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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 APRIL 28, 2001
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
INCORPORATION OR ORGANIZATION) 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 filing requirements
for the past 90 days.
YES [X] NO [ ]
As of May 25, 2001, 7,318,969,402 shares of the registrant's common stock were
outstanding.
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CISCO SYSTEMS, INC.
FORM 10-Q FOR THE QUARTER ENDED APRIL 28, 2001
INDEX
Page
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Part I. Financial Information
Item 1. Financial Statements (Unaudited)
a) Consolidated Statements of Operations for the three and nine
months ended April 28, 2001 and April 29, 2000 3
b) Consolidated Balance Sheets at April 28, 2001 and July 29, 2000 4
c) Consolidated Statements of Cash Flows for the nine months ended
April 28, 2001 and April 29, 2000 5
d) Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
Part II. Other Information
Item 1. Legal Proceedings 41
Item 2. Changes in Securities and Use of Proceeds 41
Item 6. Exhibits and Reports on Form 8-K 42
Signature 43
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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)
(UNAUDITED)
Three Months Ended Nine Months Ended
----------------------- ------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
------- ------ -------- -------
NET SALES $ 4,728 $4,933 $ 17,995 $13,208
Cost of sales 4,400 1,761 9,359 4,688
------- ------ -------- -------
GROSS MARGIN 328 3,172 8,636 8,520
Operating expenses:
Research and development 1,028 727 2,987 1,870
Sales and marketing 1,351 1,037 4,147 2,788
General and administrative 195 156 587 415
Restructuring costs and other
special charges 1,170 -- 1,170 --
Amortization of goodwill and
purchased intangible assets 276 51 757 122
In-process research and development 109 488 855 912
------- ------ -------- -------
Total operating expenses 4,129 2,459 10,503 6,107
------- ------ -------- -------
OPERATING INCOME (LOSS) (3,801) 713 (1,867) 2,413
Net gains realized on minority investments -- 156 190 187
Interest and other income, net 236 158 741 380
------- ------ -------- -------
INCOME (LOSS) BEFORE PROVISION
FOR (BENEFIT FROM) INCOME TAXES (3,565) 1,027 (936) 2,980
Provision for (benefit from) income taxes (872) 386 85 1,108
------- ------ -------- -------
NET INCOME (LOSS) $(2,693) $ 641 $ (1,021) $ 1,872
======= ====== ======== =======
Net income (loss) per share--basic $ (0.37) $ 0.09 $ (0.14) $ 0.27
======= ====== ======== =======
Net income (loss) per share--diluted $ (0.37) $ 0.08 $ (0.14) $ 0.25
======= ====== ======== =======
Shares used in per-share calculation--basic 7,251 7,036 7,170 6,927
======= ====== ======== =======
Shares used in per-share calculation--diluted 7,251 7,548 7,170 7,408
======= ====== ======== =======
See Notes to Consolidated Financial Statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT PAR VALUE)
(UNAUDITED)
April 28, July 29,
2001 2000
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 5,102 $ 4,234
Short-term investments 1,098 1,291
Accounts receivable, net of allowance for doubtful accounts
of $150 at April 28, 2001 and $43 at July 29, 2000 1,983 2,299
Inventories, net 1,913 1,232
Deferred tax assets 950 1,091
Lease receivables 488 588
Prepaid expenses and other current assets 542 375
------- -------
Total current assets 12,076 11,110
Investments 9,936 13,688
Restricted investments 1,211 1,286
Property and equipment, net 2,410 1,426
Goodwill and purchased intangible assets, net 4,955 4,087
Lease receivables 403 527
Other assets 2,799 746
------- -------
TOTAL ASSETS $33,790 $32,870
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 664 $ 739
Income taxes payable 111 233
Accrued compensation 1,206 1,317
Deferred revenue 2,585 1,386
Other accrued liabilities 2,441 1,521
Restructuring liabilities 668 -
------- -------
Total current liabilities 7,675 5,196
Deferred tax liabilities - 1,132
Minority interest 22 45
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; 7,311 and 7,138 shares issued and
outstanding at April 28, 2001 and July 29, 2000, respectively 18,745 14,609
Retained earnings 7,337 8,358
Accumulated other comprehensive income 11 3,530
------- -------
Total shareholders' equity 26,093 26,497
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $33,790 $32,870
======= =======
See Notes to Consolidated Financial Statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
Nine Months Ended
------------------------------
April 28, April 29,
2001 2000
--------- ----------
Cash flows from operating activities:
Net income (loss) $ (1,021) $ 1,872
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 1,615 468
Provision for doubtful accounts 123 24
Provision for inventory 2,697 237
Deferred income taxes (1,431) (346)
Tax benefits from employee stock option plans 705 930
Adjustment to conform fiscal year ends of pooled acquisitions - (18)
In-process research and development 739 912
Net gains on minority investments and provision for losses 43 24
Noncash restructuring costs and other special charges 501 -
Change in operating assets and liabilities:
Accounts receivable 197 (667)
Inventories (1,730) (427)
Prepaid expenses and other current assets (66) (24)
Accounts payable (85) 310
Income taxes payable 786 148
Accrued compensation (108) 237
Deferred revenue 1,000 494
Other accrued liabilities 74 308
Restructuring liabilities 668 -
-------- -------
Net cash provided by operating activities 4,707 4,482
-------- -------
Cash flows from investing activities:
Purchases of short-term investments (2,870) (1,431)
Sales and maturities short-term investments 3,459 1,428
Purchases of investments (14,613) (9,797)
Sales and maturities of investments 12,732 8,775
Purchases of restricted investments (758) (272)
Sales and maturities of restricted investments 941 181
Acquisition of property and equipment (1,814) (671)
Acquisition of businesses, net of cash and cash equivalents (13) 34
Net change in lease receivables 224 (397)
Purchases of minority investments (960) (108)
Lease deposit (320) -
Purchase of minority interest of Cisco Systems, K.K. (Japan) (365) -
Other (573) (615)
-------- -------
Net cash used in investing activities (4,930) (2,873)
-------- -------
Cash flows from financing activities:
Issuance of common stock 1,106 1,218
Other (15) (2)
-------- -------
Net cash provided by financing activities 1,091 1,216
-------- -------
Net increase in cash and cash equivalents 868 2,825
Cash and cash equivalents, beginning of period 4,234 913
-------- -------
Cash and cash equivalents, end of period $ 5,102 $ 3,738
======== =======
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. (together with its subsidiaries, "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
advantages to its 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-week or 53-week period ending on the last
Saturday in July. Fiscal 2001 and 2000 are 52-week fiscal years.
Basis of Presentation
The accompanying financial data as of April 28, 2001 and for the three and nine
months ended April 28, 2001 and April 29, 2000 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 omitted pursuant to such
rules and regulations. The July 29, 2000 Consolidated 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 for the fiscal year ended July 29, 2000.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present a fair statement of financial
position as of April 28, 2001, results of operations for the three and nine
months ended April 28, 2001 and April 29, 2000, and cash flows for the nine
months ended April 28, 2001 and April 29, 2000 have been made. The results of
operations for the three and nine months ended April 28, 2001 are not
necessarily indicative of the operating results for the full fiscal year or any
future periods.
Certain amounts from the previous periods have been reclassified to conform with
the current period presentation.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Computation of Net Income (Loss) per Share
Basic net income (loss) per share is computed using the weighted-average number
of common shares outstanding during the period. Diluted net income (loss) per
share is computed using the weighted-average number of common and dilutive
common-equivalent shares outstanding during the period. Diluted net loss per
share excludes common-equivalent shares outstanding as their effect is
antidilutive. Dilutive common-equivalent shares primarily consist of employee
stock options.
