10Q- Q1'15
Table of Contents


 
 
 
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 
_____________________________________
FORM 10-Q
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 25, 2014

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 
_____________________________________
CISCO SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
California
 
77-0059951
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
170 West Tasman Drive
San Jose, California 95134
(Address of principal executive office and zip code)
(408) 526-4000
(Registrant’s telephone number, including area code)
_____________________________________ 
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.    Yes x   No  o  
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).  Yes x    No  o  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting 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
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨  No  x
Number of shares of the registrant’s common stock outstanding as of November 14, 2014: 5,113,588,147
____________________________________ 


1
Table of Contents


Cisco Systems, Inc.
Form 10-Q for the Quarter Ended October 25, 2014
INDEX
 
 
 
 
Page
Part I
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
Part II.
 
 
Item 1.
 
 
Item 1A.
 
 
Item 2.
 
 
Item 3.
 
 
Item 4.
 
 
Item 5.
 
 
Item 6.
 
 
 
 
 


2
Table of Contents


PART I. FINANCIAL INFORMATION 
Item 1.
Financial Statements (Unaudited)
CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except par value)
(Unaudited)
 
October 25, 2014
 
July 26, 2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
4,387

 
$
6,726

Investments
47,720

 
45,348

Accounts receivable, net of allowance for doubtful accounts of $276 at October 25, 2014 and $265 at July 26, 2014
4,375

 
5,157

Inventories
1,676

 
1,591

Financing receivables, net
4,265

 
4,153

Deferred tax assets
2,689

 
2,808

Other current assets
1,284

 
1,331

Total current assets
66,396

 
67,114

Property and equipment, net
3,233

 
3,252

Financing receivables, net
3,691

 
3,918

Goodwill
24,364

 
24,239

Purchased intangible assets, net
3,066

 
3,280

Other assets
3,228

 
3,331

TOTAL ASSETS
$
103,978

 
$
105,134

LIABILITIES AND EQUITY

 

Current liabilities:

 

Short-term debt
$
1,357

 
$
508

Accounts payable
1,022

 
1,032

Income taxes payable
94

 
159

Accrued compensation
2,638

 
3,181

Deferred revenue
9,449

 
9,478

Other current liabilities
5,496

 
5,451

Total current liabilities
20,056

 
19,809

Long-term debt
19,615

 
20,401

Income taxes payable
1,504

 
1,851

Deferred revenue
4,295

 
4,664

Other long-term liabilities
1,793

 
1,748

Total liabilities
47,263

 
48,473

Commitments and contingencies (Note 12)

 

Equity:
 
 
 
Cisco shareholders’ equity:
 
 
 
Preferred stock, no par value: 5 shares authorized; none issued and outstanding
—

 
—

Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized; 5,109 and 5,107 shares issued and outstanding at October 25, 2014 and July 26, 2014, respectively
41,984

 
41,884

Retained earnings
14,273

 
14,093

Accumulated other comprehensive income
451

 
677

Total Cisco shareholders’ equity
56,708

 
56,654

Noncontrolling interests
7

 
7

Total equity
56,715

 
56,661

TOTAL LIABILITIES AND EQUITY
$
103,978

 
$
105,134

See Notes to Consolidated Financial Statements.

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Table of Contents


CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per-share amounts)
(Unaudited) 
 
Three Months Ended
 
October 25, 2014
 
October 26, 2013
REVENUE:
 
 
 
Product
$
9,435

 
$
9,397

Service
2,810

 
2,688

Total revenue
12,245


12,085

COST OF SALES:



Product
3,919

 
3,747

Service
993

 
931

Total cost of sales
4,912


4,678

GROSS MARGIN
7,333

 
7,407

OPERATING EXPENSES:



Research and development
1,583

 
1,724

Sales and marketing
2,515

 
2,411

General and administrative
504

 
515

Amortization of purchased intangible assets
71

 
65

Restructuring and other charges
318

 
237

Total operating expenses
4,991


4,952

OPERATING INCOME
2,342


2,455

Interest income
179

 
169

Interest expense
(139
)
 
(140
)
Other income (loss), net
(22
)
 
56

Interest and other income (loss), net
18


85

INCOME BEFORE PROVISION FOR INCOME TAXES
2,360


2,540

Provision for income taxes
532

 
544

NET INCOME
$
1,828


$
1,996




 


Net income per share:


 


Basic
$
0.36


$
0.37

Diluted
$
0.35


$
0.37

Shares used in per-share calculation:





Basic
5,112

 
5,378

Diluted
5,156

 
5,430







Cash dividends declared per common share
$
0.19

 
$
0.17

See Notes to Consolidated Financial Statements.

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Table of Contents


CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
(Unaudited)
 
Three Months Ended
 
October 25, 2014
 
October 26, 2013
Net income
$
1,828

 
$
1,996

Available-for-sale investments:
 
 
 
Change in net unrealized gains, net of tax benefit (expense) of $14 and $(53) for the three months ended October 25, 2014 and October 26, 2013, respectively
(22
)
 
121

Net gains reclassified into earnings, net of tax expense of $2 and $31 for the three months ended October 25, 2014 and October 26, 2013, respectively
(5
)
 
(52
)

(27
)
 
69

Cash flow hedging instruments:
 
 
 
Change in unrealized gains and losses, net of tax benefit (expense) of $3 and $(3) for the three months ended October 25, 2014 and October 26, 2013, respectively
(53
)
 
35

Net (gains) losses reclassified into earnings
4

 
(9
)

(49
)
 
26

Net change in cumulative translation adjustment and other, net of tax benefit (expense) of $11 and $(3) for the three months ended October 25, 2014 and October 26, 2013, respectively
(150
)
 
73

Other comprehensive income (loss)
(226
)
 
168

Comprehensive income
1,602

 
2,164

Comprehensive (income) loss attributable to noncontrolling interests
—

 
(4
)
Comprehensive income attributable to Cisco Systems, Inc.
$
1,602

 
$
2,160

See Notes to Consolidated Financial Statements.


