10-QPeriod: Q2 FY2006

CISCO SYSTEMS, INC. Quarterly Report for Q2 Ended Jan 28, 2006

Filed February 21, 2006For Securities:CSCO

Summary

Cisco Systems, Inc. reported solid financial results for the second quarter and first six months of fiscal year 2006, demonstrating year-over-year growth in net sales and net income. The company's performance was driven by continued strength across its geographic segments, customer markets, and product families, with notable increases in revenue from the United States and Canada, European Markets, Emerging Markets, and Asia Pacific, partially offset by a decline in the Japan theater. The adoption of SFAS 123(R) significantly impacted reported expenses due to stock-based compensation, which reduced net income compared to the pro forma figures of the prior year. However, the underlying operational performance remained robust, with gross margins showing improvement due to lower manufacturing costs and higher shipment volumes. The company also highlighted its strategic focus on key growth areas, including the commercial market segment, expanding advanced technologies, and further penetrating emerging markets. Cisco continues to actively manage its capital through a substantial stock repurchase program, demonstrating a commitment to returning value to shareholders. Significant upcoming events include the anticipated closing of the Scientific-Atlanta acquisition and a substantial debt offering to help finance this strategic acquisition and for general corporate purposes.

Key Highlights

  • 1Total net sales increased by 9.3% to $6.63 billion for the quarter and 9.5% to $13.18 billion for the six-month period, year-over-year.
  • 2Operating income saw a slight decrease of 4.4% to $1.73 billion for the quarter but declined 6.7% to $3.35 billion for the six-month period, impacted by increased operating expenses, particularly due to SFAS 123(R) adoption.
  • 3Net income for the quarter was $1.38 billion, a decrease of 1.8% from the prior year, and for the six-month period was $2.64 billion, a decrease of 5.9%. The adoption of SFAS 123(R) significantly impacted these figures.
  • 4Diluted earnings per share were $0.22 for the quarter and $0.42 for the six-month period, reflecting the impact of SFAS 123(R).
  • 5Cash flow from operations remained strong, with $1.9 billion generated in the second quarter and $3.3 billion in the first six months.
  • 6The company continued its aggressive stock repurchase program, buying back $4.2 billion in the first six months of fiscal 2006.
  • 7Cisco announced definitive agreement to acquire Scientific-Atlanta, Inc. for approximately $6.9 billion and planned to issue $6.5 billion in senior unsecured notes to finance the acquisition and for general corporate purposes.

Frequently Asked Questions

Cisco adopted SFAS 123(R) on July 31, 2005. This accounting standard requires the recognition of compensation expense for stock-based awards, such as employee stock options, which significantly increased operating expenses and reduced reported net income and EPS compared to prior periods that did not recognize such expenses (or recognized them on a pro forma basis). For the second quarter of fiscal 2006, stock-based compensation expense was $285 million (or $188 million net of tax), compared to $36 million (net of tax) related to acquisitions in the prior year's quarter. For the six-month period, it was $630 million ($416 million net of tax), compared to $76 million (net of tax) in the prior year.

Cisco experienced year-over-year growth in net sales. For the second quarter ended January 28, 2006, total net sales were $6.63 billion, up 9.3% from $6.06 billion in the prior year. For the six-month period ended January 28, 2006, total net sales were $13.18 billion, up 9.5% from $12.03 billion in the prior year. Growth was seen across most geographic theaters and product families, with particular strength in Switches and Routers.

Cisco has agreed to acquire Scientific-Atlanta, Inc. for approximately $6.9 billion, a transaction expected to close in early March 2006. To finance this acquisition and for general corporate purposes, Cisco planned to issue $6.5 billion in senior unsecured notes in February 2006. The company also continues to utilize its stock repurchase program, having repurchased $4.2 billion of stock in the first six months of fiscal 2006.

Yes, Cisco highlighted several risks, including fluctuations in operating results due to demand, competition, and product cycles; economic and geopolitical uncertainties; the difficulty in predicting revenue; potential gross margin variability; disruptions to its distribution model; inventory management challenges; volatility in the service provider market; supply chain and manufacturing capacity constraints; intense competition; the need for new product development; risks associated with acquisitions; increased investment in engineering and sales; dependence on Internet growth; potential for regulatory changes; and the impact of litigation and tax examinations.