Recent Accounting Pronouncement
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 accepted accounting principles to revenue
recognition in financial statements. At this time, management does not expect
the adoption of SAB 101 to have a material effect on the Company's operations or
financial position. The Company is required to adopt SAB 101 in the fourth
quarter of fiscal 2001.
3. RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES AND PROVISION FOR INVENTORY
On April 16, 2001, the Company announced a restructuring program to prioritize
its initiatives around high-growth areas of its business, focus on profit
contribution, reduce expenses, and improve efficiency due to macro-economic and
capital spending issues affecting the networking industry. This restructuring
program includes a worldwide workforce reduction, consolidation of excess
facilities, and restructuring of certain business functions.
As a result of the restructuring program and decline in forecasted revenue, the
Company recorded restructuring costs and other special charges of $1.17 billion
classified as operating expenses and an additional excess inventory charge of
$2.25 billion classified as cost of sales.
The following paragraphs provide detailed information relating to the
restructuring costs and other special charges and provision for inventory which
were recorded during the third quarter of fiscal 2001.
Worldwide workforce reduction
The restructuring program will result in the reduction of approximately 6,000
regular employees across all business functions, operating units, and geographic
regions. The worldwide workforce reductions started in the third quarter of
fiscal 2001 and will be substantially completed in the fourth quarter of fiscal
2001. The Company recorded a workforce reduction charge of approximately $397
million relating primarily to severance and fringe benefits. In addition, the
number of temporary and contract workers employed by the Company will also be
reduced.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Consolidation of excess facilities and other special charges
The Company recorded a restructuring charge of $484 million relating to
consolidation of excess facilities and other special charges. The consolidation
of excess facilities includes the closure of certain corporate facilities, sales
offices, and operational centers related to business activities that have been
exited or restructured. The Company recorded a restructuring charge of
approximately $263 million for excess facilities relating primarily to lease
terminations and non-cancelable lease costs. Property and equipment that was
disposed or removed from operations resulted in a charge of $141 million and
consisted primarily of leasehold improvements, computer equipment and related
software, production and engineering equipment, and office equipment, furniture,
and fixtures. The Company also recorded other restructuring costs and special
charges of $80 million relating primarily to payments to suppliers and vendors
to terminate agreements and professional fees incurred in connection with the
restructuring activities.
Impairment of goodwill and purchased intangible assets
Due to the decline in current business conditions, the Company restructured
certain of its businesses and realigned resources to focus on profit
contribution, high-growth markets, and core opportunities. As a result, the
Company recorded a charge of $289 million related to the impairment of goodwill
and purchased intangible assets, measured as the amount by which the carrying
amount exceeded the present value of the estimated future cash flows for
goodwill and purchased intangible assets, as follows (in millions):
Amount
Acquired Company Impaired
- ------------------------------------ --------
Monterey Networks, Inc. $ 108
HyNEX, Ltd. 79
Clarity Wireless, Inc. (Broadband Customer Premise Equipment) 53
Other 49
-----
Total $ 289
=====
The results of operations relating to these businesses are not material on
either an individual or an aggregate basis.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A summary of the restructuring costs and other special charges is outlined as
follows (in millions):
Restructuring
Total Noncash Cash Liabilities at
Charge Charges Payments April 28, 2001
-------- -------- ----------- -----------------
Workforce reduction $ 397 $ (71) $ - $326
Consolidation of excess
facilities and other charges 484 (141) (1) 342
Impairment of goodwill and
purchased intangible assets 289 (289) - -
------ ----- --- ----
Total $1,170 $(501) $(1) $668
====== ===== === ====
Remaining cash expenditures relating to workforce reductions and termination of
agreements will be substantially paid in the fourth quarter of fiscal 2001.
Amounts related to the net lease expense due to the consolidation of facilities
will be paid over the respective lease terms through fiscal 2007. The Company
expects to substantially complete implementation of its restructuring program
during the next six months.
Provision for Inventory
The Company recorded a provision for inventory, including purchase commitments,
totaling $2.36 billion during the third quarter of fiscal 2001, of which $2.25
billion related to an additional excess inventory charge. This additional excess
inventory charge was due to a sudden and significant decrease in forecasted
revenue and was calculated in accordance with the Company's policy, which is
based on inventory levels in excess of 12-month demand for each specific
product.
4. BUSINESS COMBINATIONS
During the first nine months of fiscal 2001, the Company completed 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 in-process research and development ("in-process R&D")
were determined through established valuation techniques in the high-technology
communications equipment industry and were expensed upon acquisition because
technological feasibility had not been established and no future alternative
uses existed. Amounts allocated to goodwill and purchased intangible assets are
amortized on a straight-line basis over periods not exceeding five years.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following is a summary of purchase transactions completed in the first nine
months of fiscal 2001 (in millions):
Consideration Goodwill and
Including Assumed In-Process Purchased Intangible
Acquired Company Liabilities R&D Expense Assets
- ----------------------- ------------------ -------------- --------------------
IPmobile, Inc. $ 422 $181 $ 157
NuSpeed, Inc. 463 164 214
IPCell Technologies, Inc 213 75 102
PixStream Incorporated 395 67 315
Active Voice Corporation 266 37 250
Radiata, Inc. 211 29 170
Other 900 302 379
------ ---- ------
Total $2,870 $855 $1,587
====== ==== ======
The remaining purchase price of $428 million was allocated primarily to deferred
stock-based compensation and tangible assets.
Other Purchase Combinations Completed as of April 28, 2001
During the nine months ended April 28, 2001, the Company acquired Netiverse,
Inc.; HyNEX, Ltd.; Komodo Technology, Inc.; Vovida Networks, Inc.; ExiO
Communications, Inc.; and the broadband subscriber management business of CAIS
Software Solutions, Inc. for a total purchase price of $900 million, paid in
common stock and cash. Total in-process R&D related to these acquisitions
amounted to $302 million.
Total in-process R&D expense for the nine months ended April 28, 2001 and April
29, 2000 was $855 million and $912 million, respectively. The in-process R&D
expense that was attributable to stock consideration for the same periods was
$739 million and $912 million, respectively.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Minority Interest
In the third quarter of fiscal 2001, the Company purchased a portion of the
minority interest of Cisco Systems, K.K. (Japan) for approximately $365 million.
As a result, the Company increased its ownership to 87.8% of the voting rights
of Cisco Systems, K.K. (Japan) and recorded goodwill of $339 million.