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Table of Contents


CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
 
Three Months Ended

October 25, 2014
 
October 26, 2013
Cash flows from operating activities:
 
 
 
Net income
$
1,828

 
$
1,996

Adjustments to reconcile net income to net cash provided by operating activities:

 

Depreciation, amortization, and other
596

 
591

Share-based compensation expense
369

 
309

Provision for receivables
43

 
23

Deferred income taxes
236

 
130

Excess tax benefits from share-based compensation
(71
)
 
(55
)
(Gains) losses on investments and other, net
29

 
(108
)
Change in operating assets and liabilities, net of effects of acquisitions and divestitures:

 

Accounts receivable
723

 
361

Inventories
(107
)
 
22

Financing receivables
(2
)
 
(37
)
Other assets
5

 
28

Accounts payable
(5
)
 
(29
)
Income taxes, net
(398
)
 
(389
)
Accrued compensation
(495
)
 
(460
)
Deferred revenue
(328
)
 
(307
)
Other liabilities
68

 
574

Net cash provided by operating activities
2,491

 
2,649

Cash flows from investing activities:
 
 
 
Purchases of investments
(9,761
)
 
(8,835
)
Proceeds from sales of investments
3,450

 
4,733

Proceeds from maturities of investments
3,906

 
4,058

Acquisition of businesses, net of cash and cash equivalents acquired
(184
)
 
(2,447
)
Purchases of investments in privately held companies
(50
)
 
(134
)
Return of investments in privately held companies
42

 
33

Acquisition of property and equipment
(285
)
 
(315
)
Proceeds from sales of property and equipment
3

 
156

Other
2

 
(4
)
Net cash used in investing activities
(2,877
)
 
(2,755
)
Cash flows from financing activities:
 
 
 
Issuances of common stock
353

 
444

Repurchases of common stock - repurchase program
(1,088
)
 
(1,898
)
Shares repurchased for tax withholdings on vesting of restricted stock units
(342
)
 
(286
)
Short-term borrowings, original maturities less than 90 days, net
(4
)
 
(2
)
Issuances of debt
—

 
4

Repayments of debt
(3
)
 
—

Excess tax benefits from share-based compensation
71

 
55

Dividends paid
(973
)
 
(914
)
Other
33

 
32

Net cash used in financing activities
(1,953
)
 
(2,565
)
Net (decrease) increase in cash and cash equivalents
(2,339
)
 
(2,671
)
Cash and cash equivalents, beginning of period
6,726

 
7,925

Cash and cash equivalents, end of period
$
4,387

 
$
5,254

 
 
 
 
Supplemental cash flow information:
 
 
 
Cash paid for interest
$
263


$
221

Cash paid for income taxes, net
$
694


$
803

See Notes to Consolidated Financial Statements.

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Table of Contents


CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(in millions, except per-share amounts)
(Unaudited)
Three Months Ended October 25, 2014
Shares of
Common
Stock
 
Common Stock
and
Additional
Paid-In Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total Cisco
Shareholders’
Equity
 
Non-controlling
Interests
 
Total  Equity
BALANCE AT JULY 26, 2014
5,107

 
$
41,884

 
$
14,093

 
$
677

 
$
56,654

 
$
7

 
$
56,661

Net income
 
 
 
 
1,828

 
 
 
1,828

 
 
 
1,828

Other comprehensive income (loss)
 
 
 
 
 
 
(226
)
 
(226
)
 
—

 
(226
)
Issuance of common stock
57

 
353

 
 
 
 
 
353

 
 
 
353

Repurchase of common stock
(41
)
 
(338
)
 
(675
)
 
 
 
(1,013
)
 
 
 
(1,013
)
Shares repurchased for tax withholdings on vesting of restricted stock units
(14
)
 
(342
)
 
 
 
 
 
(342
)
 
 
 
(342
)
Cash dividends declared ($0.19 per common share)
 
 
 
 
(973
)
 
 
 
(973
)
 
 
 
(973
)
Tax effects from employee stock incentive plans
 
 
55

 
 
 
 
 
55

 
 
 
55

Share-based compensation expense
 
 
369

 
 
 
 
 
369

 
 
 
369

Purchase acquisitions and other
 
 
3

 
 
 
 
 
3

 
 
 
3

BALANCE AT OCTOBER 25, 2014
5,109

 
$
41,984

 
$
14,273

 
$
451

 
$
56,708

 
$
7

 
$
56,715


Three Months Ended October 26, 2013
Shares of
Common
Stock
 
Common Stock
and
Additional
Paid-In Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total Cisco
Shareholders’
Equity
 
Non-controlling
Interests
 
Total  Equity
BALANCE AT JULY 27, 2013
5,389

 
$
42,297

 
$
16,215

 
$
608

 
$
59,120

 
$
8

 
$
59,128

Net income
 
 
 
 
1,996

 
 
 
1,996

 
 
 
1,996

Other comprehensive income (loss)
 
 
 
 
 
 
164

 
164

 
4

 
168

Issuance of common stock
58

 
444

 
 
 
 
 
444

 
 
 
444

Repurchase of common stock
(84
)
 
(662
)
 
(1,338
)
 
 
 
(2,000
)
 
 
 
(2,000
)
Shares repurchased for tax withholdings on vesting of restricted stock units
(12
)
 
(286
)
 
 
 
 
 
(286
)
 
 
 
(286
)
Cash dividends declared ($0.17 per common share)
 
 
 
 
(914
)
 
 
 
(914
)
 
 
 
(914
)
Tax effects from employee stock incentive plans
 
 
35

 
 
 
 
