CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
For additional discussion of our strategy and priorities, see Item 1. Business in our Annual Report on Form 10-K for the fiscal year ended July 29, 2017.30, 2022.
The following is a summary of our other key financial measures for the second quarter and first six months of fiscal 20182023 (in millions):
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended July 29, 2017,30, 2022, as updated as applicable in Note 2 to the Consolidated Financial Statements herein, describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies.
Revenue Recognition
Revenue is recognized when allWe enter into contracts with customers that can include various combinations of the following criteria have been met:
Persuasive evidence of an arrangement exists. Contracts, Internet commerce agreements,products and customer purchase ordersservices which are generally used todistinct and accounted for as separate performance obligations. As a result, our contracts may contain multiple performance obligations. We determine the existence of an arrangement.
Delivery has occurred. Shipping documents and customer acceptance, when applicable,whether arrangements are used to verify delivery. For software, delivery is considered to have occurred upon unrestricted license access and license term commencement, when applicable.
The fee is fixed or determinable. We assessdistinct based on whether the fee is fixedcustomer can benefit from the product or determinable basedservice on the payment terms associatedits own or together with the transactionother resources that are readily available and whether our commitment to transfer the sales price is subjectproduct or service to refund or adjustment.
Collectibility is reasonably assured. We assess collectibility based primarily on the creditworthiness of the customer is separately identifiable from other obligations in the contract. We classify our hardware, perpetual software licenses, and SaaS as determineddistinct performance obligations. Term software licenses represent multiple obligations, which include software licenses and software maintenance. In transactions where we deliver hardware or software, we are typically the principal and we record revenue and costs of goods sold on a gross basis.
We recognize revenue upon transfer of control of promised goods or services in a contract with a customer in an amount that reflects the consideration we expect to receive in exchange for those products or services. Transfer of control occurs once the customer has the contractual right to use the product, generally upon shipment, electronic delivery (or when the software is available for download by credit checksthe customer), or once title and analysis, as wellrisk of loss has transferred to the customer. Transfer of control can also occur over time for software maintenance and services as the customer’s payment history.
In instances where final acceptance ofcustomer receives the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met. When a sale involves multiple deliverables, such as sales of products that include services, the multiple deliverables are evaluated to determine the unit of accounting, and the entire fee from the arrangement is allocated to each unit of accounting based on the relative selling price. Revenue is recognized when the revenue recognition criteria for each unit of accounting are met. For hosting arrangements, we recognize revenue ratablybenefit over the hosting period, while usagecontract term. Our hardware and perpetual software licenses are distinct performance obligations where revenue is recognized based on utilization. Software subscriptionupfront upon transfer of control. Term software licenses include multiple performance obligations where the term licenses are recognized upfront upon transfer of control, with the associated software maintenance revenue is deferred and recognized ratably over the subscriptioncontract term upon deliveryas services and software updates are provided. SaaS arrangements do not include the right for the customer to take possession of the first productsoftware during the term, and commencement of the term.
The amount oftherefore have one distinct performance obligation which is satisfied over time with revenue recognized ratably over the contract term as the customer consumes the services. On our product sales, we record consideration from shipping and handling on a gross basis within net product sales. We record our revenue net of any associated sales taxes.
Revenue is allocated among these performance obligations in a given periodmanner that reflects the consideration that we expect to be entitled to for the promised goods or services based on standalone selling prices (SSP). SSP is affected by ourestimated for each distinct performance obligation and judgment as to whether an arrangement includes multiple deliverables and, if so, our valuation of the units of accounting. Our multiple element arrangements may contain only deliverables within the scope of Accounting Standards Codification (ASC) 605, Revenue Recognition, deliverables within the scope of ASC 985-605, Software-Revenue Recognition, or a combination of both. According to the accounting guidance prescribedbe required in ASC 605, we use vendor-specific objectivetheir determination. The best evidence of sellingSSP is the observable price (VSOE) for each of those units, when available. We determine VSOE based on our normal pricing and discounting practices for the specifica product or service when sold separately.we sell the goods separately in similar circumstances and to similar customers. In determining VSOE,instances where SSP is not directly observable, we requiredetermine SSP using information that a substantial majority of the historical standalone transactions have the selling prices for a product or service fall within a reasonably narrow pricing range, generally evidenced by approximately 80% of such historical standalone transactions falling within plus or minus 15% of the median rates. When VSOE does not exist, we apply the selling price hierarchy to applicable multiple-deliverable arrangements. Under the selling price hierarchy, third-party evidence of selling price (TPE) will be considered if VSOE does not exist,may include market conditions and estimated selling price (ESP) will be used if neither VSOE nor TPE is available. Generally, we are not ableother observable inputs.
We assess relevant contractual terms in our customer contracts to determine TPE because our go-to-market strategy differs from that of othersthe transaction price. We apply judgment in our markets,identifying contractual terms and determining the extent of our proprietary technology varies among comparable products or services from those of our peers. In determining ESP, we apply significant judgmenttransaction price as we weigh a variety of factors, based on the characteristics of the deliverable. We typically arrive at an ESP for a product or service that is not sold separately by considering company-specific factors such as geographies, competitive landscape, internal costs, profitability objectives, pricing practices used to establish bundled pricing, and existing portfolio pricing and discounting.
As our business and offerings evolve over time, our pricing practices may be required to be modified accordingly, which could result in changes in selling prices, including both VSOEestimate variable consideration when determining the amount of revenue to recognize. Variable consideration includes potential contractual penalties and ESP, in subsequent periods. There were no material impacts during the first six months of fiscal 2018, nor do we currently expect a material impact in the next 12 months on our revenue recognition due to any changes in our VSOE, TPE, or ESP.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
We make sales to distributors which we refer to as two-tier sales to the end customer. Revenue from two-tier distributors is recognized based on a sell-through method using point-of-sale information provided by these distributors. Distributors participate in various rebate, cooperative marketing and other incentive programs that we offer to our distributors, channel partners and customers. When determining the amount of revenue to recognize, we maintain estimated accrualsestimate the expected usage of these programs, applying the expected value or most likely estimate and allowances for these programs.update the estimate at each reporting period as actual utilization becomes available. We also consider the customers’ right of return in determining the transaction price, where applicable. If actual credits received by distributors under these programs were to deviate significantly from our estimates, which are based on historical experience, our revenue could be adversely affected.
AllowancesSee Note 3 to the Consolidated Financial Statements for Receivables and Sales Returns
The allowances for receivables were as follows (in millions, except percentages):
|
| | | | | | | | |
| | | January 27,
2018 | | July 29,
2017 |
| Allowance for doubtful accounts | | $ | 181 |
| | $ | 211 |
|
| Percentage of gross accounts receivable | | 4.4 | % | | 3.9 | % |
| Allowance for credit loss—lease receivables | | $ | 165 |
| | $ | 162 |
|
Percentage of gross lease receivables(1) | | 5.6 | % | | 5.5 | % |
| Allowance for credit loss—loan receivables | | $ | 94 |
| | $ | 103 |
|
| Percentage of gross loan receivables | | 1.9 | % | | 2.3 | % |
(1)Calculated as allowance for credit loss on lease receivables as a percentage of gross lease receivables and residual value before unearned income.
The allowance for doubtful accounts is based on our assessment of the collectibility of customer accounts. We regularly review the adequacy of these allowances by considering internal factors such as historical experience, credit quality and age of the receivable balances as well as external factors such as economic conditions that may affect a customer’s ability to pay as well as historical and expected default frequency rates, which are published by major third-party credit-rating agencies and are updated on a quarterly basis. We also consider the concentration of receivables outstanding with a particular customer in assessing the adequacy of our allowances for doubtful accounts. If a major customer’s creditworthiness deteriorates, if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our operating results.
The allowance for credit loss on financing receivables is also based on the assessment of collectibility of customer accounts. We regularly review the adequacy of the credit allowances determined either on an individual or a collective basis. When evaluating the financing receivables on an individual basis, we consider historical experience, credit quality and age of receivable balances, and economic conditions that may affect a customer’s ability to pay. When evaluating financing receivables on a collective basis, we use expected default frequency rates published by a major third-party credit-rating agency as well as our own historical loss rate in the event of default, while also systematically giving effect to economic conditions, concentration of risk and correlation. Determining expected default frequency rates and loss factors associated with internal credit risk ratings, as well as assessing factors such as economic conditions, concentration of risk, and correlation, are complex and subjective. Our ongoing consideration of all these factors could result in an increase in our allowance for credit loss in the future, which could adversely affect our operating results. Both accounts receivable and financing receivables are charged off at the point when they are considered uncollectible.
A reserve for future sales returns is established based on historical trends in product return rates. The reserve for future sales returns as of January 27, 2018 and July 29, 2017 was $121 million and $122 million, respectively, and was recorded as a reduction of our accounts receivable and revenue. If the actual future returns were to deviate from the historical data on which the reserve had been established, our revenue could be adversely affected.more details.
Inventory Valuation and Liability for Purchase Commitments with Contract Manufacturers and Suppliers
Inventory is written down based on excess and obsolete inventories, determined primarily by future demand forecasts. Inventory write-downs are measured as the difference between the cost of the inventory and market,net realizable value, based upon assumptions about future demand, and are charged to the provision for inventory, which is a component of our cost of sales. At the point of the loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
We record a liability for firm, noncancelable, and unconditional purchase commitments with contract manufacturers and suppliers for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of January 27, 2018, the liability for these purchase commitments was $159 million, compared with $162 million as of July 29, 2017, and was included in other current liabilities.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Our provision for inventory was $31$92 million and $35$45 million for the first six months of fiscal 20182023 and 2017,2022, respectively. The provision for the liability related to purchase commitments with contract manufacturers and suppliers was $44$199 million and $74$80 million for the first six months of fiscal 20182023 and 2017,2022, respectively. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, or if supply constraints were to continue, we could be required to increase our inventory write-downs, and our liability for purchase commitments with contract manufacturers and suppliers, and accordingly our profitability, could be adversely affected. We regularly evaluate our exposure for inventory write-downs and the adequacy of our liability for purchase commitments. While we saw further improvements in the second quarter of fiscal 2023, we continue to manage through significant supply constraints seen industry-wide due to component shortages caused, in part, by the COVID-19 pandemic. For further discussion around the Supply Constraints Impacts and Risks, see “Result of Operations—Product Gross Margin—Supply Constraints Impact and Risks” and “Liquidity and Capital Resources—Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility to help ensure competitive lead times with the risk of inventory obsolescence, particularly in light of current macroeconomic uncertainties and conditions and the resulting potential for changes in future demand forecast.Supply Chain.”
Loss Contingencies and Product Warranties
We are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate information available to us to determine whether such accruals should be made or adjusted and whether new accruals are required.
Third parties, including customers, have in the past and may in the future assert claims or initiate litigation related to exclusive patent, copyright, trademark, and other intellectual property rights to technologies and related standards that are relevant to us. These assertions have increased over time as a result of our growth and the general increase in the pace of patent claims assertions, particularly in the United States. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results, and financial condition could be materially and adversely affected.
In fiscal 2014, we recorded a charge to product cost of sales of $655 million resulting from failures related to products containing memory components manufactured by a single supplier between 2005 and 2010. We perform regular assessments of the sufficiency of this liability and reduced the amount by $74 million and $164 million in fiscal 2016 and fiscal 2015, respectively based on updated analyses. During the second quarter of fiscal 2017, we further reduced the liability by $141 million to reflect lower than expected defects, actual usage history, and estimated lower future remediation costs as more of the impacted products age and near the end of the support period covered by the remediation program. In addition, during the second quarter of fiscal 2017, we recorded a $125 million charge to product cost of sales related to the expected remediation costs for anticipated failures in future periods of a widely-used component sourced from a third party which is included in several of our products. The liabilities related to the supplier component remediation matters as of January 27, 2018 and July 29, 2017 were $120 million and $174 million, respectively.
Estimating these liabilities is complex and subjective, and if we experience changes in a number of underlying assumptions and estimates such as a change in claims compared with our expectations, or if the cost of servicing these claims is different than expected, our estimated liabilities for these matters may be impacted.
Our products are generally covered by a warranty for periods ranging from 90 days to five years, and for some products we provide a limited lifetime warranty. We accrue for warranty costs as part of our cost of sales based on associated material costs, technical support labor costs, and associated overhead. Material cost is estimated based primarily upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the equipment. Technical support labor cost is estimated based primarily upon historical trends in the rate of customer cases and the cost to support the customer cases within the warranty period. Overhead cost is applied based on estimated time to support warranty activities.
If we experience an increase in warranty claims compared with our historical experience, or if the cost of servicing warranty claims is greater than expected, our profitability could be adversely affected.
Fair Value Measurements
Our fixed income and publicly traded equity securities, collectively, are reflected in the Consolidated Balance Sheets at a fair value of $56.1 billion as of January 27, 2018, compared with $58.8 billion as of July 29, 2017. Our fixed income investment portfolio as of January 27, 2018 consisted primarily of high quality investment-grade securities. See Note 8 to the Consolidated Financial Statements.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
As described more fully in Note 9 to the Consolidated Financial Statements, a valuation hierarchy is based on the level of independent, objective evidence available regarding the value of the investments. It encompasses three classes of investments: Level 1 consists of securities for which there are quoted prices in active markets for identical securities; Level 2 consists of securities for which observable inputs other than Level 1 inputs are used, such as quoted prices for similar securities in active markets or quoted prices for identical securities in less active markets and model-derived valuations for which the variables are derived from, or corroborated by, observable market data; and Level 3 consists of securities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value.
Our Level 2 securities are valued using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. We use inputs such as actual trade data, benchmark yields, broker/dealer quotes, and other similar data, which are obtained from independent pricing vendors, quoted market prices, or other sources to determine the ultimate fair value of our assets and liabilities. We use such pricing data as the primary input, to which we have not made any material adjustments during the periods presented, to make our assessments and determinations as to the ultimate valuation of our investment portfolio. We are ultimately responsible for the financial statements and underlying estimates.
The inputs and fair value are reviewed for reasonableness, may be further validated by comparison to publicly available information, and could be adjusted based on market indices or other information that management deems material to its estimate of fair value. The assessment of fair value can be difficult and subjective. However, given the relative reliability of the inputs we use to value our investment portfolio, and because substantially all of our valuation inputs are obtained using quoted market prices for similar or identical assets, we do not believe that the nature of estimates and assumptions affected by levels of subjectivity and judgment was material to the valuation of the investment portfolio as of January 27, 2018. Level 3 assets do not represent a significant portion of our total assets measured at fair value on a recurring basis as of January 27, 2018 and July 29, 2017.
Other-than-Temporary Impairments
We recognize an impairment charge when the declines in the fair values of our fixed income or publicly traded equity securities below their cost basis are judged to be other than temporary. The ultimate value realized on these securities, to the extent unhedged, is subject to market price volatility until they are sold.
If the fair value of a debt security is less than its amortized cost, we assess whether the impairment is other than temporary. An impairment is considered other than temporary if (i) we have the intent to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovery of its entire amortized cost basis, or (iii) we do not expect to recover the entire amortized cost of the security. If an impairment is considered other than temporary based on (i) or (ii) described in the prior sentence, the entire difference between the amortized cost and the fair value of the security is recognized in earnings. If an impairment is considered other than temporary based on condition (iii), the amount representing credit loss, defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security, will be recognized in earnings, and the amount relating to all other factors will be recognized in other comprehensive income (OCI). In estimating the amount and timing of cash flows expected to be collected, we consider all available information, including past events, current conditions, the remaining payment terms of the security, the financial condition of the issuer, expected defaults, and the value of underlying collateral.
For publicly traded equity securities, we consider various factors in determining whether we should recognize an impairment charge, including the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the issuer, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.
We also have investments in privately held companies, some of which are in the startup or development stages. As of January 27, 2018, our investments in privately held companies were $982 million, compared with $983 million as of July 29, 2017, and were included in other assets. We monitor these investments for events or circumstances indicative of potential impairment, and we make appropriate reductions in carrying values if we determine that an impairment charge is required, based primarily on the financial condition and near-term prospects of these companies. These investments are inherently risky because the markets for the technologies or products these companies are developing are typically in the early stages and may never materialize.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Goodwill and Purchased Intangible Asset Impairments
Our methodology for allocating the purchase price relating to purchase acquisitions is determined through established valuation techniques. Goodwill represents a residual value as of the acquisition date, which in most cases results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquired company over the fair value of net assets acquired, including contingent consideration. We perform goodwill impairment tests on an annual basis in the fourth fiscal quarter and between annual tests in certain circumstances for each reporting unit. The assessment of fair value for goodwill and purchased intangible assets is based on factors that market participants would use in an orderly transaction in accordance with the new accounting guidance for the fair value measurement of nonfinancial assets.
The goodwill recorded in the Consolidated Balance Sheets as of January 27, 2018 and July 29, 2017 was $30.4 billion and $29.8 billion, respectively. In response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill. There was no impairment of goodwill in each of the first six months of fiscal 20182023 and 2017.2022.
The fair value of acquired technology and patents, as well as acquired technology under development, is determined at acquisition date primarily using the income approach, which discounts expected future cash flows to present value. The discount rates used in the present value calculations are typically derived from a weighted-average cost of capital analysis and then adjusted to reflect risks inherent in the development lifecycle as appropriate. We consider the pricing model for products related to these acquisitions to be standard within the high-technology communications industry, and the applicable discount rates represent the rates that market participants would use for valuation of such intangible assets.
We make judgments about the recoverability of purchased intangible assets with finite lives whenever events or changes in circumstances indicate that an impairment may exist. Recoverability of purchased intangible assets with finite lives is measured by comparing the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. We review indefinite-lived intangible assets for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Assumptions and estimates about future values and remaining useful lives of our purchased intangible assets are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
strategy and our internal forecasts.
There were no impairment charges related to purchased intangible assets for the first six months of fiscal 2018, and there were $42 million of such impairment charges for the first six months of fiscal 2017. Our ongoing consideration of all the factors described previously could result in additional impairment charges in the future, which could adversely affect our net income.
Income Taxes
We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective tax rates differ from the statutory rate, primarily due to the tax impact of state taxes, foreign operations, R&D tax credits, domestic manufacturingforeign-derived intangible income deductions, global intangible low-taxed income, tax audit settlements, nondeductible compensation, and international realignments, and transfer pricing adjustments.realignments. Our effective tax rate was 371.6%18.8% and20.8% 17.5% in the second quarter of fiscal 20182023 and 2017, respectively. Our effective tax rate was 203.1%2022, respectively, and21.1% 21.0% and 18.0% in the first six months of fiscal 20182023 and 2017,2022, respectively.
The Tax Act, enacted on December 22, 2017, lowers the U.S. federal corporation income tax rate from 35% to 21% effective January 1, 2018, while also imposing a mandatory one-time transition tax on accumulated earnings of foreign subsidiaries. During the three months ended January 27, 2018, the Company recorded a provisional tax expense of $11.1 billion related to the Tax Act, comprised of $9.0 billion of U.S. transition tax, $1.2 billion of foreign withholding tax and $0.9 billion of DTA re-measurement.
In December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118, which addresses how a company recognizes provisional estimates when a company does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The measurement period ends when a company has obtained, prepared, and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. The final impact of the Tax Act may differ from the provisional estimates due to changes in interpretations of the Tax Act, and legislative action to address questions that arise because of the Tax Act, by changes in accounting standard for income taxes and related interpretations in response to the Tax Act, and updates or changes to estimates used in the provisional amounts. We have determined that the $9.0 billion of tax expense for the U.S. transition tax on accumulated earnings of foreign subsidiaries, the $1.2 billion of foreign withholding tax, and the $0.9 billion of tax expense for DTA re-measurement were each provisional amounts and reasonable estimates as of January 27, 2018. Estimates used in the provisional amounts include: the anticipated reversal pattern of the gross DTAs; and earnings, cash positions, foreign taxes and withholding taxes attributable to foreign subsidiaries.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest and penalties.
Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by changes to domestic manufacturingforeign-derived intangible income deduction, global intangible low-tax income and base erosion and anti-abuse tax laws, regulations, or interpretations thereof; by expiration of or lapses in tax incentives; by transfer pricing adjustments, including the effect of acquisitions on our intercompany R&D cost-sharing arrangement and legal structure; by tax effects of nondeductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by changes in tax laws and regulations, treaties, or interpretations thereof, including changes to the taxation of earnings of our foreign subsidiaries, the deductibility of expenses attributable to foreign income, and the foreign tax credit rules. Significant judgment is required to determine the recognition and measurement attributes prescribed in the accounting guidance for uncertainty in income taxes. The Organisation for Economic Co-operation and Development (OECD), an international association comprised of 3538 countries, including the United States, has made changes and is contemplating additional changes to numerous long-standing tax principles. There can be no assurance that these changes and any contemplated changes if finalized, once adopted by countries, will not have an adverse impact on our provision for income taxes. As a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries iswas subject to reduced tax rates. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service (IRS) and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse impact on our operating results and financial condition.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS
Revenue
The following table presents the breakdown of revenue between product and service (in millions, except percentages):
| | | | | Three Months Ended | | Six Months Ended | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent |
| Revenue: | | | | | | | | | | | | | | | | | Revenue: | | | | | | | | | | | | | | | | |
| Product | | $ | 8,709 |
| | $ | 8,491 |
| | $ | 218 |
| | 3 | % | | $ | 17,763 |
| | $ | 17,793 |
| | $ | (30 | ) | | — | % | Product | | $ | 10,155 | | | $ | 9,353 | | | $ | 802 | | | 9 | % | | $ | 20,400 | | | $ | 18,882 | | | $ | 1,518 | | | 8 | % |
| Percentage of revenue | | 73.3 | % | | 73.3 | % | | |
| | |
| | 73.9 | % | | 74.3 | % | | |
| | |
| Percentage of revenue | | 74.7 | % | | 73.5 | % | | | | | | 74.9 | % | | 73.7 | % | |
| Service | | 3,178 |
| | 3,089 |
| | 89 |
| | 3 | % | | 6,260 |
| | 6,139 |
| | 121 |
| | 2 | % | Service | | 3,437 | | | 3,367 | | | 70 | | | 2 | % | | 6,824 | | | 6,738 | | | 86 | | | 1 | % |
| Percentage of revenue | | 26.7 | % | | 26.7 | % | | |
| | |
| | 26.1 | % | | 25.7 | % | | |
| | |
| Percentage of revenue | | 25.3 | % | | 26.5 | % | | | | | | 25.1 | % | | 26.3 | % | |
| Total | | $ | 11,887 |
| | $ | 11,580 |
| | $ | 307 |
| | 3 | % | | $ | 24,023 |
| | $ | 23,932 |
| | $ | 91 |
| | — | % | Total | | $ | 13,592 | | | $ | 12,720 | | | $ | 872 | | | 7 | % | | $ | 27,224 | | | $ | 25,620 | | | $ | 1,604 | | | 6 | % |
We manage our business primarily on a geographic basis, organized into three geographic segments. Our revenue, which includes product and service for each segment, is summarized in the following table (in millions, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent |
| Revenue: | | | | | | | | | | | | | | | | |
| Americas | | $ | 7,825 | | | $ | 7,146 | | | $ | 679 | | | 9 | % | | $ | 15,738 | | | $ | 14,706 | | | $ | 1,032 | | | 7 | % |
| Percentage of revenue | | 57.6 | % | | 56.2 | % | | | | | | 57.8 | % | | 57.4 | % | | | | |
| EMEA | | 3,728 | | | 3,564 | | | 164 | | | 5 | % | | 7,404 | | | 6,867 | | | 537 | | | 8 | % |
| Percentage of revenue | | 27.4 | % | | 28.0 | % | | | | | | 27.2 | % | | 26.8 | % | | | | |
| APJC | | 2,039 | | | 2,010 | | | 29 | | | 1 | % | | 4,082 | | | 4,046 | | | 36 | | | 1 | % |
| Percentage of revenue | | 15.0 | % | | 15.8 | % | | | | | | 15.0 | % | | 15.8 | % | | | | |
| Total | | $ | 13,592 | | | $ | 12,720 | | | $ | 872 | | | 7 | % | | $ | 27,224 | | | $ | 25,620 | | | $ | 1,604 | | | 6 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent |
| Revenue: | | | | | | | | | | | | | | | | |
| Americas | | $ | 7,004 |
| | $ | 6,660 |
| | $ | 344 |
| | 5 | % | | $ | 14,354 |
| | $ | 14,103 |
| | $ | 251 |
| | 2 | % |
| Percentage of revenue | | 58.9 | % | | 57.5 | % | | | | | | 59.7 | % | | 58.9 | % | | | | |
| EMEA | | 3,062 |
| | 3,065 |
| | (3 | ) | | — | % | | 5,971 |
| | 6,078 |
| | (107 | ) | | (2 | )% |
| Percentage of revenue | | 25.8 | % | | 26.5 | % | | | | | | 24.9 | % | | 25.4 | % | | | | |
| APJC | | 1,821 |
| | 1,855 |
| | (34 | ) | | (2 | )% | | 3,698 |
| | 3,751 |
| | (53 | ) | | (1 | )% |
| Percentage of revenue | | 15.3 | % | | 16.0 | % | | | | | | 15.4 | % | | 15.7 | % | | | | |
| Total | | $ | 11,887 |
| | $ | 11,580 |
| | $ | 307 |
| | 3 | % | | $ | 24,023 |
| | $ | 23,932 |
| | $ | 91 |
| | — | % |
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
Total revenue increased by 3%7%. Product revenue increased by 9% and service revenue each increased by 3%2%. The increase inOur total revenue reflected solid growth in the Americas segment, while revenue declined in the APJC segment and was flat in the EMEA segment. The emerging countriesacross each of BRICM, in the aggregate, experienced 2% product revenue growth, with increases in China, Russia and Brazil partially offset by decreases in the other two BRICM countries.our geographic segments.
