04 November 2009

CSCO: Income Statement Analysis for the October 2009 Quarter

Cisco Systems (NASDAQ: CSCO) earned $0.30 per share in the first quarter of fiscal 2010, which ended 24 October 2009, down from $0.37 in the same quarter of last year.

On a non-GAAP (i.e., "pro forma" or "ex-items") basis, Cisco's earnings per share slid from $0.42 to $0.36.  The main differences between GAAP and non-GAAP Net Income involved share-based compensation and amortization of acquisition-related intangible assets.

This post examines the Income Statement for the quarter in the earnings announcement, and it compares the entries on each line to our "look-ahead" estimates.  Our target for Cisco's GAAP Net Income in the latest quarter was $0.28 per share ($0.02 less than actual earnings).

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 various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Cisco Systems, the proud plumber of the Internet, has a dominant position in the market for enterprise networking products and services, such as routers.  Some background information about Cisco 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 12.7 percent less than in the October 2008 quarter.  While this is a substantial decrease, Revenue exceeded the 15-to-17-percent decline that Cisco estimated in early August when providing guidance for the October quarter.

Our estimate that Revenue would drop 15.8 percent was based on the company's guidance, which proved too pessimistic.

Revenue from the sale of routers was down 17 percent in the quarter.  Revenue from switches fell about 21 percent.

Japan, which contributed only 4.4 percent of Cisco's total Revenue, was the only "geography" in which Revenue increased.

The Cost of Goods Sold was 34.7 percent of Revenue, which translates into a Gross Margin of 65.3 percent. The margin was up from 64.7 percent in the year-earlier quarter, and it substantially more profitable than our 63.5-percent margin. 

The quarter ending January 2006 was the last time the GAAP Gross Margin was over 65 percent.

The non-GAAP Gross Margin was 66.3 percent.

Research and Development spending was 13.6 percent of Revenue, whereas we expected 13.8 percent.

Sales, General, and Administrative expenses were 27.0 percent of Revenue, much more than our 24.7 percent target.

Other operating expenses (amortization of purchased intangible assets and in-process R&D) were $27 million less than our $132 million 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, which we define as the difference between Revenue and the operating expenses identified above, was 14.4 percent less than last year's value.  Our prediction for Operating Income was 3.8 percent too low.  Greater-than-expected Revenue and Gross Margin outweighed higher-than-expected SG&A expenses.

Interest and Other Income was $90 million more than our $25 million target, which was taken without alteration from Cisco's guidance.  Other income was $123 million in the October 2008 quarter.

The Income Tax Rate was 20.2 percent, instead of the predicted 22 percent.

Net Income was 18.8 percent less than last year's value, but it beat our prediction by 10.8 percent.  Better-than-expected nonoperating income and a lower tax rate added to the good Operating results.

The adoption of two accounting standards involving Revenue recognition added $0.005 to earnings per share.

In summary, Revenue in the October 2009 quarter was considerably less than in the October 2008 quarter, but the decline wasn't nearly as steep as expected.   The Cost of Goods Sold came close to matching our estimate, but this value was much less than we expected as a percentage of Revenue.  As a result, the Gross Margin soared beyond our target.  Other operating expenses were more than expected, but the difference wasn't enough to prevent Net Income from besting our estimate by $0.02 per share.

The earnings release included the following announcement:

Cisco also announced that on November 4, 2009 its board of directors authorized up to $10 billion in additional repurchases of its common stock. Cisco’s board had previously authorized up to $62 billion in stock repurchases. There is no fixed termination date for the repurchase program. The remaining authorized amount for stock repurchases under this program, including the additional authorization, is approximately $13.1 billion.

Full disclosure: Long CSCO at time of writing.

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