11 December 2010

CSCO: Financial Gauge Analysis for the October 2010 Quarter

Cisco Systems (NASDAQ: CSCO) earned $0.34 per diluted share on a GAAP basis in the October-ending first quarter of fiscal 2011, up 12 percent from $0.30 in the same three months of last year. 

Non-GAAP earnings rose 17 percent, from $0.36 to $0.42 per share.  The non-GAAP results for the latest quarter exclude items totaling $666 million pretax, $481 million ($0.08 per share) after-tax.

A previous article examined Cisco's Income Statement for the October quarter in some detail.  Reported GAAP earnings were $0.02 less than the $0.36 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 latest 10-Q report.

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

Cisco Systems, Inc., the proud plumber of the Internet, has a dominant role in markets for enterprise networking products and services. 

The company categorizes its products as Routers, Switches, New Products, and other.  Switches generated 42 percent of net product sales in fiscal 2010

Cisco's earnings rose 27 percent in fiscal 2010, which ended in July, from $6.13 billion to $7.77 billion.  Revenue increased 11 percent, from $36.1 billion to $40.0 billion.  Fiscal 2010 included a 53rd week.

In fiscal 2011, Cisco Systems will issue its first cash dividend.  The amount and timing of the dividend have not yet been disclosed.

The company's market value is currently around $110 billion, on a fully diluted basis.  The value dipped about 16 percent one day last month because an update to Cisco's guidance was more cautious than expected.

Cisco's business segments for financial data reporting are defined by geographic region or "theaters."  The U.S./Canada segment provided 54.3 percent of fiscal 2010's Total Revenue.

Juniper Systems (NASDAQ: JNPR) is usually considered Cisco's most direct competitor in the enterprise market.

Cisco has long been a serial acquirer, insatiably gobbling up companies of all sizes.  In 2010, Cisco's two largest acquisitions were Tandberg, for $3.3 billion, and Starent Networks, for $2.6 billion.

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 Management30 Oct 201031 Jul 201024 Oct 20095-Yr Avg
Current Ratio2.
LTD to Equity27.3%27.5%25.7%23.4%
Debt/CFO (years)
Inventory/CGS (days)30.630.232.137.5
Finished Goods/Inventory59.1%63.8%65.2%60.2%
Days of Sales Outstanding (days)36.535.731.233.9
Working Capital/Revenue78.1%80.6%78.7%57.6%
Cash Conversion Cycle Time (days)47.546.242.848.5
Gauge Score (0 to 25)118913

The Cash Management gauge added three points to its score, getting back into double digits for the first time in more than a year.  The rise was due in large part to the significant reduction in the Finished Goods ratio.

Cisco's hoard of Cash and Short-term Investments totaled $38.9 billion, an historically high amount, on 30 October 2010.  Working Capital -- the difference between Current Assets and Current Liabilities -- is now $32.3 billion, which appears to be substantially more than necessary for day-to-day business.  This stockpile of liquid funds has not yet been appreciably diminished by acquisitions, nor by share repurchases.

In the most recent quarter, Cisco spent $2.5 billion to repurchase 113 million of the company's shares.  Cisco repurchased 325 million shares for $7.8 billion, for an average price of $24.02 per share, during fiscal 2010.

More of Cisco's cash will be returned to investors when the company starts paying a dividend during the current fiscal year.

Long-term Debt, which got as high as $15.2 billion when Cisco issued $5 billion in new debt last November, is now down to $12.2 billion.  In addition, Cisco has $3.1 billion in obligations due to mature in the next year.  Total debt remained steady at 1.5 years of Cash Flow from Operations.

Cisco's Inventory has become leaner.  When measured in days of Cost of Goods Sold, the Inventory was reduced by 1.5 days over the last four quarters.  This decrease continued a multi-year inventory improvement trend.  The lower proportion of Finished Goods in the Inventory is also positive. 

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.

Growth30 Oct 201031 Jul 201024 Oct 20095-Yr Avg
Revenue Growth20.0%10.9%-13.7%6.1%
Operating Profit Growth-0.7%-3.0%3.7%5.9%
CFO Growth19.4%2.8%-26.0%1.4%
Net Income Growth38.3%26.6%-28.9%4.4%
Gauge Score (0 to 25)16909
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 soared an impressive 7 points in the October quarter, led by accelerating Revenue growth and a more robust increases in Cash Flow from Operations.  The growth rates, including the measure related to Net Income, have become more what one expects from a company with Cisco's ambitions.

Revenue in the October quarter surged 19.2 percent, from $9.0 billion last year to $10.75 billion in the most recent three months.  This increase enabled the trailing-year Revenue growth to reach 20 percent for the first time in three years.

Revenue is now increasing at a faster pace than Assets, which contributes to the Growth gauge score.

Stronger results in the last few quarters have dramatically turned around the Cash Flow and Net Income growth rates.

Profitability30 Oct 201031 Jul 201024 Oct 20095-Yr Avg
Operating Expense/Revenue76.3%75.9%78.3%75.5%
Free Cash Flow/Invested Capital51.0%54.4%52.3%63.4%
Accrual Ratio10.5%11.7%7.9%9.4%
Gauge Score (0 to 25)15151214

The Profitability Gauge held onto its healthy 15-point score.  The gauge benefits from the high percentages for the Return on Invested Capital and its Free Cash Flow equivalent. 

The Operating Margin degraded a slight 40 basis points compared to July, but Operating Expenses are a significantly lower percentage of each Revenue dollar than they were one year ago.

The Accrual Ratio is still high, which is a negative indicator with respect to earnings quality.  However, the ratio moved in the right direction in October.  Continued growth in Cash Flow will help this Profitability metric.

Value30 Oct 201031 Jul 201024 Oct 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)10.210.713.512.5
Gauge Score (0 to 25)11919
Share Price ($)$22.86$23.07$24.17-

The Value gauge score got back into double digits after a six-quarter absence.  A lower Price/Earnings multiple helped.

This gauge will nearly always do well when share prices fall despite strong earnings growth.

The Price-to-Sales Ratio and the EV/CFO are also both relatively low for Cisco.

Cisco's current share price today is under $20.  At this price, rather than the quarter-end price, the Value gauge would jump to 16 of the 25 possible points and seven more points would be tacked onto the Overall gauge score.

Overall30 Oct 201031 Jul 201024 Oct 20095-Yr Avg
Gauge Score (0 to 100)51422345

Three of the four category gauges improved during the October quarter, and the fourth was unchanged.  Growth increased the most, and all four measures now have scores over 10 of the 25 possible points.

The Overall gauge rose to 51 points, a good result.  It more than doubled in the last year.  Today's lower stock price would bring the score up to 58, just below the next tier of attractiveness.

Full disclosure: Long CSCO at time of writing.

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