CFRA Hits Cisco

A searing financial report piles on concerns about Cisco's future

February 15, 2001

3 Min Read
CFRA Hits Cisco

The Center for Financial Research and Analysis (CFRA) released a report this week that suggests that Cisco Systems Inc.'s (Nasdaq: CSCO) most recent quarter was much worse than it first appeared.

It’s bad enough that the networking titan missed earnings expectations for the first time in more than six years. But a copy of the CFRA report, obtained by Light Reading from a source (the CFRA declined to provide Light Reading with a copy), shows that disappointment with Cisco could have been much worse.

The CFRA's six-page analysis points out that Cisco's reported pro forma earnings of 18 cents a share -- a penny lower than Wall Street's expectations -- was actually $0.1760 per share rounded up. Indeed, Cisco was only $0.0011 a share away from an even bigger embarrassment.

Such observations might be old news to some, but it does make Cisco's projected revenue growth of 40 percent for fiscal 2001 seem a hard mark to hit. That estimate, it's worth noting, is itself much lower than the 50 percent to 60 percent range Cisco had given late last year (see Cisco Misscos!).

Cisco also received a bit of help because its effective tax rate --the ratio of tax paid in a tax year to taxable income -- has been at 28 percent since October 2000, the report states. If Cisco's effective tax rate had been at 30 percent (as it was from January 2000 to October 2000), Cisco would have had to shave some $36 million ($0.01 per share) from its fiscal Q2 earnings.

More worrisome is that Cisco's inventories are on the rise while its revenue growth and gross margins are lower than they've been in at least a year. The CFRA, which is an independent financial research organization, notes that Cisco now has 90 days worth of sales in inventory (DSI), up from 75 days last quarter and 41 days for Q2 2000.

The implications of such inventory buildups in systems vendors span the industry, analysts say. First, it means Cisco will be buying less from its suppliers. Second, it means service providers have obviously cut spending more (and faster) than previously thought.

As several analysts have noted, service providers with less to spend may hold out for good deals from equipment vendors. When they do this, companies such as Cisco will take a hit on gross margins. This is because the cost of the components used to make some systems was set at a time when components were scarce and demand was exceptional.

As if there aren't enough investor worries about Cisco, the CFRA report also brings up Cisco’s practice of pooling accounting, where it makes acquisitions and only records the costs of the acquired firm’s assets, not the price paid for the acquired firm.

“CFRA believes that CSCO may have obtained a boost to reported revenue and earnings growth…as a result of the Company’s decision to refrain from restating financial results to reflect the operations of certain acquisitions,” it states.

Citing the July 2000 issue of Barron’s, the Economist recently reported that, for the fiscal year ending July 2000, Cisco’s accounting allowed it to do $16 billion worth of acquisitions while only reporting $134 million in costs.

If its acquisitions via pooling have indeed given Cisco an earnings boost, it reinforces a sobering thought about Cisco’s most recent quarter: It may have been much worse than it looked.

Cisco officials did not respond to requests for comment.

-- Phil Harvey, senior editor, Light Reading

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