04 February 2010

CSCO: Income Statement Analysis for the January 2010 Quarter

Cisco Systems (NASDAQ: CSCO) earned $0.30 per share, on a GAAP basis, in fiscal 2010's second quarter, which on ended 23 January 2010.  This result was 23 percent more profitable than earnings per share of $0.26 in the same quarter of the previous year.

On a non-GAAP (i.e., "pro forma" or "ex-items") basis, Cisco's earnings per share rose from $0.32 to $0.40.  The main differences between GAAP and non-GAAP Net Income involved share-based compensation and amortization of acquisition-related intangible assets.

This post examines Cisco's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Our target for GAAP Net Income in the latest quarter was $0.32 per share.

The principal sources for the income statement analysis were the earnings announcement, Chief Financial Officer Frank Calderoni's discussion of the results, and the conference call transcript (available from Seeking Alpha) and presentation [pdf].

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.  Additional 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 of $9.8 billion in the January 2010 quarter was 8.0 percent greater than in the same quarter of the previous year.  Cisco's guidance had been to expect Revenue growth between 1 and 4 percent.  This guidance was the basis for our estimate of $9.3 billion, which Cisco exceeded by 5.3 percent.

Sales of switches increased 13 percent to $3.4 billion.  Services were responsible for $1.8 billion of Revenue, up 6 percent.  Router sales grew a tepid 2 percent to $1.6 billion.

The Revenue growth rate was 12 percent or higher in the U.S. and Canada (the company's largest market), Asia-Pacific, and Japan.  Revenue fell 3 percent in Europe (the second-largest market) and increased only 1 percent in Emerging Markets.

The Cost of Goods Sold was 35.5 percent of Revenue, which translates into a Gross Margin of 64.5 percent.  The margin was up from 63.0 percent in the year-earlier quarter.  The margin matched our expectation.

The non-GAAP Gross Margin, which we don't track, was 66.3 percent.  It's interesting that the margin was exactly the same for product and service sales.

Research and Development spending of $1.25 billion was essentially flat, relative to January 2009, and it was just slightly greater than our expectations.  Because Revenue was much greater in the later period, R&D fell from 14.1 percent of Revenue to 12.7 percent.

Sales, General, and Administrative expenses were also essentially unchanged from the year-earlier period.  However, these expenses were 12 percent more than we had estimated.  SG&A declined from 27.9 percent of Revenue to 26.3 percent.

Other operating expenses (amortization of purchased intangible assets and in-process R&D) were $6 million more 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. 

The various operating items mentioned above combined to produce Operating Income, as we define it, of $2.37 billion. This was 34 percent greater than in the January 2009 quarter.  The increase can be attributed to higher Revenue, an expanded Gross Margin, and good control of operating costs.

Our Operating Income estimate was almost on the money.  Our underestimates of Revenue and SG&A expenses nearly canceled each other out.  Dumb luck.

Non-operating items, such as interest, summed to a net expense of $15 million, compared to a gain of $95 million last year and our estimate of a $75 million gain.  Long-term debt increased to $15.2 billion on 23 January 2010 from $10.3 billion last July.

The Income Tax Rate was 21.3 percent, instead of the guided 22 percent.
Net Income of $1.85 billion ($0.32 per share) was up 23 percent from last year's ($1.5 billion ($0.26 per share).  Our predicted value was lucky to be very close.

In summary, Revenue in the January 2010 quarter was up 8 percent from the same period of the previous year.  This growth rate was better than the company had anticipated.  Profitability was boosted by the expanded Gross Margin and control over other operating costs.  Interest expenses were a bit higher.

Full disclosure: Long CSCO at time of writing.

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