MSFT: Financial Analysis through June 2007

We have analyzed Microsoft's (MSFT) financial results for the fiscal year and quarter that ended on 30 June 2007, as reported in a Form 10-K filed with the SEC. The more complete data in the 10-K did not change the results of the analysis performed on the preliminary financial results reported in a press release.

Microsoft sells operating systems, server applications, business solutions, video game consoles, music players, and computer peripherals. The company also provides online information services.

On 30 January 2007, after several delays, Microsoft launched the consumer version of the Vista operating system. First quarter revenues surged 32 percent over sales in the period ending March 2006. Quarterly net income increased an impressive 65 percent, although the increase was a tepid 3 percent when assessed on a year-over-year basis.

Microsoft shares, after years of stagnant performance, moved up nicely in anticipation of the Vista release and in response to a massive stock buyback. The shares retreated somewhat after Steve Ballmer threw cold water on the most optimistic expectations, and the company was ordered to pay $1.5 billion to Alcatel-Lucent (later overturned) for infringing on digital music technology. However, the shares were subsequently carried back up toward their January highs when the overall market rallied. Use of Vista will expand if for no other reason that manufacturers will install it on new computers; however, consumers have reported reasons to wait for changes.

More recently, when the company announced that the second-quarter results would include a $1 billion charge to repair faulty Xbox games, the shares fell a minuscule $0.02.

When we analyzed Microsoft after the first quarter, the Overall score was a very good 51 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 18 points. Cash Management and Value were weakest at 11 points each. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

• Cash Management: 7 of 25
• Growth: 22 of 25
• Profitability: 15 of 25
• Value: 8 of 25

• Overall: 46 of 100

Before we examine each gauge, let's compare the latest Income Statement to our expectations.

($M)		2Q-2007 (actual*)	2Q-2007 (predicted)	2Q-2006 (actual)
Revenue		13371	13300	11804
Op expenses
	CGS	(2180)	(2394)	(2130)
	R&D	(1948)	(1862)	(1861)
	SG&A	(4197)	(3990)	(3932)
	Other	0	0	0
Operating Income		5046	5054	3881
Other income
	Investments	0	0	0
	Interest, etc.	295	400	377
Pretax income		5341	5454	4258
Income tax		(1557)	(1691)	(1430)
Net Income		3784	3763	2828
		0.39/sh	0.38/sh	0.28/sh

* To make the 2Q-2007 actual results comparable with our prediction, we backed out the charges for Xbox repairs. This decreases CGS by $1057 million and increases Income tax by $308 million. It's possible that the charges should be distributed differently.


Revenue was near the upper end of the range predicted by the company. We thought the Cost of Goods Sold (CGS) would be 18 percent of Revenue, and the actual value was 16.3 percent (if we backed out the Xbox charges correctly). Research and Development (R&D) expenses were 14.6 percent of Revenue, a shade more than our 14 percent estimate. Sales, General, and Administrative (SG&A) expenses were 31.4 percent of Revenue percent, 1.4 percent greater than our forecast.

The higher R&D and SG&A expenses were canceled out by the lower CGS, which resulted in Operating Income almost exactly at the forecast value.

Non-operating income was $105 million less than expected. However, the Income Tax Rate was only 29 percent instead of the predicted 31 percent. By coincidence, these differences also canceled each other out. This led to a Net Income that just slightly exceeded our prediction.


Cash Management. This gauge decreased from 11 points in March to 7 points.

The measures that helped the gauge were:

• Debt/CFO = 0
• LTD/Equity = 0%
• Current Ratio =1.7 (down from 2.2 last year, and much high levels before that, since large amounts of cash -- $27 billion in FY2006 -- have been spent repurchasing common stock)

The measures that hurt the gauge were:

• Accounts Receivable/Revenue =74 days, up from 68 days
• Working Capital/Market Capitalization = 5.8 percent, down from 11 percent (lowered by stock repurchases, see above)
• Cash Conversion Cycle Time = 9.6 days, up from 9.4 days

Growth. This gauge increased from 18 points in March to 22 points.

