UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________________________
FORM 10-K
(Mark one)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended July 28, 2018 |
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____ to ____ |
Commission file number 0-18225
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CISCO SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California | 77-0059951 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |
170 West Tasman Drive San Jose, California | 95134-1706 | |
(Address of principal executive offices) | (Zip Code) | |
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class: | Name of Each Exchange on which Registered | |
Common Stock, par value $0.001 per share | The Nasdaq Stock Market LLC | |
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes o No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | o | ||||
Non-accelerated filer | o | (Do not check if a smaller reporting company) | Smaller reporting company | o | |||
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Aggregate market value of registrant’s common stock held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock on January 26, 2018 as reported by the Nasdaq Global Select Market on that date: $207,120,318,133
Number of shares of the registrant’s common stock outstanding as of August 31, 2018: 4,571,334,136
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement relating to the registrant’s 2018 Annual Meeting of Shareholders, to be held on December 12, 2018, are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.
PART I | ||||
Item 1. | ||||
Item 1A. | ||||
Item 1B. | ||||
Item 2. | ||||
Item 3. | ||||
Item 4. | ||||
PART II | ||||
Item 5. | ||||
Item 6. | ||||
Item 7. | ||||
Item 7A. | ||||
Item 8. | ||||
Item 9. | ||||
Item 9A. | ||||
Item 9B. | ||||
PART III | ||||
Item 10. | ||||
Item 11. | ||||
Item 12. | ||||
Item 13. | ||||
Item 14. | ||||
PART IV | ||||
Item 15. | ||||
This Annual Report on Form 10-K, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” "momentum," “seeks,” “estimates,” “continues,” “endeavors,” “strives,” “may,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below, under “Item 1A. Risk Factors,” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.
PART I
Item 1. | Business |
General
Cisco designs and sells a broad range of technologies that have been powering the Internet since 1984. Across networking, security, collaboration, applications and the cloud, our evolving intent-based technologies are constantly learning and adapting to provide customers with a highly secure, intelligent platform for their digital business.
We conduct our business globally, and manage our business by geography. Our business is organized into the following three geographic segments: Americas; Europe, Middle East, and Africa (EMEA); and Asia Pacific, Japan, and China (APJC). For revenue and other information regarding these segments, see Note 17 to the Consolidated Financial Statements.
Our products and technologies are grouped into the following categories: Infrastructure Platforms; Applications; Security and Other Products. In addition to our product offerings, we provide a broad range of service offerings, including technical support services and advanced services. Increasingly, we are delivering our technologies through software and services. Our customers include businesses of all sizes, public institutions, governments, and service providers. These customers often look to us as a strategic partner to help them use information technology (IT) to differentiate themselves and drive positive business outcomes.
We were incorporated in California in December 1984, and our headquarters are in San Jose, California. The mailing address of our headquarters is 170 West Tasman Drive, San Jose, California 95134-1706, and our telephone number at that location is (408) 526-4000. Our website is www.cisco.com. Through a link on the Investor Relations section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC): our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. All such filings are available free of charge. The information posted on our website is not incorporated into this report.
Strategy and Priorities
As our customers add billions of new connections to their enterprises, and as more applications move to a multi-cloud environment, we believe the network continues to be extremely critical. We believe that our customers are looking for intent-based networks that provide meaningful business value through automation, security, and analytics across private, hybrid, and multi-cloud environments. Our vision is to deliver highly secure, software-defined, automated and intelligent platforms for our customers. Our strategic priorities include the following: accelerating our pace of innovation, increasing the value of the network, and transforming our business model.
Accelerating Pace of Innovation — Enabling Network Automation
In fiscal 2017, we announced the initial development of new network product offerings that feature our intent-based networking technology. The intent-based networking platform is designed to be intelligent, highly secure, powered by “intent” and informed by “context”—features aiming to constantly learn, adapt, automate and protect in order to optimize network operations and defend against an evolving cyber threat landscape. To further our innovation in this area, we are applying the latest technologies such as machine learning and advanced analytics, to operate and define the network. From a security standpoint, these new network product offerings are designed to enable customers to detect threats, for instance, in encrypted traffic, and we have created what is in our view the only network that is designed for security while maintaining privacy.
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Our Catalyst 9000 series of switches represent the initial build of our intent-based networking capabilities and provide highly differentiated advancements in security, programmability, and performance, while lowering operating costs by innovating at the hardware and software layers. Our intent-based network started with the Software-Defined Access (SD-Access) technology, one of our leading enterprise architectures. These offerings are designed to provide a single, highly secure network fabric that helps ensure policy consistency and network assurance; enables faster launches of new business services; and significantly improves issue resolution times while being open and extendable. SD-Access, built on the principles of Cisco Digital Networking Architecture (DNA), provides what we see as a transformational shift in the building and managing of networks.
For the data center, our Application Centric Infrastructure (ACI) solutions deliver centralized application-driven policy automation, management, and visibility of both physical and virtual environments as a single system.
Increasing the Value of the Network
Unlocking the Power of Data. Our customers are increasingly using technology, and specifically, networks to grow their businesses, drive efficiencies, and more effectively compete. We believe data is one of an organization's most strategic assets, and this data is increasingly distributed across every organization and ecosystem, on customer premises, at the edge of the network, and in the cloud. As the number of new devices connected to the Internet grows, we believe the network will play an even more critical role in enabling our customers to aggregate, automate, and draw actionable insights from this highly distributed data, where there is a premium on security and speed. We believe this is driving our customers to adopt entirely new IT architectures and organizational structures and, more specifically, to seek network deployment solutions that deliver greater agility, productivity, security, and other advanced network capabilities.
Security is Foundational. We believe that security is the top IT priority for many of our customers. Our security strategy is focused on delivering an effective cybersecurity architecture combining network, cloud and endpoint-based solutions. Through our industry-leading Cisco Talos offering, we intend to protect against and provide security across the entire attack continuum before, during, and after a cyberattack to help our customers shorten the time between threat detection and response.
Powering a Multi-Cloud World. Our customers are operating in multi-cloud environments with private, public, and hybrid clouds. Our cloud strategy is to deliver solutions designed to simplify, secure, and transform how customers work in this multi-cloud world to maximize business outcomes.
As our customers navigate the multi-cloud world, they need to connect new devices, protect their assets and monitor cloud consumption, and they also require advisory cloud services that are provided in a consistent manner. We are focused on enabling simple, intelligent, automated and highly secure clouds by delivering the infrastructure to navigate the complex IT environment through our software and subscription-based offerings including Webex, Meraki cloud networking, and certain other of our Security and Applications offerings. We believe that customers and partners view our approach to the cloud as differentiated and unique, recognizing that we offer a solution for all cloud environments, including private, hybrid, and public clouds.
In our view, over the next several years, customers will be increasingly writing modern applications that can run on any hybrid cloud, and will be adding billions of connections to their environment. We believe Cisco is uniquely positioned to enable successful business outcomes for customers in hybrid and multi-cloud environments. In our view, the network has never been more critical to business success and we believe our customers will benefit from the insights and intelligence that we are making accessible through our highly differentiated platforms.
Transforming our Business Model
We are transforming our offerings to meet the evolving needs of our customers. As part of the transformation of our business, we continued to make strides during fiscal 2018 to develop and sell more software and subscription-based offerings, which we expect will increase the amount of our recurring revenue. The Catalyst 9000 series of switches are an example of how we are beginning to shift more of our core business to a subscription-based model. Historically, our various networking technology products have aligned with their respective product categories. However, increasingly, our offerings are crossing multiple product categories. As our core networking evolves, we expect we will add more common software features across our core networking platforms. With respect to the disaggregation of hardware and software and how our customers want to consume our technology, we are increasing the amount of software offerings that we provide. We have various types of software arrangements including system software, on premise software, hybrid software and SaaS offerings. In terms of monetization, our software offerings fall into the broad categories of subscription arrangements and perpetual licenses.
For a discussion of the risks associated with our strategy, see “Item 1A. Risk Factors,” including the risk factor entitled “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 suffer.” For information regarding sales of our major products and services, see Note 17 to the Consolidated Financial Statements.
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Products and Services
Our products and services are grouped into the following categories:
Infrastructure Platforms
Infrastructure Platforms consist of our core networking technologies of switching, routing, data center products, and wireless that are designed to work together to deliver networking capabilities and transport and/or store data. These technologies consist of both hardware and software offerings that help our customers build networks, automate, orchestrate, integrate, and digitize data. We believe it is critical for us to continue to deliver continuous value to our customers. Over fiscal 2018, we made ongoing progress in shifting more of our business to software and subscriptions across our core networking portfolio, and in expanding our software offerings. Our objective is to continue moving to cloud-managed solutions across our entire enterprise networking portfolio. We continue to expand on our intent driven infrastructure, which focuses on simplicity, automation, and security, allowing enterprises to manage and govern the interactions of users, devices and applications across their IT environments. In fiscal 2017, we launched our Cisco Catalyst 9000 series of switches, which were developed for security, mobility, the Internet of Things (IoT), and the cloud. These switches form the foundation for our leading enterprise architectures, built on the principles of Cisco DNA. We continue to expand on this technology by extending SD-Access and Cisco DNA Center to the IoT environment and Application Centric Infrastructure (ACI) to the public cloud.
Our switching portfolio encompasses campus switching offerings as well as data center switching offerings. Our campus switching offerings provide the foundation for converged data, voice, video, and IoT services. These switches offer enhanced security and reliability and are designed to scale efficiently as our customers grow. Within campus switching are the recently launched Catalyst 9000 series of switches that include hardware with embedded software, along with, a software subscription referred to as Cisco DNA. Cisco DNA provides automation, analytics and security features and can be centrally monitored, managed, and configured. Our data center switching offerings provide the foundation for mission critical data centers with high availability, scalability, and security across traditional data centers and private and public cloud data centers.
Our routing portfolio interconnects public and private wireline and mobile networks and mobile networks, delivering highly secure and reliable service to campus, data center and branch networks. Our routing solutions are designed to meet the scale, reliability, and security needs of our customers. During fiscal 2018, we introduced the principles of Cisco DNA into our routing portfolio along with software-defined wide area network (SD-WAN), increasing flexibility and simplicity and delivery through the cloud.
Our Data Center portfolio incorporates various technologies and solutions including the Cisco Unified Computing System (Cisco UCS), HyperFlex (HX), and software management capabilities which combine computing, networking, and storage infrastructure management and virtualization to deliver agility, simplicity and scale. These products are designed to extend the power and simplicity of unified computing for data-intensive workloads, applications at the edge, and the next generation of distributed application architectures.
Our Wireless portfolio provides indoor and outdoor wireless coverage designed for seamless roaming use of voice, video, and data applications. These products include wireless access points that are standalone, controller appliance-based, switch-converged, and Meraki cloud-managed offerings. In fiscal 2018, we expanded our capabilities to include network assurance and automation through our Cisco DNA Center and location-based services.
Applications
The Applications product category consists primarily of software-related offerings that utilize the core networking and data center platforms to provide their functions. Our Applications offerings consist of both hardware and software-based solutions, including both software licenses and software-as-a-service. Applications include our collaboration offerings (unified communications, Cisco TelePresence and conferencing) as well as the IoT and analytics software offerings from Jasper and AppDynamics, respectively.
