22 September 2010

CSCO: Financial Gauge Analysis for the July 2010 Quarter

Cisco Systems (NASDAQ: CSCO) earned $0.33 per diluted share on a GAAP basis in fiscal 2010's fourth quarter, which ended on 31 July 2010.  Earnings per share were nearly 80 percent more than the $0.19 Cisco made in the same quarter of 2009.

Non-GAAP earnings, which exclude certain items, rose from $0.31 to $0.43 per share.

A previous article examined Cisco's Income Statement for the July quarter.  Reported GAAP earnings were $0.05 less than the $0.38 per share we had forecast. 

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for Cisco and the associated financial gauge scores.  The metrics were calculated using data from Cisco's current and historical financial statements, including those in the company's recently published Annual Report for fiscal 2010.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a dominant role in markets for enterprise networking products and services.  Its products are broadly categorized as routers, switches, or advanced technologies. 

In fiscal 2010, which ended in July, Cisco's earnings increased from $6.13 billion to $7.77 billion.  Revenue rose from $36.1 billion to $40.0 billion.

The company's reportable business segments are defined not by product types but by geographic region.  The U.S./Canada segment provided 54.3 percent of fiscal 2010's total Revenue.  The proportion of revenue generated by the U.S./Canada segment increased from 53.6 percent in fiscal 2009.

In a major diversification effort, Cisco began promoting in 2009 the Unified Computing System "to unite computing, network, storage access, and virtualization resources" for large data centers.  Since the UCS platform includes computer servers, storage systems [from EMC (NYSE: EMC)], and networking gear, the UCS puts Cisco into direct competition with heavyweights Hewlett-Packard (NYSE: HPQ), IBM (NYSE: IBM), and others.  HP responded by challenging Cisco on its home turf by acquiring network equipment maker 3Com (NASDAQ: COMS).

Cisco is also investing to become a substantial force in the smart grid market.

Interestingly, Cisco also intends to expand its product line with a tablet computer, called the Cius, for business customers.  The device, which won't be widely available until next year, runs the Android operating system promoted by Google (NASDAQ: GOOG) for mobile devices.  Cisco might be satisfied if the tablet's videoconferencing capabilities merely increases the demand for enterprise network infrastructure.   It's worth remembering that Cisco recently acquired, for $3.3 billion, video-specialist Tandberg.

Additional background information about Cisco and the business environment in which it is currently operating 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 Management31 Jul 201001 May 201025 Jul 20095-Yr Avg
Current Ratio2.
LTD to Equity27.5%27.6%26.6%21.9%
Debt/CFO (years)
Inventory/CGS (days)30.230.731.738.9
Finished Goods/Inventory63.8%64.8%64.4%59.3%
Days of Sales Outstanding (days)35.733.031.533.6
Working Capital/Revenue80.6%83.5%70.5%55.0%
Cash Conversion Cycle Time (days)46.243.942.549.0
Gauge Score (0 to 25)861413

The Cash Management gauge score added a couple of points, as the Balance Sheet remained rock solid and the company's Inventory became a tad leaner.  Other cash efficiency metrics either did not improve or did not improve enough to make the gauge score more attractive.

Cisco's hoard of Cash and Short-term Investments amounted to $39.9 billion, a record quarter-end amount, on 31 July.  This stockpile of liquid funds grew larger than last year's $35.0 billion, despite acquisitions and large share repurchases.  Working Capital -- the difference between Current Assets and Current Liabilities -- reached $32.2 billion, which appears to be substantially more than necessary for day-to-day business.  It will allow the company to start paying a dividend before the end of fiscal 2011. 

Working Capital is up from $30.5 billion at the end of fiscal 2009.

Cisco repurchased 325 million shares for $7.8 billion, for an average price of $24.02 per share, during the last four quarters.   Cisco shares closed the fiscal year at $23.07.

Long-term Debt, which increased to $15.2 billion when Cisco issued $5 billion in new debt last November, is now $12.2 billion with $3.1 billion due to mature in the next year.  Total debt edged down to 1.5 years of Cash Flow from Operations.

Cisco's Inventory became slightly leaner over the last year.  When measured in days of Cost of Goods Sold, the Inventory was reduced by 1.5 days.  This reduction continued a multi-year inventory improvement trend.  It's also positive that the proportion of Finished Goods in the Inventory is less than it was one year earlier. 

Cash efficiency suffered when judged by increases in Days of Sales Outstanding and the related Cash Conversion Cycle Time.  These rises put downward pressure on the Cash Management gauge.

Growth31 Jul 201001 May 201025 Jul 20095-Yr Avg
Revenue Growth10.9%-0.5%-8.7%10.0%
Operating Profit Growth7.1%4.7%7.5%12.5%
CFO Growth2.8%-22.0%-18.1%12.1%
Net Income Growth26.6%-2.2%-23.8%13.6%
Gauge Score (0 to 25)10219
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 Growth gauge began to recover after two years of low-single-digit readings.  Revenue and Net Income growth rates have become more what one expects from a company with Cisco's growth heritage.

Revenue in the July quarter increased 27 percent, from $8.54 billion last year to $10.84 billion in the most recent three months.  This rise enabled the trailing-year Revenue growth to get into positive territory after a year's absence.

However, Cisco increased its Assets faster than Revenue in the last year.  The reverse would have a positive effect on the gauge score.

Stronger results in the last few quarters have also turned around the Cash Flow and Net Income growth rates, especially the latter.  The Cash Flow growth rate, which is tepid at best, was hurt by the big increase in Accounts Receivable.  The increase might be due in part to sales occurring near the end of the quarter.

Profitability31 Jul 201001 May 201025 Jul 20095-Yr Avg
Operating Expense/Revenue75.9%76.5%78.1%75.3%
Free Cash Flow/Invested Capital54.4%47.1%61.4%65.6%
Accrual Ratio11.7%15.7%9.1%9.7%
Gauge Score (0 to 25)15121214

Big increases in the Return on Invested Capital and its Free Cash Flow equivalent resulted in a solid improvement in the Profitability Gauge score. 

The Operating Margin improved because Revenue increased faster than expenses over the last four quarters.

The Accrual Ratio is still high, which is a negative indicator with respect to earnings quality.  However, the ratio moved in the right direction during the July quarter, and we will watch it carefully in fiscal 2011.  Better growth in Cash Flow growth will also help this Profitability metric.

Value31 Jul 201001 May 201025 Jul 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)10.715.010.411.8
Gauge Score (0 to 25)9099
Share Price ($)$23.07$26.93$21.88-

The Value gauge score recovered from its recent stumble because profits soared in the July quarter while the company's share price declined 14 percent.  This combination of events caused the Price/Earnings multiple to fall below its recent range for Cisco.

The Price-to-Sales Ratio is now also relatively low.

The share price today is near $21.50.  At this lower price, the Value gauge would gain 3 or 4 points. 

Overall31 Jul 201001 May 201025 Jul 20095-Yr Avg
Gauge Score (0 to 100)42204146

All gauges improved during the July quarter, with Growth and Value registering the most impressive gains.  Although the 42-point Overall score might not seem too impressive, the doubling of the score in one quarter is a material change.  It will probably take additional rises in Cash Management efficiency and Cash Flow from Operations to get the Overall gauge up to the next tier of attractiveness.

Full disclosure: Long CSCO at time of writing.

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