All relevant measures helped the gauge:

• Revenue growth = 15 percent, up from 11 percent
• Revenue/Assets = 81 percent, up from 64 percent (buyback aided)
• Net Income growth = 12 percent, up from 3 percent
• CFO growth =24 percent, up from -13 percent

Profitability. This gauge increased from 14 points in March to 15 points.

The measures that helped the gauge were:

• ROIC = 52 percent (!), up from 34 percent
• FCF/Equity = 50 percent, up from 32 percent
• Accrual Ratio = -2.3 percent, down from -0.3 percent

The decreasing Accrual Ratio tells us that more of the company's Net Income is due to Cash Flow from Operations (CFO), and, therefore, less is due to changes in non-operational Balance Sheet accruals.

The measures that hurt the gauge were:

• Operating Expenses/Revenue = 64 percent, up from 63 percent

The increase in operating expenses was basically the result of a decrease (as a result of the Xbox charge) in Gross Margin. Other expenses were lower.

Value. Microsoft's stock price rose over the course of the quarter from $27.87 to $29.47. The Value gauge, based on the latter price, dropped to 9 points, compared to 11 points three months ago (and 18 points twelve months ago).

• Enterprise Value/Cash Flow = 14.7, down from a 15.8 median
• P/E = 20, down from a median value over 24
• P/E to S&P 500 average P/E = 22.7 percent premium, less than half the historic premium (in days of yore)
• Price/Revenue ratio = 5.6, down from a median value of 6.8.

The average P/E for the Software and Programming industry is a more expensive 28. The average Price/Revenue for the industry is 5.9.

Now at a 46 out of 100 possible points, the Overall gauge is down a little from March. The score is good, not great.

BUD: Financial Analysis through June 2007 (Updated)

We have updated our analysis of Anheuser-Busch's (BUD) financial results for the quarter that ended on 30 June 2007 to address the financial statements reported to the SEC on Form 10-Q. Our initial evaluation was based on the data reported in a press release.

The gauge scores previously calculated didn't change as a result of the new information. As it turned out, the only data in the 10-Q relevant to our analysis that wasn't available previously was the inventory composition. The following table is extracted for Note 7 to the financial statements.

The company’s inventories were comprised of the following as of June 30, 2007 and December 31, 2006 (in millions).

	June 30, 2007		Dec. 31, 2006
Raw Materials	$295.3		$385.6
Work-in-Process	120.1		110.8
Finished Goods	284.2		198.5
Total Inventories	$699.6		$694.9

For our purposes, Finished Goods/Inventory is the metric of interest. The ratio, which contributes to our Cash Management gauge, was 40.6 percent in June 2007, a rather substantial increase from 28.6 percent in December 2006. In March 2007, midway between these two periods, finished goods were 35.5 percent of total inventories.

In general, we do not like to see unusual increases in the Finished Goods ratio because the rise could be an early warning sign that sales were below expectations. It can be an omen, in the worst cases, of vendor returns of unsold product and write downs of inventory no longer marketable.

For BUD, we should take into account that beer sales zoom in the summer. The company undoubtedly wants to have enough product ready for sale when potential consumers are hot, thirsty, and milling around barbecues. Perhaps this situation, coupled with a July 4 holiday weekend, justifies a spike in finished goods at the end of June. Let's look at the historical results to see if this true.

Date	Finished Goods / Inventory (%)	Increase from previous quarter
June 2007	41	+5
June 2006	N/A	N/A
June 2005	32	-1
June 2004	35	+1
June 2003	42	+1
June 2002	40	+4
June 2001	35	0
June 2000	31	0

We see that an increase in the Finished Goods/Inventory ratio from March to June is not automatic. The seasonal pattern does not, in and of itself, explain the surge in finished goods. It's also apparent that the recent 41 percent ratio isn't unprecedented, but it is definitely at the upper end of the range for BUD in June.

