Cisco Systems, Inc. — Q1 Fiscal 2013 10-Q
Reporting period: Three months ended October 27, 2012. The financial statements are unaudited; comparisons are with the three months ended October 29, 2011 unless otherwise noted. Cisco designs, manufactures, and sells networking and communications products and provides related services.
Financial results and liquidity
| Metric | Q1 FY2013 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $11.876 billion | $11.256 billion | +5.5% |
| Gross margin | $7.239 billion; 61.0% | $6.890 billion; 61.2% | Margin down 0.2 points |
| Operating income | $2.651 billion; 22.3% of sales | $2.210 billion; 19.6% | +20%; margin up 2.7 points |
| Net income | $2.092 billion | $1.777 billion | +17.7% |
| Diluted EPS | $0.39 | $0.33 | +18.2% |
| Cash from operating activities | $2.465 billion | $2.333 billion | +$132 million |
- Product sales rose 3.9% to $9.297 billion; service revenue rose 11.9% to $2.579 billion. Product gross margin was 59.7%, down 0.5 points; service gross margin was 65.5%, up 0.4 points.
- Operating expenses were $4.588 billion, down from $4.680 billion, including restructuring charges of $59 million versus $202 million. The effective tax rate was 20.5%, compared with 20.8%.
- Cash and cash equivalents were $4.773 billion and investments were $40.227 billion at quarter-end, totaling $45.0 billion, down from $48.716 billion at July 28, 2012. Cash declined by $5.026 billion during the quarter, primarily reflecting $4.9 billion of net cash used for acquisitions.
- Long-term debt was $16.272 billion and short-term debt was $55 million. Cisco reported $16.010 billion principal amount of long-term debt, no commercial paper outstanding, and no borrowings under its $3.0 billion revolving credit facility. It was in compliance with debt covenants.
- Current assets were $57.907 billion versus current liabilities of $17.114 billion. Deferred revenue totaled $12.623 billion, down from $12.880 billion at fiscal year-end. DSO improved to 30 days from 34.
- Cash dividends paid were $744 million, or $0.14 per share; the Board declared another $0.14 quarterly dividend after quarter-end. Cisco repurchased $253 million of shares under its repurchase program.
Material changes and business developments
- Sales growth was led by the Americas (+6.6%) and APJC (+10.4%); EMEA was essentially flat. U.S. sales increased 10%.
- By product category, Data Center sales rose 61%, Wireless 38%, and Service Provider Video 30%. Switching fell 2%, NGN Routing fell 2%, and Collaboration fell 8%.
- The July 30 acquisition of NDS cost approximately $5.0 billion and contributed about 2 percentage points to total sales growth and about 20 percentage points to Service Provider Video growth. The purchase-price allocation remained preliminary; goodwill increased to $20.443 billion from $16.998 billion.
- On November 18, Cisco announced a definitive agreement to acquire Meraki for approximately $1.2 billion in cash, expected to close in Q2 FY2013 subject to customary conditions, including regulatory review.
Outlook, commentary, and key risks
- The filing provides no numerical revenue, earnings, or margin guidance. Management said it expected European economic conditions to deteriorate further and challenges to continue through FY2013. It also cited reduced public-sector spending and cautious customer IT investment.
- Management attributed improved operating profitability to sales growth, expense discipline, and lower restructuring charges. It warned that pricing pressure, sales discounts, and a mix shift toward lower-margin Service Provider Video and Unified Computing System products could weigh on product margins.
- Cisco said available cash, investments, operating cash generation, capital-market access, and committed credit lines were expected to meet liquidity needs for at least the next 12 months. However, $37.5 billion of cash and investments were held by foreign subsidiaries; repatriation could trigger additional taxes.
- Brazilian tax authorities asserted claims against Cisco’s Brazilian subsidiary totaling approximately $427 million in taxes, $1.1 billion in interest, and $1.9 billion in penalties. Cisco disputes the claims, but said it could not determine the likelihood of an unfavorable outcome or reasonably estimate a loss.
- Potential Insieme milestone payments could result in up to approximately $863 million of compensation expense if earned; payments are expected primarily in FY2016 and FY2017. Cisco also reported a $42 million quarterly loss from its VCE joint venture and expected further investment and possible losses.
- Other material uncertainties include competition and technology transitions, supply-chain and inventory risks, customer credit and financing exposure, foreign-exchange and investment-market volatility, tax examinations, and intellectual-property litigation. The VirnetX patent trial was scheduled for March 2013; Cisco said it could not reasonably estimate the outcome.
Important facts for investors to verify
- Whether sales and service growth persist, particularly in Data Center, Wireless, and Service Provider Video, and whether weakness in EMEA, public-sector demand, Switching, Routing, and Collaboration deepens.
- How NDS integration, purchase accounting, and the proposed Meraki acquisition affect future revenue, margins, cash, goodwill, and intangible-asset amortization.
- Whether product pricing, discounts, and lower-margin product mix pressure gross margins beyond the quarter’s 61.0% consolidated rate.
- Developments in the Brazilian tax claims, VirnetX litigation, Insieme milestones, and VCE investment and losses.
- Cash generation, foreign-held liquidity and potential repatriation taxes, debt maturities, capital returns, and Cisco’s stated ability to fund needs for at least 12 months.