Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Second quarter of fiscal 2013, the three months ended January 26, 2013; comparisons are with the quarter ended January 28, 2012. Six-month results cover the six months ended January 26, 2013. Financial statements are unaudited. Cisco designs and sells networking and communications products and related services worldwide.
Financial performance
| Metric | Q2 FY2013 | Q2 FY2012 | Six months FY2013 | Six months FY2012 |
|---|---|---|---|---|
| Net sales | $12.098 billion | $11.527 billion | $23.974 billion | $22.783 billion |
| Gross margin | $7.343 billion; 60.7% | $7.065 billion; 61.3% | $14.582 billion; 60.8% | $13.955 billion; 61.3% |
| Operating income | $2.789 billion; 23.1% of sales | $2.734 billion; 23.7% | $5.440 billion; 22.7% | $4.944 billion; 21.7% |
| Net income | $3.143 billion | $2.182 billion | $5.235 billion | $3.959 billion |
| Diluted EPS | $0.59 | $0.40 | $0.98 | $0.73 |
| Operating cash flow | Six-month: $5.814 billion | Prior six-month: $5.434 billion |
Revenue and margin trends
- Q2 sales grew 5.0%; product sales rose 3.5% and services 10.5%. Six-month sales grew 5.2%; product sales rose 3.7% and services 11.2%.
- Q2 product gross margin declined to 59.1% from 60.0%; service gross margin was 66.3% in both periods. Management attributed product-margin pressure to discounts and pricing, mix toward lower-margin video and data-center products, and acquisition-related amortization and inventory adjustments, partly offset by productivity gains.
- Q2 sales by geography: Americas +8.9%, APJC +8.3%, and EMEA −4.8%. Management cited European weakness and lower public-sector spending, particularly in the U.S.
- Product growth was strongest in Data Center (+64.6%), Wireless (+27.1%) and Service Provider Video (+20.3%, substantially reflecting NDS). NGN Routing (−5.9%) and Collaboration (−10.8%) declined.
Cash, debt and liquidity
- Cash and cash equivalents were $6.847 billion; investments were $39.529 billion. Combined cash and investments totaled $46.376 billion, down $2.340 billion from July 28, 2012.
- Cash and investments exceeded reported short- and long-term debt of $16.291 billion. Long-term debt principal was $16.0 billion; no commercial paper was outstanding. Cisco reported compliance with debt covenants and no borrowings under its $3.0 billion revolving credit facility.
- Six-month investing cash outflow was $7.196 billion, including $6.035 billion for acquisitions. Financing cash outflow was $1.570 billion, including $1.487 billion of dividends paid and $645 million of repurchases under the stock repurchase program.
- Deferred revenue was $13.321 billion, up $441 million from fiscal year-end; accounts-receivable DSO was 34 days. Inventory was $1.574 billion, with $3.824 billion in supplier and contract-manufacturer purchase commitments.
- $39.4 billion of cash and investments was held by foreign subsidiaries. The company noted that repatriating those funds could result in additional U.S. and foreign taxes. Management said available liquidity, operating cash generation and financing access should meet requirements for at least 12 months.
Material changes and unusual items
- Q2 net income included approximately $926 million in tax benefits: a $794 million net benefit from settling IRS audits for fiscal 2002–2007 and $132 million from reinstatement of the federal R&D tax credit. The Q2 effective tax rate was −13.1%, versus 20.6% a year earlier. Management said these benefits accounted for approximately 96% of the year-over-year increase in quarterly net income.
- Six-month acquisition cash outlays were $6.035 billion. Cisco completed the NDS acquisition for approximately $5.005 billion and acquired Meraki for approximately $974 million, among other transactions. Goodwill rose to $21.361 billion from $16.998 billion, primarily reflecting acquisitions.
- Cisco agreed to acquire Intucell for approximately $475 million in cash and retention-based incentives, subject to customary closing conditions. It also agreed to sell its Linksys product line, with closing expected in Q3 FY2013.
- Q2 restructuring charges were $13 million; six-month charges were $72 million, compared with $205 million in the prior-year six-month period. Cisco said its fiscal 2011 restructuring was substantially complete.
Outlook, commentary and risks
The filing provides no specific quantified revenue or EPS guidance. Management emphasized long-term profitable growth and investment in core networking, collaboration, data center and cloud, video, and business-transformation architectures. It noted that new products and market transitions may support growth but can pressure margins.
- Management expected European economic weakness to continue and described cautious IT capital spending and reduced public-sector spending as ongoing challenges. Quarterly results may fluctuate with large, sporadic orders, shipment timing, customer acceptance, and revenue-recognition timing.
- Key business risks include intense competition and pricing pressure, product transitions and execution, supply-chain constraints, inventory obsolescence, customer credit and financing exposure, and possible margin pressure from product and geographic mix.
- Brazilian authorities asserted claims against Cisco’s subsidiary totaling approximately $426 million in taxes, $1.1 billion in interest and $1.9 billion in penalties. Cisco disputes the claims but said it cannot determine the likelihood of an unfavorable outcome or reasonably estimate a loss range; resolution may take several years.
- Other notable litigation includes VirnetX patent claims, with trial scheduled for March 2013, and TiVo patent claims, with trial scheduled for March 2014. Cisco said it could not reasonably estimate the outcomes. The company also disclosed shareholder class and derivative actions.
- Potential contingent compensation and consideration from acquisitions could reach $1.1 billion, including up to $863 million in Insieme milestone payments, if applicable conditions are met. Cisco expected such payments, if earned, primarily in fiscal 2016 and 2017.
Important facts for investors to verify
- How much of reported earnings growth reflects the one-time $926 million tax benefit, and what earnings and tax rates look like excluding it.
- Whether revenue growth in data center, wireless, video and services can continue, and whether product gross margins stabilize despite pricing and mix pressure.
- Whether EMEA weakness and lower public-sector spending persist, and how customer demand and large-order timing affect subsequent quarters.
- Integration and returns from NDS, Meraki and other acquisitions; the Intucell transaction; and the potential Insieme milestone and contingent-payment exposure.
- Developments in the Brazilian tax claims and patent litigation, including any changes to estimated exposure or case outcomes.
- Cash availability and tax implications of foreign-held funds, alongside acquisition spending, debt maturities, dividends, repurchases and customer-financing exposure.