01—Abstract
Summary
Summary of the 10-K filed September 10, 2003. Cited figures are marked; the original filing is the authoritative source.
Cisco's fiscal 2003 10-K (fiscal year ended July 26, 2003) shows a company that stabilized revenue after a difficult two years while sharply improving profitability.
Net sales were $18.9 billiona, essentially flat versus $18.9 billion in fiscal 2002 (down 0.2%), with product sales down 0.7% and service revenue up 2.1% to $3.3 billion. Net income rose 89% to $3.6 billion ($0.50 diluted EPS vs. $0.25), helped by a 6.6-point expansion in gross margin to 70.1%, driven mainly by lower manufacturing and inventory-related costs, lower standard component costs, and the absence of the prior-year inventory charges that depressed fiscal 2002. Operating expenses fell 8% as R&D, sales and marketing spending declined, and the company also took smaller investment impairment charges than in the prior year ($520 million in net losses and impairments versus $1.1 billion).
The balance sheet remains very strong, with $20.7 billionb in cash and investments, although that figure fell $804 million as Cisco repurchased $6.0 billion of its own stock during the year. Operating cash flow was $5.2 billion, down from $6.6 billion, and capital expenditures dropped sharply to $717 million from $2.6 billion. Management's risk factors are notably cautious: they state they do not expect the trend of lower service provider capital spending to reverse in the near term, and they flag gross margin sustainability, inventory management, the pending Andiamo acquisition (which will require a roughly $400 million non-cash charge on adoption of FIN 46 and ongoing variable stock compensation adjustments), and an ongoing securities class action.
For investors, the key question is whether the margin recovery and buybacks can be sustained without a meaningful revenue rebound. Demand from service providers remains weak, product revenue declined in the Americas and Japan, and growth came mainly from security, IP telephony, and the Linksys consumer acquisition, while routers fell 11.4%c. The filing portrays a company that has restored earnings power through cost control and margin management, but top-line growth remains the unresolved issue.
02—Key points
Key Highlights
- Net sales were $18.9 billion, flat year over year (down 0.2%), with product revenue down 0.7% to $15.6 billion and service revenue up 2.1% to $3.3 billion.
- Net income more than doubled to $3.6 billion from $1.9 billion, and diluted EPS rose to $0.50 from $0.25, partly reflecting lower impairment and special charges.
- Gross margin expanded to 70.1% from 63.5%, driven by lower component costs, value engineering, and the absence of the prior-year excess inventory charges.
- Operating expenses fell about 8% to $8.4 billion, with R&D down 9.1% to $3.1 billion and sales and marketing down 3.5% to $4.1 billion.
- Cisco repurchased 424 million shares for $6.0 billion in fiscal 2003; $5.2 billion remained authorized under the buyback program.
- Cash and total investments were $20.7 billion, but operating cash flow declined to $5.2 billion from $6.6 billion, and capex fell to $717 million from $2.6 billion.
- Management expects lower service provider capital spending to persist near term, and the pending Andiamo acquisition will add a roughly $400 million non-cash cumulative charge in fiscal 2004 under FIN 46.
03—Questions
Frequently Asked Questions
Why did net income more than double even though revenue was flat?
Net income rose to $3.6 billion from $1.9 billion mainly because gross margin improved from 63.5% to 70.1%, reflecting lower manufacturing variances, production overhead, warranty and inventory charges, and lower component costs. Fiscal 2002 also carried large charges, including an $858 million impairment on publicly traded equity securities, compared with $412 million in fiscal 2003, which lowered the year-over-year comparison.
Is Cisco's revenue growing again?
Not meaningfully. Net sales were $18.9 billion, essentially unchanged from fiscal 2002. Routers declined 11.4%, Americas product sales fell 2.0%, and Japan fell 8.1%. Growth came from switches (up 0.9%), security and IP telephony products (other products up 35.7%), EMEA and Asia Pacific, and service revenue. Management said it does not expect service provider capital spending to rebound in the near term.
How is Cisco using its cash, and how much is left for buybacks?
Cisco returned substantial cash to shareholders through repurchases, spending $6.0 billion to retire 424 million shares in fiscal 2003. Cumulative repurchases since the program began total $7.8 billion, with $5.2 billion of authorization remaining. The company also spent $717 million on capital expenditures and invested in acquisitions, including Linksys. The Board increased the program by $5.0 billion in March 2003 with no termination date.
What are the main risks to the margin improvement and the outlook?
Management warns that gross margins may not be sustainable, citing changes in product and customer mix, component cost increases, excess inventory, price competition, and warranty costs. Other risks include the concentration of sales in the volatile service provider market, dependence on distributors, customer credit risk, and the ongoing securities class action and derivative lawsuits filed in 2001. Management also notes that a $400 million non-cash charge and variable stock compensation adjustments tied to the Andiamo acquisition will affect future operating results.
What is the Andiamo acquisition and why does it matter to investors?
Andiamo Systems is a privately held storage switch developer in which Cisco invested $84 million in convertible debt and $76 million in non-convertible debt. Cisco has agreed to acquire the remaining equity, with the price set by a formula tied to Andiamo's revenue and Cisco's market capitalization, capped at roughly $2.5 billion in stock. Because of FIN 46, Cisco will consolidate Andiamo starting in fiscal 2004, recording an approximately $400 million cumulative non-cash charge and ongoing variable stock compensation adjustments until the deal closes, expected by July 31, 2004.
04—Continue