5. BALANCE SHEET AND CASH FLOW DETAILS
The following tables provide details of selected balance sheet items (in
millions):
April 28, July 29,
2001 2000
---------- -----------
Inventories, net:
Raw materials $ 947 $ 145
Work in process 338 472
Finished goods 542 496
Demonstration goods 86 119
------- -------
Total $ 1,913 $ 1,232
======= =======
Goodwill and purchased intangible assets, net:
Goodwill $ 3,991 $ 2,937
Purchased intangible assets 2,016 1,558
------- -------
6,007 4,495
Less, accumulated amortization (1,052) (408)
------- -------
Total $ 4,955 $ 4,087
======= =======
Other assets:
Deferred tax assets $ 907 $ -
Minority investments, net 635 181
Income tax receivable 443 -
Lease deposit 320 -
Structured loans, net 91 205
Inventory financing - 25
Other 403 335
------- -------
Total $ 2,799 $ 746
======= =======
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table presents the details of the amortization of goodwill and
purchased intangible assets (in millions):
Three Months Ended Nine Months Ended
------------------------ ------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
---------- ---------- ----------- ----------
Reported as:
Cost of sales $ 6 $ 6 $ 16 $ 18
Operating expenses 276 51 757 122
---- --- ---- ----
Total $282 $57 $773 $140
==== === ==== ====
The following table presents supplemental cash flow information (in millions):
Nine Months Ended
-----------------------------
April 28, April 29,
2001 2000
---------- ----------
Utilization of inventory financing to purchase inventory $ 765 $ -
===== ======
6. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, are as follows (in
millions):
Three Months Ended Nine Months Ended
----------------------------- ----------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
--------- ------- --------- ---------
Net income (loss) $(2,693) $ 641 $(1,021) $ 1,872
Other comprehensive income (loss):
Change in net unrealized gains
on investments (1,241) (111) (3,504) 1,408
Change in accumulated translation
adjustments (13) (9) (15) (5)
------- ----- ------- -------
Total $(3,947) $ 521 $(4,540) $ 3,275
======= ===== ======= =======
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. INCOME TAXES
The Company received net income tax refunds of $22 million for the nine months
ended April 28, 2001 and paid income taxes of $217 million for the nine months
ended April 29, 2000. The Company's income taxes currently payable for federal
and state purposes have been reduced by the tax benefits of employee stock
option transactions. These benefits totaled $705 million and $930 million in the
first nine months of fiscal 2001 and 2000, respectively, and were credited
directly to shareholders' equity. Benefits increasing gross deferred tax assets
totaled $833 million in the first nine months of fiscal 2001, and were credited
directly to shareholders' equity. In addition, the Company's valuation allowance
against gross deferred tax assets attributable to employee stock option
transactions has been increased by $879 million in the first nine months of
fiscal 2001 and was reflected as a debit to shareholders' equity.
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, dial-up 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 system that 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 management system. The Company does not allocate
research and development, sales and marketing, or general and administrative
expenses to its geographic theaters, 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 geographic
theater's performance. Information from this internal management system differs
from the amounts reported under generally accepted accounting principles due to
certain corporate level adjustments not included in the internal management
system. These corporate level adjustments are primarily sales adjustments
relating to reserves for leases and structured loans, deferred revenue, two-tier
distribution, and other timing differences. Based on established criteria, the
Company has four reportable segments: the Americas; Europe, the Middle East, and
Africa ("EMEA"); Asia Pacific; and Japan.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Summarized financial information by theater for the three and nine months ended
April 28, 2001 and April 29, 2000, as taken from the internal management system
discussed above, is as follows (in millions):
Three Months Ended Nine Months Ended
--------------------------- -----------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
------- ------ -------- --------
Net sales:
Americas $ 3,225 $ 3,384 $ 12,054 $ 8,925
EMEA 1,358 1,203 5,194 3,305
Asia Pacific 478 505 1,878 1,139
Japan 341 253 1,259 592
Sales adjustments (674) (412) (2,390) (753)
------- ------- -------- --------
Total $ 4,728 $ 4,933 $ 17,995 $ 13,208
======= ======= ======== ========
Gross margin:
Americas $ 2,377 $ 2,440 $ 8,753 $ 6,497
EMEA 1,019 902 3,916 2,468
Asia Pacific 311 363 1,297 830
Japan 259 197 980 466
------- ------- -------- --------
Standard margin 3,966 3,902 14,946 10,261
Sales adjustments (674) (412) (2,390) (753)
Cost of sales adjustments 113 186 469 311
Production overhead (150) (133) (451) (322)
Manufacturing variances and other
related costs (2,927) (371) (3,938) (977)
------- ------- -------- --------
Total $ 328 $ 3,172 $ 8,636 $ 8,520
======= ======= ======== ========
The net sales and standard margins by geographic theater differ from the amounts
recognized under generally accepted accounting principles because the Company
does not allocate certain sales adjustments, cost of sales adjustments,
production overhead, and manufacturing variances and other related costs to the
theaters. The above table reconciles the net sales and standard margins by
geographic theater to net sales and gross margin as reported in the Consolidated
Statements of Operations by including such adjustments.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table presents net sales for groups of similar products and
services (in millions):
Three Months Ended Nine Months Ended
------------------------- -------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
-------- -------- --------- ---------
Routers $ 1,747 $ 1,999 $ 6,940 $ 5,285
Switches 2,558 1,938 8,650 5,216
Access 452 632 1,878 1,614
Other 645 776 2,917 1,846
Sales adjustments (674) (412) (2,390) (753)
------- ------- -------- --------
Total $ 4,728 $ 4,933 $ 17,995 $ 13,208
======= ======= ======== ========
Substantially all of the Company's assets at April 28, 2001 and July 29, 2000
were attributable to U.S. operations. No single customer accounted for 10% or
more of net sales during the three and nine months ended April 28, 2001 and
April 29, 2000.
9. NET INCOME (LOSS) PER SHARE
The following table presents the calculation of basic and diluted net income
(loss) per share (in millions, except per-share amounts):
Three Months Ended Nine Months Ended
------------------------- -------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
-------- -------- -------- -------
Net income (loss) $ (2,693) $ 641 $ (1,021) $1,872
======== ====== ======== ======
Weighted-average shares--basic 7,251 7,036 7,170 6,927
Effect of dilutive securities -- 512 -- 481
-------- ------ -------- ------
Weighted-average shares--diluted 7,251 7,548 7,170 7,408
======== ====== ======== ======
Net income (loss) per share--basic $ (0.37) $ 0.09 $ (0.14) $ 0.27
======== ====== ======== ======
Net income (loss) per share--diluted $ (0.37) $ 0.08 $ (0.14) $ 0.25
======== ====== ======== ======
The common-equivalent shares which were antidilutive for the three and nine
months ended April 28, 2001 were 235 million and 382 million, respectively.
15
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
10. LEGAL PROCEEDINGS
Beginning on April 20, 2001, a number of purported shareholder class action
lawsuits have been filed in the United States District Court for the Northern
District of California against the Company and certain of its officers and
directors. The lawsuits are essentially identical, and purport to bring suit on
behalf of those who purchased the Company's publicly traded securities between
August 10, 1999 and April 16, 2001. Plaintiffs allege that defendants made false
and misleading statements, purport to assert claims for violations of the
federal securities laws, and seek unspecified compensatory damages and other
relief. The Company believes the claims are without merit and intends to defend
the actions vigorously.
In addition, beginning on April 23, 2001, a number of purported shareholder
derivative lawsuits have been filed in the Superior Court of California, County
of Santa Clara, against the Company (as a nominal defendant), its directors and
certain officers. At least one purported derivative suit has also been filed in
the United States District Court for the Northern District of California, and
another has been filed in the Superior Court of California, County of San Mateo.
The complaints in the various derivative actions include claims for breach of
fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment and
violations of the California Corporations Code, seek compensatory and other
damages, disgorgement and other relief, and are based on essentially the same
allegations as the class actions.
16
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-Q, including,
without limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," "projections," 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.
