Cisco Systems, Inc. — Q1 FY2010 Form 10-Q
Reporting period: Three months ended October 24, 2009; comparisons are with the three months ended October 25, 2008 unless otherwise noted. Financial statements are unaudited. Amounts below are in U.S. dollars; financial statement figures are in millions unless specified.
Financial performance
| Metric | Q1 FY2010 | Q1 FY2009 | Change |
|---|---|---|---|
| Net sales | $9,021 | $10,331 | Down 12.7% |
| Product sales | $7,200 | $8,635 | Down 16.6% |
| Service sales | $1,821 | $1,696 | Up 7.4% |
| Gross margin | $5,888; 65.3% | $6,681; 64.7% | Margin up 0.6 percentage points |
| Operating income | $2,124 | $2,482 | Down 14.4% |
| Net income | $1,787 | $2,201 | Down 18.8% |
| Diluted EPS | $0.30 | $0.37 | Down 18.9% |
| Cash from operations | $1,488 | $2,718 | Down $1,230 |
- Product gross margin was 65.5%, unchanged year over year; service gross margin improved to 64.5% from 60.6%. Lower manufacturing costs offset pricing, discount, rebate, and volume pressures on product margins.
- R&D was $1,224, sales and marketing $1,995, and general and administrative expense $440. R&D and sales and marketing declined; G&A increased. Total operating expenses were $3,764, down from $4,199, but rose as a proportion of sales.
- The effective tax rate was 20.2%, versus 15.5%; the prior-year rate included a $106 million R&D tax-credit benefit. Interest income declined to $168 million from $259 million, while interest expense increased to $114 million from $64 million.
Balance sheet, liquidity, and capital
- At October 24, cash and cash equivalents were $4.774 billion and investments were $30.591 billion, totaling $35.365 billion, up $364 million from fiscal year-end. Cash alone fell $944 million.
- Operating cash flow was $1.488 billion. Investing activities used $1.253 billion and financing activities used $1.179 billion; stock repurchases were the principal financing outflow.
- Current assets were $44.697 billion and current liabilities $13.162 billion. Total liabilities were $28.654 billion; equity was $40.026 billion.
- Long-term debt carrying value was $10.273 billion, representing $10.0 billion principal of senior notes. Cisco also had an undrawn $2.9 billion revolving credit facility and reported compliance with debt covenants.
- Deferred revenue was $9.271 billion, down $122 million from July 25. Accounts receivable was $3.159 billion; DSO improved to 32 days from 34. Inventory was $1.089 billion, with annualized turns of 11.6.
- Cash and investments held outside the United States totaled $30.6 billion; repatriation could result in additional U.S. and foreign withholding taxes.
- In November 2009, after quarter-end, Cisco completed a $5.0 billion senior-note offering for general corporate purposes. The filing states it expected available cash, operating cash flow, capital-market access, and credit lines to meet requirements for at least 12 months.
Changes versus the prior comparable period
- Management attributed the 13% sales decline partly to the prior-year quarter not reflecting the economic downturn until its later stages. Sales rose 6% sequentially, and the year-over-year decline was smaller than in the three preceding quarters.
- Sales fell across the four largest geographic theaters. Emerging Markets declined 29.8%, European Markets 15.4%, and United States and Canada 10.1%; Japan increased 2.4%.
- Router sales fell 17.1%, switching sales 20.9%, and advanced technologies sales 14.7%. “Other” product sales increased 9.6%, aided by Flip video cameras, TelePresence, and Unified Computing System sales. Wireless grew within advanced technologies.
- Service revenue increased across all theaters. Overall gross margin improved despite lower sales, while net income and diluted EPS each fell approximately 19%.
- Operating cash flow decreased substantially year over year. Share repurchases rose to $1.8 billion from about $1.0 billion, while capital expenditure fell to $160 million from $361 million.
Outlook, commentary, risks, and unusual items
- Management cited positive signs in sequential revenue and enterprise momentum, particularly in the United States and Canada, but provided no numerical revenue or earnings guidance in the supplied filing text. It described the recovery and future demand as uncertain.
- Strategic priorities include core networking, data-center virtualization, video and collaboration, Unified Computing System, and selected market adjacencies. Management anticipated continued competition and industry consolidation in the enterprise data-center market.
- Purchase commitments with manufacturers and suppliers rose to $2.8 billion from $2.2 billion, amid longer lead times and supplier constraints. Management warned that weaker-than-expected demand could lead to excess inventory, obsolescence charges, or margin pressure.
- Pending acquisitions: Tandberg’s tender offer was extended and its consideration increased to a U.S.-dollar equivalent of $3.4 billion as of November 16, subject to exchange-rate movements; Starent was proposed for approximately $2.9 billion. Both were subject to customary approvals and conditions, with expected closings in the first half of calendar 2010; completion was not assured.
- The board authorized an additional $10 billion for share repurchases on November 4. Cisco repurchased 76 million shares under the program during the quarter for $1.753 billion at a weighted-average $22.99 per share.
- Brazilian authorities were investigating alleged import-tax evasion and other transactions involving Cisco’s subsidiary, employees, and an importer. Cisco disputed the asserted claims but said it could not estimate the likelihood or range of loss; U.S. authorities were also investigating related allegations.
- Other exposures include customer financing and guarantees, investment and foreign-exchange volatility, intellectual-property litigation, and contingent acquisition-related compensation. Financing guarantees had maximum potential payments of $756 million; the filing does not indicate that this amount is a probable loss.
- Early adoption of revised multiple-deliverable revenue guidance increased reported quarterly sales by approximately $50 million versus the prior accounting method. The company said future impacts could change as sales practices and pricing evolve. No fixed-income or publicly traded equity investment impairment charges were recorded in the quarter.
Most important facts for investors to verify
- Whether sequential growth and improving enterprise momentum continued, and whether product sales recovered from the steep year-over-year declines.
- Whether service growth and cost controls can sustain gross margins as product mix, pricing, and competitive conditions change.
- Whether operating cash generation remains sufficient alongside repurchases, acquisition spending, customer financing, and the additional $5 billion of debt issued after quarter-end.
- How supplier constraints and the higher purchase commitments affect shipment timing, inventory exposure, and margins.
- The final terms, currency impact, regulatory status, and integration costs of the Tandberg and Starent transactions.
- Developments in the Brazilian investigation, tax uncertainties, and credit quality of financing receivables and guarantee counterparties.