21 December 2008

CSCO: Look Ahead to January 2009 Quarterly Results

The second quarter of Cisco Systems' fiscal 2009 will end on 24 January, and the company will report its results in early February.

This post describes a model of the Income Statement for the quarter. The model serves as a baseline for identifying and assessing deviations, positive or negative, from the expected in the actual data. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a commanding position in the market for enterprise networking products and services, such as routers. After acquiring Linksys and, more recently, Scientific Atlanta, Cisco now also sells devices intended for home use.

In the first quarter of fiscal 2009, which ended on 25 October 2008, the GCFR Overall Gauge of Cisco increased from 61 to 64 of the 100 possible points. Our initial and updated analysis reports explained the score in some detail.

The rising score was primarily the result of the Value gauge strengthening from 16 to 20 of the 25 possible points. The contrarian Value gauge tends to move in the opposite direction of the share price, and the stock market crash of 2008 has cut deeply into equity prices. The effects of the slowing worldwide economy were seen Cisco's falling Revenue, Cash Flow, and Net Income growth rates, which squeezed the Growth gauge down to a mere 2 of the 25 possible points.

In response to declining sales, Cisco Systems announced in late November that it would cut costs by closing its North American units for 5 days around New Years Day.

Leaders at Cisco often express confidence that the company's Revenue can expand over the long term at a rate between 12 and 17 percent. As recently as 3 December 2008, CEO John Chambers was quoted by Reuters as saying: "We're very comfortable, with the appropriate normal economic conditions, of growing our business in the 12 to 17 percent range." The company adds caveats indicating that Revenue in some quarters will be above or below this range.

In fact, Cisco's guidance for Revenue in the January quarter is "for revenue to decrease in the 5 to 10% range year over year." This quote is taken from the Seeking Alpha transcript of Cisco's conference call on 5 November 2008. [The GCFR definition of "year-over-year" is "the last four quarters compared to the four previous quarters." We learned the hard way that Cisco's alternative definition is "this quarter compared to the year-earlier quarter."]

Our target for the Revenue in the January 2009 quarter is $9.04 billion. This amount was determined by trimming 8 percent from the $9.83 billion figure for sales in the quarter that ended 26 January 2008. The target value is about 12.5 percent less than Revenue in the October 2008 quarter.

Management's guidance for Gross Margin in the January quarter is 64 percent. We're going to be a slightly more conservative and use 63.75 percent. In other words, our forecast for Cost of Goods Sold (CGS) is (1 - 0.6375) * $9.04 billion, which is $3.3 billion.

Cisco expects the quarter's Operating Expenses to be between 39 and 41 percent of Revenue. Operating Expenses, as Cisco defines the term, include Research and Development and Sales, General, and Administrative costs. [On GCFR Income Statements, CGS is also listed as an Operating Expense.] The guidance implies that Cisco expects the sum of R&D and SG&A costs to be between $3.5 billion and $3.7 billion. We're going to assume the higher figure because Cisco's guidance typically refers to non-GAAP results that exclude costs we track. Given past results, we have apportioned the $3.7 billion as $1.25 billion for R&D and $2.45 billion for SG&A.

Cisco always reports various other operating charges, including payroll tax on stock options, amortization of deferred compensation, amortization of purchased intangible assets, and the mysterious in-process research and development. The average value for these charges in the last 10 quarters, discarding the highest and lowest values, is $126 million.

These figures would result in Operating Income, as we define it, of $1.94 billion. This result is 19.3 percent below the comparable year-earlier value.

Cisco indicated that Interest and Other Income would be about $130 million in the January quarter. This is $100 million less than the equivalent figure in January 2008 quarter.

Pretax income would, therefore, be about $2.1 billion. Management forecasts a 22 percent Income Tax Rate, which would lead to Provisions for Income Taxes of $455 million.

Given all of the following, it's should be clear why we're looking to see GAAP Net Income in the quarter equal to $1.6 billion (about $0.27 per share), which is 21.6 percent below earnings 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.


January 2009
January 2008
9,045 9,831
Op expenses

CGS (3,279)

R&D (1,250)

SG&A (2,450)

Other (126)
Operating Income
1,940 2,404
Other income


Interest, etc.
130 234
Pretax income

2,070 2,638
Income tax

Net Income
1,615 2,060

Shares outstanding


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