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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 JANUARY 29, 2000
OR
[ ] 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 (I.R.S. Employer Identification
incorporation or organization) 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 filing requirements
for the past 90 days.
YES [X] NO [ ]
As of February 25, 2000, 3,468,815,049 shares of the Registrant's common stock
were outstanding.
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CISCO SYSTEMS, INC.
FORM 10-Q FOR THE QUARTER ENDED JANUARY 29, 2000
INDEX
Page
Facing sheet 1
Index 2
Part I. Financial Information
Item 1. Financial Statements
a) Consolidated statements of operations for the three and six months 3
ended January 29, 2000 and January 23, 1999
b) Consolidated balance sheets at January 29, 2000 and 4
July 31, 1999
c) Consolidated statements of cash flows for the six months ended 5
January 29, 2000 and January 23, 1999
d) Notes to consolidated financial statements 6
Item 2. Management's Discussion and Analysis of Financial 18
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 38
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds 39
Item 6. Exhibits and Reports on Form 8-K 40
Signature 41
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
Three Months Ended Six Months Ended
--------------------- ---------------------
January 29, January 23, January 29, January 23,
2000 1999 2000 1999
------ ------ ------ ------
(Unaudited) (Unaudited)
Net sales $4,350 $2,845 $8,264 $5,443
Cost of sales 1,536 988 2,923 1,885
------ ------ ------ ------
Gross margin 2,814 1,857 5,341 3,558
Operating expenses:
Research and development 598 372 1,135 711
Sales and marketing 924 576 1,737 1,096
General and administrative 143 82 253 159
Amortization of goodwill and
purchased intangible assets 47 12 71 23
Purchased research and
development 43 349 424 390
------ ------ ------ ------
Total operating expenses 1,755 1,391 3,620 2,379
------ ------ ------ ------
Operating income 1,059 466 1,721 1,179
Interest and other income, net 151 79 253 146
------ ------ ------ ------
Income before provision for
income taxes 1,210 545 1,974 1,325
Provision for income taxes 385 263 729 534
------ ------ ------ ------
Net income $ 825 $ 282 $1,245 $ 791
====== ====== ====== ======
Net income per share--basic $ .24 $ .09 $ .37 $ .24
====== ====== ====== ======
Net income per share--diluted $ .23 $ .08 $ .34 $ .23
====== ====== ====== ======
Shares used in per-share
calculation--basic 3,413 3,274 3,401 3,251
====== ====== ====== ======
Shares used in per-share
calculation--diluted 3,648 3,486 3,629 3,453
====== ====== ====== ======
See notes to consolidated financial statements
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CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
January 29, July 31,
2000 1999
------- -------
(Unaudited)
ASSETS
Current assets:
Cash and equivalents $ 3,719 $ 886
Short-term investments 249 1,189
Accounts receivable, net of allowance for doubtful
accounts of $29 at January 29, 2000 and
$27 at July 31, 1999 1,711 1,249
Inventories, net 695 656
Deferred tax assets 711 571
Prepaid expenses and other current assets 637 170
------- -------
Total current assets 7,722 4,721
Investments 9,819 7,032
Restricted investments 1,107 1,080
Property and equipment, net 1,004 822
Other assets, net 1,739 1,191
------- -------
Total assets $21,391 $14,846
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 482 $ 372
Income taxes payable 595 630
Accrued payroll and related expenses 814 679
Other accrued liabilities 1,887 1,353
------- -------
Total current liabilities 3,778 3,034
Deferred tax liabilities 1,045 --
Minority interest 45 44
Shareholders' equity:
Preferred stock, no par value, 5 shares authorized:
none issued or outstanding at January 29, 2000
and July 31, 1999
Common stock and additional paid-in capital,
$0.001 par value, 10,000 shares authorized:
3,445 shares issued and outstanding at
January 29, 2000 and 3,374 at July 31, 1999 7,691 5,665
Retained earnings 7,011 5,805
Accumulated other comprehensive income 1,821 298
------- -------
Total shareholders' equity 16,523 11,768
------- -------
Total liabilities and shareholders' equity $21,391 $14,846
======= =======
See notes to consolidated financial statements
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CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Six Months Ended
------------------------
January 29, January 23,
2000 1999
------- -------
(Unaudited)
Cash flows from operating activities:
Net income $ 1,245 $ 791
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 308 229
Deferred income taxes (106) (107)
Tax benefits from employee stock plans 697 398
Adjustments to conform fiscal year end of pooled acquisitions (18) 1
Purchased research and development from acquisitions 424 298
Change in operating assets and liabilities:
Accounts receivable (461) (175)
Inventories (38) (114)
Prepaid expenses and other current assets (43) (68)
Income taxes payable (35) 50
Accounts payable 91 96
Accrued payroll and related expenses 132 119
Other accrued liabilities 519 172
------- -------
Net cash provided by operating activities 2,715 1,690
------- -------
Cash flows from investing activities:
Purchases of short-term investments (417) (309)
Proceeds from sales and maturities of short-term
investments 1,227 890
Purchases of investments (5,988) (1,895)
Proceeds from sales and maturities of investments 5,800 970
Purchases of restricted investments (158) (496)
Proceeds from sales and maturities of restricted
investments 123 251
Acquisition of property and equipment (411) (282)
Acquisition of businesses, net of cash acquired and
purchased research and development (11) (19)
Increase in lease receivables (262) (137)
Other (433) (128)
------- -------
Net cash used in investing activities (530) (1,155)
------- -------
Cash flows from financing activities:
Issuance of common stock 642 376
Other 6 11
------- -------
Net cash provided by financing activities 648 387
------- -------
Net increase in cash and equivalents 2,833 922
Cash and equivalents, beginning of period 886 609
------- -------
Cash and equivalents, end of period $ 3,719 $ 1,531
======= =======
See notes to consolidated financial statements
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Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS
Cisco Systems, Inc. ("Cisco" or the "Company") is the worldwide leader in
networking for the Internet. Cisco hardware, software, and service offerings are
used to create Internet solutions so that individuals, companies, and countries
have seamless access to information - regardless of differences in time and
place. Cisco solutions provide competitive advantage to our customers through
more efficient and timely exchange of information, which in turn leads to cost
savings, process efficiencies, and closer relationships with their customers,
prospects, business partners, suppliers, and employees. These solutions form the
networking foundation for companies, universities, utilities, and government
agencies worldwide.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
The Company's fiscal year is the 52- or 53-week period ending on the last
Saturday in July. Fiscal year 2000 is a 52-week year while fiscal 1999 was a
53-week year.
Basis of Presentation
All historical financial information has been restated to reflect the
acquisitions of StratumOne Communications, Inc.("StratumOne") and TransMedia
Communications, Inc.("TransMedia") in the first quarter of fiscal 2000 and
Cerent Corporation ("Cerent") and WebLine Communications Corporation ("Webline")
in the second quarter of fiscal 2000 which were accounted for as poolings of
interests. In addition, the historical financial information has been restated
to reflect the acquisition of Fibex Systems which was completed in the fourth
quarter of 1999 and accounted for as a pooling of interests.
The accompanying financial data as of January 29, 2000 and for the three and six
months ended January 29, 2000 and January 23, 1999, has been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission ("SEC"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or
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omitted pursuant to such rules and regulations. The July 31, 1999 balance sheet
was derived from audited financial statements, but does not include all
disclosures required by generally accepted accounting principles. 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/A for the year ended July
31, 1999 and Current Report on Form 8-K/A filed February 3, 2000.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position as of
January 29, 2000, results of operations for the three and six months ended
January 29, 2000 and January 23, 1999, and cash flows for the six months ended
January 29, 2000 and January 23, 1999 have been made. The results of operations
for the three and six months ended January 29, 2000 are not necessarily
indicative of the operating results for the full year.
