Our analysis after the October quarter noted higher SG&A expenses and greater-than-expected costs due to amortization of purchased intangible assets. We also observed that non-operating income was up substantially and the Income Tax Rate was artificially low because of a $162 million settlement. The non-operating results enabled Net Income to outshine expectations.
The Value Gauge read zero points in October, a rock-bottom level signaling that the stock, then $33, had become quite expensive. The Overall Gauge was a quite modest 27 points. Our gauge scores for Cisco had actually been weak for several quarters. The market didn't reach this conclusion until the effects of the subprime fiasco on national and global economic conditions became clearer late in 2007. Cisco shares are under $25 today.
Cisco's latest results will give us some hints as to whether the market might have over-reacted on the downside or whether the shares might fall further still.
When discussing October's results, Cisco management reiterated previous guidance that the company can grow over the long term at 12 to 17 percent per year with some periods outside either end of this range. For the January quarter, the company stated that they expect Revenue Growth near the top of the range, at "16 percent year-over-year." The GCFR definition of "year-over-year" is "the last four quarters compared to the four previous quarters." However, Cisco uses an alternative definition of "this quarter compared to the year-earlier quarter." One definition would set the revenue target at $9.2 billion, and the other leads to $9.8 billion. The higher value is the one we believe reflects Cisco's intent.
Management's guidance for Gross Margin is 65.5 percent, a figure that seems a little high. This ratio has been recently been closer to 64.5 percent. We'll split the difference, and set the target at 65 percent. Therefore, our forecast for Cost of Goods Sold (CGS) is 35 percent of $9.8 billion, which is $3.4 billion. (The cost would be about $50 million less if the Gross Margin is 65.5 percent.)
Cisco stated that they expect the quarter's Operating Expenses to be about 36 percent of Revenue. On Cisco's Income Statement, Operating Expenses include Research and Development (R&D) costs, Sales, General, and Administrative (SG&A) costs, and other various other charges, but not CGS. The 36 percent figure seems low, based on past results. We have no reason to believe that R&D expenses will be any lower than 12.5 percent of Revenue. This would equate to $1.2 billion. Similarly, we don't see why we should expect SG&A expenses to be much less than 25 percent of Revenue, which would be about $2.5 billion.
The R&D and SG&A estimates combine to 37.5 percent of Revenue, a point and a half above the guidance. Cisco executives are certainly better informed than we are, but we will stick with the GCFR methodology of using corporate guidance to modulate extrapolations of past results, not replace them.
The various other operating changes mentioned above include payroll tax on stock options, amortization of deferred compensation, amortization of purchased intangible assets, and the mysterious in-process research and development. We don't know how to forecast these costs, but $100 million seem reasonable.
These figures would result in Operating Income of $2.6 billion, compared to $2.13 billion in the year-earlier quarter.
Cisco indicated that interest and other income would be $225 million, which is close to the average for non-operating income during the previous four quarters. Pre-tax income would, therefore, be about $2.8 billion.
The income tax rate has been forecast at 24 percent. As a result, provisions for income taxes are estimated at $700 million.
Therefore, we're looking to see Net Income in the quarter of $2.14 billion. This would equate to $0.34 per share.
| ($M) | | January 2008 (predicted) | January 2007 (actual) |
| Revenue | | 9789 | 8439 |
| Op expenses | | | |
| | CGS | (3426) | (3051) |
| | R&D | (1224) | (1094) |
| | SG&A | (2447) | (2066) |
| | Other | (100) | (98) |
| Operating Income | | 2592 | 2130 |
| Other income | | | |
| | Investments | 0 | 0 |
| | Interest, etc. | 225 | 205 |
| Pretax income | | 2817 | 2335 |
| Income tax | | (676) | (414) |
| Net Income | | 2141 | 1921 |
| | | $0.34/sh | $0.31/sh |
| | | | |
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