In addition to the impact of macroeconomic factors, including a reducedthe IT spending environment and reductions inthe level of spending by government entities, revenue by segment in a particular period may be significantly impacted by several factors related to revenue recognition, including the complexity of transactions such as multiple-element arrangements;multiple performance obligations; the mix of financing arrangements provided to channel partners and customers; and final acceptance of the product, system, or solution, among other factors. In addition, certain customers tend to make large and sporadic purchases, and the revenue related to these transactions may also be affected by the timing of revenue recognition, which in turn would impact the revenue of the relevant segment. As has been the case in certain emerging countries from time to time, customers require greater levels of financing arrangements, service, and support, and these activities may occur in future periods, which may also impact the timing of the recognition of revenue.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
Total revenue was flat.increased by 6%. Product revenue was flat whileincreased by 8% and service revenue increased by 2%1%. Our total revenue grew in the Americas segment and declined in the EMEA and APJCreflected growth across each of our geographic segments. Product revenue for the emerging countries of BRICM, in the aggregate, was flat, as revenue increases in Brazil, Russia and China were offset by decreases in the other two BRICM countries.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Product Revenue by Segment
The following table presents the breakdown of product revenue by segment (in millions, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Dollars |
| Product revenue: | | | | | | | | | | | | | | | | |
| Americas | | $ | 5,728 | | | $ | 5,127 | | | $ | 601 | | | 12 | % | | $ | 11,574 | | | $ | 10,649 | | | $ | 925 | | | 9 | % |
| Percentage of product revenue | | 56.4 | % | | 54.8 | % | | | | | | 56.8 | % | | 56.4 | % | | | | |
| EMEA | | 2,917 | | | 2,760 | | | 157 | | | 6 | % | | 5,803 | | | 5,273 | | | 530 | | | 10 | % |
| Percentage of product revenue | | 28.7 | % | | 29.5 | % | | | | | | 28.4 | % | | 27.9 | % | | | | |
| APJC | | 1,510 | | | 1,466 | | | 44 | | | 3 | % | | 3,023 | | | 2,961 | | | 62 | | | 2 | % |
| Percentage of product revenue | | 14.9 | % | | 15.7 | % | | | | | | 14.8 | % | | 15.7 | % | | | | |
| Total | | $ | 10,155 | | | $ | 9,353 | | | $ | 802 | | | 9 | % | | $ | 20,400 | | | $ | 18,882 | | | $ | 1,518 | | | 8 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent |
| Product revenue: | | | | | | | | | | | | | | | | |
| Americas | | $ | 4,988 |
| | $ | 4,695 |
| | $ | 293 |
| | 6 | % | | $ | 10,380 |
| | $ | 10,175 |
| | $ | 205 |
| | 2 | % |
| Percentage of product revenue | | 57.3 | % | | 55.3 | % | | | | | | 58.4 | % | | 57.2 | % | | | | |
| EMEA | | 2,375 |
| | 2,392 |
| | (17 | ) | | (1 | )% | | 4,614 |
| | 4,756 |
| | (142 | ) | | (3 | )% |
| Percentage of product revenue | | 27.3 | % | | 28.2 | % | | | | | | 26.0 | % | | 26.7 | % | | | | |
| APJC | | 1,346 |
| | 1,404 |
| | (58 | ) | | (4 | )% | | 2,769 |
| | 2,862 |
| | (93 | ) | | (3 | )% |
| Percentage of product revenue | | 15.4 | % | | 16.5 | % | | | | | | 15.6 | % | | 16.1 | % | | | | |
| Total | | $ | 8,709 |
| | $ | 8,491 |
| | $ | 218 |
| | 3 | % | | $ | 17,763 |
| | $ | 17,793 |
| | $ | (30 | ) | | — | % |
Americas
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
Product revenue in the Americas segment increased by 6%12%, led by solidwith growth in the service provider and public sector markets and, to a lesser extent, growth in the commercial market. These increases were partially offset by a product revenue decline in the enterprise market. The product revenue increase in the public sector market was due primarily to higher sales to the U.S. federal government.across all customer markets. From a country perspective, product revenue increased by 5% in the United States, 19% in Canada, Brazil and Mexico by 11%, 9%, 44% and 11% in Brazil, partially offset by a decrease of 4% in Mexico., respectively.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
The increase in productProduct revenue in the Americas segment was ledincreased by solid9%, with growth in the commercial market and, to a lesser extent, growth in the public sector and service provideracross all customer markets. These increases were partially offset by a product revenue decline in the enterprise market. The product revenue growth in the public sector market was due primarily to higher sales to the U.S. federal government. From a country perspective, product revenue increased by 1% in the United States, 20% inCanada, Brazil and 8% in Canada, partially offsetMexico by a decrease of 16% in Mexico.8%, 11%, 29% and 17%, respectively.
EMEA
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
Product revenue in the EMEA segment decreasedincreased by 1%6%, leddriven by growth in the public sector, enterprise and commercial markets, partially offset by a decline in the service provider marketmarket. From a country perspective, product revenue increased in Germany and to a lesser extent, a declineFrance by 24% and 28%, respectively. Product revenue in the enterprise market, partially offset by product revenue growth in the public sector and commercial markets. Product revenue from emerging countries within EMEA increased by 7% while product revenue for the remainder of the EMEA segment decreased by 3%.United Kingdom was flat.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
The decrease in productProduct revenue in the EMEA segment of 3% wasincreased by 10%, driven by growth in the public sector, commercial and enterprise markets, partially offset by a decline in the service provider marketmarket. From a country perspective, product revenue increased in Germany, the United Kingdom and to a lesser extent,France by 22%, 3% and 29%, respectively.
APJC
Three Months Ended January 28, 2023 Compared with Three Months Ended January 29, 2022
Product revenue in the APJC segment increased by 3%, driven by growth in the commercial and public sector markets, partially offset by a decline in the enterprise market. We experiencedThe service provider market in this geographic segment was flat. From a country perspective, product revenue increased in India, Australia and China by 59%, 4% and 20%, respectively, partially offset by a decline in Japan of 12%.
Six Months Ended January 28, 2023 Compared with Six Months Ended January 29, 2022
Product revenue in the APJC segment increased by 2%, driven by growth in the commercial and public sector markets, partially offset by declines in the enterprise and commercial markets in this segment. Product revenue from emerging countries within EMEA increased by 1% whileservice provider markets. From a country perspective, product revenue for the remainderincreased in India and China by 49% and 27%, respectively, partially offset by declines in Japan and Australia of the EMEA segment decreased by 4%.11% and 2%, respectively.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
APJC
Three Months Ended January 27, 2018 Compared with Three Months Ended January 28, 2017
Product revenue in the APJC segment decreased by 4%. The product revenue decrease was led by a decline in the service provider market, partially offset by solid growth in the commercial and enterprise markets. Product revenue in the public sector market was flat. From a country perspective, product revenue decreased by 21% in Japan and 11% in India, while product revenue increased by 8% in China.
Six Months Ended January 27, 2018 Compared with Six Months Ended January 28, 2017
The decrease in product revenue in the APJC segment of 3% was led by decline in the service provider market, partially offset by product revenue growth in the commercial, enterprise and public sector markets. From a country perspective, product revenue decreased by 15% in Japan and 5% in India, while product revenue increased by 3% in China.
Product Revenue by Groups of Similar ProductsCategory
In addition to the primary view on a geographic basis, we also prepare financial information related to groups of similar productsproduct categories and customer markets for various purposes. Effective in the first quarter of fiscal 2018, we began reporting our product revenue in the following categories: Infrastructure Platforms, Applications, Security, and Other Products. This change better aligns our product categories with our evolving business model. Prior period amounts have been reclassified to conform to the current period’s presentation.
The following table presents product revenue for groups of similar productsby category (in millions, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent |
| Product revenue: | | | | | | | | | | | | | | | | |
| Secure, Agile Networks | | $ | 6,746 | | | $ | 5,899 | | | $ | 847 | | | 14 | % | | $ | 13,430 | | | $ | 11,867 | | | $ | 1,563 | | | 13 | % |
| Internet for the Future | | 1,306 | | | 1,322 | | | (16) | | | (1) | % | | 2,616 | | | 2,695 | | | (79) | | | (3) | % |
| Collaboration | | 958 | | | 1,067 | | | (109) | | | (10) | % | | 2,044 | | | 2,176 | | | (132) | | | (6) | % |
| End-to-End Security | | 943 | | | 883 | | | 60 | | | 7 | % | | 1,914 | | | 1,778 | | | 136 | | | 8 | % |
| Optimized Application Experiences | | 199 | | | 180 | | | 19 | | | 11 | % | | 393 | | | 361 | | | 32 | | | 9 | % |
| Other Products | | 3 | | | 2 | | | 1 | | | 25 | % | | 4 | | | 5 | | | (1) | | | (17) | % |
| Total | | $ | 10,155 | | | $ | 9,353 | | | $ | 802 | | | 9 | % | | $ | 20,400 | | | $ | 18,882 | | | $ | 1,518 | | | 8 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent |
| Product revenue: | | | | | | | | | | | | | | | | |
| Infrastructure Platforms | | $ | 6,694 |
| | $ | 6,545 |
| | $ | 149 |
| | 2 | % | | $ | 13,664 |
| | $ | 13,818 |
| | $ | (154 | ) | | (1 | )% |
| Applications | | 1,184 |
| | 1,116 |
| | 68 |
| | 6 | % | | 2,387 |
| | 2,252 |
| | 135 |
| | 6 | % |
| Security | | 558 |
| | 528 |
| | 30 |
| | 6 | % | | 1,143 |
| | 1,068 |
| | 75 |
| | 7 | % |
| Other Products | | 273 |
| | 302 |
| | (29 | ) | | (10 | )% | | 569 |
| | 655 |
| | (86 | ) | | (13 | )% |
| Total | | $ | 8,709 |
| | $ | 8,491 |
| | $ | 218 |
| | 3 | % | | $ | 17,763 |
| | $ | 17,793 |
| | $ | (30 | ) | | — | % |
Infrastructure PlatformsSecure, Agile Networks
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
The Infrastructure PlatformsSecure, Agile Networks product category represents our core networking offerings related to switching, enterprise routing, wireless, and compute. Secure, Agile Networks revenue increased by 14%, or $847 million, with growth across the data center. The Infrastructure Platformsportfolio except servers. Revenue grew in campus switching, primarily driven by strong growth in our Catalyst 9000 series and Meraki switching offerings. Data center switching revenue declined, although we had revenue growth in our Nexus 9000 series. Enterprise routing had strong growth primarily driven by our Catalyst 8000 series, SD-WAN and IoT routing offerings. Wireless had strong double-digit growth driven by our WiFi-6 products and Meraki offerings.
Six Months Ended January 28, 2023 Compared with Six Months Ended January 29, 2022
Revenue from the Secure, Agile Networks product category increased by 2%13%, or $149 million, and we saw broad strength$1.6 billion, with growth across the portfolio. Withinportfolio except servers. Revenue grew in campus switching we had strongprimarily driven by growth in our dataCatalyst 9000 series and Meraki switching offerings. Data center switching revenue declined, although we had revenue growth in our Nexus 9000 series. The increase in enterprise routing was primarily driven by growth in our Catalyst 8000 series and we saw solid momentum with our intent-based networking Catalyst 9000 Series. Our revenue from data center alsoSD-WAN offerings. Wireless had strong double-digit growth driven by higher sales of serverour WiFi-6 products and Meraki offerings.
Internet for the Future
Three Months Ended January 28, 2023 Compared with Three Months Ended January 29, 2022
The Internet for the Future product category includes our hyperconverged data center offering, HyperFlex. We experienced solid revenue growth from wireless productsrouted optical networking, public 5G, silicon and optics offerings. Revenue in our Internet for the Future product category decreased by 1%, or $16 million, primarily driven by declines in our Wave 2 offerings as well as Meraki.Optical and Edge portfolio, partially offset by growth in our Cisco 8000 series offerings. We had a modest decrease in sales of routing products driven by continued weaknessalso saw growth in the servicewebscale provider market.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
The Infrastructure PlatformsRevenue in our Internet for the Future product category decreased by 1%3%, or $154$79 million, with the vast majority of the decreaseprimarily driven by lower revenue from routing products. declines in our Cable, Optical and Edge portfolio, partially offset by growth in our Cisco 8000 series offerings. We also saw growth in the webscale provider market.
Collaboration
Three Months Ended January 28, 2023 Compared with Three Months Ended January 29, 2022
The decreaseCollaboration product category consists of our Collaboration Devices, Meetings, Calling and contact center offerings. Revenue in routing revenue wasour Collaboration product category decreased by 10%, or $109 million, primarily driven by weaknessdeclines in the service provider marketMeetings and a slowdown in enterprise routing sales. Our switching revenue decreased modestly but we saw solid momentum in campus switching with our intent-based networking Catalyst 9000 Series. Within switching, we experienced an increase in sales of data center switches, drivenCollaboration Devices, partially offset by strengthgrowth in our Application Centric Infrastructure (ACI) portfolio. We experienced solid revenue growth from wireless products and our datacontact center products driven by higher sales of server products and HyperFlex.
offerings.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Six Months Ended January 28, 2023 Compared with Six Months Ended January 29, 2022
ApplicationsRevenue in our Collaboration product category decreased by 6%, or $132 million, primarily driven by declines in Meetings and Collaboration Devices.
End-to-End Security
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
The Applications product category includes our collaboration offerings (unified communications, Cisco TelePresence and conferencing) as well as IoT and analytics software offerings from AppDynamics and Jasper. Revenue in our ApplicationsEnd-to-End Security product category increased by 6%7%, or $68$60 million primarily driven by increased revenuegrowth in Telepresence, Conferencingour Unified Threat Management and analytics from our fiscal 2017 acquisition of AppDynamics partially offset by decreased revenue from unified communications endpoints. We continue to increase the amount of deferred revenue and the proportion of recurring revenue related to our Applications product category.Zero Trust offerings.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
Revenue in our ApplicationsEnd-to-End Security product category increased by 6%8%, or $135$136 million with analytics fromprimarily driven by growth in our fiscal 2017 acquisition of AppDynamics driving the majority of the increaseUnified Threat Management and a modest revenue increase from collaborationZero Trust offerings. The growth in our Zero Trust portfolio was driven by strong growth in our Duo offerings.
SecurityOptimized Application Experiences
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
The Optimized Application Experiences product category includes our full stack observability and cloud-native platforms offerings. Revenue in our SecurityOptimized Application Experiences product category increased 6%11%, or $30$19 million, driven by higher sales of unified threat management and web security products. We continue to increase the amount of deferred revenue and the proportion of recurring revenue related togrowth in our Security product category.ThousandEyes offerings.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
Revenue in our SecurityOptimized Application Experiences product category increased 7%9%, or $75$32 million, driven by higher sales of unified threat management and web security products.growth in our ThousandEyes offerings.
Other Products
Three Months Ended January 27, 2018 Compared with Three Months Ended January 28, 2017
The decrease in revenue from our Other Products category of 10%, or $29 million, was driven by a decrease in revenue from Service Provider Video software and solutions.
Six Months Ended January 27, 2018 Compared with Six Months Ended January 28, 2017
The decrease in revenue from our Other Products category of 13%, or $86 million, was driven by a decrease in revenue from Service Provider Video software and solutions.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Service Revenue by Segment
The following table presents the breakdown of service revenue by segment (in millions, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent |
| Service revenue: | | | | | | | | | | | | | | | | |
| Americas | | $ | 2,097 | | | $ | 2,019 | | | $ | 78 | | | 4 | % | | $ | 4,164 | | | $ | 4,057 | | | $ | 107 | | | 3 | % |
| Percentage of service revenue | | 61.0 | % | | 60.0 | % | | | | | | 61.0 | % | | 60.2 | % | | | | |
| EMEA | | 812 | | | 804 | | | 8 | | | 1 | % | | 1,601 | | | 1,594 | | | 7 | | | — | % |
| Percentage of service revenue | | 23.6 | % | | 23.9 | % | | | | | | 23.5 | % | | 23.7 | % | | | | |
| APJC | | 529 | | | 544 | | | (15) | | | (3) | % | | 1,059 | | | 1,086 | | | (27) | | | (2) | % |
| Percentage of service revenue | | 15.4 | % | | 16.1 | % | | | | | | 15.5 | % | | 16.1 | % | | | | |
| Total | | $ | 3,437 | | | $ | 3,367 | | | $ | 70 | | | 2 | % | | $ | 6,824 | | | $ | 6,738 | | | $ | 86 | | | 1 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent |
| Service revenue: | | | | | | | | | | | | | | | | |
| Americas | | $ | 2,016 |
| | $ | 1,965 |
| | $ | 51 |
| | 3 | % | | $ | 3,974 |
| | $ | 3,928 |
| | $ | 46 |
| | 1 | % |
| Percentage of service revenue | | 63.4 | % | | 63.6 | % | | | | | | 63.5 | % | | 64.0 | % | | | | |
| EMEA | | 687 |
| | 673 |
| | 14 |
| | 2 | % | | 1,357 |
| | 1,322 |
| | 35 |
| | 3 | % |
| Percentage of service revenue | | 21.6 | % | | 21.8 | % | | | | | | 21.7 | % | | 21.5 | % | | | | |
| APJC | | 475 |
| | 451 |
| | 24 |
| | 5 | % | | 929 |
| | 889 |
| | 40 |
| | 4 | % |
| Percentage of service revenue | | 15.0 | % | | 14.6 | % | | | | | | 14.8 | % | | 14.5 | % | | | | |
| Total | | $ | 3,178 |
| | $ | 3,089 |
| | $ | 89 |
| | 3 | % | | $ | 6,260 |
| | $ | 6,139 |
| | $ | 121 |
| | 2 | % |
Three Months Ended January 27, 2018 Compared with Three Months Ended January 28, 2017Amounts may not sum and percentages may not recalculate due to rounding.
Service revenue increased 3%. Technical support services revenue and advanced services revenue each increased by 3%. Technical support services revenue increased across all geographic segments. The increase2% in technical support services revenue wasthe second quarter of fiscal 2023 compared with the second quarter of fiscal 2022, primarily driven by an increase in software and solution support offerings. Advanced services revenue, which relates to professional services for specific customer network needs, had solid revenue growth in our EMEAsolution support offerings and Americas segments and declinedmaintenance business, partially offset by declines in our advisory services and software support offerings. Service revenue increased in the Americas and EMEA segments, partially offset by a decline in the APJC segment.
Six Months Ended January 27, 2018 Compared with Six Months Ended January 28, 2017segment for the second quarter of fiscal 2023.
Service revenue increased across all geographic segments. Technical1% in the first six months of fiscal 2023 compared to the first six months of fiscal 2022, primarily driven by revenue growth in our solution support offerings and maintenance business, offset by declines in our advisory services and software support offerings. Service revenue increased in the Americas segment, partially offset by 2% and advanced services increased by 3%. Technical support servicesa decline in the APJC segment for the first six months of fiscal 2023. Service revenue had solid growth in APJC and increased to a lesser extent in our Americas and EMEA segments. Advanced services revenue had strong growth infor the EMEA segment and grew modestly in our APJC and Americas segments.was flat.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Gross Margin
The following table presents the gross margin for products and services (in millions, except percentages):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | AMOUNT | | PERCENTAGE | | AMOUNT | | PERCENTAGE |
| | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 |
| Gross margin: | | | | | | | | | | | | | | | | |
| Product | | $ | 5,355 |
| | $ | 5,186 |
| | 61.5 | % | | 61.1 | % | | $ | 10,794 |
| | $ | 11,085 |
| | 60.8 | % | | 62.3 | % |
| Service | | 2,143 |
| | 2,090 |
| | 67.4 | % | | 67.7 | % | | 4,131 |
| | 4,075 |
| | 66.0 | % | | 66.4 | % |
| Total | | $ | 7,498 |
| | $ | 7,276 |
| | 63.1 | % | | 62.8 | % | | $ | 14,925 |
| | $ | 15,160 |
| | 62.1 | % | | 63.3 | % |
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | | AMOUNT | | PERCENTAGE | | AMOUNT | | PERCENTAGE |
| | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 |
| Gross margin: | | | | | | | | | | | | | | | | |
| Product | | $ | 6,117 | | | $ | 5,784 | | | 60.2 | % | | 61.8 | % | | $ | 12,183 | | | $ | 11,640 | | | 59.7 | % | | 61.6 | % |
| Service | | 2,310 | | | 2,265 | | | 67.2 | % | | 67.3 | % | | 4,590 | | | 4,462 | | | 67.3 | % | | 66.2 | % |
| Total | | $ | 8,427 | | | $ | 8,049 | | | 62.0 | % | | 63.3 | % | | $ | 16,773 | | | $ | 16,102 | | | 61.6 | % | | 62.8 | % |
Product Gross Margin
The following table summarizes the key factors that contributed to the change in product gross margin percentage for the second quarter and first six months of fiscal 20182023, as compared with the corresponding prior year periods:
| | | | | | | | | | | | | | |
| | Product Gross Margin Percentage |
| | | Three Months Ended | | Six Months Ended |
| Fiscal 2022 | | 61.8 | % | | 61.6 | % |
Productivity (1) | | (4.3) | % | | (4.4) | % |
| Product pricing | | 1.3 | % | | 1.4 | % |
| Mix of products sold | | 0.9 | % | | 0.5 | % |
| Others | | 0.5 | % | | 0.6 | % |
| Fiscal 2023 | | 60.2 | % | | 59.7 | % |
|
| | | | | | |
| | | Product Gross Margin Percentage |
| | | Three Months Ended | | Six Months Ended |
| Fiscal 2017 | | 61.1 | % | | 62.3 | % |
| Product pricing | | (1.3 | )% | | (1.7 | )% |
| Legal and indemnification settlements | | — | % | | (0.7 | )% |
| Amortization of purchased intangibles | | (0.4 | )% | | (0.4 | )% |
| Mix of products sold | | 0.5 | % | | 0.3 | % |
Productivity (1) | | 1.7 | % | | 0.9 | % |
| Other | | (0.1 | )% | | 0.1 | % |
| Fiscal 2018 | | 61.5 | % | | 60.8 | % |
(1)Productivity includes overall manufacturing-related costs, such as component costs, warranty expense, provision for inventory, freight, logistics, shipment volume, and other items not categorized elsewhere.
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
Product gross margin increaseddecreased by 0.41.6 percentage points primarily driven by negative impacts from productivity, improvementslargely driven by increased costs related to supply constraints from component and a favorable mix impactother costs. These impacts were partially offset by unfavorable impacts fromfavorable pricing and product pricing.
Productivity improvements weremix. The favorable pricing was primarily driven by value engineering efforts (e.g. component redesign, board configuration, test processes,price increases implemented during fiscal 2022. These benefits are recognized as we ship our products. We implemented the price increases to partially offset increases in commodity and transformation processes), lower warranty expenses and continued operational efficiency in manufacturing operations. Our productivity continued to be negatively impacted by an increase in the cost of certain memory components which are currently constrained. We expect the higher costs on these memory components to continue to impact productivity in the near term. The favorable product mix impact was driven by our products within the Infrastructure Platforms product category. The negative pricing impact was driven by typical market factors and impacted each of our geographic segments and customer markets.
Our product gross margin was also negatively impacted by higher amortization expense from purchased intangible assets.other costs.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
Product gross margin decreased by 1.51.9 percentage points due largely to unfavorableprimarily driven by negative impacts from product pricing and a charge of $127 million to product cost of sales recorded in the first six months of fiscal 2018productivity, largely driven by increased costs related to legalsupply constraints from component, freight, logistics and indemnification settlements,other costs. These impacts were partially offset by productivityfavorable pricing. The benefit we saw from favorable pricing was primarily driven by price increases implemented during fiscal 2022. We also saw benefits and favorablefrom product mix.
TheSupply Constraints Impacts and Risks
While we saw further improvements in the second quarter of fiscal 2023, we continue to manage through significant supply constraints seen industry-wide due to component shortages caused, in part, by the COVID-19 pandemic, and for which the duration of such constraints is uncertain. These shortages have resulted in increased costs (i.e., component and other commodity costs, freight, expedite fees, etc.) which have had a negative pricing impact was driven by typical market factors and impacted each ofon our geographic segments and customer markets. While productivity was positive to overall product gross margin and have resulted in extended lead times for us and our customers. We have taken a number of steps in order to mitigate the benefit was lower than the prior year assupply constraint related impacts including: partnering with several of our key suppliers utilizing our volume purchasing ability and extending supply coverage, including, in certain cases, revising supplier arrangements; paying significantly higher component and logistics costs to secure supply; modifying our product designs in order to leverage alternate suppliers, where possible; and continually optimizing our inventory build and customer delivery plans, among others. We believe these improvements were adversely impacted by an increaseactions are helping us to optimize our access to critical components and meet customer demand for our products. As a result, in the cost of certain memory components which are currently constrained. In addition, productivity was negatively impacted by decreases in Infrastructure Platforms revenue which limited our abilityorder to generate cost savings. Productivity improvements were driven by value engineering efforts, lower warranty expenses and continued operational efficiency in manufacturing operations. Our product gross margin was also negatively impacted by higher amortization expense from purchased intangible assets.
secure supply to meet customer
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
demand, we have increased our inventory balances, inventory purchase commitments, and inventory deposits and prepayments (see “Liquidity and Capital Resources—Inventory Supply Chain”), which, in turn, has increased our supply chain exposure. Additionally, in certain situations, we have prepaid or made deposits with suppliers to secure future supply. These actions significantly increase the risk of future material excess and obsolete inventory and related losses if customer demand were to suddenly and significantly decrease in future periods. While we believe we are taking the right strategic and operational actions to address the supply situation, we recognize the increased risks.
Service Gross Margin
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
Our service gross margin percentage decreased by 0.30.1 percentage points primarily due to increasedhigher headcount-related costs and unfavorable mix. These cost impacts weredelivery costs, partially offset by the resulting benefit to gross margin of higher sales volume in both advanced services and technical support services.favorable mix of service offerings.
Our service gross margin normally experiences some fluctuations due to various factors such as the timing of contract initiations andin our renewals, our strategic investments in headcount, and the resources we deploy to support the overall service business. Another factor isOther factors include the mix of service offerings, as the gross margin from our advanced services is typically lower than the gross margin from technical support services.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
Service gross margin percentage decreasedincreased by 0.41.1 percentage points primarily due largely to increased headcount-related costs and, to a lesser extent, increased delivery costs. These cost impacts were partially offset by the resulting benefit to gross marginfavorable mix of service offerings, higher sales volume in both advanced services and technical support services.lower headcount-related and delivery costs.
Gross Margin by Segment
The following table presents the total gross margin for each segment (in millions, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Six Months Ended |
| AMOUNT | | PERCENTAGE | | AMOUNT | | PERCENTAGE |
| January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 |
| Gross margin: | | | | | | | | | | | | | | | |
| Americas | $ | 4,920 | | | $ | 4,611 | | | 62.9 | % | | 64.5 | % | | $ | 9,904 | | | $ | 9,486 | | | 62.9 | % | | 64.5 | % |
| EMEA | 2,469 | | | 2,381 | | | 66.2 | % | | 66.8 | % | | 4,795 | | | 4,509 | | | 64.8 | % | | 65.7 | % |
| APJC | 1,298 | | | 1,337 | | | 63.6 | % | | 66.5 | % | | 2,571 | | | 2,654 | | | 63.0 | % | | 65.6 | % |
| Segment total | 8,687 | | | 8,328 | | | 63.9 | % | | 65.5 | % | | 17,269 | | | 16,649 | | | 63.4 | % | | 65.0 | % |
Unallocated corporate items (1) | (260) | | | (279) | | | | | | | (496) | | | (547) | | | | | |
| Total | $ | 8,427 | | | $ | 8,049 | | | 62.0 | % | | 63.3 | % | | $ | 16,773 | | | $ | 16,102 | | | 61.6 | % | | 62.8 | % |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | AMOUNT | | PERCENTAGE | | AMOUNT | | PERCENTAGE |
| | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 |
| Gross margin: | | | | | | | | | | | | | | | |
| Americas | $ | 4,614 |
| | $ | 4,288 |
| | 65.9 | % | | 64.4 | % | | $ | 9,336 |
| | $ | 9,121 |
| | 65.0 | % | | 64.7 | % |
| EMEA | 1,977 |
| | 2,012 |
| | 64.6 | % | | 65.6 | % | | 3,816 |
| | 4,025 |
| | 63.9 | % | | 66.2 | % |
| APJC | 1,094 |
| | 1,121 |
| | 60.1 | % | | 60.4 | % | | 2,259 |
| | 2,325 |
| | 61.1 | % | | 62.0 | % |
| Segment total | 7,685 |
| | 7,421 |
| | 64.7 | % | | 64.1 | % | | 15,411 |
| | 15,471 |
| | 64.2 | % | | 64.6 | % |
Unallocated corporate items (1) | (187 | ) | | (145 | ) | | | | | | (486 | ) | | (311 | ) | | | | |
| Total | $ | 7,498 |
| | $ | 7,276 |
| | 63.1 | % | | 62.8 | % | | $ | 14,925 |
| | $ | 15,160 |
| | 62.1 | % | | 63.3 | % |
| | | | | | | | | | | | | | | | |
(1)The unallocated corporate items include the effects of amortization and impairments of acquisition-related intangible assets, share-based compensation expense, significant litigation settlements and other contingencies, charges related to asset impairments and restructurings, and certain other charges. We do not allocate these items to the gross margin for each segment because management does not include such information in measuring the performance of the operating segments.