Our strategy is to make collaboration more effective, comprehensive, and less complex by creating innovative solutions through combining the power of software, hardware, and the network. We offer a portfolio of solutions which can be delivered from the cloud, premise or mixed environments, and which integrate voice, video, and messaging on fixed and mobile networks across a wide range of devices/endpoints such as mobile phones, tablets, desktop and laptop computers, video units and collaboration appliances. Growth in cloud-connected products and services was highlighted by the acquisition of BroadSoft, a leading provider of cloud-based unified communications. In addition, we announced innovative new cloud-connected products and services within our Collaboration portfolio including the Cisco WebexVirtual Assistant, AI driven voice assistance for workplace collaboration, and Webex Room telepresence endpoint devices. For on-premise collaboration markets, we launched multi-party Internet Protocol (IP) Phones to extend our reach into third-party call control platforms as well as a new series of telephony headsets which offer innovative integration with our market leading IP phone business.
Our analytics solutions seek to help businesses deliver consistently high quality digital experiences by connecting end-user experience and application performance to business outcomes. Our applications monitor, correlate, analyze, and act on application
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performance and business performance data in real time. This automated, cross-stack intelligence enables developers, IT operations, and business owners to make mission critical and strategic improvements.
We continue to invest in IoT as the number of connected IoT devices continues to grow. Our Jasper Control Center Platform enables enterprises to automate the lifecycle of connected devices, including tools designed to automatically and remotely onboard, manage and monetize their IoT devices.
Security
The Security product category primarily includes our unified threat management products, advanced threat security products, and web security products that are designed to provide a highly secure environment for our customers. Security continues to be the top IT priority for many of our customers and we continue to believe that security solutions will help to protect the digital economy. We believe that security will be an enabler that helps safeguard our customers’ business interests and can help create competitive advantage for them. Our approach is designed to provide protection across the entire attack continuum before, during, and after a cyber-attack and to help our customers shorten the time to threat detection and response. In our view, the escalation of ransomware and other malware events in the past year demonstrates that organizations are more critically exposed than ever.
Our security portfolio is designed to increase capability while reducing complexity by delivering simple, open, and automated solutions resulting in more effective security. Our security portfolio spans endpoints, the network, and the cloud. Our offerings cover the following network-related areas: network and data center security, advanced threat protection, web and email security, access and policy, unified threat management, and advisory, integration, and managed services. Our offerings are powered by Cisco Talos, our industry-leading, cloud delivered threat intelligence platform.
In fiscal 2018, we continued to invest in cloud security. These investments include introducing our Stealthwatch Cloud, behavioral threat detection for IaaS (infrastructure as a service) and PaaS (platform as a service) environments, extending our Umbrella Platform capabilities, and providing new functions such as shadow IT discovery in CloudLock, our CASB (Cloud Access Security Broker) solution. We significantly extended our endpoint security portfolio (Advanced Malware Protection for Endpoints) with new exploit prevention capabilities for fileless malware. We remain focused on delivering an integrated architecture across our Security products, highlighted by the introduction of Cisco Visibility, a unified threat management platform across many of our products.
Other Products
Our Other Products category primarily consists of Service Provider Video Software and Solutions and cloud and system management products. We announced a definitive agreement to sell our Service Provider Video Software and Solutions business in the fourth quarter of fiscal 2018. We expect this transaction to close in the first half of fiscal 2019 subject to regulatory approvals and customary closing conditions.
Services
In addition to our product offerings, we provide a broad range of service and support options for our customers, including technical support services and advanced services. In fiscal 2019, we introduced Customer Experience, combining our overall service and support offerings into one organization that is responsible for the end-to-end customer experience.
Technical support services help our customers ensure their products operate efficiently, remain available, and benefit from the most up-to-date system, and application software. These services help customers protect their network investments, manage risk, and minimize downtime for systems running mission-critical applications. A key example is Cisco Smart Services, which leverages the intelligence from the installed base of our products and customer connections to protect and optimize network investment for our customers and partners. We have expanded our Technical Services offerings from traditional hardware support to software, solutions, and premium support and outcome based offers.
Advanced services are part of a comprehensive program that is focused on providing responsive, preventive, and consultative support of our technologies for specific networking needs. We are investing in and expanding our advanced services in the areas of cloud, security, and analytics, which reflects our strategy of selling customer outcomes. We are focused on three priorities including, utilizing Technology Advisory Services to drive higher product and services pull-through; Assessment and Migration services providing the tools, expertise and methodologies to enable our customers to migrate to new technology platforms; and providing optimization services aligned with customers’ measurable business outcomes.
We believe this strategy, along with our architectural approach and networking expertise, has the potential to further differentiate us from competitors.
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Customers and Markets
Many factors influence the IT, collaboration, and networking requirements of our customers. These include the size of the organization, number and types of technology systems, geographic location, and business applications deployed throughout the customer’s network. Our customer base is not limited to any specific industry, geography, or market segment. In each of the past three fiscal years, no single customer accounted for 10% or more of revenue. Our customers primarily operate in the following markets: enterprise, commercial, service provider, and public sector.
Enterprise
Enterprise businesses are large regional, national, or global organizations with multiple locations or branch offices and typically employ 1,000 or more employees. Many enterprise businesses have unique IT, collaboration, and networking needs within a multivendor environment. We plan to take advantage of the network-as-a-platform strategy to integrate business processes with technology architectures to assist customer growth. We offer service and support packages, financing, and managed network services, primarily through our service provider partners. We sell these products through a network of third-party application and technology vendors and channel partners, as well as selling directly to these customers.
Commercial
We define commercial businesses as organizations which typically have fewer than 1,000 employees. We sell to the larger, or midmarket, customers within the commercial market through a combination of our direct sales force and channel partners. These customers typically require the latest advanced technologies that our enterprise customers demand, but with less complexity. Small businesses, or organizations with fewer than 100 employees, require information technologies and communication products that are easy to configure, install, and maintain. We sell to these smaller organizations within the commercial market primarily through channel partners.
Service Providers
Service providers offer data, voice, video, and mobile/wireless services to businesses, governments, utilities, and consumers worldwide. This customer market category includes regional, national, and international wireline carriers, as well as Internet, cable, and wireless providers. We also include media, broadcast, and content providers within our service provider market, as the lines in the telecommunications industry continue to blur between traditional network-based, content-based and application-based services. Service providers use a variety of our products and services for their own networks. In addition, many service providers use Cisco data center, virtualization, and collaboration technologies to offer managed or Internet-based services to their business customers. Compared with other customers, service providers are more likely to require network design, deployment, and support services because of the greater scale and higher complexity of their networks, whose requirements are addressed, we believe, by our architectural approach.
Public Sector
Public sector entities include federal governments, state and local governments, as well as educational institution customers. Many public sector entities have unique IT, collaboration, and networking needs within a multivendor environment. We sell to public sector entities through a network of third-party application and technology vendors and channel partners, as well as through direct sales.
Sales Overview
As of the end of fiscal 2018, our worldwide sales and marketing departments consisted of approximately 25,200 employees, including managers, sales representatives, and technical support personnel. We have field sales offices in 96 countries, and we sell our products and services both directly and through a variety of channels with support from our salesforce. A substantial portion of our products and services is sold through channel partners, and the remainder is sold through direct sales. 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. Some service providers are also systems integrators.
Distributors typically hold inventory and 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 two-tier distributors is recognized based on a sell-through method using point of sales information provided by these distributors. Starting in fiscal 2019, in connection with the adoption of ASC 606, Revenue from Contracts with Customers, a new accounting standard related to revenue recognition, we will start recognizing revenue from two-tier distributors on a sell-in method. For further discussion of ASC 606, see Note 2 to the Consolidated Financial Statements. 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.
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For information regarding risks related to our channels, see “Item 1A. Risk Factors,” including the risk factors entitled “Disruption of, or changes in, our distribution model could harm our sales and margins” and “Our inventory management relating to our sales to our two-tier distribution channel is complex, and excess inventory may harm our gross margins.”
For information regarding risks relating to our international operations, see “Item 1A. Risk Factors,” including the risk factors entitled “Our operating results may be adversely affected by unfavorable economic and market conditions and the uncertain geopolitical environment;” “Entrance into new or developing markets exposes us to additional competition and will likely increase demands on our service and support operations;” “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 are exposed to fluctuations in currency exchange rates that could negatively impact our financial results and cash flows;” and “Man-made problems such as cyber-attacks, data protection breaches, malware or terrorism may disrupt our operations, harm our operating results and financial condition, and damage our reputation, and cyber-attacks or data protection breaches on our customers' networks, in cloud-based services provided by or enabled by us, could result in claims of liability against us, damage our reputation or otherwise harm our business,” among others.
Our service offerings complement our products through a range of consulting, technical, project, quality, and software maintenance services, including 24-hour online and telephone support through technical assistance centers.
Financing Arrangements
We provide financing arrangements for certain qualified customers to build, maintain, and upgrade their networks. We believe customer financing is a competitive advantage in obtaining business, particularly for those customers involved in significant infrastructure projects. Our financing arrangements include the following:
Leases: |
• Sales-type |
• Direct financing |
• Operating |
Loans |
Financed service contracts |
Channels financing arrangements |
End-user financing arrangements |
Product Backlog
Our product backlog at July 28, 2018 was approximately $6.6 billion, an increase of 38% year over year. The product backlog includes orders confirmed for products planned to be shipped within 90 days to customers with approved credit status. Subscription-based sales arrangements are not included in product backlog. Our cycle time between order and shipment is generally short and customers occasionally change delivery schedules. Additionally, orders can be canceled without significant penalties. As a result of these factors, we do not believe that our product backlog, as of any particular date, is necessarily indicative of actual product revenue for any future period.
Acquisitions, Investments, and Alliances
The markets in which we compete require a wide variety of technologies, products, and capabilities. Our growth strategy is based on the components of innovation, which we sometimes refer to as “build, buy, partner, invest, and co-develop". This five-prong approach to how we innovate can be summarized as follows:
Build | Working within Cisco, with the developer community, or with customers |
Buy | Acquiring or divesting, depending on goals |
Partner | Strategically partnering to further build out the business |
Invest | Making investments in areas where technology is in its infancy or where there is no dominant technology |
Co-develop | Developing new solutions with multi-party teams that may include customers, channel partners, startups, independent software vendors, and academics |
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Acquisitions
We have acquired many companies, and we expect to make future acquisitions. Mergers and acquisitions of high-technology companies are inherently risky, especially if the acquired company has yet to generate revenue. No assurance can be given that our previous or future acquisitions will be successful or will not materially adversely affect our financial condition or operating results. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products and technologies to an inability to do so. The risks associated with acquisitions are more fully discussed in “Item 1A. Risk Factors,” including the risk factor entitled “We have made and expect to continue to make acquisitions that could disrupt our operations and harm our operating results.”
Investments in Privately Held Companies
We make investments in privately held companies that develop technology or provide services that are complementary to our products or that provide strategic value. The risks associated with these investments are more fully discussed in “Item 1A. Risk Factors,” including the risk factor entitled “We are exposed to fluctuations in the market values of our portfolio investments and in interest rates; impairment of our investments could harm our earnings.”
Strategic Alliances
We pursue strategic alliances with other companies in areas where collaboration can produce industry advancement and acceleration of new markets. The objectives and goals of a strategic alliance can include one or more of the following: technology exchange, product development, joint sales and marketing, or new market creation. Companies with which we have added or expanded strategic alliances during fiscal 2018 and in recent years include Apple, Google, Salesforce.com and Ericsson, among others.