We manage our business on four geographic theaters: the Americas; Europe, the
Middle East, and Africa ("EMEA"); Asia Pacific; and Japan. Summarized financial
information by theater for the first three and nine months of fiscal 2001 and
2000 is summarized in the following table (in millions):
Three Months Ended Nine Months Ended
-------------------------- ----------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
-------- -------- -------- ---------
Net sales:
Americas $ 3,225 $ 3,384 $ 12,054 $ 8,925
EMEA 1,358 1,203 5,194 3,305
Asia Pacific 478 505 1,878 1,139
Japan 341 253 1,259 592
Sales adjustments (674) (412) (2,390) (753)
------- ------- -------- --------
Total $ 4,728 $ 4,933 $ 17,995 $ 13,208
======= ======= ======== ========
Gross margin:
Americas $ 2,377 $ 2,440 $ 8,753 $ 6,497
EMEA 1,019 902 3,916 2,468
Asia Pacific 311 363 1,297 830
Japan 259 197 980 466
------- ------- -------- --------
Standard margin 3,966 3,902 14,946 10,261
Sales adjustments (674) (412) (2,390) (753)
Cost of sales adjustments 113 186 469 311
Production overhead (150) (133) (451) (322)
Manufacturing variances
and other related costs (2,927) (371) (3,938) (977)
------- ------- -------- --------
Total $ 328 $ 3,172 $ 8,636 $ 8,520
======= ======= ======== ========
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18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Net sales in the third quarter of fiscal 2001 were $4.73 billion, compared with
$4.93 billion in the third quarter of fiscal 2000, a decrease of 4.2%. The
decrease in net sales for the third quarter of fiscal 2001 related primarily to
decreased unit sales of router and access products (see Note 8 to the
Consolidated Financial Statements) due to a slowdown in the U.S. economy. Net
sales in the first nine months of fiscal 2001 were $17.99 billion, compared with
$13.21 billion in the first nine months of fiscal 2000, an increase of 36.2%.
The increase in net sales for the first nine months of fiscal 2001 was primarily
a result of increased unit sales of router, switch, and access products; growth
in the sales of add-on boards that provide increased functionality; increased
sales of optical transport products; and increased maintenance, service, and
support sales. Net sales in the third quarter of fiscal 2001 were $4.73 billion,
compared with $6.75 billion in the second quarter of fiscal 2001, a decrease of
29.9%.
Gross margin in the third quarter of fiscal 2001 was 6.9%, compared with 64.3%
in the third quarter of fiscal 2000. Gross margin in the first nine months of
fiscal 2001 was 48.0%, compared with 64.5% in the first nine months of fiscal
2000. The gross margin for the third quarter and first nine months of fiscal
2001 included an additional excess inventory charge of $2.25 billion as
discussed below.
The following table shows the standard margins for each theater:
Three Months Ended Nine Months Ended
------------------------- --------------------------
April 28, April 29, April 28, April 29,
2001 2000 2001 2000
--------- --------- --------- ---------
Standard margin:
Americas 73.7% 72.1% 72.6% 72.8%
EMEA 75.0% 75.0% 75.4% 74.7%
Asia Pacific 65.1% 71.9% 69.1% 72.9%
Japan 76.0% 77.9% 77.8% 78.7%
The net sales and standard margins by geographic theater differ from the amounts
recognized under generally accepted accounting principles because we do not
allocate certain sales adjustments, cost of sales adjustments, production
overhead, and manufacturing variances and other related costs to the theaters.
Sales adjustments relate to reserves for leases and structured loans, deferred
revenue, two-tier distribution, and other timing differences.
Standard margins decreased or remained relatively constant for three geographic
theaters as compared with the third quarter and first nine months of fiscal
2000. Standard margins vary quarter to quarter due to a number of reasons
including, but not limited to, shifts in product mix, introduction of new
products, sales discounts, and sales channels.
The decreases in the overall gross margin were primarily due to an additional
excess inventory charge included in manufacturing variances and other related
costs; shifts in product mix; lower shipment volumes and related manufacturing
overhead; introduction of new products, which generally have lower margins when
first released; higher production-related costs and inventory
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
reserves; the continued pricing pressure seen from competitors in certain
product areas; and the above-mentioned sales adjustments, which were not
included in the standard margins.
We recorded a provision for inventory, including purchase commitments, totaling
$2.36 billion in the third quarter of fiscal 2001, of which $2.25 billion
related to an additional excess inventory charge. Inventory purchases and
commitments are based upon future sales forecasts. To mitigate the component
supply constraints that have existed in the past, we built inventory levels for
certain components with long lead times and entered into certain longer-term
commitments for certain components. Due to the sudden and significant decrease
in demand for our products, inventory levels exceeded our requirements based on
current 12-month sales forecasts. This additional excess inventory charge was
calculated based on the inventory levels in excess of 12-month demand for each
specific product. We do not currently anticipate that the excess inventory
subject to this provision will be used at a later date based on our current
12-month demand forecast.
We expect gross margin to continue to be adversely affected by increases in
material or labor costs, heightened price competition, increasing levels of
services, higher inventory balances, obsolescence charges, loss of cost savings,
introduction of new products for new high-growth markets, and changes in
channels of distribution or in the mix of products sold, in particular, optical
and access products. If product or related warranty costs associated with our
products are greater than we have experienced, gross margin may also be
adversely affected. Our gross margin 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 a lower gross margin. These distribution channels are generally given
privileges to return inventory. In addition, increasing third-party and
indirect-distribution channels generally results 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 net sales from lower
margin businesses (for example, service provider markets), which could adversely
affect our future operating results.
Research and development, sales and marketing, and general and administrative
expenses as a percentage of net sales for the three and nine months ended April
28, 2001 have increased compared with the same periods in the prior fiscal year
primarily due to effect of the decrease in net sales in third quarter of fiscal
2001.
Research and development ("R&D") expenses in the third quarter of fiscal 2001
were $1.03 billion, compared with $727 million in the third quarter of fiscal
2000, an increase of 41.4%. R&D expenses, as a percentage of net sales,
increased to 21.7% in the third quarter of fiscal 2001, compared with 14.7% in
the third quarter of fiscal 2000. R&D expenses in the first nine months of
fiscal 2001 were $2.99 billion, compared with $1.87 billion in the first nine
months of fiscal 2000, an increase of 59.7%. R&D expenses, as a percentage of
net sales, increased to
19
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
16.6% in the first nine months of fiscal 2001, compared with 14.2% in the first
nine months of fiscal 2000. The increases reflected R&D efforts in a wide
variety of areas such as data, voice, and video integration, wireless access,
dial access, enterprise switching, optical transport, content networking,
security, network management, high-end routing and switching technologies,
digital subscriber line ("DSL") technologies, cable, and other broadband
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. We also
continued 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 businesses as an alternative
to internal R&D. All of our R&D costs are expensed as incurred.
Sales and marketing expenses in the third quarter of fiscal 2001 were $1.35
billion, compared with $1.04 billion in the third quarter of fiscal 2000, an
increase of 30.3%. Sales and marketing expenses, as a percentage of net sales,
increased to 28.6% in the third quarter of fiscal 2001, compared with 21.0% in
the third quarter of fiscal 2000. Sales and marketing expenses in the first nine
months of fiscal 2001 were $4.15 billion, compared with $2.79 billion in the
first nine months of fiscal 2000, an increase of 48.7%. Sales and marketing
expenses, as a percentage of net sales, increased to 23.0% in the first nine
months of fiscal 2001, compared with 21.1% in the first nine months of fiscal
2000. The increases in sales and marketing expenses in absolute dollars were
principally due to an increase in the size of our direct sales force and related
commissions, additional marketing and advertising investments associated with
existing and new product introductions, the expansion of distribution channels
and markets, and general corporate branding. The increases also reflected our
efforts to invest in certain key areas, such as expansion of our end-to-end
networking strategy and service provider coverage, in order to be positioned to
take advantage of future market opportunities.
