Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter ended April 27, 2013. The unaudited filing compares the three- and nine-month periods with those ended April 28, 2012. Dollar amounts are in U.S. dollars.
Financial performance
| Metric | Q3 FY2013 | Q3 FY2012 | Nine months FY2013 | Nine months FY2012 |
|---|---|---|---|---|
| Revenue | $12.216B | $11.588B | $36.190B | $34.371B |
| Gross margin | $7.511B; 61.5% | $7.169B; 61.9% | $22.093B; 61.0% | $21.124B; 61.5% |
| Operating income | $2.942B; 24.1% margin | $2.750B; 23.7% margin | $8.382B; 23.2% margin | $7.694B; 22.4% margin |
| Net income | $2.478B | $2.165B | $7.713B | $6.124B |
| Diluted EPS | $0.46 | $0.40 | $1.44 | $1.13 |
| Operating cash flow | Not presented for the quarter | Not presented for the quarter | $8.908B | $8.403B |
- Q3 revenue grew 5.4% year over year: product revenue rose 5.0% and service revenue 7.1%. For the first nine months, revenue rose 5.3%, with product revenue up 4.1% and services up 9.8%.
- Growth was led by the Americas; EMEA revenue declined year over year. In Q3, Data Center sales increased 77% and Service Provider Video 30%, while Switching declined 1.7% and Collaboration declined 0.9%.
- Gross margin contracted 0.4 percentage points in Q3 and 0.5 points for the nine-month period. Management cited pricing, discounts and product mix, including growth in lower-margin Data Center and Service Provider Video products; productivity gains partly offset these pressures.
- Operating margin improved, which management attributed mainly to expense control; nine-month results also benefited from lower restructuring charges. Diluted EPS growth also reflected lower diluted share counts.
Balance sheet, liquidity and capital allocation
- At April 27, 2013, cash and cash equivalents were $5.122B and investments were $42.266B, totaling $47.388B, down from $48.716B at July 28, 2012. About $39.5B was held by foreign subsidiaries; $7.9B was available in the United States. Repatriation of foreign funds could incur additional taxes.
- Current assets were $61.417B and current liabilities $21.063B. Total debt was about $16.248B, including $3.292B classified as short-term; senior-note principal was $16.0B. Cisco reported compliance with debt covenants and no borrowings under its $3.0B revolving credit facility.
- Cash from operations of $8.908B was partly offset by $10.653B of investing outflows, including $6.371B spent on acquisitions, and $2.932B of financing outflows. Cash dividends paid were $2.392B and stock repurchases under the program were $1.554B.
- Deferred revenue was $12.685B, down from $12.880B. Accounts receivable was $4.942B; days sales outstanding rose to 37 from 34. Inventory declined to $1.469B, while supplier and contract-manufacturer purchase commitments increased to $4.215B.
- Management stated that available cash, investments, operating cash generation and access to financing were expected to meet liquidity needs for at least the next 12 months.
Material changes, outlook and notable items
- Net income benefited substantially from tax items. The nine-month effective tax rate was 7.7%, versus 21.2% a year earlier, reflecting approximately $794M from an IRS settlement, $152M from reinstatement of the federal R&D tax credit and a further $117M net tax benefit, largely from lapses of assessment periods in foreign jurisdictions. Q3’s effective tax rate was 15.9%, versus 22.1%.
- The IRS settlement resolved federal income tax audit matters through fiscal 2007. Cisco reported $1.8B of gross unrecognized tax benefits at quarter-end, of which $1.5B would affect the effective tax rate if realized.
- Cisco completed the $5.0B NDS acquisition at the start of fiscal 2013 and acquired Meraki, Intucell and other businesses. Acquisition spending contributed to lower cash and increases in goodwill and purchased intangible assets. Cisco also completed the sale of its Linksys product line; the financial impact was not material.
- Management’s stated priorities include core networking, collaboration, data center and cloud, video, and business-transformation architectures. It described continued macroeconomic challenges, particularly European weakness, lower public-sector spending and cautious customer IT investment. It warned that newer products and competitive pricing may continue to pressure product margins. The filing provides no specific numeric revenue or earnings guidance.
- Contingencies include Brazilian tax claims against Cisco’s subsidiary totaling approximately $432M in alleged taxes, $1.2B in interest and $1.9B in penalties; Cisco disputes the claims and cannot estimate the likelihood or range of loss. In XpertUniverse litigation, a jury awarded $70M on a fraud-by-concealment claim; Cisco filed post-trial motions and said it would appeal if necessary. A VirnetX jury found no infringement, but a new-trial motion remained pending. TiVo litigation remained pending, with trial scheduled for 2014.
- Potential future Insieme milestone payments could produce up to approximately $863M of compensation expense if earned. Cisco expected the related determination might arise in fiscal 2014, with payments primarily in fiscal 2016 and 2017.
Important facts for investors to verify
- How much reported earnings growth reflects the unusually low tax rate and tax benefits, and what normalized tax rate may apply going forward.
- Whether revenue growth persists excluding NDS and other acquisitions, and whether fast-growing Data Center and Video sales can offset softness in other product lines without further margin erosion.
- Whether accounts-receivable days, financing receivables and supplier purchase commitments remain manageable amid uncertain demand and customer financing needs.
- The availability and tax cost of foreign-held cash, debt maturities beginning in 2014, and the sustainability of dividends and repurchases relative to operating cash flow.
- Developments in the Brazilian tax claims, XpertUniverse post-trial motions, TiVo litigation and potential Insieme milestone obligations.