28 June 2008

CSCO: Look Ahead to July 2008 Results

Our analysis of Cisco's April 2008 quarter, the third of the fiscal year, resulted in an Overall Gauge score of 46 of the 100 possible points, just about matching the score after the January quarter. Both Revenue and Net Income grew at decelerating rates, although earnings benefited to some extent from a decline in the effective income tax rate. More positively, the Return on Invested Capital and the ratio of Free Cash Flow to Stockholders' Equity both remained at lofty levels.

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 near the $23 lows seen in both February and April.

After the U.S. markets close on 5 August 2008, Cisco will report its results for the quarter and fiscal year that will end on 31 July 2008. In anticipation of this report, we've modeled the company's Income Statement for the quarter. The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

Cisco's guidance refers to the non-GAAP results that accompany the required GAAP results provided each quarter. This complicates our analysis because GCFR only examines the GAAP figures. The differences between the two sets of results can be significant: Cisco told investors to expect GAAP earnings to be $0.04 to $0.06 less per share (roughly $300 million) than non-GAAP earnings.

When discussing April's results during the quarterly conference call with analysts, Cisco management restated the company's long-term objective of growth between 12 and 17 percent. However, for the July quarter, as a consequence of softness in some U.S. and European markets, management expects, with all the usual caveats, "revenue growth of approximately 9% to 10% 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 ago that Cisco uses an alternative definition of "this quarter compared to the year-earlier quarter."]

Applying a 9.5 percent growth factor to Cisco's $9.43 billion Revenue in the July 2007 quarter, yields a $10.3 billion Revenue target for the July 2008 quarter.

Management's guidance for Gross Margin is 65.0 percent. We're more comfortable, given the company's performance in recent quarters, setting the target at a more conservative 64.5 percent. Therefore, our forecast for Cost of Goods Sold (CGS) is 35.5 percent of $10.3 billion, which is $3.7 billion.

Cisco stated that they expect the quarter's Operating Expenses to be between 36 and 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 13.0 percent of Revenue. This would equate to $1.3 billion, given the $10.3 billion Revenue estimate. Similarly, we expect SG&A expenses to be 26 percent of Revenue, which would be about $2.7 billion.

Our R&D and SG&A estimates sum to 39 percent of Revenue, a signficant 2 to 2.5 points above the guidance. This may be one place we're seeing a difference between GAAP and non-GAAP results, or the company may have made more progress controlling costs than we have recognized.

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. In each of the last three quarters, these other charges totaled about $120 million. We assume the July figure will be somewhat higher, say $140 million, because fiscal fourth quarters seem to attract extra expenses.

These figures would result in Operating Income of $2.5 billion, compared to $2.3 billion in the year-earlier quarter, for an increase of 8.3 percent.

Cisco indicated that Interest and other income would be $140 million in the July quarter. The equivalent figure in the year-earlier quarter was substantially higher at $228 million. The gulf between these two values will make the current quarter look less favorable. The $140 million figure might be a little conservative, so we will round it up to $150 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 $635 million.

Therefore, we're looking to see Net Income in the quarter of $2.0 billion (about $0.33 per share), a modest 4.1 percent above the results of the year-earlier quarter.

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.


July 2008
July 2007
10329 9433
Op expenses

CGS (3667)

R&D (1343)

SG&A (2686)

Other (140)
Operating Income
2494 2303
Other income


Interest, etc.
150 228
Pretax income

2644 2531
Income tax

Net Income
2009 1930

Shares outstanding


No comments:

Post a Comment