General and administrative ("G&A") expenses in the third quarter of fiscal 2001
were $195 million, compared with $156 million in the third quarter of fiscal
2000, an increase of 25.0%. G&A expenses, as a percentage of net sales,
increased to 4.1% in the third quarter of fiscal 2001, compared with 3.2% in the
third quarter of fiscal 2000. G&A expenses in the first nine months of fiscal
2001 were $587 million, compared with $415 million in the first nine months of
fiscal 2000, an increase of 41.4%. G&A expenses, as a percentage of net sales,
remained relatively constant at 3.3% in the first nine months of fiscal 2001,
compared with 3.1% in the first nine months of fiscal 2000. The increases in G&A
expenses in absolute dollars were primarily related to the addition of new
personnel and investments in infrastructure.
Amortization of goodwill and purchased intangible assets included in operating
expenses was $276 million in the third quarter of fiscal 2001, compared with $51
million in the third quarter of fiscal 2000. Amortization of goodwill and
purchased intangible assets included in operating expenses was $757 million in
the first nine months of fiscal 2001, compared with $122 million in the first
nine months of fiscal 2000. Amortization of goodwill and purchased intangible
assets primarily relates to various purchase acquisitions (see Note 4 and Note 5
to the Consolidated
20
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Financial Statements). We expect amortization of goodwill and purchased
intangibles assets to continue to increase if we acquire companies and
technologies.
The amount expensed to in-process research and development ("in-process R&D")
arose from the purchase acquisitions (see Note 4 to the Consolidated Financial
Statements). The fair values of the existing products and patents, as well as
the technology currently under development, were determined 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 increased the overall discount rate for acquisitions
completed in the current year. We consider the pricing model for products
related to these acquisitions to be standard within the high-technology
communications equipment industry. However, 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 significant anticipated cost savings.
The development of these technologies remains a significant risk 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 technologies into commercially viable products consists principally of
planning, designing, and testing activities necessary to determine that the
products 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.
21
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following table summarizes the significant assumptions underlying the
valuations for our significant purchase acquisitions completed in fiscal 2001
and 2000 (in millions, except percentages):
Estimated Cost to Risk-Adjusted
Complete Technology at Discount Rate for
Acquired Company Time of Acquisition In-Process R&D
- ---------------- ---------------------- -----------------
FISCAL 2001
- -----------
IPmobile, Inc. $15 42.5 %
NuSpeed, Inc. $ 6 40.0 %
IPCell Technologies, Inc. $10 30.0 %
PixStream Incorporated $ 2 35.0 %
Active Voice Corporation $ 5 40.0 %
Radiata, Inc. $ 3 30.0 %
FISCAL 2000
- -----------
Monterey Networks, Inc. $ 4 30.0 %
The optical systems business of Pirelli S.p.A $ 5 20.0 %
Aironet Wireless Communications, Inc. $ 3 23.5 %
Atlantech Technologies $ 6 37.5 %
JetCell, Inc. $ 7 30.5 %
PentaCom, Ltd. $13 30.0 %
Qeyton Systems $ 6 35.0 %
Regarding our purchase acquisitions completed in fiscal 2001 and 2000, actual
results to date have been consistent, in all material respects, with our
assumptions at the time of the acquisitions except for certain purchase
acquisitions as discussed below. 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. Failure to achieve the expected levels of revenue and
net income from these products will negatively impact the return on investment
expected at the time that the acquisitions were completed and may result in
impairment of any other assets related to the development activities.
Due to the decline in current business conditions, we restructured certain of
our businesses and realigned resources to focus on profit contribution,
high-growth markets and core opportunities. Based upon impairment analyses which
indicated that the carrying amount of the goodwill and purchased intangible
assets will not be fully recovered through estimated undiscounted future
operating cash flows, a charge of $289 million was recorded related to the
impairment of goodwill and purchased intangible assets, measured as the amount
by which the carrying amount exceeded the present value of the estimated future
cash flows for goodwill and purchased intangible assets (see Note 3 to the
Consolidated Financial Statements).
There were no net gains realized on minority investments in the third quarter of
fiscal 2001, compared with $156 million in the third quarter of fiscal 2000. Net
gains realized on minority investments were $190 million in the first nine
months of fiscal 2001, compared with $187 million in the first nine months of
fiscal 2000.
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23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Interest and other income, net, was $236 million in the third quarter of fiscal
2001, compared with $158 million in the third quarter of fiscal 2000. Interest
and other income, net, was $741 million in the first nine months of fiscal 2001,
compared with $380 million in the first nine months of fiscal 2000. The
increases were primarily due to interest income related to the general increase
in cash and investments generated from our operations.
The effective tax rate was 24.5% for the third quarter of fiscal 2001 and (9.1%)
for the first nine months of fiscal 2001. The effective tax rate differs from
the statutory rate primarily due to the impact of nondeductible in-process R&D,
acquisition-related costs, research and experimentation tax credits, and the tax
impact of foreign operations. Our future effective tax rates could be adversely
affected if earnings are lower than anticipated in countries where we have lower
effective rates or by unfavorable changes in tax laws and regulations.
Restructuring Costs and Other Special Charges and Provision for Inventory
On April 16, 2001, we announced a restructuring program to prioritize our
initiatives around high-growth areas of our business, focus on profit
contribution, reduce expenses, and improve efficiency due to macro-economic and
capital spending issues affecting the networking industry. This restructuring
program includes a worldwide workforce reduction, consolidation of excess
facilities, and restructuring of certain business functions.
As a result of the restructuring program and decline in forecasted revenue, we
recorded restructuring costs and other special charges of $1.17 billion
classified as operating expenses and an additional excess inventory charge of
$2.25 billion classified as cost of sales. When the restructuring program is
fully implemented, we expect pretax savings in operating expenses will
approximate $1.00 billion on an annualized basis. The pretax savings will be
phased-in beginning the fourth quarter of fiscal 2001.
The following paragraphs provide detailed information relating to the
restructuring costs and other special charges and provision for inventory which
were recorded in the third quarter of fiscal 2001.
Worldwide workforce reduction
The restructuring program will result in the reduction of approximately 6,000
regular employees across all business functions, operating units, and geographic
regions. The worldwide workforce reductions started in the third quarter of
fiscal 2001 and will be substantially completed in the fourth quarter of fiscal
2001. We recorded a workforce reduction charge of approximately $397 million
relating primarily to severance and fringe benefits. In addition, the number of
temporary and contract workers employed by us will also be reduced.
Consolidation of excess facilities and other special charges
We recorded a charge of $484 million relating to consolidation of excess
facilities and other special charges. The consolidation of excess facilities
includes the closure of certain corporate
23
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
facilities, sales offices, and operational centers related to business
activities that have been exited or restructured. We recorded a restructuring
charge of approximately $263 million for excess facilities relating primarily to
lease terminations and non-cancelable lease costs. Property and equipment that
was disposed or removed from operations resulted in a charge of $141 million and
consisted primarily of leasehold improvements, computer equipment and related
software, production and engineering equipment, and office equipment, furniture,
and fixtures. We also recorded other restructuring costs and special charges of
$80 million relating primarily to payments to suppliers and vendors to terminate
agreements and professional fees incurred in connection with the restructuring
activities.
