Cisco Systems, Inc. — Q3 FY2016 Form 10-Q
Reporting period: Quarter ended April 30, 2016; unaudited. Cisco’s fiscal 2016 is a 53-week year. Q3 contained 14 weeks, versus 13 weeks in the prior-year quarter, affecting year-over-year comparisons.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Revenue | $12.0B | $12.1B | $36.6B | $36.3B |
| Gross margin | 64.3% | 62.0% | 62.8% | 60.4% |
| Operating income | $3.0B | $2.9B | $9.4B | $7.9B |
| Operating margin | 24.9% | 24.1% | 25.6% | 21.7% |
| Net income | $2.35B | $2.44B | $7.93B | $6.66B |
| Diluted EPS | $0.46 | $0.47 | $1.56 | $1.29 |
- Q3 revenue fell 1.1%; product revenue declined 4.8% to $8.9B, while service revenue rose 11.2% to $3.1B. Management estimated the extra week added about $265M of revenue, including $200M from service subscriptions and $65M from SaaS.
- For the first nine months, revenue increased 0.8%; product revenue decreased 0.5% and service revenue increased 5.0%. Net income rose 19% and diluted EPS rose 21%.
- Q3 operating cash flow was not separately stated in the provided filing text. For the first nine months, operating cash flow was $9.75B, up from $8.41B; capital expenditures were $880M, giving company-defined free cash flow of $8.87B versus $7.51B.
- Cash, cash equivalents and investments totaled $63.5B at April 30, 2016, versus $60.4B at July 25, 2015. Cash and cash equivalents alone were $8.9B. Cisco reported $57.2B of cash and investments held by foreign subsidiaries and $6.3B available in the United States.
- Debt was $28.6B carrying value, including $4.2B current and $24.4B long-term debt. The company issued $7.0B of senior notes in February and repaid $3.0B of notes at maturity. It reported compliance with debt covenants and no borrowings under its $3.0B revolving credit facility.
- Deferred revenue was $15.3B, comprising $9.9B service and $5.4B product. Accounts receivable were $4.0B; DSO improved to 33 days from 38 at fiscal year-end.
Material changes and management commentary
- Q3 revenue excluding the prior-year SP Video CPE business increased 3%. Cisco completed the sale of that business in November 2015; it generated $519M of prior-year Q3 revenue. The sale also supported higher gross margins.
- Product category trends were mixed: Q3 Security grew 17% and Collaboration 10%; Switching declined 3% and NGN Routing 5%. Service Provider Video revenue fell 49%, largely reflecting the divested business. Management cited cautious service-provider capital spending and macroeconomic uncertainty affecting enterprise spending.
- Regional revenue increased in APJC, led by China, and declined in the Americas and EMEA. Management reported Q3 product revenue growth of 44% in China and 16% in India, alongside declines in Russia, Mexico and Brazil.
- Nine-month results benefited from a $285M pretax gain on the SP Video CPE sale, lower restructuring charges, and comparison with a $188M prior-year patent portfolio charge. The effective tax rate was 16.8% for the nine months, including approximately $558M in tax benefits tied to an IRS settlement and reinstatement of the federal R&D tax credit; Q3’s rate was 23.8%.
- Cisco completed 12 acquisitions in the nine months, with total purchase consideration of $3.38B; the largest included Jasper, Acano, OpenDNS and Lancope. Goodwill increased to $26.8B from $24.5B. The company also recorded $63M of impairment charges on private-company investments and $44M on acquired intangible assets for the nine months.
- Shareholders received $3.4B in dividends and Cisco repurchased $3.1B of shares under its repurchase program in the nine months. Management’s stated policy is to return at least 50% of annual free cash flow through dividends and buybacks.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided in the supplied filing text. Management said cash, investments, operating cash generation and access to capital are expected to meet liquidity requirements for at least the next 12 months.
- Management cautioned that service-provider demand, enterprise spending, macroeconomic conditions, foreign exchange, competitive pricing, product mix and supply-chain constraints could affect revenue and margins. It also noted that recent improvement in some emerging markets may not be sustainable.
- Material legal matters include Brazilian tax claims totaling $233M in asserted taxes, $1.2B in interest and $1.1B in penalties; Cisco disputed the claims and could not estimate a possible loss. A jury found willful infringement in the SRI patent case and awarded $23.7M; further court decisions and appeal remained pending. Cisco also disclosed a U.S. investigation into possible FCPA violations involving Russia and certain CIS operations, which represented less than 2% of revenue; the outcome was undetermined.
- Other exposures include financing receivables of $8.6B, $3.8B in inventory purchase commitments, $1.1B in operating-lease commitments and up to $400M of potential future acquisition-related compensation expense. The supplier-component remediation liability was $286M.
Most important facts for investors to verify
- Underlying demand and growth after accounting for the extra reporting week and the SP Video CPE divestiture.
- Whether service, Security and Collaboration growth can offset weakness in core Switching, Routing and service-provider markets.
- Sustainability of gross-margin improvement and the extent to which nine-month earnings benefited from the divestiture, prior-year charges and tax items.
- Debt and capital-return plans alongside the concentration of cash and investments in foreign subsidiaries and potential repatriation taxes.
- Developments in the Brazilian tax claims, SRI and other patent litigation, and the FCPA investigation.