Cisco Beat Earnings, Took a Beating on Layoffs

No reason to celebrate an estimate-beating quarter

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Aug 18, 2016
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Cisco (CSCO, Financial) reported its fourth quarter earnings with numbers that beat analyst estimates. Instead of being rewarded, however, the company was faced with a string of bad news concerning massive expected layoffs. One tech news site, CRN, reported that the company might lay off 20% of its workforce, or 14,000 employees.

What is significant is that the number reported was way off the company’s own announcement during the fourth quarter earnings call that their restructuring will be impacting 5500 employees, or 7%, of their global workforce.

How is the Restructuring Announcement Affecting Them?

"We expect to reinvest substantially all of the cost savings from these actions back into these businesses and will continue to aggressively invest to focus on our areas of future growth. The restructuring will eliminate up to 5,500 positions, representing approximately 7 percent of our global workforce, and we will take action under this plan beginning in the first quarter of fiscal 2017." - CSCO Press Release

So, instead of focusing on the fourth quarter results, all eyes turned towards the restructuring process and the stock is dowm more than 1% since Wednesday.

Companies resort to workforce reduction when there is dire stress to their overall numbers and, as such, always brings a wave of negative sentiment along with it. The market’s reaction is understandable, but let’s take a closer look to see if Cisco’s layoff announcement is a sign of more trouble to come.

No Growth Inevitably Leads to Cost-Cutting

After seeing its revenue grow since the fourth quarter of 2014, Cisco’s quarterly sales numbers turned negative from the second quarter of this year. Cisco ended the year with flat growth, reporting $49.2 billion in sales, the exact same number they had last year, while net income grew 20% to reach $10.7 billion compared to last year.

The other big factor that took all the shine from their fourth quarter earnings beat was their bittersweet guidance. Cisco expects to post -1% to 1% growth next year and if they hit the mid range, it will be a flat annual revenue number- a clear indication that the company is finding it hard to steer itself in the market.

With sales growth expected to stay flat, the company is trying to save on the costs front, starting with their restructuring plan so they can at least continue to show margin expansion.

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The State of Cisco’s Business

Cisco sells technology equipment to businesses around the world and most of us have used Cisco’s networking products in one form or other. With large enterprises and network carriers slowing down on their IT spends, Cisco’s primary switches and routers business has been facing a slowdown. Cisco’s switching business reported flat growth for the year, while their routing business was down by 4%. Together, both these segments account for 44% of Cisco’s total revenue and if these segments slow down, then Cisco will slow down as a whole

“A big pivot is reasonable,” says IDC analyst Rohit Mehra. “Cisco’s bread-and-butter business, switching and-routing business, isn’t going away but it has slowed, as has wireless LAN. They need to do something new.”

- USA Today

Possible Growth Supporters

Cisco’s wireless and security segments are growing, but with just $4.59 billion in annual revenues out of their total $49.25 billion, the growth in these segments will not be good enough to mask the slowdown in its near-$22 billion dollar switching and routing business. Nevertheless, Cisco continues to invest heavily in wireless and security, while also trying to catapult itself into the cloud on the back of a growing cloud and Internet of Things industry.

With the workforce reduction, Cisco has sent a clear signal that the company is on a transformational path. Switching and routing are not the type of businesses that will vanish overnight, but the question remains on how far it can grow or for how long it will keep slowing down.

With IT spending from enterprises moving toward third party infrastructure managers, Cisco understands the need to steer into the new direction. But with tepid growth expectations for next year, the stock will be under tremendous pressure in the next four to eight quarters as investors watch every move the company makes.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.

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