Therefore, our concern about the inventory composition isn't abated by the historical record. It's unfortunate BUD didn't provide inventory composition data last summer. We'd like to have another recent data point.

Readers might want to check out BUD's discussion of inventory during a recent conference call with financial analysts. The finished goods composition was not specifically addressed because the figures were not yet available.

WMT: Financial Analysis through July 2007

We have analyzed Wal-Mart's (WMT) preliminary financial results for the quarter that ended on 31 July 2007. Our evaluation will be updated after the company formally submits a complete 10-Q report to the SEC.

Wal-Mart is the world's largest retailer. With annual sales of about $350 billion, Wal-Mart holds the number 2 spot on the Fortune 500 list of America's largest corporations. Wal-Mart's disruptive cost-cutting strategies have revolutionized the marketplace for better and for worse, depending on your point of view. Its visibility and role in advancing globalization have made Wal-Mart a lightning rod for criticism. Wal-Mart transformed retailing by using information technology to manage its supply chain and by pressuring manufacturers to squeeze every penny out of their costs. Rival discounters fell by the wayside, and manufacturers with higher costs suffered mightily. On the other hand, Wal-Mart's discounting is responsible for lower inflation (and thus interest rates), although this effect might not have been reflected fully in the published statistics.

When we analyzed Wal-Mart after the April quarter, the Overall score was 26 points. Of the four individual gauges that fed into this composite result, Value was the strongest at 11 points. Profitability was weakest at 2 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the July 2007 quarter, our gauges display the following scores:

• Cash Management: 6 of 25
• Growth: 9 of 25
• Profitability: 3 of 25
• Value: 11 of 25
  

• Overall: 30 of 100
  

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.

($ M)		July 2007 (actual)	July 2007 (predicted)	July 2006 (actual)
Revenue (1)		91990	92000	84524
Op expenses
	CGS	(70589)	(70840)	(64585)
	SG&A	(17130)	(17020)	(15741)
	Other	(0)	(0)	(0)
Operating Income (2)		4271	4140	4198
Other income
	Investments	(106)	(100)	(91)
	Interest, etc.	616	600	513
Pretax income		4781	4640	4620
Income tax		(1676)	(1601)	(1636)
Net Income		3105	3039	2984
		$0.76/sh	0.74/sh	0.72/sh
Discontinued ops				(901)

<sup>1. Revenue for the July 2007 quarter was not a prediction.
2. The company includes some income in operating income that we treat as non-operating income.</sup>


Wal-Mart, in its most recent monthly sales report, previously reported that total net sales in the July 2007 quarter were approximately $92 billion. The exact number was $91.99. This figure is 8.8 percent above the sales in the July 2006 quarter, and it equates to year-over-year sales growth of 9.7 percent.

We thought the Cost of Goods Sold (CGS) would be 77 percent of Revenue, and the actual value was 76.7 percent. Sales, General, and Administrative (SG&A) expenses were 18.6 percent of Revenue, compared to our forecast of 18.5 percent.

Operating Income was 3.2 percent above the forecast value because of the slightly lower (as a percent of revenue) CGS.

Non-operating income was a trivial $10 million greater than expected. The Income Tax Rate was 35.1 percent, instead of the predicted 34.5 percent. As a result, Net Income exceeded our prediction by 2.2 percent.


Cash Management. This gauge increased from 4 points in April to 6 points now.

The measures that helped the gauge were:

• Cash Conversion Cycle Time (CCCT) = 11.2 days, down from 12.9 days, for this measure of efficiency
• LTD/Equity = 44.8%, up from 42.7 percent in July 2006, down from 49 percent three months ago
• Inventory/CGS = 43.9 days, compared to 45.5 and 45.6 days 3 and 12 months ago, respectively
  

The measures that hurt the gauge were:

• Current Ratio =0.84; weaker than we like, but insignificant; just slightly below the 0.9 typical value for Wal-Mart
• Debt/CFO = 2.0 years; compared to 2.1 and 2.0 years 3 and 12 months ago, respectively
• Days of Sales Outstanding (DSO) = 2.7 days, greater than the 2.3-day level one year earlier
• Working Capital/Market Capitalization = -3.8 percent, down from -3.6 percent
  

Growth. This gauge increased from 4 points in April to 9 points now.

