Cisco Systems, Inc. — FY2015 Form 10-K
Reporting period: Fiscal year ended July 25, 2015 (52 weeks), with fourth-quarter results for the three months then ended. Cisco designs and sells networking products and provides related services and integrated solutions. Its reportable segments are the Americas, EMEA, and APJC. CEO Charles Robbins succeeded John Chambers in July 2015; Chambers became Executive Chairman.
Financial performance and liquidity
| Metric | FY2015 | FY2014 | Change |
|---|---|---|---|
| Revenue | $49.161 billion | $47.142 billion | +4.3% |
| Gross margin | $29.681 billion; 60.4% | $27.769 billion; 58.9% | Margin +1.5 pts |
| Operating income | $10.770 billion; 21.9% of revenue | $9.345 billion; 19.8% | +15.3%; margin +2.1 pts |
| Net income | $8.981 billion | $7.853 billion | +14.4% |
| Diluted EPS | $1.75 | $1.49 | +17.4% |
| Operating cash flow | $12.552 billion | $12.332 billion | +$220 million |
| Free cash flow (company-defined) | $11.325 billion | $11.057 billion | +$268 million |
| Cash, cash equivalents and investments | $60.416 billion | $52.074 billion | +$8.342 billion |
| Debt | $25.354 billion | $20.845 billion | +$4.509 billion |
| Deferred revenue | $15.183 billion | $14.142 billion | +$1.041 billion |
Product revenue rose 4.4% to $37.750 billion and service revenue rose 4.0% to $11.411 billion. Product gross margin improved to 59.3% from 56.8%; service gross margin declined to 64.0% from 66.0%. Cisco reported total assets of $113.481 billion and total liabilities of $53.774 billion at year-end. Current assets were $76.283 billion and current liabilities $23.623 billion. Of cash and investments, $53.4 billion was held by foreign subsidiaries; distribution to the U.S. could trigger additional taxes.
Cash generation funded $4.234 billion of program repurchases and $4.086 billion of dividends. Cisco issued $5.0 billion of senior notes in June 2015; no commercial paper or revolving-credit borrowings were outstanding at year-end. Management said available liquidity, operating cash flow, capital-market access and committed credit lines should meet requirements for at least the next 12 months.
Fourth-quarter snapshot
Q4 revenue was $12.843 billion, up 3.9% year over year; gross margin was 60.2% versus 59.9%, operating income was $2.881 billion versus $2.681 billion, and net income was $2.319 billion versus $2.247 billion. Diluted EPS was $0.45 versus $0.43. Revenue grew 7% in the Americas and was flat in EMEA and APJC. Collaboration and Data Center product revenue each grew 14% year over year.
Material changes and management commentary
- Growth returned after FY2014 revenue fell 3%. FY2015 revenue increased $2.019 billion, led by the Americas (+6.7%); EMEA rose 2.6%, while APJC declined 2.3%.
- Data Center revenue grew 22.0% to $3.220 billion and Security grew 11.6% to $1.747 billion. Switching rose 5.3%; NGN Routing rose 1.2%. Service Provider Video fell 10.4% to $3.555 billion, continuing weakness in that business.
- Management attributed improved product margins partly to manufacturing productivity and the absence of FY2014’s $655 million supplier-component remediation charge. FY2015 included a favorable $164 million adjustment to that remediation liability. Offsetting items included $188 million of Rockstar patent-related expense, pricing pressure, and approximately $175 million of purchased-intangible impairment charges.
- Deferred product revenue increased 21%, primarily from subscription and software arrangements, with contributions from Collaboration, Security and Wireless. Product backlog declined to $5.1 billion from $5.4 billion; management cautioned that backlog is not necessarily indicative of future revenue.
- The August 2014 restructuring generated $489 million of FY2015 charges; total pretax charges are estimated at approximately $700 million, with completion expected in the first half of FY2016. Planned savings are to be reinvested in growth areas; expected cost savings are not expected to be material.
Outlook, risks and contingencies
The filing gives no quantified forward revenue or earnings guidance. Management said weakness in several emerging countries was expected to continue for at least a few quarters and identified ongoing service-provider-market challenges. Its strategy emphasizes integrated network architectures, security, cloud, software, data center and virtualization, while maintaining routing and switching leadership.
- Key operating risks include intense competition and price pressure, rapid technology shifts, adoption of new products, volatile service-provider spending, macroeconomic and geopolitical uncertainty, and foreign-exchange effects.
- Supply-chain constraints, component shortages, purchase commitments and distributor inventory could affect shipments, revenue predictability and margins. Product gross margin may also face pressure from pricing, product/geographic mix and growth in comparatively lower-margin offerings.
- Brazilian tax authorities asserted claims against Cisco’s subsidiary totaling approximately $262 million in taxes, $1.1 billion in interest and $1.2 billion in penalties. Cisco disputes the claims, but said it cannot determine the likelihood of an unfavorable outcome or reasonably estimate a loss; a final judicial determination is not expected for several years.
- Cisco was investigating alleged potential Foreign Corrupt Practices Act violations involving Russia and certain Commonwealth of Independent States operations and resellers, in cooperation with the SEC and Department of Justice. The company did not expect a material consolidated financial impact.
- Other notable exposures include $25.3 billion of senior notes, $4.078 billion of supplier and contract-manufacturer purchase commitments, customer financing and guarantees, and pending intellectual-property matters. The filing describes the company’s controls over financial reporting as effective; the independent auditor issued an unqualified opinion.
Important facts for investors to verify
- Whether growth in Data Center, Security and recurring subscription/software revenue can offset continuing weakness in Service Provider Video, service providers and selected emerging markets.
- Whether FY2015 margin improvement is sustainable after separating operating productivity from the prior-year remediation charge and FY2015’s favorable liability adjustment; monitor pricing and product mix.
- Debt maturities and the role of offshore-held cash: $53.4 billion of cash and investments was held by foreign subsidiaries, while year-end debt was $25.354 billion.
- Developments in the Brazilian tax claims and the Russia/CIS investigation, including any change in estimated exposure or expected financial impact.
- Completion and costs of the restructuring, the Technicolor connected-devices divestiture (announced for approximately $600 million, subject to adjustments and closing conditions), and the subsequent OpenDNS acquisition completed August 26, 2015 for approximately $635 million.