Companies with which we have strategic alliances in some areas may be competitors in other areas, and in our view this trend may increase. The risks associated with our strategic alliances are more fully discussed in “Item 1A. Risk Factors,” including the risk factor entitled “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.”
Competition
We compete in the networking and communications equipment markets, providing products and services for transporting data, voice, and video traffic across intranets, extranets, and the Internet. These markets are characterized by rapid change, converging technologies, and a migration to networking and communications solutions that offer relative advantages. These market factors represent both an opportunity, and 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 our new product markets. 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 these companies 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 within the data center. 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
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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 |
• | 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. Therefore, 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.
Research and Development
We regularly introduce new products and features to address the requirements of our markets. We allocate our research and development budget among our product categories, which consist of Infrastructure Platforms, Applications, Security, and Other Product technologies. Our research and development expenditures were $6.3 billion, $6.1 billion, and $6.3 billion in fiscal 2018, 2017, and 2016, respectively. These expenditures are applied generally to all product areas, with specific areas of focus being identified from time to time. Recent areas of increased focus include our intent-based networking technologies (which encompasses switching, routing, and wireless technologies within Infrastructure Platforms), security, and analytics products. Our expenditures for research and development costs were expensed as incurred.
The industry in which we compete is subject to rapid technological developments, evolving standards, changes in customer requirements, and new product introductions and enhancements. As a result, our success depends in part upon our ability, on a cost-effective and timely basis, to continue to enhance our existing products and to develop and introduce new products that improve performance, and reduce total cost of ownership. To achieve these objectives, our management and engineering personnel work with customers to identify and respond to customer needs, as well as with other innovators of Internet working products, including universities, laboratories, and corporations. We also expect to continue to make acquisitions and investments, where appropriate, to provide us with access to new technologies. Nonetheless, there can be no assurance that we will be able to successfully develop products to address new customer requirements and technological changes or that those products will achieve market acceptance.
Manufacturing
We rely on contract manufacturers for all of our manufacturing needs. We presently use a variety of independent third-party companies to provide services related to printed-circuit board assembly, in-circuit test, product repair, and product assembly. Proprietary software on electronically programmable memory chips is used to configure products that meet customer requirements and to maintain quality control and security. The manufacturing process enables us to configure the hardware and software in unique combinations to meet a wide variety of individual customer requirements. The manufacturing process uses automated testing equipment and burn-in procedures, as well as comprehensive inspection, testing, and statistical process controls, which are designed to help ensure the quality and reliability of our products. The manufacturing processes and procedures are generally certified to International Organization for Standardization (ISO) 9001 or ISO 9003 standards.
Our arrangements with contract manufacturers generally provide for quality, cost, and delivery requirements, as well as manufacturing process terms, such as continuity of supply; inventory management; flexibility regarding capacity, quality, and cost
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management; oversight of manufacturing; and conditions for use of our intellectual property. We have not entered into any significant long-term contracts with any manufacturing service provider. We generally have the option to renew arrangements on an as-needed basis. These arrangements generally do not commit us to purchase any particular amount or any quantities beyond certain amounts covered by orders or forecasts that we submit covering discrete periods of time, defined as less than one year.
Patents, Intellectual Property, and Licensing
We seek to establish and maintain our proprietary rights in our technology and products through the use of patents, copyrights, trademarks, and trade secret laws. We have a program to file applications for and obtain patents, copyrights, and trademarks in the United States and in selected foreign countries where we believe filing for such protection is appropriate. We also seek to maintain our trade secrets and confidential information by nondisclosure policies and through the use of appropriate confidentiality agreements. We have obtained a substantial number of patents and trademarks in the United States and in other countries. There can be no assurance, however, that the rights obtained can be successfully enforced against infringing products in every jurisdiction. Although we believe the protection afforded by our patents, copyrights, trademarks, and trade secrets has value, the rapidly changing technology in the networking industry and uncertainties in the legal process make our future success dependent primarily on the innovative skills, technological expertise, and management abilities of our employees rather than on the protection afforded by patent, copyright, trademark, and trade secret laws.
Many of our products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe, based upon past experience and standard industry practice that such licenses generally could be obtained on commercially reasonable terms. Nonetheless, there can be no assurance that the necessary licenses would be available on acceptable terms, if at all. Our 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, inclusion in our products of software or other intellectual property licensed from third parties on a nonexclusive basis can limit our ability to protect our proprietary rights in our products.
The industry in which we compete is characterized by rapidly changing technology, a large number of patents, and frequent claims and related litigation regarding patent and other intellectual property rights. There can be no assurance that our patents and other proprietary rights will not be challenged, invalidated, or circumvented; that others will not assert intellectual property rights to technologies that are relevant to us; or that our rights will give us a competitive advantage. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as the laws of the United States. The risks associated with patents and intellectual property are more fully discussed in “Item 1A. Risk Factors,” including the risk factors entitled “Our proprietary rights may prove difficult to enforce,” “We may be found to infringe on intellectual property rights of others,” and “We rely on the availability of third-party licenses.”
Employees
Employees are summarized as follows (approximate numbers):
July 28, 2018 | |
Employees by geography: | |
United States | 37,800 |
Rest of world | 36,400 |
Total | 74,200 |
Employees by line item on the Consolidated Statements of Operations: | |
Cost of sales (1) | 20,200 |
Research and development | 21,400 |
Sales and marketing | 25,200 |
General and administrative | 7,400 |
Total | 74,200 |
(1) Cost of sales includes manufacturing support, services, and training.
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Executive Officers of the Registrant
The following table shows the name, age, and position as of August 31, 2018 of each of our executive officers:
Name | Age | Position with the Company | ||
Charles H. Robbins | 52 | Chairman and Chief Executive Officer | ||
Mark Chandler | 62 | Executive Vice President, Chief Legal Officer and Chief Compliance Officer | ||
Gerri Elliott | 62 | Executive Vice President and Chief Sales and Marketing Officer | ||
David Goeckeler | 56 | Executive Vice President and General Manager, Security and Networking Business | ||
Kelly A. Kramer | 51 | Executive Vice President and Chief Financial Officer | ||
Maria Martinez | 60 | Executive Vice President and Chief Customer Experience Officer | ||
Irving Tan | 48 | Senior Vice President, Operations | ||
Mr. Robbins has served as Chief Executive Officer since July 2015, as a member of the Board of Directors since May 2015 and as Chairman of the Board since December 2017. He joined Cisco in December 1997, from which time until March 2002 he held a number of managerial positions within Cisco’s sales organization. Mr. Robbins was promoted to Vice President in March 2002, assuming leadership of Cisco’s U.S. channel sales organization. Additionally, in July 2005 he assumed leadership of Cisco’s Canada channel sales organization. In December 2007, Mr. Robbins was promoted to Senior Vice President, U.S. Commercial, and in August 2009 he was appointed Senior Vice President, U.S. Enterprise, Commercial and Canada. In July 2011, Mr. Robbins was named Senior Vice President, Americas. In October 2012, Mr. Robbins was promoted to Senior Vice President, Worldwide Field Operations, in which position he served until assuming the role of Chief Executive Officer. He is a member of the board of directors of BlackRock, Inc.
Mr. Chandler joined Cisco in July 1996, upon Cisco’s acquisition of StrataCom, Inc., where he served as General Counsel. He served as Cisco’s Managing Attorney for Europe, the Middle East, and Africa from December 1996 until June 1999; as Director, Worldwide Legal Operations from June 1999 until February 2001; and was promoted to Vice President, Worldwide Legal Services in February 2001. In October 2001, Mr. Chandler was promoted to Vice President, Legal Services and General Counsel, and in May 2003 he additionally was appointed Secretary, a position he held through November 2015. In February 2006, Mr. Chandler was promoted to Senior Vice President, and in May 2012 he was appointed Chief Compliance Officer. In June 2018, Mr. Chandler was promoted to Executive Vice President and Chief Legal Officer. Before joining StrataCom, Mr. Chandler had served as Vice President, Corporate Development and General Counsel of Maxtor Corporation.
Ms. Elliott joined Cisco in April 2018. Ms. Elliott is a former Executive Vice President of Juniper Networks, Inc., where she served as EVP and Chief Customer Officer from March 2013 to February 2014, EVP and Chief Sales Officer from July 2011 to March 2013 and EVP, Strategic Alliances from June 2009 to July 2011. Before joining Juniper, Ms. Elliott held a series of senior executive positions with Microsoft Corporation from 2001-2008 including Corporate Vice President of Microsoft’s Industry Solutions Group, Worldwide Public Sector and North American Enterprise Sales organizations. Prior to joining Microsoft Corporation, Ms. Elliott spent 22 years at IBM Corporation, where she held several senior executive positions both in the U.S. and internationally. Since 2014 Ms. Elliott has served as a director on several public company boards including Whirlpool Corporation (since 2014), Bed Bath & Beyond, Inc. (2014-17), Imperva, Inc. (2015-18), Marvell Technology Group Ltd. (2017-18) and Mimecast Ltd. (2017-18), and during this period she also founded and led the development of Broadrooms.com, an informational resource for executive women who serve or want to serve on corporate boards in the U.S.
Mr. Goeckeler joined Cisco in May 2000, from which time until December 2010 he held a variety of leadership positions within Cisco’s engineering organization, covering such technology focus areas as voice over IP, mobility, video infrastructure and networking. In December 2010, Mr. Goeckeler was promoted to Vice President, Engineering, in which his responsibilities included leading various product and platform-related initiatives within Cisco’s Service Provider Business group. In October 2012, Mr. Goeckeler assumed leadership of engineering in Cisco's Security Business, and in November 2014 was promoted to Senior Vice President. In March 2016 he was elevated to Senior Vice President and General Manager of the Security Business. In May 2016, Mr. Goeckeler added networking to his oversight responsibilities, assuming the role of Senior Vice President, Networking and Security Business, and was promoted to Executive Vice President in July 2017. In March 2018, Mr. Goeckeler assumed the added responsibility for Cisco's IoT and analytics businesses.
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Ms. Kramer joined Cisco in January 2012 as Senior Vice President, Corporate Finance. She served in that position until October 2014 and served as Cisco’s Senior Vice President, Business Technology and Operations Finance from October 2013 until December 2014. She was appointed to her current position effective January 2015. From January 2009 until she joined Cisco, Ms. Kramer served as Vice President and Chief Financial Officer of GE Healthcare Systems. Ms. Kramer served as Vice President and Chief Financial Officer of GE Healthcare Diagnostic Imaging from August 2007 to January 2009 and as Chief Financial Officer of GE Healthcare Biosciences from January 2006 to July 2007. Prior to that, Ms. Kramer held various leadership positions with GE corporate and other GE businesses. She is a member of the board of directors of Gilead Sciences, Inc.
Ms. Martinez joined Cisco in April 2018. Prior to joining Cisco, she served in a variety of senior executive roles at Salesforce.com, inc. including President, Global Customer Success and Latin America from March 2016 to April 2018; President, Sales and Customer Success from February 2013 to March 2016; Executive Vice President and Chief Growth Officer from February 2012 to February 2013; and Executive Vice President, Customers for Life from February 2010 to February 2012. Ms. Martinez’s experience prior to Salesforce includes Corporate Vice President of Worldwide Services at Microsoft Corporation, President and Chief Executive Officer of Embrace Networks, Inc. and various senior leadership roles at Motorola, Inc. and AT&T Inc./Bell Laboratories. Ms. Martinez was a member of the board of directors of Plantronics, Inc. from September 2015 to April 2018.
