Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Third quarter of fiscal 2015, ended April 25, 2015; comparisons are with the quarter ended April 26, 2014. Nine-month results cover the same comparative periods. Financial statements are unaudited.
Business context and results
Cisco designs, manufactures, and sells networking products and related services. Its business is managed across the Americas, EMEA, and APJC. Q3 revenue grew 5.1% to $12.14 billion, led by product sales; management described growth as solid and profitable despite weakness in service providers and certain emerging markets.
Key financial metrics
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Revenue | $12.14 billion | $11.55 billion | $36.32 billion | $34.79 billion |
| Gross margin | $7.53 billion; 62.0% | $7.01 billion; 60.7% | $21.95 billion; 60.4% | $20.36 billion; 58.5% |
| Operating income | $2.93 billion; 24.1% of revenue | $2.54 billion; 22.0% | $7.89 billion; 21.7% | $6.66 billion; 19.2% |
| Net income | $2.44 billion | $2.18 billion | $6.66 billion | $5.61 billion |
| Diluted EPS | $0.47 | $0.42 | $1.29 | $1.06 |
| Operating cash flow | Quarterly value not stated | Quarterly value not stated | $8.41 billion | $8.72 billion |
Q3 product revenue increased 5.7% to $9.33 billion and service revenue increased 3.2% to $2.81 billion. Data Center revenue rose 21% in the quarter; Security rose 14% and Switching rose 6%. Service Provider Video fell 5%. By geography, Americas revenue rose 8.4%, EMEA 1.7%, and APJC declined 1.2%.
For the first nine months, free cash flow, as defined by Cisco (operating cash flow less property and equipment purchases), was $7.51 billion, down from $7.77 billion. Capital expenditures were $907 million. Cash dividends paid were $3.02 billion, and stock repurchases under the program were $3.23 billion.
At April 25, 2015, cash and cash equivalents were $3.87 billion and investments were $50.55 billion, totaling $54.42 billion. Total debt carrying value was approximately $21.0 billion, including $4.42 billion short-term and $16.59 billion long-term debt. Current assets were $69.33 billion and current liabilities $23.25 billion. Deferred revenue totaled $14.18 billion. Of cash and investments, $51.8 billion was held by foreign subsidiaries; repatriation could trigger additional U.S. and foreign taxes.
Material changes versus comparable periods
- Q3 revenue rose 5.1%, net income rose 11.7%, and diluted EPS rose 11.9%. Nine-month revenue rose 4.4%, net income rose 18.8%, and diluted EPS rose 21.7%; Cisco attributed part of the EPS growth to a lower diluted share count.
- Q3 gross margin increased 1.3 percentage points, but included a $164 million reduction to the supplier-component remediation liability, which benefited product gross margin by about 1.8 percentage points and total gross margin by about 1.4 points. The comparable nine-month margin improvement also reflects the prior-year $655 million remediation charge.
- Service gross margin declined: 63.4% versus 65.4% in Q3 and 63.9% versus 66.2% for the nine-month period, reflecting higher delivery, outside-service, and personnel costs and investment in security and cloud services.
- Q3 Americas growth contrasted with a decline in APJC. Product revenue in China fell 30% for the quarter and 25% for the nine months; BRICM product revenue declined 6% in Q3. Data Center and Security were growth areas, while Service Provider Video weakened.
- Inventory increased to $1.76 billion from $1.59 billion, while annualized inventory turns fell to 10.1 from 12.7. Purchase commitments with suppliers and contract manufacturers rose to $4.50 billion from $4.17 billion.
Outlook, commentary, risks, and unusual items
- No specific numerical revenue or earnings guidance is provided in the supplied filing text. Management expected service-provider and certain emerging-market challenges to continue for a few more quarters, while expressing confidence in Cisco’s positioning for an eventual upturn.
- The FY2015 restructuring plan generated $411 million of charges in the first nine months; aggregate pre-tax charges are not expected to exceed $600 million, with remaining charges expected in the rest of fiscal 2015. Cisco said it planned to reinvest substantially all resulting savings in growth areas.
- Other notable items include a $188 million Q1 charge related to Rockstar patent claims; the subsequent $300 million payment for a patent license and dismissal of that litigation; and a $126 million nine-month gain associated with the VCE restructuring. Purchased intangible asset impairment charges were $57 million for the nine months.
- Brazilian tax authorities asserted claims totaling approximately $2.7 billion for taxes, interest, and penalties. Cisco disputes the claims, but said it cannot determine the likelihood of an unfavorable outcome or reasonably estimate a loss range. Cisco also reported an SEC/DOJ-requested investigation into possible FCPA violations involving Russia and certain CIS operations; it did not expect a material adverse financial effect.
- On May 15, 2015, after quarter-end, Cisco entered into a new undrawn $3.0 billion revolving credit facility expiring in 2020, replacing its prior facility. Management said liquidity resources should meet requirements for at least the next 12 months.
- Key operating risks include volatile service-provider spending, macroeconomic and geopolitical weakness, price competition, product and geographic mix, supply-chain constraints, inventory obsolescence, customer credit exposure, foreign-exchange movements, tax uncertainty, and execution risks in new growth markets.
Important facts for investors to verify
- How much of the reported margin and earnings improvement reflects recurring operations versus the $164 million remediation-liability release and other unusual items.
- Whether service-provider, China, and broader emerging-market weakness persists, and whether Data Center, Security, and other growth categories can offset it.
- The trend in service gross margin, inventory turns, supplier commitments, and financing-receivable credit quality.
- The availability and tax cost of foreign-held cash, and Cisco’s capacity to sustain dividends and repurchases alongside debt obligations.
- Developments in the Brazilian tax claims and the Russia/CIS investigation, including any change in Cisco’s assessment of potential exposure.