Cisco Systems, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended July 28, 2018 (52 weeks); fourth quarter ended the same date. Dollar figures are U.S. dollars.
Business context and reporting period
Cisco designs and sells networking, security, collaboration, application, cloud and related services worldwide. It reports geographically across the Americas, EMEA, and APJC. Its strategy emphasizes intent-based networking, security, multi-cloud, and a shift toward software and subscription offerings.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $49.330 billion | $48.005 billion |
| Gross margin | $30.606 billion; 62.0% | $30.224 billion; 63.0% |
| Operating income | $12.309 billion; 25.0% of revenue | $11.973 billion; 24.9% |
| Net income | $110 million; diluted EPS $0.02 | $9.609 billion; diluted EPS $1.90 |
| Operating cash flow | $13.666 billion | $13.876 billion |
| Free cash flow (company-defined) | $12.832 billion | $12.912 billion |
FY2018 revenue rose 3%: product revenue increased 3% to $36.709 billion and service revenue increased 3% to $12.621 billion. By product category, Infrastructure Platforms grew 2% to $28.270 billion, Applications grew 10% to $5.035 billion, Security grew 9% to $2.353 billion, and Other Products declined 13% to $1.050 billion.
Product gross margin fell to 60.7% from 61.6%; service gross margin fell to 66.0% from 66.8%. The filing reports pricing pressure, unfavorable product mix, higher constrained-component costs, and a $127 million legal and indemnification settlement charge as factors weighing on product margin. Productivity partly offset these pressures.
At July 28, 2018, cash and cash equivalents were $8.934 billion and investments were $37.614 billion, totaling $46.548 billion, down from $70.492 billion a year earlier. Total debt was $25.569 billion, including $5.238 billion classified as short-term; no commercial paper was outstanding. Current assets were $61.837 billion and current liabilities were $27.035 billion. Deferred revenue increased 6% to $19.685 billion, including $6.120 billion related to recurring software and subscriptions.
Cash returned to shareholders included $17.661 billion of repurchases and $5.968 billion of dividends. The annual dividend declared per share rose to $1.24 from $1.10. Cisco had approximately $19.0 billion of repurchase authorization remaining and expected to use it over the next 12 to 18 months.
Material changes versus the prior comparable period
- Revenue growth resumed after a 3% decline in FY2017. FY2018 growth was broad across geographies; Americas revenue rose 3%, EMEA 4%, and APJC 2%.
- Applications and Security grew faster than the overall business, while Infrastructure Platforms grew modestly. Service-provider weakness continued to affect routing and related sales.
- Net income fell 99% year over year, principally because FY2018 included a provisional $10.4 billion Tax Act expense: $8.1 billion U.S. transition tax, $1.2 billion foreign withholding tax, and $1.1 billion deferred-tax remeasurement. The reported effective tax rate was 99.2%, versus 21.8% in FY2017.
- Cash and investments declined by $23.944 billion, mainly reflecting repurchases, dividends, debt reduction, acquisitions and capital spending, partly offset by operating cash generation. Debt declined from $33.717 billion to $25.569 billion.
- Product backlog was approximately $6.6 billion, up 38% year over year, but Cisco cautioned that cancellations, short shipment cycles, and exclusion of subscription arrangements limit its predictive value.
Fourth-quarter snapshot
Q4 revenue was $12.844 billion, up 6% year over year; product revenue rose 7% and service revenue 3%. Gross margin was 61.7%, down 0.5 percentage points, while operating margin increased 1.1 points to 26.1%. Net income was $3.803 billion and diluted EPS was $0.81, increases of 57% and 69%, respectively; results benefited in part from an $863 million Tax Act-related tax benefit. Q4 operating income was $3.346 billion.
Outlook, risks, contingencies and unusual items
- Outlook: The filing provides no specific full-year revenue or earnings guidance. Management described broad business strength but continued uncertainty in service providers and a challenging, competitive environment. It expects higher component costs to affect productivity in the near term and plans continued investment in priority areas.
- Revenue standard: Cisco planned to adopt ASC 606 in FY2019 using the modified retrospective method. It estimated adoption could increase Q1 FY2019 year-over-year revenue by about 1%; the filing also estimated a roughly $2.3 billion cumulative increase to opening retained earnings.
- Restructuring and portfolio actions: A FY2018 restructuring plan was estimated to incur approximately $300 million in pretax charges; $108 million was incurred in FY2018, with substantial completion expected in FY2019. Cisco agreed to sell its Service Provider Video Software and Solutions business, with closing expected in the first half of FY2019, subject to approvals and other conditions.
- Acquisitions: Cisco completed eight acquisitions in FY2018, including BroadSoft. After year-end, it announced an agreement to acquire Duo Security for approximately $2.35 billion in cash and assumed equity awards, subject to customary conditions and approvals.
- Litigation: Brazilian tax authorities asserted claims against Cisco’s subsidiary totaling $218 million in taxes, $1.4 billion in interest, and $1.0 billion in penalties. Cisco disputes the claims, but said it could not assess the likelihood of an unfavorable outcome or reasonably estimate any loss; resolution may take years.
- Subsequent event: Cisco and Arista entered a settlement term sheet in August 2018 under which Arista paid Cisco $400 million on August 20, 2018; the payment was to be reflected in Q1 FY2019 results.
- Key operating risks: Pricing and intense competition, service-provider spending volatility, component supply constraints and purchase commitments, channel and inventory management, technology transitions, cybersecurity and product vulnerabilities, foreign exchange, customer financing exposure, and tax and regulatory uncertainty.
Most important facts for investors to verify
- Separate the $10.4 billion annual Tax Act charge from the $863 million Q4 tax benefit when assessing normalized earnings and the future tax burden.
- Track recurring software and subscription growth, deferred revenue, and the actual revenue and cash-flow effects of ASC 606 adoption.
- Monitor product gross margin, component availability and costs, and service-provider demand, particularly for routing.
- Review the outcome and financial exposure of the Brazilian tax claims, along with the closing and consideration for the SPVSS sale and Duo acquisition.
- Assess capital returns and balance-sheet commitments against operating cash flow, including debt maturities, purchase commitments of $6.477 billion, and the remaining repurchase authorization.