Mr. Tan joined Cisco in December 2005, serving in manager-level and director-level positions within Cisco’s Sales and Managed Services functions until March 2008, at which time he joined Hewlett Packard Corporation as General Manager of its Communications and Media Solutions Group in Asia Pacific and Japan. In April 2009, Mr. Tan rejoined Cisco, serving as Sales Director in charge of Malaysia and Singapore, and in February 2013 he was promoted to Vice President, Sales with responsibility for the Southeast Asia region. In April 2014, Mr. Tan was promoted to Senior Vice President, Sales with responsibility for Cisco’s APJ geography. In January 2018, he was promoted to his current position.
Item 1A. | Risk Factors |
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.
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 | ||
• | 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 | ||
• | The timing, size, and mix of orders from customers | ||
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• | Manufacturing and customer lead times | ||
• | 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 | ||
• | 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 | ||
• | Our ability to achieve targeted cost reductions | ||
• | Benefits anticipated from our investments in engineering, sales, service, and marketing | ||
• | 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 ENVIRONMENT
Challenging economic conditions 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:
• | 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 | ||
• | Increased price competition for our products, not only from our competitors but also as a consequence of customers disposing of unutilized products | ||
• | Risk of excess and obsolete inventories | ||
• | Risk of supply constraints | ||
• | Risk of excess facilities and manufacturing capacity | ||
• | Higher overhead costs as a percentage of revenue and higher interest expense | ||
The global macroeconomic environment has been challenging and inconsistent. 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 as a result of the recent United Kingdom “Brexit” referendum to withdraw from 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
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is 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 expect to realign and dedicate resources into key priority and growth areas, such as Security and Applications, while also focusing on maintaining leadership in Infrastructure Platforms and in Services. However, the return on our 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 REVENUE FOR A PARTICULAR PERIOD IS DIFFICULT TO PREDICT, AND A SHORTFALL IN REVENUE MAY HARM OUR OPERATING RESULTS
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 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. 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. 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 than normal manufacturing lead times in the past which have caused some customers to place the same order multiple times within our various sales channels and to cancel the duplicative orders upon receipt of the product, or to 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, 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 purchase commitments. Increases in our purchase commitments to shorten lead times could also lead to excess and obsolete inventory charges 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 on a year-over-year basis and could decline in future quarters due to adverse impacts from various factors, including:
• | 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 | ||
• | 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, which could be significant especially during periods of supply constraints such as those impacting the market for memory components | ||
• | Excess inventory and inventory holding charges | ||
• | Obsolescence charges | ||
• | Changes in shipment volume | ||
• | The timing of revenue recognition and revenue deferrals | ||
• | Increased cost (including those caused by tariffs), 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 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 Infrastructure Platforms and Applications products, in addition to longer sales cycles. Although product orders from the service provider market increased in the fourth quarter of fiscal 2018, service provider product orders decreased in the first nine months 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 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
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spending and expansion plans. These conditions have materially harmed our business and operating results in the past, and some of these or other conditions in the service provider market 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. 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:
• | 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 | ||
• | 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 | ||
• | 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. For information regarding our competitors, see the section entitled “Competition” contained in Item 1. Business of this report.
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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:
• | 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 | ||
• | 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
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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:
• | Any financial problems of either contract manufacturers or component suppliers could either limit supply or increase costs | ||
• | Reservation of manufacturing capacity at our contract manufacturers by other companies, inside or outside of our industry, could either limit supply or increase costs | ||
• | Industry consolidation occurring within one or more component supplier markets, such as the semiconductor market, could either limit supply or increase costs | ||
A reduction or interruption in supply; a significant increase in the price of one or more components; 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 times in the past. 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. 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.
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We believe that we may be faced with the following challenges in the future:
• | New markets in which we participate may grow quickly, which may make it difficult to quickly obtain significant component capacity | ||
• | As we acquire companies and new technologies, we may be dependent, at least initially, on unfamiliar supply chains or relatively small supply partners | ||
• | 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 purchase commitments. Increases in our purchase commitments to shorten lead times could also lead to excess and obsolete inventory charges 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 regarding our purchase commitments with contract manufacturers and suppliers, see Note 12 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 SUFFER
The markets for our products are characterized by rapidly changing technology, evolving industry standards, new product introductions, and evolving methods of building and operating networks. Our operating results depend on our ability to develop and introduce new products into existing and emerging markets and to reduce the production costs of existing products. Many of our strategic initiatives and investments we have made, and our architectural approach, are designed to enable the increased use of the network as the platform for automating, orchestrating, integrating, and delivering an ever-increasing array of IT-based products and services. For example, in June 2017 we announced 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 related to digital transformation and IoT; the transition in cloud; and the move towards more programmable, flexible and virtual networks.
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, 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 priorities to developing new products before knowing whether our investments will result in products 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 have 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
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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 depends on several factors, including proper new product definition, component costs, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, or achieve market acceptance of our products or that products and technologies developed by others will not render our products 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.
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 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.
We initiated a restructuring plan in the third quarter of fiscal 2018. The implementation of this restructuring plan may be disruptive to our business, and following completion of the restructuring plan 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 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 Security and Applications, and we also intend to focus on maintaining leadership in Infrastructure Platforms 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, 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
A substantial portion of our business 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 of 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
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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 RESULTS
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:
• | 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 | ||
• | 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 | ||
• | Potential difficulties in completing projects associated with in-process research and development intangibles | ||
• | Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions | ||
• | Initial dependence on unfamiliar supply chains or relatively small supply partners | ||
• | Insufficient revenue to offset increased expenses associated with acquisitions | ||
• | 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 | ||
• | Issue common stock that would dilute our current shareholders’ percentage ownership | ||
• | Use a substantial portion of our cash resources, or incur debt | ||
• | 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 | ||
• | Incur amortization expenses related to certain intangible assets | ||
• | Incur tax expenses related to the effect of acquisitions on our legal structure | ||
• | Incur large and immediate write-offs and restructuring and other related expenses | ||
• | 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
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risk factors above, including the risk factor entitled “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 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 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
There has been a trend toward industry consolidation in our markets for several years. 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
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 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, 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.
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. 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 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, including impacts from global central bank monetary policy; issues related to the political relationship between the United States and other countries that can affect the willingness of customers in those countries to purchase products from companies
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headquartered in the United States; and the challenging and inconsistent global macroeconomic environment, any or all of which could have a material adverse effect on our operating results and financial condition, including, among others, the following:
• | Foreign currency exchange rates | ||
• | Political or social unrest | ||
• | Economic instability or weakness or natural disasters in a specific country or region, including the current economic challenges in China and global economic ramifications of Chinese economic difficulties; instability as a result of Brexit; environmental protection measures, 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 | ||
• | Political considerations that affect service provider and government spending patterns | ||
• | Health or similar issues, such as a pandemic or epidemic | ||
• | Difficulties in staffing and managing international operations | ||
• | Adverse tax consequences, including imposition of withholding or other taxes on our global operations | ||
WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS AND TO 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, there can be no assurance that such programs will be effective in reducing our credit risks.
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 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 securities and equity investments in publicly traded companies, the values of which are subject to market price volatility to the extent unhedged. If such investments suffer market price declines, as we experienced with some of our investments in the past, we may recognize
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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 portfolio 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.
WE 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 to 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.
Currently, we enter into foreign exchange forward contracts and options to reduce the short-term impact of foreign currency fluctuations on certain foreign currency receivables, investments, and payables. In addition, we periodically hedge anticipated foreign currency cash flows. Our attempts to hedge against these risks may result in an adverse impact on our net income.
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 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) to the Consolidated Financial Statements contained in this report.
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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 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 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.
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, sales or other taxes on Internet product or service sales, and access charges for Internet service providers. The adoption of regulation of the Internet and Internet commerce could decrease demand for our products and, at the same time, increase the cost 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
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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 $218 million for the alleged evasion of import and other taxes, $1.4 billion for interest, and $1.0 billion for various penalties, all determined using an exchange rate as of July 28, 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 Note 12 to the Consolidated Financial Statements, subsection (h) "Legal Proceedings."
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 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 36 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.
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MAN-MADE PROBLEMS SUCH AS CYBER-ATTACKS, DATA PROTECTION BREACHES, MALWARE OR TERRORISM MAY DISRUPT OUR OPERATIONS, HARM OUR OPERATING RESULTS AND FINANCIAL CONDITION, 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 CLAIMS OF LIABILITY AGAINST 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, malware, 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 parties to disrupt the operations of the Internet or undermine our own security efforts may be costly to implement and meet with resistance, and may not be successful. Breaches of network security in our customers’ networks, or in cloud-based services provided by or enabled by us, regardless of whether the breach is attributable to a vulnerability in our products or services, could result in claims of liability against us, damage our reputation or otherwise harm our business.
In addition, the continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to the economies of the United States and other countries and create further uncertainties or otherwise materially harm 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.
VULNERABILITIES AND CRITICAL SECURITY DEFECTS, PRIORITIZATION DECISIONS REGARDING REMEDYING VULNERABILITIES OR SECURITY DEFECTS, FAILURE OF THIRD PARTY PROVIDERS TO REMEDY VULNERABILITIES OR SECURITY DEFECTS, OR CUSTOMERS NOT DEPLOYING SECURITY RELEASES OR DECIDING NOT TO UPGRADE PRODUCTS, SERVICES OR SOLUTIONS COULD RESULT IN CLAIMS OF LIABILITY AGAINST US, DAMAGE OUR REPUTATION OR OTHERWISE HARM OUR BUSINESS
The products and services we sell to customers, and our cloud-based solutions, inevitably contain vulnerabilities or critical security defects which have not been remedied and cannot be disclosed without compromising security. We may also make prioritization decisions in determining which vulnerabilities or security defects to fix, and the timing of these fixes, which could result in an exploit which compromises security. Customers also need to test security releases before they can be deployed which can delay implementation. In addition, we rely on third-party providers of software and cloud-based service and we cannot control the rate at which they remedy vulnerabilities. Customers may also not deploy a security release, or decide not to upgrade to the latest versions of our products, services or cloud-based solutions containing the release, leaving them vulnerable. Vulnerabilities and critical 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 releases or deciding not to upgrade products, services or solutions could result in claims of liability against us, damage our reputation or otherwise harm our business.
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 and in the past have established a joint venture to market services associated with our Cisco Unified Computing System products. 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 the joint venture. 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.
OUR STOCK PRICE MAY BE 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,
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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 fiscal 2018, we have senior unsecured notes outstanding in an aggregate principal amount of $25.8 billion that mature at specific dates from calendar year 2019 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 July 28, 2018. The outstanding senior unsecured notes bear fixed-rate interest payable semiannually, except $1.0 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.
Item 1B. | Unresolved Staff Comments |
Not applicable.