Computation of Net Income Per Common Share
Basic net income per common share is computed using the weighted average number
of common shares outstanding during the period. Diluted net income per share is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist primarily of stock options.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. Management does not believe this will have a
material effect on the Company's operations or financial position.
Implementation of this standard has recently been delayed by the FASB for a
twelve-month period. The Company will now be required to adopt SFAS 133 for its
first quarterly filing of fiscal 2001.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the
SEC's views in applying generally
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accepted accounting principles to revenue recognition in financial statements.
The Company is required to adopt SAB 101 in the first quarter of fiscal 2001.
Management does not expect the adoption of SAB 101 to have a material effect on
the Company's operations or financial position.
3. BUSINESS COMBINATIONS
Purchase Combinations
The Company has made a number of purchase acquisitions. The consolidated
financial statements include the operating results of each business from the
date of acquisition. Pro forma results of operations have not been presented
because the effects of these acquisitions were not material on either an
individual or an aggregate basis.
The amounts allocated to purchased research and development expense were
determined through established valuation techniques in the high-technology
communications industry and were expensed upon acquisition because technological
feasibility had not been established and no future alternative uses existed.
Research and development costs to bring the products from the acquired companies
to technological feasibility are not expected to have a material impact on the
Company's future results of operations or cash flows. Amounts allocated to
goodwill and purchased intangible assets are amortized on a straight-line basis
over periods not exceeding five years.
In September 1999, the Company completed its purchase of Monterey Networks, Inc.
("Monterey"), a developer of infrastructure-class, optical cross-connect
technology that is used to increase network capacity at the core of an optical
network. The Company's acquired technology consists of one product currently
under development which will result in a wavelength router that would
intelligently route signals over long-haul optical pipes created by dense wave
division multiplexing ("DWDM"). Also in September 1999, the Company completed
its purchase of MaxComm Technologies, Inc. ("MaxComm"), a developer of broadband
Internet technology that brings data and multiple voice lines to consumers. The
Company's acquired technology consists of one product currently under
development which will allow the end user to create an easily adaptable home
local area network utilizing their existing in-home wiring to support up to four
separate phone lines with different numbers.
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In November 1999, the Company completed its purchase of Calista Inc. ("Calista")
and Tasmania Network Systems, Inc. ("Tasmania"). Calista is a developer of
Internet technology that allows different business phone systems to work
together over an open Internet-based infrastructure. The Company's acquired
technology consists of one product currently under development which will link
up telecommuters or branch office phones to the corporate PBX over the Internet
or intranet. Tasmania is a leading developer of network caching software
technology. The Company's acquired technology consists of one product currently
under development which will improve the performance of cache technology.
In December 1999, the Company acquired Internet Engineering Group, LLC ("IEng")
and Worldwide Data Systems, Inc. ("Worldwide"). IEng is a developer of
high-performance software to enable service providers to build next-generation
high speed networks. Worldwide is a leader in consulting and engineering
services for the convergence of data and voice networks.
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Each of the completed purchase acquisition transactions is further outlined
below:
Summary of purchase transactions (in millions):
Purchased
Research &
Development Form of Consideration and Other
Entity Name Consideration Charge Notes to Acquisition
----------- ------------- ------ --------------------
Fiscal 2000
Monterey $517 $354 Common stock and options
assumed; $14 in liabilities
assumed; goodwill and other
intangibles recorded of $154
MaxComm $ 73 $ 27 Common stock and options
assumed; goodwill and other
intangibles recorded of $41
Calista $ 57 $ 28 Common stock and options
assumed; $3 in liabilities
assumed; goodwill and other
intangibles recorded of $34
Tasmania $ 26 $ 15 Common stock; goodwill and
other intangibles recorded of
$13
Total purchased research and development expense for the six months ended
January 29, 2000 and January 23, 1999 was $424 million and $390 million,
respectively. The purchased research and development expense for the six months
ended January 29, 2000 was attributable to stock consideration. The purchased
research and development expense that was attributable to stock consideration
for the six months ended January 23, 1999 was $298 million. The purchased
research and development expense attributable to a cash purchase
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transaction for the six months ended January 23, 1999 was $92 million.
Poolings of Interests Combinations
In September 1999, the Company acquired StratumOne, a developer of highly
integrated, high-performance semiconductor technology, and TransMedia, a
provider of Media Gateway technology that unites the multiple networks of public
voice communications. Under the terms of the agreements, approximately 12.3
million shares of common stock were issued to acquire StratumOne and TransMedia,
and options to purchase an additional 1.4 million shares were assumed. Also in
September 1999, the Company acquired Cocom A/S, ("Cocom"), an European developer
of high-speed Internet access solutions over cable, satellite, and wireless
networks based on international standards. Under the terms of the agreement,
approximately 1.0 million shares of common stock were issued to acquire Cocom.
Based on the shares of common stock and options exchanged, the values of the
acquisitions were approximately $435 million, $407 million, and $66 million for
StratumOne, Transmedia, and Cocom, respectively.
In November 1999, the Company completed the acquisitions of Cerent and Webline.
Cerent is a developer of next-generation optical transport products, and Webline
is a provider of customer interaction management software for Internet customer
service and e-commerce. Under the terms of the agreements, approximately 98.1
million and 3.7 million shares of common stock were issued to acquire Cerent and
Webline, respectively. The Company also assumed outstanding options that were
converted into options to purchase approximately 1.8 million shares and 0.6
million shares of the Company's common stock for Cerent and Webline,
respectively. Based on the shares of common stock and options exchanged, the
values of the acquisitions were approximately $6.9 billion and $325 million for
Cerent and Webline, respectively.
In December 1999, the Company acquired V-Bits, Inc. ("V-Bits"), a provider of
standards-based digital video processing systems for cable television service
providers. Under the terms of the agreement, approximately 1.4 million shares of
common stock and options were exchanged to acquire V-Bits. Based on the shares
of common stock and options exchanged, the value of the acquisition was
approximately $128 million.
All historical financial information contained herein has been restated to
reflect the acquisitions of StratumOne, TransMedia, Cerent, and Webline. The
historical operations of Cocom and V-Bits
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were not material to the Company's consolidated operations, therefore prior
period statements have not been restated for these acquisitions.
Acquisitions Pending or Completed After January 29, 2000
In November 1999, the Company announced a definitive agreement to acquire
Aironet Wireless Communications, Inc. ("Aironet") for approximately $799 million
payable in common stock. Aironet is a leading developer of standards-based, high
speed wireless local area network products ("LAN"). The Aironet acquisition is
expected to be completed in the third quarter of fiscal 2000. In December 1999,
the Company announced a definitive agreement to acquire the optical systems
business of Pirelli S.p.A of Milan, Italy ("Pirelli") for an aggregate amount of
up to $2.15 billion payable in common stock, of which a portion is contingent on
revenue targets and other performance milestones. Pirelli is a recognized
innovator in both optical component technology and optical systems for service
providers. The Company completed the acquisition of Pirelli in February 2000.
Aironet and Pirelli will be accounted for as purchases.
In March 2000, the Company announced a definitive agreement to acquire Atlantech
Technologies ("Atlantech") for approximately $180 million payable in common
stock. Atlantech is a leading provider of network element management software,
which is designed to help configure and monitor network hardware. Atlantech will
be accounted for as a purchase.
In January and February 2000, the Company announced definitive agreements to
acquire Altiga Networks ("Altiga"), Compatible Systems ("Compatible"), and
Growth Networks Inc. ("Growth") for an aggregate of approximately $922 million
payable in common stock. The acquisitions of Altiga and Compatible enhance the
Company's New World Virtual Private Networks offerings by providing customers
with industry-leading remote access and extranet solutions. Growth is a market
leader in Internet switching fabrics, a new category of networking silicon.
