Cisco Systems, Inc. — Fiscal 2016 Form 10-K
Reporting period: Fiscal year ended July 30, 2016 (53 weeks); comparable fiscal 2015 was 52 weeks. Fourth-quarter results cover the three months ended July 30, 2016. Amounts are in U.S. dollars.
Business context
Cisco designs and sells networking, communications, security, data-center and related products, and provides technical support and advanced services. It reports three geographic segments: Americas, EMEA, and APJC. Management’s strategy emphasizes integrated architectures, security, cloud, IoT, software and subscription offerings, and a shift toward more recurring revenue.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Revenue | $49.247 billion | $49.161 billion |
| Gross margin | $30.960 billion; 62.9% | $29.681 billion; 60.4% |
| Operating income | $12.660 billion; 25.7% of revenue | $10.770 billion; 21.9% |
| Net income | $10.739 billion; diluted EPS $2.11 | $8.981 billion; diluted EPS $1.75 |
| Cash from operations | $13.570 billion | $12.552 billion |
| Free cash flow, as defined by Cisco | $12.424 billion | $11.325 billion |
- Product revenue was $37.254 billion, down 1.3%; service revenue was $11.993 billion, up 5.1%. Excluding the divested SP Video CPE business, total revenue increased 3%, though FY2016 included an extra week that management estimated added about $265 million of revenue.
- Cash, cash equivalents and investments totaled $65.756 billion, including $7.631 billion of cash and cash equivalents. About $59.8 billion was held by foreign subsidiaries; $5.9 billion was available in the United States.
- Debt was $28.643 billion on the balance sheet, including $28.4 billion principal of senior notes. Cisco issued $7.0 billion of notes in February 2016; no commercial paper or revolving-credit-facility borrowings were outstanding at year-end. The company reported compliance with debt covenants.
- Deferred revenue increased 8% to $16.472 billion. Net accounts receivable was $5.847 billion; days sales outstanding rose to 42 from 38. Inventory declined 25% to $1.217 billion, and annualized inventory turns improved to 14.6 from 12.1.
- Dividends paid were $4.750 billion; the declared dividend was $0.94 per share. Cisco repurchased $3.918 billion of shares under its program and stated an intention to return at least 50% of annual free cash flow through dividends and repurchases.
Material changes versus the prior period
- Reported annual revenue was nearly flat, while net income rose 19.6% and diluted EPS rose 20.6%. The 53rd week contributed estimated revenue of $265 million.
- Gross margin increased 2.5 percentage points. Management attributed the improvement to productivity, higher service margins, and the sale of the lower-margin SP Video CPE business, among other factors. The divestiture generated a $253 million pretax gain.
- The SP Video CPE business was sold in November 2015. FY2016 included $504 million of its revenue versus $1.846 billion in FY2015; this revenue will not recur. Excluding that business, FY2016 product revenue increased 2% and total revenue increased 3%.
- Security product revenue grew 12.7%, Collaboration 8.7%, Data Center 4.5%, and Wireless 3.3%. NGN Routing declined 3.8%; Service Provider Video declined 31.8%, principally reflecting the divestiture.
- Regional revenue was down 0.8% in the Americas and 0.3% in EMEA, while APJC increased 5.2%. Management reported that service-provider and emerging-country business momentum weakened in Q4 after improvement in the preceding three quarters.
- Annual results included a $367 million tax benefit from an IRS settlement and $226 million of U.S. R&D tax-credit benefits. The effective tax rate declined to 16.9% from 19.8%.
Outlook, risks and unusual items
- The filing provides no numerical revenue or earnings guidance. Management described the macroeconomic environment as uncertain, noted cautious service-provider capital spending, and said it continued to invest in security, IoT, collaboration, data center, cloud and software while transitioning toward subscriptions and recurring revenue.
- In August 2016, Cisco announced a restructuring affecting up to 5,500 employees, about 7% of its workforce. It estimated pretax charges of up to $700 million in fiscal 2017; substantially all expected savings are to be reinvested, so material net cost savings are not expected.
- Brazilian tax authorities’ remaining asserted claims total approximately $2.749 billion, comprising $249 million in taxes, $1.3 billion in interest and $1.2 billion in penalties. Cisco disputes the claims; it said outcome and potential loss could not be reasonably estimated and a final decision may take years.
- Other disclosed litigation includes a $23.7 million jury award to SRI International, subject to post-trial proceedings and appeal, and patent and trade-secret cases whose outcomes Cisco said it could not reasonably estimate. The SEC and Department of Justice decided not to bring enforcement actions following the company’s investigation into allegations involving Russia and certain CIS operations.
- Key operating risks include intense price and technology competition, product-transition execution, volatile service-provider demand, global economic and currency conditions, customer and channel-partner credit exposure, supply constraints and inventory obsolescence, cybersecurity, acquisitions, and intellectual-property claims.
- PwC issued an unqualified opinion on the financial statements and stated that internal control over financial reporting was effective as of July 30, 2016.
Most important facts for investors to verify
- How much of revenue, margin and EPS growth persists after accounting for the extra fiscal week, the SP Video CPE sale and the $253 million divestiture gain.
- The sustainability of service and subscription growth, deferred-revenue expansion, and momentum in Security and Collaboration versus weakness in routing and service-provider markets.
- The effect of the $367 million IRS settlement and R&D tax credits on the reported effective tax rate, and the potential implications of $65.6 billion in indefinitely reinvested foreign earnings.
- Cash availability and capital-allocation plans in light of $28.4 billion of senior-note principal and $4.15 billion of scheduled principal payments in fiscal 2017.
- Developments in the Brazilian tax claims, restructuring charges, acquisition integration, and other significant litigation or contingencies.