12 May 2010

CSCO: Income Statement Analysis for the April 2010 Quarter

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

Non-GAAP earnings rose 40 percent, from $0.30 to $0.42 per share.  Share-based compensation, amortization of acquisition-related intangible assets, and other acquisition-related expenses are usually the main differences between the GAAP and non-GAAP results.  In the latest quarter, the GAAP results included a one-time $158 million tax benefit ($0.03 per share) that was excluded from non-GAAP earnings.

The latest quarter included a rare 14th week.

This post examines Cisco's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.02 better than the $0.35 per share we had forecast.  Earnings were $0.01 less than our estimate if the special tax benefit is excluded.

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 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, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a dominant role in markets for enterprise networking products and services.  Cisco categorizes its products as routers, switches, and advanced technologies.  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 $10.4 billion in the quarter was 27 percent more than last year's $8.2 billion.  Our $10.2 billion estimate, based on Cisco's guidance to expect Revenue growth between 23 and 26 percent, was 1.6 percent too low.  

Product and Service sales increased 31 percent and 11 percent, respectively.  Product sales were responsible for 81 percent of total revenue.

Sales of switches (the company's largest product category) increased a stunning 40 percent to $3.7 billion.  Router sales were $1.7 billion, up 23 percent.  Advanced technologies -- security, Unified Communications, wireless, storage, etc. -- achieved an 18 percent sales increase to $2.4 billion.

Cisco has five business segments, which are defined by the "geography" they serve: United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan.  The U.S. & Canada segment provided roughly 54 percent of the quarter's Total Revenue.  Revenue increased by 25 percent or more at four of the five segments.  The Asia Pacific segment had the fastest Revenue growth, 41 percent.  Revenue rose (only?) 15 percent in Europe.

The Cost of Goods Sold increased to $3.7 billion (36.1 percent of Revenue) from $2.9 billion in the year-earlier quarter.  The latest results translate into a Gross Margin of 63.95 percent, 12 basis points less profitable than last year.

The non-GAAP Gross Margin was 65.2 percent, beating the 64-to-65 percent range in Cisco's guidance. 

We had assumed the GAAP Gross Margin would be 64.5 percent, which turned out to be 55 basis points too high.

The Gross Margins for Products and Services were 64.3 percent and 62.3 percent, respectively.

Research and Development spending increased 13.5 percent, from $1.24 billion to $1.41 billion.  R&D spending included a share-based compensation expense of $129 million, up 37 percent from last year.   With Revenue up sharply, R&D expenses fell from 15.2 percent of Revenue to 13.6 percent.

R&D was 10.7 percent more than we expected.

Sales, General, and Administrative expenses of $2.76 billion were up 22 percent from last year's $2.26 billion.  As a percentage of Revenue, SG&A declined from 27.7 percent to 26.6 percent.

These expenses were 10 percent more than our $2.5 billion estimate. 

Other operating expenses (amortization of purchased intangible assets) were $117 million, or $13 million less than the $130 million we had estimated.

Subtracting the various operating expenses from Revenue yields Operating Income of $2.345 billion, up 46 percent from $1.6 billion in the year-earlier quarter.  The increase can be credited to higher Revenue, partially offset by greater R&D and SG&A expenses.

Operating Income was 12.3 percent less than our $2.67 billion target.  Although Revenue was more than we expected, the Gross Margin was slightly less and both R&D and SG&A expenses were more than we anticipated. 

Non-operating items, such as interest, summed to a net gain of $58 million, compared to $80 million last year.  We had estimated a $20 million net expense for this category, so we were off by $78 million.  The non-operating item that surprised us was "other" income of $82 million.

The effective Income Tax Rate was a mere 8.8 percent because of the one-time tax credit.  We had assumed the rate would be equal to the 22 percent mentioned in the company's earlier guidance. 

Bottom-line GAAP Net Income of $2.19 billion ($0.37/share) exceeded last year's $1.35 billion ($0.23 per share) by more than 60 percent.  Our estimate was $2.07 billion ($0.37 per share). 

In summary, Revenue increased 27 percent and was strong across products and geographies.  GAAP operating expenses, which include rising share-based compensation, were higher than we anticipated, but the non-GAAP figures were in line with Cisco's guidance.  Other, non-operating income was better than we expected, and a tax benefit added $0.03 to GAAP net income.

Full disclosure: Long CSCO at time of writing.

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