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Cisco Gets a C

By Rich Smith – Updated Nov 16, 2016 at 1:15PM

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Cisco gets at best a passing grade for its first-quarter earnings.

So much for "the halcyon days of the Internet Bubble."

In previewing the fiscal first quarter 2006 earnings report for Cisco Systems (NASDAQ:CSCO) -- which reported Wednesday night -- I alluded to the Internet king's history of, among other things, beating estimates and racking up stellar sales and earnings growth. Back in the late 1990s, Internet dictionaries bore little pictures of stylized bridges next to their entries defining "whisper number" and "beat by a penny." Cisco was practically synonymous with the concept of underpromising and overdelivering.

Harking back to those happier times, Cisco made a half-hearted attempt at claiming to "beat by a penny" Wednesday. The company reported $0.20 per share in net profit, then immediately claimed that, absent the effects of expensing its stock options, it would have reported $0.25. With the effect, it really -- you guessed it -- beat analysts' pro forma (Latin for "What year is this, 1999?") estimates of $0.24 per share by exactly $0.01. In fact, once you back out the stock option expensing numbers from the year-ago quarter as well, then comparing fiscal Q1 2006 with fiscal Q1 2005, Cisco actually boosted its profits by 18% year over year -- a bit better than analysts' forecasts of a 14% improvement.

It's also worth noting that Cisco did precisely what I predicted it would and took advantage of its lagging stock price this past quarter to ramp up its share buybacks. In fiscal Q1 2006, the company bought back 194 million shares at an average price of $18.03 (6% less than it was paying for each of the 130 million shares it repurchased in fiscal Q4 2005). These buybacks are starting to make themselves felt on the company's income statement. Over the last year, Cisco has slashed its diluted share count by an impressive 6.4%, which contributed mightily to its year-over-year improvement in profits per diluted share (sans options expenses).

Unfortunately, Cisco still came up short on the cash flow front. As I calculate its free cash flow for the quarter (cash from operations minus capital expenditures, and also minus cash spent to acquire new businesses), the company generated just $1.065 billion in fiscal Q1 2006, a slight decline from last year's $1.071 billion. Not only does this show a decline in cash generation, it also demonstrates that Cisco's free cash flow still doesn't back up its reported generally accepted accounting principles -- and certainly not its pro forma -- profits numbers. That's not at all the "reversal of [the company's fiscal 2005 trend]" that we were hoping to see. On the contrary, the discrepancy between reported profits and actual cash generation appears to be getting worse.

Here at the Fool, we recently held a knock-down, drag-out duel over Cisco. Relive it in:

Fool contributor Rich Smith does not own shares of Cisco .

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