Cisco Systems, Inc. (CSCO), the proud plumber of the Internet, has a commanding position in the market for enterprise networking devices. After acquiring Linksys and, more recently, Scientific Atlanta, Cisco now also sells devices intended for home use.
Our analysis of the January quarter found that Cisco performed well: Revenue grew at the upper end of the company's long-term target, and Net Income in the trailing four quarters grew by nearly 25 percent. However, Cash Flow from Operations, an important GCFR metric, rose at less than half that pace. Net Income expectations have been met, to some extent, by greater Interest and other Non-operating Income and by a lower Income Tax Rate.
Despite these few concerns, the Overall Gauge advanced in January to 47 (of 100 possible) points from 29 points the previous October. The increase was aided by Cisco shares falling in price from $33.06 to $24.50 during the November-to-January quarter. The share price decline caused the Value Gauge to increase from 0 points (a prescient warning of overvaluation) to a more appealing 12 (of 25 possible) points. January's results also resulted in Cash Management, Growth, and Profitability gauges scores between 10 and 13 points.
Cisco shares have bounced off the low prices hit in February and are now trading at over $25.
We've made estimates for Cisco's Income Statement in the April 2008 quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data, which the company will publish on 6 May 2008. Our estimates are derived from trends in the company's historical financial results and guidance provided by company management.
When discussing January's results, Cisco management reported that product order growth was strong in the beginning of the quarter but then slowed to weaker-than-expected levels. Management said they believe the slowdown to be a short-term phenomenon. Nevertheless, Cisco lowered its Revenue forecast for the April 2008 quarter to 10 percent growth "year-over-year." [The GCFR definition of "year-over-year" is "the last four quarters compared to the four previous quarters." We learned the hard way a few quarters a ago that Cisco uses an alternative definition of "this quarter compared to the year-earlier quarter."] Since Revenue in the April 2007 quarter was $8.9 billion, the company's forecast for the quarter just concluded is $9.75 billion.
The 10 percent rate is below the company's long-term (and frequently stated) growth objective of 12 to 17 percent. Quarter-to-quarter deviations outside this range are not unusual.
Management's guidance for Gross Margin is 65.0 percent, a figure that seems a little high given the order slowdown and the fact that the margin in recent quarters has been closer to 64.5 percent. We're more comfortable with the lower number and will use it as our target. Therefore, our forecast for Cost of Goods Sold (CGS) is 35.5 percent of $9.75 billion, which is $3.5 billion.
Cisco stated that they expect the quarter's Operating Expenses to be about 37 percent of Revenue. On Cisco's Income Statement, Operating Expenses include Research and Development (R&D) and Sales, General, and Administrative (SG&A) costs, but not CGS. Based on past results, we expect R&D expenses will be 12.5 percent of Revenue. This would equate to $1.2 billion, given the $9.75 billion Revenue estimate. Similarly, we expect SG&A expenses to be 26 percent of Revenue, which would be about $2.5 billion.
The R&D and SG&A estimates combine to 38.5 percent of Revenue, 1.5 points above the guidance. We might be too conservative, Cisco might be too optimistic, or the guidance might exclude some non-recurring costs: we will find out on 6 May. (Is there a seasonal factor that would explain lower costs in April quarters?) Cisco executives certainly know their business infinitely better than we so; however, lacking a reason to believe costs will drop substantially, we will stick with the GCFR methodology of using corporate guidance to modulate extrapolations of past results, not replace them.
Cisco always reports various other operating changes, including 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 $120 million seem reasonable given past results.
These figures would result in Operating Income of $2.4 billion, compared to $2.2 billion in the year-earlier quarter.
Cisco indicated that interest and other income would be $200 million in the April quarter. This might be a little conservative. We will set the target for $220 million. Pre-tax income would, therefore, be about $2.6 billion.
Management forecasts a 24 percent rate for income taxes, which we have no reason to doubt. As a result, provisions for income taxes are estimated at $633 million.
Therefore, we're looking to see Net Income in the quarter of $2.00 billion. This would equate to $0.32 per share, depending on the number of shares outstanding.
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | | April 2008 (predicted) | April 2007 (actual) |
| Revenue | | 9753 | 8866 |
| Op expenses | | | |
| | CGS | (3462) | (3219) |
| | R&D | (1219) | (1144) |
| | SG&A | (2536) | (2208) |
| | Other | (120) | (98) |
| Operating Income | | 2416 | 2197 |
| Other income | | | |
| | Investments | 0 | 0 |
| | Interest, etc. | 220 | 222 |
| Pretax income | | 2636 | 2419 |
| Income tax | | (633) | (545) |
| Net Income | | 2003 | 1874 |
| | | $0.32/sh | $0.30/sh |
| Shares outstanding | | 6175 | 6244 |
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