail to his view of the global economy.
"I would say that if you just go around the world right now and you look at what's happening in Hong Kong, you look at the China-U.S. trade situation, you look at what's going on in D.C., you've got Brexit, you've got uncertainty in Latin America," Robbins said. "If they get resolved, then you could see some of the uncertainty removed, and I think ... business confidence just suffers when there's lack of clarity."
That murky economic picture isn't inspiring governments and business leaders around the world to make big investments in networking infrastructure. Cisco could use a return to normalcy in any or all of the issues Robbins listed. If and when that happens, the business should start booming again. Pent-up demand for 5G wireless systems and their internet backbone support links should boost the networking hardware industry in a hurry.
We just don't have a reliable timeline for any of those geopolitical improvements.
2. The big strategy shift is on track
Cisco has been inching away from hardware sales in recent years in order to focus on high-margin software and services instead. If the wider profit margins weren't reason enough for this move, the company also aims for mostly renewable sales through subscription programs and multiyear contracts. Robbins provided a fresh update on how that transformation is going.
"We are on track with where we said we would be at the end of fiscal year 2020," he said. "This transition to software not only aligns to how our customers want to consume our technology, but we also believe it will lessen the impact of macroeconomic shifts in the future."
Cisco's stated goal is to collect 30% of total sales from software by the end of fiscal year 2020. Here in the first quarter of that reporting year, Cisco passed the 20% mark in this category, and 71% of those software sales were tied to subscription contracts.
3. Pricing changes
Technology companies like Cisco are always battling price reductions over time. CFO Kelly Kramer provided the following update on how Cisco's pricing trends are working out:
We had a really very, very good quarter on price. It is the lowest in some time in terms of the least amount of price erosion. Where we have price elasticity, we'll raise prices, and we've been effective in driving some product transitions and we've been realizing that benefit. I will say, we didn't feel the impact of it this quarter, but we are starting to see pricing pressure in the server market that we expect to accelerate next quarter, but that's of course included in the guidance. But for Q1, it was a very, very strong pricing quarter, which has been fantastic.
Things will get tougher over the next couple of quarters as current trends across the tech industry and the global economy play themselves out. Lower memory chip prices will lower Cisco's hardware production costs but will also make for a more competitive and price-sensitive server systems market. And the unpredictable economy may move the needle on Cisco's prices as well, but Kramer couldn't predict in which direction or by how much. They call it "unpredictable" for a reason, after all.