Amounts may not sum and percentages may not recalculate due to rounding.
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
The Americas segmentWe experienced a gross margin percentage increase due to productivity improvements and favorable product mix, partially offset by negative impacts from pricing. The favorable mix impact was driven by our products within the Infrastructure Platforms product category.
The gross margin percentage decrease in our EMEAAmericas segment was due primarily to negative impacts from pricing and mixproductivity, partially offset by productivity improvements. Lower service gross margin also contributed to the decrease in the grossfavorable pricing and favorable product mix.
Gross margin in this geographic segment.our EMEA segment decreased primarily due to negative impacts from productivity, partially offset by favorable pricing and favorable product mix.
OurThe APJC segment gross margin percentage decreaseddecrease was primarily due to negative impacts from pricingproductivity, and to a lesser extent, unfavorable impacts from product mix, partially offset by productivity improvements. Lowerfavorable pricing and higher service gross margin also contributed to the decrease in the overallmargin.
The gross margin percentage for a particular segment may fluctuate, and period-to-period changes in thissuch percentages may or may not be indicative of a trend for that segment.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
We experiencedThe Americas segment had a gross margin percentage increase in our Americas segment due todecrease driven by negative impacts from productivity, improvements and, to a lesser extent, a favorable product mix, partially offset by unfavorable impacts from pricing.favorable pricing and favorable product mix.
The gross margin percentage decrease in our EMEA segment was primarily due primarily to the negative impacts from pricingproductivity, and to a lesser extent, an unfavorable impacts from product mix, partially offset by productivity improvements.favorable pricing.
The APJC segment gross margin percentage decreased due primarily todecrease was driven by negative impacts from productivity and unfavorable impacts from pricing, partially offset by productivity improvements and favorable product mix.
Research and Development (“R&D”), Sales and Marketing, and General and Administrative (“G&A”) Expenses
R&D, sales and marketing, and G&A expenses are summarized in the following table (in millions, except percentages):
| | | | Three Months Ended | | Six Months Ended | | Three Months Ended | | Six Months Ended |
| | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | Variance
in Percent |
| Research and development | $ | 1,549 |
| | $ | 1,508 |
| | $ | 41 |
| | 3 | % | | $ | 3,116 |
| | $ | 3,053 |
| | $ | 63 |
| | 2 | % | Research and development | $ | 1,855 | | | $ | 1,670 | | | $ | 185 | | | 11 | % | | $ | 3,636 | | | $ | 3,384 | | | $ | 252 | | | 7 | % |
| Percentage of revenue | 13.0 | % | | 13.0 | % | | | | | | 13.0 | % | | 12.8 | % | | | | | Percentage of revenue | 13.6 | % | | 13.1 | % | | 13.4 | % | | 13.2 | % | |
| Sales and marketing | 2,235 |
| | 2,222 |
| | 13 |
| | 1 | % | | 4,569 |
| | 4,640 |
| | (71 | ) | | (2 | )% | Sales and marketing | 2,384 | | | 2,266 | | | 118 | | | 5 | % | | 4,775 | | | 4,527 | | | 248 | | | 5 | % |
| Percentage of revenue | 18.8 | % | | 19.2 | % | | | | | | 19.0 | % | | 19.4 | % | | | | | Percentage of revenue | 17.5 | % | | 17.8 | % | | 17.5 | % | | 17.7 | % | |
| General and administrative | 483 |
| | 456 |
| | 27 |
| | 6 | % | | 1,040 |
| | 1,011 |
| | 29 |
| | 3 | % | General and administrative | 582 | | | 544 | | | 38 | | | 7 | % | | 1,147 | | | 1,095 | | | 52 | | | 5 | % |
| Percentage of revenue | 4.1 | % | | 3.9 | % | | | | | | 4.3 | % | | 4.2 | % | | | | | Percentage of revenue | 4.3 | % | | 4.3 | % | | 4.2 | % | | 4.3 | % | |
| Total | $ | 4,267 |
| | $ | 4,186 |
| | $ | 81 |
| | 2 | % | | $ | 8,725 |
| | $ | 8,704 |
| | $ | 21 |
| | — | % | Total | $ | 4,821 | | | $ | 4,480 | | | $ | 341 | | | 8 | % | | $ | 9,558 | | | $ | 9,006 | | | $ | 552 | | | 6 | % |
| Percentage of revenue | 35.9 | % | | 36.1 | % | | | | | | 36.3 | % | | 36.4 | % | | | | | Percentage of revenue | 35.5 | % | | 35.2 | % | | | | 35.1 | % | | 35.2 | % | | | |
R&D Expenses
Three Months Ended January 28, 2023 Compared with Three Months Ended January 29, 2022
R&D expenses increased in the second quarter and first six months of fiscal 2018, as compared with the corresponding periods of fiscal 2017, primarily due to higher headcount-related expenses, higher discretionary spendingshare-based compensation expense and higher share-based compensation expense,discretionary spending, partially offset by lower contracted services and lower acquisition-related costs.spending.
We continue to invest in R&D in order to bring a broad range of products to market in a timely fashion. If we believe that we are unable to enter a particular market in a timely manner with internally developed products, we may purchase or license technology from other businesses, or we may partner with or acquire businesses as an alternative to internal R&D.
Six Months Ended January 28, 2023 Compared with Six Months Ended January 29, 2022
Sales and Marketing Expenses
Sales and marketingR&D expenses increased in the second quarter of fiscal 2018, as compared with the second quarter of fiscal 2017, due to higher headcount-related expenses, higher discretionary spending and higher share-based compensation expense, partially offset by lower contracted services and lower discretionary spending.
Sales and Marketing Expenses
Three Months Ended January 28, 2023 Compared with Three Months Ended January 29, 2022
Sales and marketing expenses decreased inincreased primarily due to higher headcount-related expenses, higher share-based compensation expense and higher discretionary spending, partially offset by lower contracted services spending.
Six Months Ended January 28, 2023 Compared with Six Months Ended January 29, 2022
Sales and marketing expenses increased primarily due to higher headcount-related expenses, higher discretionary spending and higher share-based compensation expense, partially offset by lower contracted services spending.
G&A Expenses
For each of the second quarter and first six months of fiscal 2018, as compared with the first six months of fiscal 2017,2023, G&A expenses increased due to higher headcount-related expenses, higher discretionary spending and higher share-based compensation expense, partially offset by lower contracted services spending and lower discretionary spending, partially offset by higher headcount-related expensesacquisition and to a lesser extent, higher share-based compensation expense.divestitures related costs.
G&A Expenses
G&A expenses increased in the second quarter of fiscal 2018, as compared with the second quarter of fiscal 2017, due to increases in contracted services, share-based compensation expense, headcount-related expenses and discretionary spending, partially offset by the gains on divestitures.
G&A expenses increased in the first six months of fiscal 2018, as compared with the first six months of fiscal 2017, due to increases in contracted services, share-based compensation expense, discretionary spending and acquisition-related costs, partially offset by a decrease in headcount-related expenses.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Effect of Foreign Currency
In the second quarter of fiscal 2018,2023, foreign currency fluctuations, net of hedging, increaseddecreased the combined R&D, sales and marketing, and G&A expenses by approximately $24$121 million, or 0.6%3.2%, compared with the second quarter of fiscal 2017.2022.
In the first six months of fiscal 2018,2023, foreign currency fluctuations, net of hedging, increaseddecreased the combined R&D, sales and marketing, and G&A expenses by approximately $41$263 million, or 0.5%2.9%, compared with the first six months of fiscal 2017.
Share-Based Compensation Expense
The following table presents share-based compensation expense (in millions):
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 |
| Cost of sales—product | | $ | 23 |
| | $ | 19 |
| | $ | 46 |
| | $ | 40 |
|
| Cost of sales—service | | 31 |
| | 34 |
| | 65 |
| | 67 |
|
| Share-based compensation expense in cost of sales | | 54 |
| | 53 |
| | 111 |
| | 107 |
|
| Research and development | | 134 |
| | 129 |
| | 270 |
| | 255 |
|
| Sales and marketing | | 135 |
| | 125 |
| | 270 |
| | 265 |
|
| General and administrative | | 64 |
| | 45 |
| | 128 |
| | 94 |
|
| Restructuring and other charges | | 12 |
| | — |
| | 18 |
| | 3 |
|
| Share-based compensation expense in operating expenses | | 345 |
| | 299 |
| | 686 |
| | 617 |
|
| Total share-based compensation expense | | $ | 399 |
| | $ | 352 |
| | $ | 797 |
| | $ | 724 |
|
The increase in share-based compensation expense in the second quarter and first six months of fiscal 2018, as compared with the corresponding periods of fiscal 2017, was due primarily to higher expense related to equity awards assumed with respect to our recent acquisitions and higher restructuring charges.2022.
Amortization of Purchased Intangible Assets
The following table presents the amortization of purchased intangible assets including impairment charges related to purchased intangible assets (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 |
| Amortization of purchased intangible assets: | | | | | | | | |
| Cost of sales | | $ | 158 | | | $ | 201 | | | $ | 316 | | | $ | 403 | |
| Operating expenses | | 71 | | | 79 | | | 142 | | | 163 | |
| Total | | $ | 229 | | | $ | 280 | | | $ | 458 | | | $ | 566 | |
|
| | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 |
| Amortization of purchased intangible assets: | | | | | | | | |
| Cost of sales | | $ | 160 |
| | $ | 124 |
| | $ | 314 |
| | $ | 253 |
|
| Operating expenses: | | | | | | | | |
| Amortization of purchased intangible assets | | 60 |
| | 64 |
| | 121 |
| | 142 |
|
| Restructuring and other charges | | — |
| | — |
| | — |
| | 38 |
|
| Total | | $ | 220 |
| | $ | 188 |
| | $ | 435 |
| | $ | 433 |
|
AmortizationFor each of the second quarter and first six months of fiscal 2023, the decrease in amortization of purchased intangible assets increased forwas primarily due to certain purchased intangible assets that became fully amortized, partially offset by amortization of purchased intangibles from our recent acquisitions.
Restructuring and Other Charges
In the second quarter of fiscal 2018, as compared2023, we announced a restructuring plan in order to rebalance the organization and enable further investment in key priority areas. This rebalancing includes talent movement options and restructuring. Additionally, we have begun optimizing our real estate portfolio, aligned to the broader hybrid work strategy. The total pretax charges are estimated to be approximately $600 million and is expected to impact approximately 5% of our global workforce. In connection with this restructuring plan, we incurred charges of $243 million in the second quarter of fiscal 2017, due to amortization of purchased intangible assets from our recent acquisitions.
Amortization of purchased intangible assets increased slightly forand the first six months of fiscal 2018, as compared with2023. We expect the first six months of fiscal 2017, dueplan to amortization of purchased intangible assets from our recent acquisitions, partially offsetbe substantially completed by the impactend of the impairment charges in the prior period.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Restructuring and Other Charges
We incurred restructuring and other charges of $98 million and $133 million for the secondfirst quarter of fiscal 2018 and fiscal 2017, respectively, and $250 million and $544 million for first six months of fiscal 2018 and fiscal 2017, respectively. These charges were related primarily to employee severance charges for employees impacted by the restructuring action announced in August 2016. In the second quarter of fiscal 2018, we extended the restructuring action to include an additional $150 million of estimated additional pretax charges for employee severance and other one-time termination benefits. We have substantially completed the restructuring action and have incurred cumulative charges of $1.0 billion as of January 27, 2018.
2024. We expect to reinvest substantially all of the cost savings from thethis restructuring actionplan in our key priority areas. As a result, the overall cost savings from thethis restructuring actionplan are not expected to be material for future periods.
Operating Income
The following table presents our operating income and our operating income as a percentage of revenue (in millions, except percentages): | | | | | Three Months Ended | | Six Months Ended | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | January 27,
2018 | | January 28,
2017 | | January 28,
2023 | | January 29,
2022 | | January 28,
2023 | | January 29,
2022 |
| Operating income | | $ | 3,073 |
| | $ | 2,893 |
| | $ | 5,829 |
| | $ | 5,770 |
| Operating income | | $ | 3,292 | | | $ | 3,487 | | | $ | 6,832 | | | $ | 6,925 | |
| Operating income as a percentage of revenue | | 25.9 | % | | 25.0 | % | | 24.3 | % | | 24.1 | % | Operating income as a percentage of revenue | | 24.2 | % | | 27.4 | % | | 25.1 | % | | 27.0 | % |
For the second quarter of fiscal 2018, as comparedThree Months Ended January 28, 2023 Compared with the second quarter of fiscal 2017,Three Months Ended January 29, 2022
Operating income decreased by 6%, and operating income increased by 6% and as a percentage of revenue operating income increaseddecreased by 0.93.2 percentage points. These increaseschanges resulted primarily from a revenue increase,due to a gross margin percentage increasedecrease (driven by negative impacts from productivity partially offset by favorable pricing and a decrease infavorable product mix) and higher restructuring and other charges, related to the restructuring actions announced in August 2016.partially offset by a revenue increase.
For the first six months of fiscal 2018, as comparedSix Months Ended January 28, 2023 Compared with the first six months of fiscal 2017,Six Months Ended January 29, 2022
Operating income decreased by 1%, and operating income increased by 1% and as a percentage of revenue operating income increaseddecreased by 0.21.9 percentage points. These increaseschanges resulted primarily from a decrease in restructuring and other charges related to the restructuring actions announced in August 2016, partially offset by a gross margin percentage decrease driven(driven by unfavorablenegative impacts from productivity, partially offset by favorable pricing, and the charge of $127 million for legalto a lesser extent, favorable product mix) and indemnification settlements.higher restructuring and other charges, partially offset by a revenue increase.
Interest and Other Income (Loss), Net
Interest Income (Expense), Net The following table summarizes interest income and interest expense (in millions):
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars |
| Interest income | | $ | 396 |
| | $ | 329 |
| | $ | 67 |
| | $ | 775 |
| | $ | 624 |
| | $ | 151 |
|
| Interest expense | | (247 | ) | | (222 | ) | | (25 | ) | | (482 | ) | | (420 | ) | | (62 | ) |
| Interest income (expense), net | | $ | 149 |
| | $ | 107 |
| | $ | 42 |
| | $ | 293 |
| | $ | 204 |
| | $ | 89 |
|
Interest income increased driven by an increase in our portfolio of cash, cash equivalents, and fixed income investments as well as higher yields on our portfolio. The increase in interest expense was driven by higher average debt balances and the impact of higher effective interest rates.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Interest and Other Income (Loss), Net
Interest Income (Expense), Net The following table summarizes interest income and interest expense (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | Six Months Ended |
| | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars |
| Interest income | | $ | 219 | | | $ | 111 | | | $ | 108 | | | $ | 388 | | | $ | 232 | | | $ | 156 | |
| Interest expense | | (107) | | | (88) | | | (19) | | | (207) | | | (177) | | | (30) | |
| Interest income (expense), net | | $ | 112 | | | $ | 23 | | | $ | 89 | | | $ | 181 | | | $ | 55 | | | $ | 126 | |
For the each of the second quarter and first six months of fiscal 2023, the increase in interest income was driven by higher average balance of cash and available-for-sale debt investments and higher interest rates. The increase in interest expense was primarily driven by higher interest rates, partially offset by a lower average debt balance.
Other Income (Loss), Net The components of other income (loss), net, are summarized as follows (in millions):
| | | | | Three Months Ended | | Six Months Ended | | Three Months Ended | | Six Months Ended |
| | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | January 27,
2018 | | January 28,
2017 | | Variance
in Dollars | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars | | January 28,
2023 | | January 29,
2022 | | Variance
in Dollars |
| Gains (losses) on investments, net: | | | | | | | | | | | | | Gains (losses) on investments, net: | | | | | | | | | | | | |
| Publicly traded equity securities | | $ | 154 |
| | $ | 4 |
| | $ | 150 |
| | $ | 183 |
| | $ | 9 |
| | $ | 174 |
| |
| Fixed income securities | | (96 | ) | | (34 | ) | | (62 | ) | | (92 | ) | | (24 | ) | | (68 | ) | |
| Total available-for-sale investments | | 58 |
| | (30 | ) | | 88 |
| | 91 |
| | (15 | ) | | 106 |
| |
| Privately held companies | | 2 |
| | (3 | ) | | 5 |
| | 37 |
| | (53 | ) | | 90 |
| |
| Available-for-sale debt investments | | Available-for-sale debt investments | | $ | (3) | | | $ | 10 | | | $ | (13) | | | $ | (9) | | | $ | 16 | | | $ | (25) | |
| Marketable equity investments | | Marketable equity investments | | 19 | | | (18) | | | 37 | | | (2) | | | (13) | | | 11 | |
| Privately held investments | | Privately held investments | | 19 | | | 121 | | | (102) | | | (73) | | | 326 | | | (399) | |
| Net gains (losses) on investments | | 60 |
| | (33 | ) | | 93 |
| | 128 |
| | (68 | ) | | 196 |
| Net gains (losses) on investments | | 35 | | | 113 | | | (78) | | | (84) | | | 329 | | | (413) | |
| Other gains (losses), net | | (50 | ) | | (4 | ) | | (46 | ) | | (56 | ) | | 10 |
| | (66 | ) | Other gains (losses), net | | (24) | | | (20) | | | (4) | | | (39) | | | (49) | | | 10 | |
| Other income (loss), net | | $ | 10 |
| | $ | (37 | ) | | $ | 47 |
| | $ | 72 |
| | $ | (58 | ) | | $ | 130 |
| Other income (loss), net | | $ | 11 | | | $ | 93 | | | $ | (82) | | | $ | (123) | | | $ | 280 | | | $ | (403) | |
Three Months Ended January 27, 201828, 2023 Compared with Three Months Ended January 28, 201729, 2022
The changedecrease in total net gains (losses) on available-for-sale investments was primarily attributable to higher realized gains on publicly traded equity securities, partially offset by higher realized losses on fixedour other income securities as a result of market conditions and the timing of sales of these securities.
The change in net gains (losses) on investments in privately held companies was primarily due to lower impairment charges on investments in privately held companies partially offset by lower realized gains on investments in privately held companies.
The change in other gains (losses)(loss), net was primarily driven by lower unrealized gains on our privately held investments and changes in net unfavorable foreign exchange impactsgains (losses) on available-for-sale debt investments and to a lesser extent, impacts frommarketable equity derivatives.investments.
Six Months Ended January 27, 201828, 2023 Compared with Six Months Ended January 28, 201729, 2022
The changedecrease in total net gains (losses) on available-for-sale investments was primarily attributable to higher realized gains on publicly traded equity securities, partially offset by higher realized losses on fixedour other income securities as a result of market conditions and the timing of sales of these securities and $26 million of impairment charges on publicly traded equity securities.
The change in net gains (losses) on investments in privately held companies was primarily due to lower impairment charges and higher realized gains on investments in privately held companies.
The change in other gains (losses)(loss), net was primarily driven by net unfavorable foreign exchange impactsrealized and unrealized losses on our privately held investments.
Provision for Income Taxes
Three Months Ended January 28, 2023 Compared with Three Months Ended January 29, 2022
The provision for income taxes resulted in an effective tax rate of 18.8% for the second quarter of fiscal 2023 compared with 17.5% for the second quarter of fiscal 2022. The increase in the effective tax rate was primarily due to a lesser extent, impacts from equity derivatives.decrease in stock based compensation windfall and the impact of new U.S. foreign tax credit regulations effective for fiscal 2023. The increase was partially offset by a U.S. foreign-derived intangible income deduction benefit driven by the capitalization and amortization of R&D expenses effective for fiscal 2023 as required by the Tax Cuts and Jobs Act.
Six Months Ended January 28, 2023 Compared with Six Months Ended January 29, 2022
The provision for income taxes resulted in an effective tax rate of 21.0% for the first six months of fiscal 2023 compared with 18.0% for the first six months of fiscal 2022. The increase in the effective tax rate was primarily due to an increase in net discrete tax expenses, a decrease in stock based compensation windfall, and the impact of new U.S. foreign tax credit regulations effective for fiscal 2023. The increase was partially offset by a U.S. foreign-derived intangible income deduction benefit driven by the capitalization and amortization of R&D expenses effective for fiscal 2023 as required by the Tax Cuts and Jobs Act.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Provision for Income Taxes
On December 22, 2017, the Tax Act was enacted. The Tax Act significantly revises the U.S. corporate income tax by, among other things, lowering the statutory corporate income tax rate (“federal tax rate”) from 35% to 21% effective January 1, 2018, implementing a modified territorial tax system, and imposing a mandatory one-time transition tax on accumulated earnings of foreign subsidiaries. As a fiscal-year taxpayer, certain provisions of the Tax Act impact us in fiscal 2018, including the change in the federal tax rate and the one-time transition tax, while other provisions will be effective at the beginning of fiscal 2019, including the implementation of a modified territorial tax system and other changes to how foreign earnings are subject to U.S. tax, and elimination of the domestic manufacturing deduction.
As a result of the decrease in the federal tax rate from 35% to 21% effective January 1, 2018, we have computed our income tax expense for the July 28, 2018 fiscal year using a blended federal tax rate of 27%. The 21% federal tax rate will apply to our fiscal year ending July 27, 2019 and each year thereafter. We must remeasure our deferred tax assets and liabilities ("DTA") using the federal tax rate that will apply when the related temporary differences are expected to reverse.
As of January 27, 2018, we had approximately $75 billion in undistributed earnings for certain foreign subsidiaries. Substantially all of these undistributed earnings are subject to the U.S. mandatory one-time transition tax and are eligible to be repatriated to the U.S. without additional U.S. tax under the Tax Act. We have historically asserted our intention to indefinitely reinvest foreign earnings in certain foreign subsidiaries. We have reevaluated our historic assertion as a result of enactment of the Tax Act and no longer consider these earnings to be indefinitely reinvested in our foreign subsidiaries. As a result of this change in assertion, we have recorded a $1.2 billion tax expense for foreign withholding tax in the second quarter of fiscal 2018. In the third quarter of fiscal 2018, we anticipate repatriating $67 billion of foreign subsidiary earnings to the U.S. (in the form of cash, cash equivalents, or investments), of which $26 billion was repatriated to the U.S. in February 2018.
During the three months ended January 27, 2018, we recorded a provisional tax expense of $11.1 billion related to the Tax Act, comprised of $9.0 billion of U.S. transition tax, $1.2 billion of foreign withholding tax (discussed above), and $0.9 billion re-measurement of net DTA. We plan to pay the transition tax in installments over eight years in accordance with the Tax Act. The $1.2 billion foreign withholding tax was paid in February 2018. The Tax Act is discussed more fully in Note 16 to the Consolidated Financial Statements.
The provision for income taxes resulted in an effective tax rate of 371.6% for the second quarter of fiscal 2018 compared with 20.8% for the second quarter of fiscal 2017, a net 350.8 percentage point increase for the second quarter of fiscal 2018 as compared with the second quarter of fiscal 2017. The provision for income taxes resulted in an effective tax rate of 203.1% for the first six months of fiscal 2018 as compared with 21.1% for the first six months of fiscal 2017, a net 182.0 percentage point increase for the first six months of fiscal 2018 as compared with the first six months of fiscal 2017. The increase in the effective tax rate was primarily due to the mandatory one-time transition tax on accumulated earnings of foreign subsidiaries, foreign withholding tax, and DTA re-measurement during the second quarter of fiscal 2018.
As a result of the adoption of the new accounting standard on share-based compensation, our effective tax rate will increase or decrease based upon the tax effect of the difference between the share-based compensation expenses and the benefits taken on the company's tax returns. We recognize excess tax benefits on a discrete basis and therefore anticipate the effective tax rate to vary from quarter to quarter depending on our share price in each period.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
LIQUIDITY AND CAPITAL RESOURCES
The following sections discuss the effects of changes in our balance sheet, our capital allocation strategy including stock repurchase program and dividends, our contractual obligations, and certain other commitments and activities on our liquidity and capital resources.
Balance Sheet and Cash Flows
Cash and Cash Equivalents and Investments The following table summarizes our cash and cash equivalents and investments (in millions):
| | | | January 27,
2018 | | July 29,
2017 | | Increase (Decrease) | | January 28,
2023 | | July 30,
2022 | | Increase (Decrease) |
| Cash and cash equivalents | $ | 17,624 |
| | $ | 11,708 |
| | $ | 5,916 |
| Cash and cash equivalents | $ | 9,009 | | | $ | 7,079 | | | $ | 1,930 | |
| Fixed income securities | 54,439 |
| | 57,077 |
| | (2,638 | ) | |
| Publicly traded equity securities | 1,620 |
| | 1,707 |
| | (87 | ) | |
| Available-for-sale debt investments | | Available-for-sale debt investments | 12,772 | | | 11,947 | | | 825 | |
| Marketable equity securities | | Marketable equity securities | 280 | | | 241 | | | 39 | |
| Total | $ | 73,683 |
| | $ | 70,492 |
| | $ | 3,191 |
| Total | $ | 22,061 | | | $ | 19,267 | | | $ | 2,794 | |
The net increase in cash and cash equivalents and investments in the first six months of fiscal 20182023 was primarily driven by cash provided by operating activities of $7.2 billion and a net increase in debt of $5.7$8.7 billion. These sourcesThis source of cash werewas partially offset by cash returned to shareholdersstockholders in the form of repurchases of common stock of $5.5$1.8 billion under the stock repurchase program and cash dividends of $2.9 billion;$3.1 billion, a net cash paid for acquisitionsdecrease of $0.8 billion;debt of $0.6 billion and capital expenditures of $0.4$0.3 billion.
