Hi John and thread, I've done a little digging into the prior 10Qs and 10Ks, and I'm ready to shed some light on some of the topics we've been discussion, including goodwill, inventory benefit, and contribution to cash flows from options exercises. If you care, then read on. It's going to be a long one. Overall, Cisco comes out looking good.
Goodwill
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Goodwill did indeed remain static from 7/31 to 10/31 (went from 4,659 to 4,666), but this is nothing to be alarmed about. The new accounting rules for goodwill focus on marking to market in the case of an impairment. Cisco just finished amortizing $1 billion in goodwill in FY 01, and wrote off another approximately $270 million in their effort to mark goodwill to market. It's not surprising that goodwill remained largely unchanged in Q1 of FY02, since they had just finished marking it to market and no net impairment occurred in that quarter. Perfectly acceptable and predictable.
Inventory
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Of the $2.2 billion written off, $843 million still sits on the books, $555 million was scrapped, $447 million was given back to settle purchase commitments, $121 was sold at bargain prices to recover some money, and ONLY $283 million was actually used . That means management was 90% correct when they said the inventory was useless and so would be written off. The cash flow benefit was huge in FY 01 when they wrote the inventory off (approx $2,775 million), but in Q1 FY02, the benefit was actually negative $29 million. As the remaining inventory is disposed of, it might benefit earnings a little, but not materially. In addition, it will actually hurt cash flows, which is the more important number anyway.
Stock Options
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Now for John and my favorite topic of debate - stock options! Back in FY01, John was indeed right that stock options were contributing greatly to Cisco's cash hoard (approximately $1,397 million added to operating cashflows in FY01). However, as I asserted in my rebuttals to John, stock options exercises are no longer materially contributing to Cisco's cash hoard. In Q1, the tax benefit from employee stock options was $43 million out of a total of $1,384 million in operating cash flows. Not significant at all. In addition, there was no net dilutive effect on EPS from stock options either in all of FY01 or in Q1 of FY02. So EPS was not effected by stock options exercises for the last year and then some.
However, there is an interesting thing that raised it's ugly head in Q1. Losses from investments actually contributed $971 million to operating cash flows, which is a significant portion of OCF. Of the total of $1,384 OCF, after adjustments for provision for doubtful accounts and inventory, tax benefits of stock options, and losses from investments, the adjusted OCF, which we can say truly came from the operations of the business, was only $373 million. So we'll have to watch these items in the 10Q for Q2, but my conclusion is that contrary to John's concerns, options are no longer a big inflator of cash flows. Instead we have a replacement - impairment of investments.
O/S shares
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Two pieces of good news here. Cisco is starting to be responsible and we haven't seen a dilutive effect of stock options in about a year. Also Cisco is buying back stock aggressively, $171 million worth in Q1, but it really isn't enough to make a dent in the huge o/s share number and really their buybacks are just to offset lot's of option grants. So in essence, they sold a lot of shares to you all during the peak times and now they are transfer that to employees during the recession. Who knows whether they will actually be worth anything. If they expire worthless, then fully dilute o/s shares go down and EPS goes up. A very large portion of o/s grants are underwater, so we'll see many of these expire worthless as employees leave and contracts expire.
Additional Paid in Capital
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APIC went from $5,731 to $14,609 to $20,051 to $20,372 from FY99 to FY00 to FY01 to Q1FY02. At the same time, Retained Earnings and Comprehensive Income went from $6,080 to $11,888 to $7,069 to $7,078. Lastly, cash and investments went from $10,214 to $20,499 to $18,517 to $19,080. That tells me that Cisco transferred a very large amount of shareholder cash from all of us to the never never land of the ether. In two years, from 1999 to 2001, $14.6 billion ($20,372-$5,731)left our hands and went into Cisco's coffers. In addition to that amount, they managed to earn around $1 billion. Cash and investments only increased around $9 billion ($19,080-10,214). So of $15.6 billion, mostly our money, they managed to squander roughly $6.6 billion. That money is gone and it came out of our pockets. Luckily, they are managing the business better now.
Deferred Revenue
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Yep, deferred revenue did decrease from Q4'01 to Q1'02 from $3,214 to $2,784 million, and someone said it decrease again in Q2, although I have no verification of that. So if that's the case, then we need to watch the trend to make sure Cisco isn't accelerating recognition of deferred revenue to feed the current quarters numbers. However, book to bill was 1.0, so that eases my concern a bit. It could be that what we are seeing is just normal fluctuation, but it's worth it to keep our eyes open in Q2's 10Q to watch for trends around this.
Guesses for what we'll find in Q2 10Q
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Based on my knowledge of what occurred in the marketplace and what I found in prior financial statements, I expect that the increase of $2 billion in cash in Q2 was almost all due to operations. I think this, because in Q2 the market has not really moved anywhere, so investment losses won't play a big factor, especially since they have already marked their investments to market in prior quarters. In addition, Q1 proved to us conclusively that stock options exercises are no longer contributing to cash in any noticeable way. Lastly, we're seeing that inventory sales and usage is also not contributing in any significant way. So from a cash standpoint, my guess is that Q2 operating cash flows were very solid and of very high quality. In other words, the Cisco we know and love could very well have gotten it's act back together. But we'll see for sure in the 10Q, when it comes out.
Conclusion
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Much of Cisco's previously used shenanigans have run there course. What we are starting to see now are increasingly higher quality numbers, which is a very good sign. Management is clearly do their job. However, I am still concerned about their o/s share number. It will be very difficult for Cisco to grow EPS and OCF/share, with a 7.3 billion o/s share number. All typical valuation models look at these stats in part, so that's bad news for the stock. But at least we can say that Cisco is fundamentally sound and getting stronger every quarter. |
