How did Cisco's profitability change in fiscal 2006?

Net income was $5.58 billion, down slightly from $5.74 billion in fiscal 2005, while diluted EPS rose to $0.89 from $0.87. Revenue growth of about $3.7 billion was offset by a gross margin decline to 65.8% and by $1.05 billion of pre-tax stock-based compensation expense under SFAS 123(R), which began in fiscal 2006. Operating expenses rose 27% to $11.8 billion, partly reflecting the acquisition.

What was the impact of the Scientific-Atlanta acquisition?

Cisco completed the roughly $7.1 billion acquisition of Scientific-Atlanta on February 24, 2006. It contributed $989 million of net sales over five months and added set-top boxes and video systems to Cisco's portfolio. The deal added about $3.8 billion of goodwill and $1.9 billion of purchased intangibles, which will increase amortization expense (scheduled at $525 million in fiscal 2007). Management noted that Scientific-Atlanta's lower gross margin model reduced overall margin.

How is Cisco's balance sheet and liquidity position?

Cash, cash equivalents, and investments totaled $17.8 billion at July 29, 2006. Long-term debt was $6.3 billion after the February 2006 issuance of $6.5 billion in senior notes, with about $6.0 billion of interest rate swaps converting most fixed-rate debt to LIBOR-based floating rates. Total shareholders' equity was $23.9 billion. The company stated it was in compliance with all debt covenants and expects its resources to meet needs for at least the next 12 months.

What are the main risks highlighted in the filing?

Key risks include volatile and lumpy service provider demand, price competition from Asian rivals (especially China), dependence on contract manufacturers and single-source components (including Scientific-Atlanta's Juarez, Mexico plant), the challenge of integrating acquisitions, foreign currency exposure (about 47.5% of sales were outside the U.S.), and ongoing litigation including a $91.75 million securities class action settlement and a derivative suit. The filing also flags that future goodwill impairments could affect earnings.

CSCO 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed September 18, 2006. Cited figures are marked; the original filing is the authoritative source.

Cisco Systems' fiscal 2006 10-K (fiscal year ended July 29, 2006) shows a company in the middle of a major strategic expansion.

Net sales rose 14.9% to $28.5 billion^a, and net income was essentially flat at $5.58 billion versus $5.74 billion, held back by $836 million of after-tax stock-based compensation expense recognized for the first time under SFAS 123(R). Diluted EPS was $0.89 versus $0.87. Growth was driven by advanced technologies (up 34% to $6.2 billion), switching and routing (each up roughly 9% or more), and the February 2006 acquisition of Scientific-Atlanta for about $7.1 billion, which contributed $989 million of sales in five months but compressed gross margin to 65.8% from 67.2%.

Balance sheet and cash flow changes are notable. Cisco issued $6.5 billion^b of senior notes to fund the Scientific-Atlanta deal, leaving $6.3 billion of long-term debt, and it repurchased $8.3 billion of stock during the year. Operating cash flow was a strong $7.9 billion, and cash and investments totaled $17.8 billion.

Goodwill rose to $9.2 billion and purchased intangibles to $2.2 billion^c, so future amortization and impairment risk is higher. Backlog grew to about $3.0 billion from $2.0 billion. Management also flagged risks including price-focused competition from Asia (especially China), volatility in service provider demand, customer financing exposure, and the pending settlement of a $91.75 million securities class action.

For investors, the key takeaways are that the top line and balance sheet remain strong, while margin pressure from the Scientific-Atlanta integration and the new stock-compensation expense weighed on earnings growth. The company's ability to execute on its video, service provider, and advanced technology strategy, and to manage the lower-margin mix, will determine whether the investments translate into durable profit growth.

02—Key points

Key Highlights

Net sales grew 14.9% to $28.5 billion, with product sales up 14.7% and service revenue up 15.7% to $4.6 billion.
Net income was $5.58 billion ($0.89 diluted EPS), roughly flat versus $5.74 billion, after $836 million of after-tax SFAS 123(R) stock-based compensation expense.
Gross margin fell to 65.8% from 67.2%, mainly due to the lower-margin Scientific-Atlanta business model and stock-compensation charges.
Advanced technologies revenue rose 34% to $6.2 billion, with Scientific-Atlanta contributing about $875 million of product sales in this category.
Scientific-Atlanta acquisition (about $7.1 billion total purchase price) added $989 million in net sales and $3.8 billion of goodwill, while $6.5 billion of senior notes were issued to fund it.
Operating cash flow was $7.9 billion; $8.3 billion was used to repurchase 435 million shares, with $4.6 billion of the $40 billion authorization remaining.
Backlog rose to approximately $3.0 billion from $2.0 billion a year earlier, and the company has no cash dividends and no customer above 10% of sales.

03—Questions

Frequently Asked Questions

How did Cisco's profitability change in fiscal 2006?
Net income was $5.58 billion, down slightly from $5.74 billion in fiscal 2005, while diluted EPS rose to $0.89 from $0.87. Revenue growth of about $3.7 billion was offset by a gross margin decline to 65.8% and by $1.05 billion of pre-tax stock-based compensation expense under SFAS 123(R), which began in fiscal 2006. Operating expenses rose 27% to $11.8 billion, partly reflecting the acquisition.
What was the impact of the Scientific-Atlanta acquisition?
Cisco completed the roughly $7.1 billion acquisition of Scientific-Atlanta on February 24, 2006. It contributed $989 million of net sales over five months and added set-top boxes and video systems to Cisco's portfolio. The deal added about $3.8 billion of goodwill and $1.9 billion of purchased intangibles, which will increase amortization expense (scheduled at $525 million in fiscal 2007). Management noted that Scientific-Atlanta's lower gross margin model reduced overall margin.
How is Cisco's balance sheet and liquidity position?
Cash, cash equivalents, and investments totaled $17.8 billion at July 29, 2006. Long-term debt was $6.3 billion after the February 2006 issuance of $6.5 billion in senior notes, with about $6.0 billion of interest rate swaps converting most fixed-rate debt to LIBOR-based floating rates. Total shareholders' equity was $23.9 billion. The company stated it was in compliance with all debt covenants and expects its resources to meet needs for at least the next 12 months.
What are the main risks highlighted in the filing?
Key risks include volatile and lumpy service provider demand, price competition from Asian rivals (especially China), dependence on contract manufacturers and single-source components (including Scientific-Atlanta's Juarez, Mexico plant), the challenge of integrating acquisitions, foreign currency exposure (about 47.5% of sales were outside the U.S.), and ongoing litigation including a $91.75 million securities class action settlement and a derivative suit. The filing also flags that future goodwill impairments could affect earnings.

04—Continue

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