Our total inIn the second quarter of fiscal 2023, we deferred our federal tax payment due to the IRS tax relief related to the California floods. We expect our cash and cash equivalents and investments held by various foreign subsidiaries was $71.3 billion and $67.5 billion aspaid for income taxes for the second half of January 27, 2018 and July 29, 2017, respectively. The balance of cash and cash equivalents and investments available in the United States as of January 27, 2018 and July 29, 2017 was $2.4 billion and $3.0 billion, respectively. During the three months ended January 27, 2018,fiscal 2023 to increase as a result of payment of the previously deferred second quarter federal tax payment and the effects of capitalization and amortization of R&D expenses as required by the Tax Act, all historical undistributed foreign subsidiary earnings were subject to a mandatory one-time transition tax, which resulted in a provisional tax expense of $9.0 billion. We plan to pay the transition tax in installments over eight years in accordance with the TaxCuts and Jobs Act. Approximately $0.8 billion is payable in less than one year; $1.4 billion is payable between 1 to 3 years; another $1.4 billion is payable between 3 to 5 years; and the remaining $5.4 billion is payable in more than 5 years. In February 2018, we repatriated to the U.S. $26 billion of historical undistributed foreign subsidiary earnings and paid foreign withholding tax of $1.2 billion. In the third quarter of fiscal 2018, we anticipate repatriating to the U.S. an additional $41 billion of historical undistributed foreign subsidiary earnings. Future repatriation of cash and other property held by our foreign subsidiaries will generally not be subject to U.S. federal tax. As we evaluate the impact of the Tax Act and the future cash needs of our global operations, we may revise the amount of foreign earnings considered to be permanently reinvested in our foreign subsidiaries.
In addition to cash requirements in the normal course of business, in the third quarter of fiscal 2018, we closed the acquisition of BroadSoft for a purchase price of approximately $1.9 billion net of cash and investments. Additionally, $9.0 billion of commercial paper notes and $4.75 billion of long term debt which were outstanding at January 27, 2018 will mature within the next 12 months from the balance sheet date. See further discussion of liquidity under “Liquidity and Capital Resource Requirements” below.
We maintain an investment portfolio of various holdings, types, and maturities. We classify our investments as short-term investments based on their nature and their availability for use in current operations. We believe the overall credit quality of our portfolio is strong, with our cash equivalents and our fixed incomeavailable-for-sale debt investment portfolio consisting primarily of high quality investment-grade securities. We believe that our strong cash and cash equivalents and investments position allows us to use our cash resources for strategic investments to gain access to new technologies, for acquisitions, for customer financing activities, for working capital needs, and for the repurchase of shares of common stock and payment of dividends as discussed below.
Securities Lending We periodically engage in securities lending activities with certain of our available-for-sale debt investments. These transactions are accounted for as a secured lending of the securities, and the securities are typically loaned only on an overnight basis. We require collateral equal to at least 102% of the fair market value of the loaned security and that the collateral be in the form of cash or liquid, high-quality assets. We engage in these secured lending transactions only with highly creditworthy counterparties, and the associated portfolio custodian has agreed to indemnify us against collateral losses. We did not experience any losses in connection with the secured lending of securities during the periods presented. As of January 28, 2023 and July 30, 2022, we had no outstanding securities lending transactions.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Free Cash Flow and Capital Allocation As part of our capital allocation strategy, we intendtarget to return a minimum of 50% of our free cash flow annually to our shareholdersstockholders through cash dividends and repurchases of common stock.
We define free cash flow as net cash provided by operating activities less cash used to acquire property and equipment. The following table reconciles our net cash provided by operating activities to free cash flow (in millions):
| | | | Six Months Ended | | Six Months Ended |
| | January 27,
2018 | | January 28,
2017 | | January 28,
2023 | | January 29,
2022 |
| Net cash provided by operating activities | $ | 7,150 |
| | $ | 6,502 |
| Net cash provided by operating activities | $ | 8,701 | | | $ | 5,888 | |
| Acquisition of property and equipment | (379 | ) | | (526 | ) | Acquisition of property and equipment | (346) | | | (232) | |
| Free cash flow | $ | 6,771 |
| | $ | 5,976 |
| Free cash flow | $ | 8,355 | | | $ | 5,656 | |
We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, the rate at which products are shipped during the quarter (which we refer to as shipment linearity), the timing and collection of accounts receivable and financing receivables, inventory and supply chain management,
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
deferred revenue, and the timing and amount of tax and other payments. For additional discussion, see “Part II, Item 1A. Risk Factors” in this report.
We consider free cash flow to be a liquidity measure that provides useful information to management and investors because of our intent to return a stated percentage of free cash flow to shareholdersstockholders in the form of dividends and stock repurchases. We further regard free cash flow as a useful measure because it reflects cash that can be used to, among other things, invest in our business, make strategic acquisitions, repurchase common stock, and pay dividends on our common stock, after deducting capital investments. A limitation of the utility of free cash flow as a measure of financial performance and liquidity is that the free cash flow does not represent the total increase or decrease in our cash balance for the period. In addition, we have other required uses of cash, including repaying the principal of our outstanding indebtedness. Free cash flow is not a measure calculated in accordance with U.S. generally accepted accounting principles and should not be regarded in isolation or as an alternative for net incomecash provided by operating activities or any other measure calculated in accordance with such principles, and other companies may calculate free cash flow in a different manner than we do.
The following table summarizes the dividends paid and stock repurchases (in millions, except per-share amounts):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | | DIVIDENDS | | STOCK REPURCHASE PROGRAM | | |
| Quarter Ended | | Per Share | | Amount | | Shares | | Weighted-Average Price per Share | | Amount | | TOTAL |
| Fiscal 2018 | | | | | | | | | | | | |
| January 27, 2018 | | $ | 0.29 |
| | $ | 1,425 |
| | 103 |
| | $ | 39.07 |
| | $ | 4,011 |
| | $ | 5,436 |
|
| October 28, 2017 | | $ | 0.29 |
| | $ | 1,436 |
| | 51 |
| | $ | 31.80 |
| | $ | 1,620 |
| | $ | 3,056 |
|
| | | | | | | | | | | | | |
| Fiscal 2017 | | | | | | | | | | | |
|
|
| July 29, 2017 | | $ | 0.29 |
| | $ | 1,448 |
| | 38 |
| | $ | 31.61 |
| | $ | 1,201 |
| | $ | 2,649 |
|
| April 29, 2017 | | $ | 0.29 |
| | $ | 1,451 |
| | 15 |
| | $ | 33.71 |
| | $ | 503 |
| | $ | 1,954 |
|
| January 28, 2017 | | $ | 0.26 |
| | $ | 1,304 |
| | 33 |
| | $ | 30.33 |
| | $ | 1,001 |
| | $ | 2,305 |
|
| October 29, 2016 | | $ | 0.26 |
| | $ | 1,308 |
| | 32 |
| | $ | 31.12 |
| | $ | 1,001 |
| | $ | 2,309 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | DIVIDENDS | | STOCK REPURCHASE PROGRAM | | |
| Quarter Ended | | Per Share | | Amount | | Shares | | Weighted-Average Price per Share | | Amount | | TOTAL |
| Fiscal 2023 | | | | | | | | | | | | |
| January 28, 2023 | | $ | 0.38 | | | $ | 1,560 | | | 26 | | | $ | 47.72 | | | $ | 1,256 | | | $ | 2,816 | |
| October 29, 2022 | | $ | 0.38 | | | $ | 1,560 | | | 12 | | | $ | 43.76 | | | 502 | | | $ | 2,062 | |
| | | | | | | | | | | | |
| Fiscal 2022 | | | | | | | | | | | | |
| July 30, 2022 | | $ | 0.38 | | | $ | 1,567 | | | 54 | | | $ | 44.02 | | | $ | 2,402 | | | $ | 3,969 | |
| April 30, 2022 | | $ | 0.38 | | | $ | 1,555 | | | 5 | | | $ | 54.20 | | | $ | 252 | | | $ | 1,807 | |
| January 29, 2022 | | $ | 0.37 | | | $ | 1,541 | | | 82 | | | $ | 58.36 | | | $ | 4,824 | | | $ | 6,365 | |
| October 30, 2021 | | $ | 0.37 | | | $ | 1,561 | | | 5 | | | $ | 56.49 | | | $ | 256 | | | $ | 1,817 | |
On February 14, 2018,15, 2023, our Board of Directors declared a quarterly dividend of $0.33$0.39 per common share to be paid on April 25, 201826, 2023 to all shareholdersstockholders of record as of the close of business on April 5, 2018.2023. Any future dividends are subject to the approval of our Board of Directors.
On February 14, 2018, our Board of Directors authorized a $25 billion increase to the stock repurchase program. The remaining authorized amount for stock repurchases under this program including the additional authorization, is approximately $31$13.4 billion, with no termination date. We expect
Accounts Receivable, Net The following table summarizes our accounts receivable, net (in millions):
| | | | | | | | | | | | | | | | | |
| | January 28,
2023 | | July 30,
2022 | | Increase (Decrease) |
| Accounts receivable, net | $ | 5,237 | | | $ | 6,622 | | | $ | (1,385) | |
Our accounts receivable net, as of January 28, 2023 decreased by approximately 21%, as compared with the end of fiscal 2022, primarily due to utilize this remaining authorizedtiming and amount for stock repurchases overof product and service billings in the next 18 to 24 months.
second quarter of fiscal 2023 compared with the fourth quarter of fiscal 2022.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Accounts Receivable, Net The following table summarizes our accounts receivable, net (in millions):
|
| | | | | | | | | | | |
| | January 27,
2018 | | July 29,
2017 | | Increase (Decrease) |
| Accounts receivable, net | $ | 3,963 |
| | $ | 5,146 |
| | $ | (1,183 | ) |
Our accounts receivable net, as of January 27, 2018 decreased by approximately 23%, as compared with the end of fiscal 2017, primarily due to product billings being more linear and the amount and timing of service billings in the second quarter of fiscal 2018 compared with the fourth quarter of fiscal 2017.
Inventory Supply Chain The following table summarizes our inventories and inventory purchase commitments with contract manufacturers and suppliers (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | January 28,
2023 | | July 30,
2022 | | July 31,
2021 | | Variance vs. July 30, 2022 | | Variance vs. July 31, 2021 |
| Inventories | $ | 3,140 | | | $ | 2,568 | | | $ | 1,559 | | | $ | 572 | | | $ | 1,581 | |
| Inventory purchase commitments | $ | 10,951 | | | $ | 12,964 | | | $ | 10,254 | | | $ | (2,013) | | | $ | 697 | |
| Inventory deposits and prepayments | $ | 1,688 | | | $ | 1,484 | | | $ | 162 | | | $ | 204 | | | $ | 1,526 | |
|
| | | | | | | | | | | |
| | January 27,
2018 | | July 29,
2017 | | Increase (Decrease) |
| Inventories | $ | 1,896 |
| | $ | 1,616 |
| | $ | 280 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| January 28,
2023 | | July 30,
2022 | | July 31,
2021 | | Variance vs.
July 30, 2022 | | Variance vs.
July 31, 2021 |
| Less than 1 year | $ | 8,651 | | | $ | 9,954 | | | $ | 6,903 | | | $ | (1,303) | | | $ | 1,748 | |
| 1 to 3 years | 1,693 | | | 2,240 | | | 1,806 | | | (547) | | | (113) | |
| 3 to 5 years | 607 | | | 770 | | | 1,545 | | | (163) | | | (938) | |
| Total | $ | 10,951 | | | $ | 12,964 | | | $ | 10,254 | | | $ | (2,013) | | | $ | 697 | |
Inventory as of January 27, 201828, 2023 increased by 17%22% and 101% from our inventory balancebalances at the end of fiscal 2017.2022 and fiscal 2021, respectively. Inventory purchase commitments with contract manufacturers and suppliers decreased by 16% and increased by 7% from our balances at the end of fiscal 2022 and fiscal 2021, respectively. The increasedecrease in inventory purchase commitments as compared with the end of fiscal 2022 was primarily due to higher levelsfulfillment of manufactured finished goodscustomer demand as our supply availability improved and our continued efforts to work with contract manufacturers and suppliers to optimize our inventory and purchase commitments position. We increased our balances in support of currentprior fiscal years in order activity and an increase in raw materialsto address significant supply constraints seen industry-wide. The increases were primarily due to securing memoryarrangements to secure supply which is currently constrained.
Our finished goods consist of distributor inventory and deferred cost of salespricing for certain product components and manufactured finished goods. Distributor inventorycommitments with contract manufacturers to meet customer demand and deferred cost of sales are related to unrecognized revenue on shipments to distributors and retail partnersaddress extended lead times, as well as shipmentsadvance payments with suppliers to customers. Manufactured finished goods consist primarilysecure future supply, as a result of build-to-orderthe supply constraints. We have partnered with several of our key suppliers utilizing our volume purchasing and build-to-stock products.extending supply coverage, including revising supplier arrangements. As discussed, our risks of future material excess and obsolete inventory and related losses are further outlined in the Result of Operations—Product Gross Margin section.
We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with contract manufacturers and suppliers that allow them to procure inventory based upon criteria as defined by us or that establish the parameters defining our requirements and our commitment to securing manufacturing capacity.
Our inventory purchase commitments are for short-term product manufacturing requirements as well as for commitments to suppliers to secure manufacturing capacity. Certain of our inventory purchase commitments with contract manufacturers and suppliers relate to arrangements to secure long-termsupply and pricing for certain product components for multi-year periods. A significant portion of our reported purchase commitments arising from these agreements are firm, noncancelable, and unconditional commitments. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. We believe our inventory and purchase commitments levels are in line with our current demand forecasts. The following table summarizes our purchase commitments with contract manufacturers and suppliers as of the respective period ends (in millions):
|
| | | | | | | |
| Commitments by Period | January 27,
2018 | | July 29,
2017 |
| Less than 1 year | $ | 4,498 |
| | $ | 4,620 |
|
| 1 to 3 years | 690 |
| | 20 |
|
| 3 to 5 years | 540 |
| | — |
|
| Total | $ | 5,728 |
| | $ | 4,640 |
|
Purchase commitments with contract manufacturers and suppliers increased by approximately 23% compared to the end of fiscal 2017. On a combined basis, inventories and purchase commitments with contract manufacturers and suppliers increased by 22% compared with the end of fiscal 2017.
We record a liability, included in other current liabilities, for firm, noncancelable, and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory.
Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility to help ensure competitive lead times with the risk of inventory obsolescence because of supply constraints, rapidly changing technology and customer requirements. We believe the amount of our inventory and inventory purchase commitments is appropriate for our current and expected customer demand and revenue levels.
Financing Receivables and Guarantees The following table summarizes our financing receivables (in millions):
| | | | | | | | | | | | | | | | | |
| | January 28,
2023 | | July 30,
2022 | | Increase (Decrease) |
| Loan receivables, net | $ | 6,042 | | | $ | 6,739 | | | $ | (697) | |
| Lease receivables, net | 1,069 | | | 1,175 | | | (106) | |
| Total, net | $ | 7,111 | | | $ | 7,914 | | | $ | (803) | |
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Financing Receivables and Guarantees The following table summarizes our financing receivables (in millions):
|
| | | | | | | | | | | |
| | January 27,
2018 | | July 29,
2017 | | Increase (Decrease) |
| Lease receivables, net | $ | 2,620 |
| | $ | 2,650 |
| | $ | (30 | ) |
| Loan receivables, net | 4,752 |
| | 4,457 |
| | 295 |
|
| Financed service contracts, net | 2,466 |
| | 2,487 |
| | (21 | ) |
| Total, net | $ | 9,838 |
| | $ | 9,594 |
| | $ | 244 |
|
Financing ReceivablesOur financing arrangements include leases, loans and financed service contracts. Lease receivables include sales-type and direct-financing leases. Arrangements related to leases are generally collateralized by a security interest in the underlying assets. Our loan receivables include customerscustomer financing for purchases of our hardware, software and services (including technical support and advanced services), and also may include additional funds for other costs associated with network installation and integration of our products and services. We also provide financingLease receivables include sales-type leases. Arrangements related to certain qualified customers for long-term service contracts, which primarily relate to technical support services. The majority ofleases are generally collateralized by a security interest in the revenue from these financed service contracts is deferred and is recognized ratably over the period during which the services are performed.underlying assets. Financing receivables increaseddecreased by 3%. We expect to continue to expand10%, as compared with the useend of our financing programs in the near term.fiscal 2022.
Financing GuaranteesIn the normal course of business, third parties may provide financing arrangements to our customers and channel partners under financing programs. The financing arrangements to customers provided by third parties are related to leases and loans and typically have terms of up to three years. In some cases, we provide guarantees to third parties for these lease and loan arrangements. The financing arrangements to channel partners consist of revolving short-term financing provided by third parties, generally with payment terms generally ranging from 60 to 90 days. In certain instances, these financing arrangements result in a transfer of our receivables to the third party. The receivables are derecognized upon transfer, as these transfers qualify as true sales, and we receive payments for the receivables from the third party based on our standard payment terms.
The volume of channel partner financing was $13.6$15.1 billionand $13.2$13.4 billion for the first six months of fiscal 20182023 and 2017,2022, respectively. These financing arrangements facilitate the working capital requirements of the channel partners, and in some cases, we guarantee a portion of these arrangements. The balance of the channel partner financing subject to guarantees was $1.0$1.6 billion and $1.4 billion as of each of January 27, 201828, 2023 and July 29, 2017.30, 2022, respectively. We could be called upon to make payments under these guarantees in the event of nonpayment by the channel partners or end-user customers.partners. Historically, our payments under these arrangements have been immaterial. Where we provide a guarantee, we defer the revenue associated with the channel partner and end-user financing arrangement in accordance with revenue recognition policies, or we record a liability for the fair value of the guarantees. In either case, the deferred revenue is recognized as revenue when the guarantee is removed. As of January 27, 2018,28, 2023, the total maximum potential future payments related to these guarantees was approximately $341$180 million, of which approximately $131$35 million was recorded as deferred revenue.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Borrowings
Senior NotesThe following table summarizes the principal amount of our senior notes (in millions):
| | | | | | | | | | | | | | | | | |
| | Maturity Date | | January 28,
2023 | | July 30,
2022 |
| Senior notes: | | | | | |
| Fixed-rate notes: | | | | | |
| 2.60% | February 28, 2023 | | $ | 500 | | | $ | 500 | |
| 2.20% | September 20, 2023 | | 750 | | | 750 | |
| 3.625% | March 4, 2024 | | 1,000 | | | 1,000 | |
| 3.50% | June 15, 2025 | | 500 | | | 500 | |
| 2.95% | February 28, 2026 | | 750 | | | 750 | |
| 2.50% | September 20, 2026 | | 1,500 | | | 1,500 | |
| 5.90% | February 15, 2039 | | 2,000 | | | 2,000 | |
| 5.50% | January 15, 2040 | | 2,000 | | | 2,000 | |
| Total | | | $ | 9,000 | | | $ | 9,000 | |
|
| | | | | | | | | |
| | Maturity Date | | January 27,
2018 | | July 29,
2017 |
| Senior notes: | | | | | |
| Floating-rate notes: | | | | | |
| Three-month LIBOR plus 0.60% | February 21, 2018 | | $ | 1,000 |
| | $ | 1,000 |
|
| Three-month LIBOR plus 0.31% | June 15, 2018 | | 900 |
| | 900 |
|
| Three-month LIBOR plus 0.50% | March 1, 2019 | | 500 |
| | 500 |
|
| Three-month LIBOR plus 0.34% | September 20, 2019 | | 500 |
| | 500 |
|
| Fixed-rate notes: | | | | | |
| 1.40% | February 28, 2018 | | 1,250 |
| | 1,250 |
|
| 1.65% | June 15, 2018 | | 1,600 |
| | 1,600 |
|
| 4.95% | February 15, 2019 | | 2,000 |
| | 2,000 |
|
| 1.60% | February 28, 2019 | | 1,000 |
| | 1,000 |
|
| 2.125% | March 1, 2019 | | 1,750 |
| | 1,750 |
|
| 1.40% | September 20, 2019 | | 1,500 |
| | 1,500 |
|
| 4.45% | January 15, 2020 | | 2,500 |
| | 2,500 |
|
| 2.45% | June 15, 2020 | | 1,500 |
| | 1,500 |
|
| 2.20% | February 28, 2021 | | 2,500 |
| | 2,500 |
|
| 2.90% | March 4, 2021 | | 500 |
| | 500 |
|
| 1.85% | September 20, 2021 | | 2,000 |
| | 2,000 |
|
| 3.00% | June 15, 2022 | | 500 |
| | 500 |
|
| 2.60% | February 28, 2023 | | 500 |
| | 500 |
|
| 2.20% | September 20, 2023 | | 750 |
| | 750 |
|
| 3.625% | March 4, 2024 | | 1,000 |
| | 1,000 |
|
| 3.50% | June 15, 2025 | | 500 |
| | 500 |
|
| 2.95% | February 28, 2026 | | 750 |
| | 750 |
|
| 2.50% | September 20, 2026 | | 1,500 |
| | 1,500 |
|
| 5.90% | February 15, 2039 | | 2,000 |
| | 2,000 |
|
| 5.50% | January 15, 2040 | | 2,000 |
| | 2,000 |
|
| Total | | | $ | 30,500 |
| | $ | 30,500 |
|
Interest is payable semiannually on each class of the senior fixed-rate notes, each of which is redeemable by us at any time, subject to a make-whole premium. Interest is payable quarterly on the floating-rate notes. We were in compliance with all debt covenants as of January 27, 2018.28, 2023.
Commercial Paper We have a short-term debt financing program in which up to $10.0 billion is available through the issuance of commercial paper notes. We use the proceeds from the issuance of commercial paper notes for general corporate purposes. We had $9.0 billion and $3.2 billionno commercial paper notes outstanding as of January 27, 201828, 2023 and $0.6 billion in commercial paper outstanding as of July 29, 2017, respectively.30, 2022.
Credit FacilitiesFacilityOn May 15, 2015,13, 2021, we entered into a 5-year credit agreement with certain institutional lenders that provides for a $3.0 billion unsecured revolving credit facility that is scheduled to expire on May 15, 2020. 13, 2026. As of January 28, 2023, we were in compliance with the required interest coverage ratio and the other covenants, and we had not borrowed any funds under the credit agreement.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Any advances under the 5-year credit agreement will accrue interest at rates that are equal to, based on certain conditions, either (a) with respect to loans in U.S. dollars, (i) LIBOR or (ii) the Base Rate (to be defined as the highest of (a)(x) the Bank of America prime rate, (y) the Federal Funds rate plus 0.50% and (z) a daily rate equal to one-month LIBOR plus 1.0%), (b) Bank of America’s “prime rate” as announced from timewith respect to time, orloans in Euros, EURIBOR, (c) LIBOR, orwith respect to loans in Yen, TIBOR and (d) with respect to loans in Pounds Sterling, SONIA plus a comparable or successor rate that is approved by the Administrative Agent (“Eurocurrency Rate”), for an interest period of one month plus 1.00%, or (ii) the Eurocurrency Rate,credit spread adjustment, plus a margin that is based on our senior debt credit ratings as published by Standard & Poor’s Financial Services, LLC and Moody’s Investors Service, Inc., provided that in no event will the Eurocurrency Rateinterest rate be less than zero.0.0%. We will pay a quarterly commitment fee during the term of the 5-year credit agreement which may vary depending on our senior debt credit ratings. In addition, the 5-year credit agreement incorporates certain sustainability-linked metrics. Specifically, our applicable interest rate and commitment fee are subject to upward or downward adjustments if we achieve, or fail to achieve, certain specified targets based on two key performance indicator metrics: (i) social impact and (ii) foam reduction. We may also, upon the agreement of either the then-existing lenders or additional lenders not currently parties to the agreement, increase the commitments under the credit facility by up to an additional $2.0 billion and/orand, at our option, extend the expiration datematurity of the credit facility for an additional year up to May 15,two times. The credit agreement requires that we comply with certain covenants, including that we maintain an interest coverage ratio as defined in the agreement.
Remaining Performance Obligations The following table presents the breakdown of remaining performance obligations (in millions):
| | | | | | | | | | | | | | | | | |
| | January 28,
2023 | | July 30,
2022 | | Increase (Decrease) |
| Product | $ | 14,517 | | | $ | 14,090 | | | $ | 427 | |
| Service | 17,255 | | | 17,449 | | | (194) | |
| Total | $ | 31,772 | | | $ | 31,539 | | | $ | 233 | |
| | | | | |
| Short-term RPO | $ | 16,865 | | | $ | 16,936 | | | $ | (71) | |
| Long-term RPO | 14,907 | | | 14,603 | | | 304 | |
| Total | $ | 31,772 | | | $ | 31,539 | | | $ | 233 | |
Total remaining performance obligations as of January 28, 2023 increased 1% compared to the end of fiscal 2022. Remaining performance obligations for product increased by 3% compared to the end of fiscal 2022. Remaining performance obligations for service decreased 1%. We expect approximately 53% of total remaining performance obligations to be recognized as revenue over the next 12 months.
Deferred Revenue The following table presents the breakdown of deferred revenue (in millions):
| | | | | | | | | | | | | | | | | |
| | January 28,
2023 | | July 30,
2022 | | Increase (Decrease) |
| Product | $ | 10,679 | | | $ | 10,427 | | | $ | 252 | |
| Service | 13,248 | | | 12,837 | | | 411 | |
| Total | $ | 23,927 | | | $ | 23,264 | | | $ | 663 | |
| Reported as: | | | | | |
| Current | $ | 13,109 | | | $ | 12,784 | | | $ | 325 | |
| Noncurrent | 10,818 | | | 10,480 | | | 338 | |
| Total | $ | 23,927 | | | $ | 23,264 | | | $ | 663 | |
Total deferred revenue increased 3% compared to the end of fiscal 2022. The increase in deferred product revenue was primarily due to increased deferrals related to our recurring software offerings. The increase in deferred service revenue of 3% was driven by the impact of contract renewals, partially offset by amortization of deferred service revenue.
Contractual Obligations
Transition Tax Payable
The income tax payable outstanding as of January 28, 2023 for the U.S. transition tax on accumulated earnings for foreign subsidiaries is $5.5 billion. Approximately $1.4 billion is payable in less than one year and $4.1 billion is payable between 1 to 3 years.
For our Contractual Obligations see ourAnnual Report on Form 10-K for the fiscal year ended July 30, 2022.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
In addition, on March 30, 2017 we entered into a 364-Day credit agreement with certain institutional lenders that provides for a $2.0 billion unsecured revolving credit facility that is scheduled to expire on March 29, 2018. The credit agreement also provides us the option to, for a fee, convert any borrowings outstanding thereunder on March 29, 2018 to a term loan maturing no later than March 29, 2019. The interest rate applicable to outstanding balances under the credit agreement will be based on either (i) the higher of (a) the rates on overnight Federal Funds transactions with members of the Federal Reserve System (i.e., Federal Funds rate) plus 0.50%, (b) Bank of America’s “prime rate” as announced from time to time or (c) LIBOR for an interest period of one month plus 1.00%, or (ii) LIBOR plus a margin that is based on our senior debt credit ratings as published by S&P Global Rating, a business unit of Standard & Poor’s Financial Services LLC, and Moody’s Investors Service, Inc.
