Cisco Systems, Inc. — Form 10-Q Summary
Business context and period: Cisco designs and sells networking, security, collaboration, cloud and related technology, as well as services. This unaudited report covers the three and six months ended January 27, 2018 (fiscal 2018 Q2); comparisons are with the periods ended January 28, 2017. Amounts are in U.S. dollars.
Key financial results
| Metric | Three months ended Jan. 27, 2018 | Six months ended Jan. 27, 2018 |
|---|---|---|
| Revenue | $11.887 billion; up 3% | $24.023 billion; approximately flat |
| Gross margin | $7.498 billion; 63.1% versus 62.8% | $14.925 billion; 62.1% versus 63.3% |
| Operating income | $3.073 billion; 25.9% of revenue versus 25.0% | $5.829 billion; 24.3% of revenue versus 24.1% |
| Net income (loss) | $(8.778) billion; diluted loss per share $(1.78) | $(6.384) billion; diluted loss per share $(1.29) |
| Cash from operations | Not separately presented in the supplied filing text | $7.150 billion versus $6.502 billion |
| Free cash flow | Not separately presented in the supplied filing text | $6.771 billion versus $5.976 billion |
The net loss primarily reflects a provisional $11.1 billion tax expense related to the Tax Act, rather than an operating loss. Product and service revenue each rose 3% in Q2. For the first six months, product revenue was flat and service revenue rose 2%. Recurring software and subscription product deferred revenue was $5.451 billion, up 36% year over year.
Balance sheet, liquidity and capital allocation
- At January 27, 2018, cash and cash equivalents were $17.624 billion and investments were $56.059 billion, totaling $73.683 billion, up from $70.492 billion at July 29, 2017. Cisco reported $71.3 billion of cash and investments held by foreign subsidiaries and $2.4 billion available in the United States.
- Total debt was $39.366 billion: $13.741 billion short-term and $25.625 billion long-term. Commercial paper outstanding was $8.992 billion; $30.5 billion of senior-note principal was outstanding. Cisco said it was in compliance with debt covenants and had not drawn on its revolving credit facilities.
- Current assets were $86.050 billion and current liabilities $35.364 billion. Deferred revenue totaled $18.788 billion. Financing receivables, net, were $9.838 billion.
- Six-month operating cash flow of $7.150 billion less $379 million of capital expenditures produced Cisco-defined free cash flow of $6.771 billion. Operating cash flow included a $10.246 billion positive change in net income taxes within operating assets and liabilities.
- During the six months, Cisco repurchased $5.457 billion of shares under its program and paid $2.861 billion in dividends. Management’s policy is to return at least 50% of annual free cash flow through dividends and repurchases. After quarter end, the board authorized an additional $25 billion of buybacks; approximately $31 billion was then available under the program.
Material changes and management commentary
- Q2 revenue increased 3%, operating margin improved by 0.9 percentage points, and operating income rose 6%. For the six-month period, revenue was flat and operating margin improved 0.2 percentage points, while total gross margin fell 1.2 percentage points.
- Security and Applications product revenue each grew 6% in Q2; Infrastructure Platforms grew 2%. For six months, Applications grew 6%, Security 7%, Infrastructure Platforms declined 1%, and Other Products declined 13%. Management cited continued weakness and uncertainty in the service-provider market.
- Q2 gross-margin improvement reflected productivity and favorable product mix, partly offset by pricing pressure. Management said constrained memory-component supply was raising costs and expected the impact to continue in the near term. The six-month product margin was also affected by a $127 million legal and indemnification settlement charge.
- Cisco incurred $250 million of restructuring and other charges in the first six months and said the restructuring plan was substantially complete, with cumulative charges of about $1.0 billion. It expected to reinvest substantially all related savings in priority areas, so future net cost savings were not expected to be material.
- Following enactment of the Tax Act, Cisco recorded provisional charges of $9.0 billion for the U.S. transition tax, $1.2 billion for foreign withholding tax, and $0.9 billion for deferred-tax-asset remeasurement. Cisco anticipated repatriating $67 billion of foreign earnings in fiscal Q3; $26 billion had been repatriated in February 2018. It planned to pay the transition tax over eight years. The tax accounting remained provisional and could change.
- After quarter end, Cisco completed its approximately $1.9 billion BroadSoft acquisition on February 1, 2018. The filing gives no specific full-year revenue or earnings guidance. Management said it remained focused on innovation, Security and Applications growth, and shifting toward software and subscriptions, while describing the overall environment as uncertain and competitive.
Risks, contingencies and unusual items
- Brazilian federal and São Paulo authorities asserted claims totaling $257 million of taxes, $1.6 billion of interest and $1.2 billion of penalties. Cisco disputed the claims but said it could not assess the likelihood of an adverse outcome or reasonably estimate a loss range.
- Other disclosed litigation included the SRI patent matter, with a $57 million judgment under appeal and an ongoing royalty through patent expiration in 2018; Cisco did not expect the ultimate loss to be material. The filing also described unresolved patent and contract disputes.
- Key business risks include service-provider spending weakness, intense competition and pricing pressure, component constraints and potential excess inventory, and the execution and returns of investments in new products and acquisitions.
- Revenue-recognition rules scheduled for adoption in fiscal 2019 were expected to accelerate recognition for certain term software, enterprise-license and distributor sales; Cisco’s preliminary view was that the overall adoption-year revenue impact would not be material, though actual impacts could vary.
Important facts for investors to verify
- How the provisional Tax Act accounting is finalized, the resulting tax cash payments, and the timing and location of foreign-cash repatriation.
- Whether service-provider demand, pricing pressure and constrained memory supply affect future revenue and product margins.
- How Cisco funds near-term debt maturities and balances debt, buybacks, dividends and acquisition spending.
- Whether recurring software and subscription growth translates into sustained revenue, cash flow and profitability as accounting recognition changes.
- Developments in the Brazilian tax claims and other litigation or indemnification exposures.