21 February 2009

CSCO: Financial Analysis through January 2009 (Update)

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.

We previously posted an analysis of Cisco System's press release announcing results for the three months that ended on 24 January 2009, which was the second quarter of the company's fiscal 2009.

The company has since submitted a more complete 10-Q, which we reviewed to determine if the analysis needed updating. 

Instead, we discovered that we made a data entry error when performing our initial analysis that caused us to report, on 5 February 2009, an Overall gauge score for Cisco that was four points too low.  We entered the wrong value for Cash Flow from Operations into a spreadsheet that computes the metrics that drive the gauge scores.  Correcting the mistake increased the Overall gauge score from 62 to 66 points.

We apologize for the error.

The correct set of scores is shown below:

Independent of our data entry error, the 10-Q would not have changed the gauge scores from our initial evaluation.  In addition, neither the error, nor the formal report altered our evaluation of Cisco's Income Statement.


The following metrics were affected by our error:

Originally reported figure
Correct figure
Debt/CFO0.6 years0.5 years
CFO growth4.6%16.5%
FCF/Equity28.6% 32.2%
Accrual Ratio10.8%8.7%
Enterprise Value/Cash Flow (EV/CFO)5.85.2

We did observe a few interesting tidbits of information in the 10-Q:

1.  The allowance for doubtful receivables increased from $177 million in July 2008 to $191 million in October 2008 to $230 million in January 2009.

2.  Note 1 of the financial statements includes the following statement:  "These [cost allocation] changes also resulted in reclassifications to prior period gross margin by theater amounts."  The meaning of the phrase "theater amounts" is not known to us.  Cisco uses the term "theater" when referring to the geographic areas in which it operates.

3.  We continued to be intrigued by Cisco's purchase of Nuova Systems, Inc., which developed technologies for enterprise data centers.  Cisco first bought approximately 80 percent of Nuova in August 2006.  In 2008, Cisco exercised an option to purchase the remaining 20 or so percent.  The selling shareholders, which included several former Cisco execs, will receive up to three payments, to be made between fiscal years 2010 and 2012, with the amounts determined by an undisclosed formula.  Cisco originally indicated that the potential payout for the remaining interests in Nuova would be between $10 and $578 million.  The latest 10-Q states that Cisco has recorded total compensation charges of $317 million for these payments.  The amount can be adjusted as high as $678 million, $100 million more than the amount first cited.  Since Nuova had 76 employees in August 2006, the total charge to Cisco will be between $3.9 and $8.9 million per Nuova employee.

4.  Cisco lists short-term investments of $25.4 billion on its Balance Sheet.  Of this amount, fixed income securities comprise 97 percent, and the rest are publicly traded equity securities.  The unrealized loss on the fixed income securities is less than 1 percent, indicating the high proportion of government-backed debt and that 61 percent of these securities mature in less than one year.  The unrealized loss on equity securities is 23 percent.

5. In December 2008, Brazil asserted claims against Cisco related to alleged evasion of import taxes and other improper transactions.  Cisco denies the allegation and asserts "there is no legal basis for its alleged liability."  Cisco, for numerous reasons, indicates it is unable to estimate the range of the potential loss.  One of the reasons is "complexities and uncertainty surrounding the judicial process in Brazil."

6.  Cisco repurchased 83 million of its shares, at a cost of $1.6 billion, during the January quarter.  The average price per share was $19.48.  The current price is $15.08.

7. On 9 February 2009, Cisco made a commitment to issue $4.0 billion of senior unsecured notes.  Half of the notes will mature in 2019, and the other half will mature in 2039.  The company only needed $500 million to pay of maturing debt.  As of 24 January 2009, Cisco had long-term debt of $6.35 billion.  The increase to $10.35 billion will lift the Long-term Debt/Equity Ratio from 17.3 percent to 28.1 percent.  The decision by cash-rich Cisco to issue more debt led to speculation the company was planning for future acquisitions.

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