In some ways it seems to me as if Cisco Systems (Nasdaq: CSCO) is now engaged in a game of Can you top this? with itself. Cisco has been a publicly traded company for 40 quarters. Last night's fiscal Q2 2000 earnings marked the 40th consecutive time that the company has matched or exceeded the expectations of the Wise. It's also the eighth consecutive quarter in which it has grown revenues on a sequential quarterly basis. From top to bottom the financial results were truly outstanding, as we'll see below.
First thing I'd like to do is share some of the highlights from the conference call. As always, the number one thing on this list is how much Cisco's management team continues to impress me. John Chambers and Co. clearly have a solid handle on how to successfully run their business. Cisco sees a vast number of "enormous" opportunities that lie ahead in its industry. The company actually sees many more opportunities available than it can fund at its current spending levels. Based on these opportunities to expand, I was quite happy to hear that Cisco expects to invest up to 38-39% of its revenues in the coming year. To meet this level of spending, the company will grow its spending at a rate slightly faster than it expects sales. As in the past, Cisco still expects to grow its sales by 30-50% annually, though that rate will depend upon the execution of Cisco and its competitors.
From a Rule Maker perspective, one of the most awesome results of the quarter is the growth in Cisco's cash balance, which is up 64% on a year-over-year basis. Our company continues to generate operating cash flow of approximately $400 million per month and its total balance of cash, short- and long-term investments is now up to $14.9 billion! If you couple that with its 53% revenue growth, it's pretty easy to see why this company is viewed as a gorilla. For a company the size of Cisco to grow at this rate is astounding.
With that kind of performance, it's really no surprise that Cisco has been the best-performing stock in our portfolio. Our shares have nearly quadrupled in value during our relatively short 18 months of ownership. Such rapid appreciation now gives Cisco a fully diluted market cap of $475 billion, making Cisco the second most highly valued enterprise in all the world. (Microsoft is #1, of course, and General Electric is right behind Cisco at #3.)
At the risk of sounding like a cheerleader, I consider Cisco to be the best-run company I've come across. It's actually a company that I've studied in great depth, as I'm in the midst of preparing a detailed research report on Cisco, which is expected to be available for purchase from the Fool in early March. In the report, I'm taking a close look at Cisco's business, its products, its prospects, and -- dare I say it in a column for the Rule Maker Portfolio -- its valuation.
From a Rule Maker perspective, the just-completed quarter was actually Cisco's best quarter yet, as it registered a score of 56 on our RM Ranker (available for free download on our RM Spreadsheets page).
Here are the financial highlights for the quarter:
- Revenues of $4.35 billion, beating estimates of $4.1 billion.
- Pro forma net income of $0.25 per share, beating estimates of $0.24.
- Year-over-year sales growth of 53%.
- Quarter-to-quarter sales growth of 9% (the eighth straight quarter of sequential sales growth).
- Gross margins of 64.7%.
- Net margins of 20.8%.
- Cash of $4.0 billion (excludes investments of $9.8 billion and restricted investments of $1.1 billion).
- No debt.
- Flow Ratio of 0.99.
What I'd like to do now is take Cisco through the five quantitative elements of our basic Rule Maker criteria and see how things shake out. Then, I'll wrap up with a few of the other highlights from the conference call.
- Sales Growth of 10% or More -- Cisco's Q299 sales were $2.8 billion. This quarter they were $4.4 billion, an increase of 53%. No need to say more.
- Gross Margins of 50% or More -- Cisco's gross margin for the quarter was a healthy 64.7%, which was down from last year's 65.3% but up slightly from last quarter's 64.6%. The biggest factors affecting gross margins are ongoing cost reductions, value engineering efforts, product mix, and continued pricing pressure from competitors. Management's guidance is for gross margins to fall from the present level. Even so, it's still well above our target and light years ahead of its major competitors, who on average have a gross margin below 45%.
- Net Margins of at Least 7% -- On a pro forma basis, Cisco rang in with a solid 20.8% net profit margin. This is down about 0.5 percentage points from the same quarter last year, but it's nearly three times our target. Again, Cisco's net margins are in a different league than its competitors, only one of whom even hit double digits.
- Cash-to-Debt of 1.5 or Greater -- Cisco continues to have a debt-free balance sheet, whereas its two largest competitors in terms of size -- Lucent and Nortel -- continue to sport negative net cash on their balance sheets.
- Flow Ratio of 1.25 or Less -- Cisco's flow ratio fell from 1.12 in the second quarter of last year to 0.99 this quarter. This is the second-best result I've seen in the time that I've followed the company. One of the key drivers behind the declining flow ratio was Cisco's ever-speedier inventory turnover (cost of goods sold over 12 months divided by the average of beginning and ending inventory over that same period), which has improved from 7.2 to 9.1 in the past year. Our CFO, Larry Carter, attributed this improvement to ongoing market acceptance of Cisco's products and a rebalancing of its inventory.
Cisco expects that its inventory turnover will remain at current levels over the near term. It's also important to note that Cisco's accounts receivables and inventory both grew at slower rates than sales on a year-over-year basis. That's something we especially like to keep an eye on in light of what happened to Lucent.
Next, 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:
- During Q2, 85% of Cisco's sales were handled over the Internet. Not surprisingly, this provides significant cost efficiencies for the company.
- Once again during the quarter, Cisco's orders were greater than its shipments, meaning that its book-to-bill ratio is greater than 1.0. This is a good sign for the future.
- Cisco breaks its sales into four geographic regions: EMEA (primarily Europe), the Americas, Asia, and Japan. Sales in all regions were at or above Cisco's expectations.
- The growth rate for Cisco's traditional core products -- routers and switches -- was much slower than that of its access and other products. Contrary to what you might expect, this actually bodes well for the company's future as it means that Cisco is making successful inroads into new areas of the networking business.
- Cisco's optical business (excluding the Pirelli acquisition, as it has not yet closed) is generating sales at a $400 million annual rate. The company is quite pleased with this figure.
Long-term Cisco shareholders should find the conference call (available until February 15 -- link at bottom) to be highly informative. Listening to the call will give you insight into Cisco's business, its strategy, and the people that make up its management team.
One last item of interest is that Cisco announced yet another stock split, of the 2-for-1 variety this time. It's been said many times in various corners of Fooldom that stock splits matter little to long-term investors. It's like exchanging four quarters for a dollar, or slicing a pizza into a different number of pieces, or... you know the analogies. The business as a whole is unaffected by how you slice it up.
During the call our company's CFO stated two primary reasons for splitting the stock. The first is that Cisco is increasingly optimistic about its long-term market opportunities in the New World of communications. The second is that it makes the stock more "affordable" to individual investors and helps to broaden its investor base. While I'm encouraged to hear the first reason, I don't find much value in the second. The commission structure for the vast majority of brokerage accounts today is such that there is no difference in the commission paid whether one buys one share or 1,000.
Below, I've included some relevant links including one to Cisco's Q&A on the stock split. It includes answers to such questions as, "Do I still get split shares if I buy after the record date (February 22) but before the split date (March 22)." The short answer to that is... yes.
Cisco Q2 RM Ranker
Cisco Q2 Earnings Release
Cisco Q2 Earnings Conference Call
Cisco Stock Split Q&A