Item 2. | Properties |
Our corporate headquarters are located at an owned site in San Jose, California, in the United States of America. The locations of our headquarters by geographic segment are as follows:
Americas | EMEA | APJC | ||
San Jose, California, USA | Amsterdam, Netherlands | Singapore | ||
In addition to our headquarters site, we own additional sites in the United States, which include facilities in the surrounding areas of San Jose, California; Research Triangle Park, North Carolina; Richardson, Texas; Lawrenceville, Georgia; and Boxborough, Massachusetts. We also own land for expansion in some of these locations. In addition, we lease office space in many U.S. locations.
Outside the United States our operations are conducted primarily in leased sites. Other significant sites (in addition to the two non-U.S. headquarters locations) are located in Belgium, Canada, China, Germany, India, Israel, Japan, Mexico, Poland, and the United Kingdom.
We believe that our existing facilities, including both owned and leased, are in good condition and suitable for the conduct of our business. For additional information regarding obligations under operating leases, see Note 12 to the Consolidated Financial Statements.
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Item 3. | Legal Proceedings |
For a description of our material pending legal proceedings, see Note 12 “Commitments and Contingencies - (h) Legal Proceedings” of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference.
Item 4. | Mine Safety Disclosures |
Not applicable.
PART II
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities |
(a) | Cisco common stock is traded on the Nasdaq Global Select Market under the symbol CSCO. Information regarding quarterly cash dividends declared on Cisco’s common stock during fiscal 2018 and 2017 may be found in Supplementary Financial Data on page 114 of this report. There were 40,817 registered shareholders as of August 31, 2018. The high and low common stock sales prices per share for each period were as follows: |
FISCAL 2018 | FISCAL 2017 | ||||||||||||||
Fiscal Quarter | High | Low | High | Low | |||||||||||
First quarter | $ | 34.73 | $ | 30.36 | $ | 31.95 | $ | 29.86 | |||||||
Second quarter | $ | 42.69 | $ | 33.67 | $ | 31.89 | $ | 29.12 | |||||||
Third quarter | $ | 46.16 | $ | 37.35 | $ | 34.53 | $ | 30.42 | |||||||
Fourth quarter | $ | 46.37 | $ | 40.94 | $ | 34.60 | $ | 30.37 | |||||||
(b) | Not applicable. |
(c) | Issuer purchases of equity securities (in millions, except per-share amounts): |
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs | |||||||||
April 29, 2018 to May 26, 2018 | 44 | $ | 44.63 | 44 | $ | 23,076 | |||||||
May 27, 2018 to June 23, 2018 | 41 | $ | 43.65 | 41 | $ | 21,271 | |||||||
June 24, 2018 to July 28, 2018 | 53 | $ | 42.65 | 53 | $ | 19,036 | |||||||
Total | 138 | $ | 43.58 | 138 | |||||||||
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. As of July 28, 2018, the remaining authorized amount for stock repurchases under this program, including the additional authorization, is approximately $19.0 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).
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Stock Performance Graph
The information contained in this Stock Performance Graph section shall not be deemed to be “soliciting material” or “filed” or incorporated by reference in future filings with the SEC, or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, except to the extent that Cisco specifically incorporates it by reference into a document filed under the Securities Act of 1933 or the Securities Exchange Act of 1934.
The following graph shows a five-year comparison of the cumulative total shareholder return on Cisco common stock with the cumulative total returns of the S&P 500 Index, and the S&P Information Technology Index. The graph tracks the performance of a $100 investment in the Company’s common stock and in each of the indexes (with the reinvestment of all dividends) on the date specified. Shareholder returns over the indicated period are based on historical data and should not be considered indicative of future shareholder returns.
Comparison of 5-Year Cumulative Total Return Among Cisco Systems, Inc.,
the S&P 500 Index, and the S&P Information Technology Index
July 2013 | July 2014 | July 2015 | July 2016 | July 2017 | July 2018 | ||||||||||||||||||
Cisco Systems, Inc. | $ | 100.00 | $ | 105.04 | $ | 118.32 | $ | 131.64 | $ | 140.72 | $ | 196.18 | |||||||||||
S&P 500 | $ | 100.00 | $ | 119.40 | $ | 128.10 | $ | 136.90 | $ | 158.98 | $ | 184.80 | |||||||||||
S&P Information Technology | $ | 100.00 | $ | 131.22 | $ | 144.52 | $ | 159.12 | $ | 207.12 | $ | 268.65 | |||||||||||
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Item 6. | Selected Financial Data |
Five Years Ended July 28, 2018 (in millions, except per-share amounts)
Years Ended | July 28, 2018 (1) | July 29, 2017 | July 30, 2016 (2)(3) | July 25, 2015 (2) | July 26, 2014 (4) | ||||||||||||||
Revenue | $ | 49,330 | $ | 48,005 | $ | 49,247 | $ | 49,161 | $ | 47,142 | |||||||||
Net income | $ | 110 | $ | 9,609 | $ | 10,739 | $ | 8,981 | $ | 7,853 | |||||||||
Net income per share—basic | $ | 0.02 | $ | 1.92 | $ | 2.13 | $ | 1.76 | $ | 1.50 | |||||||||
Net income per share—diluted | $ | 0.02 | $ | 1.90 | $ | 2.11 | $ | 1.75 | $ | 1.49 | |||||||||
Shares used in per-share calculation—basic | 4,837 | 5,010 | 5,053 | 5,104 | 5,234 | ||||||||||||||
Shares used in per-share calculation—diluted | 4,881 | 5,049 | 5,088 | 5,146 | 5,281 | ||||||||||||||
Cash dividends declared per common share | $ | 1.24 | $ | 1.10 | $ | 0.94 | $ | 0.80 | $ | 0.72 | |||||||||
Net cash provided by operating activities | $ | 13,666 | $ | 13,876 | $ | 13,570 | $ | 12,552 | $ | 12,332 | |||||||||
July 28, 2018 | July 29, 2017 | July 30, 2016 | July 25, 2015 | July 26, 2014 | |||||||||||||||
Cash and cash equivalents and investments | $ | 46,548 | $ | 70,492 | $ | 65,756 | $ | 60,416 | $ | 52,074 | |||||||||
Total assets | $ | 108,784 | $ | 129,818 | $ | 121,652 | $ | 113,373 | $ | 105,070 | |||||||||
Debt | $ | 25,569 | $ | 33,717 | $ | 28,643 | $ | 25,354 | $ | 20,845 | |||||||||
Deferred revenue | $ | 19,685 | $ | 18,494 | $ | 16,472 | $ | 15,183 | $ | 14,142 | |||||||||
(1) | In fiscal 2018, Cisco recorded a provisional tax expense of $10.4 billion related to the enactment of the Tax Cuts and Job Act ("the Tax Act") comprised of $8.1 billion of U.S. transition tax, $1.2 billion of foreign withholding tax, and $1.1 billion re-measurement of net deferred tax assets and liabilities (DTA). |
(2) | In the second quarter of fiscal 2016, Cisco completed the sale of the SP Video CPE Business. As a result, revenue from this portion of the Service Provider Video product category will not recur in future periods. The sale resulted in a pre-tax gain of $253 million net of certain transaction costs. The years ended July 30, 2016 and July 25, 2015 include SP Video CPE Business revenue of $504 million and $1,846 million, respectively. |
(3) | In fiscal 2016 Cisco recognized total tax benefits of $593 million for the following: i) the Internal Revenue Service (IRS) and Cisco settled all outstanding items related to Cisco’s federal income tax returns for fiscal 2008 through fiscal 2010, as a result of which Cisco recorded a net tax benefit of $367 million; and ii) the Protecting Americans from Tax Hikes Act of 2015 reinstated the U.S. federal research and development (R&D) tax credit permanently, as a result of which Cisco recognized tax benefits of $226 million, of which $81 million related to fiscal 2015 R&D expenses. |
(4) | In the second quarter of fiscal 2014, Cisco recorded a pre-tax charge of $655 million to product cost of sales, which corresponds to $526 million, net of tax, for the expected remediation cost for certain products sold in prior fiscal years containing memory components manufactured by a single supplier between 2005 and 2010. See Note 12(f) to the Consolidated Financial Statements. |
No other factors materially affected the comparability of the information presented above.
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
This Annual Report on Form 10-K, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “momentum,” “seeks,” “estimates,” “continues,” “endeavors,” “strives,” “may,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those under “Part I, Item 1A. Risk Factors,” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.
OVERVIEW
Cisco designs and sells a broad range of technologies that have been powering the Internet since 1984. Across networking, security, collaboration, applications and the cloud, our evolving intent-based technologies are constantly learning and adapting to provide customers with a highly secure, intelligent platform for their digital business.
A summary of our results is as follows (in millions, except percentages and per-share amounts):
Three Months Ended | Years Ended | |||||||||||||||||||||
July 28, 2018 | July 29, 2017 | Variance | July 28, 2018 | July 29, 2017 | Variance | |||||||||||||||||
Revenue | $ | 12,844 | $ | 12,133 | 6 | % | $ | 49,330 | $ | 48,005 | 3 | % | ||||||||||
Gross margin percentage | 61.7 | % | 62.2 | % | (0.5 | ) | pts | 62.0 | % | 63.0 | % | (1.0 | ) | pts | ||||||||
Research and development | $ | 1,626 | $ | 1,499 | 8 | % | $ | 6,332 | $ | 6,059 | 5 | % | ||||||||||
Sales and marketing | $ | 2,348 | $ | 2,318 | 1 | % | $ | 9,242 | $ | 9,184 | 1 | % | ||||||||||
General and administrative | $ | 543 | $ | 495 | 10 | % | $ | 2,144 | $ | 1,993 | 8 | % | ||||||||||
Total R&D, sales and marketing, general and administrative | $ | 4,517 | $ | 4,312 | 5 | % | $ | 17,718 | $ | 17,236 | 3 | % | ||||||||||
Total as a percentage of revenue | 35.2 | % | 35.5 | % | (0.3 | ) | pts | 35.9 | % | 35.9 | % | — | pts | |||||||||
Amortization of purchased intangible assets included in operating expenses | $ | 33 | $ | 58 | (43 | )% | $ | 221 | $ | 259 | (15 | )% | ||||||||||
Restructuring and other charges included in operating expenses | $ | 26 | $ | 142 | (82 | )% | $ | 358 | $ | 756 | (53 | )% | ||||||||||
Operating income as a percentage of revenue | 26.1 | % | 25.0 | % | 1.1 | pts | 25.0 | % | 24.9 | % | 0.1 | pts | ||||||||||
Income tax percentage (1) | (5.9 | )% | 23.8 | % | (29.7 | ) | pts | 99.2 | % | 21.8 | % | 77.4 | pts | |||||||||
Net income (1) | $ | 3,803 | $ | 2,424 | 57 | % | $ | 110 | $ | 9,609 | (99 | )% | ||||||||||
Net income as a percentage of revenue | 29.6 | % | 20.0 | % | 9.6 | pts | 0.2 | % | 20.0 | % | (19.8 | ) | pts | |||||||||
Earnings per share—diluted (1) | $ | 0.81 | $ | 0.48 | 69 | % | $ | 0.02 | $ | 1.90 | (99 | )% | ||||||||||
(1) Fourth quarter and fiscal year 2018 results include an $863 million benefit and a $10.4 billion charge, respectively, related to the enactment of the Tax Act.
