The Cisco Kid Rides Again

By Phil Weiss (TMF Grape)

TOWACO, NJ (August 11, 1999) -- Wow! Awesome! Yahoo! (oops, wrong company). I think those words best sum up my reaction after taking a look through the financials released with Cisco System's (Nasdaq: CSCO) earnings report last night and listening to the earnings conference call, as well.

Before we get to some of the details, I thought that I'd highlight what impressed me the most while I listened to the call and reviewed the numbers. (If any of you wonder why Matt has spent time trying to pressure Coke to hold open conference calls, then all you need to do is listen in on Cisco's call to get an idea about all the interesting info that's covered.) The thing that I was most impressed by while listening to the call was the quality and vision of Cisco's management team. These are the kind of people that I want running my company. They're forward thinking, they think long-term over short-term, and they have a well-thought-out strategy in place that they execute very well.

Here are the financial highlights for the quarter:

- Revenues of $3.55 billion, beating estimates for $3.4 billion
- Net income of $0.21 per share, beating estimates for $0.20
- Year-over-year sales growth of 48%
- Gross margins of 64.7%
- Net margins of 20.5%
- Cash of $2.0 billion (excludes investments of $7 billion and restricted investments of $1.1 billion)
- No debt
- Flow Ratio of 0.87
- Rule Maker Ranker score of 52 (top tier)

What I'd like to do now is take Cisco through the 10 basic criteria that we look for in our Rule Making investments and see how things shake out. Then, I'll wrap things up with a few of the other highlights from the conference call.

1. Dominant Brand -- Cisco currently sells twenty different product lines. It has the #1 market position in 16 of these 20 markets; it's #2 in the other four. It's hard to imagine being much more dominant than that.

2. Repeat Purchase Business -- The growth rate of Cisco's industry is in the range of 30 to 50 percent. In order to have that kind of growth rate you have to be able to sell products to your customers over and over again. To me, the answer to this one is yes.

3. Convenience -- During the call it was said that Cisco receives close to $1 billion per month of online orders. That sure sounds like it's made its business convenient for its customers.

4. Expanding Possibilities -- Cisco expects that its market will grow at a rate of 30 to 50 percent over the next several years in those countries with a growing economy. Provided that it executes properly Cisco should be able to grow within this range. It's also regularly offering new products and expanding its business through partnerships and investments. To me these are all good indicators of continued future success for this Rule Maker.

5. Your Familiarity and Interest -- I use Cisco's products nearly every day. I even think it's pretty safe to assume that you're using them as you read this report. I enjoy following this company and learning about what its future may hold. I also enjoy listening to a management team that sounds like it has a clue about what's going on.

6. Sales Growth of 10% or more on a comparable quarter basis -- Cisco's July 1998 sales were $2.4 billion. This quarter they were $3.5 billion, which is an increase of 48%. In case you think that's an aberration, then you should also know that sales for the year increased by 43%.

7. Gross Margins of 50% or more -- This quarter Cisco continued to shine with gross margins of 64.7%, which was down from last year's 65.8%. The decline is attributable to product mix variances and continued pricing pressure from various competitors (Lucent and Nortel were specifically mentioned during the conference call). Ongoing cost reductions helped to offset some of this decline. Management's guidance is that it expects this number to continue to fall. However, it's still well within our comfort range and eons ahead of the competition. I'm not overly concerned here.

8. Net Margins of at least 7% -- Cisco rang in with a solid 20.5%. This is a bit lower than last year's fourth quarter, but still much higher than our target level. It also trounces the competition yet again. One thing that may help here in fiscal 2000 is that Cisco forecasts that its effective tax rate will fall from 33% to 30% due to the implementation of some international tax planning ideas. (Since that's an area of expertise for me, it will be interesting to see if I can figure out what some of them are when I read the annual report in a few months.)

9. Cash-to-Debt Ratio of 1.5 or greater -- Cisco continues to have a debt-free balance sheet. Its two largest competitors in terms of size both currently have debt that exceeds their available cash balance.

10. Flow Ratio of 1.25 or less -- Cisco's score on this one was the best it's ever been. Last year at this time it was 1.17. Now it's 0.87. That's really quite an impressive improvement. I'm also willing to bet that you'll be hard-pressed to find another company that carries a material amount of inventory on its balance sheet with a flow ratio lower than Cisco's. Amazingly the flow ratio fell even though inventory increased by about 80% over the year earlier figure. The primary reason for the decline was the continued decline in days sales outstanding (accounts receivable/(sales/90)). This figure fell from 49 days a year ago to 32 this year. As a matter of fact, it even fell four days from last quarter. Even more unbelievable was the fact that accounts receivable balance this quarter was lower than it was last quarter even as sales increased by 12%. The improvement was primarily due to excellent shipment linearity during the quarter as well as continued process improvements and great execution in the management of these assets.

As promised, here is a summary of some of the other impressive facts I heard and/or learned while listening in on the conference call:

- The sum of cash, short term, long term and restricted investments increased by approximately $1.6 billion from last quarter. In addition our company is now generating approximately $400 million of cash flow from operations every month!

- Our company's CEO, John Chambers, said that if the company continues to execute well, then Cisco is positioned to be the company that will lead the Internet revolution. That is certainly one revolution that I want to be a part of.

- Cisco breaks its sales into four geographic regions: EMEA (primarily Europe), the Americas, Asia, and Japan. All but Japan (28% of revenues) showed 45% year-over-year growth led by Europe's 55% surge. Sequential quarterly growth for all but Japan (slight increase) was at least 9%.

