Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2020, ended January 25, 2020. Financial statements are unaudited. Comparisons are with the corresponding periods of fiscal 2019 unless otherwise noted.
Business context and operating results
Cisco sells networking, security, collaboration, applications and cloud technologies, alongside related services. Management described a challenging and increasingly uncertain global macroeconomic environment, with particular weakness in service providers and emerging markets. Cisco is shifting toward more software and subscription offerings while continuing investment in strategic areas.
Key financial metrics
| Metric | Q2 FY2020 | Q2 FY2019 | First half FY2020 | First half FY2019 |
|---|---|---|---|---|
| Revenue | $12.005B | $12.446B | $25.164B | $25.518B |
| Gross margin | $7.764B; 64.7% | $7.773B; 62.5% | $16.228B; 64.5% | $15.919B; 62.4% |
| Operating income | $3.380B; 28.2% of revenue | $3.211B; 25.8% | $6.959B; 27.7% | $7.016B; 27.5% |
| Net income | $2.878B | $2.822B | $5.804B | $6.371B |
| Diluted EPS | $0.68 | $0.63 | $1.36 | $1.40 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $7.387B | $7.560B |
| Free cash flow | Not provided for quarter | Not provided for quarter | $6.996B | $7.087B |
Amounts in the table are in U.S. dollars; B means billion. For Q2, product revenue fell 6% to $8.671B while service revenue rose 5% to $3.334B. Security revenue increased 9%; Infrastructure Platforms and Applications each declined 8%. For the first half, product revenue declined 3% and services increased 4%.
- Profitability and margins: Q2 net income rose 2% and diluted EPS rose 8%, aided by a 245 million decline in diluted weighted-average shares. Higher gross margin reflected productivity and product mix, partly offset by pricing pressure. First-half net income and diluted EPS fell 9% and 3%, respectively.
- Cash, liquidity and debt: Cash and investments totaled $27.062B at January 25, down $6.351B from July 27, 2019. Current assets were $40.053B and current liabilities $22.088B. Debt was $15.993B carrying value, including $1.499B current and $14.494B long-term; no commercial paper was outstanding. Cisco reported compliance with debt covenants and said available liquidity and expected funding sources should cover requirements for at least 12 months.
- Cash deployment: First-half dividends paid were $2.972B and share repurchases under the program were $1.648B. Cisco reported a $3.470B net reduction in short-term borrowings and $5.220B of debt repayments. The Board subsequently declared a $0.36 quarterly dividend, payable April 22, 2020.
- Deferred revenue and contracted business: Deferred revenue was $18.686B, up $219M from fiscal year-end. Remaining performance obligations were $24.9B, of which approximately 55% was expected to be recognized over the next year.
Material changes versus prior period
- Quarterly revenue declined 4%; first-half revenue declined 1%. Weak product sales were partly offset by growth in services.
- Q2 gross margin improved 2.2 percentage points and operating margin improved 2.4 points. For the first half, gross margin improved 2.1 points, while operating income declined slightly.
- First-half effective tax rate increased to 19.6% from 12.1%; Q2 rate rose to 18.6% from 15.6%. The prior-year first-half rate included a $152M tax benefit related to adoption of revenue-recognition accounting. Fiscal 2020 first-half results included a $102M tax benefit from settlement of an IRS audit.
- First-half G&A expense was up 35%, primarily reflecting the prior-year benefit of a $400M Arista litigation settlement. Q2 restructuring charges were $42M versus $186M a year earlier; the fiscal 2018 restructuring plan was completed in Q2.
- Cash and investments declined primarily due to debt reduction, dividends, buybacks, capital expenditures and acquisitions, partly offset by operating cash flow. The company made no repurchases under its program in the prior-year first half’s comparison? The filing reports $10.042B of first-half FY2019 repurchases, versus $1.638B in FY2020.
Outlook, management commentary, risks and contingencies
- Outlook: The filing provides no specific numerical revenue or earnings guidance. Management expects ongoing uncertainty in service-provider and emerging-country markets and cited broader macroeconomic weakness affecting enterprise and commercial demand. It plans continued investment in priority areas to pursue long-term profitable growth. Results for the quarter and first half are not necessarily indicative of full-year results.
- Restructuring and acquisition: A new fiscal 2020 restructuring plan, initiated in the third quarter, carries estimated pretax charges of approximately $300M and is expected to be substantially completed in fiscal 2021; substantially all savings are expected to be reinvested. Cisco also had a pending Acacia Communications acquisition for approximately $2.6B net of cash and marketable securities, expected to close in the second half of fiscal 2020 subject to customary conditions and regulatory approvals.
- Key operating risks: Competition and pricing, reduced customer IT spending, service-provider weakness, demand volatility, product and customer mix, supply constraints, inventory obsolescence, and the transition to subscription revenue could affect results. The risk factors specifically identify potential supply-chain disruption from the then-recent coronavirus outbreak.
- Legal matters: Brazilian authorities’ remaining asserted claims total approximately $1.6B ($0.2B taxes, $0.9B interest and $0.5B penalties); Cisco disputes the claims but says it cannot assess the likelihood of an unfavorable outcome or reasonably estimate a loss range. A separate $0.8B federal penalty-and-interest claim was dismissed on its merits during Q2. Cisco said it did not expect the other discussed legal matters to have a material adverse effect, while noting uncertainty.
- Other exposures: Approximately $0.7B of U.S. transition tax was payable within one year. Financing guarantees had maximum potential future payments of $271M, with $82M associated deferred revenue. Inventory purchase commitments totaled $4.5B. Cisco stated that a 50-basis-point interest-rate change would alter the fair value of financing receivables by about $0.1B.
Most important facts for investors to verify
- Whether product demand stabilizes, particularly in Infrastructure Platforms, service providers, enterprise/commercial markets and emerging countries, and whether Security and services growth continues.
- Whether margin gains from productivity and product mix can persist despite pricing pressure, and how restructuring reinvestment affects expenses and returns.
- Cash conversion, the pace of debt repayment and shareholder distributions, and the funding and closing of the Acacia transaction.
- Developments in the Brazilian tax litigation, the Acacia regulatory process, and the new restructuring plan’s costs and execution.
- Effects of macroeconomic and coronavirus-related supply-chain disruptions on customer demand, component availability, inventory, and purchase commitments.