Cisco Systems, Inc. (CSCO), the proud plumber of the Internet, has a commanding position in the market for enterprise networking products and services.
When we analyzed Cisco after the results from the January quarter became available, the Overall Gauge advanced to 48 (of 100 possible) points from 29 points the previous October. Of the four individual gauges that fed into this composite result, all were between 10 and 13 (of 25 possible) points. The Value Gauge's rise from 0 to 12 points was abetted by a substantial decline in the price of Cisco shares in the January quarter.
Cisco management, when discussing January's results, reported that product order growth was strong in the beginning of the second quarter but then slowed to weaker-than-expected levels. Although believing the downturn to be a short-term phenomenon, Cisco lowered its Revenue forecast for the April 2008 quarter to 10 percent growth from the company's long-term target of 12 to 17 percent.
Now, with data available from the April 2008 quarter, our gauges display the following scores:
- Cash Management: 10 of 25 (down from 12 in January)
- Growth: 9 of 25 (down from 10)
- Profitability: 15 of 25 (up from 13)
- Value: 10 of 25 (down from 11)
- Overall: 46 of 100 (up from 48)
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 non-GAAP results exclude $729 million of expenses ($536 million after tax).
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | | April 2008 (actual) | April 2008 (predicted) | April 2007 (actual) |
| Revenue | | 9791 | 9753 | 8866 |
| Op expenses | | | | |
| | CGS | (3486) | (3462) | (3219) |
| | R&D | (1439) | (1219) | (1144) |
| | SG&A | (2608) | (2536) | (2208) |
| | Other | (117) | (120) | (98) |
| Operating Income | | 2141 | 2416 | 2197 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. | 168 | 220 | 222 |
| Pretax income | | 2309 | 2636 | 2419 |
| Income tax | | (536) | (633) | (545) |
| Net Income | | 1773 | 2003 | 1874 |
| | | $0.29/sh | $0.32/sh | $0.30/sh |
| Shares outstanding | | 6069 | 6175 | 6244 |
Revenue in the April 2008 quarter was 10.4 percent greater than in the year-earlier quarter. The growth rate was just slightly higher than Cisco's reduced guidance of 10.0 percent. Trailing four quarters, year-over-year Revenue growth is now 15.3 percent.
Cisco achieved a Gross Margin of 64.4 percent in the quarter, which almost satisfied our 64.5 percent target. [The company's guidance was to expect a 65 percent margin, and we did well by trimming it by 0.5 percent.] The actual Gross Margin is equivalent to a Cost of Goods Sold (CGS) of 35.6 percent of Revenue.
Research and Development (R&D) expenses were 14.7 percent of Revenue; these expenses were substantially more than the 12.5 percent prediction. Sales, General, and Administrative (SG&A) expenses, at 26.6 percent of Revenue, exceeded our 26.0 percent estimate. [For both R&D and SG&A, some of the extra expenses are excluded in Cisco's non-GAAP presentations.]
Other operating expenses (primarily amortization of purchased intangible assets) were within $3 million of our prediction.
Much higher than expected R&D was the principal reason Operating Income fell 11.4 percent below the forecast value.
Non-operating interest and other income was $52 million less than expected. The Income Tax Rate was trimmed to 23.2 percent, instead of the predicted 24 percent. Net Income fell short of the prediction by 11.5 percent.
Cash Management. This gauge decreased from 12 points in January to 10 points now.
| March 2008 | 3 months ago | 12 months ago | |
| Current Ratio | 2.6 | 2.7 | 2.6 |
| LTD/Equity | 19.4% | 20.9% | 22.7% |
| Debt/CFO | 0.6 yrs | 0.6 yrs | 0.7 yrs |
| Inventory/CGS | 34.2 days | 39.5 days | 39.4 days |
| Finished Goods/Inventory | 68.0% | 64.7% | 58.3% |
| Days of Sales Outstanding (DSO) | 35.1 days | 34.3 days | 33.9 days |
| Working Capital/Market Capitalization | 12.8% | 12.8% | 10.7% |
| Cash Conversion Cycle Time (CCCT) | 47.0 days | 50.1 days | 47.5 days |
The Inventory data is mixed. Total inventory as percentage of CGS is down significantly, but the percentage of Finished Goods in the Inventory is up significantly. We prefer to see declines in both of these metrics, and we raise a red flag when both are increasing.
Growth. This gauge decreased from 10 points in January to 9 points now.
| March 2008 | 3 months ago | 12 months ago | |
| Revenue growth | 15.3% | 18.0% | 23.6% |
| Revenue/Assets | 67.6% | 68.1% | 68.5% |
| CFO growth | 16.7% | 12.0% | 20.8% |
| Net Income growth | 14.7% | 24.7% | 24.6% |
As predicted, Revenue growth has decelerated. Net income benefited from a change in the income tax rate from 23.5 to 21.1 percent, but still declined. Cash Flow growth, on the other hand, has held up well.
Profitability. This gauge increased from 13 points in January to 15 points now.
| March 2008 | 3 months ago | 12 months ago | |
| Operating Expenses/Revenue | 74.7% | 74.0% | 73.7% |
| ROIC | 22.7% | 22.4% | 22.8% |
| FCF/Equity | 30.3% | 28.7% | 30.1% |
| Accrual Ratio | 12.2% | 17.8% | 31.6% |
Cisco is to be commended for maintaining ROIC and FCF at loftly levels, despite an increase in Operating Expenses as a percentage of Revenues. The decreasing Accrual Ratio tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in non-operational Balance Sheet accruals.
Value. Cisco shares increased in price from $24.50 on 31 January to $25.64 on 30 April. The Value gauge, based on the latter price, decreased from 11 to 10 points.
| March 2008 | 3 months ago | 12 months ago | 5-year median | |
| P/E | 19.5 | 18.8 | 24.0 | 24.3 |
| P/E to S&P 500 average P/E | 117% | 113% | 145% | 144% |
| Price/Revenue | 4.0 | 4.0 | 5.0 | 5.0 |
| Enterprise Value/Cash Flow (EV/CFO) | 12.2 | 12.7 | 15.6 | 15.6 |
Revenue decelerated in the quarter, which put pressure on Operating Expenses and, thus, GAAP Net Income. We suspect that the company won't be able keep decreasing the Income Tax Rate, which directly benefits the bottom line. The Sales slowdown might also have caused a backup in the Finished Goods inventory. However, increasing Cash Flow has improved Earnings quality. All in all, we're encouraged by the Overall gauge score of 46 points, which is pretty good. Cisco Systems makes a lot of money; it has minimal debt; and the shares now trade at modest levels as measured by our Value gauge.
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