01—Abstract
Summary
Summary of the 10-K filed September 25, 1998. Cited figures are marked; the original filing is the authoritative source.
Cisco Systems' fiscal 1998 10-K (year ended July 25, 1998) shows a company at peak growth momentum.
Net sales rose 31.3% to $8.46 billiona from $6.44 billion, and net income grew 28.7% to $1.35 billion. Diluted EPS was $0.84 (adjusted for the September 1998 three-for-two split), up from $0.68. Excluding nonrecurring purchased R&D charges of $594 million and a $5 million investment gain, pro forma diluted EPS would have been $1.17.
Gross margin held steady at 65.5%, and operating cash flow more than doubled to $2.88 billionb. Cash, short-term investments and investments totaled $5.2 billion, and shareholders' equity reached $7.1 billion. The filing also flags several headwinds.
Sales growth in Japan and much of Asia slowed, and international sales fell to 40.9%c of total from 43.5%. Management expects gross margins to decline over time as lower-margin access and switching products for small and medium businesses grow faster than its high-margin router business. R&D expense is expected to grow faster than sales, and management warned that quarterly results will be hard to predict.
Other risks include a Lucent patent infringement suit covering eight patents, growing competition from large telecom equipment vendors such as Lucent, Nortel and Ericsson, dependence on a few single-source component suppliers, and concentration of headquarters and manufacturing in Silicon Valley, which is exposed to earthquakes. For investors, the central question is whether Cisco can keep growing revenue at a high rate while holding margins as it moves into lower-priced access products and into the telecom carrier market. The filing supports strong near-term profitability and a large cash position, but it also signals that growth and margins may become harder to sustain.
02—Key points
Key Highlights
- Net sales grew 31.3% to $8.46 billion in fiscal 1998, driven by Catalyst 5500 switches, Cisco 3600 access servers and Cisco 1600 small-office routers.
- Net income rose to $1.35 billion, but included $594 million of purchased R&D charges; pro forma diluted EPS excluding nonrecurring items was $1.17 versus the reported $0.84.
- Gross margin edged up to 65.5% from 65.2%, but management expects margins to decline as lower-margin small and medium business products grow faster.
- Operating cash flow nearly doubled to $2.88 billion, and cash plus investments reached $5.2 billion with no borrowings under the $500 million credit line.
- International sales share fell to 40.9% from 43.5%, with Japan and much of Asia weak, while Europe's share of revenue rose sharply (Europe sales $2.28 billion vs. $396 million in 1997).
- R&D spending reached $1.02 billion (12.1% of sales) and is expected to grow faster than sales, reflecting investment in voice, video, DSL and security.
- Lucent filed a suit alleging infringement of eight patents; management believes Cisco has meritorious defenses but cannot predict the outcome.
03—Questions
Frequently Asked Questions
How did Cisco's revenue and profitability perform in fiscal 1998?
Net sales rose 31.3% to $8.46 billion and net income rose about 29% to $1.35 billion. Diluted EPS was $0.84, or $1.17 excluding the $594 million of purchased R&D charges and a small investment gain. Growth came mainly from high-end switches, access servers and small-office routers, plus higher service contract sales.
Are Cisco's gross margins under pressure?
Margins were stable in 1998 at 65.5%, up slightly from 65.2%. However, management expects gross margins to decline over time because demand for lower-margin access and switching products for small and medium businesses is growing faster than demand for its higher-margin routers. Competitive pressure from large telecom vendors and a shift to indirect channels also could weigh on margins.
What risks does the filing highlight for investors?
Key risks include a Lucent patent suit covering eight patents, competition from larger telecom equipment makers and well-funded startups, dependence on single-source components, slower sales in Asia, possible Internet regulation, and variable quarterly results driven by large orders and acquisition charges. The company's headquarters and main manufacturing sites are in Silicon Valley, which is exposed to earthquakes and flooding. Stock price volatility is also a noted risk factor.
How strong is Cisco's balance sheet and cash generation?
Cash, short-term investments and long-term investments totaled $5.2 billion at July 25, 1998, up $2.6 billion over the year. Operating cash flow was $2.88 billion, and shareholders' equity grew to $7.1 billion. The company had a $500 million unused line of credit and no debt borrowings, and management said its resources would cover working capital and capital expenditure needs through fiscal 1999.
04—Continue