These credit agreements require that we comply with certain covenants, including that we maintain interest coverage ratios as defined in these agreements. As of January 27, 2018, we were in compliance with the required interest coverage ratios and the other covenants, and we had not borrowed any funds under these credit facilities.
Deferred Revenue The following table presents the breakdown of deferred revenue (in millions):
|
| | | | | | | | | | | |
| | January 27,
2018 | | July 29,
2017 | | Increase (Decrease) |
| Service | $ | 10,963 |
| | $ | 11,302 |
| | $ | (339 | ) |
| Product: | | | | |
|
|
| Deferred revenue related to recurring software and subscription offers | 5,451 |
| | 4,971 |
| | 480 |
|
| Other product deferred revenue | 2,374 |
| | 2,221 |
| | 153 |
|
| Total product deferred revenue | 7,825 |
| | 7,192 |
| | 633 |
|
| Total | $ | 18,788 |
| | $ | 18,494 |
| | $ | 294 |
|
| Reported as: | | | | | |
| Current | $ | 11,102 |
| | $ | 10,821 |
| | $ | 281 |
|
| Noncurrent | 7,686 |
| | 7,673 |
| | 13 |
|
| Total | $ | 18,788 |
| | $ | 18,494 |
| | $ | 294 |
|
Deferred product revenue increased 9% primarily due to increased deferrals related to recurring software and subscription offers. The portion of product deferred revenue related to recurring software and subscription offers grew 36% on a year-over-year basis to $5.5 billion as of January 27, 2018. Security and Applications continued to experience strong product deferred revenue growth during the period. The 3% decrease in deferred service revenue was driven by the impact of ongoing amortization of deferred service revenue.
Contractual Obligations
Operating Leases
We lease office space in many U.S. locations. Outside the United States, larger leased sites include sites in Belgium, Canada, China, Germany, India, Israel, Japan, Mexico, Poland and the United Kingdom. We also lease equipment and vehicles. The future minimum lease payments under all of our noncancelable operating leases with an initial term in excess of one year as of January 27, 2018 were $1.2 billion.
Other Commitments
In connection with our acquisitions, we have agreed to pay certain additional amounts contingent upon the achievement of certain agreed-upon technology, development, product, or other milestones or the continued employment with us of certain employees of the acquired entities. See Note 1214 to the Consolidated Financial Statements.
Insieme Networks, Inc.In fiscal 2012, we made an investment in Insieme, an early stage company focused on research and development in the data center market. This investment included $100 million of funding and a license to certain of our technology. During fiscal 2014, we acquired the remaining interests in Insieme, at which time the former noncontrolling interest holders became eligible to receive up to two milestone payments, which were determined using agreed-upon formulas based primarily on revenue for certain of Insieme’s products. The former noncontrolling interest holders earned the maximum amount related to these two milestone payments and were paid approximately $422 million during the first six months of fiscal 2017. During the first six months of fiscal 2017, we recorded compensation expense of $32 million related to these milestone payments. We do not expect a material amount of future compensation expense or further milestone payments related to this acquisition.
CISCO SYSTEMS, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Other Funding CommitmentsWe also have certain funding commitments primarily related to our investments in privately held companies and venture funds,investments, some of which aremay be based on the achievement of certain agreed-upon milestones and some of whichor are required to be funded on demand. The funding commitments were $215 million$0.3 billion and $0.4 billion as of January 27, 2018, compared with $216 million as of28, 2023 and July 29, 2017.30, 2022, respectively.
Off-Balance Sheet Arrangements
We consider our investments in unconsolidated variable interest entities to be off-balance sheet arrangements. In the ordinary course of business, we have investments in privately held companies including venture fundsinvestments and provide financing to certain customers. Certain of these investments are considered to be variable interest entities. We evaluate on an ongoing basis our investments in these privately held companiesinvestments and customer financings, and we have determined that as of January 27, 201828, 2023 there were no material unconsolidated variable interest entities.
On an ongoing basis, we reassess our investments in privately held companiesinvestments and customer financings to determine if they are variable interest entities and if we would be regarded as the primary beneficiary pursuant to the applicable accounting guidance. As a result of this ongoing assessment, we may be required to make additional disclosures or consolidate these entities. Because we may not control these entities, we may not have the ability to influence these events.
We provide financing guarantees, which are generally for various third-party financing arrangements extended to our channel partners and end-user customers.partners. We could be called upon to make payments under these guarantees in the event of nonpayment by the channel partners or end-user customers.partners. See the previous discussion of these financing guarantees under “Financing Receivables and Guarantees.”
Securities Lending
We periodically engage in securities lending activities with certain of our available for sale investments. These transactions are accounted for as a secured lending of the securities, and the securities are typically loaned only on an overnight basis. The average daily balance of securities lending for the six months ended January 27, 2018 and January 28, 2017 was $0.4 billion and $0.9 billion, respectively. We require collateral equal to at least 102% of the fair market value of the loaned security and that the collateral be in the form of cash or liquid, high-quality assets. We engage in these secured lending transactions only with highly creditworthy counterparties, and the associated portfolio custodian has agreed to indemnify us against collateral losses. As of January 27, 2018 and July 29, 2017, we had no outstanding securities lending transactions. We believe these arrangements do not present a material risk or impact to our liquidity requirements.
Liquidity and Capital Resource Requirements
Based on past performance and current expectations, we believe our cash and cash equivalents, investments, cash generated from operations, and ability to access capital markets and committed credit lines will satisfy, through at least the next 12 months, our liquidity requirements, both in total and domestically, including the following: working capital needs (including inventory and other supply related payments), capital expenditures, investment requirements, stock repurchases, cash dividends, contractual obligations, commitments, principal and interest payments on debt, pending acquisitions, future customer financings, and other liquidity requirements associated with our operations. We expect increased payments related to inventory and other supply related payments through at least the next 12 months. There are no other transactions, arrangements, or relationships with unconsolidated entities or other persons that are reasonably likely to materially affect the liquidity and the availability of, as well as our requirements for, capital resources.
|
| | | | |
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Our financial position is exposed to a variety of risks, including interest rate risk, equity price risk, and foreign currency exchange risk.
Interest Rate Risk
Fixed Income SecuritiesAvailable-for-Sale Debt Investments We maintain an investment portfolio of various holdings, types, and maturities. Our primary objective for holding fixed income securitiesavailable-for-sale debt investments is to achieve an appropriate investment return consistent with preserving principal and managing risk. At any time, a sharp rise in market interest rates could have a material adverse impact on the fair value of our fixed incomeavailable-for-sale debt investment portfolio. Conversely, declines in interest rates, including the impact from lower credit spreads, could have a material adverse impact on interest income for our investment portfolio. We may utilize derivative instruments designated as hedging instruments to achieve our investment objectives. We had no outstanding hedging instruments for our fixed income securitiesavailable-for-sale debt investments as of January 27, 2018.28, 2023. Our fixed incomeavailable-for-sale debt investments are held for purposes other than trading. Our fixed incomeavailable-for-sale debt investments are not leveraged as of January 27, 2018.28, 2023. We monitor our interest rate and credit risks, including our credit exposures to specific rating categories and to individual issuers. We believe the overall credit quality of our portfolio is strong.
Financing Receivables As of January 27, 2018,28, 2023, our financing receivables had a carrying value of $9.8$7.1 billion, compared with $9.6$7.9 billion as of July 29, 2017.30, 2022. As of January 27, 2018,28, 2023, a hypothetical 50 basis points (“BPS”) increase or decrease in market interest rates would change the fair value of our financing receivables by a decrease or increase of approximately $0.1 billion, respectively.
Debt As of January 27, 2018,28, 2023, we had $30.5$9.0 billion in principal amount of senior fixed-rate notes outstanding, which consisted of $2.9 billion floating-rate notes and $27.6 billion fixed-rate notes.outstanding. The carrying amount of the senior notes was $30.4$8.9 billion, and the related fair value based on market prices was $31.8$9.4 billion. As of January 27, 2018,28, 2023, a hypothetical 50 BPS increase or decrease in market interest rates would change the fair value of the fixed-rate debt, excluding the $6.8$1.5 billion of hedged debt, by a decrease or increase of approximately $0.6$0.3 billion, respectively. However, this hypothetical change in interest rates would not impact the interest expense on the fixed-rate debt that is not hedged.
Equity Price Risk
Marketable Equity InvestmentsThe fair value of our marketable equity investments in publicly traded companies is subject to market price volatility. We may hold equity securities for strategic purposes or to diversify our overall investment portfolio. Our equity portfolio consists of securities with characteristics that most closely match the Standard & Poor’s 500 Index or NASDAQ Composite Index. These equity securities are held for purposes other than trading. To manage our exposure to changes in theThe total fair value of certainour marketable equity securities we may enter into equity derivatives designated as hedging instruments.
Publicly Traded Equity Securities The following tables present the hypothetical fair values of publicly traded equity securities as a result of selected potential decreases was $280 millionand increases in the price of each equity security in the portfolio, excluding hedged equity securities, if any. Potential fluctuations in the price of each equity security in the portfolio of plus or minus 10%, 20%, and 30% were selected based on potential near-term changes in those security prices. The hypothetical fair values$241 million as of January 27, 201828, 2023 and July 29, 2017 are as follows (in millions):30, 2022, respectively.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | VALUATION OF SECURITIES GIVEN AN X% DECREASE IN EACH STOCK’S PRICE | | FAIR VALUE AS OF JANUARY 27, 2018 | | VALUATION OF SECURITIES GIVEN AN X% INCREASE IN EACH STOCK’S PRICE |
| | (30)% | | (20)% | | (10)% | | 10% | | 20% | | 30% |
| Publicly traded equity securities | $ | 888 |
| | $ | 1,015 |
| | $ | 1,142 |
| | $ | 1,269 |
| | $ | 1,396 |
| | $ | 1,523 |
| | $ | 1,650 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | VALUATION OF SECURITIES GIVEN AN X% DECREASE IN EACH STOCK’S PRICE | | FAIR VALUE AS OF JULY 29, 2017 | | VALUATION OF SECURITIES GIVEN AN X% INCREASE IN EACH STOCK’S PRICE |
| | (30)% | | (20)% | | (10)% | | 10% | | 20% | | 30% |
| Publicly traded equity securities | $ | 1,195 |
| | $ | 1,366 |
| | $ | 1,536 |
| | $ | 1,707 |
| | $ | 1,878 |
| | $ | 2,048 |
| | $ | 2,219 |
|
Investments in Privately Held Companies We have also invested in privately held companies.Investments These investments are recorded in other assets in our Consolidated Balance Sheets and are accounted for using primarily either the cost or the equity method. As of January 27, 2018, theSheets. The total carrying amount of our investments in privately held companiesinvestments was $982 million, compared with $983 million at$1.8 billion and $1.9 billion as of January 28, 2023 and July 29, 2017.30, 2022, respectively. Some of the privately heldthese companies in which we invested are in the startup or development stages. These investments are inherently risky because the markets for the technologies or products these companies are developing are typically in the early stages and may never materialize. We could lose our entire investment in these companies. Our evaluation of investments in privately held companiesinvestments is based on the fundamentals of the businesses invested in, including, among other factors, the nature of their technologies and potential for financial return.
Foreign Currency Exchange Risk
Our foreign exchange forward and option contracts outstanding as of the respective period-ends are summarized in U.S. dollar equivalents as follows (in millions):
| | | | January 27, 2018 | | July 29, 2017 | | January 28, 2023 | | July 30, 2022 |
| | Notional Amount | | Fair Value | | Notional Amount | | Fair Value | | Notional Amount | | Fair Value | | Notional Amount | | Fair Value |
| Forward contracts: | | | | | | | | Forward contracts: | | | | | | | |
| Purchased | $ | 3,204 |
| | $ | 64 |
| | $ | 2,562 |
| | $ | 39 |
| Purchased | $ | 2,559 | | | $ | (7) | | | $ | 2,578 | | | $ | (50) | |
| Sold | $ | 506 |
| | $ | — |
| | $ | 729 |
| | $ | (2 | ) | Sold | $ | 1,996 | | | $ | 12 | | | $ | 1,943 | | | $ | 50 | |
| Option contracts: | | | | | | | | |
| Purchased | $ | 194 |
| | $ | 6 |
| | $ | 528 |
| | $ | 7 |
| |
| Sold | $ | 174 |
| | $ | — |
| | $ | 486 |
| | $ | (1 | ) | |
We conduct business globally in numerous currencies. The direct effect of foreign currency fluctuations on revenue has not been material because our revenue is primarily denominated in U.S. dollars. However, if the U.S. dollar strengthens relative to other currencies, such strengthening could have an indirect effect on our revenue to the extent it raises the cost of our products to non-U.S. customers and thereby reduces demand. A weaker U.S. dollar could have the opposite effect. However, the precise indirect effect of currency fluctuations is difficult to measure or predict because our revenue is influenced by many factors in addition to the impact of such currency fluctuations.
Approximately 70% of our operating expenses are U.S.-dollar denominated. In the first six months of fiscal 2018,2023, foreign currency fluctuations, net of hedging, increaseddecreased our combined R&D, sales and marketing, and G&A expenses by approximately $41$263 million, or 0.5%2.9%, compared with the first six months of fiscal 2017.2022. To reduce variability in operating expenses and service cost of sales caused by non-U.S.-dollar denominated operating expenses and costs, we may hedge certain forecasted foreign currency transactions with currency options and forward contracts. These hedging programs are not designed to provide foreign currency protection over long time horizons. In designing a specific hedging approach, we consider several factors, including offsetting exposures, significance of exposures, costs associated with entering into a particular hedge instrument, and potential effectiveness of the hedge. The gains and losses on foreign exchange contracts mitigate the effect of currency movements on our operating expenses and service cost of sales.
We also enter into foreign exchange forward and option contracts to reduce the short-term effects of foreign currency fluctuations on receivables and payables that are denominated in currencies other than the functional currencies of the entities. The market risks associated with these foreign currency receivables investments, and payables relate primarily to variances from our forecasted foreign currency transactions and balances. We do not enter into foreign exchange forward or option contracts for speculative purposes.
|
| | | | |
| Item 4. | Controls and Procedures |
Evaluation of disclosure controls and procedures. Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our second quarter of fiscal 20182023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
BrazilBrazilian authorities have investigated our Brazilian subsidiary and certain of its former employees, as well asFor a Brazilian importerdescription of our products,pending legal proceedings, see Note 14, “Commitments and its affiliates and employees, relating to alleged evasion of import taxes and alleged improper transactions involving the subsidiary and the importer. Brazilian tax authorities have assessed claims against our Brazilian subsidiary based on a theory of joint liability with the Brazilian importer for import taxes, interest, and penalties. In addition to claims asserted by the Brazilian federal tax authorities in prior fiscal years, tax authorities from the Brazilian state of Sao Paulo have asserted similar claims on the same legal basis in prior fiscal years.
The asserted claims by Brazilian federal tax authorities that remain are for calendar years 2003 through 2007, and the asserted claims by the tax authorities from the state of Sao Paulo are for calendar years 2005 through 2007. The total asserted claims by Brazilian state and federal tax authorities aggregate to $257 million for the alleged evasion of import and other taxes, $1.6 billion for interest, and $1.2 billion for various penalties, all determined using an exchange rate as of January 27, 2018. We have completed a thorough review of the matters and believe the asserted claims against our Brazilian subsidiary are without merit, and we are defending the claims vigorously. While we believe there is no legal basis for the alleged liability, due to the complexities and uncertainty surrounding the judicial process in Brazil and the nature of the claims asserting joint liability with the importer, we are unable to determine the likelihood of an unfavorable outcome against our Brazilian subsidiary and are unable to reasonably estimate a range of loss, if any. We do not expect a final judicial determination for several years.
SRI International On September 4, 2013, SRI International, Inc. (“SRI”) asserted patent infringement claims against usContingencies—(f) Legal Proceedings” in the U.S. District Court for the DistrictNotes to Consolidated Financial Statements.
SSL SSL Services, LLC (“SSL”) has asserted claims for patent infringement against us in the U.S. District Court for the Eastern District of Texas. The proceeding was instituted on March 25, 2015. SSL alleges that our AnyConnect products that include Virtual Private Networking functions infringed a U.S. patent owned by SSL. SSL seeks money damages from us. On August 18, 2015, we petitioned the Patent Trial and Appeal Board (“PTAB”) of the United States Patent and Trademark Office to review whether the patent SSL has asserted against us is valid over prior art. On February 23, 2016, a PTAB multi-judge panel found a reasonable likelihood that we would prevail in showing that SSL’s patent claims are unpatentable and instituted proceedings. On June 28, 2016, in light of the PTAB’s decision to review the patent’s validity, the district court issued an order staying the district court case pending the final written decision from the PTAB. On February 22, 2017, following a hearing, the PTAB issued its Final Written Decision that the patent’s claims are unpatentable. SSL has appealed this decision to the Court of Appeals for the Federal Circuit. We believe we have strong arguments that our products do not infringe and the patent is invalid. If we do not prevail and a jury were to find that our AnyConnect products infringe, we believe damages, as appropriately measured, would be immaterial. Due to uncertainty surrounding patent litigation processes, we are unable to reasonably estimate the ultimate outcome of this litigation at this time.
Straight Path On September 24, 2014, Straight Path IP Group, Inc. (“Straight Path”) asserted patent infringement claims against us in the U.S. District Court for the Northern District of California, accusing our 9971 IP Phone, Unified Communications Manager working in conjunction with 9971 IP Phones, and Video Communication Server products of infringement. All of the asserted patents have expired and Straight Path was therefore limited to seeking monetary damages for the alleged past infringement. On November 13, 2017, the Court granted our motion for summary judgment of non-infringement, thereby dismissing Straight Path's claims against us and cancelling a trial which had been set for March 12, 2018. On January 16, 2018, Straight Path appealed to the U.S. Court of Appeal for the Federal Circuit.
DXC Technology On August 21, 2015, Cisco and Cisco Systems Capital Corporation (“Cisco Capital”) filed an action in Santa Clara County Superior Court for declaratory judgment and breach of contract against HP Inc. (“HP”) regarding a services agreement for management services of a third party’s network. HP prepaid the service agreement through a financing arrangement with Cisco Capital. HP terminated its agreement with us, and pursuant to the terms of the service agreement with HP, we determined the credit HP was entitled to receive under the agreement. HP disputed our credit calculation and contended that we owe a larger credit to HP than we had calculated. In December 2015, we filed an amended complaint which dropped the breach of contract claim in light of HP’s continuing payments to Cisco Capital under the financing arrangement. On January 19, 2016, HP Inc. filed a counterclaim for breach of contract simultaneously with its answer to the amended complaint. DXC Technology Corporation (“DXC”) reported that it is the party in interest in this matter pursuant to the Separation and Distribution Agreement between the then Hewlett-Packard Co. and Hewlett Packard Enterprise Company (“HPE") and the subsequent Separation and Distribution Agreement between HPE and DXC. On January 8, 2018, the court continued the trial date from March 12, 2018 to June 11, 2018. We are unable to reasonably estimate the ultimate outcome of this litigation due to uncertainty surrounding the litigation process. However, we do not anticipate that our obligation, if any, regarding the final outcome of the dispute would be material.
In addition, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business, including intellectual property litigation. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. For additional information regarding intellectual property litigation, see “Part II, Item 1A. Risk Factors-We may be found to infringe on intellectual property rights of others” herein.
Set forth below and elsewhere in this report and in other documents we file with the SEC are descriptions of the risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. The descriptions below include any material changes to and supersede the description of the risk factors affecting our business previously disclosed in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended July 29, 2017.30, 2022.
OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, WHICH MAY ADVERSELY AFFECT OUR STOCK PRICERisks Related to our Business and Industry
Our business, results of operations and financial condition have been adversely affected and could in the future be materially adversely affected by the COVID-19 pandemic.
The COVID-19 pandemic and the resulting containment measures have caused economic and financial disruptions globally, including in most of the regions in which we sell our products and services and conduct our business operations. Beginning in the second half of fiscal 2020, the COVID-19 pandemic impacted our financial results and business operations. While we saw further improvements in the second quarter of fiscal 2023, we continue to manage through significant supply constraints seen industry-wide due to component shortages which have resulted in extended lead times and higher supply chain costs. The magnitude and duration of the disruption of the pandemic, its continuing impact on us, and resulting decline in global business activity is uncertain.
The COVID-19 pandemic and the responsive measures taken in many countries have adversely affected and could in the future materially adversely affect our business, results of operations and financial condition. Shelter-in-place and/or lockdown orders globally and other measures have and could in the future impact our supply chain. In addition, current and future restrictions or disruptions of transportation, such as reduced availability of air transport, port closures, and increased border controls or closures, can also impact our ability to meet customer demand and could materially adversely affect us. Our customers have also experienced, and may continue to experience, disruptions in their operations, which can result in delayed, reduced, or canceled orders, and increased collection risks, and which may adversely affect our results of operations.
The COVID-19 pandemic has also led to increased disruption and volatility in capital markets and credit markets. The pandemic and resulting economic uncertainty could adversely affect our liquidity and capital resources in the future. The inputs into certain of our judgments, assumptions, and estimates considered the economic implications of the COVID-19 pandemic on our critical and significant accounting estimates. The actual results that we experience may differ materially from our estimates. As the COVID-19 pandemic continues to develop, many of our estimates could require increased judgment and carry a higher degree of variability and volatility. As events continue to evolve our estimates may change materially in future periods.
The extent of the impact of the COVID-19 pandemic on our operational and financial performance is currently uncertain and will depend on many factors outside our control, including, without limitation, the timing, extent, trajectory and duration of the pandemic, the efficacy of available vaccines, the imposition of protective public safety measures, and the impact of the pandemic on the global economy. Potential negative impacts of these external factors include, but are not limited to, material adverse effects on demand for our products and services; our supply chain and sales and distribution channels; collectability of customer accounts; our ability to execute strategic plans; impairments; and our profitability and cost structure. To the extent the COVID-19 pandemic adversely affects our business, results of operations and financial condition, it may also have the effect of exacerbating the other risks discussed in this “Risk Factors” section.
Our operating results may fluctuate in future periods, which may adversely affect our stock price.
Our operating results have been in the past, and will continue to be, subject to quarterly and annual fluctuations as a result of numerous factors, some of which may contribute to more pronounced fluctuations in an uncertain global economic environment. These factors include:
•Fluctuations in demand for our products and services, especially with respect to service providers and Internet businesses, in part due to changes in the global economic environment
•Changes in sales and implementation cycles for our products and reduced visibility into our customers’ spending plans and associated revenue
•Our ability to maintain appropriate inventory levels and purchase commitments
•Price and product competition in the communications and networking industries, which can change rapidly due to technological innovation and different business models from various geographic regions
•The overall movement toward industry consolidation among both our competitors and our customers
•The introduction and market acceptance of new technologies and products, and our success in new and evolving markets, and in emerging technologies, as well as the adoption of new standards
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| • | | Fluctuations in demand for our products and services, especially with respect to service providers and Internet businesses, in part due to changes in the global economic environment |
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| • | | Changes in sales and implementation cycles for our products and reduced visibility into our customers’ spending plans and associated revenue |
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| • | | Our ability to maintain appropriate inventory levels and purchase commitments |
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| • | | Price and product competition in the communications and networking industries, which can change rapidly due to technological innovation and different business models from various geographic regions |
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| • | | The overall movement toward industry consolidation among both our competitors and our customers |
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| • | | The introduction and market acceptance of new technologies and products, and our success in new and evolving markets, and in emerging technologies, as well as the adoption of new standards |
•The transformation of our business to deliver more software and subscription offerings where revenue is recognized over time |
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| • | | The transformation of our business to deliver more software and subscription offerings where revenue is recognized over time |
•Variations in sales channels, product costs, mix of products sold, or mix of direct sales and indirect sales |
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| • | | Variations in sales channels, product costs, mix of products sold, or mix of direct sales and indirect sales |
•The timing, size, and mix of orders from customers |
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| • | | The timing, size, and mix of orders from customers |
•Manufacturing and customer lead times |
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| • | | Manufacturing and customer lead times |
•Fluctuations in our gross margins, and the factors that contribute to such fluctuations |
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| • | | Fluctuations in our gross margins, and the factors that contribute to such fluctuations, as described below |
•The ability of our customers, channel partners, contract manufacturers and suppliers to obtain financing or to fund capital expenditures, especially during a period of global credit market disruption or in the event of customer, channel partner, contract manufacturer or supplier financial problems |
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| • | | The ability of our customers, channel partners, contract manufacturers and suppliers to obtain financing or to fund capital expenditures, especially during a period of global credit market disruption or in the event of customer, channel partner, contract manufacturer or supplier financial problems |
•Actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities, and other items reflected in our Consolidated Financial Statements |
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| • | | Actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities, and other items reflected in our Consolidated Financial Statements |
•How well we execute on our strategy and operating plans and the impact of changes in our business model that could result in significant restructuring charges |
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| • | | How well we execute on our strategy and operating plans and the impact of changes in our business model that could result in significant restructuring charges |
•Our ability to achieve targeted cost reductions |
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| • | | Our ability to achieve targeted cost reductions |
•Benefits anticipated from our investments |
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| • | | Benefits anticipated from our investments in engineering, sales, service, and marketing |
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| • | | Changes in tax laws or accounting rules, or interpretations thereof |
As a consequence, operating results for a particular future period are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition that could adversely affect our stock price.
OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED BY UNFAVORABLE ECONOMIC AND MARKET CONDITIONS AND THE UNCERTAIN GEOPOLITICAL ENVIRONMENTOur operating results may be adversely affected by unfavorable economic and market conditions and the uncertain geopolitical environment.
Challenging economic conditions, including rising inflation, or other changes, worldwide have from time to time contributed, and may continue to contribute, to slowdowns in the communications and networking industries at large, as well as in specific segments and markets in which we operate, resulting in:
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| • | | Reduced demand for our products as a result of continued constraints on IT-related capital spending by our customers, particularly service providers, and other customer markets as well |
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| • | | Increased price competition for our products, not only from our competitors but also as a consequence of customers disposing of unutilized products |
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| • | | Risk of excess and obsolete inventories |
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| • | | Risk of supply constraints |
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| • | | Risk of excess facilities and manufacturing capacity |
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| • | | Higher overhead costs as a percentage of revenue and higher interest expense |
The global macroeconomic environment has beencontinues to be challenging and inconsistent. Instabilityinconsistent, and is being significantly impacted by the COVID-19 pandemic. In certain prior periods, we have seen a broad-based weakening in the global macroeconomic environment which has impacted and could impact in the future certain of our markets. Additionally, instability in the global credit markets, the impact of uncertainty regarding global central bank monetary policy, the instability in the geopolitical environment in many parts of the world including(including as a result of the recent United Kingdom “Brexit” referendum to withdraw fromon-going Russia and Ukraine war, and China-Taiwan relations), the European Union, the current
economic challenges in China, including global economic ramifications of Chinese economic difficulties, and other disruptions may continue to put pressure on global economic conditions. If global economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate further, we may experience material impacts on our business, operating results, and financial condition.