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Fiscal 2018 Compared with Fiscal 2017
In fiscal 2018, we saw broad strength across the business and delivered solid revenue growth, margins, cash flow and returns for our shareholders. We remain focused on accelerating innovation across our portfolio, and we believe that we have made continued progress on our strategic priorities. Our product revenue reflected growth in Infrastructure Platforms, Applications and Security, and we continued to make progress in the transition of our business model to increased software and subscriptions. We continue to operate in a challenging and highly competitive environment. We experienced some weakness in the service provider market and we expect ongoing uncertainty in that area. While the overall environment remains uncertain, we continue to aggressively invest in priority areas with the objective of driving profitable growth over the long term.
Total revenue increased by 3% compared with fiscal 2017. Within total revenue, product and service revenue each increased by 3%. Total gross margin decreased by 1.0 percentage points, driven primarily by unfavorable impacts from pricing, a $127 million legal and indemnification settlement charge, and unfavorable product mix, partially offset by productivity benefits. While productivity was positive to overall product gross margin, the benefit was lower than in the prior year as these improvements were adversely impacted by an increase in the cost of certain components which are currently constrained. As a percentage of revenue, research and development, sales and marketing, and general and administrative expenses, collectively, were flat. Operating income as a percentage of revenue increased by 0.1 percentage points. Diluted earnings per share and net income each decreased by 99% due to the $10.4 billion provisional tax expense related to the Tax Act, comprised of $8.1 billion U.S. transition tax, $1.2 billion of foreign withholding tax, and $1.1 billion of net deferred tax assets re-measurement.
In terms of our geographic segments, revenue from the Americas increased by $0.7 billion, EMEA revenue increased by $0.4 billion, and revenue in our APJC segment increased by $0.2 billion. These increases reflect broad strength across several countries within these segments. The “BRICM” countries experienced product revenue growth of 2% in the aggregate, driven by increased product revenue in the emerging countries of Brazil, Russia, India and China of 17%, 10%, 3% and 3%, respectively, partially offset by a product revenue decline of 16% in Mexico.
From a customer market standpoint, we experienced solid product revenue growth in the commercial market and, to a lesser extent, in the enterprise and public sector markets. Product revenue in the service provider market declined with ongoing uncertainty in that area.
From a product category perspective, the product revenue increase of 3% was driven by a 2% product revenue increase in Infrastructure Platforms and solid product revenue growth in Applications and Security of 10% and 9%, respectively. We saw broad strength across the portfolio, with the exception of routing related to the weakness in the service provider market.
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Fourth Quarter Snapshot
For the fourth quarter of fiscal 2018, as compared with the fourth quarter of fiscal 2017, total revenue increased by 6%. Within total revenue, product revenue increased by 7% and service revenue increased by 3%. With regard to our geographic segment performance, on a year-over-year basis, revenue in the Americas, EMEA and APJC increased by 5%, 8% and 6%, respectively. From a product category perspective, we experienced broad strength across the portfolio. Total gross margin decreased by 0.5 percentage points, driven by some specific transactions with service providers in our APJC segment. Our gross margin also decreased due to unfavorable pricing, product mix and higher component costs, partially offset by improved productivity benefits. As a percentage of revenue, research and development, sales and marketing, and general and administrative expenses collectively decreased by 0.3 percentage points. Operating income as a percentage of revenue increased by 1.1 percentage points. Diluted earnings per share increased by 69% and net income increased by 57%, due in part to an $863 million tax benefit related to the Tax Act.
Strategy and Priorities
As our customers add billions of new connections to their enterprises, and as more applications move to a multi-cloud environment, we believe the network continues to be extremely critical. We believe that our customers are looking for intent-based networks that provide meaningful business value through automation, security, and analytics across private, hybrid, and multi-cloud environments. Our vision is to deliver highly secure, software-defined, automated and intelligent platforms for our customers. Our strategic priorities include the following: accelerating our pace of innovation, increasing the value of the network, and transforming our business model.
For a full discussion of our strategy and priorities, see Item 1. Business.
Other Key Financial Measures
The following is a summary of our other key financial measures for fiscal 2018 compared with fiscal 2017 (in millions):
Fiscal 2018 | Fiscal 2017 | |||
Cash and cash equivalents and investments | $46,548 | $70,492 | ||
Cash provided by operating activities | $13,666 | $13,876 | ||
Deferred revenue | $19,685 | $18,494 | ||
Repurchases of common stock—stock repurchase program | $17,661 | $3,706 | ||
Dividends | $5,968 | $5,511 | ||
Inventories | $1,846 | $1,616 | ||
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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 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 all of the following criteria have been met:
• | Persuasive evidence of an arrangement exists. Contracts, Internet commerce agreements, and customer purchase orders are generally used to determine the existence of an arrangement. |
• | Delivery has occurred. Shipping documents and customer acceptance, when applicable, 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 assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. |
• | Collectibility is reasonably assured. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. |
In instances where final acceptance of 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 ratably over the hosting period, while usage revenue is recognized based on utilization. Software subscription revenue is deferred and recognized ratably over the subscription term upon delivery of the first product and commencement of the term.
The amount of revenue recognized in a given period is affected by our 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 prescribed in ASC 605, we use vendor-specific objective evidence of selling price (VSOE) for each of those units, when available. We determine VSOE based on our normal pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, we require 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, and estimated selling price (ESP) will be used if neither VSOE nor TPE is available. Generally, we are not able to determine TPE because our go-to-market strategy differs from that of others in our markets, and the extent of our proprietary technology varies among comparable products or services from those of our peers. In determining ESP, we apply significant judgment 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 VSOE and ESP, in subsequent periods. There were no material impacts during fiscal 2018 from changes in VSOE, TPE, or ESP.
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 cooperative marketing and other incentive programs, and we maintain estimated accruals and allowances for these programs. 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.
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In May 2014, the Financial Accounting Standards Board (FASB) issued ASC 606, Revenue from Contracts with Customers, a new accounting standard related to revenue recognition. ASC 606 will supersede nearly all U.S. GAAP on revenue recognition and eliminate industry-specific guidance. The underlying principle of the new standard is to recognize revenue when a customer obtains control of promised goods or services at an amount that reflects the consideration that is expected to be received in exchange for those goods or services. It also requires increased disclosures including the nature, amount, timing, and uncertainty of revenues and cash flows related to contracts with customers.
ASC 606 allows two methods of adoption: i) retrospectively to each prior period presented (“full retrospective method”), or ii) retrospectively with the cumulative effect recognized in retained earnings as of the date of adoption (“modified retrospective method”). We will adopt the new standard using the modified retrospective method at the beginning of our first quarter of fiscal 2019.
We do not expect that ASC 606 will have a material impact on total revenue for fiscal 2019 based on two factors: i) revenue will be accelerated consistent with the changes in timing as indicated in the table in Note 2 to the Consolidated Financial Statements, largely offset by ii) the reduction of revenue from software arrangements where revenue was previously deferred in prior periods and recognized ratably over time as required under the current standard. This preliminary assessment is based on the types and number of revenue arrangements currently in place. The exact impact of ASC 606 will be dependent on facts and circumstances at adoption and could vary from quarter to quarter.
For the first quarter of fiscal 2019, we expect that the adoption of ASC 606 may increase total revenue by about 1% on a year-over-year basis. For further discussion of ASC 606, including the estimated impacts on transition date, see Note 2 to the Consolidated Financial Statements.
Allowances for Receivables and Sales Returns
The allowances for receivables were as follows (in millions, except percentages):
July 28, 2018 | July 29, 2017 | |||||||
Allowance for doubtful accounts | $ | 129 | $ | 211 | ||||
Percentage of gross accounts receivable | 2.3 | % | 3.9 | % | ||||
Allowance for credit loss—lease receivables | $ | 135 | $ | 162 | ||||
Percentage of gross lease receivables (1) | 4.7 | % | 5.5 | % | ||||
Allowance for credit loss—loan receivables | $ | 60 | $ | 103 | ||||
Percentage of gross loan receivables | 1.2 | % | 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.
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A reserve for future sales returns is established based on historical trends in product return rates. The reserve for future sales returns as of July 28, 2018 and July 29, 2017 was $123 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.
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, 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.
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.
Our provision for inventory was $63 million, $74 million, and $65 million in fiscal 2018, 2017, and 2016, respectively. The provision for the liability related to purchase commitments with contract manufacturers and suppliers was $105 million, $124 million, and $134 million in fiscal 2018, 2017, and 2016, 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, 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.
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.
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 $37.6 billion as of July 28, 2018, compared with $58.8 billion as of July 29, 2017. Our fixed income investment portfolio, as of July 28, 2018, consisted primarily of high quality investment-grade securities. See Note 8 to the Consolidated Financial Statements.
As described more fully in Note 2 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.
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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 fiscal 2018 and 2017, 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 July 28, 2018.
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 July 28, 2018, our investments in privately held companies were $1,096 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.
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 July 28, 2018 and July 29, 2017 was $31.7 billion and $29.8 billion, respectively. The increase in goodwill during fiscal 2018 was due in large part to our acquisition of BroadSoft. 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 fiscal 2018, 2017, and 2016. For the annual impairment testing in fiscal 2018, the excess of the fair value over the carrying value for each of our reporting units was $73.0 billion for the Americas, $53.0 billion for EMEA, and $35.5 billion for APJC.
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During the fourth quarter of fiscal 2018, we performed a sensitivity analysis for goodwill impairment with respect to each of our respective reporting units and determined that a hypothetical 10% decline in the fair value of each reporting unit would not result in an impairment of goodwill for any reporting unit.
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 strategy and our internal forecasts. Our impairment charges related to purchased intangible assets were $1 million, $47 million, and $74 million during fiscal 2018, 2017, and 2016, respectively. 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 manufacturing deductions, tax audit settlements, nondeductible compensation, international realignments, and transfer pricing adjustments. Our effective tax rate was 99.2%, 21.8%, and 16.9% in fiscal 2018, 2017, and 2016, respectively.
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 DTA using the federal tax rate that will apply when the related temporary differences are expected to reverse.
In December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118, which addresses how a company recognizes provisional estimates when it 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, any 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 any updates or changes to estimates used in the provisional amounts. We have determined that the $8.1 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 $1.1 billion of tax expense for DTA re-measurement were each provisional amounts and reasonable estimates for fiscal 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.
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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 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 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 36 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. 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 (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.
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RESULTS OF OPERATIONS
Revenue
The following table presents the breakdown of revenue between product and service (in millions, except percentages):
Years Ended | 2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
July 28, 2018 | July 29, 2017 | July 30, 2016 | Variance in Dollars | Variance in Percent | Variance in Dollars | Variance in Percent | ||||||||||||||||||||
Revenue: | ||||||||||||||||||||||||||
Product | $ | 36,709 | $ | 35,705 | $ | 37,254 | $ | 1,004 | 3 | % | $ | (1,549 | ) | (4 | )% | |||||||||||
Percentage of revenue | 74.4 | % | 74.4 | % | 75.6 | % | ||||||||||||||||||||
Service | 12,621 | 12,300 | 11,993 | 321 | 3 | % | 307 | 3 | % | |||||||||||||||||
Percentage of revenue | 25.6 | % | 25.6 | % | 24.4 | % | ||||||||||||||||||||
Total | $ | 49,330 | $ | 48,005 | $ | 49,247 | $ | 1,325 | 3 | % | $ | (1,242 | ) | (3 | )% | |||||||||||
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):
Years Ended | 2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
July 28, 2018 | July 29, 2017 | July 30, 2016 | Variance in Dollars | Variance in Percent | Variance in Dollars | Variance in Percent | ||||||||||||||||||||
Revenue: | ||||||||||||||||||||||||||
Americas | $ | 29,070 | $ | 28,351 | $ | 29,392 | $ | 719 | 3 | % | $ | (1,041 | ) | (4 | )% | |||||||||||
Percentage of revenue | 58.9 | % | 59.1 | % | 59.7 | % | ||||||||||||||||||||
EMEA | 12,425 | 12,004 | 12,302 | 421 | 4 | % | (298 | ) | (2 | )% | ||||||||||||||||
Percentage of revenue | 25.2 | % | 25.0 | % | 25.0 | % | ||||||||||||||||||||
APJC | 7,834 | 7,650 | 7,553 | 184 | 2 | % | 97 | 1 | % | |||||||||||||||||
Percentage of revenue | 15.9 | % | 15.9 | % | 15.3 | % | ||||||||||||||||||||
Total | $ | 49,330 | $ | 48,005 | $ | 49,247 | $ | 1,325 | 3 | % | $ | (1,242 | ) | (3 | )% | |||||||||||
Amounts may not sum and percentages may not recalculate due to rounding.
