14 April 2009

CSCO: Look Ahead to April 2009 Quarterly Results

The GCFR Overall Gauge of Cisco Systems, Inc. (NASDAQ: CSCO) edged up from 64 to 66 points of the 100 possible points in the three months that ended on 24 January 2009, which was the second quarter of the company's fiscal 2009.  Our initial and updated analysis reports explained in some detail how this score was attained. 

Subsequent tweaks to our gauges added 5 points to Cisco's score.  The Overall Gauge, by our current reckoning, stands at 71 points.

We have now modeled Cisco's Income Statement for the quarter that will end 25 April 2009.  The intent of this exercise was to produce a baseline for identifying any deviations, positive or negative, in the actual data that the company is scheduled to announce on 6 May 2009.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

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.  Cisco also sells devices intended for home use.

In a major shift, Cisco is preparing to sell computer servers, equipped with virtualization software, for large data centers.  This move will put the company into competition with Hewlett-Packard (NYSE: HPQ) and IBM (NYSE: IBM), with whom Cisco has partnered in other segments of the market.

Cisco has long been a serial acquirer, insatiably gobbling up companies of all sizes.  The current recession has not deterred Cisco from continuing this strategy.  Bloomberg reported earlier this month that Cisco would be taking advantage of lower equity prices to accelerate the expansion of its product line. 

Tom Taulli recently commented at BloggingStocks on Cisco's latest $105 million meal: Tidal Software, which writes programs for data centers.  Another recent acquisition, for $590 million, was Pure Digital Technologies.  This firm created the popular Flip Video camcorders that allow consumers to capture, edit, and share video.  More than two million of these devices, with associated software, have been sold.

Current economic conditions have slowed Cisco.  With sales falling, the company closed its North American units for 5 days around New Years Day.  Revenue in the January 2009 quarter was 7.5 percent less than in the January 2008 quarter.  The router product line suffered the largest drop in Revenue (-23 percent). Net Income was 27 percent below the comparable year-earlier figure.

Of the four GCFR individual gauges, Value and Cash Management were especially strong, at 23 and 19 points respectively, after the January quarter.  Profitability was a solid 15 points.  However, Growth was a mere 3 of 25 possible points.  The contrary Value gauge was signaling that the 40 percent drop in Cisco's price per share was excessive.

For the latest management guidance on Cisco's financial prospects, we turn to the Seeking Alpha transcript of Cisco's conference call on 4 February 2009.  Management assumed that sales declines, which were worsening over the course of the January quarter, would continue into the April quarter.  They estimated that Revenue in the April 2009 quarter would be 15 to 20 percent less than that in the April 2008 period.

Given the very sobering guidance, and the fact that the worldwide economy has remained weak, we are setting our target for Cisco's Revenue in the April 2009 quarter at $8.1 billion.  This amount is 17.5 percent less than the $9.8 billion sales figure for the April 2008 quarter.  The target value is about 11 percent less than Revenue in the January 2009 quarter.

Management's guidance for Gross Margin in the January quarter is 63 percent.  We're going to be more conservative and use 62.5 percent.  In other words, our forecast for Cost of Goods Sold (CGS) is (1 - 0.625) * $8.1 billion, which is $3.0 billion.

Cisco expects Operating Expenses will be between 40 and 42 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 $3.2 billion and $3.4 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 $3.4 billion as $1.2 billion for R&D and $2.2 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 $120 million.

These figures would result in Operating Income, as we define it, of $1.53 billion.  This result is 28.6 percent below the comparable year-earlier value.

Cisco indicated that Interest and Other Income would be about $80 million in the April quarter.  This is half the equivalent year-earlier figure.

Pretax income would, therefore, be about $1.6 billion.  Management forecasts a 22 percent Income Tax Rate, which would lead to Provisions for Income Taxes of $354 million.

Given all of the following, it should be clear why we're looking to see GAAP Net Income in the quarter equal to $1.25 billion (about $0.22 per share), which is 29 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.


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