Cisco FY 01 Analysis Part 2: Income Statement & Cash Flow Analysis
Cisco's business in 2001 was subject to a discontinuity in business conditions between 1H FY01 and 2H FY01.
As though they fell off a cliff. Indeed, looking closely it is apparent that the business fell off a cliff after running at full speed!
Second, and as a consequence of this effect, the business metrics are further complicated by the inventory and restructuring charges.
So a direct comparison of FY 01 with FY 00 is of no use whatsoever.
However, because the discontinuity happened early in the third quarter, we gain considerable insight by looking at the first and second half results as though they were separable.
The methodology is not difficult. We have the full year's results from form 10-K and the first half results from form 10-Q. Subtracting first half revenue from full year gives second half revenue; first half COGS from total COGS gives second half COGS; and so on.
FY01 1H 2001 2H 2001
Revenue $22,293 $13,267 $9,026
Cost of Sales $11,221 $ 4,959 $6,262
Gross Margin $11,072 $ 8,308 $2,764
Operating Cost $13,076 $ 6,374 $6,702
EBIT ($ 874) $ 2,629 ($3,503)
Taxes $ 140 $ 957 ($ 817)
Net Income ($1,014) $1,672 ($2,686)
EPSs -0.14 0.23 -0.37
One can see immediately that the business complexion changed considerably.
However, the comparison is not quite fair or useful because the results are clouded by the inventory provision and the restructuring charge.
These were:
Inventory Charge 2,062 applied to COGS
Restructuring Charge 1,170 applied to Operations
Adjusting for these we have:
FY00 Adj 1H 2H (Adj)
Revenue $22,293 $13,267 $9,026
Cost of Sales $ 9,159 $ 4,959 $4,200
Gross Margin $13,134 $ 8,308 $4,826
Operating Cost $11,906 $ 6,374 $5,532
EBIT $ 1,228 $ 2,629 ($1,401)
So while revenues declined by a third, COGS and OC declined by only half of this rate. Even after the effects of the charges. Costs must come into alignment with revenues or the company will face serious profitability issues.
Most of the industry has dismissed the potential of a discontinuous return, or a "V" shaped recovery. Which implies that the future should be extrapolated from the current trajectory, not based on behavior of the business prior to the discontinuity.
Also, the third quarter was transitionary, and cost containment would have taken some time to kick in. Consequently the only representative indication of the future business trajectory comes from the fourth quarter.
This is not provided in the 10K. But it was published on form 8-K when earnings were announced. At least for earnings and balance sheet.
Below find a the 4'th quarter data also multiplied by four to annualize and compared with FY 00
4Q 01 Annualized FY 00
Revenue $ 4,298 $17,192 $18,928
Cost of Sales $ 1,862 $ 7,448 $ 6,746
Gross Margin $ 2,436 $ 9,744 $12,182
Operating Cost $ 2,573 $10,292 $ 8,947
EBIT $ 62 $ 248 $ 4,343
Taxes $ 55 $ 220 $ 1,675
Net Income $ 7 $ 28 $ 2,668
EPS $ 0.00 $ 0 $ 0.39
So right away we can conclude:
(a) Revenue rate is lower than FY 00 by 10%
(b) COGS structure is increased by 10%
(c) Causing Gross Margins to decrease by 20%
(d) Operating costs are also increased by 15%
(e) Almost completely negating net margin
This is not your father's oldsmobile. So trailing twelve months overstate the current position of the company.
Next we look at the free cash flow, calculated below. Nine month data was extracted from the third quarter 10-Q
Free Cash Flow
FY 00 FY 01 = 9 months + 4Q
Net Income $ 2,668 ($ 1,014) ($ 1,021) $ 7
Depreciation $ 863 $ 2,236 $ 1,615 $ 621
In-progress R&D $ 1,279 $ 739 $ 739 $ 0
P, P & E ($ 1,086) ($ 2,271) ($ 1,814) ($ 457)
Tech Licenses ($ 444) ($ 4) 0 ($ 4)
Total $ 3,280 ($ 314) ($ 481) $ 167
Where we see that Cisco has returned the machine to positive Free Cash Flow in the 4'th quarter. If only barely.
Note that I include amortization of In Process R&D and purchase of technology licenses, as they are the software equivalent to depreciation and PP&E respectively.
So the bottom line here is that Cisco is carrying a cost structure for a larger revenue stream. Coupled with a decline in gross margins, the profitability will suffer unless revenues increase substantially.
It appears that management have more work cut out for them to size the cost structure of the business with the revenue stream.
John
