Cisco Systems, Inc. — Q3 Fiscal 2020 Form 10-Q
Reporting period: Third quarter ended April 25, 2020; comparisons are with the quarter ended April 27, 2019. Nine-month figures compare the corresponding fiscal 2019 period. Amounts are in U.S. dollars; financial statement amounts are generally in millions.
Business context and results
Cisco designs and sells networking, security, collaboration, applications and cloud-related technologies and services. Management said the COVID-19 pandemic affected results and operations, particularly through manufacturing challenges and component constraints, while the broader macroeconomic environment weakened. Results for the quarter are not necessarily indicative of future periods.
| Metric | Q3 FY2020 | Q3 FY2019 | Change |
|---|---|---|---|
| Revenue | $11.983B | $12.958B | -8% |
| Product revenue | $8.597B | $9.722B | -12% |
| Service revenue | $3.386B | $3.236B | +5% |
| Gross margin | $7.771B; 64.9% | $8.173B; 63.1% | Margin +1.8 points |
| Operating income | $3.414B | $3.513B | -3% |
| Net income | $2.774B | $3.044B | -9% |
| Diluted EPS | $0.65 | $0.69 | -6% |
| Effective tax rate | 19.4% | 15.8% | +3.6 points |
For the first nine months, revenue was $37.147B, down 3%; operating income was $10.373B, down 1%; net income was $8.578B, down 9%; and diluted EPS was $2.01, down 4%. Gross margin was 64.6%, up 2.0 percentage points. The nine-month effective tax rate rose to 19.6% from 13.4%.
Revenue trends and material changes
- Q3 product declines were led by Infrastructure Platforms, down 15%, and Applications, down 5%; Security grew 6%. Service revenue increased across all geographic segments.
- Revenue declined in all three geographic segments in Q3: Americas 8%, EMEA 7%, and APJC 9%. Product revenue in the BRICM emerging markets fell 25% in aggregate.
- Management attributed improved gross margin primarily to productivity and product mix, partly offset by unfavorable pricing. Product gross margin rose to 63.7% from 62.0%; service gross margin increased to 67.7% from 66.3%.
- Operating expenses included $128M of Q3 restructuring and other charges. Nine-month charges were $354M, including $226M under the completed FY2018 plan. The new FY2020 plan is expected to incur approximately $300M in total pretax charges and be substantially completed in FY2021; Cisco expects to reinvest substantially all savings.
- Nine-month G&A comparisons were affected by a $400M Arista litigation settlement benefit in Q1 FY2019. Fiscal 2019 product comparisons also include the divested SPVSS business, which contributed $168M of revenue in that nine-month period.
Cash flow, financial position and liquidity
- Nine-month operating cash flow was $11.624B, versus $11.889B; capital expenditures were $562M, producing company-defined free cash flow of $11.062B, versus $11.188B.
- Cash, cash equivalents and investments totaled $28.574B at April 25, 2020, down from $33.413B at July 27, 2019. Cash and cash equivalents alone were $10.366B.
- Total debt was $16.084B ($4.506B current and $11.578B long-term), down from $24.666B at fiscal year-end. Cisco had no commercial paper outstanding and reported compliance with debt covenants.
- Current assets were $41.307B and current liabilities $25.937B. Deferred revenue was $18.648B; remaining performance obligations were $25.5B, of which Cisco expected approximately 56% to be recognized over the next year.
- Nine-month dividends paid were $4.491B and share repurchases under the program were $2.659B. Management’s stated capital-allocation intent is to return at least 50% of annual free cash flow through dividends and repurchases.
- On May 15, 2020, after quarter-end, Cisco entered a 364-day, $2.75B unsecured revolving credit facility; it had not borrowed under it. Management said existing liquidity, operating cash generation and access to capital were expected to cover requirements for at least the next 12 months, while noting pandemic-related capital-market uncertainty.
Outlook, risks and unusual items
- The filing provides no specific revenue or earnings guidance. Management described ongoing uncertainty in service-provider and emerging markets and broader weakness affecting enterprise and commercial customers.
- COVID-19 risks include supply-chain disruption, component shortages, delayed or reduced customer orders, weaker customer collections, shifts or reductions in IT spending, and heightened volatility in markets and accounting estimates. Management said the pandemic had not materially affected liquidity to date, but future effects were uncertain.
- Cisco announced a $2.5B Business Resiliency Program for customer and partner financing, including payment deferrals. It also reported nearly $300M committed to pandemic response efforts.
- The pending Acacia Communications acquisition was expected to cost approximately $2.6B net of cash and marketable securities and was expected to close in Q4 FY2020, subject to customary closing conditions and regulatory approvals.
- Remaining Brazilian tax claims asserted against Cisco’s subsidiary totaled approximately $1.2B, including tax, interest and penalties. Cisco disputes the claims; it could not estimate the likelihood or range of loss, and expects resolution to take several years. Other disclosed patent matters include the Centripetal and Finjan cases; outcomes were uncertain, and Cisco said it could not reasonably estimate some litigation outcomes.
- Other relevant exposures include $5.1B of inventory purchase commitments, $9.473B of net financing receivables, and $215M of maximum potential financing-guarantee payments before associated deferred revenue.
Important facts for investors to verify
- Whether supply constraints and COVID-19 effects continue to pressure product revenue, customer demand and collections.
- Whether Security growth and recurring software and subscription activity can offset weakness in Infrastructure Platforms and other product categories; review deferred revenue and RPO conversion.
- How restructuring costs, reinvestment of expected savings, pricing pressure and productivity affect future margins and operating income.
- Cash deployment and debt maturities, including the planned Acacia acquisition, transition-tax payments and shareholder returns; note the new credit facility was entered into after quarter-end.
- Developments in Brazilian tax disputes and patent litigation, and any resulting changes to contingencies or financial estimates.
- Changes in credit quality of financing receivables and customer or channel-partner financing guarantees amid economic uncertainty.