Cisco Systems, Inc. — Fiscal 2023 First-Quarter Form 10-Q
Reporting period: Three months ended October 29, 2022; unaudited. Comparisons are with the three months ended October 30, 2021 unless stated otherwise. Cisco notes that quarterly results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 FY2023 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $13.632 billion | $12.900 billion | Up 6% |
| Gross margin | $8.346 billion; 61.2% | $8.053 billion; 62.4% | Margin down 1.2 percentage points |
| Operating income | $3.540 billion; 26.0% of revenue | $3.438 billion; 26.7% | Income up 3%; margin down 0.7 points |
| Net income | $2.670 billion | $2.980 billion | Down 10% |
| Diluted EPS | $0.65 | $0.70 | Down 7% |
| Operating cash flow | $3.962 billion | $3.427 billion | Up 16% |
| Free cash flow | $3.786 billion | $3.305 billion | Up 15% |
Product revenue rose 8% to $10.245 billion; service revenue was nearly flat at $3.387 billion. Total software revenue was $3.9 billion, up 5%, including subscription revenue growth of 11%. Product gross margin fell to 59.2% from 61.5%, principally because of component, freight and logistics costs associated with supply constraints; pricing and product mix partly offset the pressure. Service gross margin increased to 67.3% from 65.2%.
By product category, Secure, Agile Networks grew 12%, End-to-End Security 9%, and Optimized Application Experiences 7%; Internet for the Future declined 5% and Collaboration declined 2%. Revenue grew 11% in EMEA and 5% in the Americas, while APJC was essentially flat. Management said product demand declined from the unusually high level in the year-ago quarter despite overall revenue growth.
Net income was pressured by the swing in interest and other income (loss), net, to a $65 million loss from $219 million of income, and by a higher effective tax rate of 23.2% versus 18.5%. The change in other income primarily reflected lower gains on privately held investments: investment losses were $119 million, compared with gains of $216 million a year earlier.
Financial position, cash flow and capital allocation
- At October 29, 2022, cash and cash equivalents were $7.292 billion and investments were $12.492 billion, totaling $19.784 billion. Total current assets were $36.141 billion and current liabilities were $24.896 billion.
- Debt carrying value was $8.878 billion: $1.249 billion current and $7.629 billion long-term. Senior notes had $9.0 billion principal outstanding. Cisco reported no commercial paper outstanding, no borrowings under its $3.0 billion revolving credit facility, and compliance with debt covenants.
- Operating cash flow was $3.962 billion; capital expenditures were $176 million. Cisco paid $1.560 billion in dividends and repurchased $502 million of stock under its repurchase program. The quarterly dividend was $0.38 per share. Cisco targets returning at least 50% of annual free cash flow to stockholders through dividends and repurchases.
- Inventory was $2.664 billion. Inventory purchase commitments were $12.608 billion and supplier deposits and prepayments were $1.748 billion. These elevated supply-chain balances reflect efforts to secure components and reduce lead times.
- Remaining performance obligations were $30.910 billion, down 2% from fiscal year-end; management expected approximately 53% to be recognized as revenue over the next 12 months. Deferred revenue was $23.019 billion.
Outlook, risks and contingencies
The filing provides no clear numerical revenue or earnings guidance. Management described the macroeconomic and competitive environment as challenging and uncertain, and said supply constraints had eased modestly but were expected to continue for an uncertain duration. It cited lower product demand versus an unusually strong comparison period, ongoing investment in priority areas, and continued progress toward a greater mix of software and subscriptions.
Supply shortages have increased component and logistics costs, extended lead times, and reduced product margins. Cisco warns that its inventory, purchase commitments and supplier prepayments increase exposure to excess or obsolete inventory if demand falls below expectations. A significant portion of purchase commitments is firm and noncancelable.
After the quarter, in fiscal Q2, Cisco announced a restructuring plan with estimated pretax charges of approximately $600 million, expected to affect about 5% of its global workforce and to be substantially completed by the end of fiscal Q1 2024. Charges are primarily expected to be cash-based. Cisco said it expects to reinvest substantially all cost savings, so future net savings are not expected to be material.
Material disclosed legal matters include Brazilian tax claims totaling $1.351 billion, including tax, interest and penalties; Cisco said it believes the claims lack merit but cannot estimate the likelihood or range of loss. In the Centripetal patent case, the Federal Circuit vacated the prior $1.9 billion damages judgment and remanded the case for further proceedings; the litigation remains ongoing. Cisco also disclosed other patent and commercial disputes and stated that outcomes cannot currently be estimated for certain matters.
Cisco believes cash, investments, operating cash generation and access to capital will meet liquidity needs for at least the next 12 months. Other disclosed exposures include a $6.183 billion U.S. transition-tax payable, customer financing receivables of $7.301 billion, and maximum potential payments of $162 million under channel-partner financing guarantees.
Important facts for investors to verify
- Whether component availability, freight costs and customer demand improve enough to stabilize product gross margin and limit excess-inventory exposure.
- Whether software subscription growth and the $30.910 billion remaining-performance-obligation balance translate into recognized revenue as expected.
- Whether the higher effective tax rate and investment losses persist, and how they affect earnings relative to operating cash generation.
- Actual restructuring charges, workforce impacts and reinvestment outcomes, as well as developments in the Brazilian tax and patent litigation matters.