The measures that helped the gauge were:

• Revenue/Assets = 2.287, up from 2.26 in a year; sales efficiency is improving
  

The measures that hurt the gauge were:

• Revenue growth = 9.7 percent, down from 10.0 percent in a year
• Net Income growth = 6.9 percent, down from 8.3 percent in a year
• CFO growth = 5.8 percent, down from 10.7 percent in a year
  

The income tax rate was steady at 34.4 percent

Profitability. This gauge increased from 2 points in April to 3 points now.

The measures that helped the gauge were:

• ROIC = 11.7 percent, down from 12.3 percent in a year
  

The measures that hurt the gauge were:

• FCF/Equity = 5.9 percent, down from 6.2 percent in a year
• Accrual Ratio =unchanged at 5.6 percent
• Operating Expenses/Revenue = 95.2 percent, up from 95.1 percent in a year
  

Value. Wal-Mart's stock price inched up over the quarter from $47.69 to $47.92. The Value gauge, based on the latter price, didn't change from 11 points three months ago (and 17 points twelve months ago).

• Enterprise Value/Cash Flow = 11.4, down from 11.7 in July 2006, and much below a longer term median value over 14
• P/E = 15, down from 16 a year ago, and (again) much below longer-term values
  
• P/E to S&P 500 average P/E = 5 percent discount, lower than its five-year median of a 13 percent premium
  
• Price/Revenue ratio = 0.5, lower than its five-year median of 0.7

The average P/E for the Retail - Department and Discount industry is currently a more expensive 16. The average Price/Revenue for the industry is currently 0.65.

Now at a so-so 30 out of 100 possible points, the Overall gauge rebounded a few points from April's below-the-zone 26 points. However, the increase is certainly not enough to cause any excitement. Wal-Mart needs to reverse the upward drift in its SG&A expenses and improve Cash Flow to stir any optimism. The recent earnings numbers were in-line with historic averages and previously reported data, which some analysts seem not to have considered.

WMT: Reporting on Tuesday

On Tuesday, Wal-Mart (WMT) will report its earnings for the quarter that ended on 31 July 2007.

Wal-Mart, the world's largest retailer, has been struggling. Competition, the economy, the low single digits. Target, which appeals to a somewhat more affluent customers, has been eroding Wal-Mart's market share from above. From below, high gas prices have taken a bite out of the wallets and pocketbooks of Wal-Mart's core customers. The company is responding by cutting back on plans to open new stores and by offering generic prescriptions drugs for $4.

We no longer have to rely on Wal-Mart's prediction of 1 to 2 percent sales growth in comparable stores to estimate the total Revenue in the quarter. The company, in its most recent monthly sales report, has already reported that total net sales for the quarter that ended July 31, 2007 were approximately $92 billion. This figure is 8.9 percent above the sales in the July 2006 quarter, and it equates to year-over-year sales growth of 9.7 percent. Using the monthly data, it appears that the sales growth in comparable stores was about 1.95 percent.

Wal-Mart's Gross Margin has been steady at 23 percent of revenue. We can, therefore, assume that the Cost of Goods Sold (CGS) in the July quarter was 77 percent of $92 billion, or $70.84 billion.

Wal-Mart's Sales, General, and Administrative (SG&A) expenses as a percent of revenue have been creeping up slowly. After a long stretch at around 18 percent, the climb has resumed. We will assume 18.5 percent. Thus, we're expecting SG&A expenses to be 18.5 percent of $92 billion, or $17.02 billion.

These assumptions would result in an Operating Income of $4.14 billion.

As for non-operating expenses, we'll extrapolate on recent trends and assume $600 million net interest and other income, and a $100 million deduction for minority interests. These values would bring pre-tax income to $4.64 billion.

