Cisco Systems, Inc. — FY2014 Form 10-K
Business context and reporting period. Cisco designs, manufactures, and sells IP networking products and related services to enterprises, service providers, commercial customers, public institutions, and individuals. It reports by the Americas, EMEA, and APJC. This annual report covers the 52 weeks ended July 26, 2014; the fourth quarter ended on that date.
Financial performance
Amounts are in U.S. dollars; financial figures are in millions except per-share data.
| Metric | FY2014 | FY2013 | Change |
|---|---|---|---|
| Revenue | $47,142 | $48,607 | -3.0% |
| Product revenue | $36,172 | $38,029 | -4.9% |
| Service revenue | $10,970 | $10,578 | +3.7% |
| Gross margin | $27,769 | $29,440 | -5.7% |
| Gross margin percentage | 58.9% | 60.6% | -1.7 pts |
| Operating income | $9,345 | $11,196 | -17% |
| Operating margin | 19.8% | 23.0% | -3.2 pts |
| Net income | $7,853 | $9,983 | -21.3% |
| Diluted EPS | $1.49 | $1.86 | -19.9% |
| Cash provided by operating activities | $12,332 | $12,894 | -4.4% |
| Free cash flow (company-defined) | $11,057 | $11,734 | -5.8% |
| Cash, cash equivalents, and investments | $52,074 | $50,610 | +$1,464 |
| Total debt, carrying amount | $20,909 | $16,211 | +$4,698 |
| Deferred revenue | $14,142 | $13,423 | +5.4% |
Product gross margin fell to 56.8% from 59.1%; service gross margin improved to 66.0% from 65.7%. Cash and investments exceeded total debt, but $47.4 billion of cash and investments was held by foreign subsidiaries; repatriation could trigger additional taxes. Cisco reported current assets of $67.1 billion and current liabilities of $19.8 billion. The $3.0 billion revolving credit facility was undrawn, and the company reported compliance with debt covenants.
Fourth-quarter snapshot: Revenue was $12,357 million, down 0.5% year over year; net income was $2,247 million versus $2,270 million; diluted EPS was $0.43 versus $0.42. Gross margin was 59.9%, compared with 59.2%, while operating margin declined to 21.7% from 22.7%.
Material changes versus the prior year
- Product revenue declined across all geographic segments and customer markets. Revenue fell 3% in the Americas, 1.7% in EMEA, and 5.2% in APJC. Product revenue in Brazil, Russia, India, China, and Mexico declined 11% in aggregate.
- Service-provider demand weakened, and product transitions weighed on core routing and switching. Switching revenue declined 4.8%, NGN Routing 7.0%, and Service Provider Video 18.2%.
- Growth areas included Data Center, up 27.3%; Security, up 16.2%; and Wireless, up 1.7%. Service revenue increased 3.7%, slower than in prior years.
- Product margin was pressured by pricing, product mix, acquired-intangible amortization, and a $655 million charge for remediation of products with supplier memory components. Productivity improvements partly offset these items.
- Net income comparisons were also affected by fiscal 2013 tax benefits: a $794 million IRS settlement benefit and $184 million of federal R&D tax credits. The FY2014 effective tax rate was 19.2%, versus 11.1%.
Cash, capital allocation, and debt
- Capital expenditures were $1,275 million, producing company-defined free cash flow of $11,057 million. The company stated an intention to return at least 50% of annual free cash flow to shareholders through dividends and repurchases.
- FY2014 dividends paid were $3,758 million; Cisco repurchased $9,539 million of shares under its program. The annual dividend declared per share rose to $0.72 from $0.62.
- Senior notes had $20.75 billion principal outstanding at year-end, including $2.4 billion of floating-rate notes; carrying value was $20.9 billion. The company issued $8.0 billion of notes in March 2014 and repaid $3.3 billion of maturing notes. No commercial paper was outstanding at year-end.
- Inventory increased 8% to $1,591 million; supplier and contract-manufacturer purchase commitments rose 3% to $4,169 million. Product backlog increased to $5.4 billion from $4.9 billion, but Cisco cautioned that backlog is not necessarily indicative of future revenue.
Outlook, management commentary, risks, and unusual items
- Management said weakness in emerging countries, service-provider spending, and routing and switching product transitions could continue for at least several quarters. It provided no specific forward revenue or earnings guidance in the supplied filing text.
- In August 2014, after fiscal year-end, Cisco announced a restructuring affecting up to 6,000 employees, approximately 8% of its workforce. Expected pre-tax charges were not to exceed $700 million, primarily in FY2015; the company planned to reinvest substantially all cost savings in growth areas.
- The $655 million supplier-component remediation charge was recorded in FY2014; the remaining remediation liability was $670 million at year-end. Cisco noted estimates could change with claim levels and servicing costs.
- Brazilian tax authorities asserted claims of approximately $389 million in taxes, $1.3 billion in interest, and $1.7 billion in penalties. Cisco disputed the claims, could not estimate the likelihood or range of loss, and expected resolution to take several years.
- Cisco was cooperating with SEC and Department of Justice investigations into possible Foreign Corrupt Practices Act violations involving Russia and certain CIS operations and resellers; the outcome was undetermined. Patent litigation, including Rockstar claims and possible customer indemnification obligations, also remained unresolved.
- Key business risks include intense pricing and technology competition, uncertain IT and service-provider spending, product-transition execution, supply constraints and inventory exposure, customer and channel credit risk, foreign exchange, acquisitions, cybersecurity and product quality, and tax uncertainty. Cisco recorded $1,348 million of share-based compensation and $418 million of restructuring and other charges in FY2014.
The financial statements received an unqualified audit opinion, and the auditor and management concluded internal control over financial reporting was effective as of July 26, 2014.
Most important facts for investors to verify
- Whether product revenue and gross margins stabilize, particularly in switching, routing, service-provider video, and emerging markets, and whether growth businesses can offset core declines.
- The ultimate cost and duration of the supplier-component remediation, and progress against the FY2015 restructuring plan and its estimated charges.
- Developments in the Brazilian tax claims, FCPA investigation, and patent litigation, including any change in estimated exposure or indemnification obligations.
- Cash generation, the location and tax availability of offshore cash, debt maturities, and continued dividends and repurchases amid higher debt.
- Whether Cisco’s strategic investments in data center, security, software, cloud, and new networking architectures deliver returns as management expects.