Impairment of goodwill and purchased intangible assets
Due to the decline in current business conditions, we restructured certain of
our businesses and realigned resources to focus on profit contribution,
high-growth markets, and core opportunities. As a result, a charge of $289
million was recorded related to the impairment of goodwill and purchased
intangible assets, measured as the amount by which the carrying amount exceeded
the present value of the estimated future cash flows for goodwill and purchased
intangible assets, as follows (in millions):
Amount
Acquired Company Impaired
- -------------------------- --------
Monterey Networks, Inc. $108
HyNEX, Ltd. 79
Clarity Wireless, Inc. (Broadband Customer Premise Equipment) 53
Other 49
----
Total $289
====
The results of operations relating to these businesses are not material on
either an individual or an aggregate basis.
24
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
A summary of the restructuring cost and other special charges is outlined as
follows (in millions):
Restructuring
Total Noncash Cash Liabilities at
Charge Charges Payments April 28, 2001
------- ------- -------- --------------
Workforce reduction $ 397 $ (71) $-- $326
Consolidation of excess
facilities and other charges 484 (141) (1) 342
Impairment of goodwill and
purchased intangible assets 289 (289) -- --
------ ----- --- ----
Total $1,170 $(501) $(1) $668
====== ===== === ====
Remaining cash expenditures relating to workforce reductions and termination of
agreements will be substantially paid in the fourth quarter of fiscal 2001.
Amounts related to the net lease expense due to the consolidation of facilities
will be paid over the respective lease terms through fiscal 2007. We expect to
substantially complete implementation of our restructuring program during the
next six months.
Provision for Inventory
We recorded a provision for inventory, including purchase commitments, totaling
$2.36 billion during the third quarter of fiscal 2001, of which $2.25 billion
related to an additional excess inventory charge. Inventory purchases and
commitments are based upon future sales forecast. To mitigate the component
supply constraints that have existed in the past, we built inventory levels for
certain components with long lead times and entered into certain longer-term
commitments for certain components. Due to the sudden and significant decrease
in demand for our products, inventory levels exceeded our requirements based on
current 12-month sales forecasts. This additional excess inventory charge was
calculated based on the inventory levels in excess of 12-month demand for each
specific product. We do not currently anticipate that the excess inventory
subject to this provision will be used at a later date based on our current
12-month demand forecast.
25
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Liquidity and Capital Resources
Cash and cash equivalents and total investments were $17.35 billion at April 28,
2001, a decrease of $3.15 billion from July 29, 2000. The decrease was primarily
a result of a decrease in our net unrealized gains on publicly held investments
of $5.44 billion ($3.50 billion, net of tax) and cash used in investing
activities of $4.93 billion, which includes $1.81 billion in capital
expenditures and $960 million in purchases of minority investments, offset by
cash provided by operating activities of $4.71 billion and financing activities
of $1.09 billion.
Accounts receivable decreased 13.7% from July 29, 2000 to April 28, 2001. Days
sales outstanding in receivables increased to 38 days at April 28, 2001 from 37
days at July 29, 2000. The decrease in accounts receivable and the relatively
consistent days sales outstanding were primarily due to a decrease in net sales
and the linearity of shipments during the third quarter of fiscal 2001.
Inventories increased 55.3% from July 29, 2000 to April 28, 2001. Inventory
turns were 7.9 at April 28, 2001 and 7.8 at July 29, 2000. Inventory turns,
excluding the $2.25 billion additional excess inventory charge during the third
quarter of fiscal 2001, were 3.9 at April 28, 2001. The inventory levels and
inventory turns reflected new product introductions, lower shipment volumes, and
purchases of certain components with long lead times, combined with the decrease
in demand of products due to certain unfavorable economic conditions. 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.
We have entered into certain lease agreements in San Jose, California, where our
headquarters operations are established, and in Boxborough, Massachusetts;
Littleton, Massachusetts; Salem, New Hampshire; Richardson, Texas; and Research
Triangle Park, North Carolina, where we have expanded certain R&D and
customer-support activities. In connection with these transactions, we pledged
$1.21 billion of our investments as collateral for certain obligations of the
leases. We may 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 our liquidity position. At April 28, 2001, we had a
line of credit totaling $500 million, which expires in July 2002. There have
been no borrowings under this agreement. We believe that our current cash and
cash equivalents, short-term investments, line of credit, and cash generated
from operations will satisfy our expected working capital (including
restructuring liabilities), capital expenditure, and investment requirements at
least through the next 12 months. Remaining cash expenditures relating to
workforce reductions and termination of agreements will be substantially paid in
the fourth quarter of fiscal 2001. Amounts related to the net lease expense due
to the consolidation of facilities will be paid over the respective lease terms
through fiscal 2007.
26
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 or year 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 and annual fluctuations
as a result of a number of factors. These factors include:
- - Overall information technology spending;
- - Changes in general economic conditions and specific market conditions in
the communications and networking industries;
- - Fluctuations in demand for our products and services;
- - The long sales and implementation cycle for our products and the reduced
visibility into our customers' spending plans and associated revenue;
- - Inventory levels exceeding our requirements based upon future sales
forecast;
- - Existing network capacity, sharing of existing network capacity, and
network capacity utilization rates of our customers;
- - Increased price and product competition in the networking industry;
- - The overall trend toward industry consolidation;
- - The introduction and market acceptance of new technologies and products,
as well as the adoption of new networking standards;
- - Variations in sales channels, product costs, or mix of products sold;
- - The timing of orders, timing of shipments, and the ability to satisfy all
contractual obligations in customer contracts;
- - Manufacturing lead times;
- - The impact of acquired businesses and technologies;
- - The geographical mix of our revenue and the associated impact on gross
margin;
- - Our ability to achieve targeted cost reductions;
- - Adverse changes in the public and private equity and debt markets and the
ability of our customers and suppliers to obtain financing or to fund
capital expenditures;
- - The trend towards sales of integrated network solutions; and
- - The timing and amount of employer payroll tax to be paid on employees'
gains on stock options exercised.
As a consequence, operating results for a particular future period are difficult
to predict, especially in recent periods. Any of the foregoing factors, or any
other factors discussed
27
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
elsewhere herein, could have a material adverse effect on our business, results
of operations and financial condition.
In response to changes in industry and market conditions, we may strategically
realign our resources and consider restructuring, disposing or otherwise
exiting businesses. Any decision to limit investment in or to dispose or
otherwise exit businesses may result in the recording of accrued liabilities for
special one-time charges, such as workforce reduction costs. Additionally,
estimates with respect to the useful life and ultimate recoverability of our
carrying basis of assets, including goodwill and purchased intangible assets,
could change as a result of such assessments and decisions.
WE ARE EXPOSED TO GENERAL ECONOMIC AND MARKET CONDITIONS
Our business is subject to the effects of general economic conditions in the
United States and globally, and, in particular, market conditions in the
communications and networking industries. In recent quarters, our operating
results have been adversely affected as a result of recent unfavorable economic
conditions and reduced capital spending, particularly in the United States. In
particular, sales to service providers, e-commerce and Internet businesses, and
the manufacturing industry in the United States were adversely affected during
the second and third quarters of fiscal 2001. If the economic conditions in the
United States and globally do not improve, or if we experience a worsening in
the global economic slowdown, we may continue to experience material adverse
impacts on our business, operating results, and financial condition.
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 in particular periods may decline. In
addition, as a result of a variety of factors discussed herein, operating
results for a particular quarter are extremely difficult to predict. Our ability
to meet financial expectations could also be adversely affected if the
non-linear sales pattern seen in certain of our recent quarters recurs in future
periods. We generally have had at least 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 place the same orders within our various sales
channels, cancel orders, or not place further orders if shorter lead times are
available from other manufacturers.