 
35

 
 
 
35

Share-based compensation expense
 
 
309

 
 
 
 
 
309

 
 
 
309

Purchase acquisitions and other
 
 
29

 
 
 
 
 
29

 
 
 
29

BALANCE AT OCTOBER 26, 2013
5,351

 
$
42,166

 
$
15,959

 
$
772

 
$
58,897

 
$
12

 
$
58,909


Supplemental Information
In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of October 25, 2014, the Company’s Board of Directors had authorized an aggregate repurchase of up to $97 billion of common stock under this program with no termination date. The stock repurchases since the inception of this program and the related impacts on Cisco shareholders’ equity are summarized in the following table (in millions): 
 
Shares of
Common
Stock
 
Common Stock
and Additional
Paid-In Capital
 
Retained
Earnings
 
Total Cisco
Shareholders’
Equity
Repurchases of common stock under the repurchase program
4,329

 
$
21,662

 
$
67,796

 
$
89,458

See Notes to Consolidated Financial Statements.


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Table of Contents


CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.
Basis of Presentation
The fiscal year for Cisco Systems, Inc. (the “Company” or “Cisco”) is the 52 or 53 weeks ending on the last Saturday in July. Fiscal 2015 and fiscal 2014 are each 52-week fiscal years. The Consolidated Financial Statements include the accounts of Cisco and its subsidiaries. All intercompany accounts and transactions have been eliminated. The Company conducts business globally and is primarily managed on a geographic basis in the following three geographic segments: the Americas; Europe, Middle East, and Africa (EMEA); and Asia Pacific, Japan, and China (APJC).
The accompanying financial data as of October 25, 2014 and for the three months ended October 25, 2014 and October 26, 2013 has been prepared by the Company, without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (GAAP) have been condensed or omitted pursuant to such rules and regulations. The July 26, 2014 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 26, 2014.
The Company consolidates its investments in a venture fund managed by SOFTBANK Corp. and its affiliates (“SOFTBANK”) as this is a variable interest entity and the Company is the primary beneficiary. The noncontrolling interests attributed to SOFTBANK are presented as a separate component from the Company’s equity in the equity section of the Consolidated Balance Sheets. SOFTBANK’s share of the earnings in the venture fund are not presented separately in the Consolidated Statements of Operations as these amounts are not material for any of the fiscal periods presented.
In the opinion of management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present fairly the consolidated balance sheet as of October 25, 2014; the results of operations; statements of comprehensive income, cash flows, and equity for the three months ended October 25, 2014 and October 26, 2013, as applicable, have been made. The results of operations for the three months ended October 25, 2014 are not necessarily indicative of the operating results for the full fiscal year or any future periods.
Certain reclassifications have been made to the amounts in prior periods in order to conform to the current period’s presentation. The Company has evaluated subsequent events through the date that the financial statements were issued.

2.
Recent Accounting Pronouncements
(a)
New Accounting Updates Recently Adopted
In March 2013, the FASB issued an accounting standard update requiring an entity to release into net income the entire amount of a cumulative translation adjustment related to its investment in a foreign entity when as a parent it sells either a part or all of its investment in the foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets within the foreign entity. This accounting standard update became effective for the Company beginning in the first quarter of fiscal 2015. The application of this accounting standard update did not have any impact to the Company's Consolidated Financial Statements.
In July 2013, the FASB issued an accounting standard update that provides explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward or a tax credit carryforward exists. Under the new standard update, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, is to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward or a tax credit carryforward. This accounting standard update became effective for the Company beginning in the first quarter of fiscal 2015 and applied prospectively. The application of this accounting standard update did not have a material impact to the Company's Consolidated Financial Statements.





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Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

(b)
Recent Accounting Standards or Updates Not Yet Effective
In April 2014, the FASB issued an accounting standard update that changes the criteria for reporting discontinued operations. This accounting standard update raises the threshold for a disposal transaction to qualify as a discontinued operation and requires additional disclosures about discontinued operations and disposals of individually significant components that do not qualify as discontinued operations. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2016. Early adoption is permitted, but only for disposals that have not been reported in financial statements previously issued. The Company is currently evaluating the impact of this accounting standard update on its Consolidated Financial Statements.
In May 2014, the FASB issued an accounting standard update related to revenue from contracts with customers, which will supersede nearly all current U.S. GAAP guidance on this topic and eliminate industry-specific guidance. The underlying principle is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2018. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption.  Early adoption is not permitted.  The Company is currently evaluating the impact of this accounting standard update on its Consolidated Financial Statements.

3.
Business Combinations
The Company completed two business combinations during the three months ended October 25, 2014. A summary of the allocation of the total purchase consideration is presented as follows (in millions):
 
Purchase Consideration
 
Net Liabilities
Assumed
 
Purchased Intangible Assets
 
Goodwill
Metacloud, Inc.
$
149

 
$
(7
)
 
$
29

 
$
127

Other
38

 
(10
)
 
29

 
19

Total acquisitions
$
187

 
$
(17
)
 
$
58

 
$
146

On September 29, 2014, the Company completed its acquisition of Metacloud, Inc. ("Metacloud"), a provider of private clouds for global organizations. With its acquisition of Metacloud, the Company aims to advance its Intercloud strategy to deliver a globally distributed, highly secure cloud platform capable of meeting customer demands.
The total purchase consideration related to the Company’s business combinations completed during the three months ended October 25, 2014 consisted of cash consideration along with vested share-based awards assumed. The total cash and cash equivalents acquired from these business combinations was approximately $3 million. Total transaction costs related to the Company’s business combination activities were $2 million and $6 million for the three months ended October 25, 2014 and October 26, 2013, respectively. These transaction costs were expensed as incurred in general and administrative (G&A) expenses in the Consolidated Statements of Operations.
The Company’s purchase price allocation for business combinations completed during recent periods is preliminary and subject to revision as additional information about fair value of assets and liabilities becomes available. Additional information, which existed as of the acquisition date but at that time was unknown to the Company may become known to the Company during the remainder of the measurement period, a period not to exceed 12 months from the acquisition date. Adjustments in the purchase price allocation may require a recasting of the amounts allocated to goodwill retroactive to the period in which the acquisition occurred.
The goodwill generated from the Company’s business combinations completed during the three months ended October 25, 2014 is primarily related to expected synergies. The goodwill is generally not deductible for income tax purposes.
The Consolidated Financial Statements include the operating results of each business combination from the date of acquisition. Pro forma results of operations for the acquisitions completed during the three months ended October 25, 2014 have not been presented because the effects of the acquisitions, individually and in the aggregate, were not material to the Company’s financial results.