Altiga, Compatible and Growth will be accounted for as poolings of interests.
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4. BALANCE SHEET DETAIL
(In millions)
Inventories, net: January 29, July 31,
2000 1999
------- -------
(Unaudited)
Raw materials $ 91 $ 143
Work in process 263 198
Finished goods 280 280
Demonstration systems 61 35
------- -------
Total $ 695 $ 656
======= =======
Other Assets, net: January 29, July 31,
2000 1999
------- -------
(Unaudited)
Goodwill-gross $ 374 $ 157
Purchased intangible assets-gross 763 395
Less: Accumulated amortization (175) (92)
------- -------
Intangibles, net 962 460
Investments in nonpublic companies 351 179
Net investment in leases 212 500
Other assets 214 52
------- -------
Total $ 1,739 $ 1,191
======= =======
Amortization expense for the three months ended January 29, 2000 and January 23,
1999 was $53 million and $12 million, respectively. Amortization expense for the
six months ended January 29, 2000 and January 23, 1999 was $83 million and $23
million, respectively. The following table presents the details of the
amortization expense as reported in the consolidated statements of operations
(in millions):
Three Months Six Months
Ended Ended
------------------ ------------------
January 29, January 23, January 29, January 23,
2000 1999 2000 1999
--- --- --- ---
(Unaudited) (Unaudited)
Reported as:
Cost of sales $ 6 $-- $12 $--
Operating expenses 47 12 71 23
--- --- --- ---
Total amortization expense $53 $12 $83 $23
=== === === ===
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5. COMPREHENSIVE INCOME
The following table presents the calculation of comprehensive income as required
by SFAS No. 130. Comprehensive income has no impact on the Company's net income,
balance sheet, or shareholders' equity. The components of comprehensive income,
net of tax, are as follows (in millions):
Three Months Six Months
Ended Ended
--------------------------- --------------------------
January 29, January 23, January 29, January 23,
2000 1999 2000 1999
------- ------- ------- -------
(Unaudited) (Unaudited)
Net income $ 825 $ 282 $ 1,245 $ 791
Other comprehensive
income (loss):
Change in unrealized gain
on investments, net 999 74 1,519 91
Change in accumulated
translation adjustments (2) - 4 11
------- ------- ------- -------
Total comprehensive income $ 1,822 $ 356 $ 2,768 $ 893
======= ======= ======= =======
6. INCOME TAXES
The Company paid income taxes of $174 million and $184 million for the six
months ended January 29, 2000 and January 23, 1999, respectively. The Company's
income taxes currently payable for federal, state, and foreign purposes have
been reduced by the tax benefit from stock option transactions. The benefit
totaled $697 million and $398 million for the six months ended January 29, 2000
and January 23, 1999, respectively, and was credited directly to shareholders'
equity.
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7. SHAREHOLDERS' EQUITY AND STOCK SPLIT
On November 10, 1999, the shareholders of the Company approved an increase to
the authorized number of shares of common stock from 5.4 billion to 10 billion
shares.
Cisco's Board of Directors authorized the splitting of the Company's common
stock on a two-for-one basis for shareholders of record on February 22, 2000.
Shares resulting from the split are expected to be distributed by the transfer
agent on March 22, 2000. All share and per-share numbers contained herein do not
reflect this stock split.
8. SEGMENT INFORMATION AND MAJOR CUSTOMERS
The Company's operations involve the design, development, manufacturing,
marketing, and technical support of networking products and services. The
Company offers end-to-end networking solutions for its customers. Cisco products
include routers, LAN and ATM switches, dialup access servers, and network
management software. These products, integrated by the Cisco IOS(R) software,
link geographically dispersed LANs, WANs, and IBM networks.
The Company conducts business globally and is managed geographically. The
Company's management relies on an internal management accounting system which
provides sales and standard cost information by geographic theater. Sales are
attributed to a theater based on the ordering location of the customer. The
Company's management makes financial decisions and allocates resources based on
the information it receives from this internal system. The Company does not
allocate marketing, engineering, or administrative expenses to geographical
segments as management does not use this information to measure the performance
of the operating segments. Management does not believe that allocating these
expenses is material in evaluating a geographical segment's performance.
Information from this internal management system differs from the amounts
reported under generally accepted accounting principles due to certain corporate
level adjustments. These corporate level adjustments are primarily sales
adjustments related to credit memos and returns. Based on the criteria set forth
in SFAS No. 131, the Company has four reportable segments: the Americas, EMEA,
Asia/Pacific, and Japan.
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Summarized financial information by segment for the three and six months ended
January 29, 2000 and January 23, 1999, as taken from the internal management
information system discussed above, is as follows (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 29, January 23, January 23, January 23,
2000 1999 2000 1999
------- ------- ------- -------
(Unaudited) (Unaudited)
Net Sales:
U.S./Americas $ 2,872 $ 1,885 $ 5,530 $ 3,672
EMEA 1,082 759 2,102 1,424
Asia/Pacific 351 186 634 350
Japan 182 158 339 284
Sales adjustments (137) (143) (341) (287)
------- ------- ------- -------
Total - Net Sales $ 4,350 $ 2,845 $ 8,264 $ 5,443
======= ======= ======= =======
Standard Margin:
U.S./Americas $ 2,113 $ 1,361 $ 4,050 $ 2,665
EMEA 801 570 1,566 1,055
Asia/Pacific 259 134 467 257
Japan 144 123 269 217
Sales adjustments (137) (143) (341) (287)
Production overhead (106) (61) (189) (117)
Manufacturing variances
and other related costs (260) (127) (481) (232)
------- ------- ------- -------
Total - Gross Margin $ 2,814 $ 1,857 $ 5,341 $ 3,558
======= ======= ======= =======
The standard margins by geographical segment differ from the amounts recognized
under generally accepted accounting principles because the Company does not
allocate certain sales adjustments, production overhead, and manufacturing
variances and other related costs to the segments. The above table reconciles
the net sales and standard margins by geographic segment to net sales and gross
margins as reported in the consolidated statements of operations by including
such adjustments.
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The following table presents external net sales for groups of similar products
and services (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 29, January 23, January 29, January 23,
2000 1999 2000 1999
------- ------- ------- -------
(Unaudited) (Unaudited)
Routers $ 1,688 $ 1,285 $ 3,286 $ 2,442
Switches 1,695 1,188 3,267 2,317
Access 507 256 982 463
Other 597 259 1,070 508
Sales adjustments (137) (143) (341) (287)
------- ------- ------- -------
Total - Net Sales $ 4,350 $ 2,845 $ 8,264 $ 5,443
======= ======= ======= =======
Substantially all of the Company's assets at January 29, 2000 and July 31, 1999
were attributable to U.S. operations. No single customer accounted for 10% or
more of total revenue during the three or six months ended January 29, 2000 and
January 23, 1999.
