Cisco Systems, Inc. — Form 10-Q Summary
Business context and reporting period. This unaudited filing covers Cisco’s second quarter and first six months of fiscal 2010, ended January 23, 2010; comparatives are the periods ended January 24, 2009. Cisco designs, develops, manufactures, markets, and supports networking products and services. Fiscal 2010 is a 53-week year.
Financial performance
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Q2 FY2010 | Q2 FY2009 | Six months FY2010 | Six months FY2009 |
|---|---|---|---|---|
| Net sales | $9,815 | $9,089 | $18,836 | $19,420 |
| Gross margin | $6,332 | $5,723 | $12,220 | $12,404 |
| Gross margin percentage | 64.5% | 63.0% | 64.9% | 63.9% |
| Operating income | $2,370 | $1,773 | $4,494 | $4,255 |
| Net income | $1,853 | $1,504 | $3,640 | $3,705 |
| Diluted EPS | $0.32 | $0.26 | $0.62 | $0.63 |
- Quarterly sales rose 8.0% year over year; product sales increased 8.6% and service sales 5.6%. Six-month sales declined 3.0%, as product sales fell 5.0% while service sales increased 6.5%.
- Q2 product gross margin was 64.7%, up from 62.7%; service gross margin was 63.7%, versus 63.9%. Management attributed improved product margin principally to lower manufacturing costs, favorable mix, and higher shipment volume, partly offset by discounts and pricing.
- Six-month cash from operations was $3,974, down from $5,916. Investing activities used $8,185, including $2,308 for acquisitions; financing activities provided $3,203, including $4,944 from debt issuance and $3,244 used for share repurchases. Ending cash and cash equivalents were $4,710.
- At January 23, 2010, cash and investments totaled $39,638, compared with $35,001 at fiscal year-end. Current assets were $50,139 and current liabilities $14,405. Long-term debt was $15,194, versus $10,295 at July 25, 2009; total liabilities were $34,871.
- Deferred revenue was $9,657, up from $9,393. Accounts receivable rose to $4,237 and DSO to 39 days from 34; inventory was $1,215, and supplier and contract-manufacturer purchase commitments were $3,327, up from $2,157.
Material changes versus comparable periods
- Q2 was Cisco’s first year-over-year revenue-growth quarter since Q1 FY2009 and the third consecutive quarter of sequential revenue growth, according to management. Net income and diluted EPS each increased 23% year over year; six-month net income declined 2%.
- Q2 sales increased in four of five geographic theaters, led by the United States and Canada (+12.4%) and Asia Pacific (+16.5%); European Markets declined 3.4%. For the six-month period, European Markets and Emerging Markets fell 9.6% and 15.1%, respectively.
- Quarterly switching sales increased 12.9%, while router sales rose 2.2% and advanced-technology sales 0.7%. For the six months, all three categories declined; “other” product sales grew, partly reflecting Flip video camera sales from Pure Digital.
- Operating expenses were nearly flat in Q2 year over year and decreased 5.3% for the six months. General and administrative expense increased 22.9% in Q2 and 17.0% for the six months.
Outlook, management commentary, risks, and unusual items
- Management described an improving economic and customer-spending environment, but gave no quantified revenue, earnings, or margin guidance in the supplied filing text. It expects to increase headcount in coming quarters and believes available liquidity will meet requirements for at least the next 12 months.
- Management highlighted data-center virtualization, video, collaboration, and other market adjacencies as strategic opportunities. It cautioned that returns on these investments may be lower or slower than expected, and that new products and lower-margin markets could affect margins.
- Longer-than-normal product lead times and supplier constraints persisted, although lead times improved during Q2. Management said further component shortages could delay shipments and adversely affect results. Higher receivables, DSO, and purchase commitments reflect shipment timing, demand, and supply constraints.
- In November 2009, Cisco issued $5.0 billion of senior unsecured notes, bringing principal debt to $15.0 billion. It reported compliance with debt covenants and no borrowings under its $3.0 billion revolving credit facility.
- Cisco acquired Starent Networks and ScanSafe for aggregate purchase consideration of $2,793 million, including $2,636 million for Starent. It also had a pending Tandberg acquisition, with consideration equivalent to approximately $3.3 billion at the January 23 exchange rate; tendered and owned shares represented 91.1%. Closing was expected in the first half of calendar 2010, subject to conditions and regulatory approvals.
- Brazilian authorities assessed Cisco’s subsidiary approximately $180 million in alleged import taxes, $80 million in interest, and $1.5 billion in penalties. Cisco disputes the claims, intends to defend them, and said it could not determine the likelihood of an unfavorable outcome or reasonably estimate a loss range; a final judicial decision was not expected for several years.
- The filing identifies risks from economic uncertainty, volatile service-provider spending, competition and pricing, supply constraints, inventory obsolescence, customer credit and financing exposure, foreign-exchange movements, acquisitions, intellectual-property claims, and tax uncertainty. A potential loss on Tandberg-related currency contracts could be up to approximately $300 million under the described exchange-rate scenario; gains or losses would be offset to the extent the acquisition consideration moves correspondingly, but a failed transaction could leave unwind exposure.
- Other notable items: Cisco repurchased $3.3 billion of stock in the first six months, with $11.6 billion remaining authorized; the effective tax rate was 20.8% for the six months, compared with 17.2%, partly reflecting expiration of the U.S. federal R&D tax credit. The company reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Most important facts for investors to verify
- Whether Q2’s sales recovery broadened beyond the strongest theaters and products, particularly given the six-month decline and weakness in Europe and Emerging Markets.
- Whether lead times and component availability improved without creating excess inventory or further increases in purchase commitments; monitor DSO and cash conversion.
- How gross margins respond to discounts, product mix, manufacturing costs, and growth in lower-margin adjacencies.
- The final cost, timing, financing, regulatory status, and currency exposure of the Tandberg transaction, and integration and performance of the Starent and ScanSafe acquisitions.
- Developments in the Brazilian tax and penalty claims, the Xilinx-related tax uncertainty, and Cisco’s ability to sustain cash generation while funding debt, repurchases, acquisitions, and customer financing.