Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Third quarter ended May 1, 2010; fiscal 2010 is a 53-week year, and this quarter had 14 weeks versus 13 weeks in the prior-year quarter. Financial statements are unaudited. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and operating results
Cisco designs, develops, manufactures, markets, and supports networking products and services. Management highlighted recovery across customer markets and geographic theaters, expansion into adjacent markets including data-center virtualization, video and collaboration, and continued investment in core networking.
| Metric | Q3 FY2010 | Q3 FY2009 | Nine months FY2010 | Nine months FY2009 |
|---|---|---|---|---|
| Net sales | $10,368 | $8,162 | $29,204 | $27,582 |
| Gross margin | $6,630; 63.9% | $5,229; 64.1% | $18,850; 64.5% | $17,633; 63.9% |
| Operating income | $2,345 | $1,607 | $6,839 | $5,862 |
| Net income | $2,192 | $1,348 | $5,832 | $5,053 |
| Diluted EPS | $0.37 | $0.23 | $0.99 | $0.86 |
| Cash from operations | $3.0 billion | Not stated here | $6.941 billion | $7.912 billion |
Financial position, liquidity and capital allocation
- Cash and cash equivalents plus investments totaled $39.106 billion at May 1, 2010, up from $35.001 billion at July 25, 2009. $30.8 billion was held outside the United States.
- Total debt was $15.246 billion, including $3.127 billion classified as short-term debt; total debt at July 25, 2009 was $10.295 billion. Cisco issued $5.0 billion of senior notes in November 2009. It reported compliance with debt covenants and no borrowings under its $3.0 billion revolving credit facility.
- Current assets were $49.758 billion and current liabilities were $18.439 billion. Deferred revenue was $10.303 billion, up from $9.393 billion at fiscal year-end.
- Operating cash flow was $6.941 billion for the first nine months, versus $7.912 billion a year earlier. Investing activities used $11.233 billion, including $4.950 billion net cash paid for acquisitions; financing activities provided $2.535 billion.
- Cisco repurchased $5.5 billion of shares under its program during the first nine months. Remaining authorized repurchases were $9.3 billion, with no termination date.
- Management stated that cash, investments, operating cash generation, capital-market access and credit lines should meet liquidity needs for at least the next 12 months.
Material changes versus comparable periods
- Q3 sales increased 27.0% year over year; management estimated the extra fiscal week added approximately 4–5 percentage points to reported year-over-year revenue growth. Nine-month sales rose 5.9%.
- Q3 product sales rose 31.4%, led by switches (+40.5%), routers (+23.4%) and advanced technologies (+18.2%). Service revenue increased 10.9%. For the nine-month period, switches increased 7.4%, routers 0.7%, and advanced technologies were essentially flat.
- Q3 gross margin percentage declined 0.2 percentage points. Product margin improved, but service margin fell to 62.3% from 65.2%; the service mix included a higher proportion of lower-margin advanced services. Nine-month gross margin improved 0.6 percentage points.
- Q3 net income increased 62.6%; nine-month net income increased 15.4%. The Q3 comparison benefited from higher revenue, lower operating expenses as a percentage of sales, and a $158 million tax benefit related to the Xilinx tax decision.
- Goodwill increased to $16.668 billion from $12.925 billion, primarily reflecting acquisitions. Cisco completed acquisitions including Starent Networks and Tandberg; purchase consideration for business combinations completed during the nine months totaled $6.061 billion.
Outlook, commentary and key risks
- Outlook: The filing provides no specific numerical revenue or earnings guidance. Management described improving market conditions, expected to increase headcount in upcoming quarters, and anticipated continued investment in growth initiatives and adjacent markets.
- Supply and demand: Demand improvement and supplier constraints contributed to longer-than-normal lead times, although lead times improved on most products during Q3. Inventory rose to $1.250 billion, and purchase commitments more than doubled to $4.320 billion. Further component constraints or weaker-than-expected demand could affect shipments, margins or inventory obsolescence.
- Working capital: Days sales outstanding rose to 39 days from 34 at fiscal year-end; management attributed the increase mainly to shipments concentrated late in the quarter and the Tandberg acquisition. Financing receivables and guarantees, net of allowances and related deferred revenue, totaled $2.848 billion.
- Acquisition and execution risks: Integration of Tandberg, Starent and other acquisitions, competition in data-center markets, and the uncertain returns on investments in new markets could affect results. Goodwill and purchased intangible assets increased materially.
- Tax and unusual items: The Q3 effective tax rate was 8.8%, versus 20.1% a year earlier; the $158 million Xilinx-related benefit contributed to the lower rate. Cisco reported $2.6 billion of unrecognized tax benefits at May 1, 2010. The extra fiscal week also boosted reported quarterly growth.
- Contingencies: Brazilian authorities asserted import-tax claims of about $190 million, interest of $85 million and penalties of about $1.6 billion. Cisco disputed liability and said it could not estimate the likelihood or range of loss. A patent suit by Network-1 was scheduled for trial in July 2010; Cisco said it could not estimate the outcome. The filing states other ordinary-course legal matters were not expected to have a material adverse effect.
- Other risks: Results remain exposed to economic and geopolitical uncertainty, volatile service-provider spending, pricing and competition, foreign exchange and investment-market movements, customer credit risk, and dependence on suppliers and contract manufacturers.
Important facts for investors to verify
- Assess the underlying sales trend after considering the extra week, and track whether growth broadens across products, regions and customer markets.
- Monitor service gross margin, product discounts and pricing, and the sustainability of consolidated margins.
- Follow supplier lead times, inventory, purchase commitments, DSO and cash conversion for signs of supply pressure or excess inventory.
- Review acquisition integration and the contribution of Tandberg and Starent, alongside the rise in goodwill, intangibles and debt.
- Evaluate the recurring earnings impact of the Q3 tax benefit, future tax rates and resolution of the Brazilian and patent proceedings.