Cisco's (CSCO--Nasdaq) earnings news was met with a sigh of relief. The market had expected $4.70 billion to $4.80 billion in revenue and 9 cents earnings per share--possibly slightly higher with aggressive cost-cutting. The company delivered those numbers and more. It reported revenue of $4.82 billion for its fiscal third quarter, ending April 27, and earnings per share of 10 cents based on generally accepted accounting principles and 11 cents on the infamous pro forma basis. The company's stock share price immediately moved up in the after-hours market.
Cisco's revenue grew by only 2% year over year. In another time, that might be a disappointment, but in comparison with its peer group, all of which lost money this quarter, Cisco looks like a hero. The growth suggests that the company gained market share during the downturn, and Cisco saw increased adoption of its products in some of the faster-growing areas, including wireless LAN, enterprise virtual private networks, and enterprise security. This resulted in a pro-forma gross margin of 63.1%, up from 54.5% last year. With flat revenue, the company is clearly working hard to keep component costs down. It helps to have wiped out a lot of old inventory. Operating margins expanded to 21%, up from 1.8% last year.
Controlling costs is a driving force this year. That includes a steady reduction in staff over the past four quarters, from 39,660 last year to 35,935, a cut of more than 9%. The company's revenue-per-employee goal is $700,000 a year. That figure is around $530,000 today.
In response to all the concerns about off-balance-sheet items, Cisco eliminated its synthetic real-estate leases and has purchased all its properties. The total value of the real estate was $1.60 billion. What isn't so clear is whether the property is still worth $1.60 billion. My guess is that Cisco would have to take a partial write-down on these assets if they were to be put on the market today.
The company emphasizes its conservative revenue-recognition guidelines. I will say that, despite a very tough market environment, the management team led by John Chambers continues to execute according to their plans.
What's not to like? Look at some of Cisco's major markets. The wire line networking business is horrible. Every day, another carrier talks about lower capital expenditures. The result is that access equipment sales will continue to be sluggish. If that isn't bad enough, IT budgets are starting out much lower than prior years. Visibility of sales in the next quarter is murky at best.
Fiscal 2001 revenue was $22.29 billion, resulting in earnings per share of 41 cents. Wall Street analysts' consensus for fiscal 2002 revenue is $19.11 billion, generating earnings per share of 32 cents. Analysts' estimates range from 28 cents to 36 cents. Revenue for 2003 and earnings-per-share estimates are $22.20 billion and 47 cents, with an estimated range of 33 cents to 60 cents.
The Standard and Poor's 500 Index price-earnings market multiple is around 21. Cisco has historically been able to justify a 50% premium to the market multiple because of its financial stability and market leadership. This implies a fair value of $14.80, about where the stock is trading after reporting earnings. Based on my estimate of 89 cents per share cash flow from operations in fiscal 2002, the stock trades at roughly 14.7 times 2002 operations earnings per share.
Cisco has $21.10 billion in cash and equivalents, and it still has authority to buy back about another $2 billion of its own stock. The company said it would be a more aggressive buyer of its own stock at these fair-value levels.
Despite the near-term enthusiasm for the earnings news, Cisco's no bargain. The market is pricing its stock fairly at $14 to $15 per share.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected].