Cisco Systems, Inc. — Q1 FY2017 Form 10-Q
Reporting period: Three months ended October 29, 2016; comparative quarter ended October 24, 2015. Financial statements are unaudited. Cisco designs and sells networking and related technology products and provides associated services.
Financial performance
| Metric | Q1 FY2017 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $12.352 billion | $12.682 billion | Down 2.6% |
| Product revenue | $9.302 billion | $9.844 billion | Down 5.5% |
| Service revenue | $3.050 billion | $2.838 billion | Up 7.5% |
| Gross margin | $7.884 billion; 63.8% | $7.832 billion; 61.8% | Margin up 2.0 points |
| Operating income | $2.877 billion; 23.3% of revenue | $3.079 billion; 24.3% | Down 6.6% |
| Net income | $2.322 billion | $2.430 billion | Down 4.4% |
| Diluted EPS | $0.46 | $0.48 | Down 4.2% |
| Operating cash flow | $2.730 billion | $2.766 billion | Down $36 million |
Free cash flow, as defined by Cisco (operating cash flow less property and equipment purchases), was $2.455 billion, versus $2.504 billion. The effective tax rate was 21.4%, down from 22.5%.
Balance sheet, debt and capital returns
- Cash, cash equivalents and investments totaled $70.968 billion at October 29, up $5.212 billion from July 30. Of this amount, $60.6 billion was held by foreign subsidiaries; distribution to the U.S. could incur additional taxes.
- Total debt carrying value was $34.789 billion, including $4.155 billion current and $30.634 billion long-term. Cisco issued $6.25 billion of senior notes in September. It reported compliance with debt covenants and no commercial paper or revolving-credit-facility borrowings.
- Current assets were $83.141 billion and current liabilities $23.217 billion. Deferred revenue was $16.951 billion, up $479 million from July 30; recurring software and subscription product deferred revenue was $3.801 billion, up 48% year over year.
- Quarterly dividends paid were $1.308 billion ($0.26 per share); stock repurchases under the program were $1.001 billion. The remaining authorized repurchase amount was $14.4 billion.
Material changes and operating trends
- Revenue excluding the prior-year contribution from the divested Service Provider Video CPE business increased 1%; reported revenue fell 2.6%. The divestiture accounted for $411 million of prior-year product revenue.
- Product revenue, excluding that divested business, declined 1%. Switching fell 7.3%; NGN Routing grew 6.1% and Security grew 11.3%. Service Provider Video revenue fell sharply, primarily because of the divestiture.
- Service revenue growth was broad-based; technical support services increased 10%, while advanced services were flat.
- Gross margin improved with productivity gains and the exit of the lower-margin video business, partly offset by pricing pressure and product mix. Operating income and earnings declined, primarily reflecting higher restructuring charges.
- By geography, Americas revenue declined 4.5%, EMEA declined 2.6%, and APJC grew 5.6%. Management cited weakness in service providers and emerging markets, including product revenue declines in Mexico, Brazil and China.
Outlook, management commentary and risks
- No specific numerical revenue or earnings guidance is provided in the supplied filing text. Management described a challenging, volatile and highly competitive environment, with increased weakness in service-provider momentum and continuing weakness across emerging countries. It said the macro outlook remained uncertain while Cisco continued investing in security, IoT, collaboration, next-generation data center, cloud and software.
- An August 2016 restructuring plan may affect up to 5,500 employees, approximately 7% of the workforce. Cisco recorded $411 million of related charges in the quarter, estimated total pretax charges of up to approximately $700 million, and expected substantial completion by fiscal year-end. Substantially all cost savings are expected to be reinvested, so material net future-period savings are not expected.
- Other unusual items included $42 million of purchased-intangible impairment charges and $47 million of impairment charges on privately held investments. Cisco acquired CloudLock and two other businesses for total purchase consideration of $258 million.
- Brazilian authorities’ asserted tax claims against Cisco’s subsidiary totaled $253 million in taxes, $1.3 billion in interest and $1.2 billion in penalties. Cisco disputes the claims and is defending them; it cannot estimate the likelihood or range of loss, and no final decision is expected for several years.
- Other legal matters include a $23.7 million SRI patent-infringement jury award, subject to post-trial motions and appeal, and pending patent proceedings. Cisco said it did not expect the cited matters to have a material effect, while acknowledging uncertainty.
- Management stated that cash, investments, operating cash generation and access to capital markets and committed credit lines should meet liquidity needs for at least the next 12 months. Key risks include demand and spending uncertainty, intense competition and pricing, product transitions, supply-chain and inventory exposure, customer financing and credit risk, foreign exchange, interest rates, taxes, and litigation.
Important facts for investors to verify
- Whether service-provider and emerging-market weakness persists, and whether switching demand stabilizes.
- Whether service growth and recurring software/subscription deferred revenue translate into sustained recognized revenue and cash flow.
- The restructuring’s final charges, execution, and effect of reinvesting expected savings on margins and growth.
- Debt, interest expense and capital returns following the $6.25 billion note issuance, alongside the large overseas-held cash and investment balance.
- Developments in the Brazilian tax dispute and patent matters, including any change in estimated exposure or outcomes.