Cisco Earnings Preview

<I>Street Insight's</I> Bob Faulkner previews the Cisco earnings call slated for after the close.
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Cisco Systems

(CSCO) - Get Report

will report its results after the close tonight for the first quarter of fiscal 2006 (which ends July 31, 2006).

There is a conference call at 4:30 pm EST. Current consensus is for pro-forma EPS of 24 cents and revenue of $6.58 billion (+10% year-over-year; flat quarter-over-quarter).

What Do I Expect?

At this juncture, I think it's safe to say the quarter will be in line with management's expectations. No more, no less. Most communications-equipment companies have seen steady and solid growth, but nothing suggesting any dramatic acceleration from the current pace. If there is one area of concern, it will be on the competitive front as Huawei continues to leverage its advantage in China and penetrate North American and European markets with aggressive pricing.

Last Quarter

In Cisco's last quarter, revenue was $6.58 billion (+11% year-on-year; +6% quarter-on-quarter). Pro forma EPS were 25 cents (GAAP EPS = 24 cents). The company's gross margins increased 110 basis points sequentially at both the product and corporate levels. Operating margins rose 80 basis points quarter over quarter due to headcount additions.

Finances

CSCO's balance sheet is one of the best among technology companies. It generated a very strong $2.4 billion in cash from operations; accounts/receivable days' sales declined to 30 from 33; and inventory turns increased to 5.4 times from 5.3 times last quarter. While the cash position was essentially flat, the company repurchased approximately 130 million shares of its stock.

Growth by Product Line

From a product perspective, routers increased 3% year over year, switches +8% year over year, advanced technologies +27% year over year and services +15%. The book-bill ratio exceeded one for the second consecutive quarter and product orders increased 7% sequentially vs. 6.5% for product revenue. Orders were particularly strong for advanced technologies, up in the low-30% range year over year and high single-digits quarter over quarter. Orders for its commercial business grew in the low-20% range year over year and midteens sequentially. Enterprise orders were characterized as "solid," with midteens-type growth both YY and QQ.

Growth by Region

Geographically, orders from North America were very balanced with 23% growth on both a year-over-year and quarter-over-quarter basis. Europe, Middle East and Asia experienced high-teens order growth year over year and midsingle digits sequentially. While Asia Pacific was characterized as "solid," the company indicated China was down on a year-over-year basis as CSCO continues to play on what management described as an "un-level playing field." Japan continues to be a struggle with orders down to the low-double digits year over year and midsingle digits quarter over quarter. The company will be implementing a new geographic alignment when it reports results for Q1/06.

Guidance for the First Quarter

As an experiment, management provided guidance for Q1/F06 and for the entire fiscal year. For Q1/F06, revenue should be up approximately 10% year over year, with orders up in the 11%-15% range. Gross margins will be about 67% with operating margins in the 30% range. Other Income should be about $140 million; the tax rate will be about 28% and investors should plan for about 50 million fewer shares outstanding. The company will implement FAS123 in Q1 (expensing of stock options) and at this time anticipates it will reduce GAAP EPS by an additional $0.03-$0.04/share.

Guidance for Fiscal 2006

For the fiscal year, CSCO anticipates product revenue to increase in the 10%-12% range and orders to grow 10%-15%. GMs should be in the 66%-67% range and, while operating expenses will trend up in the first half, full-year operating expenses should run about 36% of revenue. The company expects other income to be approximately $500 million to $600 million with a tax rate of 28% and a quarterly decline of 50 million in shares outstanding.

Last Quarter's Disappointment

Prior to the last conference call, investors were anticipating an upside surprise. Not only did the company fail to provide such, but the guidance for Q1 and the fiscal year was below expectations. Management also admonished investors that its guidance was realistic and was obviously being ignored by the Street.

At the time of publication, Faulkner had no positions in Cisco.

Bob Faulkner has been in the investment business for 18 years with an exclusive focus on technology stocks. He started as a sell-side analyst with Wood Gundy and Alex. Brown & Sons. In 1990, he moved to the asset management side with portfolio management/analytical positions at 1838 Investment Advisors and Merrill Lynch. Bob has an M.B.A. from Seton Hall and a B.S. from Waynesburg College.