06 August 2009

CSCO: Income Statement Analysis for the July 2009 Quarter

Cisco Systems (NASDAQ: CSCO) earned $0.19 per share in the three months that ended on 25 July 2009, down from $0.33 in the same quarter of last year.  The May-to-July period is the fourth quarter of Cisco's fiscal year.

On a non
-GAAP ("pro forma" or "ex-items") basis, Cisco's earnings per share slid from $0.40 to $0.31.  The difference between GAAP and non-GAAP Net Income was $758 million in the latest quarter!

This post examines the GAAP-compliant Income Statement for the quarter and compares it to our "look-ahead" estimates, which were published on 7 July.  Our target for Cisco's Net Income in the latest quarter was $0.25 per share.

In a second article, we will report Cisco's scores as measured by the GCFR Financial Gauges.  The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Our principal sources were the earnings announcement and the presentation material used during the post-announcement conference call with analysts.  Some background information about Cisco Systems and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue was 17.6 percent less than in the July 2008 quarter.  This performance was certainly consistent with the 18-percent decline that we expected from the guidance issued by Cisco when presenting the results of the April quarter.

Revenue from the sale of routers was down 27 percent in the quarter.  Revenue from switches and advanced technologies fell about 20 percent.

Fiscal 2009 Revenue was 8.7 percent less than in the preceding year.  This rate of contraction was the worst for Cisco since the 15 percent drop in fiscal 2002, which included the 9-11 terrorist attack.

The Cost of Goods Sold was 36.0 percent of Revenue, which translates into a Gross Margin of 64.0 percent.  The margin was down from 64.3 percent in the year-earlier quarter.  We had expected a 63-percent margin, based on Cisco's guidance that the Gross Margin would be between 63 and 64 percent.
The non-GAAP Gross Margin in the latest quarter was over 65 percent.

Research and Development spending was 15 percent of Revenue, whereas we expected 14 percent.

Sales, General, and Administrative expenses were a hefty 29.3 percent of Revenue, much more than our 26 percent target.

Other operating expenses (amortization of purchased intangible assets and in-process R&D) were about $100 million more than our prediction.  Our estimate was computed by taking the average value for these charges in the last 10 quarters, and discarding the highest and lowest values.

Operating Income was 42 percent less than last year's value, and it was 20 percent less than our prediction.  Higher-than-expected SG&A and other operating expenses were the main reasons Operating Income fell so far short  of our estimate.

Interest and Other Income was more than double our target, which was taken without alteration from Cisco's guidance.  This item was still less than half the comparable value in the June 2008 quarter.

The Income Tax Rate was 29.5 percent, instead of the predicted 22 percent.  A decision by the U.S. Court of Appeals for the Ninth Circuit in a case dealing with the tax treatment of share-based compensation expenses, led to tax adjustments that pushed up Cisco's tax rate.  The higher rate shaved almost $0.02 from earnings per share.

Net Income was 46 percent less than last year's value, and it missed our prediction by 26 percent.

In summary, Revenue fell sharply but no more than expected. Although the Cost of Goods Sold was a little less than we predicted, other GAAP costs were dramatically higher.  Cisco would claim that many recurring non-GAAP costs were cut.

To add a little salt to the wound, a court case in which Cisco was not a direct party led to tax changes that further depressed earnings.

More positively, Chairman and CEO CEO John Chambers stated,

"We saw a number of positive signs this quarter in the economy and in our business, especially comparing our sequential quarter-over-quarter order trends. If we continue to see these positive order trends for the next one to two quarters, we believe there is a good chance we will look back and see that the tipping point occurred in our business in Q4."

Full disclosure: Long CSCO at time of writing.

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