Our operating results in one or more segments may also be affected by uncertain or changing economic conditions particularly germane to that segment or to particular customer markets within that segment. For example, emerging countries in the aggregate experienced a decline in product orders in the first quarter of fiscal 2018, in fiscal 2017, and in certain prior periods.
In addition, reports of certain intelligence gathering methods of the U.S. government could affect customers’ perception of the products of IT companies which design and manufacture products in the United States. Trust and confidence in us as an IT supplier isare critical to the development and growth of our markets. Impairment of that trust, or foreign regulatory actions taken in response to reports of certain intelligence gathering methods of the U.S. government, could affect the demand for our products from customers outside of the United States and could have an adverse effect on our operating results.
WE HAVE BEEN INVESTING AND EXPECT TO CONTINUE TO INVEST IN KEY PRIORITY AND GROWTH AREAS AS WELL AS MAINTAINING LEADERSHIP IN INFRASTRUCTURE PLATFORMS AND IN SERVICES, AND IF THE RETURN ON THESE INVESTMENTS IS LOWER OR DEVELOPS MORE SLOWLY THAN WE EXPECT, OUR OPERATING RESULTS MAY BE HARMED
We expectOur revenue for a particular period is difficult to realignpredict, and dedicate resources into key priority and growth areas, such as Security and Applications, while also focusing on maintaining leadershipa shortfall in Infrastructure Platforms and in Services. However, the return on our investmentsrevenue may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments (including if our selection of areas for investment does not play out as we expect), or if the achievement of these benefits is delayed,harm our operating results may be adversely affected.
OUR REVENUE FOR A PARTICULAR PERIOD IS DIFFICULT TO PREDICT, AND A SHORTFALL IN REVENUE MAY HARM OUR OPERATING RESULTSresults.
As a result of a variety of factors discussed in this report, our revenue for a particular quarter is difficult to predict, especially in light of a challenging and inconsistent global macroeconomic environment (including as a result of the Russia and Ukraine war), the significant impacts of the COVID-19 pandemic, and related market uncertainty.
Our revenue may grow at a slower rate than in past periods, or decline as it did in the first quarter of fiscal 2018 and in fiscal 2017 on a year-over-year basis.certain prior periods. Our ability to meet financial expectations could also be adversely affected if the nonlinear sales pattern seen in some of our past quarters recurs in future periods. We have experienced periods of
time during which shipments have exceeded net bookings or manufacturing issues have delayed shipments, leading to nonlinearity in shipping patterns. In addition to making it difficult to predict revenue for a particular period, nonlinearity in shipping can increase costs, because irregular shipment patterns result in periods of underutilized capacity and periods in which overtime expenses may be incurred, as well as in potential additional inventory management-related costs. In addition, to the extent that manufacturing issues and any related component shortages result in delayed shipments in the future, and particularly in periods in which our contract manufacturers are operating at higher levels of capacity, it is possible that revenue for a quarter could be adversely affected if such matters occur and are not remediated within the same quarter.
The timing of large orders can also have a significant effect on our business and operating results from quarter to quarter, primarily in the United States and in emerging countries.quarter. From time to time, we receive large orders that have a significant effect on our operating results in the period in which the order is recognized as revenue. The timing of such orders is difficult to predict, and the timing of revenue recognition from such orders may affect period to period changes in revenue. As a result, our operating results could vary materially from quarter to quarter based on the receipt of such orders and their ultimate recognition as revenue.
Inventory management remains an area of focus. We have experienced longer Longer than normal manufacturing lead times in the past which have caused, and in the future could cause, some customers to place the same or a similar order multiple times within our various sales channels and to cancel the duplicative orders upon shipment or receipt of the product, or to also place orders with other vendors with shorter manufacturing lead times. Such multiple ordering (along with other factors) or risk of order cancellation may cause difficulty in predicting our revenue and, as a result, could impair our ability to manage parts inventory effectively. In addition,revenue. Further, our efforts to improve manufacturing lead-time performance may result in corresponding reductions in order backlog. A decline in backlog levels could result in more variability and less predictability in our quarter-to-quarter revenue and operating results. In addition, when facing component supply-related challenges we have increased our efforts in procuring components in order to meet customer expectations, which in turn contribute to an increase in inventory and purchase commitments. IncreasesIn recent periods, we increased our inventory and purchase commitments in light of the significant supply constraints seen industry-wide due to component shortages, caused in part by the COVID-19 pandemic. While we saw further improvements of the industry-wide supply constraints in the second quarter of fiscal 2023, we expect such constraints to continue for an uncertain duration. These increases in our inventory and purchase commitments to shorten lead times could also lead to material excess and obsolete inventory charges in future periods if the demand for our products is less than our expectations.
We plan our operating expense levels based primarily on forecasted revenue levels. These expenses and the impact of long-term commitments are relatively fixed in the short term. A shortfall in revenue could lead to operating results being below expectations because we may not be able to quickly reduce these fixed expenses in response to short-term business changes.
Any of the above factors could have a material adverse impact on our operations and financial results.
WE EXPECT GROSS MARGIN TO VARY OVER TIME, AND OUR LEVEL OF PRODUCT GROSS MARGIN MAY NOT BE SUSTAINABLE
Our product gross margins declined in the first quarter For additional information and a further discussion of fiscal 2018current impacts and in fiscal 2017,risks related to our significant supply constraints, inventory commitments and in certain other prior periods,our purchase commitments with contract manufacturers and could decline in future quarters due to adverse impacts from various factors, including:
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| • | | Changes in customer, geographic, or product mix, including mix of configurations within each product group |
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| • | | Introduction of new products, including products with price-performance advantages, and new business models including the transformation of our business to deliver more software and subscription offerings |
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| • | | Our ability to reduce production costs |
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| • | | Entry into new markets or growth in lower margin markets, including markets with different pricing and cost structures, through acquisitions or internal development |
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| • | | Increases in material, labor or other manufacturing-related costs, which could be significant especially during periods of supply constraints such as those impacting the market for memory components |
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| • | | Excess inventory and inventory holding charges |
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| • | | Changes in shipment volume |
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| • | | The timing of revenue recognition and revenue deferrals |
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| • | | Increased cost, loss of cost savings or dilution of savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand or if the financial health of either contract manufacturers or suppliers deteriorates |
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| • | | Lower than expected benefits from value engineering |
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| • | | Increased price competition, including competitors from Asia, especially from China |
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| • | | Changes in distribution channels |
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| • | | Increased warranty costs |
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| • | | Increased amortization of purchased intangible assets, especially from acquisitions |
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| • | | How well we execute on our strategy and operating plans |
Changes in service gross margin may result from various factors such as changes in the mix between technical support servicessuppliers, see “Results of Operations—Product Gross Margin—Supply Constraints Impacts and advanced services, as well as the timing of technical support service contract initiationsRisks”, “Liquidity and renewalsCapital Resources—Inventory Supply Chain” and the addition of personnel and other resources to support higher levels of service business in future periods.
SALES TO THE SERVICE PROVIDER MARKET ARE ESPECIALLY VOLATILE, AND WEAKNESS IN ORDERS FROM THIS INDUSTRY MAY HARM OUR OPERATING RESULTS AND FINANCIAL CONDITION
SalesNote 14 to the service provider market have been characterized by large and sporadic purchases, especially relatingConsolidated Financial Statements.
Supply chain issues, including financial problems of contract manufacturers or component suppliers, or a shortage of adequate component supply or manufacturing capacity that increase our costs or cause a delay in our ability to our router sales and sales of certain other Infrastructure Platforms and Applications products, in addition to longer sales cycles. Productfulfill orders, from the service provider market decreased in the first half of fiscal 2018 and in fiscal 2017, and at various times in the past we have experienced significant weakness in product orders from service providers. Product orders from the service provider market could continue to decline and, as has been the case in the past, such weakness could persist over extended periods of time given fluctuating market conditions. Sales activity in this industry depends upon the stage of completion of expanding network infrastructures; the availability of funding; and the extent to which service providers are affected by regulatory, economic, and
business conditions in the country of operations. Weakness in orders from this industry, including as a result of any slowdown in capital expenditures by service providers (which may be more prevalent during a global economic downturn, or periods of economic, political or regulatory uncertainty), could have a materialan adverse effectimpact on our business, operating results, and financial condition. Such slowdowns may continue or recur in future periods. Orders from this industry could decline for many reasons other than the competitiveness of our products and services within their respective markets. For example, in the past, many of our service provider customers have been materially and adversely affected by slowdowns in the general economy, by overcapacity, by changes in the service provider market, by regulatory developments, and by constraints on capital availability, resulting in business failures and substantial reductions in spending and expansion plans. These conditions have materially harmed our business and operating results, and our failure to estimate customer demand properly may result in the past, and some of theseexcess or other conditions in the service provider marketobsolete component supply, which could adversely affect our business and operating results in any future period. Finally, service provider customers typically have longer implementation cycles; require a broader range of services, including design services; demand that vendors take on a larger share of risks; often require acceptance provisions, which can lead to a delay in revenue recognition; and expect financing from vendors. All these factors can add further risk to business conducted with service providers.
DISRUPTION OF OR CHANGES IN OUR DISTRIBUTION MODEL COULD HARM OUR SALES AND MARGINS
If we fail to manage distribution of our products and services properly, or if our distributors’ financial condition or operations weaken, our revenue and gross margins could be adversely affected.
A substantial portion of our products and services is sold through our channel partners, and the remainder is sold through direct sales. Our channel partners include systems integrators, service providers, other resellers, and distributors. Systems integrators and service providers typically sell directly to end users and often provide system installation, technical support, professional services, and other support services in addition to network equipment sales. Systems integrators also typically integrate our products into an overall solution, and a number of service providers are also systems integrators. Distributors stock inventory and typically sell to systems integrators, service providers, and other resellers. We refer to sales through distributors as our two-tier system of sales to the end customer. Revenue from distributors is generally recognized based on a sell-through method using information provided by them. These distributors are generally given business terms that allow them to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. If sales through indirect channels increase, this may lead to greater difficulty in forecasting the mix of our products and, to a degree, the timing of orders from our customers.
Historically, we have seen fluctuations in our gross margins based on changes in the balance of our distribution channels. Although variability to date has not been significant, there can be no assurance that changes in the balance of our distribution model in future periods would not have an adverse effect on our gross margins and profitability.
Some factors could result in disruption of or changes in our distribution model, which could harm our sales and margins, including the following:
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| • | | We compete with some of our channel partners, including through our direct sales, which may lead these channel partners to use other suppliers that do not directly sell their own products or otherwise compete with them |
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| • | | Some of our channel partners may demand that we absorb a greater share of the risks that their customers may ask them to bear |
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| • | | Some of our channel partners may have insufficient financial resources and may not be able to withstand changes and challenges in business conditions |
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| • | | Revenue from indirect sales could suffer if our distributors’ financial condition or operations weaken |
In addition, we depend on our channel partners globally to comply with applicable regulatory requirements. To the extent that they fail to do so, that could have a material adverse effect on our business, operating results, and financial condition. Further, sales of our products outside of agreed territories can result in disruption to our distribution channels.
THE MARKETS IN WHICH WE COMPETE ARE INTENSELY COMPETITIVE, WHICH COULD ADVERSELY AFFECT OUR ACHIEVEMENT OF REVENUE GROWTH
The markets in which we compete are characterized by rapid change, converging technologies, and a migration to networking and communications solutions that offer relative advantages. These market factors represent a competitive threat to us. We compete with numerous vendors in each product category. The overall number of our competitors providing niche product solutions may increase. Also, the identity and composition of competitors may change as we increase our activity in newer product areas, and in key priority and growth areas. For example, as products related to network programmability, such as SDN products, become more prevalent, we expect to face increased competition from companies that develop networking products based on commoditized
hardware, referred to as "white box" hardware, to the extent customers decide to purchase those product offerings instead of ours. In addition, the growth in demand for technology delivered as a service enables new competitors to enter the market.
As we continue to expand globally, we may see new competition in different geographic regions. In particular, we have experienced price-focused competition from competitors in Asia, especially from China, and we anticipate this will continue. Our competitors include Amazon Web Services LLC; Arista Networks, Inc.; ARRIS Group, Inc.; Check Point Software Technologies Ltd.; Dell Technologies Inc.; Extreme Networks, Inc.; F5 Networks, Inc.; FireEye, Inc.; Fortinet, Inc.; Hewlett-Packard Enterprise Company; Huawei Technologies Co., Ltd.; Juniper Networks, Inc.; Lenovo Group Limited; Microsoft Corporation; New Relic, Inc.; Nokia Corporation; Nutanix, Inc.; Palo Alto Networks, Inc.; Symantec Corporation; Ubiquiti Networks and VMware, Inc.; among others.
Some of our competitors compete across many of our product lines, while others are primarily focused in a specific product area. Barriers to entry are relatively low, and new ventures to create products that do or could compete with our products are regularly formed. In addition, some of our competitors may have greater resources, including technical and engineering resources, than we do. As we expand into new markets, we will face competition not only from our existing competitors but also from other competitors, including existing companies with strong technological, marketing, and sales positions in those markets. We also sometimes face competition from resellers and distributors of our products. Companies with which we have strategic alliances in some areas may be competitors in other areas, and in our view this trend may increase.
For example, the enterprise data center is undergoing a fundamental transformation arising from the convergence of technologies, including computing, networking, storage, and software, that previously were segregated. Due to several factors, including the availability of highly scalable and general purpose microprocessors, ASICs offering advanced services, standards based protocols, cloud computing and virtualization, the convergence of technologies within the enterprise data center is spanning multiple, previously independent, technology segments. Also, some of our current and potential competitors for enterprise data center business have made acquisitions, or announced new strategic alliances, designed to position them to provide end-to-end technology solutions for the enterprise data center. As a result of all of these developments, we face greater competition in the development and sale of enterprise data center technologies, including competition from entities that are among our long-term strategic alliance partners. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us.
The principal competitive factors in the markets in which we presently compete and may compete in the future include:
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| • | | The ability to sell successful business outcomes |
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| • | | The ability to provide a broad range of networking and communications products and services |
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| • | | The ability to introduce new products, including providing continuous new customer value and products with price-performance advantages |
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| • | | The ability to reduce production costs |
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| • | | The ability to provide value-added features such as security, reliability, and investment protection |
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| • | | Conformance to standards |
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| • | | The ability to provide financing |
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| • | | Disruptive technology shifts and new business models |
We also face competition from customers to which we license or supply technology and suppliers from which we transfer technology. The inherent nature of networking requires interoperability. As such, we must cooperate and at the same time compete with many companies. Any inability to effectively manage these complicated relationships with customers, suppliers, and strategic alliance partners could have a material adverse effect on our business, operating results, and financial condition and accordingly affect our chances of success.
OUR INVENTORY MANAGEMENT RELATING TO OUR SALES TO OUR TWO-TIER DISTRIBUTION CHANNEL IS COMPLEX, AND EXCESS INVENTORY MAY HARM OUR GROSS MARGINS
We must manage our inventory relating to sales to our distributors effectively, because inventory held by them could affect our results of operations. Our distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high, or delay orders in anticipation of new products. They also may adjust their orders in response to the supply of our products and the products of our competitors that are available to them, and in response to seasonal fluctuations in end-user demand. Revenue to our distributors generally is recognized based on a sell-through method using information provided by them, and they are generally given business terms that allow them to return a portion of inventory, receive credits for changes in selling price, and participate in various cooperative marketing programs. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology and customer requirements. When facing component supply-related challenges, we have increased our efforts in procuring components in order to meet customer expectations. If we ultimately determine that we have excess inventory, we may have to reduce our prices and write down inventory, which in turn could result in lower gross margins.
SUPPLY CHAIN ISSUES, INCLUDING FINANCIAL PROBLEMS OF CONTRACT MANUFACTURERS OR COMPONENT SUPPLIERS, OR A SHORTAGE OF ADEQUATE COMPONENT SUPPLY OR MANUFACTURING CAPACITY THAT INCREASED OUR COSTS OR CAUSED A DELAY IN OUR ABILITY TO FULFILL ORDERS, COULD HAVE AN ADVERSE IMPACT ON OUR BUSINESS AND OPERATING RESULTS, AND OUR FAILURE TO ESTIMATE CUSTOMER DEMAND PROPERLY MAY RESULT IN EXCESS OR OBSOLETE COMPONENT SUPPLY, WHICH COULD ADVERSELY AFFECT OUR GROSS MARGINS
The fact that we do not own or operate the bulk of our manufacturing facilities and that we are reliant on our extended supply chain could have an adverse impact on the supply of our products and on our business and operating results:
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| • | | Any financial problems of either contract manufacturers or component suppliers could either limit supply or increase costs |
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| • | | Reservation of manufacturing capacity at our contract manufacturers by other companies, inside or outside of our industry, could either limit supply or increase costs |
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| • | | Industry consolidation occurring within one or more component supplier markets, such as the semiconductor market, could either limit supply or increase costs |
results. Financial problems of either contract manufacturers or component suppliers, reservation of manufacturing capacity at our contract manufacturers by other companies, and industry consolidation occurring within one or more component supplier markets, such as the semiconductor market, in each case, could either limit supply or increase costs.A reduction or interruption in supply;supply, including disruptions on our global supply chain, caused in part by public health emergencies (including the COVID-19 pandemic), geopolitical tensions (including as a result of China-Taiwan relations) or a significant natural disaster (including as a result of climate change); a significant increase in the price of one or more components;components (including as a result of inflation); a failure to adequately authorize procurement of inventory by our contract manufacturers; a failure to appropriately cancel, reschedule, or adjust our requirements based on our business needs; or a decrease in demand for our products could materially adversely affect our business, operating results, and financial condition and could materially damage customer relationships. Furthermore, as a result of binding price or purchase commitments with suppliers, we may be obligated to purchase components at prices that are higher than those available in the current market. In the event that we become committed to purchase components at prices in excess of the current market price when the components are actually used, our gross margins could decrease. We have experienced longer than normal lead timesIn addition, vendors may be under pressure to allocate product to certain customers for business, regulatory or political reasons, and/or demand changes in the past.agreed pricing as a condition of supply. Although we have generally secured additional supply or taken other mitigation actions when significant disruptions have occurred, if similar situations occur in the future, they could have a material adverse effect on our business, results of operations, and financial condition. See the risk factor above entitled “Our revenue for a particular period is difficult to predict, and a shortfall in revenue may harm our operating results.”
Our growth and ability to meet customer demands depend in part on our ability to obtain timely deliveries of parts from our suppliers and contract manufacturers. We have experienced component shortages in the past, including shortages caused by manufacturing process issues, that have affected our operations.operations, including longer than normal lead times. There is currently a market shortage of semiconductor and other component supply which has affected, and could further affect, lead times, the cost of that supply, and our ability to meet customer demand for our products if we cannot secure sufficient supply in a timely manner. We continue to manage through significant supply constraints seen industry-wide due to component shortages, including significant constraints with certain critical components which prevents us from completing manufacturing of certain of our products. For example, we saw an additional unanticipated supply challenge with COVID-19 related lockdowns in certain parts of China in the second half of fiscal 2022 that resulted in a severe shortage of certain critical components. While we saw further improvements of the industry-wide supply constraints in the second quarter of fiscal 2023, we expect such constraints to continue for an uncertain duration. Additionally, we may in the future experience a shortage of certain component parts as a result of our own manufacturing issues, manufacturing issues at our suppliers or contract manufacturers, capacity problems experienced by our suppliers or contract manufacturers including capacity or cost problems resulting from industry consolidation, or strong demand in the industry for those parts. Growth in the economy is likely to create greater pressures on us and our suppliers to accurately project overall component demand and component demands within specific product categories and to establish optimal component levels and manufacturing capacity, especially for labor-intensive components, components for which we purchase a substantial portion of the supply, or the re-ramping of manufacturing capacity for highly complex products. During periods of shortages or delays the price of components may increase, or the components may not be available at all, and we may also encounter shortages if we do not accurately anticipate our needs. We may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenue and gross margins could suffer until other sources can be developed.
Our operating results would also be adversely affected if, anticipating greater demand than actually develops, we commit to the purchase of more components than we need, which is more likely to occur in a period of demand uncertainties such as we are currently experiencing. There can be no assurance that we will not encounter these problems in the future. Although in many cases we use standard parts and components for our products, certain components are presently available only from a single source or limited sources, and a global economic downturn and related market uncertainty could negatively impact the availability of components from one or more of these sources, especially during times such as we have recently seen when there are supplier constraints based on labor and other actions taken during economic downturns. We may not be able to diversify sources in a timely manner, which could harm our ability to deliver products to customers and seriously impact present and future sales.
We believe that we may be faced with the following challenges in the future:
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| • | | New markets in which we participate may grow quickly, which may make it difficult to quickly obtain significant component capacity |
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| • | | As we acquire companies and new technologies, we may be dependent, at least initially, on unfamiliar supply chains or relatively small supply partners |
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| • | | We face competition for certain components that are supply-constrained, from existing competitors, and companies in other markets |
Manufacturing capacity and component supply constraints could continue to be significant issues for us. We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to improve manufacturing lead-time performance and to help ensure adequate component supply, we enter into agreements with contract manufacturers and suppliers that either allow them to procure inventory based upon criteria as defined by us or that establish the parameters defining our requirements. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. When facing component supply-related challenges we have increased our efforts in procuring components in order to meet customer expectations, which in turn contributes to an increase in inventory and purchase commitments. IncreasesIn recent periods, we increased our inventory and purchase commitments in light of the significant supply constraints seen industry-wide due to component shortages, caused in part by the COVID-19 pandemic. These increases in our inventory and purchase commitments to shorten lead times could also lead to material excess and obsolete inventory charges in future periods if the demand for our products is less than our expectations. If we fail to anticipate customer demand properly, an oversupply of parts could result in excess or obsolete components that could adversely affect our gross margins. For additional information regardingand a further discussion of current impacts and risks related to our significant supply constraints, inventory commitments and our purchase commitments with contract manufacturers and suppliers, see “Results of Operations—Product Gross Margin—Supply Constraints Impacts and Risks”, “Liquidity and Capital Resources—Inventory Supply Chain” and Note 1214 to the Consolidated Financial Statements.
WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ENHANCEMENTS TO EXISTING PRODUCTS, AND IF WE FAIL TO PREDICT AND RESPOND TO EMERGING TECHNOLOGICAL TRENDS AND CUSTOMERS’ CHANGING NEEDS, OUR OPERATING RESULTS AND MARKET SHARE MAY SUFFERWe expect gross margin to vary over time, and our level of product gross margin may not be sustainable.
Our level of product gross margins declined in the first half of fiscal 2023, and have declined in certain prior periods on a year-over-year basis, and could decline in future periods due to adverse impacts from various factors, including:
•Changes in customer, geographic, or product mix, including mix of configurations within each product group
•Introduction of new products, including products with price-performance advantages, and new business models including the transformation of our business to deliver more software and subscription offerings
•Our ability to reduce production costs
•Entry into new markets or growth in lower margin markets, including markets with different pricing and cost structures, through acquisitions or internal development
•Sales discounts
•Increases in material, labor or other manufacturing-related costs (i.e. component costs, broker fees, expedited freight and overtime) or higher supply chain logistics costs, any of which could be significant, especially during periods of supply constraints for certain costs, such as those currently impacting the market for components, including semiconductors and memory, and which costs have in the past and may continue to be exacerbated by inflation
•Excess inventory, inventory holding charges, and obsolescence charges
•Changes in shipment volume
•The timing of revenue recognition and revenue deferrals
•Increased costs (including those caused by tariffs or economic conditions, including inflation), loss of cost savings or dilution of savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand or if the financial health of either contract manufacturers or suppliers deteriorates
•Lower than expected benefits from value engineering
•Increased price competition, including competitors from Asia, especially from China
•Changes in distribution channels
•Increased warranty or royalty costs
•Increased amortization of purchased intangible assets, especially from acquisitions
•How well we execute on our strategy and operating plans
Changes in service gross margin may result from various factors such as changes in the mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals and the addition of personnel and other resources to support higher levels of service business in future periods.
Sales to the service provider market are especially volatile, and weakness in orders from this industry may harm our operating results and financial condition.
Sales to the service provider market have been characterized by large and sporadic purchases, especially relating to our router sales and sales of certain other Secure, Agile Networks and Collaboration products, in addition to longer sales cycles. Service provider product orders decreased during the first half of fiscal 2023 and in certain prior periods, and at various times in the past, including in recent quarters, we have experienced significant weakness in product orders from service providers. Product orders from the service provider market could continue to decline and, as has been the case in the past, such weakness could persist over extended periods of time given fluctuating market conditions. Sales activity in this industry depends upon the stage of completion of expanding network infrastructures; the availability of funding; and the extent to which service providers are affected by regulatory, economic, and business conditions in the country of operations. Weakness in orders from this industry, including as a result of any slowdown in capital expenditures by service providers (which may be more prevalent during a global economic downturn, or periods of economic, political or regulatory uncertainty), could have a material adverse effect on our business, operating results, and financial condition. Such slowdowns may continue or recur in future periods. Orders from this industry could decline for many reasons other than the competitiveness of our products and services within their respective markets. For example, in the past, many of our service provider customers have been materially and adversely affected by slowdowns in the general economy, by overcapacity, by changes in the service provider market, by regulatory developments, and by constraints on capital availability, resulting in business failures and substantial reductions in spending and expansion plans. These conditions have materially harmed our business and operating results in the past, and could affect our business and operating results in any future period. Finally, service provider customers typically have longer implementation cycles; require a broader range of services, including design services; demand that vendors take on a larger share of risks; often require acceptance provisions, which can lead to a delay in revenue recognition; and expect financing from vendors. All these factors can add further risk to business conducted with service providers.
Disruption of or changes in our distribution model could harm our sales and margins.
If we fail to manage distribution of our products and services properly, or if our distributors’ financial condition or operations weaken, our revenue and gross margins could be adversely affected. A substantial portion of our products and services is sold through our channel partners, and the remainder is sold through direct sales. Our channel partners include systems integrators,
service providers, other resellers, and distributors. Systems integrators and service providers typically sell directly to end users and often provide system installation, technical support, professional services, and other support services in addition to network equipment sales. Systems integrators also typically integrate our products into an overall solution, and a number of service providers are also systems integrators. Distributors stock inventory and typically sell to systems integrators, service providers, and other resellers. We refer to sales through distributors as our two-tier system of sales to the end customer. If sales through indirect channels increase, this may lead to greater difficulty in forecasting the mix of our products and, to a degree, the timing of orders from our customers.
