05 August 2007

CSCO: Reports on Tuesday

In this unsettled market, a good earnings report on Tuesday from Cisco Systems (CSCO) could be a stabilizing force. The quarter that ended in July was the fourth of Cisco's fiscal year, and by all indications it was an excellent year for the networking powerhouse.

As shown on this chart, Cisco shares began the fiscal year at $17.88 and ended July 2007 at $28.91. There was a short dalliance over $30.

Our calculations after the April quarter set the Overall gauge at a modest 40 points, but it was significantly higher than the two previous quarters. The Growth gauge was strong, and the Profitability gauge was steady. The double-weighted Value gauge was, however, keeping the Overall gauge in check. As fast as the company grew in the last year, the stock price increased faster for a time, and the Value gauge frowns on that. We were also a little concerned about Inventory levels after the April quarter. Total inventories were down -- we like lean and mean -- but Finished Goods/Inventory was up. It was almost as if the company was ratcheting down production, which didn't make a lot of sense.

Cisco indicated last May in a conference call that Revenue in the July quarter would be between $9.2 and $9.3 billion. By their reckoning, this would equate to year-over-year revenue growth of 15 to 16 percent. They must have updated the previous year's baseline, because our calculations show this to be a 22 percent increase over previously reported revenue figures. No matter, we're comfortable with the $9.25 billion estimate because it consistent with the trend line. We know that the fast-growing Scientific Atlanta segment has been an upward force on revenues.

As a result of competitive pressures, the Gross Margin has been tilting downward over the last few years from a peak of 70 percent to a still-admirable 64 percent. We would have assumed the lower value as our estimate for the last quarter, but Cisco's guidance, with ample caveats, was 64.5 percent. We'll use their number. Therefore, the forecast for Cost of Goods Sold (CGS) is 35.5 percent of $9.25 billion, or $3.3 billion.

Research and Development (R&D) expenses are usually about 13 percent of revenue, maybe a little more. This would equate to $1.2 billion in the last quarter, if the revenue estimate is achieved.

Similarly, Sales, General, and Administrative (SG&A) expenses tend to be around 25 percent of revenue, or about $2.3 billion for the fourth quarter. We wouldn't be surprised if the company could shave this by a half-percent of revenue, but we will be conservative.

Cisco usually 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 they have been averaging about $100 million per quarter. We'll assume $150 million because the final quarter of a fiscal year tends to be a magnet for extra charges.

These figures would result in Operating Income of $2.3 billion, compared to $2.0 billion in the year-earlier quarter.

Non-operating interest and other income has been around $200 million per quarter, and the company indicated that this is a reasonable estimate for the fourth quarter.

The effective income tax rate has dropped to about 25 percent, or a little lower. This is consistent with Cisco's guidance.

Therefore, we're looking to see Net Income in the fourth quarter of $1.88 billion. Depending on how active the company has been at repurchasing its shares, this would equate to about $0.30 per share.


July 2007
July 2006
9250 7984
Op expenses

CGS (3284)

R&D (1203)

SG&A (2313)

Other (150)
Operating Income
2301 1990
Other income


Interest, etc.
200 156
Pretax income

2501 2146
Income tax

Net Income
1876 1544


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