- Our company has four primary concerns on going forward: worldwide business conditions, Y2K issues, government temptation to overregulate, and competition. Y2K is being viewed as a one quarter phenomenon. While it's expected that there will be some slowdown in spending during the fiscal second quarter (calendar fourth quarter), Cisco expects that as little as possible of this slowdown will be directed toward Internet spending due to the many growth opportunities that exist in the marketplace. However, at this point, it's hard to have a handle on what second quarter results will look like.

- Cisco takes advantage of its own technology to make its business run more smoothly. Its financial systems work so well that management has the ability to know what's going on at any time and can react very quickly where necessary. This also enables its personnel to focus more on planning and strategy rather than number crunching. Chambers believes that this gives our company a significant advantage over its old world competitors (telecom companies). He actually believes that the company's internal systems will have as much of an impact on future success (or lack thereof ) as will the whole e-commerce arena.

- I also was impressed by what I learned when Cisco discussed its decision to make a $1 billion investment in KPMG earlier this week, rather than opting to purchase International Network Services as Lucent did yesterday. Chambers said that he'd rather make a $1 billion investment providing access to 4,000 consultants from KPMG instead of spending $3.7 billion for about 2,000 INS consultants incurring other ongoing costs as well. Cisco actually had a number of chances to purchase INS over the last year and turned them down. To me, this decision makes sense. It also is a real life example of why Cisco's financial statements look so much better than Lucent's.

- Here's one last interesting tidbit for all those that think this whole dot.com thing is a bubble or some sort of hysteria. During the call, Cisco quoted a recent University of Texas study that found that as of 1998 the Internet economy had generated $300 billion of revenues and created approximately 1.2 million new jobs in just five years. That revenue figure is equal to what was generated by the automobile, energy, and telecommunications industries in a century.

If you've never listened in on a conference call, and especially if you're a Cisco shareowner or prospective shareowner, I encourage you to give it a shot. The WebCast replay is available thru August 18.

If you have any questions about tonight's report or want to continue this discussion, please ask them on either our RM Companies Board or the Cisco Message Board.

08/11/99 Close

Stock Change    Bid
AXP   +2 1/2    127.00
CHV   -  3/4     96.06
CSCO  +4 3/16    62.94
DPH   +  3/16    17.75
EK    -  1/4     71.31
GM    +1 3/16    62.00
GPS   +  3/4     38.50
INTC  +4 1/4     76.00
KO    -  3/8     59.44
MSFT  +1 1/4     84.19
PFE   +  5/16    33.00
SGP   +  15/16   47.94
TROW  +  1/16    33.44
XON   +  3/4     81.94
YHOO  +  9/16   128.06

                  Day     Month  Year    History
        R-MAKER  +2.31%  -2.27%   9.31%  37.66%
        S&P:     +1.60%  -2.02%   6.49%  31.76%
        NASDAQ:  +3.01%  -2.79%  16.98%  55.18%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
   6/23/98   68 Cisco Syst    29.21     62.94   115.50%
    2/3/98   54 Microsoft     45.13     84.19    86.52%
    5/1/98   82 Gap Inc.      23.05     38.50    67.01%
   2/13/98   52 Intel         46.93     76.00    61.95%
   5/26/98   18 AmExpress    104.07    127.00    22.04%
    2/3/98   66 Pfizer        27.43     33.00    20.29%
    6/3/99   11 *Delphi Au    17.19     17.75     3.26%
   8/21/98   44 Schering-P    47.99     47.94    -0.12%
    2/6/98   56 T. Rowe Pr    33.67     33.44    -0.70%
   2/27/98   27 Coca-Cola     69.11     59.44   -13.99%
   2/17/99   16 Yahoo Inc.   126.31    128.06     1.39%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     81.94    27.36%
   3/12/98   15 Chevron       83.34     96.06    15.26%
   3/12/98   20 Eastman Ko    63.15     71.31    12.93%
   3/12/98   17 *General M    61.28     62.00     1.17%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
   6/23/98   68 Cisco Syst  1985.95   4279.75  $2293.80
    2/3/98   54 Microsoft   2437.28   4546.13  $2108.85
   2/13/98   52 Intel       2440.28   3952.00  $1511.72
    5/1/98   82 Gap Inc.    1890.33   3157.00  $1266.67
   5/26/98   18 AmExpress   1873.20   2286.00   $412.80
    2/3/98   66 Pfizer      1810.58   2178.00   $367.42
    6/3/99   11 *Delphi Au   189.09    195.25     $6.16
   8/21/98   44 Schering-P   2111.7   2109.25    -$2.45
   2/27/98   27 Coca-Cola   1865.89   1604.81  -$261.08
    2/6/98   56 T. Rowe Pr  1885.70   1872.50   -$13.20
   2/17/99   16 Yahoo Inc.  2020.95   2049.00    $28.05

Foolish Four Stocks
    Rec'd    #  Security     In At     Value    Change
   3/12/98   15 Chevron     1250.14   1440.94   $190.80
   3/12/98   20 Eastman Ko  1262.95   1426.25   $163.30
   3/12/98   20 Exxon       1286.70   1638.75   $352.05
   3/12/98   17 *General M  1041.80   1054.00    $12.20

                              CASH    $100.83
                             TOTAL  $33890.46

Notes: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.

*Although DPH is not a Foolish Four stock, it was spun-off from GM on June 3, 1999

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