Cisco Systems, Inc. — Fiscal 2021 First-Quarter Form 10-Q
Reporting period: Three months ended October 24, 2020; unaudited. Comparisons are with the three months ended October 26, 2019 unless otherwise noted. Cisco sells networking, security, collaboration, applications and cloud-related products and services globally.
Financial performance and position
| Metric | Q1 FY2021 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $11.929 billion | $13.159 billion | Down 9% |
| Product revenue | $8.587 billion | $9.878 billion | Down 13% |
| Service revenue | $3.342 billion | $3.281 billion | Up 2% |
| Gross margin | $7.581 billion; 63.6% | $8.464 billion; 64.3% | Margin down 0.7 percentage points |
| Operating income | $2.570 billion; 21.5% of revenue | $3.579 billion; 27.2% | Income down 28% |
| Net income | $2.174 billion | $2.926 billion | Down 26% |
| Diluted EPS | $0.51 | $0.68 | Down 25% |
| Operating cash flow | $4.096 billion | $3.587 billion | Up $509 million |
| Free cash flow | $3.925 billion | $3.385 billion | Up $540 million |
Amounts are in U.S. dollars. Product gross margin fell to 62.7% from 64.3%, reflecting pricing pressure and higher logistics costs, partly offset by favorable product mix. Service gross margin rose to 65.8% from 64.3%.
Liquidity and debt: Cash, cash equivalents and investments totaled $30.012 billion at October 24, 2020, versus $29.419 billion at July 25, 2020. Total current assets were $42.989 billion and current liabilities were $26.991 billion. Debt carrying value was $14.566 billion: $5.002 billion current and $9.564 billion long-term. Cisco reported $14.5 billion principal amount of senior notes, no commercial paper outstanding, and no borrowings under its $2.75 billion revolving credit facility. It was in compliance with debt covenants. Approximately $5.0 billion of debt principal was due within 12 months of quarter-end.
Deferred revenue was $20.473 billion, approximately flat with fiscal year-end. Remaining performance obligations were $27.469 billion, down 3%; Cisco expected approximately 53% to be recognized as revenue over the next year. Operating cash flow benefited in part from a $1.526 billion reduction in accounts receivable.
Cisco paid $1.520 billion in dividends and repurchased $800 million of shares during the quarter. Its stated policy is to return at least 50% of annual free cash flow to shareholders through dividends and repurchases.
Material changes versus the prior-year quarter
- Product weakness drove the revenue decline; Infrastructure Platforms fell 16% and Applications fell 8%, while Security grew 6%. Services increased 2%.
- Revenue declined in all geographic segments: Americas 10%, EMEA 10%, and APJC 7%. Management cited broad macroeconomic weakness, particularly in commercial and enterprise markets, and continued softness in service providers and emerging countries.
- Operating expenses included $602 million of restructuring and other charges, compared with $184 million a year earlier. Excluding no items, reported operating income and margins declined as revenue fell and restructuring charges rose.
- Interest income declined due to lower average cash and investment balances and lower interest rates; interest expense also declined, reflecting lower average debt and effective rates. The effective tax rate was 18.9%, versus 20.6%.
Outlook, management commentary and risks
Management described the operating environment as challenging and uncertain and said it expected continued uncertainty in service-provider and emerging markets. The filing does not provide a clear numerical revenue or earnings forecast for the next quarter or full fiscal year. Cisco stated that it expected existing cash, investments, operating cash generation and access to capital to meet liquidity requirements for at least the next 12 months, while cautioning that COVID-19 could adversely affect liquidity and capital resources.
A fiscal 2021 restructuring plan, including a voluntary early retirement program, is expected to incur approximately $900 million in pretax charges. Cisco had recorded $602 million in the quarter and estimated annualized cost savings of approximately $1.0 billion over the next few quarters. The plan and the prior-year plan were expected to be substantially completed in fiscal 2021.
Three acquisitions were completed for total purchase consideration of $878 million. The pending Acacia Communications acquisition was expected to close in the first half of fiscal 2021, subject to conditions and regulatory approvals, for approximately $2.6 billion net of cash and marketable securities.
Key risks and contingencies: COVID-19-related demand, supply-chain, customer-collection and market uncertainty; intense competition and product pricing pressure; component availability and inventory obsolescence; reliance on channel partners and customer financing; and foreign exchange, interest-rate and investment risks. Cisco also disclosed material patent matters. Most notably, a court awarded Centripetal Networks $1.9 billion and ongoing royalties; Cisco planned to appeal, and execution of the judgment was stayed pending appeal, with no payment then due. Cisco said it could not reasonably estimate the ultimate outcome. Brazilian tax authorities asserted claims totaling approximately $1.2 billion, including interest and penalties; Cisco disputed liability and could not estimate a possible loss. The filing also described other patent litigation and indemnification matters.
Approximately $0.7 billion of U.S. transition-tax payments was due within one year. Unrecognized tax benefits were $2.5 billion; the timing and outcomes of tax examinations and resolutions could affect results.
Important facts for investors to verify
- Whether product demand, especially in Infrastructure Platforms, commercial and enterprise customers, service providers and emerging markets, stabilized after the reported declines.
- Whether Security growth and the shift toward software, subscriptions and recurring revenue can offset hardware weakness; monitor deferred revenue and remaining performance obligations.
- Whether restructuring charges and the forecast annualized savings develop as management estimated, and whether cost reductions affect execution or growth.
- The status, appeal and potential financial exposure of the Centripetal judgment and the Brazilian tax claims, along with other litigation and indemnification matters.
- Near-term debt maturities, the Acacia acquisition’s closing and funding, transition-tax payments, and the continued adequacy of liquidity amid COVID-19 uncertainty.