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29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
As a result of our growth in past periods, our fixed costs have increased
substantially. With increased levels of spending and the impact of long-term
commitments an inability to meet expected revenue levels in a particular quarter
could have a material adverse impact on our operating results for that period as
we will not be able to quickly reduce these fixed expenses in response to
short-term business changes.
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 in-process 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, as a further example,
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.
WE EXPECT GROSS MARGIN VARIABILITY OVER TIME
We expect gross margin may be adversely affected by increases in material or
labor costs, heightened price competition, increasing levels of services, higher
inventory balances, obsolescence charges, loss of cost savings, introduction of
new products for new high-growth markets, and changes in channels of
distribution or in the mix of products sold, in particular, optical and access
products.
Inventory purchases and commitments are based upon future sales forecast. Due to
the current slowdown in the economy, our current inventory levels are higher
than our current sales forecasts, which could result in obsolescence charges or
loss of cost savings on future inventory purchases and thus gross margin may be
adversely affected. If product or related warranty costs associated with our
products are greater than we have experienced, gross margin may be adversely
affected. Our gross margin 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 a
lower gross margin. These distribution channels are generally given privileges
to return inventory. In addition, increasing third-party and
indirect-distribution channels generally results 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 net sales from lower
margin businesses (for example, service provider markets), which could adversely
affect our future operating results.
We also expect that our operating margin may decrease as we have continued to
hire additional personnel and experienced 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
WE ARE DEPENDENT UPON ADEQUATE COMPONENT SUPPLY AND MANUFACTURING CAPACITY
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. Although we generally use standard parts and components for our
products, certain components are presently available only from a single source
or limited sources.
While our suppliers have performed effectively and been relatively flexible to
date, we believe that we will be faced with the following challenges going
forward:
- - New markets that we participate in may grow quickly and thus, consume
significant component capacity;
- - As we continue to acquire companies and new technologies, we are
dependent, at least initially, on unfamiliar supply chains or relatively
small supply partners; and
- - We face competition for certain components, which are supply constrained,
from existing competitors and companies in other markets.
Manufacturing capacity and component supply constraints could be significant
issues for us. To mitigate component supply constraints that have existed in the
past, we built inventory levels for certain components with long lead times and
entered into certain longer-term commitments for certain components. A reduction
or interruption in supply, a significant increase in the price of one or more
components, or a decrease in demand of products would adversely affect our
business, operating results and financial condition, perhaps materially, and
could materially damage customer relationships.
WE COMPETE IN THE HIGHLY COMPETITIVE TELECOMMUNICATIONS EQUIPMENT MARKET
We compete in the Internet infrastructure 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 World 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 long-term attractive growth. On the other hand, we expect
the number of vendors supplying end-to-end networking solutions will decrease,
due to the rapid pace of acquisitions in the industry.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
We believe our primary competition comes from nimble start-ups and young
companies offering innovative niche solutions.
Our competitors include Alcatel, Ciena, Ericsson, Extreme Networks, Foundry
Networks, Juniper Networks, Lucent, Nortel Networks, Redback Networks, Siemens
AG, and Sycamore Networks. Some of our 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 may have greater resources, including
technical and engineering resources, than we do.
The principal competitive factors in the markets in which we presently compete
and may compete in the future are:
- - The ability to provide end-to-end networking solutions and support;
- - Performance;
- - Price;
- - The ability to provide value-added features such as security,
reliability, and investment protection;
- - Conformance to standards;
- - Market presence; and
- - The ability to provide financing.
We also face competition from customers we license technology to and suppliers
from whom we transfer technology. Networking's inherent nature requires
inter-operability. 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, or the uncontrollable and
unpredictable acts of others, could have a material adverse effect on our
business, operating results, and financial condition.
WE HAVE AND WILL CONTINUE TO INVEST IN NEW AND EXISTING MARKET OPPORTUNITIES
We have made significant investments in headcount, inventory, manufacturing
capacity, and product development through internal efforts and acquisitions, as
a result of growth in existing opportunities and new or emerging opportunities
in our target markets over the past years. We will continue to invest in these
markets either through additional investments or through re-alignment of
existing resources.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ENHANCEMENTS TO EXISTING
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
develop and introduce new products into existing and emerging markets, and to
reduce the costs to produce existing products. The success of 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.
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND
INTERNET-BASED SYSTEMS
A substantial portion of our business and revenue depends on the continued
growth of the Internet and on the deployment of our products by customers that
depend on the growth of the Internet. Spending on Internet infrastructure has
increased significantly over the past several years based upon the growth of the
Internet. There can be no assurance that spending on Internet infrastructure
will continue at these historical rates. As a result of the recent economic
slowdown and the reduction in capital spending by many of our customers,
spending on Internet infrastructure has declined significantly, which has had a
material adverse effect on our business. To the extent that the economic
slowdown and reduction in capital spending continue to adversely affect spending
on Internet infrastructure, we could continue to experience material adverse
impacts on our business, operating results and financial condition.
We believe that there will be certain 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 networking products, we 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.
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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
need to develop new products is through acquisitions of other companies and
technologies. Acquisitions involve numerous risks, including the following:
~ Difficulties in integrating the operations, technologies, and products of
the acquired companies;
~ The risk of diverting management's attention from normal daily operations
of the business;
~ Potential difficulties in completing projects associated with 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;
~ Initial dependence on unfamiliar supply chains or relatively small supply
partners;
~ Insufficient revenues to offset increased expenses associated with
acquisitions; and
~ The potential loss of key employees of the acquired companies.
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 manage any growth effectively.
Failure to manage growth effectively and successfully integrate acquisitions we
made could harm our business and operating results in a material way.
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 AG, among others, and several well-funded start-up
companies. Several of our current and potential competitors may have greater
resources, including technical and engineering 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.
SALES TO THE SERVICE PROVIDER MARKET ARE SUBJECT TO VARIATION
Sales to the service provider market have been 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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
affected by regulatory, economic 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. The recent slowdown in the general economy, changes in the service
provider market, and the constraints on capital availability have had a material
adverse effect on many of our service provider customers, with a number of such
customers going out of business or substantially reducing their expansion plans.
These conditions have had a material adverse effect on our business and
operating results, and we expect that these conditions will continue for the
foreseeable future.
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 positions in an evolving industry. We believe
that industry consolidation may result in 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.
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; service provider and
government spending patterns; and natural disasters. Any or all of these factors
could have a material adverse impact on our future international business.
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 continued to see our exposures to emerging market
currencies, such as the Korean won, increase because of our expanding presence
in these markets and their 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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
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 periodically will 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.
WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS AND TO CREDIT
EXPOSURES IN WEAKENED MARKETS
A portion of our sales is derived through our resellers in two-tier distribution
channels. These resellers/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 resellers 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, including loan financing and leasing
solutions. We expect demands for customer financing to continue. We believe
customer financing is a competitive factor in obtaining business, particularly
in supplying customers involved in significant infrastructure projects. Our loan
financing arrangements may include not only financing the acquisition of our
products but also providing additional funds for soft costs associated with
network installation and integration of our products and for working capital
purposes. Due to the current slowdown in the economy, the credit risks relating
to these resellers/customers have increased. Although we have programs in place
to monitor and mitigate the associated risk, there can be no assurance that such
programs will be effective in reducing our credit risks. We also continue to
monitor increased credit exposures from weakened financial conditions in certain
geographic regions, and the impact that such conditions may have on the
worldwide economy. We have experienced losses due to customers failing to meet
their obligations. Although these losses have not been significant, future
losses, if incurred, could harm our business and have a material adverse effect
on our operating results and financial condition.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
Furthermore, the laws of some foreign countries may not permit the protection of
our proprietary rights to the same extent as do the laws of the United States.
