Cisco: Looking Ahead to January 2010 Quarterly Results

Jan.13.11 | About: Cisco Systems, (CSCO)
This post describes our model of Cisco Systems's (NASDAQ: CSCO) Income Statement for fiscal 2011's second quarter, which will end on 29 January.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report. Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about Cisco Systems and the business environment in which it is currently operating.

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

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.

The market value of the company is currently around $120 billion, on a fully diluted basis.

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

Cisco categorizes its products as Routers, Switches, Advanced technologies, and other. Switches generated the most Revenue in fiscal 2010, $13.6 billion, which was 42 percent of net product sales.

Revenue from product sales was supplemented by $7.6 billion in Revenue from services in fiscal 2010. Service revenue was 19 percent of total Revenue in fiscal 2010.

The company's business segments for financial data reporting are defined by geographic region or "theaters": United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan. 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.

The company has the financial resources for further acquisitions. Cisco's Balance Sheet for 31 July 2010 listed nearly $40 billion in Cash and Short-term Investments.

Gartner has predicted $3.5 trillion will be spent on Information Technology in 2011, up 5.1 percent from last year. However, in a separate announcement, the well-known researcher was less sanguine about spending on Enterprise Information Technology, forecasting a modest 3.1 percent rise in 2011. Gartner commented that EIT spending growth would be "timid and at times lackluster" during the next five years.

Tepid industry spending would test Cisco's frequent assertion that its revenue can expand over the long term at a rate between 12 and 17 percent per year.

In a major diversification effort, Cisco introduced in 2009 the Unified Computing System 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 bychallenging Cisco on its home turf when it acquired 3Com.

Cisco has also branched out into home entertainment, tablet computers (the Cius), video camcorders, and smart grid technology. Cisco might be satisfied if these products merely increase the demand for enterprise network infrastructure.

In the October-ended first quarter of fiscal 2011, Cisco Systems earned $0.34 per diluted share on a GAAPbasis, up 12 percent from $0.30 in the same three months of 2009. Non-GAAP earnings rose 17 percent, from $0.36 to $0.42 per share.

Public sector and service provider businesses were soft in certain areas during the October quarter.

Readers wanting to take another look at Cisco's October 2010 quarter might wish to review our Income Statement and Financial Gauge analyses.

We're now ready to look specifically at the January 2011 quarter.

Our starting point was the conference call presentation [pdf] (transcript made available by Seeking Alpha) on 10 November after the release of the company's earnings announcement.

Cisco described its expectations (with appropriate caveats) for the second quarter of fiscal 2011 as follows:

  • Revenue growth to increase between 3 percent and 5 percent year-over-year.
  • Operating margin between 23 percent to 25 percent.
  • Earnings per share between $0.32 to $0.35 per share. (GAAP EPS will be $0.08 to $0.10 per share lower than the non-GAAP EPS.)

Since Revenue in the January 2010 quarter was $9.815 billion, the expected 3-to-5 percent rise establishes a range for Revenue in the current quarter between $10.1 billion and $10.3 billion.

We selected the mid-range value of $10.2 billion as our target for Cisco's revenue in the January 2011 quarter.

For GAAP Gross Margin, we are estimating 63 percent of revenue, which is close to its average value during the three previous quarters. Combining the Revenue and Gross Margin estimates leads to a target for the Cost of Goods Sold of (1 - 0.63) * $10.2 billion = $3.8 billion.

Research and Development expenses have been about 13 percent of Revenue in recent quarters, and we are assuming a similar proportion in the January 2011 quarter. The estimated expense is, therefore, 0.13 * $10.2 billion = $1.3 billion.

Similarly, Sales, General, and Administrative costs have been near 27 percent of Revenue for the last year. Applying this rate to our Revenue target yields an estimated expense of 0.27 * $10.2 billion = $2.75 billion.

Cisco always reports various other operating charges, such as payroll tax on stock options, amortization of deferred compensation, amortization of purchased intangible assets, and in-process research and development. These expenses are typically excluded from Cisco's non-GAAP results, but we include them since our objective is to model the GAAP figures. The special expenses have been between $113 and $138 million per quarter in the last year, which led us to choose $125 million as an estimate for the current quarter.

Subtracting the estimated operating expenses from the Revenue estimate yields a $2.22 billion target for Operating Income. This amount is 6.3 percent less than the comparable year-earlier value of $2.37 billion.

Moving to the non-operating side of the Income Statement, we expect Interest and Other Income will be about $60 million. We are using a 20-percent Income Tax Rate, which would lead to a Provision for Income Taxes of around $460 million.

This produces a bottom-line target for GAAP Net Incomein the quarter of $1.825 billion ($0.32 per share), which is 1.5 percent less than earnings of $1.85 billion ($0.32 per share) in the January 2010 quarter.

Please click here to see a normalized depiction of the projected results next to Cisco's 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.

Full disclosure: Long CSCO at time of writing.