Wal-Mart estimated that the average income tax rate for the current fiscal year will be between 34 and 35 percent. If we assume 34.5 percent, the provisions for income taxes will be $1.6 billion, and net income will be $3.04 billion ($0.74 per share).

($ M)		July 2007 (predicted)	July 2006 (actual)
Revenue		92000	84524
Op expenses
	CGS	(70840)	(64585)
	SG&A	(17020)	(15741)
	Other	(0)	(0)
Operating Income		4140	4198
Other income
	Investments	(100)	(91)
	Interest, etc.	600	513
Pretax income		4640	4620
Income tax		(1601)	(1636)
Net Income		3039	2984
		0.74/sh	0.72/sh
Discontinued ops			(901)

TDW: Financial Analysis through June 2007

We previously reviewed Tidewater's (TDW) quarterly Income Statement for the period that ended on 30 June 2007. The earlier review included a comparison of the actual income data with our expectations.

We were unable at that time to perform a complete financial analysis and compute gauge scores because the company hadn't yet made a Balance Sheet and Cash Flow Statement available for the quarter. This information gap has since been rectified, and we now have the full set of financial statements. Tidewater submitted these statements in a 10-Q report filed with the SEC.

This post reports on our evaluation of the data contained in the financial statements.


When we analyzed Tidewater after the March quarter, which was actually the fourth of their fiscal year, the Overall score was a very good 61 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 23 points. Profitability was weakest at 13 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

• Cash Management: 11 of 25
• Growth: 16 of 25
• Profitability: 7 of 25
• Value: 13 of 25
  

• Overall: 45 of 100
  

Cash Management. This gauge decreased from 17 points in March to 11 points now.

The measures that helped the gauge were:

• LTD/Equity = 15.9%, compared to 18.3 percent a year ago
• Debt/CFO = 0.7 years, compared to 0.7 and 0.8 years 3 and 12 months ago, respectively
  
• Cash Conversion Cycle Time (CCCT) = 38 days, down from 52 days, for this measure of efficiency
• Current Ratio =3.6; down to a more normal range, but still very much a sign of strength. Cash being spent on new vessels or stock repurchases is not putting the company in financial straps.

The measures that hurt the gauge were:

• Days of Sales Outstanding (DSO) = 84.5 days, not enough of an improvement from the 85.7-day level one year earlier to matter.
• Working Capital/Market Capitalization = 11.4 percent, down from 13.2 percent
  

Growth. This gauge decreased from 23 points in March to 16 points.

• Revenue growth = 21.5 percent, down from 32 percent in a year
• Revenue/Assets = 42.9 percent, up from 40.7 percent in a year; sales efficiency is improving
• Net Income growth = 34 percent, down from 137 percent in a year
• CFO growth = 27 percent, down from 116 percent in a year
  

These growth measures are all commendable. They just happen to be down from last year, when growth was achieved from a smaller base. Net income benefited from a change in the income tax rate from 27 to 20 percent The tax rate decreased as a result of a continuing shift to more operations outside the U.S.

Profitability. This gauge decreased from 13 points in March to 7 points now.

The measures that helped the gauge were:

• ROIC = 17 percent, up sharply from 12 percent in a year
• Operating Expenses/Revenue = 66 percent, down from 71 percent in a year
  

The decrease in operating expenses was primarily the result of an increase in Gross Margin.

The measures that hurt the gauge were:

• FCF/Equity = 8 percent, down from 12 percent in a year (capital investments are eating into FCF)
  
• Accrual Ratio = 8.2 percent, up from +4 percent in a year
  

The increasing Accrual Ratio tells us that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals.

Value. Tidewater's stock price rose over the course of the quarter from $58.58 to $70.88. The Value gauge, based on the latter price, dropped to 13 points, compared to 15 points three months ago.

The measures that helped the gauge were:

• Enterprise Value/Cash Flow = 8.7, down from a median of 11.6
• P/E = 11, down from a median of 18
• P/E to S&P 500 average P/E = 35 percent discount
  

The measures that hurt the gauge were:

• Price/Revenue ratio = 3.45, up from a long-term average of 2.8.

