Deferrals Bug Cisco Investors

This week Cisco Systems Inc. (Nasdaq: CSCO) reported revenue growth, but analysts and investors weren't singing the company's praises.

Since the trading day ended on February 6, Cisco's shares have dropped $1.85 (9.94%) to $16.76.

Wall Street gave the earnings announcement a lukewarm reception. One analyst, Dresdner Kleinwort Wasserstein's Ariane Mahler, recommended that her bank's clients sell their Cisco shares. In his research note, Robertson Stephens analyst Paul Johnson remarked that he thinks Cisco's valuation "represents investor expectations for growth that are unachievable given the current market conditions."

What gives?

Cisco remains a dominant company with billions in cash, but it raised eyebrows when it reported overall quarter-to-quarter revenue growth, while its revenues from products actually shrank from quarter to quarter.

The subcategory of Cisco's revenues called revenue deferrals, which aren't attributed to specific product or service categories, caused the most concern. This category reduced Cisco's revenues by more than $350 million in the first quarter but added $48 million to its revenues in the second quarter.

Table 1: Cisco's Revenue Breakdown for Fiscal 2002 ($M)
Q1 Q2
Routers 1,607 1,584
Switches 1,980 2,016
Access 308 288
Other 484 432
Services 792 768
Revenue Adjustments (396) (336)
Revenue Deferrals (352) 48
Total 4,423 4,800
Source: Company data

Put another way, if Cisco's revenue deferrals had stayed the same in Q2 as they were in Q1, Cisco would have reported a 2 percent quarterly revenue decline, not an 8 percent revenue increase.

The deferral category includes sales of contract terms requiring revenue deferral and products sold by Cisco distributors (where revenue isn't recognized until the distributor's point of sale).

"Because of how deferred revenues are derived and the source material those numbers are drawn from, the number is out of sync with what Cisco has reported previously," says Stephen Kamman at CIBC World Markets. "But the balance sheet and the income statement are in sync and there's no evidence here that Cisco's trying to be deceitful."

One thing that might have added to the revenue deferral mess is Cisco's product mix – the company likely experienced a shift from selling to more enterprise customers and fewer service providers during the second quarter. Cisco has always had to enter service provider and enterprise contracts into the same accounting system, though the two businesses differ greatly from each other in profit margins, annual spending cycles, and basic contract terms.

The upshot? Cisco doesn't appear to have done anything wrong, but it is frustrating investors all the same because:

  • The revenue deferral item obscures how individual product groups performed over time;

  • Cisco's upcoming third quarter is usually its weakest of the year, and product revenues have been sliding for several quarters now; and

  • CEO John Chambers still hasn't definitively called a bottom for Cisco's businesses, and he hasn't given long-term revenue guidance due to lack of visibility.

But considering that Cisco has billions in cash -- and considering the overall state of the industry -- its problems still appear relatively minor.

Calls to Cisco about the revenue deferral issue had not been returned by press time.

— Phil Harvey, Senior Editor, Light Reading
godbox 12/4/2012 | 10:58:00 PM
re: Deferrals Bug Cisco Investors Is this the same guy who was going around several
startups during the "boom" and telling them
they ought to be worth at least $10B-$20B on
IPO even though they had zero sales, half baked
products and are now close to bankruptcy ? (no
kidding some of his quotes (perhaps sold for
pre-IPO stock) are still on startup web pages
check them out ...) And he is talking of
unrealistic valuation ? I suspect it is
indeed the same guy. So the big bulls want to
turn into big bears now is it ? Either way
they want the public's money.

It would have been nice if LR chose commentators
who can provide insight on both sides of the story
instead of quoting a person with this sort
of track record.
Gastroenterologist 12/4/2012 | 10:57:59 PM
re: Deferrals Bug Cisco Investors I expect Paul Johnson to be subject to SEC investigation some time soon.

You would NOT believe some of the things he used to brag about doing.
developer 12/4/2012 | 10:57:58 PM
re: Deferrals Bug Cisco Investors I have worked at one of the startups where he
was spewing this BS to all the developers. And
the execs and management staff were just lapping
it all up and insisting on feeding it to the
developers. I guess we just over dosed on his
BS. Its pay back time. Paul Johnson Ha Ha....
The next time he opens his mouth anywhere near
my work I am going to jump out of the window.

Bull or Bear either way I'd say its pure
unadulterated BS!
flanker 12/4/2012 | 10:57:56 PM
re: Deferrals Bug Cisco Investors Gee, all these comments about Paul Johnson and I thought he was one of the better analysts. I may have him confused with someone else but his research is pretty comprehensive and he seems, unlike A LOT of analysts, to understand the technology.

Doesn't say much for analysts as a whole...
light-reader 12/4/2012 | 10:57:52 PM
re: Deferrals Bug Cisco Investors If you have revenues, you can defer them too.
LR, what about your main sponsor Juniper which
in any case you have to praise. LR has tried all
sorts of puffing about Juniper but nothing seem
to be working and it never seem to write anything
positive about Cash King Cisco.
Cisco's earning were not great but decent in light
of current market situation and its size.
Keep telling lies about Cisco and keep creating
smoke screens for Juniper... and you will sure
end up in drain one day.
godbox 12/4/2012 | 10:57:48 PM
re: Deferrals Bug Cisco Investors Hey before we start banging up on Mr PJ or
any analyst remember the entire industry had
a warped sense of valuation not long ago.
So maybe it was perfectly reasonable to claim
that any networking company ought to be worth
several billions regardless of business
viability :-).

Talking of unrealistic valuations, remember
Vinod Khosla claiming that there would
soon be a trillion dollar market cap company
that no one had heard of yet? And this was
when we were well into the recession!

Scott Raynovich 12/4/2012 | 10:57:45 PM
re: Deferrals Bug Cisco Investors light-reader:

FYI, Both Cisco and Juniper have been sponsors of LR, so your statement about Juniper being the "main sponsor" is both irrelevant and false.

This also shows that your attempts to uncover advertising/editorial conpiracies are fruitless...
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