9. NET INCOME PER COMMON SHARE
The following table presents the calculation of basic and diluted earnings per
share (in millions, except per-share amounts):
Three Months Ended Six Months Ended
------------------------ ------------------------
January 29, January 23, January 29, January 23,
2000 1999 2000 1999
------ ------ ------ ------
(Unaudited) (Unaudited)
Numerator:
Net income $ 825 $ 282 $1,245 $ 791
====== ====== ====== ======
Denominator:
Weighted average shares--basic 3,413 3,274 3,401 3,251
Effect of dilutive securities:
Employee stock options 235 212 228 202
------ ------ ------ ------
Weighted average share--diluted 3,648 3,486 3,629 3,453
====== ====== ====== ======
Net income per share--basic $ .24 $ .09 $ .37 $ .24
====== ====== ====== ======
Net income per share--diluted $ .23 $ .08 $ .34 $ .23
====== ====== ====== ======
10. SUBSEQUENT EVENTS
On January 31, 2000, the Company invested approximately $1 billion in
mandatorily redeemable convertible preferred stock of KPMG Consulting, Inc., a
privately held subsidiary of KPMG LLP. KPMG Consulting, Inc. is a provider of
Internet integration services.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
All historical financial information has been restated to reflect the
acquisitions of StratumOne Communications, Inc. and TransMedia Communications,
Inc. in the first quarter of fiscal 2000 and Cerent Corporation and WebLine
Communications Corporation in the second quarter of fiscal 2000 which were
accounted for as poolings of interests. In addition, the historical financial
information has been restated to reflect the acquisition of Fibex Systems which
was completed in the fourth quarter of fiscal 1999 and accounted for as a
pooling of interests.
Certain statements contained in this Quarterly Report on Form 10-Q, including,
without limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," and words of similar import, constitute "forward-looking
statements." You should not place undue reliance on these forward-looking
statements. Our actual results could differ materially from those anticipated in
these forward-looking statements for many reasons, including the risks faced by
us described below and elsewhere in this Quarterly Report, and in other
documents we file with the Securities and Exchange Commission.
Net sales grew to $4.35 billion in the second quarter of fiscal 2000 from $2.85
billion in the second quarter of fiscal 1999. Net sales for the first six months
of fiscal 2000 were $8.26 billion, compared with $5.44 billion for the first six
months of fiscal 1999. The 52.9% increase in net sales between the two
three-month periods and the 51.8% increase in net sales between the two
six-month periods were primarily a result of increasing unit sales of LAN
switching products such as the Catalyst(R) 3500 and 6000 families and the
Catalyst 2900 series of switches for smaller enterprise networks, the Cisco
12000 gigabit switch router ("GSR"), access servers such as the Cisco 2600 and
3600 families, growth in the sales of add-on boards that provide increased
functionality, and increased maintenance service contract sales. The sales
growth rate for lower-priced access and switching
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products targeted toward small and medium-sized businesses has increased faster
than that of our high-end core router products. Additionally, sales of some of
our more established product lines such as the Catalyst 5000, Cisco 2500 and
Cisco 4000 product families have decreased as a percentage of total revenue.
Sales in the second quarter of fiscal 2000 grew 52.4% in the Americas, 42.6% in
EMEA, 88.7% in Asia/Pacific and 15.2% in Japan compared to the second quarter of
fiscal 1999. Sales in the first six months of fiscal 2000 grew 50.6% in the
Americas, 47.6% in EMEA, 81.1% in Asia/Pacific and 19.4% in Japan compared to
the first six months of fiscal 1999 (See Note 8 to the consolidated financial
statements). Market demand and deployment of Internet technologies and business
solutions, as well as the overall economic health within these regions, are
primarily driving the strong growth in the Americas, EMEA, and Asia/Pacific. The
slower growth in Japan can be attributed to continued weaker economic conditions
and delayed government spending.
Gross margins decreased to 64.7% in the second quarter of fiscal 2000 from 65.3%
in the second quarter of fiscal 1999. Gross margins decreased to 64.6% in the
first six months of fiscal 2000 from 65.4% in the first six months of fiscal
1999. Standard margins for the Americas, EMEA, Asia/Pacific and Japan were
73.6%, 74.0%, 73.8%, and 79.1%, respectively, for the second quarter of fiscal
2000 compared to 72.2%, 75.1%, 72.0%, and 77.8%, respectively, for the second
quarter of fiscal 1999. Standard margins for the Americas, EMEA, Asia/Pacific
and Japan were 73.2%, 74.5%, 73.7%, and 79.4%, respectively, for the first six
months of fiscal 2000 compared to 72.6%, 74.1%, 73.4%, and 76.4%, respectively,
for the first six months of fiscal 1999 (see Note 8 to the consolidated
financial statements). The standard margins by geographical segment differ from
the amounts recognized under generally accepted accounting principles because
the Company does not allocate certain sales adjustments, production overhead,
and manufacturing variances and other related costs to the segments. Standard
margins for the Americas, where 66.0% and 66.9% of our revenues were derived in
the second quarter and the first six months of fiscal 2000, respectively,
increased by 1.4% and 0.6%, respectively, compared to the same periods in fiscal
1999. Standard margins for EMEA, where 24.9% and 25.4% of our revenues were
derived in the second quarter and the first six months of fiscal 2000,
respectively, decreased by 1.1% and increased by 0.4%, respectively, compared to
the same periods in fiscal 1999. The changes in standard margins for the
Americas and EMEA were due to a shift in revenue mix and the timing of when
certain sales adjustments are applied to geographical theatres. The decrease in
the overall gross margin was primarily due to our continued shift in revenue mix
towards our lower-margin
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products, other production related costs, and the continued pricing pressure
seen from competitors in certain product areas. The prices of component parts
have fluctuated in the recent past, and we expect that this trend may continue.
An increase in the price of component parts may have a material adverse impact
on gross margins. We expect that gross margins will continue to decrease in the
future, because we believe that the market for lower-margin remote access and
switching products for small to medium-sized businesses will continue to
increase at a faster rate than the market for our higher-margin router and
high-performance switching products. Additionally, as we focus on new market
opportunities, we face increasing competitive pressure from large
telecommunications equipment suppliers and well funded start-up companies, which
may materially adversely affect gross margins. We are attempting to mitigate
this trend through various means, such as increasing the functionality of our
products, continued value engineering, controlling royalty costs, and improving
manufacturing efficiencies. There can be no assurance that any efforts made by
us in these and other areas will successfully offset decreasing margins.
Research and development expenses increased by $226 million in the second
quarter of fiscal 2000 over the second quarter of fiscal 1999, an increase to
13.7% from 13.1% of net sales. Research and development expenses increased by
$424 million in the first six months of fiscal 2000 over the first six months of
fiscal 1999, an increase to 13.7% from 13.1% of net sales. The increases reflect
our ongoing research and development efforts in a wide variety of areas such as
voice, video, and data integration, Digital Subscriber Line ("DSL")
technologies, cable modem technology, wireless access, dial access, enterprise
switching, optical transport, security, network management, and high-end routing
technologies, among others. A significant portion of the increase was due to the
addition of new personnel, partly through acquisitions, as well as higher
expenditures on prototypes and depreciation on additional lab equipment. For the
near future, research and development expenses are expected to increase at a
rate similar to or slightly greater than the sales growth rate, as we invest in
technology to address potential market opportunities. We also continue to
purchase technology in order to bring a broad range of products to the market in
a timely fashion. If we believe that we are unable to enter a particular market
in a timely manner with internally developed products, we may license technology
from other businesses or acquire other businesses as an alternative to internal
research and development. All of our research and development costs are expensed
as incurred.
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Sales and marketing expenses increased by $348 million in the second quarter of
fiscal 2000 over the second quarter of fiscal 1999, an increase to 21.2% from
20.2% of net sales. Sales and marketing expenses increased by $641 million in
the first six months of fiscal 2000 over the first six months of fiscal 1999, an
increase to 21.0% from 20.1% of net sales. The increases were principally due to
an increase in the size of our direct sales force and related commissions,
additional marketing and advertising investments associated with the
introduction of new products, the expansion of distribution channels, and
general corporate branding. The increases also reflect our efforts to invest in
certain key areas such as expansion of our end-to-end strategy and service
provider coverage in order to position ourselves to take advantage of future
market opportunities.
