Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2014, three months ended October 26, 2013. Unaudited results are compared with the three months ended October 27, 2012; balance-sheet figures are compared with July 27, 2013.
Financial performance
| Metric | Q1 FY2014 | Comparable period / change |
|---|---|---|
| Revenue | $12.085 billion | Up 1.8% from $11.876 billion |
| Product revenue | $9.397 billion | Up 1.1% |
| Service revenue | $2.688 billion | Up 4.2% |
| Gross margin | $7.407 billion; 61.3% | $7.239 billion; 61.0% |
| Operating income | $2.455 billion; 20.3% of revenue | $2.651 billion; 22.3% |
| Net income | $1.996 billion | Down 4.6% from $2.092 billion |
| Diluted EPS | $0.37 | Down from $0.39 |
| Operating cash flow | $2.649 billion | Up from $2.465 billion |
| Free cash flow | $2.334 billion | Up from $2.200 billion |
Product gross margin rose to 60.1% from 59.7%, mainly on productivity improvements; service gross margin edged down to 65.4% from 65.5%. Operating expenses included $237 million of restructuring charges and a $257 million Insieme-related compensation charge. The effective tax rate was 21.4%, versus 20.5%.
Liquidity, debt and capital allocation
- Cash, cash equivalents and investments totaled $48.201 billion at quarter-end, down $2.409 billion from July 27, 2013. Cash and cash equivalents alone were $5.254 billion.
- Total debt carrying value was approximately $19.5 billion, including $3.279 billion short-term debt and $16.216 billion long-term debt. Cisco reported $16.0 billion principal amount of senior notes and was in compliance with debt covenants. The $3.0 billion revolving credit facility was undrawn.
- Cash and investments held by foreign subsidiaries were $42.0 billion; $6.2 billion was available in the United States. Repatriation could result in additional taxes.
- Quarter cash uses included $2.447 billion for acquisitions, $1.898 billion of stock repurchases under the program, $914 million of dividends paid, and $315 million of capital expenditures. The declared dividend was $0.17 per share, compared with $0.14 a year earlier.
- Deferred revenue was $13.207 billion, down from $13.423 billion at fiscal year-end. DSO was 39 days, versus 40; inventory was $1.466 billion and annualized inventory turns were 12.7, down from 13.8.
Material changes and business drivers
- Revenue grew in the Americas (4.2%) and EMEA (3.2%), but fell 8.7% in APJC. Product revenue across Brazil, Russia, India, China and Mexico declined 12% year over year.
- By product category, Data Center revenue increased 44.1% to $601 million and Switching grew 3.4%. Service Provider Video fell 14.1% to $987 million, including a decline of more than 20% in set-top box revenue. NGN Routing was down 0.6%.
- Management cited weaker-than-expected product orders, especially late in the quarter, in service providers and emerging markets. Product orders declined year over year and backlog fell more than expected. Management described customer IT spending as cautious and the global environment as mixed.
- Operating income fell 7%; management attributed the decline principally to the Insieme charge and workforce restructuring costs. R&D expense increased 20.5%, in part due to acquisition-related compensation.
Outlook, transactions and risks
- Management expected revenue and EPS to decline year over year in Q2 FY2014; the filing provides no numeric Q2 forecast. It said service-provider and emerging-market challenges could persist for at least several quarters.
- In August 2013 Cisco announced a workforce reduction affecting approximately 4,000 employees, or 5% of its global workforce. It recorded $237 million of charges in Q1, expects approximately $550 million of total pretax charges through fiscal 2014, and does not expect significant overall cost savings because resources will be reinvested in growth areas.
- Acquisitions completed during the quarter included Sourcefire for approximately $2.449 billion and Composite Software for $160 million. Cisco completed its acquisition of WhipTail for approximately $0.4 billion after quarter-end. Goodwill rose to $23.804 billion, largely reflecting acquisitions.
- Cisco exercised its call option to acquire the remaining interests in Insieme. The merger was expected to close in Q2 FY2014; contingent milestone payments could result in additional compensation expense. The maximum potential compensation expense was approximately $863 million, including $257 million already recorded.
- Brazilian tax authorities asserted claims totaling approximately $3.394 billion in tax, interest and penalties. Cisco disputed the claims, could not estimate the likelihood or range of loss, and said a final judicial determination was not expected for several years.
- Other exposures include customer and financing-receivable credit risk, financing guarantees, supply-chain and inventory commitments, intellectual-property litigation, and market, currency and interest-rate risks. The filing states Cisco believed available liquidity and funding sources would meet requirements for at least 12 months.
- After quarter-end, the board authorized an additional $15 billion of share repurchases. Separately, on November 20, 2013, the court vacated the $70 million XpertUniverse fraud verdict; it affirmed approximately $35,000 in patent damages plus interest, and Cisco expected an appeal.
Investor verification priorities
- Track Q2 results against management’s stated expectation of year-over-year revenue and EPS declines, particularly orders, backlog and demand from service providers and emerging markets.
- Assess whether Data Center and other growth categories can offset continued weakness in Service Provider Video, routing and APJC.
- Verify the recurring and cash-flow effects of the Insieme compensation charge, restructuring plan, and acquisition-related spending and integration.
- Monitor cash-location and repatriation constraints, debt maturities, shareholder returns, and the sustainability of operating cash flow.
- Follow the Brazilian tax proceedings and other contingencies, including the status of the XpertUniverse appeal and potential indemnification exposure.