The average P/E for the Oil Well Services and Equipment industry is currently a more expensive 18.6. The average Price/Revenue for the industry is currently 3.9.

Now at a moderate 45 out of 100 possible points, the Overall gauge has fallen from lofty levels in the 60s. We can attribute some of the drop to growth slowing from unsustainable levels, the higher stock price, and capital investing (beneficial in the long run, but it cuts into working capital and free cash flow).

CSCO: Financial Analysis through July 2007

We have analyzed Cisco Systems' (CSCO) preliminary financial results for the fiscal year and quarter that ended on 31 July 2007. Our evaluation will be updated after the company formally submits a complete 10-K report to the SEC.

Cisco, the proud plumber of the Internet, has a commanding position in the market for enterprise-level networking devices. After acquiring Linksys and, more recently, Scientific Atlanta, Cisco now also sells devices intended for home use. Cisco shares began the fiscal year at $17.88 and ended July 2007 at $28.91. There was a short dalliance over $30.

When we analyzed Cisco after the April quarter, the Overall score was a fair, but improving, 38 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 24 points. Value was weakest at 2 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the July 2007 quarter, our gauges display the following scores:

• Cash Management: 9 of 25
• Growth: 15 of 25
• Profitability: 12 of 25
• Value: 0 of 25
  

• Overall: 27 of 100
  

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.

($M)		July 2007 (actual)	July 2007 (predicted)	July 2006 (actual)
Revenue		9433	9250	7984
Op expenses
	CGS	(3365)	(3284)	(2839)
	R&D	(1178)	(1203)	(1064)
	SG&A	(2404)	(2313)	(1911)
	Other	(183)	(150)	(180)
Operating Income		2303	2301	1990
Other income
	Investments	0	0	0
	Interest, etc.	228	200	156
Pretax income		2531	2501	2146
Income tax		(601)	(625)	(602)
Net Income		1930	1876	1544
		$0.31	$0.30/sh	$0.25/sh

Revenue was 2 percent above the company's estimate, which we used. Revenue was 18.1 percent greater than in the year-earlier quarter, compared to the forecast 15.9 percent. In addition, we expected Cost of Goods Sold (CGS) to be 35.5 percent of Revenue, and the actual value was 35.7 percent. Research and Development (R&D) expenses were 12.5 percent of Revenue, a shade less than our 13 percent estimate. Sales, General, and Administrative (SG&A) expenses were 25.5 percent of Revenue, compared to our forecast of 25 percent.

The higher Revenue was offset by greater other operating costs, resulting in Operating Income almost exactly at the forecast value.

Non-operating income was $28 million more than expected. The Income Tax Rate was 23.75 percent, instead of the predicted 25 percent. As a result, Net Income exceeded our prediction by 2.9 percent.


Cash Management. This gauge decreased from 11 points in April to 9 points now.

The measures that helped the gauge were:

• Current Ratio =2.4; a sign of strength, a little higher than last year's value
• LTD/Equity = 20.4%; manageable and decreasing
• Inventory/CGS = 39.0 days, compared to 39.4 and 50 days 3 and 12 months ago, respectively
  
• Debt/CFO = 0.6 years, compared to 0.7 and 0.8 years 3 and 12 months ago, respectively
• Cash Conversion Cycle Time (CCCT) = 52.9 days, down from 55.3 days, for this measure of efficiency
  

The measures that hurt the gauge were:

• Finished Goods/Inventory = 65 percent, above its 48 percent norm
• Days of Sales Outstanding (DSO) = 38 days, greater than the 35.4-day level one year earlier
• Working Capital/Market Capitalization = 9.7 percent, down from 12.3 percent

Note that the DSO change indicates the company is having less success getting its customers to pay their bills; rapid collection is a sign of efficiency because the payments received can be re-invested sooner.

Growth. This gauge decreased from 24 points in April to 15 points now.