General and administrative expenses increased by $61 million in the second
quarter of fiscal 2000 over the second quarter of fiscal 1999, an increase to
3.3% from 2.9% of net sales. General and administrative expenses increased by
$94 million in the first six months of fiscal 2000 over the first six months of
fiscal 1999, an increase to 3.1% from 2.9% of net sales. General and
administrative expenses for the three and six months ended January 29, 2000
include acquisition related costs of approximately $25 million. Excluding the
acquisition related costs, the increases in general and administrative expenses
as a percentage of sales primarily relate to the addition of new personnel and
higher depreciation expense. It is management's intent to keep general and
administrative costs relatively constant as a percentage of net sales; however,
this is dependent upon the level of acquisition activity and our growth, among
other factors.
Amortization of goodwill and purchased intangible assets increased by $35
million in the second quarter of fiscal 2000 compared to the second quarter of
fiscal 1999. Amortization of goodwill and purchased intangible assets increased
by $48 million in the first six months of fiscal 2000 compared to the first six
months of fiscal 1999. Amortization of goodwill and purchased intangible assets
includes the amortization of goodwill and other purchased intangible assets
relating to various purchase acquisitions (See Note 4 to the consolidated
financial statements).
The amounts expensed to purchased research and development in the first six
months of fiscal 2000 arose from the completed acquisitions of Monterey,
MaxComm, Calista, and Tasmania (See Note 3 to the consolidated financial
statements).
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The fair value of the existing products and patents as well as the technology
currently under development was determined by using the income approach, which
discounts expected future cash flows to present value. The discount rates used
in the present value calculations were typically derived from a weighted average
cost of capital analysis and venture capital surveys, adjusted upward to reflect
additional risks inherent in the development life cycle. These risk factors have
increased the overall discount rate between 5% to 20% for acquisitions in the
current period. We consider the pricing model for products related to these
acquisitions to be standard within the high-technology communications industry.
We do not expect to achieve a material amount of expense reductions or synergies
as a result of integrating the acquired in-process technology. Therefore, the
valuation assumptions do not include anticipated cost savings. We expect that
products incorporating the acquired technology from these acquisitions will be
completed and begin to generate cash flows over the six to nine months after
integration. However, development of these technologies remains a significant
risk to us due to the remaining effort to achieve technical viability, rapidly
changing customer markets, uncertain standards for new products, and significant
competitive threats from numerous companies. The nature of the efforts to
develop the acquired technology into commercially viable products consists
principally of planning, designing, and testing activities necessary to
determine that the product can meet market expectations, including functionality
and technical requirements. Failure to bring these products to market in a
timely manner could result in a loss of market share, or a lost opportunity to
capitalize on emerging markets, and could have a material adverse impact on our
business and operating results.
Regarding our purchase acquisitions completed in fiscal 1999, actual results to
date have been consistent, in all material respects, with the assumptions at the
time of the acquisitions as they relate to the value of purchased in-process
research and development. The assumptions primarily consist of an expected
completion date for the in-process projects, estimated costs to complete the
projects, and revenue and expense projections once the products have entered the
market. Products from these acquisitions are being introduced to the market six
to nine months after the acquisition. Shipment volumes of products from acquired
technologies are not material to our overall position at the present time,
therefore, it is difficult to determine the accuracy of overall revenue
projections early in the technology or product lifecycle. Failure to achieve the
expected levels of revenues and net income from these products will negatively
impact the return on investment expected at the time that the acquisition was
completed
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and potentially result in impairment of any other assets related to the
development activities.
The following table summarizes the significant assumptions underlying the
valuations in fiscal 2000 and fiscal 1999 and the development costs incurred by
us in the periods after the respective acquisition date (in millions, except
percentages):
Approximate
Acquisition Assumptions Development
---------------------------------- Costs Incurred
Estimated Cost to Date After
to Complete Risk Adjusted Acquisition on
Technology at Discount Acquired
Time of Rate for In- In-Process
Entity Name Acquisition Process R&D Technology
----------- ----------- ----------- ----------
Fiscal 2000
Monterey Networks, Inc. $ 4 30% $ 8
MaxComm Technologies, Inc. $ 2 25% $ 2
Calista Inc. $ 1 37.5%
Tasmania Network Systems, $ 1 45%
Inc.
Fiscal 1999
American Internet Corp. $ 1 25% $ 1
Summa Four, Inc. $ 5 25% $18
Clarity Wireless, Inc. $42 32% $22
Selsius Systems, Inc. $15 31% $13
PipeLinks, Inc. $ 5 31% $18
Amteva Technologies, Inc. $ 4 35% $ 3
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LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents, short-term investments, and investments were $13.8 billion
at January 29, 2000, an increase of $4.7 billion from July 31, 1999. The
increase is primarily a result of unrealized gains on publicly held investments,
cash generated by operations and the exercise of employee stock options. The
cash flows from operating activities were partially offset by cash outflows from
tax payments of approximately $174 million, and cash outflows from investing
activities primarily relating to capital expenditures of approximately $411
million. On January 31, 2000, subsequent to the end of the fiscal quarter, the
Company made a cash investment of approximately $1 billion in KPMG Consulting,
Inc.
Accounts receivable increased 37.0% from July 31, 1999 to January 29, 2000. Days
sales outstanding in receivables increased to 36 days at January 29, 2000 from
32 days at July 31, 1999. Inventory levels remained relatively constant between
the two periods; however, inventory management remains an area of focus as we
balance the need to maintain strategic inventory levels to ensure competitive
lead times versus the risk of inventory obsolescence because of rapidly changing
technology and customer requirements.
At January 29, 2000, we had a line of credit totaling $500 million, which
expires July 2002. There have been no borrowings under this facility.
We have entered into certain lease arrangements in San Jose, California, and
Research Triangle Park, North Carolina, where we have established our
headquarter's operations and certain research and development and customer
support activities. In connection with these transactions, we pledged $1.1
billion of our investments as collateral for certain obligations of the leases.
We anticipate that we will occupy more leased property in the future that will
require similar pledged securities; however, we do not expect the impact of this
activity to be material to liquidity.
We believe that our current cash and equivalents, short-term investments, line
of credit, and cash generated from operations will satisfy our expected working
capital and capital expenditure requirements at least through the next 12
months.
YEAR 2000 READINESS
We have not experienced any known material adverse impacts on our current
products, internal information systems, and noninformation technology systems
(equipment and systems) as a result of the year
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2000 issue. Based on the work done, we have not incurred material costs to
address the year 2000 readiness of our systems (as a result of relatively new
information systems) and products. There can be no assurance that the cost
estimates associated with Year 2000 or leap year date issues will not have a
material adverse effect on our results of operations and financial condition.
RISK FACTORS
Set forth below and elsewhere in this Quarterly Report and in the other
documents we file with the SEC are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the forward
looking statements contained in this Quarterly Report.
YOU SHOULD EXPECT THAT OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS
The results of operations for any quarter are not necessarily indicative of
results to be expected in future periods. Our operating results have in the past
been, and will continue to be, subject to quarterly fluctuations as a result of
a number of factors. These factors include:
- - The integration of people, operations, and products from acquired
businesses and technologies;
- - Increased competition in the networking industry;
- - The overall trend toward industry consolidation;
- - The introduction and market acceptance of new technologies and
standards, including switch routers, Gigabit Ethernet switching, Tag
Switching (currently also known as multiprotocol label switching
["MPLS"]), optical transport and data, voice, and video capabilities;
- - Variations in sales channels, product costs, or mix of products sold;
- - The timing of orders and manufacturing lead times;
- - The trend towards sales of integrated network solutions;
- - Employer payroll taxes to be paid on an employee's gain on stock options
exercised. Such payroll taxes are recorded as operating expenses and
could be material based upon the number of optionees who exercise their
options and the price of our common stock; and
- - Changes in general economic conditions and specific economic conditions
in the computer and networking industries.
