Cisco Systems, Inc. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2018, ended April 28, 2018. Financial statements are unaudited; comparisons are with the periods ended April 29, 2017, or July 29, 2017 for balance-sheet data.
Business context and results
Cisco sells networking, security, collaboration, cloud-related and other technology products, along with associated services. It reports geographically across the Americas, EMEA, and APJC, and by product categories including Infrastructure Platforms, Applications, Security and Other Products.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $12.463B | $11.940B | $36.486B | $35.872B |
| Gross margin | $7.759B; 62.3% | $7.518B; 63.0% | $22.684B; 62.2% | $22.678B; 63.2% |
| Operating income | $3.134B; 25.1% of revenue | $3.169B; 26.5% | $8.963B; 24.6% | $8.939B; 24.9% |
| Net income (loss) | $2.691B | $2.515B | $(3.693)B | $7.185B |
| Diluted EPS | $0.56 | $0.50 | $(0.76) | $1.42 |
| Operating cash flow | Not separately stated | Not separately stated | $9.566B | $9.875B |
Financial position and capital allocation
- At April 28, 2018, cash and cash equivalents were $6.719B and investments were $47.712B, totaling $54.431B, down $16.061B from July 29, 2017. Current assets were $67.141B and current liabilities $28.642B.
- Total debt was $28.072B carrying value ($7.736B short-term and $20.336B long-term), versus $33.717B at July 29, 2017. Cisco reported compliance with debt covenants, no commercial paper outstanding, and no borrowing under its $3.0B revolving credit facility.
- Operating cash flow was $9.566B; capital expenditures were $620M; company-defined free cash flow was $8.946B. Cash dividends paid were $4.433B and repurchases under the stock program were $11.562B during the nine months.
- Deferred revenue was $18.953B, up $459M from fiscal year-end. Product deferred revenue for recurring software and subscriptions was $5.635B, up 29% year over year.
- Inventory rose to $1.900B from $1.616B. Supplier and contract-manufacturer purchase commitments totaled $6.227B, versus $4.640B at fiscal year-end.
Material changes and management commentary
- Q3 revenue grew 4% year over year: product revenue rose 5% and services 3%. Nine-month revenue increased 2%.
- Q3 product growth was strongest in Applications (+19%) and Security (+11%); Infrastructure Platforms increased 2%, while Other Products declined 6%. Management cited strength across much of the portfolio, offset by routing weakness and continued service-provider market uncertainty.
- Q3 gross margin fell 0.7 percentage points. Management cited pricing pressure, higher memory costs and acquired-intangible amortization, partly offset by productivity improvements. It expected elevated costs for constrained memory components to continue in the near term.
- Nine-month product gross margin was pressured by pricing and a $127M legal and indemnification settlement charge. Service gross margin also declined, reflecting higher headcount-related and delivery costs and unfavorable mix.
- Nine-month net loss primarily reflected $11.1B of provisional Tax Act expense: $8.9B U.S. transition tax, $1.2B foreign withholding tax and $1.0B deferred-tax-asset remeasurement. The nine-month effective tax rate was 139.1%; Q3 rate was 17.3%. Cisco said the tax amounts remained provisional and could change.
- Cisco repatriated $67B of foreign subsidiary earnings in Q3 and paid $1.2B of foreign withholding tax. It plans to pay the transition tax in installments over eight years. Cash and investments held by foreign subsidiaries fell to $6.9B from $67.5B at fiscal year-end.
- Seven acquisitions were completed in the first nine months, including BroadSoft for $2.179B in purchase consideration. A new restructuring plan carries estimated pretax charges of approximately $300M and is expected to be substantially completed in fiscal 2019; the prior plan, with cumulative charges of approximately $1.0B, was completed.
Outlook, risks and contingencies
- No numerical revenue or earnings guidance is provided in the supplied filing text. Management described the overall environment as uncertain, cited ongoing service-provider weakness, and said it would continue investing in priority areas.
- Management expected to use the remaining approximately $25.1B stock repurchase authorization over the next 15 to 21 months. It stated that available liquidity, operating cash generation and financing access should meet requirements for at least the next 12 months.
- Cisco plans to adopt the new revenue recognition standard in fiscal 2019. Its preliminary assessment anticipated faster recognition for certain software arrangements and two-tier distributor sales, but no material total-revenue impact in the adoption year; actual effects may vary.
- Key operating risks include competition and pricing, service-provider demand, memory supply constraints and costs, inventory and purchase-commitment exposure, execution of acquisitions and restructuring, and cybersecurity and intellectual-property claims.
- Brazilian authorities’ asserted claims against Cisco’s subsidiary were $234M in taxes, $1.5B in interest and $1.1B in penalties. Cisco disputed the claims and said it could not estimate the likelihood or range of loss; a final judicial determination was not expected for several years.
- Other disclosed matters include patent and commercial litigation. Cisco recorded $127M of legal and indemnification settlement charges in the nine-month period. It said the ultimate costs of ordinary-course proceedings were not expected to materially adversely affect its consolidated position, results or cash flows.
Important facts for investors to verify
- How the provisional $11.1B Tax Act expense and related deferred tax estimates are finalized, and the timing of transition-tax payments.
- Whether revenue growth and recurring software and subscription deferrals continue, particularly given service-provider and routing weakness.
- Whether memory availability and costs, pricing pressure and supplier commitments affect future margins or inventory risk.
- Cash generation and liquidity after substantial repurchases and dividends, including debt maturities and the planned repurchase pace.
- Developments in the Brazilian tax claims, pending litigation and the estimated $300M restructuring plan.