The networker's earnings growth stemmed almost entirely from cost cutting, along with wider gross margins for its products. Cisco's top line -- the dollar value of products and services it sold -- was actually 2.5% lower than the same quarter last year and 1.9% lower for fiscal 2003 vs. 2002.
The bright side is a dramatic increase in product gross margins -- from 67% to more than 70%. Much of this, however, was offset by lower gross margins for services, which saw costs increase 19% on a mere 1% increase in revenues.
The company also repurchased nearly $6 billion in stock during fiscal 2003, showing that it has finally decided to share some of its enormous stash with shareholders -- maybe. The number of diluted shares used to calculate earnings declined by more than 2.4%. But while Cisco bought back 424 million shares, in the past three years the company has granted on average 299 million employee options. Investors better keep an eye on this year's grants when the 10-K is released in a few weeks, as the benefits of that $6 billion in shareholder equity could evaporate.
The dark side is that Cisco clearly strained to reach its numbers, managing no top-line growth whatsoever. Annual sales and marketing, and research and development costs were substantially lower than in 2002. The former could imply more streamlined operations, but the latter is a nearly unmistakable sign that Cisco is shortchanging its future to improve current results.
So while we can look at the 27% bottom-line earnings growth and say "good times!" almost every other number in Cisco's results says anything but. Operating cash flows declined by more than 20% to $5.2 billion for the year. And let's not forget that 2002 was a miserable year for router sales, so you can't argue that the hurdle was set too high.
And keep in mind, even with the 7% sell off in early morning trading, Cisco sells at a gaudy 27 times free cash flow. In other words, people who invest in Cisco are not only expecting a massive "Internet changes everything" type rally in equipment spending, but also that this rally happens soon. And they assume that Cisco shares will not be heavily diluted meanwhile.
None of this is supported by yesterday's results. CEO John Chambers was cautiously optimistic that a sector recovery is coming and that first-quarter 2004 revenues will be 2%-4% higher. Given current multiples, I'd say he'd better hope for a darn sight more than that. Cisco's results show nothing more than a company treading water, cutting costs wherever possible -- amid little evidence of economic improvement, the kind that generates things like, oh, jobs and capital spending.
No company in the history of mankind ever cost-cut its way to prosperity. Eventually Cisco's going to have to show real top-line growth, or its stock could once again get hammered.