Cisco Systems, Inc. (CSCO), the proud plumber of the Internet, has a commanding position in the market for enterprise networking products and services, such as routers. The latest leg down in equity markets have brought Cisco shares to newer lows.
Earlier, when we analyzed Cisco's April quarter, the Overall Gauge measured 43 (of 100 possible) points. Of the four individual gauges that fed into April's composite result, Profitability was the strongest at 12 (of 25) points, and Growth was weakest at 9 (of 25) points. The Value gauge has perked up as the price of Cisco shares have fallen.
Now, with data available from the July 2008 quarter, our gauges display the following scores:
- Cash Management: 16 of 25 (up from 10 in April)
- Growth: 11 of 25 (up from 9)
- Profitability: 15 of 25 (up from 12)
- Value: 16 of 25 (up from 11)
- Overall: 62 of 100 (up from 43)
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 expenses of $532 million ($381 million after tax).
| ($M) | | July 2008 (actual) | July 2008 (predicted) | July 2007 (actual) |
| Revenue (1) | | 10364 | 10329 | 9433 |
| Op expenses | | | | |
| | CGS (2) | (3698) | (3667) | (3365) |
| | R&D | (1306) | (1343) | (1178) |
| | SG&A (3) | (2682) | (2686) | (2404) |
| | Other (4) | (149) | (140) | (183) |
| Operating Income | | 2529 | 2494 | 2303 |
| Other income | | | | |
| | Investments | 0 | 0 | 0 |
| | Interest, etc. (5) | 157 | 150 | 228 |
| Pretax income | | 2686 | 2644 | 2531 |
| Income tax | | (672) | (635) | (601) |
| Net Income | | 2014 | 2009 | 1930 |
| | | $0.33 | $0.33/sh | $0.31/sh |
| Shares outstanding | | 6034 | 6030 | 6275 |
(2) Total cost of sales
(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 July 2008 quarter was 9.9 percent greater than in the year-earlier quarter. Cisco's guidance for the quarter had been to expect Revenue growth of 9 to 10 percent. Our target was the 9.5 percent midpoint of the range. Revenue in the most recent four quarters (i.e., fiscal 2008) exceeded Revenue in the four previous quarters (i.e., fiscal 2007) by 13.2 percent.
Cisco achieved a Gross Margin of 64.3 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 35.7 percent of Revenue.
Research and Development (R&D) expenses were 12.6 percent of Revenue, a little less than the 13.0 percent prediction. Sales, General, and Administrative (SG&A) expenses, at 25.9 percent of Revenue were almost identical to our 26.0 percent estimate.
Other operating expenses (primarily amortization of purchased intangible assets) were $9 million more than our prediction.
The slightly higher than anticipated Revenue, offset partially by higher miscellaneous expenses, was the principal reason Operating Income surpassed our forecast value by 1.4 percent.
Non-operating interest and other income was $7 million more than expected. The Income Tax Rate was 25 percent, instead of the predicted 24 percent.
Net Income essentially matched our prediction.
Cash Management. This gauge increased from 10 points in April to 16 points now.
| July 2008 | 3 months ago | 12 months ago | |
| Current Ratio | 2.6 | 2.6 | 2.4 |
| LTD/Equity | 18.6% | 19.4% | 20.4% |
| Debt/CFO | 0.6 yrs | 0.6 yrs | 0.6 yrs |
| Inventory/CGS | 33.2 days | 34.2 days | 39.0 days |
| Finished Goods/Inventory | 67.4% | 68.0% | 64.9% |
| Days of Sales Outstanding (DSO) | 36.0 days | 35.1 days | 38.1 days |
| Working Capital/Market Capitalization | 15.6% | 12.8% | 9.7% |
| Cash Conversion Cycle Time (CCCT) | 47.6 days | 47.0 days | 52.9 days |
With just a couple of minor exceptions, the Cash Management metrics improved during the July quarter. The percentage of Finished Goods in the Inventory is higher than we prefer, but down a little from the April quarter. Days of Sales Outstanding is up from April, but down from July 2007. We prefer to see steady declines in both of these metrics.
Growth. This gauge increased from 9 points in April to 11 points now.
| July 2008 | 3 months ago | 12 months ago | |
| Revenue growth | 13.2% | 15.3% | 22.6% |
| Revenue/Assets | 67.3% | 67.6% | 65.5% |
| CFO growth | 19.6% | 16.7% | 27.9% |
| Net Income growth | 9.8% | 14.7% | 31.4% |
As predicted, Revenue growth has decelerated. Cash Flow from Operations rebounded, but didn't match fiscal 2007's torrid pace. Net income, which benefited from a change in the income tax rate from 22.5 to 21.5 percent, also slowed.
Profitability. This gauge increased from 12 points in April to 15 points now.
| July 2008 | 3 months ago | 12 months ago | |
| Operating Expenses/Revenue | 74.9% | 74.7% | 73.9% |
| ROIC | 21.7% | 22.7% | 20.7% |
| FCF/Equity | 31.5% | 30.3% | 28.1% |
| Accrual Ratio (*) | 0.3% | 4.1% | 10.4% |
Cisco is to be commended for maintaining ROIC and FCF at loftly levels, despite a challenging economic conditions. 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 decreased in price from $25.64 on 30 April to $21.99 on 31 July. The Value gauge, based on the latter price, increased from 11 to 16 points.
| July 2008 | 3 months ago | 12 months ago | 5-year median | |
| P/E | 16.5 | 19.5 | 23.8 | 23.7 |
| P/E to S&P 500 average P/E | 94% | 108% | 150% | 142% |
| Price/Revenue | 3.4 | 4.0 | 5.0 | 5.0 |
| Enterprise Value/Cash Flow (EV/CFO) | 9.4 | 12.2 | 15.7 | 15.4 |
This may be the closest we've ever come to predicting a company's actual quarterly results. To be sure, we benefited from company-provided guidance.
The July results led to increases in all four of the gauge scores. The Overall Gauge score of 62 points, of 100 possible points, is a very good score. It could be suggesting that Cisco shares, which have dropped steeply in the last three quarters, may have bottomed.
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