The measures that helped the gauge were:

• Revenue growth = 22.6 percent, up from 14.9 percent in a year
• Net Income growth = 31.4 percent, up from -2.8 percent in a year
• CFO growth = 27.9 percent, up from 4.4 percent in a year

Net income benefited significantly from a change in the income tax rate from 26.9 to 22.5 percent

The measures that hurt the gauge were:

• Revenue/Assets = 65.5 percent, down from 65.8 percent in a year
  

Profitability. This gauge decreased from 14 points in April to 12 points now.

The measures that helped the gauge were:

• ROIC = 20.7 percent, up from 20.3 percent in a year
• FCF/Equity = 28.1 percent, down from 29.8 percent in a year
  

The measures that hurt the gauge were:

• Operating Expenses/Revenue = 73.9 percent, up from 73.7 percent in a year
• Accrual Ratio = -2.8 percent, up from -3.6 percent in a year

The increasing Accrual Ratio tells us that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals.

Value. Cisco's stock price rose over the course of the quarter from $26.74 to $28.91. The Value gauge, based on the latter price, dropped to 0 points from 2 points three months ago (and 13 points twelve months ago, when the price was much cheaper).

The measures that helped the gauge were:

• Enterprise Value/Cash Flow = 16.4, up from a 15.6 median value and 12.6 in July 2006
• P/E = 24.7, about the same as its 24.3 median, but up from 19.9 a year ago
  
• P/E to S&P 500 average P/E = 47 percent premium, up from a median premium of 43 percent
  
• Price/Revenue ratio = 5.2, compared to its median of 5.0

The average P/E for the Computer Peripherals industry is also about 24. The average Price/Revenue for the industry is currently 3.8.

By the most popular yardsticks, Cisco had an excellent quarter: Revenue, Cash Flow, and Net Income all increased sharply. But, our gauges aren't impressed. The Overall gauge is a mere 27 points. For one thing, the Growth gauge is the one that generally correlates least with stock price gains. One can argue that the Value gauge overreacted to small increases in each price measure, but it is signaling that the stock price is getting expensive.

KG: Financial Analysis through June 2007

We have analyzed King Pharmaceuticals' (KG) preliminary financial results for the quarter that ended on 30 June 2007. Our evaluation will be updated after the company formally submits a complete 10-Q report to the SEC.


King Pharmaceuticals sells brand-name prescription pharmaceuticals, most notably Altace®. This ACE inhibitor, which is used to treat patients with cardiovascular risks, accounts for about 1/3 of King's net sales.

King experienced some difficulties in the early years of this decade, including Medicaid overcharge allegations, inventory management challenges, and a proposed merger with Mylan Labs that fell apart after Carl Icahn raised objections. King stock plunged 84 percent from $46.05 per share in July 2001 to $7.55 in April 2005, before rebounding to about $20. King has dealt with these problems. But, it now faces a challenge that could be more difficult to surmount: the looming loss of patent protection on Altace and other key products.

When we analyzed King after the March quarter, the Overall score was an excellent 59 points. Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 19 points. Profitability and Value were weakest at 13 points each. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]


Now, with the available data from the June 2007 quarter, our gauges display the following scores:

• Cash Management: 16 of 25
• Growth: 19 of 25
• Profitability: 16 of 25
• Value: 7 of 25

• Overall: 50 of 100

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.

($ M)		June 2007 (actual)	June 2007 (predicted)	June 2006 (actual)
Revenue		543	535	500
Op expenses
	CGS (1)	(126)	(123)	(107)
	Depreciation (2)	(40)	(37)	(39)
	R&D	(37)	(37)	(35)
	SG&A (3)	(173)	(187)	(154)
	Other (4)	(78)	(20)	(0)
Operating Income		88	130	165
Other income
	Investments	0	0	0
	Interest, etc.	7	7	5
Pretax income		95	137	170
Income tax		(30)	(45)	(59)
Net Income		65	92	111
		$0.27/sh	0.37/sh	0.46/sh

<sup>1. Includes contract termination cost of $3.845 million.
2. Includes $1.5 million for "accelerated depreciation"
3. Includes co-promotion, legal, and professional fees.
4. Mostly asset impairment charges; also in-process R&D upon acquisition, restructuring charges</sup>


Revenue was 1.5 percent above our estimate. We expected Revenue to be 7 percent greater than in the year-earlier quarter, and the actual increase was 8.6 percent. In addition, we thought the Cost of Goods Sold (CGS) would be 23 percent of Revenue, and the actual value was 23.2 percent.

