The good news from Cisco's
Another number showing substantial health is free cash flow. The company turned in free cash flow of $2.2 billion for the first six months of the year, up from $2 billion a year ago. This number comes with a bullet, though: every bit of the growth in free cash flow can be attributed to a 2,700% increase in tax benefits for stock options. It looks like Cisco employees are taking the price-rise opportunity to exercise some of the enormous stock option grants for which the company is known. Regardless of what adjustments you would make to the reported number, this result is quite strong.
One of the brightest stars for Cisco this quarter was its Linksys division, acquired in 2002. The wireless networking outfit showed a revenue increase of more than 39% to $165 million, as the concept of wireless networks in home and office has begun to fully achieve acceptance in the marketplace.
Many Cisco reports are likely to suggest that the company's price movement (it was down strongly after-hours) is because its earnings were lower.
Cisco's earnings came in lower due to an accounting change of $567 million from the treatment of stock options granted to employees of acquired startup Andiamo Systems. Accounting adjustments are just that -- adjustments. So only as much as investors only look at the bottom line and say "they earned less" and run to the exits would this be in any way a plausible explanation. This may be the case with some, but it's not very smart. Earnings at Cisco -- including all of the adjustments both required and not required by accounting practices -- were fine.
Then again, $567 million in charges for stock options for a startup?
Much more to the point was the comment from Cisco executives that they were finding corporate executives "more cautious" about technology spending than typical "at this stage of a recovery." Which is a little funny since as a child of the 1990s, Cisco would have never seen a situation like this before. So the comment struck me as a little odd, but it had to strike Cisco investors as shocking. At free cash flow ratios approaching 40 and operating earnings multiples approaching the same level, Cisco isn't priced for "more cautious" -- it's priced for "full steam ahead."
Cisco didn't deliver this. The recovery simply isn't as strong as it would need to be to justify prices. Investors discounted a growth rate that the company could not provide. There may be other reasons for the stock's probable drop today, but none bigger than that one -- and that's not the company's fault by any stretch.