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Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

4.
Goodwill and Purchased Intangible Assets
(a)
Goodwill
The following table presents the goodwill allocated to the Company’s reportable segments as of and during the three months ended October 25, 2014 (in millions):
 
Balance at July 26, 2014
 
Acquisitions
 
Other
 
Balance at October 25, 2014
Americas
$
15,080

 
$
75

 
$
(11
)
 
$
15,144

EMEA
5,715

 
60

 
(6
)
 
5,769

APJC
3,444

 
11

 
(4
)
 
3,451

Total
$
24,239

 
$
146

 
$
(21
)
 
$
24,364

The column entitled “Other” primarily includes purchase accounting adjustments.

(b)
Purchased Intangible Assets
The following table presents details of the Company’s intangible assets acquired through business combinations completed during the three months ended October 25, 2014 (in millions, except years):
 
FINITE LIVES
 
INDEFINITE
LIVES
 
TOTAL
 
TECHNOLOGY
 
CUSTOMER
RELATIONSHIPS
 
IPR&D
 
 
Weighted-
Average Useful
Life (in Years)
 
Amount
 
Weighted-
Average Useful
Life (in Years)
 
Amount
 
Amount
 
Amount
Metacloud, Inc.
3.0
 
$
24

 
5.0
 
$
3

 
$
2

 
$
29

Other
5.0
 
21

 
5.0
 
4

 
4

 
29

Total
 
 
$
45

 
 
 
$
7

 
$
6

 
$
58


The following tables present details of the Company’s purchased intangible assets (in millions): 
October 25, 2014
 
Gross
 
Accumulated Amortization
 
Net
Purchased intangible assets with finite lives:
 
 
 
 
 
 
Technology
 
$
4,150

 
$
(2,166
)
 
$
1,984

Customer relationships
 
1,713

 
(788
)
 
925

Other
 
51

 
(16
)
 
35

Total purchased intangible assets with finite lives
 
5,914

 
(2,970
)
 
2,944

In-process research and development, with indefinite lives
 
122

 
—

 
122

Total
 
$
6,036

 
$
(2,970
)
 
$
3,066

 
July 26, 2014
 
Gross
 
Accumulated
Amortization
 
Net
Purchased intangible assets with finite lives:
 
 
 
 
 
 
Technology
 
$
4,100

 
$
(1,976
)
 
$
2,124

Customer relationships
 
1,706

 
(720
)
 
986

Other
 
51

 
(13
)
 
38

Total purchased intangible assets with finite lives
 
5,857

 
(2,709
)
 
3,148

In-process research and development, with indefinite lives
 
132

 
—

 
132

Total
 
$
5,989

 
$
(2,709
)
 
$
3,280

Purchased intangible assets include intangible assets acquired through business combinations as well as through direct purchases or licenses.

10
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

The following table presents the amortization of purchased intangible assets (in millions):
 
 
Three Months Ended
 
 
October 25, 2014
 
October 26, 2013
Amortization of purchased intangible assets:
 
 
 
 
Cost of sales
 
$
189

 
$
174

Operating expenses
 
71

 
65

Total
 
$
260

 
$
239

There were no impairment charges related to purchased intangible assets during the periods presented.
The estimated future amortization expense of purchased intangible assets with finite lives as of October 25, 2014 is as follows (in millions):
Fiscal Year
Amount
2015 (remaining nine months)
$
728

2016
754

2017
580

2018
421

2019
315

Thereafter
146

Total
$
2,944


5.
Restructuring and Other Charges
Fiscal 2015 Plan
In connection with a restructuring action announced in August 2014, the Company incurred cumulative charges of $318 million for the first quarter of fiscal 2015. The Company estimates that it will recognize aggregate pre-tax charges pursuant to the restructuring action in an amount not expected to exceed $600 million, consisting of severance and other one-time termination benefits and other associated costs. These charges are primarily cash-based and the Company expects the remaining amount to be recognized during the remainder of fiscal 2015.
Fiscal 2014 Plan
The Fiscal 2014 Plan is a workforce reduction plan the Company announced in August 2013. In connection with this restructuring action, the Company incurred cumulative charges of approximately $418 million, of which $237 million was incurred during the three months ended October 26, 2013. The Company completed the Fiscal 2014 Plan at the end of fiscal 2014.
The following table summarizes the activities related to the restructuring and other charges as discussed above (in millions):
 
 
Fiscal 2014 and Prior Plans
 
Fiscal 2015 Plan
 
 
 
 
Employee
Severance
 
Other
 
Employee
Severance
 
Other
 
Total
Liability as of July 26, 2014
 
$
40

 
$
29

 
$
—

 
$
—

 
$
69

Gross charges in fiscal 2015
 
—

 
—

 
322

 
(4
)
 
318

Cash payments
 
(13
)
 
—

 
(142
)
 
—

 
(155
)
Non-cash items
 
—

 
(4
)
 
