CISCO SYSTEMS, INC. quarterly report, Q1 FY2022

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Cisco Systems, Inc. — Q1 FY2022 Form 10-Q

Reporting period: Three months ended October 30, 2021; comparisons are with the three months ended October 24, 2020, unless otherwise noted. Unaudited consolidated results. Dollar amounts are in U.S. dollars.

Business context and financial performance

Cisco designs and sells networking and related technology, including security, collaboration, applications and cloud offerings, and provides associated services. Management reported solid revenue growth and profitability, while noting that industry-wide component shortages constrained performance.

  • Revenue: $12.90 billion, up 8%. Product revenue was $9.53 billion, up 11%; service revenue was $3.37 billion, up 1%.
  • Product categories: Secure, Agile Networks revenue rose 10% to $5.97 billion; Internet for the Future rose 46% to $1.37 billion; End-to-End Security rose 4% to $895 million; Optimized Application Experiences rose 18% to $181 million. Hybrid Work declined 7% to $1.11 billion.
  • Geographies: Americas revenue grew 5% to $7.56 billion; EMEA grew 11% to $3.30 billion; APJC grew 15% to $2.04 billion.
  • Gross profit and margins: Gross margin was $8.05 billion, or 62.4% of revenue, versus $7.58 billion, or 63.6%. Product gross margin fell 1.2 percentage points to 61.5%; service gross margin fell 0.6 points to 65.2%.
  • Operating results: Operating income was $3.44 billion, up 34%; operating margin increased to 26.7% from 21.5%. Net income was $2.98 billion, up 37%, and diluted EPS was $0.70 versus $0.51. The effective tax rate was 18.5%, compared with 18.9%.
  • Cash flow: Operating cash flow was $3.43 billion, down from $4.10 billion. Free cash flow, as defined by Cisco (operating cash flow less property and equipment purchases), was $3.31 billion versus $3.93 billion.
  • Liquidity: Cash and cash equivalents plus investments totaled $23.35 billion at quarter-end, down from $24.52 billion at July 31, 2021. Current assets were $37.59 billion and current liabilities $23.24 billion.
  • Debt: Debt carrying value was $9.50 billion, down from $11.53 billion, following repayment of $2.0 billion of debt during the quarter. Cisco reported no commercial paper outstanding and no borrowings under its $3.0 billion revolving credit facility; it was in compliance with debt covenants.
  • Capital returns: Cisco paid $1.56 billion in dividends ($0.37 per share) and repurchased $256 million of shares under its repurchase program.
  • Backlog and recurring revenue indicators: Remaining performance obligations were $30.14 billion, down 2% from July 31; Cisco expects approximately 53% to be recognized over the next 12 months. Deferred revenue was $22.07 billion.

Material changes versus the prior comparable period

  • Revenue increased 8%, led by product growth; service revenue grew only 1%. Product revenue growth was broad geographically, but Hybrid Work revenue declined.
  • Gross margin declined 1.2 percentage points, primarily due to supply-related costs and pricing erosion, partly offset by favorable product mix.
  • Operating margin rose 5.2 percentage points. A major contributor was restructuring and other charges falling to $5 million from $602 million in the prior-year quarter; revenue growth and expense leverage also contributed.
  • Other income, net, increased to $187 million from $49 million, largely reflecting higher realized and unrealized gains on privately held investments. This contributed to reported earnings growth.
  • Operating cash flow declined by $669 million. The filing identifies working-capital movements, including smaller cash inflows from accounts receivable and higher inventory investment, among the period’s cash-flow factors.
  • Inventory rose to $1.83 billion from $1.56 billion at fiscal year-end. Supplier purchase commitments increased to $11.05 billion from $10.25 billion.

Outlook, management commentary and risks

  • Supply constraints: Management expected component shortages and related constraints to continue into the second half of FY2022. Higher component, freight and expedite costs affected product margins; extended lead times constrained deliveries.
  • Supply-chain exposure: Cisco increased inventory, supplier commitments and prepayments to secure supply. Management warned that a sudden decline in demand could lead to excess or obsolete inventory and related losses. Inventory purchase commitments totaled $11.05 billion, including $7.62 billion due within one year.
  • Liquidity outlook: Management said cash, investments, operating cash generation and access to capital markets and committed credit lines were expected to meet liquidity needs for at least the next 12 months. It also anticipated increased inventory and other supply-related payments.
  • Capital allocation: Cisco stated its intent to return at least 50% of annual free cash flow to stockholders through dividends and repurchases; future dividends remain subject to Board approval.
  • Legal contingencies: In the Centripetal patent case, a district court had awarded $1.9 billion plus ongoing royalties; execution was stayed pending appeal, and Cisco disputed the judgment. The filing says the ultimate outcome could not be reasonably estimated. Brazilian tax authorities asserted claims aggregating approximately $1.22 billion, including tax, interest and penalties; Cisco disputed liability and could not estimate a loss range. Cisco also described other patent and commercial disputes.
  • Other risks and uncertainty: The filing highlights COVID-19 effects, macroeconomic and geopolitical uncertainty, competition, customer demand and shipment variability, credit and investment risks, currency and interest-rate exposure, cybersecurity, and tax matters. Cisco noted $6.9 billion of U.S. transition-tax payable, with payments scheduled over several years.
  • Unusual items: The quarter included $205 million of net gains on privately held investments. Cisco also reported $89 million of acquisition-related compensation expense. Management said the pandemic had not materially affected its critical estimates in the quarter, while warning that estimates could become more volatile.
  • Formal financial guidance: The supplied filing text does not provide a clear quantified revenue, earnings or margin forecast for the full fiscal year.

Important facts for investors to verify

  • Whether supply constraints ease as expected and how component availability, lead times and associated costs affect shipments and product gross margin.
  • Whether elevated inventory, $11.05 billion of supplier commitments and $229 million of inventory prepayments remain appropriate if demand changes.
  • How much earnings growth is supported by recurring operating performance versus the prior-year restructuring comparison and current-quarter investment gains.
  • Trends in operating cash flow, working capital, deferred revenue and remaining performance obligations, including conversion of the latter into recognized revenue.
  • Developments in the Centripetal and Brazilian tax matters, and whether any eventual exposure differs from management’s stated expectations.
  • Debt maturities, the $6.9 billion transition-tax payable schedule, and continued capacity to fund dividends, repurchases and strategic investments.