Cisco Systems, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited fiscal first quarter ended October 30, 2010; comparative quarter ended October 24, 2009. Cisco designs, manufactures, and sells IP-based networking and related products and services. Segment reporting changed: Asia Pacific and Japan were combined into Asia Pacific Markets, with prior-period data reclassified.
Financial performance and liquidity
| Metric | Q1 FY2011 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $10.750 billion | $9.021 billion | +19.2% |
| Gross margin | $6.755 billion; 62.8% | $5.888 billion; 65.3% | Margin down 2.5 points |
| Operating income | $2.351 billion | $2.124 billion | +10.7% |
| Net income | $1.930 billion | $1.787 billion | +8.0% |
| Diluted EPS | $0.34 | $0.30 | +13.3% |
| Cash from operations | $1.667 billion | $1.488 billion | +12.0% |
Product revenue was $8.700 billion (+20.8%); service revenue was $2.050 billion (+12.6%). Product gross margin was 62.7%, down 2.8 points; service gross margin was 63.6%, down 0.9 points. Operating expenses rose 17.0% to $4.404 billion, but decreased as a share of revenue to 41.0% from 41.7%.
Cash and cash equivalents were $3.796 billion and investments were $35.129 billion, totaling $38.925 billion, down $936 million from July 31, 2010. Operating cash flow was $1.667 billion; investing activities used $167 million and financing activities used $2.285 billion. Cash declined by $785 million during the quarter. The company repurchased $2.5 billion of shares under its program; reported total repurchases in financing cash flows were $2.701 billion, including employee-tax-withholding share repurchases.
Total debt was $15.278 billion, including $3.064 billion current and $12.214 billion long-term. A $3.0 billion note maturity is due in February 2011. Cisco had not drawn on its $3.0 billion revolving credit facility and reported compliance with debt covenants. Current assets were $50.406 billion and current liabilities $18.120 billion. Deferred revenue was $10.736 billion, down $347 million from fiscal year-end.
Material changes and management commentary
- Revenue increased across all geographic segments, led by Emerging Markets (+40.8%); United States and Canada grew 17.8%, European Markets 10.8%, and Asia Pacific Markets 21.8%.
- Product growth included switches (+24.6%), New Products (+22.4%), and routers (+12.8%). Collaboration revenue grew 45% and data-center revenue 59%. Consumer-market sales declined.
- Gross margin contracted mainly due to higher discounts, rebates and pricing, unfavorable product mix, and lingering supply-chain costs. Manufacturing efficiencies and higher shipment volume partly offset these pressures.
- Operating expenses rose with hiring, share-based compensation, discretionary spending, and acquisition-related costs. Headcount increased by about 1,900. Cisco completed two acquisitions for aggregate consideration of $80 million.
- Cash, cash equivalents and investments held outside the United States totaled $35.1 billion. Repatriation could trigger additional U.S. income and foreign withholding taxes.
Outlook, risks and contingencies
- Management said Q2 FY2011 revenue would grow more slowly than previously anticipated, negatively affecting expected full-year revenue growth. It expected Q2 operating expenses as a percentage of revenue to rise and operating margin to face downward pressure; operating income, net income, and EPS were likely to decline year over year.
- Management cited weaker momentum, particularly in European Markets, portions of the public sector and service-provider markets, and traditional cable set-top boxes in the United States and Canada. It planned cost controls and resource shifts toward stronger opportunities.
- Cisco intended to begin paying a cash dividend during fiscal 2011. The board authorized an additional $10 billion in share repurchases on November 18, 2010.
- Brazilian authorities asserted claims against Cisco’s Brazilian subsidiary for alleged import-tax evasion and related matters: approximately $200 million in taxes, $250 million in interest, and $1.7 billion in penalties. Cisco disputed the claims, plans to defend them, and could not determine the likelihood or reasonably estimate any loss; a final judicial decision was not expected for several years.
- Other principal risks include economic uncertainty and customer spending, intense competition and pricing pressure, product and geographic mix, supply-chain constraints and inventory exposure, customer credit and financing risks, foreign exchange and investment volatility, acquisition execution, intellectual-property litigation, and tax uncertainty. Unrecognized tax benefits were $2.7 billion; approximately $2.4 billion would favorably affect the effective tax rate if recognized.
- Potential contingent payments and compensation of up to $175 million related to acquisitions and asset purchases were estimated; management expected an approximately $300 million Nuova Systems milestone payment in Q2 FY2011. Inventory purchase commitments were $4.048 billion, with a $136 million liability for excess commitments.
Important facts for investors to verify
- Whether Q2 revenue, margins, and earnings followed management’s indicated slowdown and year-over-year decline expectations.
- Whether gross-margin pressure from pricing, mix, and supply costs persisted, and whether cost controls contained expense growth.
- Cash generation, share repurchases, the February 2011 $3.0 billion debt maturity, and the planned fiscal 2011 dividend.
- Developments in the Brazilian proceedings, including any change in Cisco’s ability to estimate exposure.
- Trends in public-sector and service-provider spending, cable set-top boxes, deferred revenue, inventory, and financing-receivable allowances.