—

 
4

 
—

Liability as of October 25, 2014
 
$
27

 
$
25

 
$
180

 
$
—

 
$
232



11
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

6.
Balance Sheet Details
The following tables provide details of selected balance sheet items (in millions):
 
 
October 25, 2014
 
July 26, 2014
Inventories:
 
 
 
 
Raw materials
 
$
173

 
$
77

Work in process
 
3

 
5

Finished goods:
 
 
 

Distributor inventory and deferred cost of sales
 
654

 
595

Manufactured finished goods
 
535

 
606

Total finished goods
 
1,189

 
1,201

Service-related spares
 
275

 
273

Demonstration systems
 
36

 
35

Total
 
$
1,676

 
$
1,591

Property and equipment, net:
 
 
 
 
Land, buildings, and building and leasehold improvements
 
$
4,471

 
$
4,468

Computer equipment and related software
 
1,423

 
1,425

Production, engineering, and other equipment
 
5,728

 
5,756

Operating lease assets
 
349

 
362

Furniture and fixtures
 
498

 
509

 
 
12,469

 
12,520

Less accumulated depreciation and amortization
 
(9,236
)
 
(9,268
)
Total
 
$
3,233

 
$
3,252

 
Other assets:
 
 
 
 
Deferred tax assets
 
$
1,553

 
$
1,700

Investments in privately held companies
 
886

 
899

Other
 
789

 
732

Total
 
$
3,228

 
$
3,331

Deferred revenue:
 
 
 
 
Service
 
$
9,029

 
$
9,640

Product:
 

 
 
Unrecognized revenue on product shipments and other deferred revenue
 
4,056

 
3,924

Cash receipts related to unrecognized revenue from two-tier distributors
 
659

 
578

Total product deferred revenue
 
4,715

 
4,502

Total
 
$
13,744

 
$
14,142

Reported as:
 

 
 
Current
 
$
9,449

 
$
9,478

Noncurrent
 
4,295

 
4,664

Total
 
$
13,744

 
$
14,142






12
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

7.
Financing Receivables and Operating Leases
(a)
Financing Receivables
Financing receivables primarily consist of lease receivables, loan receivables, and financed service contracts and other. Lease receivables represent sales-type and direct-financing leases resulting from the sale of the Company’s and complementary third-party products and are typically collateralized by a security interest in the underlying assets. Loan receivables represent financing arrangements related to the sale of the Company’s products and services, which may include additional funding for other costs associated with network installation and integration of the Company’s products and services. Lease receivables consist of arrangements with terms of four years on average, while loan receivables generally have terms of up to three years. The financed service contracts and other category includes financing receivables related to technical support and advanced services, as well as receivables related to financing of certain indirect costs associated with leases. Revenue related to the technical support services is typically deferred and included in deferred service revenue and is recognized ratably over the period during which the related services are to be performed, which typically ranges from one to three years.
A summary of the Company's financing receivables is presented as follows (in millions):
October 25, 2014
Lease
Receivables
 
Loan
Receivables
 
Financed
Service
Contracts and Other
 
Total
Gross
$
3,498

 
$
1,744

 
$
3,071

 
$
8,313

Residual value
234

 
—

 
—

 
234

Unearned income
(223
)
 
—

 
—

 
(223
)
Allowance for credit loss
(248
)
 
(84
)
 
(36
)
 
(368
)
Total, net
$
3,261

 
$
1,660

 
$
3,035

 
$
7,956

Reported as:
 
 
 
 
 
 
 
Current
$
1,496

 
$
827

 
$
1,942

 
$
4,265

Noncurrent
1,765

 
833

 
1,093

 
3,691

Total, net
$
3,261

 
$
1,660

 
$
3,035

 
$
7,956

July 26, 2014
Lease
Receivables
 
Loan
Receivables
 
Financed
Service
Contracts and Other
 
Total
Gross
$
3,532

 
$
1,683

 
$
3,210

 
$
8,425

Residual value
233

 
—

 
—

 
233

Unearned income
(238
)
 
—

 
—

 
(238
)
Allowance for credit loss
(233
)
 
(98
)
 
(18
)
 
(349
)
Total, net
$
3,294

 
$
1,585

 
$
3,192

 
$
8,071

Reported as:
 
 
 
 
 
 
 
Current
$
1,476

 
$
728

 
$
1,949

 
$
4,153

Noncurrent
1,818

 
857

 
1,243

 
3,918

Total, net
$
3,294

 
$
1,585

 
$
3,192

 
$
8,071

As of October 25, 2014 and July 26, 2014, the deferred service revenue related to the financed service contracts and other was $1,672 million and $1,843 million, respectively.
Future minimum lease payments at October 25, 2014 are summarized as follows (in millions):
Fiscal Year
Amount
2015 (remaining nine months)
$
1,303

2016
1,144

2017
681

2018
281

2019
87

Thereafter
2

Total
$
3,498

Actual cash collections may differ from the contractual maturities due to early customer buyouts, refinancings, or defaults.

13
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

(b)
Credit Quality of Financing Receivables
Gross receivables less unearned income categorized by the Company’s internal credit risk rating as of October 25, 2014 and July 26, 2014 are summarized as follows (in millions):
 
