29 May 2010

CSCO: Financial Gauge Analysis for the April 2010 Quarter

Cisco Systems (NASDAQ: CSCO) earned $0.37 per diluted share on a GAAP basis in fiscal 2010's 14-week third quarter, which ended on 1 May 2010.  Reported earnings were 61 percent more than the $0.23 per share Cisco earned in the comparable 13-week quarter of 2009.

The latest quarter included a one-time $158 million ($0.03 per share) tax benefit.  Non-GAAP earnings, which exclude tax and various other special items, rose from $0.30 to $0.42 per share.

In our earlier review of Cisco's Income Statement, we compared the actual results to our "look-ahead" estimates.  Reported earnings were $0.02 better than the $0.35 per share we had forecast. 

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value for Cisco Systems.  This post reports on the metrics and the associated financial gauge scores.  The metrics were calculated using data from Cisco's current and historical financial statements, including the latest 10-Q report.

Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a dominant role in markets for enterprise networking products (routers, switches, and advanced technologies) and services.  Additional background information about Cisco can be found in the look-ahead.

In summary, Cisco's latest quarterly results produced the following changes to the gauge scores:

Current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management01 May 201023 Jan 201025 Apr 20095-Yr Avg
Current Ratio2.
Debt/CFO (years)
Inventory/CGS (days)30.731.931.240.3
Finished Goods/Inventory64.8%61.3%62.0%58.2%
Days of Sales Outstanding (days)33.032.631.933.3
Working Capital/Revenue83.5%84.8%62.0%51.9%
Cash Conversion Cycle Time (days)43.944.842.749.5
Gauge Score (0 to 25)691513

Cisco's hoard of Cash and Short-term Investments is now $39.1 billion, which is only a little less than the record-high $39.6 billion it reported three months ago.  The stockpile of liquid funds is significantly larger than last year's $33.6 billion, despite several acquisitions and large share repurchases.  Working Capital -- the difference between Current Assets and Current Liabilities -- is now $31.3 billion.  This amount is also down from last quarter but up from 12 months ago.

Tandberg and Starent Networks are two of the more recent acquisitions that involved large cash payouts, about $3 billion each.

Cisco repurchased 87 million shares for $2.25 billion during the last quarter alone.  In the first nine months of fiscal 2010, the company repurchased 226 million shares for $5.5 billion. 

Long-term Debt, which increased to $15.2 billion when Cisco issued $5 billion in new debt last November, is now $12.1 billion with $3.1 billion due within the next year.  Notes payable is a Current Liability that lowered the Current Ratio.
The Inventory level, measured in days of Cost of Goods Sold, came down slightly in the latest quarter.  This positive achievement was offset by an increase in the proportion of Finished Goods in the total Inventory.

The small increase in Days of Sales Outstanding is a minor negative.  Cisco indicated that a higher percentage of shipments occurred in the last month of the quarter.

Growth01 May 201023 Jan 201025 Apr 20095-Yr Avg
Revenue growth-0.5%-10.2%-1.7%9.7%
Operating Profit growth4.7%3.5%11.0%9.6%
CFO growth-22.0%-36.2%1.3%7.9%
Net Income growth-2.2%-19.0%-11.3%8.7%
Gauge Score (0 to 25)2019
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

The low score for this gauge seems odd since Cisco just reported 27-percent Revenue growth in the last quarter and Net Income growth over 60 percent.  These figures qualify as robust growth by nearly any standard.

However, the gauges are designed to smooth quarterly variations by operating on trailing-year data.  In the last four quarters, there were two periods when Revenue slumped 13 percent and 18 percent respectively.  The two more recent strong quarters weren't quite enough to balance the weaker periods and get the trailing-year growth rates above zero. 

The negative rates put a low cap on the Growth score.  However, if the next quarter is similar to the last two, the trailing-year growth rates will rebound significantly.

The Cash Flow rate of contraction is much steeper than the fall in Net Income, which is unusual.  The Cash Flow decline seems to have been exacerbated by a $1.7 billion increase in Accounts Receivable, which rose from $2.4 billion on 25 April 2009 to $4.1 billion on 1 May 2010.  If this is simply due to the recent acceleration in sales and the timing of these sales, it will correct itself in short order.

Profitability01 May 201023 Jan 201025 Apr 20095-Yr Avg
Operating Expenses/Revenue76.5%77.1%76.5%74.8%
Free Cash Flow/Invested Capital47.1%45.7%69.4%60.2%
Accrual Ratio15.7%13.9%9.1%8.5%
Gauge Score (0 to 25)12121214

The Operating Margin improved slightly in the latest quarter.  It's back to where it was one year earlier. 

Earning and Free Cash Flow returns on invested capital remain in all-star territory, although they are somewhat lower now than they were a year ago. 

The big increase in the Accrual Ratio, which could be a warning about the quality of earnings, is another manifestation of the Cash Flow decline discussed above.

Value01 May 201023 Jan 201025 Apr 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)011810
Share Price ($)$26.93$22.97$18.42-

Cisco's share price soared 46 percent in the four quarters ending 1 May 2010.  Since the trailing-year rates of growth for Revenue, Cash Flow and Earnings were all negative, as discussed above, the Value gauge plunged.

The share price has since fallen back to $23.16.  At this price, the Value gauge would gain 4 points.  If Cisco is as profitable in the next few quarters as it was during the last two periods, the P/E and P/Sales ratios will look a lot more appealing.

Overall01 May 201023 Jan 201025 Apr 20095-Yr Avg
Gauge Score (0 to 100)20235647

The gauges didn't change materially during the last quarter despite good results because many year-over-year (i.e., trailing year) figures were unimpressive.  The next quarter, July 2010, should be the one that will greatly improve the growth rates and valuation metrics.  A reduction in Accounts Receivable and Days of Sales Outstanding would also be helpful because of its potentially positive effect on Cash Flow

Full disclosure: Long CSCO at time of writing.

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