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Any of the above factors could have a material adverse impact on our operations
and financial results. For example, from time to time, we have made acquisitions
that result in purchased research and development expenses being charged in an
individual quarter. These charges may occur in any particular quarter resulting
in variability in our quarterly earnings. Additionally, the dollar amounts of
large orders for our products have been increasing and therefore the operating
results for a quarter could be materially adversely affected if a number of
large orders are either not received or are delayed, for example, due to
cancellations, delays, or deferrals by customers.
SINCE OUR GROWTH RATE MAY SLOW, OPERATING RESULTS FOR A PARTICULAR QUARTER ARE
DIFFICULT TO PREDICT
We expect that in the future, our net sales may grow at a slower rate than
experienced in previous periods and that on a quarter-to-quarter basis, our
growth in net sales may be significantly lower than our historical quarterly
growth rate. As a consequence, operating results for a particular quarter are
extremely difficult to predict. Our ability to meet financial expectations could
be hampered if the nonlinear sales pattern seen in past quarters reoccur in
future periods. We generally have had one quarter of the fiscal year when
backlog has been reduced. Although such reductions have not occurred
consistently in recent years, they are difficult to predict and may occur in the
future. In addition, in response to customer demand, we continue to attempt to
reduce our product manufacturing lead times, which 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 net sales and
operating results going forward. On the other hand, for certain products, lead
times are longer than our goal. If we cannot reduce manufacturing lead times for
such products, our customers may cancel orders or not place further orders if
shorter lead times are available from other manufacturers, thus creating
additional variability.
WE EXPECT GROSS MARGINS TO DECLINE OVER TIME
We expect that gross margins may be adversely affected by increases in material
or labor costs, heightened price competition, and changes in channels of
distribution or in the mix of products sold. For example, we believe that gross
margins may decline over time because the markets for lower-margin access
products targeted toward small to medium sized customers have continued to grow
at a faster rate than the markets for our higher-margin router and
high-
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performance switching products targeted toward enterprise and service provider
customers. We have recently introduced several new products, with additional new
products scheduled to be released in the future. If product or related warranty
costs associated with these new products are greater than we have experienced
historically, gross margins may be adversely affected. Our gross margins may
also be impacted by geographic mix, as well as the mix of configurations within
each product group. We continue to expand into third-party or indirect
distribution channels, which generally results in lower gross margins. In
addition, increasing third-party and indirect distribution channels generally
result in greater difficulty in forecasting the mix of our product, and to a
certain degree, the timing of orders from our customers. Downward pressures on
our gross margin may be further impacted by other factors, such as increased
percentage of revenues from service provider markets which may have lower
margins and/or an increase in product costs, which would adversely affect our
future operating results.
We also expect that our operating margins may decrease as we continue to hire
additional personnel and experience increases in overall operating expenses to
support our business. We plan our operating expense levels based primarily on
forecasted revenue levels. Because these expenses are relatively fixed in the
short term, a shortfall in revenue could lead to operating results being below
expectations.
WE COMPETE IN THE HIGHLY COMPETITIVE TELECOMMUNICATIONS EQUIPMENT MARKET
We compete in the telecommunications equipment market, providing solutions for
transporting data, voice, and video traffic across intranets, extranets, and the
Internet. The market is characterized by rapid growth, converging technologies,
and a conversion to new solutions that offer superior advantages. These market
factors represent both an opportunity and a competitive threat to us. We compete
with numerous vendors in each product category. We expect that the overall
number of competitors providing niche product solutions will increase due to the
market's attractive growth. On the other hand, we expect the number of vendors
supplying end-to-end telecommunications solutions will decrease due to the rapid
pace of acquisitions in the industry. Ultimately we believe only a few large
suppliers of end-to-end telecommunication equipment solutions will become our
primary competitors.
Our competitors include, among others, 3Com, Alcatel, Cabletron, Ericsson, IBM,
Juniper, Lucent, Nortel, and Siemens. Some of our
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competitors compete across many of our product lines, while others do not offer
as wide a breadth of solutions. Several of our current and potential competitors
have greater financial, marketing, and technical resources than us.
The principal competitive factors in the markets in which we presently compete
and may compete in the future are:
- price;
- performance;
- the ability to provide end-to-end solutions and support;
- conformance to standards;
- the ability to provide value added features such as security,
reliability, and investment protection; and
- market presence.
We also face competition from customers we license technology to and suppliers
from whom we transfer technology. Networking's inherent nature requires
interoperability. As such, we must cooperate and at the same time compete with
these companies. Our inability to effectively manage these complicated
relationships with customers and suppliers could have a material adverse effect
on our business, operating results, and financial condition.
WE EXPECT TO MAKE FUTURE ACQUISITIONS WHERE ADVISABLE AND ACQUISITIONS INVOLVE
NUMEROUS RISKS
The networking business is highly competitive, and as such, our growth is
dependent upon market growth, our ability to enhance our existing products and
our ability to introduce new products on a timely basis. One of the ways we have
addressed and will continue to address the need to develop new products is
through acquisitions of other companies. Acquisitions involve numerous risks,
including the following:
- - difficulties in integration of the operations, technologies, and
products of the acquired companies;
- - the risk of diverting management's attention from normal daily
operations of the business;
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- - potential difficulties in completing projects associated with purchased
in-process research and development;
- - risks of entering markets in which we have no or limited direct prior
experience and where competitors in such markets have stronger market
positions; and
- - the potential loss of key employees of the acquired company.
Mergers and acquisitions of high-technology companies are inherently risky, 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.
We must also maintain our ability to manage any such growth effectively. Failure
to manage growth effectively and successfully integrate acquisitions we made
could harm our business and operating results.
WE ARE EXPOSED TO FLUCTUATIONS IN THE EXCHANGE RATES OF FOREIGN CURRENCY
As a global concern, we face exposure to adverse movements in foreign currency
exchange rates. These exposures may change over time as business practices
evolve and could have a material adverse impact on our financial results.
Historically, our primary exposures have related to nondollar-denominated sales
in Japan, Canada, and Australia and nondollar-denominated operating expenses in
Europe, Latin America, and Asia where we sell primarily in U.S. dollars.
Additionally, we have recently seen our exposures to emerging market currencies,
such as the Brazilian real, Korean won, and Russian ruble, among others,
increase because of our expanding presence in these markets and the extreme
currency volatility. We will continue to monitor our exposure and may hedge
against these or any other emerging market currencies as necessary.
The increasing use of the euro as a common currency for members of the European
Union could impact our foreign exchange exposure. We are currently hedging
against fluctuations with the euro and will continue to evaluate the impact of
the euro on our future foreign exchange exposure as well as on our internal
systems. At the present time, we hedge only those currency exposures associated
with certain assets and liabilities denominated in nonfunctional currencies and
do not hedge anticipated foreign currency cash flows. The hedging activity
undertaken by us is intended to offset the impact of currency fluctuations on
certain nonfunctional currency assets and liabilities.
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WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS AND TO CREDIT
EXPOSURES IN WEAKENED MARKETS
We are experiencing a greater proportion of our sales activity through our
partners in two-tier distribution channels than we have historically. These
customers are generally given privileges to return inventory, receive credits
for changes in selling prices, and participate in cooperative marketing
programs. We maintain appropriate accruals and allowances for such exposures.
However, such partners tend to have access to more limited financial resources
than other resellers and end-user customers and therefore represent potential
sources of increased credit risk. We are experiencing increased demands for
customer financing and leasing solutions, particularly from competitive local
exchange carriers ("CLECs"). CLECs typically finance significant networking
infrastructure deployments through alternative forms of financing, including
leasing, through us. Although we have programs in place to monitor and mitigate
the associated risk, there can be no assurance that such programs will alleviate
all of our credit risk. We also continue to monitor increased credit exposures
because of the weakened financial conditions in Asia, and other emerging market
regions, and the impact that such conditions may have on the worldwide economy.
