Cisco Systems, Inc. — Q1 Fiscal 2020 Form 10-Q
Reporting period: Three months ended October 26, 2019; compared with the three months ended October 27, 2018. The financial statements are unaudited. Amounts below are in U.S. dollars.
Business context and results
Cisco designs and sells networking, security, collaboration, applications and cloud technologies, and related services. Management described a challenging, highly competitive environment, with weakness in service providers and emerging markets and broader macroeconomic pressure affecting enterprise and commercial demand. Cisco is shifting toward more software and subscription offerings while investing in priority areas.
Key financial metrics
| Metric | Q1 FY2020 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $13.159 billion | $13.072 billion | Up 1%; up 2% excluding prior-year SPVSS revenue |
| Gross margin | $8.464 billion; 64.3% | $8.146 billion; 62.3% | Margin up 2.0 percentage points |
| Operating income | $3.579 billion; 27.2% of revenue | $3.805 billion; 29.1% | Down 6%; margin down 1.9 points |
| Net income | $2.926 billion | $3.549 billion | Down 18% |
| Diluted EPS | $0.68 | $0.77 | Down 12% |
| Operating cash flow | $3.587 billion | $3.763 billion | Down $176 million |
| Free cash flow | $3.385 billion | $3.551 billion | Down $166 million |
Product revenue was essentially flat at $9.878 billion; service revenue rose 3% to $3.281 billion. Product-category performance included Security up 22%, Applications up 6%, Infrastructure Platforms down 1%, and Other Products down 85%, primarily reflecting the SPVSS divestiture. Revenue by geography: Americas $7.977 billion, up 3%; EMEA $3.283 billion, up 2%; APJC $1.899 billion, down 9%. Gross-margin improvement reflected productivity and product mix, partly offset by pricing pressure; the prior-year comparison also benefited from a $400 million Arista litigation settlement that reduced prior-year G&A expense.
Balance sheet, liquidity and capital allocation
- At October 26, 2019, cash and cash equivalents were $8.587 billion and investments were $19.448 billion, totaling $28.035 billion, down from $33.413 billion at fiscal year-end.
- Total debt was $18.497 billion: $4.000 billion current and $14.497 billion long-term. Cisco had no commercial paper outstanding and reported compliance with debt covenants. $4.0 billion of debt principal was due within the next 12 months.
- Current assets were $41.716 billion and current liabilities were $24.597 billion. Deferred revenue was $18.602 billion; remaining performance obligations were $24.9 billion, with about 56% expected to be recognized within one year.
- Cash declined mainly due to debt reduction, dividends, repurchases, acquisitions and capital expenditures. Cisco paid $1.486 billion in dividends and repurchased $768 million of shares during the quarter. Management intends to return at least 50% of annual free cash flow to shareholders, subject to Board approval of dividends.
- Management stated that cash, investments, operating cash generation and access to capital markets and credit lines should meet liquidity needs for at least the next 12 months.
Material changes, outlook and unusual items
- Net income was pressured by operating expenses and a higher effective tax rate: 20.6%, versus 9.2% a year earlier. The prior-year rate included a $152 million tax benefit related to ASC 606 adoption. In Q1 FY2020, an IRS settlement generated a $102 million net tax benefit.
- G&A expense increased 146%, primarily because the prior-year quarter included the $400 million Arista litigation settlement benefit. Restructuring charges were $184 million versus $78 million; Cisco expected the fiscal 2018 plan to be substantially complete in the first half of fiscal 2020, with no significant future charges expected under that plan.
- Management gave no specific full-year or next-quarter financial guidance in the supplied filing text. It cited ongoing uncertainty, continued service-provider and emerging-market weakness, and a broader weakening in global macroeconomic conditions. It also said it would continue investing in priority areas and expected restructuring savings to be substantially reinvested, rather than materially reducing future costs.
- Cisco had agreed to acquire Acacia Communications for approximately $2.6 billion, net of cash and marketable securities; closing was expected in the second half of fiscal 2020, subject to regulatory approvals and customary conditions.
- Brazilian tax authorities asserted claims aggregating $2.502 billion, including $202 million in taxes, $1.4 billion in interest and $0.9 billion in penalties. Cisco disputed the claims, but said it could not assess the likelihood of an unfavorable outcome or reasonably estimate a loss range.
- Other disclosed exposures include $8.3 billion of U.S. transition-tax payable, with approximately $0.7 billion due within one year; $311 million of investment funding commitments; and financing guarantees with maximum potential payments of $163 million, partly offset by $76 million of associated deferred revenue.
- Cisco adopted lease accounting ASC 842 in Q1 FY2020, recording $1.2 billion of operating lease right-of-use assets and liabilities at adoption. The filing also identifies expected-credit-loss accounting as not yet effective for Cisco and under evaluation.
Important facts for investors to verify
- Whether weakness in service providers, APJC and emerging markets persists, and whether Security and Applications growth can offset Infrastructure Platforms pressure.
- Whether gross-margin gains from productivity and product mix are sustainable amid pricing, competition and macroeconomic risks.
- How operating expenses, restructuring charges and tax-rate variability affect earnings in subsequent quarters; distinguish recurring performance from prior-period settlement and tax effects.
- Cash deployment, the $4.0 billion near-term debt maturity, transition-tax payments and the planned Acacia acquisition’s closing and funding.
- Developments in the Brazilian tax litigation and other legal, customer-credit, investment and financing-guarantee exposures.