INTERNAL CREDIT RISK RATING
October 25, 2014
1 to 4
 
5 to 6
 
7 and Higher
 
Total
Lease receivables
$
1,665

 
$
1,482

 
$
128

 
$
3,275

Loan receivables
953

 
637

 
154

 
1,744

Financed service contracts and other
1,677

 
1,296

 
98

 
3,071

Total
$
4,295

 
$
3,415

 
$
380

 
$
8,090

 
INTERNAL CREDIT RISK RATING
July 26, 2014
1 to 4
 
5 to 6
 
7 and Higher
 
Total
Lease receivables
$
1,615

 
$
1,538

 
$
141

 
$
3,294

Loan receivables
953

 
593

 
137

 
1,683

Financed service contracts and other
1,744

 
1,367

 
99

 
3,210

Total
$
4,312

 
$
3,498

 
$
377

 
$
8,187

The Company determines the adequacy of its allowance for credit loss by assessing the risks and losses inherent in its financing receivables by portfolio segment. The portfolio segment is based on the types of financing offered by the Company to its customers, which consist of the following: lease receivables, loan receivables, and financed service contracts and other.
The Company’s internal credit risk ratings of 1 through 4 correspond to investment-grade ratings, while credit risk ratings of 5 and 6 correspond to non-investment grade ratings. Credit risk ratings of 7 and higher correspond to substandard ratings.
In circumstances when collectibility is not deemed reasonably assured, the associated revenue is deferred in accordance with the Company’s revenue recognition policies, and the related allowance for credit loss, if any, is included in deferred revenue. The Company also records deferred revenue associated with financing receivables when there are remaining performance obligations, as it does for financed service contracts. Total allowances for credit loss and deferred revenue as of October 25, 2014 and July 26, 2014 were $2,054 million and $2,220 million, respectively, and they were associated with total financing receivables before allowance for credit loss of $8,324 million and $8,420 million as of their respective period ends.
The following tables present the aging analysis of gross receivables less unearned income as of October 25, 2014 and July 26, 2014 (in millions):
 
DAYS PAST DUE (INCLUDES BILLED AND UNBILLED)
 
 
 
 
 
 
 
 
October 25, 2014
31-60
 
61-90 
 
91+
 
Total
Past Due
 
Current
 
Total
 
Nonaccrual
Financing
Receivables
 
Impaired
Financing
Receivables
Lease receivables
$
80

 
$
54

 
$
196

 
$
330

 
$
2,945

 
$
3,275

 
$
47

 
$
39

Loan receivables
17

 
41

 
89

 
147

 
1,597

 
1,744

 
41

 
37

Financed service contracts and other
144

 
163

 
532

 
839

 
2,232

 
3,071

 
12

 
7

Total
$
241

 
$
258

 
$
817

 
$
1,316

 
$
6,774

 
$
8,090

 
$
100

 
$
83

 
DAYS PAST DUE (INCLUDES BILLED AND UNBILLED)
 
 
 
 
 
 
 
 
July 26, 2014
31-60
 
61-90 
 
91+
 
Total
Past Due
 
Current
 
Total
 
Nonaccrual
Financing
Receivables
 
Impaired
Financing
Receivables
Lease receivables
$
104

 
$
43

 
$
165

 
$
312

 
$
2,982

 
$
3,294

 
$
48

 
$
41

Loan receivables
2

 
1

 
16

 
19

 
1,664

 
1,683

 
19

 
19

Financed service contracts and other
301

 
238

 
230

 
769

 
2,441

 
3,210

 
12

 
9

Total
$
407

 
$
282

 
$
411

 
$
1,100

 
$
7,087

 
$
8,187

 
$
79

 
$
69

Past due financing receivables are those that are 31 days or more past due according to their contractual payment terms. The data in the preceding tables are presented by contract, and the aging classification of each contract is based on the oldest outstanding receivable, and therefore past due amounts also include unbilled and current receivables within the same contract. The balances

14
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

of either unbilled or current financing receivables included in the category of 91 days plus past due for financing receivables were $661 million and $296 million as of October 25, 2014 and July 26, 2014, respectively.
As of October 25, 2014, the Company had financing receivables of $111 million, net of unbilled or current receivables from the same contract, that were in the category of 91 days plus past due but remained on accrual status. Such balance was $78 million as of July 26, 2014. A financing receivable may be placed on nonaccrual status earlier if, in management’s opinion, a timely collection of the full principal and interest becomes uncertain.
(c)
Allowance for Credit Loss Rollforward
The allowances for credit loss and the related financing receivables are summarized as follows (in millions):
 
CREDIT LOSS ALLOWANCES
Three Months Ended October 25, 2014
Lease
Receivables
 
Loan
Receivables
 
Financed Service
Contracts and Other
 
Total
Allowance for credit loss as of July 26, 2014
$
233

 
$
98

 
$
18

 
$
349

Provisions
22

 
(13
)
 
19

 
28

Recoveries (write-offs), net
(4
)
 
1

 
—

 
(3
)
Foreign exchange and other
(3
)
 
(2
)
 
(1
)
 
(6
)
Allowance for credit loss as of October 25, 2014
$
248

 
$
84

 
$
36

 
$
368

Financing receivables as of October 25, 2014 (1)
$
3,509

 
$
1,744

 
$
3,071

 
$
8,324

 
CREDIT LOSS ALLOWANCES
Three Months Ended October 26, 2013
Lease
Receivables
 
Loan
Receivables
 
Financed Service
Contracts and Other
 
Total
Allowance for credit loss as of July 27, 2013
$
238

 
$
86

 
$
20

 
$
344

Provisions
(3
)
 
6

 
—

 
3

Foreign exchange and other
2

 
1

 
—

 
3

Allowance for credit loss as of October 26, 2013
$
237

 
$
93

 
$
20

 
$
350

Financing receivables as of October 26, 2013 (1)
$
3,549

 
$
1,808

 
$
3,018

 
$
8,375

(1) Total financing receivables before allowance for credit loss.
The Company assesses the allowance for credit loss related to financing receivables on either an individual or a collective basis. The Company considers various factors in evaluating lease and loan receivables and the earned portion of financed service contracts for possible impairment on an individual basis. These factors include the Company’s historical experience, credit quality and age of the receivable balances, and economic conditions that may affect a customer’s ability to pay. When the evaluation indicates that it is probable that all amounts due pursuant to the contractual terms of the financing agreement, including scheduled interest payments, are unable to be collected, the financing receivable is considered impaired. All such outstanding amounts, including any accrued interest, will be assessed and fully reserved at the customer level. The Company’s internal credit risk ratings are categorized as 1 through 10, with the lowest credit risk rating representing the highest quality financing receivables.
Typically, the Company also considers receivables with a risk rating of 8 or higher to be impaired and will include them in the individual assessment for allowance. These balances, as of October 25, 2014 and July 26, 2014, are presented under “(b) Credit Quality of Financing Receivables” above.
The Company evaluates the remainder of its financing receivables portfolio for impairment on a collective basis and records an allowance for credit loss at the portfolio segment level. When evaluating the financing receivables on a collective basis, the Company uses expected default frequency rates published by a major third-party credit-rating agency as well as its own historical loss rate in the event of default, while also systematically giving effect to economic conditions, concentration of risk, and correlation.