Historically, we have seen fluctuations in our gross margins based on changes in the balance of our distribution channels. There can be no assurance that changes in the balance of our distribution model in future periods would not have an adverse effect on our gross margins and profitability. Some factors could result in disruption of or changes in our distribution model, which could harm our sales and margins, including the following: competition with some of our channel partners, including through our direct sales, which may lead these channel partners to use other suppliers that do not directly sell their own products or otherwise compete with them; some of our channel partners may demand that we absorb a greater share of the risks that their customers may ask them to bear; some of our channel partners may have insufficient financial resources and may not be able to withstand changes and challenges in business conditions; and revenue from indirect sales could suffer if our distributors’ financial condition or operations weaken. In addition, we depend on our channel partners globally to comply with applicable regulatory requirements. To the extent that they fail to do so, that could have a material adverse effect on our business, operating results, and financial condition. Further, sales of our products outside of agreed territories can result in disruption to our distribution channels.
The markets in which we compete are intensely competitive, which could adversely affect our achievement of revenue growth.
The markets in which we compete are characterized by rapid change, converging technologies, and a migration to networking and communications solutions that offer relative advantages. These market factors represent a competitive threat to us. We compete with numerous vendors in each product category. The overall number of our competitors providing niche product solutions may increase. Also, the identity and composition of competitors may change as we increase our activity in newer product areas, and in key priority and growth areas. For example, as products related to network programmability, such as software defined networking (SDN) products, become more prevalent, we expect to face increased competition from companies that develop networking products based on commoditized hardware, referred to as “white box” hardware, to the extent customers decide to purchase those product offerings instead of ours. In addition, the growth in demand for technology delivered as a service enables new competitors to enter the market. As we continue to expand globally, we may see new competition in different geographic regions. In particular, we have experienced price-focused competition from competitors in Asia, especially from China, and we anticipate this will continue.
Some of our competitors compete across many of our product lines, while others are primarily focused in a specific product area. Barriers to entry are relatively low, and new ventures to create products that do or could compete with our products are regularly formed. In addition, some of our competitors may have greater resources, including technical and engineering resources, than we do. As we expand into new markets, we will face competition not only from our existing competitors but also from other competitors, including existing companies with strong technological, marketing, and sales positions in those markets. We also sometimes face competition from resellers and distributors of our products. Companies with which we have strategic alliances in some areas may be competitors in other areas, and this trend may increase. For example, the enterprise data center is undergoing a fundamental transformation arising from the convergence of technologies, including computing, networking, storage, and software, that previously were segregated. Due to several factors, including the availability of highly scalable and general purpose microprocessors, application specific integrated circuits offering advanced services, standards based protocols, cloud computing and virtualization, the convergence of technologies within the enterprise data center is spanning multiple, previously independent, technology segments. Also, some of our current and potential competitors for enterprise data center business have made acquisitions, or announced new strategic alliances, designed to position them to provide end-to-end technology solutions for the enterprise data center. As a result of all of these developments, we face greater competition in the development and sale of enterprise data center technologies, including competition from entities that are among our long-term strategic alliance partners. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us.
The principal competitive factors in the markets in which we presently compete and may compete in the future include the ability to sell successful business outcomes; the ability to provide a broad range of networking and communications products and services; product performance; price; the ability to introduce new products, including providing continuous new customer value and products with price-performance advantages; the ability to reduce production costs; the ability to provide value-added features such as security, reliability, and investment protection; conformance to standards; market presence; the ability to provide financing; and disruptive technology shifts and new business models.
We also face competition from customers to which we license or supply technology and suppliers from which we transfer technology. The inherent nature of networking requires interoperability. As such, we must cooperate and at the same time compete with many companies. Any inability to effectively manage these complicated relationships with customers, suppliers, and strategic alliance partners could have a material adverse effect on our business, operating results, and financial condition and accordingly affect our chances of success.
If we do not successfully manage our strategic alliances, we may not realize the expected benefits from such alliances, and we may experience increased competition or delays in product development.
We have several strategic alliances with large and complex organizations and other companies with which we work to offer complementary products and services. These arrangements are generally limited to specific projects, the goal of which is generally to facilitate product compatibility and adoption of industry standards. There can be no assurance we will realize the expected benefits from these strategic alliances or from joint ventures. If successful, these relationships may be mutually beneficial and result in industry growth. However, alliances carry an element of risk because, in most cases, we must compete in some business areas with a company with which we have a strategic alliance and, at the same time, cooperate with that company in other business areas. Also, if these companies fail to perform or if these relationships fail to materialize as expected, we could suffer delays in product development or other operational difficulties. Joint ventures can be difficult to manage, given the potentially different interests of joint venture partners.
Inventory management relating to our sales to our two-tier distribution channel is complex, and excess inventory may harm our gross margins.
We must manage inventory relating to sales to our distributors effectively, because inventory held by them could affect our results of operations. Our distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high, or delay orders in anticipation of new products. They also may adjust their orders in response to the supply of our products and the products of our competitors that are available to them, and in response to seasonal fluctuations in end-user demand. Our distributors are generally given business terms that allow them to return a portion of inventory, receive credits for changes in selling price, and participate in various cooperative marketing programs. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology and customer requirements. When facing component supply-related challenges, we have increased our efforts in procuring components in order to meet customer expectations. If we ultimately determine that we have excess inventory, we may have to reduce our prices and write down inventory, which in turn could result in lower gross margins.
We depend upon the development of new products and services, and enhancements to existing products and services, and if we fail to predict and respond to emerging technological trends and customers’ changing needs, our operating results and market share may suffer.
The markets for our products and services are characterized by rapidly changing technology, evolving industry standards, new product and service introductions, and evolving methods of building and operating networks. Our operating results depend on our ability to develop and introduce new products and services into existing and emerging markets and to reduce the production costs of existing products. Many ofIf customers do not purchase and/or renew our strategic initiatives and investments we have made, andofferings our architectural approach, are designed to enable the increased use of the network as the platformbusiness could be harmed. The COVID-19 pandemic may also result in long-term changes in customer needs for automating, orchestrating, integrating, and delivering an ever-increasing array of IT-basedour products and services. For example,services in June 2017various sectors, along with IT-related capital spending reductions, or shifts in spending focus, that could materially adversely affect us if we announcedare unable to adjust our Catalyst 9000 series of switches which represent the initial foundation of our intent-based networking capabilities. Other current initiatives include our focus on security; the market transition relatedproduct and service offerings to digital transformation and IoT; the transition in cloud; and the move towards more programmable, flexible and virtual networks.
match customer needs.
The process of developing new technology, including intent-based networking, more programmable, flexible and virtual networks, and technology related to other market transitions— such as security, digital transformation and IoT,Internet of Things, and cloud— is complex and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends our business could be harmed. We must commit significant resources, including the investments we have been making in our strategic priorities to developing new products and services before knowing whether our investments will result in products and services the market will accept. In particular, if our model of the evolution of networking does not emerge as we believe it will, or if the industry does not evolve as we believe it will, or if our strategy for addressing this evolution is not successful, many of our strategic initiatives and investments may be of no or limited value. For example, if we do not introduce products related to network programmability, such as software-defined-networking products, in a timely fashion, or if product offerings in this market that ultimately succeed are based on technology, or an approach to technology, that differs from ours, such as, for example, networking products based on “white box” hardware, our business could be harmed. Similarly, our business could be harmed if we fail to develop, or fail to develop in a timely fashion, offerings to address other transitions, or if the offerings addressing these other transitions that ultimately succeed are based on technology, or an approach to technology, different from ours. In addition, our business could be adversely affected in periods surrounding our new product introductions if customers delay purchasing decisions to qualify or otherwise evaluate the new product offerings.
Our strategy is to lead our customers in their digital transition with solutions that deliver greater agility, productivity, security and other advanced network capabilities, and that intelligently connect nearly everything that can be connected. Over the last few years, we We have also been transforming our business
to move from selling individual products and services to selling products and services integrated into architectures and solutions, and we are seeking to meet the evolving needs of customers which include offering our products and solutions in the manner in which customers wish to consume them. As a part of this transformation, we continue to make changes to how we are organized and how we build and deliver our technology, including changes in our business models with customers. If our strategy for addressing our customer needs, or the architectures and solutions we develop do not meet those needs, or the changes we are making in how we are organized and how we build and deliver or technology is incorrect or ineffective, our business could be harmed.
Furthermore, we may not execute successfully on our vision or strategy because of challenges with regard to product planning and timing, technical hurdles that we fail to overcome in a timely fashion, or a lack of appropriate resources. This could result in competitors, some of which may also be our strategic alliance partners, providing those solutions before we do and loss of market share, revenue, and earnings. In addition, the growth in demand for technology delivered as a service enables new competitors to enter the market. The success of new products and services depends on several factors, including proper new product and service definition, component costs, timely completion and introduction of these products and services, differentiation of new products and services from those of our competitors, and market acceptance of these products.products and services. There can be no assurance that we will successfully identify new product and services opportunities, develop and bring new products and services to market in a timely manner, or achieve market acceptance of our products and services or that products, services and technologies developed by others will not render our products, services or technologies obsolete or noncompetitive. The products and technologies in our other product categories and key priority and growth areas may not prove to have the market success we anticipate, and we may not successfully identify and invest in other emerging or new products.products and services.
CHANGES IN INDUSTRY STRUCTURE AND MARKET CONDITIONS COULD LEAD TO CHARGES RELATED TO DISCONTINUANCES OF CERTAIN OF OUR PRODUCTS OR BUSINESSES, ASSET IMPAIRMENTS AND WORKFORCE REDUCTIONS OR RESTRUCTURINGSChanges in industry structure and market conditions could lead to charges related to discontinuances of certain of our products or businesses, asset impairments and workforce reductions or restructurings.
In response to changes in industry and market conditions, we may be required to strategically realign our resources and to consider restructuring, disposing of, or otherwise exiting businesses. Any resource realignment, or decision to limit investment in or dispose of or otherwise exit businesses, may result in the recording of special charges, such as inventory and technology-related write-offs, workforce reduction or restructuring costs, charges relating to consolidation of excess facilities, or claims from third parties who were resellers or users of discontinued products. Our estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. Although in certain instances our supply agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed, our loss contingencies may include liabilities for contracts that we cannot cancel with contract manufacturers and suppliers. Further, our estimates relating to the liabilities for excess facilities are affected by changes in real estate market conditions. Additionally, we are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances, and future goodwill impairment tests may result in a charge to earnings.
In August 2016, we announced We initiated a restructuring plan. We began taking action under this plan in the second quarter of fiscal 2023, for which we expect such plan to be substantially completed by the end of the first quarter of fiscal 2017, and the plan has been substantially completed. The implementation of this restructuring plan may be disruptive to our business, and following completion of the restructuring plan our2024. Our business may not be more efficient or effective than prior to implementation of the plan. Our restructuring activities, including any related charges and the impact of the related headcount restructurings, could have a material adverse effect on our business, operating results, and financial condition.
OVER THE LONG TERM WE INTEND TO INVEST IN ENGINEERING, SALES, SERVICE AND MARKETING ACTIVITIES, AND THESE INVESTMENTS MAY ACHIEVE DELAYED, OR LOWER THAN EXPECTED, BENEFITS WHICH COULD HARM OUR OPERATING RESULTSOver the long term we intend to invest in engineering, sales, service and marketing activities, and in key priority and growth areas, and these investments may achieve delayed, or lower than expected, benefits which could harm our operating results.
While we intend to focus on managing our costs and expenses, over the long term, we also intend to invest in personnel and other resources related to our engineering, sales, service and marketing functions as we realign and dedicate resources on key priority and growth areas, such as End-to-End Security and Applications,Internet for the Future, and we also intend to focus on maintaining leadership in Infrastructure PlatformsSecure, Agile Networks and in Services. We are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments (including if our selection of areas for investment does not play out as we expect), or if the achievement of these benefits is delayed, our operating results may be adversely affected.
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND INTERNET-BASED SYSTEMS
We have made and expect to continue to make acquisitions that could disrupt our businessoperations and revenue depends on growth and evolution of the Internet, including the continued development of the Internet and the anticipated market transitions, and on the deployment ofharm our products by customers who depend on such continued growth and evolution. To the extent that an economic slowdown or uncertainty and related reduction in capital spending adversely affect spending on Internet infrastructure, including spending or investment related to anticipated market transitions, we could experience material harm to our business, operating results, and financial condition.
Because of the rapid introduction of new products and changing customer requirements related to matters such as cost-effectiveness and security, we believe that there could be performance problems with Internet communications in the future, which could receive a high degree of publicity and visibility. Because we are a large supplier of networking products, our business, operating results, and financial condition may be materially adversely affected, regardless of whether or not these problems are due to the performance of our own products. Such an event could also result in a material adverse effect on the market price of our common stock independent of direct effects on our business.
WE HAVE MADE AND EXPECT TO CONTINUE TO MAKE ACQUISITIONS THAT COULD DISRUPT OUR OPERATIONS AND HARM OUR OPERATING RESULTSresults.
Our growth depends upon market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. We intend to continue to address the need to develop new products and enhance existing products through acquisitions of other companies, product lines, technologies, and personnel. Acquisitions involve numerous risks, including the following:
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| • | | Difficulties in integrating the operations, systems, technologies, products, and personnel of the acquired companies, particularly companies with large and widespread operations and/or complex products |
•Difficulties in integrating the operations, systems, technologies, products, and personnel of the acquired companies, particularly companies with large and widespread operations and/or complex products |
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| • | | Diversion of management’s attention from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions |
•Diversion of management’s attention from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions |
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| • | | Potential difficulties in completing projects associated with in-process research and development intangibles |
•Potential difficulties in completing projects associated with in-process research and development intangibles |
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| • | | Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions |
•Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions |
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| • | | Initial dependence on unfamiliar supply chains or relatively small supply partners |
•Initial dependence on unfamiliar supply chains or relatively small supply partners |
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| • | | Insufficient revenue to offset increased expenses associated with acquisitions |
•Insufficient revenue to offset increased expenses associated with acquisitions |
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| • | | The potential loss of key employees, customers, distributors, vendors and other business partners of the companies we acquire following and continuing after announcement of acquisition plans |
Acquisitions may also cause us to:
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| • | | Issue common stock that would dilute our current shareholders’ percentage ownership |
•Issue common stock that would dilute our current stockholders’ percentage ownership |
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| • | | Use a substantial portion of our cash resources, or incur debt |
•Use a substantial portion of our cash resources, or incur debt |
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| • | | Significantly increase our interest expense, leverage and debt service requirements if we incur additional debt to pay for an acquisition |
•Assume liabilities
•Record goodwill and intangible assets that are subject to impairment testing on a regular basis and potential periodic impairment charges |
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| • | | Record goodwill and intangible assets that are subject to impairment testing on a regular basis and potential periodic impairment charges |
•Incur amortization expenses related to certain intangible assets |
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| • | | Incur amortization expenses related to certain intangible assets |
•Incur tax expenses related to the effect of acquisitions on our legal structure |
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| • | | Incur tax expenses related to the effect of acquisitions on our intercompany R&D cost sharing arrangement and legal structure |
•Incur large write-offs and restructuring and other related expenses |
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| • | | Incur large and immediate write-offs and restructuring and other related expenses |
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| • | | Become subject to intellectual property or other litigation |
Mergers and acquisitions of high-technology companies are inherently risky and subject to many factors outside of our control, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products and technologies to a failure to do so. Even when an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products.
From time to time, we have made acquisitions that resulted in charges in an individual quarter. These charges may occur in any particular quarter, resulting in variability in our quarterly earnings. In addition, our effective tax rate for future periods is uncertain and could be impacted by mergers and acquisitions. Risks related to new product development also apply to acquisitions. See the risk factors above, including the risk factor entitled “We depend upon the development of
Entrance into new productsor developing markets exposes us to additional competition and enhancements to existing products,will likely increase demands on our service and if we fail to predict and respond to emerging technological trends and customers’ changing needs, our operating results and market share may suffer” for additional information.
ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES US TO ADDITIONAL COMPETITION AND WILL LIKELY INCREASE DEMANDS ON OUR SERVICE AND SUPPORT OPERATIONSsupport operations.
As we focus on new market opportunities and key priority and growth areas, we will increasingly compete with large telecommunications equipment suppliers as well as startup companies. Several of our competitors may have greater resources, including technical and engineering resources, than we do. Additionally, as customers in these markets complete infrastructure deployments, they may require greater levels of service, support, and financing than we have provided in the past, especially in emerging countries. Demand for these types of service, support, or financing contracts may increase in the future. There can be no assurance that we can provide products, service, support, and financing to effectively compete for these market opportunities.
Further, provision of greater levels of services, support and financing by us may result in a delay in the timing of revenue recognition. In addition, entry into other markets has subjected and will subject us to additional risks, particularly to those markets, including the effects of general market conditions and reduced consumer confidence. For example, as we add direct selling capabilities globally to meet changing customer demands, we will face increased legal and regulatory requirements.
INDUSTRY CONSOLIDATION MAY LEAD TO INCREASED COMPETITION AND MAY HARM OUR OPERATING RESULTS
Industry consolidation may lead to increased competition and may harm our operating results.
There has beenis a continuing trend toward industry consolidation in our markets for several years.markets. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, some of our current and potential competitors for enterprise data center business have made acquisitions, or announced new strategic alliances, designed to position them with the ability to provide end-to-end technology solutions for the enterprise data center. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results, and financial condition. Furthermore, particularly in the service provider market, rapid consolidation will lead to fewer customers, with the effect that loss of a major customer could have a material impact on results not anticipated in a customer marketplace composed of more numerous participants.
PRODUCT QUALITY PROBLEMS COULD LEAD TO REDUCED REVENUE, GROSS MARGINS, AND NET INCOME
Product quality problems could lead to reduced revenue, gross margins, and net income.
We produce highly complex products that incorporate leading-edge technology, including both hardware and software. Software typically contains bugs that can unexpectedly interfere with expected operations. There can be no assurance that our pre-shipment testing programs will be adequate to detect all defects, either ones in individual products or ones that could affect numerous shipments, which might interfere with customer satisfaction, reduce sales opportunities, or affect gross margins. From time to time, we have had to replace certain components and provide remediation in response to the discovery of defects or bugs in products that we had shipped. There can be no assurance that such remediation, depending on the product involved, would not have a material impact. An inability to cure a product defect could result in the failure of a product line, temporary or permanent withdrawal from a product or market, damage to our reputation, inventory costs, or product reengineering expenses, any of which could have a material impact on our revenue, margins, and net income. For example, in the second quarter of fiscal 2017 we recorded a charge to product cost of sales of $125 million related
Due to the expected remediation costs for anticipated failures in future periods of a widely-used component sourced from a third party which is included in severalglobal nature of our products,operations, political or economic changes or other factors in a specific country or region could harm our operating results and in the second quarter of fiscal 2014 we recorded a pre-tax charge of $655 million related to the expected remediation costs for certain products sold in prior fiscal years containing memory components manufactured by a single supplier between 2005 and 2010.financial condition.
DUE TO THE GLOBAL NATURE OF OUR OPERATIONS, POLITICAL OR ECONOMIC CHANGES OR OTHER FACTORS IN A SPECIFIC COUNTRY OR REGION COULD HARM OUR OPERATING RESULTS AND FINANCIAL CONDITION
We conduct significant sales and customer support operations in countries around the world. As such, our growth depends in part on our increasing sales into emerging countries. We also depend on non-U.S. operations of our contract manufacturers, component suppliers and distribution partners. EmergingOur business in emerging countries in the aggregate experienced a decline in orders in the first quarter of fiscal 2018, in fiscal 2017, and in certain prior periods. We continue to assess the sustainability of any improvements in our business in these countries and there can be no assurance that our investments in these countries will be successful. Our future results could be materially adversely affected by a variety of political, economic or other factors relating to our operations inside and outside the United States, any or all of which could have a material adverse effect on our operating results and financial condition, including the following: impacts from global central bank monetary policy; issues related to the political relationship between the United States and other countries that can affect regulatory matters, affect the willingness of customers in those countries to purchase products from companies headquartered in the United States; andStates or affect our ability to procure components if a government body were to deny us access to those components; government-related disruptions or shutdowns; the challenging and inconsistent global macroeconomic environment, anyenvironment; foreign currency exchange rates; geopolitical tensions (including China-Taiwan relations); political or allsocial unrest; economic instability or weakness or natural disasters in a specific country or region, including economic challenges in China and global economic ramifications of Chinese economic difficulties; environmental protection regulations (including new laws and regulations related to climate change); trade protection measures such as tariffs, and other legal and regulatory requirements, some of which may affect our ability to import our products to, export our products from, or sell our products in various countries or affect our ability to procure components; political considerations that affect service provider and government spending patterns; health or similar issues, including pandemics or epidemics, such as the COVID-19 pandemic, which could have a materialcontinue to affect customer purchasing decisions; difficulties in staffing and managing international operations; and adverse effecttax consequences, including imposition of withholding or other taxes on our operating resultsglobal operations.
We are exposed to the credit risk of some of our customers and financial condition, including, among others, the following:
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WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS AND TO CREDIT EXPOSURES IN WEAKENED MARKETS, WHICH COULD RESULT IN MATERIAL LOSSESto credit exposures in weakened markets, which could result in material losses.
Most of our sales are on an open credit basis, with typical payment terms of 30 days in the United States, and, because of local customs or conditions, longer in some markets outside the United States. We monitor individual customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. Beyond our open credit arrangements, we have also experienced demands for customer financing and facilitation of leasing arrangements. We expect demand for customer financing to continue, and recently we have been experiencing an increase in this demand as the credit markets have been impacted by the challenging and inconsistent global macroeconomic environment, including increased demand from customers in certain emerging countries.
We believe customer financing is a competitive factor in obtaining business, particularly in serving customers involved in significant infrastructure projects. Our loan financing arrangements may include not only financing the acquisition of our products and services but also providing additional funds for other costs associated with network installation and integration of our products and services.
Our exposure to the credit risks relating to our financing activities described above may increase if our customers are adversely affected by a global economic downturn or periods of economic uncertainty. Although we have programs in place that are designed to monitor and mitigate the associated risk, including monitoring of particular risks in certain geographic areas, thereThere can be no assurance that such programs we have in place to monitor and mitigate credit risks will be effective in reducing our credit risks.
effective. In the past, there have been significant bankruptcies among customers both on open credit and with loan or lease financing
arrangements, particularly among Internet businesses and service providers, causing us to incur economic or financial losses. There can be no assurance that additional losses will not be incurred. Although these losses have not been material to date, future losses, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition. A portion of our sales is derived through our distributors. These distributors are generally given business terms that allow them to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. We maintain estimated accruals and allowances for such business terms. However, distributors tend to have more limited financial resources than other resellers and end-user customers and therefore represent potential sources of increased credit risk, because they may be more likely to lack the reserve resources to meet payment obligations. Additionally, to the degree that turmoil in the credit markets makes it more difficult for some customers to obtain financing, those customers’ ability to pay could be adversely impacted, which in turn could have a material adverse impact on our business, operating results, and financial condition.
WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS AND IN INTEREST RATES; IMPAIRMENT OF OUR INVESTMENTS COULD HARM OUR EARNINGSWe are exposed to fluctuations in the market values of our portfolio investments and in interest rates; impairment of our investments could harm our earnings.
We maintain an investment portfolio of various holdings, types, and maturities. These securities are generally classified as available-for-sale and, consequently, are recorded on our Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a component of accumulated other comprehensive income (loss), net of tax. Our portfolio includes fixed income securitiesavailable-for-sale debt investments and equity investments, in publicly traded companies, the values of which are subject to market price volatility to the extent unhedged.volatility. If such investments suffer market price declines, as we experienced with some of our investments in the past, we may recognize in earnings the decline in the fair value of our investments below their cost basis when the decline is judged to be other than temporary. For information regarding the sensitivity of and risks associated with the market value of portfoliobasis. Our privately held investments and interest rates, refer to the section titled “Quantitative and Qualitative Disclosures About Market Risk.” Our investments in private companies are subject to risk of loss of investment capital. These investments are inherently risky because the markets for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire investment in these companies. For information regarding the market risks associated with the fair value of portfolio investments and interest rates, refer to the section titled “Quantitative and Qualitative Disclosures About Market Risk.”
WE ARE EXPOSED TO FLUCTUATIONS IN CURRENCY EXCHANGE RATES THAT COULD NEGATIVELY IMPACT OUR FINANCIAL RESULTS AND CASH FLOWSWe are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows.
Because a significant portion of our business is conducted outside the United States, we face exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows. Historically, our primary exposures have related to nondollar-denominated sales in Japan, Canada, and Australia and certain nondollar-denominated operating expenses and service cost of sales in Europe, Latin America, and Asia, where we sell primarily in U.S. dollars. Additionally, we have exposures torates, including emerging market currencies which can have extreme currency volatility. An increase in the value of the dollar could increase the real cost to our customers of our products in those markets outside the United States where we sell in dollars and a weakened dollar could increase the cost of local operating expenses and procurement of raw materials to the extent that we must purchase components in foreign currencies. These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows.
Currently,Failure to retain and recruit key personnel would harm our ability to meet key objectives.
Our success has always depended in large part on our ability to attract and retain highly skilled technical, managerial, sales, and marketing personnel. Competition for such personnel is intense, especially in the Silicon Valley area of Northern California. Stock incentive plans are designed to reward employees for their long-term contributions and provide incentives for them to remain with us. Volatility or lack of positive performance in our stock price or equity incentive awards, or changes to our overall compensation program, including our stock incentive program, resulting from the management of share dilution and share-based compensation expense or otherwise, may also adversely affect our ability to retain key employees. As a result of one or more of these factors, we enter into foreignmay increase our hiring in geographic areas outside the United States, which could subject us to additional geopolitical and exchange forward contractsrate risk. The loss of services of any of our key personnel; the inability to retain and optionsattract qualified personnel in the future; or delays in hiring required personnel, particularly engineering and sales personnel, could make it difficult to reduce the short-term impact of foreign currency fluctuations on certain foreign currency receivables, investments,meet key objectives, such as timely and payables.effective product introductions. In addition, companies in our industry whose employees accept positions with competitors frequently claim that competitors have engaged in improper hiring practices. We have received these claims in the past and may receive additional claims to this effect in the future.
Adverse resolution of litigation or governmental investigations may harm our operating results or financial condition.
We are a party to lawsuits in the normal course of our business. Additionally, there are existing claims and lawsuits in Russia, and the potential for future claims and lawsuits in Russia and/or Belarus, related to the Russia and Ukraine war and related trade restrictions and sanctions. In the event of an unfavorable resolution of any of these lawsuits, the potential outcome could include the seizure of our assets in Russia and/or Belarus, which, collectively, represents less than 0.1% of our total assets at the end of the second quarter of fiscal 2023. Litigation can be costly, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of lawsuits or governmental investigations could have a material adverse effect on our business, operating results, or financial condition. For additional information regarding certain of the matters in which we periodically hedgeare involved, see Note 14 to the Consolidated Financial Statements, subsection (f) “Legal Proceedings.”
Our operating results may be adversely affected and damage to our reputation may occur due to production and sale of counterfeit versions of our products.