Although we have not experienced significant losses due to customers failing to
meet their obligations to date, such losses, if incurred, could harm our
business and have a material adverse effect on our operating results and
financial condition.
WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS
AND IN INTEREST RATES
We maintain investment portfolio holdings of various issuers, types, and
maturities. These securities are generally classified as available for sale and
consequently, are recorded on the balance sheet at fair value with unrealized
gains or losses reported as a separate component of accumulated other
comprehensive income, net of tax. Part of this portfolio includes minority
equity investments in several publicly traded companies, the values of which are
subject to market price volatility. We have also invested in numerous privately
held companies, many of which can still be considered in the startup or
development stages. These investments are inherently risky as the market for the
technologies or products they have under development are typically in the early
stages and may never materialize. We could lose our entire initial investment in
these companies. We also have certain real estate lease commitments with
payments tied to short-term interest rates. At any
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time, a sharp rise in interest rates could have a material adverse impact on the
fair value of our investment portfolio while increasing the costs associated
with our lease commitments. Conversely, declines in interest rates could have a
material impact on interest earnings for our investment portfolio. We do not
currently hedge these interest rate exposures.
Readers are referred to pages 28-29 of our fiscal 1999 Annual Report to
Shareholders for a more detailed discussion of quantitative and qualitative
disclosures about market risk. The following analysis presents the hypothetical
change in fair values of public equity investments that are sensitive to changes
in the stock market. These equity securities are held for purposes other than
trading. The modeling technique used measures the hypothetical change in fair
values arising from selected hypothetical changes in each stock's price. Stock
price fluctuations of plus or minus 15%, plus or minus 35%, and plus or minus
50% were selected based on the probability of their occurrence.
This table estimates the fair value of the publicly traded corporate equities at
a twelve-month time horizon (in millions):
Fair value
Valuation of security as of Valuation of security
given X% decrease in each January 29, given X% increase in each
stock's price 2000 stock's price
---------------------------- ----------- --------------------------
(50%) (35%) (15%) 15% 35% 50%
----- ----- ----- --- --- ---
Corporate Equities $ 1,762 $ 2,290 $ 2,995 $ 3,523 $4,051 $4,756 $5,285
Our equity portfolio consists of securities with characteristics that most
closely match the S&P Index or companies traded on the NASDAQ Exchange. The
NASDAQ Composite Index has occurrence of a 15% movement in all of the last three
years and a 35% and 50% movement in at least one of the last three years.
WE ARE EXPOSED TO UNFAVORABLE ECONOMIC CONDITIONS WORLDWIDE
As a result of recent unfavorable economic conditions, sales to certain
countries in the Pacific Rim, Eastern Europe, and Latin America have declined as
a percentage of our total revenue. If the economic conditions in these markets,
or other markets that recently experienced unfavorable conditions worsen, or if
these unfavorable conditions result in a wider regional or global economic
slowdown, this decline may have a material adverse impact on our business,
operations, and financial condition.
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WE CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC AND FASB
Recent actions and comments from the SEC have indicated they are reviewing the
current valuation methodology of purchased in-process research and development
related to business combinations. The SEC is concerned that some companies are
writing off more of the value of an acquisition than is appropriate. We believe
we are in compliance with all of the rules and related guidance as they
currently exist. However, there can be no assurance that the SEC will not seek
to reduce the amount of purchased in-process research and development previously
expensed by us. This would result in the restatement of our previously filed
financial statements and could have a material adverse effect on our results of
operations and financial condition for periods subsequent to the acquisitions.
Additionally, the Financial Accounting Standards Board ("FASB") has announced
that it plans to rescind the pooling of interests method of acquisition
accounting. If this occurs, it could alter our acquisition strategy and
potentially impair our ability to acquire companies. The FASB has also announced
that it is reviewing the current accounting rules associated with stock options.
The FASB is concerned that current practice, as outlined in Accounting
Principles Board No. 25 ("APB25"), does not accurately reflect appropriate
compensation expense under a variety of scenarios, including the assumption of
option plans from acquired companies. The changes proposed could make it more
difficult to attract and retain qualified personnel and could unfavorably impact
operating results.
OUR BUSINESS DEPENDS UPON OUR PROPRIETARY RIGHTS, AND THERE IS A RISK OF
INFRINGEMENT
Our success is dependent upon our proprietary technology. We generally rely upon
patents, copyrights, trademarks, and trade secret laws to establish and maintain
our proprietary rights in our technology and products. We have a program to file
applications for and obtain patents in the United States and in selected foreign
countries where a potential market for our products exists. We have been issued
a number of patents; other patent applications are currently pending. There can
be no assurance that any of these patents will not be challenged, invalidated,
or circumvented, or that any rights granted thereunder will provide competitive
advantages to us. In addition, there can be no assurance that patents will be
issued from pending applications, or that claims allowed on any future patents
will be sufficiently broad to protect our technology. In addition, the laws of
some foreign countries may not permit the protection of our proprietary rights
to the same
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extent as do the laws of the United States. Although we believe the protection
afforded by our patents, patent applications, copyrights, and trademarks has
value, the rapidly changing technology in the networking industry makes our
future success dependent primarily on the innovative skills, technological
expertise, and management abilities of our employees rather than on patent,
copyright, and trademark protection.
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
that based upon past experience and standard industry practice, such licenses
generally could be obtained on commercially reasonable terms. Because of the
existence of a large number of patents in the networking field and the rapid
rate of issuance of new patents, it is not economically practical to determine
in advance whether a product or any of its components infringe on patent rights
of others. From time to time, we receive notices from or are sued by third
parties regarding patent claims. If infringement is alleged, there can be no
assurance that the necessary licenses would be available on acceptable terms, if
at all, or that we would prevail in any such challenge. 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 could have a material
adverse effect on our business, operating results and financial condition.
WE FACE RISKS FROM THE UNCERTAINTIES OF REGULATION OF THE INTERNET
There are currently few laws or regulations that apply directly to access or
commerce on the Internet. We could be materially adversely affected by
regulation in any country where we operate, on such technology as voice over the
Internet, encryption technology and access charges for Internet service
providers, as well as the continuing deregulation of the telecommunications
industry. The adoption of such measures could decrease demand for our products,
and at the same time increase our cost of selling our products. Changes in laws
or regulations governing the Internet and Internet commerce could have a
material adverse effect on our business, operating results and financial
condition.
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THE ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES OUR BUSINESS AND OPERATIONS
TO RISKS
As we focus on new market opportunities, such as transporting data, voice, and
video traffic across the same network, we will increasingly compete with large
telecommunications equipment suppliers such as Alcatel, Ericsson, Lucent,
Nortel, and Siemens, among others, and several well-funded start-up companies.
Several of our current and potential competitors have greater financial,
marketing, and technical 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 experienced in the past.
We have not entered into a material amount of labor intensive service contracts
which require significant production or customization. However, we expect that
demand for these types of service contracts will 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 by us may result in less favorable
timing of revenue recognition than we have historically experienced.
WE ARE DEPENDENT UPON THE ABILITY OF SUPPLIERS TO DELIVER PARTS ON TIME
Our growth and ability to meet customer demands also depend in part on our
ability to obtain timely deliveries of parts from our suppliers. We have
experienced component shortages in the past that have adversely affected our
operations. Although we work closely with our suppliers to avoid these types of
shortages, there can be no assurance that we will not encounter these problems
in the future.
