Cisco Systems, Inc. — Q1 FY2019 Form 10-Q
Reporting period: Three months ended October 27, 2018; comparative period ended October 28, 2017. Unaudited. Cisco designs and sells networking, security, collaboration, applications and cloud technologies, and provides related services.
Financial performance and key metrics
- Revenue: $13.072 billion, up 8% year over year. Product revenue was $9.890 billion (+9%); service revenue was $3.182 billion (+3%). Revenue grew across all geographic segments: Americas +5%, EMEA +11%, APJC +12%.
- Product categories: Infrastructure Platforms $7.642 billion (+9%); Applications $1.419 billion (+18%); Security $651 million (+11%); Other Products $178 million (-38%), primarily reflecting lower SPVSS revenue.
- Profitability: Gross margin was $8.146 billion, or 62.3%, versus 61.2% a year earlier. Operating income was $3.805 billion (+38%), with a 29.1% operating margin versus 22.7%. Net income was $3.549 billion (+48%); diluted EPS was $0.77 versus $0.48. Net margin was 27.1% versus 19.7%.
- Cash flow: Operating cash flow was $3.763 billion versus $3.080 billion. Company-defined free cash flow, operating cash flow less property and equipment purchases, was $3.551 billion versus $2.912 billion.
- Liquidity and debt: Cash and cash equivalents plus investments totaled $42.593 billion at quarter-end, down from $46.548 billion at July 28, 2018. Total debt carrying value was $25.564 billion, including $7.241 billion classified as current; no commercial paper was outstanding. Cisco reported compliance with debt covenants and no borrowings under its $3 billion revolving credit facility.
- Balance sheet: Total assets were $105.429 billion and total liabilities $61.581 billion. Deferred revenue was $16.814 billion; remaining performance obligations were $22.3 billion, of which Cisco expected approximately 55% to be recognized over the next year.
Changes versus the prior comparable period
- Revenue increased 8%, supported by broad-based growth; product revenue rose faster than services. Cisco cited growth in enterprise and service-provider markets and strength in Infrastructure Platforms, Applications and Security.
- Gross margin improved 1.1 percentage points. Productivity improvements and the prior-year $122 million legal and indemnification charge helped, while product pricing was a headwind. APJC segment gross margin declined, mainly due to pricing and mix.
- Operating expenses for R&D, sales and marketing, and G&A together fell 5%. G&A declined 62%, primarily because of a $400 million benefit from the Arista litigation settlement recorded in the quarter. This benefit makes the operating-income comparison less representative of recurring expense trends.
- The effective tax rate fell to 9.2% from 19.2%, reflecting the lower U.S. federal tax rate and a $152 million tax benefit related to ASC 606 adoption. Diluted weighted-average shares fell by 380 million year over year; reported diluted EPS increased 60%.
- ASC 606 adoption accelerated revenue recognition in certain software arrangements and two-tier distributor sales. Cisco said adoption increased Q1 FY2019 revenue by $276 million and included a $2.3 billion opening retained-earnings adjustment. Prior-period results were not restated, so reported revenue is not fully comparable on the same accounting basis.
Outlook, management commentary, risks and unusual items
- Management described broad-based growth and continued progress in shifting toward software and subscriptions, while also noting a challenging, competitive and uncertain environment. It emphasized continued investment in priority areas to support long-term profitable growth. The filing provides no specific revenue or earnings guidance.
- Cisco intends to return at least 50% of annual free cash flow to shareholders through dividends and repurchases. It repurchased $5.026 billion of stock and paid $1.500 billion in dividends during the quarter; approximately $14.0 billion remained authorized, which Cisco expected to use over the next 9 to 15 months. Future dividends remain subject to Board approval.
- Cash and investments decreased mainly because of repurchases, dividends, $2.0 billion of net acquisition cash payments and capital expenditures, partly offset by operating cash flow. Cisco said available liquidity, operating cash generation and access to capital were expected to meet requirements for at least the next 12 months.
- Cisco acquired Duo Security for approximately $2.025 billion in purchase consideration. The acquisition contributed to higher goodwill and is included in Security revenue from its acquisition date. The SPVSS sale closed October 28, 2018, one day after quarter-end; Cisco expected an immaterial financial-statement impact.
- The fiscal 2018 restructuring plan was expanded by an additional estimated $300 million of pretax charges. Cisco recorded $78 million in Q1 and expected the plan to be substantially completed in FY2019; it expected substantially all savings to be reinvested, so future net cost savings were not expected to be material.
- Contingencies: Brazilian tax authorities asserted claims aggregating approximately $2.6 billion, including taxes, interest and penalties. Cisco disputes the claims, but said it could not determine the likelihood of an unfavorable outcome or reasonably estimate a loss range; a final judicial decision was not expected for several years. The company also disclosed patent and indemnification matters, including the appealed Sprint/TWC litigation, while stating it did not anticipate material exposure from that matter.
- Other risks: Results may be affected by uncertain customer spending and large-order timing, pricing and competition, service-provider demand, product and customer mix, supply constraints and inventory obsolescence, execution of software/subscription and technology transitions, acquisitions, cybersecurity and product vulnerabilities, foreign exchange and interest rates, tax-law uncertainty, and litigation. Cisco also noted that revenue-recognition estimates and distributor incentives involve judgment.
Important facts for investors to verify
- Assess underlying operating performance after separating the $400 million Arista settlement benefit, ASC 606’s $276 million revenue impact and the $152 million adoption-related tax benefit.
- Review the sustainability of product and service growth, pricing pressure, product mix and APJC margin performance, alongside the continued software and subscription transition.
- Track cash generation and capital returns against acquisition spending, debt maturities and Cisco’s stated plan to use the remaining repurchase authorization over 9 to 15 months.
- Monitor the evolving Brazilian tax claims, other litigation and indemnification exposure, and the provisional accounting for the Tax Act, including the $8.1 billion transition-tax payable.
- Compare future results with management’s stated risks and strategy; this filing provides no specific financial forecast, and quarterly results may fluctuate.