When Cisco files a 10-Q, with more complete financial statements and notes, we will re-examine the analysis and determine if adjustments are necessary.
Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a commanding position in the market for enterprise networking products and services, such as routers. After acquiring Linksys and, more recently, Scientific Atlanta, Cisco now also sells devices intended for home use.
Management at Cisco often expresses confidence that the company's Revenue can grow over the long term at a rate between 12 and 17 percent, with some quarters above or below this range. As recently as 16 September 2008, CEO John Chambers stated that he has "never been more comfortable" with this long-term forecast.
Nevertheless, Chambers now warns that Revenue could fall as much as 10 percent in the November through January quarter due to the spreading worldwide economic slump.
Three months ago, the GCFR Overall Gauge of Cisco Systems rose to 61 of the 100 possible points when we analyzed the company's 10-K annual report for the year that ended on 26 July 2008. Scores over 60 points are very good if they are increasing. The score had been 43 points after the April quarter.
The Overall gauge was able to jump as much as it did because three of the four individual gauges increased. The Growth gauge was the laggard: Revenue was up 9.9 percent, but Net Income grew by a modest 4.4 percent. The rise in the contrarian Value gauge was due to Cisco's 14 percent share price drop during the May-June-July quarter.
The price per share dropped another 19 percent during the August-September-October period.
Now, with data available from the October 2008 quarter, our gauges display the following scores:
- Cash Management: 17 of 25 (up from 16 in July)
- Growth: 2 of 25 (down from 7)
- Profitability: 14 of 25 (down from 16)
- Value: 20 of 25 (up from 16)
- Overall: 64 of 100 (up from 61)
Before examining the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously announced expectations.
We use the Income Statement prepared in accordance with U.S. GAAP, rather than the non-GAAP ("pro forma" or "ex-items") data that gets so much attention. In the latest quarter, the difference between GAAP and non-GAAP results is almost $300 million.
| ($M) | | October 2008 (actual) | October 2008 (predicted) | October 2007 (actual) |
| Revenue (1) | | 10,331 | 10,318 | 9,554 |
| Op expenses | | | | |
| | CGS (2) | (3,650) | (3,663) | (3,381) |
| | R&D | (1,406) | (1,290) | (1,192) |
| | SG&A (3) | (2,678) | (2,683) | (2,493) |
| | Other(4) | (115) | (120) | (120) |
| Operating Income | | 2,482 | 2,563 | 2,368 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. (5) | 123 | 175 | 254 |
| Pretax income | | 2,605 | 2,738 | 2,622 |
| Income tax | | (404) | (657) | (417) |
| Net Income | | 2,201 | 2,081 | 2,205 |
| | | $0.37/sh | $0.35/sh | $0.35/sh |
| Shares outstanding | | 5,972 | 6,010 | 6,330 |
(2) Total cost of sales, product and service
(3) Sales and marketing + General and administrative
(4) Amortization of purchased intangible assets + In-process research and development
(5) Interest and other income (loss), net
Revenue in the latest quarter was 8.1 percent greater than in the October 2007 quarter. This was consistent with Cisco's guidance, which we accepted, to expect Revenue growth of about 8 percent. Revenue in the last four quarters exceeded Revenue in the four previous quarters by 11 percent.
The Cost of Goods Sold (CGS) was 35.3 percent of Revenue, which translates into a Gross Margin of 64.7 percent. This margin split the difference between the company's 65-percent guidance and our more conservative 64.5-percent estimate.
Research and Development (R&D) expenses were 13.6 percent of Revenue. We were expecting 12.5 percent of Revenue, so the R&D expenses were quite a bit more than we estimated.
Sales, General, and Administrative (SG&A) expenses were 25.9 percent of Revenue, which was almost identical to our 26.0 percent estimate.
Other operating expenses (primarily amortization of purchased intangible assets) were only $5 million less than our prediction.
Operating Income was 4.8 percent above last year's value, but 3.2 percent below our prediction. The unexpectedly high R&D figure was the main reason Operating Income growth fell short of our 8.2 percent estimate.
Non-operating interest and other income was $52 million less than expected. It was also less than half the equivalent amount in the year-earlier quarter.