15
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

(d)
Operating Leases
The Company provides financing of certain equipment through operating leases, and the amounts are included in property and equipment in the Consolidated Balance Sheets. Amounts relating to equipment on operating lease assets and the associated accumulated depreciation are summarized as follows (in millions):
 
October 25, 2014
 
July 26, 2014
Operating lease assets
$
349

 
$
362

Accumulated depreciation
(197
)
 
(202
)
Operating lease assets, net
$
152

 
$
160

Minimum future rentals on noncancelable operating leases at October 25, 2014 were approximately $0.2 billion for the remaining nine months of fiscal 2015, $0.1 billion for fiscal 2016, and less than $0.1 billion per year for each of fiscal 2017 through fiscal 2019.

8.
Investments
(a)
Summary of Available-for-Sale Investments
The following tables summarize the Company’s available-for-sale investments (in millions):
October 25, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Fixed income securities:
 
 
 
 
 
 
 
U.S. government securities
$
32,343

 
$
71

 
$
—

 
$
32,414

U.S. government agency securities
1,338

 
3

 
—

 
1,341

Non-U.S. government and agency securities
1,049

 
2

 
—

 
1,051

Corporate debt securities
10,170

 
73

 
(10
)
 
10,233

U.S. agency mortgage-backed securities
875

 
9

 
—

 
884

Total fixed income securities
45,775

 
158

 
(10
)
 
45,923

Publicly traded equity securities
1,263

 
545

 
(11
)
 
1,797

Total
$
47,038

 
$
703

 
$
(21
)
 
$
47,720

 
 
 
 
 
 
 
 
July 26, 2014
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Fixed income securities:
 
 
 
 
 
 
 
U.S. government securities
$
31,717

 
$
29

 
$
(12
)
 
$
31,734

U.S. government agency securities
1,062

 
1

 
—

 
1,063

Non-U.S. government and agency securities
860

 
2

 
(1
)
 
861

Corporate debt securities
9,092

 
74

 
(7
)
 
9,159

U.S. agency mortgage-backed securities
574

 
5

 
—

 
579

Total fixed income securities
43,305

 
111

 
(20
)
 
43,396

Publicly traded equity securities
1,314

 
648

 
(10
)
 
1,952

Total
$
44,619

 
$
759

 
$
(30
)
 
$
45,348

Non-U.S. government and agency securities include agency and corporate debt securities that are guaranteed by non-U.S. governments.

16
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

(b)
Gains and Losses on Available-for-Sale Investments
The following table presents the gross realized gains and gross realized losses related to the Company’s available-for-sale investments (in millions):
 
Three Months Ended
 
October 25, 2014
 
October 26, 2013
Gross realized gains
$
21

 
$
95

Gross realized losses
(14
)
 
(12
)
Total
$
7

 
$
83

The following table presents the realized net gains (losses) related to the Company’s available-for-sale investments by security type (in millions):
 
Three Months Ended
 
October 25, 2014
 
October 26, 2013
Net gains (losses) on investments in publicly traded equity securities
$
(4
)
 
$
75

Net gains on investments in fixed income securities
11

 
8

Total
$
7

 
$
83

There were no impairment charges on available-for-sale investments for the periods presented.
The following tables present the breakdown of the available-for-sale investments with gross unrealized losses and the duration that those losses had been unrealized at October 25, 2014 and July 26, 2014 (in millions):
 
UNREALIZED LOSSES
LESS THAN 12 MONTHS
 
UNREALIZED LOSSES
12 MONTHS OR GREATER
 
TOTAL
October 25, 2014
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross 
Unrealized 
Losses
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
Corporate debt securities
$
2,491

 
$
(8
)
 
$
383

 
$
(2
)
 
$
2,874

 
$
(10
)
Total fixed income securities
2,491

 
(8
)

383


(2
)

2,874


(10
)
Publicly traded equity securities
131

 
(11
)
 
1

 
—

 
132

 
(11
)
Total
$
2,622

 
$
(19
)
 
$
384

 
$
(2
)
 
$
3,006

 
$
(21
)
 
UNREALIZED LOSSES
LESS THAN 12 MONTHS
 
UNREALIZED LOSSES
12 MONTHS OR GREATER
 
TOTAL
July 26, 2014
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross 
Unrealized 
Losses
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities 
$
7,676

 
$
(12
)
 
$
45

 
$
—

 
$
7,721

 
$
(12
)
Non-U.S. government and agency securities
361

 
(1
)
 
22

 
—

 
383

 
(1
)
Corporate debt securities
1,875

 
(3
)
 
491

 
(4
)
 
2,366

 
(7
)
Total fixed income securities
9,912

 
(16
)
 
558

 
(4
)
 
10,470

 
(20
)
Publicly traded equity securities
132

 
(10
)
 
—

 
—

 
132

 
(10
)
Total
$
10,044

 
$
(26
)
 
$
558

 
$
(4
)
 
