Cisco Systems, Inc. — Q2 FY2023 Form 10-Q
Reporting period: Quarter ended January 28, 2023. Fiscal 2023 is a 52-week year. Results are unaudited; comparisons are with the quarter ended January 29, 2022 unless stated otherwise. Amounts are U.S. dollars.
Business context and results
Cisco designs and sells networking and related technology, including security, collaboration, software and services. Management describes a continued shift toward software and subscriptions and a focus on connecting, securing and automating customers’ digital infrastructure.
| Metric | Q2 FY2023 | Year-over-year change |
|---|---|---|
| Revenue | $13.592 billion | Up 7% |
| Product revenue | $10.155 billion | Up 9% |
| Service revenue | $3.437 billion | Up 2% |
| Gross margin | $8.427 billion; 62.0% of revenue | Margin down 1.3 percentage points |
| Operating income | $3.292 billion; 24.2% of revenue | Down 6%; margin down 3.2 points |
| Net income | $2.773 billion | Down 7% |
| Diluted EPS | $0.67 | Down 6% |
Total software revenue was $4.2 billion, up 10%; subscription revenue rose 15%. Product growth was led by Secure, Agile Networks (up 14%), while Collaboration declined 10% and Internet for the Future declined 1%. Revenue grew across all geographic segments, with the strongest percentage growth in the Americas.
Six-month performance and material changes
For the six months ended January 28, 2023, revenue was $27.224 billion, up 6%; product revenue increased 8% and service revenue 1%. Gross margin was 61.6%, down 1.2 percentage points. Operating income was $6.832 billion, down 1%; net income was $5.443 billion, down 9%; diluted EPS was $1.32, down 6%. The lower earnings reflected margin pressure, higher restructuring charges, higher effective taxes and weaker investment results, among other factors.
Supply-related costs remained the main pressure on product gross margin. Favorable pricing and product mix partly offset higher component, freight and logistics costs. Management reported improved supply availability in Q2 but said constraints would continue for an uncertain duration. Cisco also noted product demand was lower than a year earlier, when demand had been unusually high, though demand improved sequentially from Q1.
Cash flow, liquidity and debt
- Operating cash flow: $8.701 billion for the first six months, versus $5.888 billion a year earlier. Capital expenditures were $346 million; company-defined free cash flow was $8.355 billion, versus $5.656 billion.
- Cash and investments: $22.061 billion at January 28, 2023, including $9.009 billion of cash and cash equivalents. This total excludes $1.5 billion of restricted cash reported in other assets.
- Debt: $1.250 billion short-term and $7.637 billion long-term debt on the balance sheet; senior-note principal totaled $9.0 billion. Cisco reported compliance with debt covenants and no borrowings under its $3.0 billion revolving credit facility.
- Working capital and obligations: Inventory was $3.140 billion, up 22% from fiscal year-end. Supplier and contract-manufacturer inventory purchase commitments totaled $10.951 billion. Deferred revenue was $23.927 billion and remaining performance obligations were $31.772 billion; management expects about 53% of RPO to be recognized within 12 months.
- Capital returns: Cisco paid $3.120 billion in dividends and repurchased $1.758 billion of stock during the first six months. A quarterly dividend of $0.39 per share was declared after quarter-end, payable April 26, 2023.
Outlook, risks and unusual items
- Management said cash, investments, operating cash generation and access to capital are expected to meet liquidity needs for at least the next 12 months. It expects higher inventory and other supply-related payments over that period. The supplied filing text does not provide a clear quantitative revenue or EPS forecast.
- A fiscal 2023 restructuring plan is expected to cost approximately $600 million pretax, affect about 5% of the global workforce and be substantially completed by the end of Q1 FY2024. Cisco expects to reinvest substantially all savings, so it does not expect material net cost savings in future periods. Q2 restructuring charges were $243 million.
- Supply constraints, elevated input and logistics costs, and the enlarged inventory and purchase-commitment position create risks of delayed shipments, excess or obsolete inventory and further margin pressure. Management reported inventory provisions of $92 million and purchase-commitment provisions of $199 million in the first six months.
- Other risks include uncertain macroeconomic and geopolitical conditions, competition, customer and channel-partner credit exposure, foreign exchange and investment volatility, cybersecurity and privacy issues, and changing tax and regulatory requirements. Private-company investment losses contributed to a $123 million net other loss for the first six months, compared with $280 million of other income a year earlier.
- Contingencies: Cisco disputes Brazilian tax claims totaling approximately $1.426 billion, including interest and penalties; it says it cannot determine the likelihood of an adverse outcome or reasonably estimate a loss. In the Centripetal patent case, a prior $1.9 billion damages judgment was vacated on appeal and remanded; further district-court proceedings were scheduled for June 2023. Cisco says it cannot reasonably estimate the ultimate outcome.
Important facts for investors to verify
- Whether supply availability improves as expected and whether elevated inventory and commitments lead to write-downs or sustain gross-margin pressure.
- Whether product demand, including Collaboration and service-provider-related demand, stabilizes amid macroeconomic uncertainty.
- How recurring software and subscription growth, deferred revenue and RPO translate into recognized revenue and cash generation.
- The final restructuring cost, timing and operational effects, given that material net savings are not expected.
- Developments in the Brazilian tax dispute and Centripetal litigation, and any change in Cisco’s assessment or financial exposure.