Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Second quarter of fiscal 2019, ended January 26, 2019; comparisons are with the quarter ended January 27, 2018. Financial statements are unaudited. Amounts are in U.S. dollars.
Business context and financial performance
Cisco designs and sells networking, security, collaboration, applications and cloud-related products and services. Management describes its priorities as accelerating innovation, increasing the value of the network, and shifting toward software and subscriptions.
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $12.446B | $11.887B | $25.518B | $24.023B |
| Gross margin | $7.773B; 62.5% | $7.498B; 63.1% | $15.919B; 62.4% | $14.925B; 62.1% |
| Operating income | $3.211B; 25.8% of revenue | $3.073B; 25.9% | $7.016B; 27.5% | $5.829B; 24.3% |
| Net income (loss) | $2.822B | $(8.778)B | $6.371B | $(6.384)B |
| Diluted EPS | $0.63 | $(1.78) | $1.40 | $(1.29) |
Revenue increased 5% in Q2 and 6% for the first six months. Q2 product revenue rose 6% and services were flat; excluding the divested SPVSS business from the prior-year comparison, total revenue grew 7%. For the first six months, product revenue rose 8% and service revenue 2%. Q2 product-category growth was led by Applications (+24%) and Security (+18%), with Infrastructure Platforms up 6%. The Americas, EMEA and APJC all recorded Q2 revenue growth.
Cash flow, balance sheet and capital allocation
- Six-month operating cash flow was $7.560B, compared with $7.150B a year earlier. Capital expenditures were $473M; company-defined free cash flow was $7.087B, versus $6.771B.
- Cash, cash equivalents and investments totaled $40.383B at January 26, 2019, down from $46.548B at July 28, 2018. Total debt carrying value was $25.630B ($9.737B current and $15.893B long-term).
- Current assets were $53.117B and current liabilities $29.479B. Deferred revenue was $17.261B, down from $19.685B at fiscal year-end; the filing attributes much of the decline to adoption of ASC 606.
- Cash returned to shareholders in the first six months included $10.062B of program repurchases and $2.970B of dividends. Cisco stated an intention to return at least 50% of annual free cash flow to shareholders. After quarter-end, the board declared a $0.35 quarterly dividend and authorized an additional $15B of repurchases, leaving approximately $24B authorized.
Material changes, outlook and notable items
- Accounting change: Cisco adopted ASC 606 using the modified retrospective method. Management said it accelerated recognition for certain software arrangements and two-tier distributor sales; adoption increased reported Q2 revenue by $267M and first-half revenue by $516M. Comparisons with prior periods are therefore affected. The transition increased retained earnings by $2.3B.
- Prior-year tax distortion: FY2018 comparative losses reflected an approximately $11.1B charge associated with the Tax Cuts and Jobs Act. Cisco completed its accounting for that Act in Q2 FY2019 and recorded a further $58M tax expense; the total tax charge was $10.5B. FY2019 effective tax rates were 15.6% for Q2 and 12.1% for the first six months.
- Margins and costs: Q2 gross margin fell 0.6 percentage points year over year, with management citing pricing and productivity pressures, including higher memory and other component costs. First-half gross margin improved 0.3 points, supported by productivity and the prior-year $127M legal settlement charge. The ongoing FY2018 restructuring plan had incurred $372M cumulatively; estimated total pretax charges are approximately $600M, with substantial completion expected in fiscal 2019.
- Acquisitions and divestiture: Cisco acquired Duo Security for approximately $2.0B in the first six months and completed the SPVSS sale on October 28, 2018. It acquired Luxtera for approximately $660M after quarter-end. The Arista litigation settlement produced a $400M benefit to G&A in Q1 FY2019.
- Outlook: The filing provides no specific numerical revenue or earnings guidance. Management reported continued investment in priority areas while noting a challenging, uncertain and highly competitive environment. It expects available cash, investments, operating cash generation and access to capital to meet liquidity needs for at least the next 12 months. Cisco expects approximately 56% of its $22.5B remaining performance obligations to be recognized as revenue over the next year.
- Risks and contingencies: Risks include volatile service-provider demand, pricing and competition, component costs and supply constraints, revenue timing and customer spending uncertainty, customer and channel-partner credit exposure, foreign exchange, taxes, cybersecurity, and intellectual-property claims. Brazilian tax authorities assert claims aggregating to $2.615B including tax, interest and penalties; Cisco disputes liability, but says it cannot estimate the likelihood or range of loss. The company was also subject to other patent and indemnification matters; management generally did not expect their outcomes to be material.
Important facts for investors to verify
- Assess reported growth and margins alongside the ASC 606 revenue acceleration and SPVSS divestiture effects.
- Review whether growth in Applications, Security and Infrastructure Platforms continues, and monitor service-provider demand, China performance and component-cost pressure.
- Track cash generation against substantial repurchases, dividends, upcoming debt maturities, the transition-tax payments and acquisition spending.
- Monitor restructuring charges, the Arista settlement’s nonrecurring benefit, and the potential outcomes of the Brazilian tax claims and other litigation.
- Check future filings for any formal guidance, changes in liquidity assumptions, or revisions to the expected timing of remaining performance obligations.