$
10,602

 
$
(30
)
As of October 25, 2014, for fixed income securities that were in unrealized loss positions, the Company has determined that (i) it does not have the intent to sell any of these investments, and (ii) it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis. In addition, as of October 25, 2014, the Company anticipates that it will recover the entire amortized cost basis of such fixed income securities and has determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three months ended October 25, 2014.
The Company has evaluated its publicly traded equity securities as of October 25, 2014 and has determined that there was no indication of other-than-temporary impairments in the respective categories of unrealized losses. This determination was based on several factors, which include the length of time and extent to which fair value has been less than the cost basis, the financial

17
Table of Contents
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

condition and near-term prospects of the issuer, and the Company’s intent and ability to hold the publicly traded equity securities for a period of time sufficient to allow for any anticipated recovery in market value.
(c)
Maturities of Fixed Income Securities
The following table summarizes the maturities of the Company’s fixed income securities at October 25, 2014 (in millions): 
 
Amortized Cost
 
Fair Value
Less than 1 year
$
16,643

 
$
16,656

Due in 1 to 2 years
14,222

 
14,270

Due in 2 to 5 years
13,884

 
13,957

Due after 5 years
1,026

 
1,040

Total
$
45,775

 
$
45,923


Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations. The remaining contractual principal maturities for mortgage-backed securities were allocated assuming no prepayments.
(d)
Securities Lending
The Company periodically engages in securities lending activities with certain of its available-for-sale investments. These transactions are accounted for as a secured lending of the securities, and the securities are typically loaned only on an overnight basis. The average daily balance of securities lending for the three months ended October 25, 2014 and October 26, 2013 was $1.0 billion and $0.6 billion, respectively. The Company requires collateral equal to at least 102% of the fair market value of the loaned security and that the collateral be in the form of cash or liquid, high-quality assets. The Company engages in these secured lending transactions only with highly creditworthy counterparties, and the associated portfolio custodian has agreed to indemnify the Company against collateral losses. The Company did not experience any losses in connection with the secured lending of securities during the periods presented. As of October 25, 2014 and July 26, 2014, the Company had no outstanding securities lending transactions.
(e)
Investments in Privately Held Companies
The carrying value of the Company’s investments in privately held companies was included in other assets. For such investments that were accounted for under the equity and cost method as of October 25, 2014 and July 26, 2014, the amounts are summarized in the following table (in millions):
 
October 25, 2014
 
July 26, 2014
Equity method investments
$
559

 
$
630

Cost method investments
327

 
269

Total
$
886

 
$
899

Variable Interest Entities
VCE Joint Venture VCE is a joint venture that the Company formed in fiscal 2010 with EMC Corporation (“EMC”), with investments from VMware, Inc. (“VMware”) and Intel Capital Corporation ("Intel"). VCE helps organizations leverage best-in-class technologies and disciplines from Cisco, EMC, and VMware to enable the transformation to cloud computing.
As of October 25, 2014, the Company’s cumulative gross investment in VCE was approximately $716 million, inclusive of accrued interest on convertible notes, and its ownership percentage was approximately 35%.  The Company did not make any investments in VCE during the three months ended October 25, 2014. As of October 25, 2014, the Company had recorded cumulative losses from VCE under the equity method of $691 million since inception, of which losses of $47 million and $53 million were recorded for the three months ended October 25, 2014 and October 26, 2013, respectively. The Company’s carrying value in VCE as of October 25, 2014 was $25 million.
EMC and the Company have entered into guarantee agreements on behalf of VCE to indemnify certain customers (the "Guarantees") for monetary damages. Such Guarantees were not material as of October 25, 2014.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

In October 2014, the Company, EMC, VMware, and Intel agreed to restructure the VCE joint venture.  Under the terms of the agreement, VCE will undergo a reorganization and recapitalization whereby VCE will pay approximately $150 million to the Company for a portion of the outstanding principal balance of the convertible notes and accrued interest on such notes.  The Company also agreed to cancel the remaining principal balance of the convertible notes held by it and the accrued interest on such notes, and to have VCE redeem a portion of the Company’s equity interest in VCE.   EMC also agreed to indemnify the Company for any liabilities incurred by the Company under the Guarantees. Following this reorganization and recapitalization, the Company’s ownership interest in VCE will be approximately 10%.  The transaction is expected to close in the second quarter of the Company's fiscal year 2015, subject to customary regulatory approvals.
Other Variable Interest Entities In the ordinary course of business, the Company has investments in other privately held companies and provides financing to certain customers. These other privately held companies and customers may be considered to be variable interest entities. The Company evaluates on an ongoing basis its investments in these other privately held companies and its customer financings, and has determined that as of October 25, 2014 there were no other variable interest entities required to be consolidated in the Company’s Consolidated Financial Statements.
9.Fair Value
Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be either recorded or disclosed at fair value, the Company considers the principal or most advantageous market in which it would transact, and it also considers assumptions that market participants would use when pricing the asset or liability.
(a)
Fair Value Hierarchy
The accounting guidance for fair value measurement requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard establishes a fair value hierarchy based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows:
Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.
Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.
Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

(b)
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis as of October 25, 2014 and July 26, 2014 were as follows (in millions):
 
OCTOBER 25, 2014
FAIR VALUE MEASUREMENTS
 
JULY 26, 2014
FAIR VALUE MEASUREMENTS
 
Level 1
 
Level 2
 
Total
Balance
 
Level 1
 
Level 2
 
Level 3
 
Total
Balance
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
2,461

 
$
—

 
$
2,461

 
$
4,935

 
$
—

 
$
—

 
$
4,935

Available-for-sale investments:
 
 
 
 
 
 
 
 
 
 
 
 

U.S. government securities
—

 
32,414

 
32,414

 
—

 
31,734

 
—

 
31,734

U.S. government agency securities
—

 
1,341

 
1,341