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Cisco Systems, Inc. (NASDAQ:CSCO) designs, manufactures and sells internet protocol-based networking and other products related to the communications and information technology industry and provides services associated with these products and their use. The company reported earnings after the market closed on 12Feb14 and on the surface all the results seemed pedestrian with the company reporting earnings of $0.47 per share (beating estimates by $0.01) on revenue of $11.2 billion (beating estimates by $170 million). What I'd like to do at this time is delve into the weeds and pick out some highlights from different portions of the report to see if the stock is worth buying at the present time.

Segment Revenue

Segment Revenues (millions)

2FQ14

2FQ13

Y/Y

Product

$ 8,423

$ 9,437

-11%

Service

$ 2,732

$ 2,661

3%

Total

$ 11,155

$ 12,098

-8%

Compared to last year total revenue was down significantly, by 8%. That shouldn't strike investors as earth shattering though because management warned us previously. But what I notice is that hardware took a severe hit while services increased at a pretty good rate. Hardware is responsible for about 76% of revenues, but I believe this is an opportunity for an activist investor to come in and take the company apart, a la International Business Machines (NYSE:IBM), which doesn't really make machines anymore.

Income Statement

Income Statement (millions)

2FQ14

2FQ13

Y/Y

Revenue

$ 11,155

$ 12,098

-8%

Cost of sales

$ 5,204

$ 4,755

9%

Gross margin

$ 5,951

$ 7,343

-19%

Research and development

$ 1,412

$ 1,452

-3%

Sales and marketing

$ 2,277

$ 2,387

-5%

General and administrative

$ 451

$ 584

-23%

Amortization of purchased intangible assets

$ 71

$ 118

-40%

Restructuring and other charges

$ 73

$ 13

462%

Operating income

$ 1,667

$ 2,789

-40%

Interest income

$ 169

$ 160

6%

Interest expense

$ (136)

$ (147)

-7%

Other income

$ 55

$ (22)

350%

Income before provision for income taxes

$ 1,755

$ 2,780

-37%

Provision for income taxes

$ 326

$ (363)

190%

Net Income

$ 1,429

$ 3,143

-55%

Non-GAAP Share-based compensation expense

$ 52

$ 47

11%

Non-GAAP Amortization of acquisition-related intangible assets

$ 182

$ 136

34%

Non-GAAP Supplier component remediation charge

$ 655

$ -

N/A

Non-GAAP Impact to cost of sales from purchase accounting adjustments to inventory

$ -

$ 16

-100%

Non-GAAP Share-based compensation expense

$ 296

$ 255

16%

Non-GAAP Amortization of acquisition-related intangible assets

$ 71

$ 118

-40%

Non-GAAP Acquisition-related/divestiture costs

$ 107

$ 39

174%

Non-GAAP Significant asset impairments and restructurings

$ 73

$ 13

462%

Non-GAAP Income tax effect of non-GAAP adjustments

$ (275)

$ (179)

54%

Non-GAAP Significant tax matters

$ (69)

$ (866)

-92%

Non-GAAP net income

$ 2,521

$ 2,722

-7%

Diluted shares outstanding

5,327

5,327

0%

Net Income per diluted share

$ 0.47

$ 0.51

-7%

Looking at the income statement at first glance is not appealing at all as you look at the bottom line and notice that earnings decreased by 7% from last year. I'd like to sift through the income statement to see why that was the case. First thing to notice is that gross margins decreased by 19% due in large part to the double whammy of decrease in revenue and cost of sales increase. On the bright sight general and administrative expenses decreased 23% and amortization of purchased intangible assets decreased 40%. Restructuring charges increased 462% from the prior year, but we also knew that was going to happen. Overall operating income dropped 40% from the prior year. Other income increased 350% but overall income before taxes decreased 37%. Because the following line item shows a 190% increase in income taxes overall net income decreased by 55%! Since the company does report earnings on a non-GAAP basis, after we take into consideration all the non-GAAP items we see that net income decreased "just 7%" and because shares weren't repurchased from the prior year earnings were also down 7%.

Balance Sheet

Balance Sheet (millions)

2FQ14

2FQ13

Y/Y

Cash and cash equivalents

$ 5,339

$ 7,925

-33%

Investments

$ 41,726

$ 42,685

-2%

Accounts receivable

$ 4,378

$ 5,470

-20%

Inventories

$ 1,548

$ 1,476

5%

Financing receivables

$ 4,016

$ 4,037

-1%

Deferred tax assets

$ 2,419

$ 2,616

-8%

Other current assets

$ 1,263

$ 1,312

-4%

Total current assets

$ 60,689

$ 65,521

-7%

Property and equipment

$ 3,234

$ 3,322

-3%

Financing receivables

$ 3,628

$ 3,911

-7%

Goodwill

$ 24,086

$ 21,919

10%

Purchased intangible assets

$ 3,693

$ 3,403

9%

Other assets

$ 3,097

$ 3,115

-1%

Total assets

$ 98,427

$ 101,191

-3%

Short-term debt

$ 4,762

$ 3,283

45%

Accounts payable

$ 891

$ 1,029

-13%

Income taxes payable

$ -

$ 192

-100%

Accrued compensation

$ 2,406

$ 3,182

-24%

Deferred revenue

$ 9,350

$ 9,262

1%

Other current liabilities

$ 5,535

$ 5,048

10%

Total current liabilities

$ 22,944

$ 21,996

4%

Long-term debt

$ 12,385

$ 12,928

-4%

Income taxes payable

$ 1,483

$ 1,748

-15%

Deferred revenue

$ 3,894

$ 4,161

-6%

Other long-term liabilities

$ 1,637

$ 1,230

33%

Total liabilities

$ 42,343

$ 42,063

1%

Total equity

$ 56,084

$ 59,128

-5%

Total liabilities and equity

$ 98,427

$ 101,191

-3%

When taking a glance at the current assets side of the balance sheet you immediately notice that cash decreased 33%! After seeing that accounts receivables decreased by 20% it isn't difficult to fathom that total current assets decreased by 7% which made total assets decrease 3%. On the short-term debt side of the equation there was a 45% increase while accounts payable decreased by 13%. Income taxes payable decreased 100% and accrued compensation decreased 24% but none of that helped as total current liabilities increased 4%. On the longer term side of the debt income taxes payable decreased 15% while other long-term liabilities increased 33% causing total liabilities to increase 1%.

Conclusion

The company reported earnings which were 7% lower than the year before on decreasing revenue while the share price was up 6.77% in the past year excluding dividends. The decrease in earnings was due primarily to lower revenues and poor operating efficiency. The diluted share count didn't budge and didn't contribute to earnings. This earning report is crappy to say the least. On a fundamental basis I believe this company is inexpensively valued with respect to 2015 earnings because it has been beaten down so badly. The stock was down 2.54% the day after reporting earnings in the face of an S&P500 which gained 0.57%. The damage could've been much worse, but I think the bleeding was not as bad because the company actually provided an 11.8% increase to the dividend. Cash flow decreased by $0.4 billion from the prior year while the cash/cash equivalents on the balance sheet decreased $3.5 billion from the end of fiscal fourth quarter of 2013. The company is in bad shape right now and I believe it is ripe for an activist investor to purge the hardware side of the business. I'm going put the stock in the penalty box till I see some revenue growth.

Disclaimer: This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing!

Disclosure: I am long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Cisco's Earnings Decrease 7% Year Over Year, But Is It A Sell?