As is the case with leading products around the world, our products are subject to efforts by third parties to produce counterfeit versions of our products. While we work diligently with law enforcement authorities in various countries to block the manufacture of counterfeit goods and to interdict their sale, and to detect counterfeit products in customer networks, and have succeeded in prosecuting counterfeiters and their distributors, resulting in fines, imprisonment and restitution to us, there can be no guarantee that such efforts will succeed. While counterfeiters often aim their sales at customers who might not have
otherwise purchased our products due to lack of verifiability of origin and service, such counterfeit sales, to the extent they replace otherwise legitimate sales, could adversely affect our operating results.
Changes in our provision for income taxes or adverse outcomes resulting from examination of our income tax returns could adversely affect our results.
Our provision for income taxes is subject to volatility and could be adversely affected by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by changes to foreign-derived intangible income, global intangible low-tax income and base erosion and anti-abuse tax laws, regulations, or interpretations thereof; by expiration of or lapses in tax incentives; by transfer pricing adjustments, including the effect of acquisitions on our legal structure; by tax effects of nondeductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by changes in tax laws and regulations, treaties, or interpretations thereof, including changes to the taxation of earnings of our foreign currency cash flows. Our attemptssubsidiaries, the deductibility of expenses attributable to hedge againstforeign income, and the foreign tax credit rules. Significant judgment is required to determine the recognition and measurement attribute prescribed in the accounting guidance for uncertainty in income taxes. The Organisation for Economic Co-operation and Development (OECD), an international association comprised of 38 countries, including the United States, has made changes and is contemplating additional changes to numerous long-standing tax principles. There can be no assurance that these risks may result inchanges and any contemplated changes if finalized, once adopted by countries, will not have an adverse impact on our provision for income taxes. Further, as a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries was subject to reduced tax rates. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.
Our business and operations are especially subject to the risks of earthquakes, floods, and other natural catastrophic events (including as a result of global climate change).
Our corporate headquarters, including certain of our research and development operations are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, a certain number of our facilities are located near rivers that have experienced flooding in the past. Also certain of our customers, suppliers and logistics centers are located in regions that have been or may be affected by earthquake, tsunami and flooding or other weather-related activity which in the past has disrupted, and in the future could disrupt, the flow of components and delivery of products. In addition, global climate change may result in significant natural disasters occurring more frequently or with greater intensity, such as drought, wildfires, storms, sea-level rise, and flooding. We have not to date experienced a material event to these matters; however, the occurrence of any such event in the future could have a material adverse impact on our business, operating results, and financial condition.
Terrorism, war, and other events may harm our business, operating results and financial condition.
The continued threat of terrorism and heightened security and military action in response thereto, or any other current or future acts of terrorism, war (such as the on-going Russia and Ukraine war), and other events (such as economic sanctions and trade restrictions, including those related to the on-going Russia and Ukraine war) may cause further disruptions to the economies of the United States and other countries and create further uncertainties or could otherwise negatively impact our business, operating results, and financial condition. Likewise, events such as loss of infrastructure and utilities services such as energy, transportation, or telecommunications could have similar negative impacts. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders or the manufacture or shipment of our products, our business, operating results, and financial condition could be materially and adversely affected. See “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Russia and Ukraine War” for a discussion of the impact on Cisco’s business of the on-going Russia and Ukraine war.
There can be no assurance that our operating results and financial condition will not be adversely affected by our incurrence of debt.
As of the end of the second quarter of fiscal 2023, we have senior unsecured notes outstanding in an aggregate principal amount of $9.0 billion that mature at specific dates from calendar year 2023 through 2040. We have also established a commercial paper program under which we may issue short-term, unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $10.0 billion, and we had no commercial paper notes outstanding under this program as of January 28, 2023. There can be no assurance that our incurrence of this debt or any future debt will be a better means of providing liquidity to us than would our use of our existing cash resources. Further, we cannot be assured that our maintenance of this indebtedness or incurrence of future indebtedness will not adversely affect our operating results or financial condition. In addition, changes by any rating agency to our credit rating can negatively impact the value and liquidity
of both our debt and equity securities, as well as the terms upon which we may borrow under our commercial paper program or future debt issuances.
Our reputation and/or business could be negatively impacted by ESG matters and/or our reporting of such matters.
There is an increasing focus from regulators, certain investors, and other stakeholders concerning environmental, social, and governance (“ESG”) matters, both in the United States and internationally. We communicate certain ESG-related initiatives, goals, and/or commitments regarding environmental matters, diversity, responsible sourcing and social investments, and other matters, in our annual Purpose Report, on our website, in our filings with the SEC, and elsewhere. These initiatives, goals, or commitments could be difficult to achieve and costly to implement. For example, in September 2021, we announced our commitment to achieve net income.zero across all scopes of greenhouse gas emissions by 2040, the achievement of which relies, in large part, on the accuracy of our estimates and assumptions around the enhanced power efficiency of our products, the adoption of renewable energy at customer sites, and the adoption of certain of our products and services by our customers. We could fail to achieve, or be perceived to fail to achieve, our 2040 net zero commitment or other ESG-related initiatives, goals, or commitments. In addition, we could be criticized for the timing, scope or nature of these initiatives, goals, or commitments, or for any revisions to them. To the extent that our required and voluntary disclosures about ESG matters increase, we could be criticized for the accuracy, adequacy, or completeness of such disclosures. Our actual or perceived failure to achieve our ESG-related initiatives, goals, or commitments could negatively impact our reputation or otherwise materially harm our business.
OUR PROPRIETARY RIGHTS MAY PROVE DIFFICULT TO ENFORCERisks Related to Intellectual Property
Our proprietary rights may prove difficult to enforce.
We generally rely on patents, copyrights, trademarks, and trade secret laws to establish and maintain proprietary rights in our technology and products. Although we have been issued numerous patents and other patent applications are currently pending, there can be no assurance that any of these patents or other proprietary rights will not be challenged, invalidated, or circumvented or that our rights will, in fact, provide competitive advantages to us. Furthermore, many key aspects of networking technology are governed by industrywide standards, which are usable by all market entrants. In addition, there can be no assurance that patents will be issued from pending applications or that claims allowed on any patents will be sufficiently broad to protect our technology. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as do the laws of the United States. The outcome of any actions taken in these foreign countries may be different than if such actions were determined under the laws of the United States. Although we are not dependent on any individual patents or group of patents for particular segments of the business for which we compete, if we are unable to protect our proprietary rights to the totality of the features (including aspects of products protected other than by patent rights) in a market, we may find ourselves at a competitive disadvantage
to others who need not incur the substantial expense, time, and effort required to create innovative products that have enabled us to be successful.
WE MAY BE FOUND TO INFRINGE ON INTELLECTUAL PROPERTY RIGHTS OF OTHERSWe may be found to infringe on intellectual property rights of others.
Third parties, including customers, have in the past and may in the future assert claims or initiate litigation related to exclusive patent, copyright, trademark, and other intellectual property rights to technologies and related standards that are relevant to us. These assertions have increased over time as a result of our growth and the general increase in the pace of patent claims assertions, particularly in the United States. Because of the existence of a large number of patents in the networking field, the secrecy of some pending patents, and the rapid rate of issuance of new patents, it is not economically practical or even possible to determine in advance whether a product or any of its components infringes or will infringe on the patent rights of others. The asserted claims and/or initiated litigation can include claims against us or our manufacturers, suppliers, or customers, alleging infringement of their proprietary rights with respect to our existing or future products or components of those products. Regardless of the merit of these claims, they can be time-consuming, result in costly litigation and diversion of technical and management personnel, or require us to develop a non-infringing technology or enter into license agreements. Where claims are made by customers, resistance even to unmeritorious claims could damage customer relationships. There can be no assurance that licenses will be available on acceptable terms and conditions, if at all, or that our indemnification by our suppliers will be adequate to cover our costs if a claim were brought directly against us or our customers. Furthermore, because of the potential for high court awards that are not necessarily predictable, it is not unusual to find even arguably unmeritorious claims settled for significant amounts. If any infringement or other intellectual property claim made against us by any third party is successful, if we are required to indemnify a customer with respect to a claim against the customer, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results, and financial condition could be materially and adversely affected. For additional information regarding our indemnification obligations, see Note 12(g)14(e) to the Consolidated Financial Statements contained in this report.
Our exposure to risks associated with the use of intellectual property may be increased as a result of acquisitions, as we have a lower level of visibility into the development process with respect to such technology or the care taken to safeguard against infringement risks. Further, in the
past, third parties have made infringement and similar claims after we have acquired technology that had not been asserted prior to our acquisition.
WE RELY ON THE AVAILABILITY OF THIRD-PARTY LICENSESWe rely on the availability of third-party licenses.
Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a nonexclusive basis could limit our ability to protect our proprietary rights in our products.
OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED AND DAMAGE TO OUR REPUTATION MAY OCCUR DUE TO PRODUCTION AND SALE OF COUNTERFEIT VERSIONS OF OUR PRODUCTSRisks Related to Cybersecurity, Privacy, and Regulatory Requirements
As is the case with leading products around the world,Cyber attacks, data breaches or malware may disrupt our operations, harm our operating results and financial condition, and damage our reputation or otherwise materially harm our business; and cyber attacks or data breaches on our customers’ or third-party providers’ networks, or in cloud-based services provided to, by, or enabled by us, could result in claims of liability against us, give rise to legal and/or regulatory action, damage our reputation or otherwise materially harm our business.
We experience cyber attacks and other attempts to gain unauthorized access to our products, areservices, and IT environment on a regular basis, and we anticipate continuing to be subject to effortssuch attempts as cyber attacks become increasingly sophisticated and more difficult to predict and protect against. Despite our implementation of security measures, (i) our products and services, and (ii) the servers, data centers, and cloud-based solutions on which our and third-party data is stored or processed (including servers, data centers and cloud-based solutions operated by third parties on which we rely) (collectively, our “IT environment”), are vulnerable to produce counterfeit versionscyber attacks, data breaches, malware, inadvertent error, disruptions from unauthorized access, tampering or other theft or misuse, including by employees, contingent workers, malicious actors, or nation-states or their agents (which cyber attack or related activity may intensify during periods of diplomatic or armed conflict, such as the Russia and Ukraine war). Such events have caused, and in the future could result in, compromise to, or the disruption of access to, the operation of our products. Whileproducts, services, and IT environment or those of our customers or third-party providers we work diligently with law enforcement authoritiesrely on, or result in various countries to block the manufacture of counterfeit goods and to interdict their sale, and to detect counterfeit products in customer networks, and have succeeded in prosecuting counterfeiters and their distributors, resulting in fines, imprisonment and restitution to us, there can be no guarantee that such efforts will succeed. While counterfeiters often aim their sales at customers who might not have otherwise purchasedconfidential information stored on our products due to lack of verifiability of origin and service, such counterfeit sales, to the extent they replace otherwise legitimate sales, could adversely affectsystems, our operating results.
OUR OPERATING RESULTS AND FUTURE PROSPECTS COULD BE MATERIALLY HARMED BY UNCERTAINTIES OF REGULATION OF THE INTERNET
Currently, few laws or regulations apply directly to access or commerce on the Internet. We could be materially adversely affected by regulation of the Internet and Internet commerce in any country where we operate. Such regulations could include matters such as voice over the Internet or using IP, encryption technology, salescustomers’ systems, or other taxes on Internet productthird-party systems being improperly accessed, processed, disclosed now or service sales, and access chargesin the future, or be lost or stolen. For example, in December 2021, multiple vulnerabilities were reported for Internet service providers. The adoptionthe widely used Java logging library, Apache Log4j. We reviewed the use of regulation of the Internet and Internet commerce could decrease demand forthis library within our products and atservices, its use in our enterprise IT environment, and its use by our third-party providers, and have taken steps to mitigate these vulnerabilities, including by providing security updates for affected products to our customers. We have not to date experienced a material event related to a cybersecurity matter; however, the same time, increaseoccurrence of any such event in the costfuture could subject us to liability to our customers, data subjects, suppliers, business partners, employees, and others, give rise to legal and/or regulatory action, could damage our reputation or could otherwise materially harm our business, any of selling our products, which could have a material adverse effect on our business, operating results, and financial condition.
CHANGES IN TELECOMMUNICATIONS REGULATION AND TARIFFS COULD HARM OUR PROSPECTS AND FUTURE SALES
Changes in telecommunications requirements, or regulatory requirements in other industries in which we operate, in the United States or other countries could affect the sales of our products. In particular, we believe that there may be future changes in U.S. telecommunications regulations that could slow the expansion of the service providers’ network infrastructures and materially adversely affect our business, operating results, and financial condition, including "net neutrality" rules to the extent they impact decisions on investment in network infrastructure.
Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our products for certain classes of customers. Additionally, in the United States, our products must comply with various requirements and regulations of the Federal Communications Commission and other regulatory authorities. In countries outside of the United States, our products must meet various requirements of local telecommunications and other industry authorities. Changes in tariffs or failure by us to obtain timely approval of products could have a material adverse effect on our business, operating results, and financial condition.
FAILURE TO RETAIN AND RECRUIT KEY PERSONNEL WOULD HARM OUR ABILITY TO MEET KEY OBJECTIVES
Our success has always depended in large part on our ability to attract and retain highly skilled technical, managerial, sales, and marketing personnel. Competition for these personnel is intense, especially in the Silicon Valley area of Northern California. Stock incentive plans are designed to reward employees for their long-term contributions and provide incentives for them to remain with us. Volatility or lack of positive performance in our stock price or equity incentive awards, or changes to our overall compensation program, including our stock incentive program, resulting from the management of share dilution and share-based compensation expense or otherwise, may also adversely affect our ability to retain key employees. As a result of one or more of these factors, we may increase our hiring in geographic areas outside the United States, which could subject us to additional geopolitical and exchange rate risk. The loss of services of any of our key personnel; the inability to retain and attract qualified personnel in the future; or delays in hiring required personnel, particularly engineering and sales personnel, could make it difficult to meet key objectives, such as timely and effective product introductions. In addition, companies in our industry whose employees accept positions with competitors frequently claim that competitors have engaged in improper hiring practices. We have received these claims in the past and may receive additional claims to this effect in the future.
ADVERSE RESOLUTION OF LITIGATION OR GOVERNMENTAL INVESTIGATIONS MAY HARM OUR OPERATING RESULTS OR FINANCIAL CONDITION
We are a party to lawsuits in the normal course of our business. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. For example, Brazilian authorities have investigated our Brazilian subsidiary and certain of its former employees, as well as a Brazilian importer of our products, and its affiliates and employees, relating to alleged evasion of import taxes and alleged improper transactions involving the subsidiary and the importer. Brazilian tax authorities have assessed claims against our Brazilian subsidiary based on a theory of joint liability with the Brazilian importer for import taxes, interest, and penalties. The asserted claims by Brazilian federal tax authorities which remain are for calendar years 2003 through 2007, and the asserted claims by the tax authorities from the state of Sao Paulo are for calendar years 2005 through 2007. The total asserted claims by Brazilian state and federal tax authorities aggregate to $257 million for the alleged evasion of import and other taxes, $1.6 billion for interest, and $1.2 billion for various penalties, all determined using an exchange rate as of January 27, 2018. We have completed a thorough review of the matters and believe the asserted claims against our Brazilian subsidiary are without merit, and we are defending the claims vigorously. While we believe there is no legal basis for the alleged liability, due to the complexities and uncertainty surrounding the judicial process in Brazil and the nature of the claims asserting joint liability with the importer, we are unable to determine the likelihood of an unfavorable outcome against our Brazilian subsidiary and are unable to reasonably estimate a range of loss, if any. We do not expect a final judicial determination for several years. An unfavorable resolution of lawsuits or governmental investigations could have a material adverse effect on our business, operating results, or financial condition. For additional information regarding certain of the matters in which we are involved, see Item 1, “Legal Proceedings,” contained in Part II of this report.
CHANGES IN OUR PROVISION FOR INCOME TAXES OR ADVERSE OUTCOMES RESULTING FROM EXAMINATION OF OUR INCOME TAX RETURNS COULD ADVERSELY AFFECT OUR RESULTS
Our provision for income taxes is subject to volatility and could be adversely affected by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by changes to domestic manufacturing deduction laws, regulations, or interpretations thereof; by expiration of or lapses in tax incentives; by transfer pricing adjustments, including the effect of acquisitions on our intercompany R&D cost sharing arrangement and legal structure; by tax effects of nondeductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by changes in tax laws and regulations, treaties, or interpretations thereof, including changes to the taxation of earnings of our foreign subsidiaries, the deductibility of expenses attributable to foreign income, and the foreign tax credit rules. Significant judgment is required to determine the recognition and
measurement attribute prescribed in the accounting guidance for uncertainty in income taxes. The Organisation for Economic Co-operation and Development (OECD), an international association comprised of 35 countries, including the United States, has made changes to numerous long-standing tax principles. There can be no assurance that these changes, once adopted by countries, will not have an adverse impact on our provision for income taxes. Further, as a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries is subject to reduced tax rates. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.
OUR BUSINESS AND OPERATIONS ARE ESPECIALLY SUBJECT TO THE RISKS OF EARTHQUAKES, FLOODS, AND OTHER NATURAL CATASTROPHIC EVENTS
Our corporate headquarters, including certain of our research and development operations are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, a certain number of our facilities are located near rivers that have experienced flooding in the past. Also certain of our suppliers and logistics centers are located in regions that have been or may be affected by earthquake, tsunami and flooding activity which in the past has disrupted, and in the future could disrupt, the flow of components and delivery of products. A significant natural disaster, such as an earthquake, a hurricane, volcano, or a flood, could have a material adverse impact on our business, operating results, and financial condition.
MAN-MADE PROBLEMS SUCH AS CYBER-ATTACKS, DATA PROTECTION BREACHES, COMPUTER VIRUSES OR TERRORISM MAY DISRUPT OUR OPERATIONS, HARM OUR OPERATING RESULTS AND DAMAGE OUR REPUTATION, AND CYBER-ATTACKS OR DATA PROTECTION BREACHES ON OUR CUSTOMERS’ NETWORKS, OR IN CLOUD-BASED SERVICES PROVIDED BY OR ENABLED BY US, COULD RESULT IN LIABILITY FOR US, DAMAGE OUR REPUTATION OR OTHERWISE HARM OUR BUSINESS
Despite our implementation of network security measures, the products and services we sell to customers, and our servers, data centers and the cloud-based solutions on which our data, and data of our customers, suppliers and business partners are stored, are vulnerable to cyber-attacks, data protection breaches, computer viruses, and similar disruptions from unauthorized tampering or human error. Any such event could compromise our networks or those of our customers, and the information stored on our networks or those of our customers could be accessed, publicly disclosed, lost or stolen, which could subject us to liability to our customers, suppliers, business partners and others, and could have a material adverse effect on our business, operating results, and financial condition and may cause damage to our reputation. Efforts to limit the ability of malicious third partiesactors to disrupt the operations of the Internet or undermine our own security efforts may beare costly to implement and meet with resistance, and may not be successful. Breaches of network security in our customers’ or third-party providers’ networks, in third-party products we use, or in cloud-based services provided to, by, or enabled by us, regardless of whether the breach is attributable to a vulnerability in our products or services, or a failure to maintain the digital security infrastructure or security tools that protect the integrity of our products, services, and IT environment, could, in each case, result in claims of liability foragainst us, damage our reputation or otherwise materially harm our business.
In addition, the continued threatVulnerabilities and critical security defects, prioritization decisions regarding remedying vulnerabilities or security defects, failure of terrorism and heightenedthird-party providers to remedy vulnerabilities or security and military actiondefects, or customers not deploying security updates in responsea timely manner or deciding not to this threat,upgrade products, services or any future actssolutions could result in claims of terrorism, may cause further disruptions to the economies of the United States and other countries and create further uncertaintiesliability against us, damage our reputation, or otherwise materially harm our business.
The products and services we sell to customers, and our cloud-based solutions, inevitably contain vulnerabilities or security defects which have not been remedied and cannot be disclosed without compromising security. We also make prioritization decisions in determining which vulnerabilities or security defects to fix and the timing of these fixes. Customers may also need to test security updates before they can be deployed which can delay implementation. When customers do not deploy security updates in a timely manner, or decide not to upgrade to the latest versions of our products, services or cloud-based solutions containing the security update, they may be left vulnerable. In addition, we rely on third-party providers of software and cloud-based services on which our and third-party data is stored or processed, and we cannot control the timing at which third-party providers remedy vulnerabilities, which could leave us vulnerable. Vulnerabilities and security defects, prioritization errors in remedying vulnerabilities or security defects, failure of third-party providers to remedy vulnerabilities or security defects, or
customers not deploying security updates in a timely manner or deciding not to upgrade products, services or solutions could result in claims of liability against us, damage our reputation or otherwise materially harm our business.
Our actual or perceived failure to adequately protect personal data could result in claims of liability against us, damage our reputation or otherwise materially harm our business.
Global privacy and data protection-related laws and regulations are evolving, extensive, and complex. Compliance with these laws and regulations is difficult and costly. In addition, evolving legal requirements restricting or controlling the collection, processing, or cross-border transmission of data, including for regulation of cloud-based services, could materially affect our customers’ ability to use, and our ability to sell, our products and services. The interpretation and application of these laws in some instances is uncertain, and our legal and regulatory obligations are subject to frequent changes. For example, the European Union’s (“EU”) General Data Protection Regulation (“GDPR”) applies to our activities conducted from an establishment in the EU or related to products and services offered in the EU and imposes a range of compliance obligations regarding the handling of personal data. Additionally, we are subject to California’s Consumer Privacy Act and other laws, regulations and obligations that relate to the handling of personal data. Our actual or perceived failure to comply with applicable laws and regulations or other obligations relating to personal data, or to protect personal data from unauthorized access, use, or other processing, could subject us to liability to our customers, data subjects, suppliers, business partners, employees, and others, give rise to legal and/or regulatory action, could damage our reputation or could otherwise materially harm our business, any of which could have a material adverse effect on our business, operating results, and financial condition. Likewise, events such as loss of infrastructure and utilities services such as energy, transportation, or telecommunications could have similar negative impacts. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders or the manufacture or shipment of our products, our
Our business, operating results and financial condition could be materially harmed by evolving regulatory uncertainty or obligations applicable to our products and adversely affected.services.
IF WE DO NOT SUCCESSFULLY MANAGE OUR STRATEGIC ALLIANCES, WE MAY NOT REALIZE THE EXPECTED BENEFITS FROM SUCH ALLIANCES AND WE MAY EXPERIENCE INCREASED COMPETITION OR DELAYS IN PRODUCT DEVELOPMENT
We have several strategic alliances with large and complex organizations and other companies withChanges in regulatory requirements applicable to the industries in which we workoperate, in the United States and in other countries, could materially affect the sales of our products and services. In particular, economic sanctions and changes to offer complementaryexport control requirements, have impacted and may continue to impact our ability to sell and support our products and services in certain jurisdictions. In addition, changes in telecommunications regulations could impact our service provider customers’ purchase of our products and services, and they could also impact sales of our own regulated offerings. Additional areas of uncertainty that could impact sales of our products and services include laws and regulations related to encryption technology, environmental sustainability (including climate change), human rights, product certification, and national security controls applicable to our supply chain. For example, new laws and regulations in the pastresponse to climate change could result in increased energy efficiency requirements for our products and increased compliance and energy costs. Changes in regulatory requirements in any of these areas could have established a joint venturematerial adverse effect on our business, operating results, and financial condition.
Risks Related to market services associated with our Cisco Unified Computing System products. These arrangements are generally limited to specific projects, the goalOwnership of which is generally to facilitate product compatibility and adoption of industry standards. There can be no assurance we will realize the expected benefits from these strategic alliances or from the joint venture. If successful, these relationshipsOur Stock
Our stock price may be mutually beneficial and result in industry growth. However, alliances carry an element of risk because, in most cases, we must compete in some business areas with a company with which we have a strategic alliance and, at the same time, cooperate with that company in other business areas. Also, if these companies fail to perform or if these relationships fail to materialize as expected, we could suffer delays in product development or other operational difficulties. Joint ventures can be difficult to manage, given the potentially different interests of joint venture partners.
OUR STOCK PRICE MAY BE VOLATILE
volatile.
Historically, our common stock has experienced substantial price volatility, particularly as a result of variations between our actual financial results and the published expectations of analysts and as a result of announcements by our competitors and us. Furthermore, speculation in the press or investment community about our strategic position, financial condition, results of operations, business, security of our products, or significant transactions can cause changes in our stock price. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies, in particular, and that have often been unrelated to the operating performance of these companies. These factors, as well as general economic and political conditions and the announcement of proposed and completed acquisitions or other significant transactions, or any difficulties associated with such transactions, by us or our current or potential competitors, may materially adversely affect the market price of our common stock in the future. Additionally, volatility, lack of positive performance in our stock price or changes to our overall compensation program, including our stock incentive program, may adversely affect our ability to retain key employees, virtually all of whom are compensated, in part, based on the performance of our stock price.
THERE CAN BE NO ASSURANCE THAT OUR OPERATING RESULTS AND FINANCIAL CONDITION WILL NOT BE ADVERSELY AFFECTED BY OUR INCURRENCE OF DEBT
As of the end of the second quarter of fiscal 2018, we have senior unsecured notes outstanding in an aggregate principal amount of $30.5 billion that mature at specific dates from calendar year 2018 through 2040. We have also established a commercial paper program under which we may issue short-term, unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $10.0 billion, and we had $9.0 billion in commercial paper notes outstanding under this program as of January 27, 2018. The outstanding senior unsecured notes bear fixed-rate interest payable semiannually, except $2.9 billion of the notes which bears interest at a floating rate payable quarterly. The fair value of the long-term debt is subject to market interest rate volatility. The instruments governing the senior unsecured notes contain certain covenants applicable to us and our wholly-owned subsidiaries that may adversely affect our ability to incur certain liens or engage in certain types of sale and leaseback transactions. In addition, we will be required to have available in the United States sufficient cash to service the interest on our debt and repay all of our notes on maturity. There can be no assurance that our incurrence of this debt or any future debt will be a better means of providing liquidity to us than would our use of our existing cash resources. Further, we cannot be assured that our maintenance of this indebtedness or incurrence of future indebtedness will not adversely affect our operating results or financial condition. In addition, changes by any rating agency to our credit rating can negatively impact the value and liquidity of both our debt and equity securities, as well as the terms upon which we may borrow under our commercial paper program or future debt issuances.
On September 13, 2001, we announced that our Board of Directors had authorized a stock repurchase program. On February 14, 2018, our Board of Directors authorized a $25 billion increase to the stock repurchase program. The remaining authorized amount for stock repurchases under this program including the additional authorization, is approximately $31$13.4 billion with no termination date.
For the majority of restricted stock units granted, the number of shares issued on the date the restricted stock units vest is net of shares withheld to meet applicable tax withholding requirements. Although these withheld shares are not issued or considered common stock repurchases under our stock repurchase program, and therefore are not included in the preceding table, they are treated as common stock repurchases in our financial statements as they reduce the number of shares that would have been issued upon vesting (see Note 13 to the Consolidated Financial Statements).vesting.
None.
Not applicable.
None.