Depreciation was 7.4 percent of Revenue, compared to our estimate of 7 percent. Research and Development (R&D) expenses were 6.8 percent of Revenue, a shade less than our 7 percent estimate. Sales, General, and Administrative (SG&A) expenses were 31.9 percent of Revenue, compared to our forecast of 35 percent.

What through the quarter out of kilter was a $74.8 million asset impairment charge. The charge resulted from a decision to sell a manufacturing plant and to drop development of a new product formulation.

The net effect was Operating Income 32 percent below the forecast value.

The Income Tax Rate was 31.6 percent, instead of the predicted 33 percent. As a result, Net Income fell below our prediction by 29 percent.


Cash Management. This gauge decreased from 19 points in March to 17 points now.

The measures that helped the gauge were:

• LTD/Equity = 16.1%; manageable, down from 18.6 percent a year ago
• Inventory/CGS = 156 days, compared to 177 and 214 days 3 and 12 months ago, respectively
• Cash Conversion Cycle Time (CCCT) = 144 days, down from 188 days, for this measure of efficiency
• Debt/CFO = 0.7 years, compared to 0.7 and 1.1 years 3 and 12 months ago, respectively
• Working Capital/Market Capitalization = 20 percent, up from 18 percent

The measures that hurt the gauge were:

• Days of Sales Outstanding (DSO) = 46 days, greater than the 43-day level one year earlier
• Current Ratio = 3.6; too much of a good thing, it was 2.3 in June 2006

Finished Goods/Inventory was not reported, it was 28 and 31 percent 3 and 12 months ago, respectively


Growth. This gauge decreased from 16 points in March to 12 points now.

The measures that helped the gauge were:

• CFO growth = 47 percent, up from -34 percent in a year
• Net Income growth = 62 percent, down from 91 percent in a year
• Revenue/Assets = 61.1 percent, up from 60.6 percent in a year

Net income benefited from a change in the income tax rate from 34.7 to 31.4 percent

The measures that hurt the gauge were:

• Revenue growth = 7 percent, down from 23 percent in a year

Profitability. This gauge increased from 13 points in March to 14 points now.

The measures that helped the gauge were:

• FCF/Equity = 20.1 percent, up from 14.9 percent in a year
• Accrual Ratio = -5.7 percent, down from -4.1 percent in a year
• ROIC = 13.9 percent, down from 16.5 percent in a year

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.

The measures that hurt the gauge were:

• Operating Expenses/Revenue = 72.1 percent, up from 66.7 percent in a year
  

The increase in operating expenses was the result of a decrease in Gross Margin and an increase in special charges.

Value. King's stock price rose over the course of the quarter from $19.67 to $20.46. The Value gauge, based on the latter price, held steady at 13 points from three months ago.

The measures that helped the gauge were:

• P/E = 16.3, about half its average
  
• P/E to S&P 500 average P/E = 2 percent discount, much lower than its five-year median of a 60 percent premium

The measures that hurt the gauge were:

• Price/Revenue ratio = 2.4, a little higher than its five-year median of 2.3
• Enterprise Value/Cash Flow = 8.2, down a little from its average

The average P/E for the Biotechnology and Drugs industry is 28. The average Price/Revenue for the industry is 8.

Now at very good 55 out of 100 possible points, the Overall gauge has been strong for eight of the last nine quarters. To some extent, the strength reflects a rebound from very tough conditions in previous years. We would feel much better about King if special operating charges weren't such a regular occurrence. We also have to worry about patent expirations.