THE LOCATION OF OUR FACILITIES SUBJECTS US TO THE RISK OF EARTHQUAKES AND FLOODS
Our corporate headquarters, including most of our research and development
operations and our manufacturing facilities, are located in the Silicon Valley
area of Northern California, a region known for seismic activity. Additionally,
one of our manufacturing facilities is located near a river that has experienced
flooding in the past. A significant natural disaster, such as an earthquake or
35
a flood, could have a material adverse impact on our business, operating results
and financial condition.
WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ARE SUBJECT TO RAPID CHANGES
IN TECHNOLOGY AND THE MARKET
Our operating results will depend to a significant extent on our ability to
reduce the costs to produce existing products. In particular, we broadened our
product line by introducing network access products. Sales of these products,
which are generally lower priced and carry lower margins than our core products,
have increased more rapidly than sales of our core products. The success of
these and other new products is dependent on several factors, including proper
new product definition, product cost, timely completion and introduction of new
products, differentiation of new products from those of our competitors, and
market acceptance of these products. The markets for our products are
characterized by rapidly changing technology, evolving industry standards,
frequent new product introductions, and evolving methods of building and
operating networks. There can be no assurance that we will successfully identify
new product opportunities, develop and bring new products to market in a timely
manner, and achieve market acceptance of our products or that products and
technologies developed by others will not render our products or technologies
obsolete or noncompetitive.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH STRATEGIC ALLIANCES
We have increased the number of our strategic alliances with large and complex
organizations. These arrangements are generally limited to specific projects,
the goal of which is generally to facilitate product compatibility and adoption
of industry standards. If successful, these relationships will be mutually
beneficial and result in industry growth. However, these alliances carry an
element of risk because, in most cases, we must compete in some business areas
with a company with which we have strategic alliances and, at the same time,
cooperate with such 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.
THE INDUSTRY IN WHICH WE COMPETE IS SUBJECT TO CONSOLIDATION
There has been a trend toward industry consolidation for several years. We
expect this trend toward industry consolidation to continue as companies attempt
to strengthen or hold their market
36
positions in an evolving industry. We believe that industry consolidation may
provide stronger competitors that are better able to compete as sole-source
vendors for customers. This could lead to more variability in operating results
as we compete to be a single vendor solution and could have a material adverse
effect on our business, operating results and financial condition.
SALES IN THE SERVICE PROVIDER MARKET ARE SUBJECT TO VARIATION
Although sales to the service provider market have grown historically, this
market is characterized by large, and often sporadic purchases. Sales activity
in this industry depends upon the stage of completion of expanding network
infrastructures, the availability of funding, and the extent that service
providers are affected by regulatory and business conditions in the country of
operations. A decline or delay in sales orders from this industry could have a
material adverse effect on our business, operating results and financial
condition.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH THE MANUFACTURE OF PARTS AND COMPONENTS
OF OUR PRODUCTS
Although we generally use standard parts and components for our products,
certain components are presently available only from a single source or limited
sources. A reduction or interruption in supply or a significant increase in the
price of one or more components would adversely affect our business, operating
results and financial condition and could materially damage customer
relationships.
WE FACE RISKS ASSOCIATED WITH CHANGES IN TELECOMMUNICATIONS REGULATION AND
TARIFFS
Changes in domestic and international telecommunications requirements could
affect the sales of our products. In particular, we believe it is possible that
there may be significant changes in domestic telecommunications regulation in
the near future that could slow the expansion of the service providers' network
infrastructures and materially adversely affect our business, operating results
and financial condition. 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
U.S., our products must comply with various Federal Communications Commission
requirements and regulations. In countries outside of the U.S., our products
must meet various requirements of local telecommunications authorities. Changes
in
37
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.
OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS
We conduct business globally. Accordingly, our future results could be
materially adversely affected by a variety of uncontrollable and changing
factors including, among others, foreign currency exchange rates; regulatory,
political, or economic conditions in a specific country or region; trade
protection measures and other regulatory requirements; government spending
patterns; and natural disasters. In the first six months of fiscal 2000, the
sales growth rate in Japan continued to be slower than that in other areas. Any
or all of these factors could have a material adverse impact on our future
international business in these or other countries.
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND
INTERNET-BASED SYSTEMS
We believe that there will be performance problems with Internet communications
in the future which could receive a high degree of publicity and visibility. As
we are a large supplier of equipment for the Internet infrastructure, customers'
perceptions of our products and the marketplace's perception of us as a supplier
of networking products may be materially adversely affected, regardless of
whether or not these problems are due to the performance of our products. Such
an event could also result in a material adverse effect on the market price of
our common stock and could materially adversely affect our business, operating
results and financial condition.
OUR STOCK PRICE MAY BE VOLATILE
Our common stock has experienced substantial price volatility, particularly as a
result of variations between our actual or anticipated financial results, the
published expectations of analysts, and as a result of announcements by our
competitors and us. 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, may materially adversely affect the market price of our
common stock in the future.
38
OTHER
PricewaterhouseCoopers LLP ("PWC"), our independent accountants, has notified us
that PWC is engaged in discussions with the Securities and Exchange Commission
following an internal review by PWC, pursuant to an administrative settlement
with the SEC, of PWC's compliance with auditor independence guidelines. PWC has
advised us that we are one of the companies affected by such discussions. We are
not involved in the discussions between the SEC and PWC and cannot predict the
result of those discussions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the caption "We Are
Exposed To Fluctuations In The Market Values Of Our Portfolio Investments And In
Interest Rates" under Item 2- Management's Discussion and Analysis of Financial
Condition and Results of Operations.
39
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) The Board of Directors approved a two-for-one stock split of the Company's
common stock to holders of record on February 22, 2000 to be distributed on
March 22, 2000. The Company's Restated Articles of Incorporation will be amended
to reflect the stock split.
(c) During the quarter, the Company issued an aggregate of approximately 6.6
million shares of its common stock in exchange for the outstanding capital stock
of Calista Inc, Tasmania Network Systems, Inc., V-Bits, Inc., WebLine
Communications Corporation, and Worldwide Data Systems, Inc. The shares were
issued pursuant to an exemption by reason of Section 4(2) of the Securities Act
of 1933. These sales were made without general solicitation or advertising. Each
purchaser was an accredited investor or a sophisticated investor (either alone
or through its representative) with access to all relevant information
necessary. The Company has filed Registration Statements on Form S-3 covering
the resale of such securities.
During the quarter, the Company issued an aggregate of approximately 98.1
million shares of its common stock in exchange for the outstanding capital stock
of Cerent Corporation. The shares were issued pursuant to an exemption by reason
of Section 3(a)(10) of the Securities Act of 1933. The terms and conditions of
such issuances were approved after a hearing upon the fairness of such terms and
conditions by a government authority expressly authorized by the law to grant
such approval.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed four reports on Form 8-K during the quarter ended January 29,
2000. Information regarding the items reported on is as follows:
Date Item Reported On
- ---- ----------------
November 4, 1999 The Company announced the completion of
the acquisitions of Cerent Corporation and
WebLine Communications Corporation.
November 17, 1999 The Company announced the acquisition of Aironet Wireless
Communications, Inc.
December 15, 1999 The Company reported that the supplementary consolidated
financial information reflected the acquisitions of Fibex
Systems, StratumOne Communications, Inc., TransMedia
Communications, Inc., Cerent Corporation and WebLine
Communications Corporation as if the acquired entities were
wholly owned subsidiaries of the Company since inception.
December 22, 1999 The Company announced the acquisition of the optical systems
business of Pirelli S.p.A of Milan, Italy.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Cisco Systems, Inc.
Date: March 13, 2000 By /s/ Larry R. Carter
------------------------------------
Larry R. Carter, Senior Vice
President,
Finance and Administration, Chief
Financial Officer, and Secretary
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EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
EX-27 Financial Data Schedule