Cisco Systems, Inc. — Form 10-Q Summary
Business context and reporting period. Unaudited results for the quarter ended January 29, 2011, and six months ended January 29, 2011; comparatives are the corresponding periods ended January 23, 2010. Cisco sells IP networking products and related services globally. All financial figures below are in U.S. dollars; amounts are in millions unless stated otherwise.
Key financial metrics
| Metric | Three months ended Jan. 29, 2011 | Year-over-year change | Six months ended Jan. 29, 2011 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $10,407 | +6.0% | $21,157 | +12.3% |
| Product sales | $8,236 | +3.3% | $16,936 | +11.6% |
| Service revenue | $2,171 | +18.1% | $4,221 | +15.3% |
| Gross margin | $6,261; 60.2% | Down 4.3 percentage points | $13,016; 61.5% | Down 3.4 percentage points |
| Operating expenses | $4,577 | +15.5% | $8,981 | +16.2% |
| Operating income | $1,684 | Down from $2,370 | $4,035 | Down from $4,494 |
| Net income | $1,521 | Down 17.9% | $3,451 | Down 5.2% |
| Diluted EPS | $0.27 | Down from $0.32 | $0.61 | Down from $0.62 |
| Operating cash flow | $2.6 billion (MD&A figure) | Quarterly comparator not stated here | $4,276 | Up from $3,974 |
Quarterly product gross margin fell to 58.9% from 64.7%; service gross margin rose to 64.8% from 63.7%. For the six-month period, product gross margin was 60.8% versus 65.1%, while service gross margin was 64.2% versus 64.1%.
At January 29, cash and cash equivalents were $4,924 and investments were $35,305, totaling $40,229, up from $39,861 at July 31, 2010. Total debt carrying amount was $15,241, including $3,089 short-term and $12,152 long-term. Current assets were $52,066 versus current liabilities of $18,505. Deferred revenue was $11,807, up $724 from fiscal year-end. Inventory increased to $1,602 from $1,327; annualized inventory turns were 10.6 versus 12.6 in the fourth quarter of fiscal 2010. Six-month capital expenditures were $652.
Material changes versus prior comparable periods
- Revenue grew, driven by services and New Products, while margins and earnings declined as cost growth outpaced sales growth. R&D and sales and marketing expenses increased, primarily due to higher headcount-related costs.
- In the quarter, New Products revenue rose 15%, while Switches fell 7%. Cisco attributed switching weakness partly to transitions from Catalyst products to Nexus and associated pricing and product mix effects. Service revenue increased 18%.
- Consumer products faced pricing and demand pressure. Traditional cable set-top box revenue fell 29% year over year; combined set-top box revenue declined 11%.
- Cash and investments rose modestly from July 31, 2010. Six-month operating cash flow improved year over year, while Cisco repurchased $4.3 billion of shares under its program.
Outlook, management commentary, risks and unusual items
- Management expected second-half fiscal 2011 revenue growth to be slower than previously anticipated, gross margin to remain around the second-quarter range, and operating expenses as a percentage of revenue to rise. It said operating income, net income and EPS would likely continue to decline year over year. Cisco planned cost-control measures and resource reallocation; no quantified revenue or earnings guidance was provided.
- Management cited challenging conditions in European Markets, public sector accounts and parts of the service-provider market, alongside strength in commercial, enterprise and service-provider areas. It expected continued consumer-market challenges.
- Purchased-intangible impairment charges were approximately $155 million for the quarter and six-month period, primarily linked to lower expected cash flows for certain consumer products. Inventory write-offs also pressured margins. The R&D tax credit’s retroactive reinstatement reduced the tax provision; the filing reports a $118 million benefit.
- Brazilian authorities asserted import-tax claims against Cisco’s subsidiary based on alleged joint liability with an importer: approximately $480 million in taxes, $535 million in interest and $2.2 billion in penalties. Cisco disputes the claims and intends to defend them; it could not assess the likelihood of an unfavorable outcome or reasonably estimate a loss range, and expected resolution to take years.
- Other key risks include pricing and competitive pressure, product-transition execution, demand uncertainty, inventory obsolescence and supplier constraints, customer financing and credit exposure, foreign exchange and investment-value changes, tax examinations, intellectual-property litigation, and acquisition integration.
- Cisco announced a commercial-paper program of up to $3.0 billion; by February 22, 2011, it had issued $2.0 billion and repaid $3.0 billion of notes at maturity. It also stated an intention to begin paying a cash dividend during fiscal 2011.
Important facts for investors to verify
- Whether revenue momentum and product transitions improve, particularly in switching, consumer products, set-top boxes and the European, public-sector and service-provider markets.
- Whether pricing, product mix, impairment charges and operating-expense growth continue to weigh on gross and operating margins.
- Inventory levels, turns, write-offs, supplier commitments and the conversion of deferred revenue into recognized sales and cash.
- Cash availability and capital allocation, including offshore cash tax implications, debt repayment, commercial-paper use, share repurchases and the planned dividend.
- Developments in the Brazilian tax dispute, unrecognized tax benefits of $2.8 billion, and other legal or tax contingencies; the filing does not provide a clear estimate of potential loss for the Brazilian matter.