During the second quarter of fiscal 2016, we completed the sale of the Customer Premises Equipment portion of our Service Provider Video Connected Devices business (“SP Video CPE Business”). SP Video CPE Business revenue was $504 million for fiscal 2016.
Fiscal 2018 Compared with Fiscal 2017
Total revenue increased by 3%. Product and service revenue each increased by 3%. Our total revenue reflected growth across each of our geographic segments. Product revenue for the emerging countries of BRICM, in the aggregate, experienced 2% product revenue growth, with increases in Brazil, Russia, India and China partially offset by a decrease in Mexico.
In addition to the impact of macroeconomic factors, including a reduced IT spending environment and reductions in 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; 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.
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Fiscal 2017 Compared with Fiscal 2016
Total revenue decreased by 3%. Total company revenue not including SP Video CPE products decreased 2%. Product revenue decreased by 4% while service revenue increased by 3%. Fiscal 2017 had 52 weeks, compared with 53 weeks in fiscal 2016, thus our results for fiscal 2017 reflect one less extra week. We estimate that the additional revenue associated with the extra week was approximately $265 million, $200 million of which was from our services subscriptions, and $65 million from our SaaS offerings such as WebEx, and a small amount from product distribution. Our total revenue declined in the Americas and EMEA geographic segments, while revenue grew in our APJC geographic segment. The emerging countries of BRICM, in the aggregate, experienced a 7% product revenue decline, with revenue declines in Mexico, China, and Brazil partially offset by increases in the other two BRICM countries.
Product Revenue by Segment
The following table presents the breakdown of product revenue by segment (in millions, except percentages):
Years Ended | 2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
July 28, 2018 | July 29, 2017 | July 30, 2016 | Variance in Dollars | Variance in Percent | Variance in Dollars | Variance in Percent | ||||||||||||||||||||
Product revenue: | ||||||||||||||||||||||||||
Americas | $ | 21,088 | $ | 20,487 | $ | 21,663 | $ | 601 | 3 | % | $ | (1,176 | ) | (5 | )% | |||||||||||
Percentage of product revenue | 57.5 | % | 57.4 | % | 58.1 | % | ||||||||||||||||||||
EMEA | 9,671 | 9,369 | 9,682 | 302 | 3 | % | (313 | ) | (3 | )% | ||||||||||||||||
Percentage of product revenue | 26.3 | % | 26.2 | % | 26.0 | % | ||||||||||||||||||||
APJC | 5,950 | 5,849 | 5,909 | 101 | 2 | % | (60 | ) | (1 | )% | ||||||||||||||||
Percentage of product revenue | 16.2 | % | 16.4 | % | 15.9 | % | ||||||||||||||||||||
Total | $ | 36,709 | $ | 35,705 | $ | 37,254 | $ | 1,004 | 3 | % | $ | (1,549 | ) | (4 | )% | |||||||||||
Amounts may not sum and percentages may not recalculate due to rounding.
Americas
Fiscal 2018 Compared with Fiscal 2017
Product revenue in the Americas segment increased by 3%, driven by solid growth in the commercial and enterprise markets and, to a lesser extent, growth in the public sector market. Product revenue in the service provider market was flat. From a country perspective, product revenue increased by 3% in the United States, 9% in Canada and 17% in Brazil, partially offset by a decrease of 16% in Mexico.
Fiscal 2017 Compared with Fiscal 2016
The 5% decrease in product revenue in the Americas segment was driven by declines in the service provider, public sector and commercial markets. Product revenue in the enterprise market was flat. The product revenue decrease in the service provider market was driven in large part by the absence of product sales related to our SP Video CPE Business in fiscal 2017. We had $378 million in product sales related to our SP Video CPE Business in fiscal 2016 in this segment. The product revenue decline in the public sector market was due primarily to lower sales to state and local governments and to the U.S. federal government. From a country perspective, product revenue decreased by 5% in the United States, 28% in Mexico and 7% in Brazil, partially offset by an increase of 2% in Canada.
EMEA
Fiscal 2018 Compared with Fiscal 2017
The increase in product revenue in the EMEA segment of 3% was driven by solid growth in the commercial and public sector markets and, to a lesser extent, growth in the enterprise market. These increases were partially offset by a product revenue decline in the service provider market. Product revenue from emerging countries within EMEA and the remainder of the EMEA segment, which primarily consists of countries in Western Europe, each increased by 3%.
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Fiscal 2017 Compared with Fiscal 2016
Product revenue in the EMEA segment decreased by 3%, driven by a decline in the service provider market and, to a lesser extent, declines in the public sector and enterprise markets. Product revenue in the commercial market was flat. The product revenue decrease in the service provider market was driven in part by the absence of product sales related to our SP Video CPE Business in fiscal 2017. We had $108 million in product sales related to our SP Video CPE Business in fiscal 2016 in this segment. Product revenue from emerging countries within EMEA and product revenue for the remainder of the EMEA segment each decreased by 3%.
APJC
Fiscal 2018 Compared with Fiscal 2017
Product revenue in the APJC segment increased by 2%. The product revenue increase was led by solid growth in the commercial and enterprise markets. These increases were partially offset by product revenue declines in the service provider and public sector markets. From a country perspective, product revenue increased by 3% in China and 3% in India, partially offset by a decrease of 3% in Japan.
Fiscal 2017 Compared with Fiscal 2016
Product revenue in the APJC segment decreased by 1%. The product revenue decrease was led by declines in the service provider and public sector markets, partially offset by product revenue growth in the commercial market. Product revenue in the enterprise market was flat. From a country perspective, product revenue decreased by 12% in China, driven by a decrease in sales of Service Provider Video Software and Solutions products, while product revenue increased by 11% in India, 9% in Australia and 2% in Japan. Product sales for this geographic segment were adversely impacted by an $18 million decrease in product sales related to the absence of our SP Video CPE Business.
Product Revenue by Groups of Similar Products
In addition to the primary view on a geographic basis, we also prepare financial information related to groups of similar products 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 revenue for groups of similar products (in millions, except percentages):
Years Ended | 2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
July 28, 2018 | July 29, 2017 | July 30, 2016 | Variance in Dollars | Variance in Percent | Variance in Dollars | Variance in Percent | ||||||||||||||||||||
Product revenue: | ||||||||||||||||||||||||||
Infrastructure Platforms | $ | 28,270 | $ | 27,779 | $ | 28,851 | $ | 491 | 2 | % | $ | (1,072 | ) | (4 | )% | |||||||||||
Applications | 5,035 | 4,568 | 4,438 | 467 | 10 | % | 130 | 3 | % | |||||||||||||||||
Security | 2,353 | 2,153 | 1,969 | 200 | 9 | % | 184 | 9 | % | |||||||||||||||||
Other Products | 1,050 | 1,205 | 1,996 | (155 | ) | (13 | )% | (791 | ) | (40 | )% | |||||||||||||||
$ | 36,709 | $ | 35,705 | $ | 37,254 | $ | 1,004 | 3 | % | $ | (1,549 | ) | (4 | )% | ||||||||||||
Amounts may not sum and percentages may not recalculate due to rounding.
Infrastructure Platforms
Fiscal 2018 Compared with Fiscal 2017
The Infrastructure Platforms product category represents our core networking offerings related to switching, routing, wireless, and the data center. Infrastructure Platforms revenue increased by 2%, or $491 million, with strength across the portfolio with the exception of routing. Switching experienced growth, with solid revenue growth in data center switching driven by an increase in sales of Cisco Nexus 9000 Series products, and with revenue growth in campus switching driven by our intent-based networking Cisco Catalyst 9000 Series. Data center had strong double digit growth driven by higher sales of server products and our hyperconverged data center offering, HyperFlex. We also experienced solid revenue growth from wireless products driven by Meraki as well as our Wave 2 offerings. We had a decrease in sales of routing products, driven by continued weakness in the service provider market.
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Fiscal 2017 Compared with Fiscal 2016
Revenue from the Infrastructure Platforms product category decreased by 4% or $1,072 million, driven primarily by lower revenue from switching products. Within switching, we experienced a decrease in sales of switching products used in campus environments, which we believe was driven both by the uncertainty in the macro environment which led to a slowdown in customer spending, as well as by a highly competitive landscape. These impacts were partially offset by an increase in sales of our ACI portfolio which is included in our data center switching portfolio. We also experienced a decrease in revenue from routing products driven by weakness in enterprise access and a decrease in revenue from data center due to lower sales of server products. We had revenue growth from wireless products driven by Meraki.
Applications
Fiscal 2018 Compared with Fiscal 2017
The Applications product category includes our collaboration offerings (unified communications, Cisco TelePresence and conferencing) as well as the Internet of Things (IoT) and analytics software offerings from Jasper and AppDynamics, respectively. Revenue in our Applications product category increased by 10%, or $467 million, with growth across all of the businesses. We experienced solid growth in the Telepresence, unified communications, conferencing and analytics from our fiscal 2017 acquisition of AppDynamics. We continued to increase the amount of deferred revenue and the proportion of recurring revenue related to our Applications product category.
Fiscal 2017 Compared with Fiscal 2016
The increase in revenue in our Applications product category by 3%, or $130 million, was in large part due to increased revenue from our IoT software offerings, driven by our fiscal 2016 Jasper acquisition. The growth in Conferencing revenue and the acquisition of AppDynamics in the third quarter of fiscal 2017 also contributed to the revenue increase in this product category. These increases in revenue were partially offset by decreased revenue from unified communications and Telepresence.
Security
Fiscal 2018 Compared with Fiscal 2017
Revenue in our Security product category increased 9%, or $200 million, driven by higher sales of unified threat management, web security, policy and access and advanced threat products. We continued to increase the amount of deferred revenue and the proportion of recurring revenue related to our Security product category.
Fiscal 2017 Compared with Fiscal 2016
Revenue in our Security product category increased 9%, or $184 million, driven by higher sales of unified threat management, advanced threat security, and web security products.
Other Products
Fiscal 2018 Compared with Fiscal 2017
The decrease in revenue from our Other Products category was primarily driven by a decrease in revenue from Service Provider Video Software and Solutions (“SPVSS”).