Non-operating interest and other income was $52 million less than expected. It was also less than half the equivalent amount in the year-earlier quarter.
The Income Tax Rate was only 15.5 percent, instead of the predicted 24 percent, because of a $106 million tax benefit. Coincidentally, the tax rate was also artificially low in the October 2007 quarter as a result of a settlement on U.S. income tax matters.
Net Income was even with last year's value and 5.8 percent above our prediction. The low tax rate made all the difference. Earnings per share were up a couple of cents because there were fewer shares outstanding. Cisco announced that it spent $1.0 billion to repurchase 46 million shares at an average price per share of $21.95.
| Cash Management | October 2008 | 3 months ago | 12 months ago |
| Current Ratio | 2.6 | 2.6 | 2.7 |
| LTD/Equity | 18.2% | 18.6% | 19.4% |
| Debt/CFO | 0.6 yrs | 0.6 yrs | 0.6 yrs |
| Inventory/CGS | 32.2 days | 33.2 days | 39.1 days |
| Finished Goods/Inventory | 64.2% | 67.4% | 68.0% |
| Days of Sales Outstanding (DSO) | 30.3 days | 36.0 days | 32.7 days |
| Working Capital/Market Capitalization | 19.6% | 15.6% | 9.8% |
| Cash Conversion Cycle Time (CCCT) | 41.6 days | 47.6 days | 47.9 days |
| Gauge Score (0 to 25) | 17 | 16 | 10 |
The Balance Sheet is strong. Cisco did a good job keeping the Inventory level under control, despite slower sales growth. Days of Sales Outstanding is down nicely, and the drop in the Cash Conversion Cycle Time also suggests improved cash management efficiency.
| Growth | October 2008 | 3 months ago | 12 months ago |
| Revenue growth | 11.1% | 13.2% | 20.5% |
| Revenue/Assets | 70.4% | 70.6% | 72.1% |
| CFO growth | 7.3% | 19.6% | 24.6% |
| Net Income growth | 1.5% | 9.8% | 33.8% |
| Gauge Score (0 to 25) | 2 | 7 | 14 |
Revenue, Cash Flow, and Net Income growth rates are all down substantially, which is why the Growth score is so low. Cash Flow from Operations was actually down in the October quarter relative to the year-earlier period. Revenue/Assets is down, but not greatly.
| Profitability | October 2008 | 3 months ago | 12 months ago |
| Operating Expenses/Revenue | 75.1% | 74.9% | 73.8% |
| ROIC | 52.2% | 52.0% | 48.2% |
| FCF/Equity | 30.1% | 32.9% | 32.3% |
| Accrual Ratio | 3.6% | 0.3% | 10.2% |
| Gauge Score (0 to 25) | 14 | 16 | 13 |
Cisco is to be commended for maintaining ROIC and FCF at lofty levels, despite a challenging economic conditions. The quarter's increase in Accrual Ratio bears watching.
| Value | October 2008 | 3 months ago | 12 months ago | 5-year median |
| P/E | 13.2 | 16.5 | 26.4 | 23.0 |
| P/E to S&P 500 average P/E | 94% | 91% | 152% | 134% |
| Price/Revenue | 2.6 | 3.4 | 5.8 | 5.0 |
| Enterprise Value/Cash Flow (EV/CFO) | 7.4 | 9.4 | 17.5 | 15.1 |
| Gauge Score (0 to 25) | 20 | 16 | 0 | 11 |
Shares of Cisco Systems decreased in price from $21.99 on 31 July to $17.77 on 31 October and appear quite attractive on a valuation basis given the historical norms. Cisco's valuation ratios can be compared with other companies in the Networking & Communication Devices industry.
| Overall | October 2008 | 3 months ago | 12 months ago |
| Gauge Score (0 to 100) | 64 | 61 | 29 |
The October results led to decreases in the (especially) Growth and Profitability gauges. However, the strong Balance Sheet and the better valuation metrics were enough to lift the Overall Gauge score by a few points. However, we though Cisco shares looked attractive last quarter and they became cheaper still.
Given the possibility of a sales decline in the current quarter, caution is advised.
CEO John Chambers noted that the current "very challenging global economy" can work to Cisco's advantage if the company's networking products and services can make customers more productive and flexible.
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