On May 1, 2018, we announced a definitive agreement to sell the SPVSS business. We expect this transaction to close in the first half of fiscal 2019 subject to regulatory approvals and customary closing conditions.
Fiscal 2017 Compared with Fiscal 2016
The decrease in revenue in our Other Products category was in large part due to a decrease in product sales of $504 million related to our SP Video CPE Business and a decrease in revenue from SPVSS products.
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Service Revenue by Segment
The following table presents the breakdown of service revenue by segment (in millions, except percentages):
Years Ended | 2018 vs. 2017 | 2017 vs. 2016 | |||||||||||||||||||||||
Years Ended | July 28, 2018 | July 29, 2017 | July 30, 2016 | Variance in Dollars | Variance in Percent | Variance in Dollars | Variance in Percent | ||||||||||||||||||
Service revenue: | |||||||||||||||||||||||||
Americas | $ | 7,982 | $ | 7,864 | $ | 7,729 | $ | 118 | 2 | % | $ | 135 | 2 | % | |||||||||||
Percentage of service revenue | 63.3 | % | 63.9 | % | 64.4 | % | |||||||||||||||||||
EMEA | 2,754 | 2,635 | 2,620 | 119 | 5 | % | 15 | 1 | % | ||||||||||||||||
Percentage of service revenue | 21.8 | % | 21.4 | % | 21.9 | % | |||||||||||||||||||
APJC | 1,885 | 1,801 | 1,644 | 84 | 5 | % | 157 | 10 | % | ||||||||||||||||
Percentage of service revenue | 14.9 | % | 14.7 | % | 13.7 | % | |||||||||||||||||||
Total | $ | 12,621 | $ | 12,300 | $ | 11,993 | $ | 321 | 3 | % | $ | 307 | 3 | % | |||||||||||
Amounts may not sum and percentages may not recalculate due to rounding.
Fiscal 2018 Compared with Fiscal 2017
Service revenue increased across all geographic segments. Technical support services revenue increased by 2% and advanced services revenue increased by 4%. Technical support services revenue increased across all geographic segments. The increase in technical support services revenue was 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 growth in the EMEA segment and, to a lesser extent, increased in our Americas and APJC segments.
Fiscal 2017 Compared with Fiscal 2016
Service revenue grew 3%. Excluding the $200 million of additional revenue as a result of the extra week in fiscal 2016, service revenue grew 4%. Service revenue grew across all of our geographic segments. Technical support services revenue increased by 3% and advanced services revenue increased by 1%. Technical support services revenue increased across all geographic segments. The increase in technical support services revenue was driven by contract initiations and renewals associated with product sales and an increase in software support offerings. Advanced services revenue had solid revenue growth in our APJC segment, declined slightly in our EMEA segment and was flat in our Americas segment.
Gross Margin
The following table presents the gross margin for products and services (in millions, except percentages):
AMOUNT | PERCENTAGE | |||||||||||||||||||
Years Ended | July 28, 2018 | July 29, 2017 | July 30, 2016 | July 28, 2018 | July 29, 2017 | July 30, 2016 | ||||||||||||||
Gross margin: | ||||||||||||||||||||
Product | $ | 22,282 | $ | 22,006 | $ | 23,093 | 60.7 | % | 61.6 | % | 62.0 | % | ||||||||
Service | 8,324 | 8,218 | 7,867 | 66.0 | % | 66.8 | % | 65.6 | % | |||||||||||
Total | $ | 30,606 | $ | 30,224 | $ | 30,960 | 62.0 | % | 63.0 | % | 62.9 | % | ||||||||
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Product Gross Margin
Fiscal 2018 Compared with Fiscal 2017
The following table summarizes the key factors that contributed to the change in product gross margin percentage from fiscal 2017 to fiscal 2018:
Product Gross Margin Percentage | |||
Fiscal 2017 | 61.6 | % | |
Product pricing | (1.4 | )% | |
Legal and indemnification settlements | (0.3 | )% | |
Mix of products sold | (0.2 | )% | |
Amortization of purchased intangible assets | (0.2 | )% | |
Productivity (1) | 1.2 | % | |
Fiscal 2018 | 60.7 | % | |
(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.
Product gross margin decreased by 0.9 percentage points due largely to unfavorable impacts from product pricing, a charge of $127 million to product cost of sales recorded in fiscal 2018 related to legal and indemnification settlements, and unfavorable product mix, partially offset by productivity benefits.
The negative pricing impact, which was lower than the year-over-year impact we experienced in fiscal 2017, was driven by typical market factors and impacted each of our geographic segments and customer markets. While productivity was positive to overall product gross margin, the benefit was lower than the prior year as these improvements were adversely impacted by an increase in the costs of certain components which are currently constrained. We expect the higher component costs to continue to impact productivity in the near term. Productivity improvements were driven by cost reductions including value engineering efforts (e.g. component redesign, board configuration, test processes, and transformation processes), lower warranty expenses and continued operational efficiency in manufacturing operations. The decrease in product gross margin was also due to an unfavorable mix of products sold driven by negative mix impacts from our Infrastructure Platforms products, partially offset by favorability from Security, Applications and Other Products. Our product gross margin in fiscal 2018 was also negatively impacted by higher amortization expense from purchased intangible assets.
Fiscal 2017 Compared with Fiscal 2016
The following table summarizes the key factors that contributed to the change in product gross margin percentage from fiscal 2016 to fiscal 2017:
Product Gross Margin Percentage | |||
Fiscal 2016 | 62.0 | % | |
Product pricing | (2.1 | )% | |
Mix of products sold | (0.3 | )% | |
Supplier component remediation adjustment | (0.1 | )% | |
Other | (0.1 | )% | |
Productivity (1) | 1.4 | % | |
SP Video CPE Business impact | 0.8 | % | |
Fiscal 2017 | 61.6 | % | |
Product gross margin decreased by 0.4 percentage points as compared with fiscal 2016. The decrease in product gross margin was largely due to unfavorable impacts from product pricing, lower productivity benefits, and unfavorable product mix, partially offset by a benefit from the divestiture of the lower margin SP Video CPE business in fiscal 2016.
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The negative pricing impact was driven by typical market factors and impacted each of our geographic segments and customer markets. While productivity was positive to overall product gross margin, the benefit was lower than the prior year as these improvements were adversely impacted by an increase in the cost of certain memory components. In addition, productivity was negatively impacted by decreases in core routing and switching revenue which limited our ability to generate cost savings. Productivity improvements were driven by value engineering efforts (e.g. component redesign, board configuration, test processes, and transformation processes), lower warranty expenses and continued operational efficiency in manufacturing operations. The decrease in product gross margin was also due to an unfavorable mix of products sold driven by negative mix impacts from our Infrastructure platform products.
Service Gross Margin
Fiscal 2018 Compared with Fiscal 2017
Our service gross margin percentage decreased by 0.8 percentage points due to increased headcount-related costs and, to a lesser extent, unfavorable mix and increased delivery costs. These cost impacts were partially offset by the resulting benefit to gross margin of higher sales volume in both advanced services and technical support services.
Our service gross margin normally experiences some fluctuations due to various factors such as the timing of contract initiations in our renewals, our strategic investments in headcount, and the resources we deploy to support the overall service business. Other 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.
Fiscal 2017 Compared with Fiscal 2016
Our service gross margin percentage increased by 1.2 percentage points due to higher sales volume, decreased delivery costs, favorable mix and, to a lesser extent, lower share-based compensation expense. These benefits to service gross margin were partially offset by increased headcount-related costs.
Gross Margin by Segment
The following table presents the total gross margin for each segment (in millions, except percentages):
AMOUNT | PERCENTAGE | ||||||||||||||||||||
Years Ended | July 28, 2018 | July 29, 2017 | July 30, 2016 | July 28, 2018 | July 29, 2017 | July 30, 2016 | |||||||||||||||
Gross margin: | |||||||||||||||||||||
Americas | $ | 18,792 | $ | 18,284 | $ | 18,986 | 64.6 | % | 64.5 | % | 64.6 | % | |||||||||
EMEA | 7,945 | 7,855 | 7,998 | 63.9 | % | 65.4 | % | 65.0 | % | ||||||||||||
APJC | 4,726 | 4,741 | 4,620 | 60.3 | % | 62.0 | % | 61.2 | % | ||||||||||||
Segment total | 31,463 | 30,880 | 31,604 | 63.8 | % | 64.3 | % | 64.2 | % | ||||||||||||
Unallocated corporate items (1) | (857 | ) | (656 | ) | (644 | ) | |||||||||||||||
Total | $ | 30,606 | $ | 30,224 | $ | 30,960 | 62.0 | % | 63.0 | % | 62.9 | % | |||||||||
Amounts may not sum and percentages may not recalculate due to rounding.
(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.
Fiscal 2018 Compared with Fiscal 2017
We experienced a slight gross margin percentage increase in our Americas segment due to productivity improvements, partially offset by unfavorable impacts from pricing and product mix. The unfavorable mix of products sold in this segment was driven by negative mix impacts from our Infrastructure Platforms products, partially offset by favorability from Security, Applications and Other products.
The gross margin percentage decrease in our EMEA segment was due primarily to negative impacts from pricing and, to a lesser extent, an unfavorable product mix, partially offset by productivity improvements. Lower service gross margin also contributed to the decrease in the gross margin in this geographic segment.
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The APJC segment gross margin percentage decreased due primarily to the negative impacts from pricing and an unfavorable product mix, partially offset by productivity improvements. Lower service gross margin also contributed to the decrease in the gross margin in this geographic segment. Our gross margin in this segment was also negatively impacted by specific transactions with service providers.
The gross margin percentage for a particular segment may fluctuate, and period-to-period changes in such percentages may or may not be indicative of a trend for that segment.
Fiscal 2017 Compared with Fiscal 2016
The Americas segment experienced a slight gross margin percentage decrease due to negative impacts from pricing and product mix, partially offset by productivity improvements and the sale of the lower margin SP Video CPE Business. The unfavorable mix impact was driven by Infrastructure Platforms products.
The gross margin percentage increase in our EMEA segment was due primarily to higher service gross margin. Product gross margin in this segment also increased slightly due to the impact of productivity improvements, the sale of the lower margin SP Video CPE Business and a favorable product mix, partially offset by unfavorable impacts from pricing.
The APJC segment gross margin percentage increased due primarily to higher service gross margin. Product gross margin in this segment decreased due to negative impacts from pricing and product mix, partially offset by productivity improvements. The unfavorable mix impact was driven by Infrastructure Platforms products.
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):
Years Ended | 2018 vs. 2017 | 2017 vs. 2016 | ||||||||||||||||||||||||
July 28, 2018 | July 29, 2017 | July 30, 2016 | Variance in Dollars | Variance in Percent | Variance in Dollars | Variance in Percent | ||||||||||||||||||||
Research and development | $ | 6,332 | $ | 6,059 | $ | 6,296 | $ | 273 | 5 | % | $ | (237 | ) | (4 | )% | |||||||||||
Percentage of revenue | 12.8 | % | 12.6 | % | 12.8 | % | ||||||||||||||||||||
Sales and marketing | 9,242 | 9,184 | 9,619 | 58 | 1 | % | (435 | ) | (5 | )% | ||||||||||||||||
Percentage of revenue | 18.7 | % | 19.1 | % | 19.5 | % | ||||||||||||||||||||
General and administrative | 2,144 | |||||||||||||||||||||||||