Although we believe the protection afforded by its 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.
Our industry is characterized by the existence of a large number of patents and
frequent claims and related litigation regarding patent and other intellectual
property rights. From time to time, third parties have asserted exclusive
patent, copyright, trademark and other intellectual property rights to
technologies and related standards that are important to us. These claims have
increased recently as a result of our acquisition of businesses and
technologies. Such parties have and may in the future assert claims or initiate
litigation against us or our manufacturers, suppliers, or customers alleging
infringement of their proprietary rights with respect to our existing or future
products. Regardless of the merit of these claims, they could be time-consuming,
result in costly litigation and diversion of technical management personnel, or
require us to develop a non-infringing technology or enter into royalty or
license agreements. If any infringement or other intellectual property claim
made against us by any third party is successful, or if we fail to develop
non-infringing technology or license the proprietary rights, our business could
be materially and adversely affected.
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 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, we believe that, based upon
industry practice, any necessary license or rights under such patents may be
obtained on terms that would not have a material adverse effect on our business,
operating results, or financial condition. Nevertheless, 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 of the Internet and Internet commerce in any country where we operate
on such technology as voice over the Internet,
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
encryption technology, and access charges for Internet service providers. We
also could be materially adversely affected by the continuing deregulation of
the telecommunications industry. The adoption of regulation of the Internet and
Internet commerce could decrease demand for our products, and at the same time
increase the cost of selling our products, which could have a material adverse
effect on our business, operating results, and financial condition.
OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO RETAIN AND RECRUIT KEY PERSONNEL
Our success has always depended in large part on our ability to attract and
retain highly skilled technical, managerial, sales, and marketing personnel. In
spite of the economic slowdown, competition for these personnel is intense,
especially in the Silicon Valley area of the San Francisco Bay Area. Volatility
or lack of positive performance in our stock price may also adversely affect our
ability to retain key employees, all of whom have been granted stock options.
The loss of services of any of our key personnel, the inability to retain and
attract qualified personnel in the future, or delays in hiring required
personnel, particularly engineers and sales personnel, could make it difficult
to meet key objectives, such as timely product introductions. In addition,
companies in the networking industry whose employees accept positions with
competitors frequently claim that competitors have engaged in improper hiring
practices. We have received these claims in the past and may receive additional
claims to this effect in the future.
WE FACE CERTAIN LITIGATION RISKS
We are a party to lawsuits in the normal course of our business. Litigation can
be expensive, lengthy and disruptive to normal business operations. Moreover,
the results of complex legal proceedings are difficult to predict. An
unfavorable resolution of a particular lawsuit could have a material adverse
effect on our business, results of operations or financial condition.
OUR BUSINESS IS SUBJECT TO THE RISKS OF EARTHQUAKES,FLOODS AND OTHER
CATASTROPHIC EVENTS
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,
certain of our facilities, which include one of our manufacturing facilities,
are located near rivers that have experienced flooding in the past. A
significant natural disaster, such as an earthquake or a flood, could have a
material adverse impact on our business, operating results, and financial
condition. In addition, despite our implementation of network security measures,
our servers are vulnerable to computer viruses, break-ins and similar
disruptions from unauthorized tampering with our computer systems. Any such
event could have a material adverse effect on our business, operating results
and financial condition.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
THE RECENT ENERGY CRISIS IN CALIFORNIA COULD DISRUPT OUR BUSINESS AND THE
BUSINESSES OF OUR SUPPLIERS AND CONTRACT MANUFACTURERS, AND COULD INCREASE OUR
EXPENSES
In recent months, the western United States (and California in particular) has
experienced repeated episodes of diminished electrical power supply, and we
anticipate that this situation could continue to worsen in the near future. As a
result of these episodes, certain of our operations or facilities have been and
may continue to be subject to "rolling blackouts" or other unscheduled
interruptions of electrical power. The prospect of such unscheduled
interruptions may continue for the foreseeable future, and we are unable to
predict their occurrence or duration. Certain of our suppliers and contract
manufacturers are also located in this area and their operations may also be
materially and adversely affected by such interruptions. These suppliers and
manufacturers may be unable to manufacture sufficient quantities of our products
to meet our demands, or they may increase the costs of such products, which in
turn could have a material adverse effect on our business or results of
operations.
WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS
AND IN INTEREST RATES
For additional information regarding the sensitivity of and risks associated
with the market value of portfolio investments and interest rates, see Item 3
"Quantitative and Qualitative Disclosures About Market Risk" contained in this
Quarterly Report.
WE CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC
The SEC has been reviewing registrants' valuation methodologies of in-process
research and development related to business combinations. We believe we are in
compliance with all of the existing rules and related guidance as applicable to
our business operations. However, the SEC may change these rules or issue new
guidance applicable to our business in the future. There can be no assurance
that the SEC will not seek to reduce the amount of 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 operating results and financial condition for periods subsequent
to the acquisitions.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH STRATEGIC ALLIANCES
We have increased the number of our strategic alliances with large and complex
organizations and our ecosystem partners. 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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RISK FACTORS
some business areas with a company with which we have a strategic alliance and,
at the same time, cooperate with that 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.
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
United States, our products must comply with various Federal Communications
Commission requirements and regulations. In countries outside of the United
States, our products must meet various requirements of local telecommunications
authorities. Changes in 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 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. Additionally, volatility or a lack of positive
performance in our stock price may adversely affect our ability to retain key
employees, all of whom have been granted stock options.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We maintain an investment portfolio of various holdings, 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, net of tax, reported as a separate component of accumulated
other comprehensive income. Part of this portfolio includes minority equity
investments in several publicly traded companies, the values of which are
subject to market price volatility. For example, as a result of recent market
price volatility of our publicly traded equity investments, we experienced a
$3.50 billion after-tax decrease in net unrealized gains during the first nine
months of fiscal 2001 on these investments. We have also invested in numerous
privately held companies, many of which can still be considered in the start-up
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 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 23 to 24 of the fiscal 2000 Annual Report to
Shareholders for a more detailed discussion of quantitative and qualitative
disclosures about market risk.
The following analysis presents the hypothetical changes 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. The following table estimates the fair
value of the publicly traded corporate equities at a 12-month horizon (in
millions):
Valuation of Securities Valuation of Securities
Given X% Decrease Fair Value Given X% Increase
in Each Stock's Price as of in Each Stock's Price
------------------------------ Apr. 28, ------------------------------
(50%) (35%) (15%) 2001 15% 35% 50%
------ ------ ------ ---------- ------ ------ ------
Corporate equities $ 932 $1,212 $1,585 $1,865 $2,145 $2,518 $2,797
Our equity portfolio consists of securities with characteristics that most
closely match the S&P Index or companies traded on the NASDAQ National Market.
The NASDAQ Composite Index has shown a 15% movement in each of the last three
years and a 35% and 50% movement in at least one of the last three years.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Beginning on April 20, 2001, a number of purported shareholder class action
lawsuits have been filed in the United States District Court for the Northern
District of California against the Company and certain of its officers and
directors. The lawsuits are essentially identical, and purport to bring suit on
behalf of those who purchased the Company's publicly traded securities between
August 10, 1999 and April 16, 2001. Plaintiffs allege that defendants made false
and misleading statements, purport to assert claims for violations of the
federal securities laws, and seek unspecified compensatory damages and other
relief. The Company believes the claims are without merit and intends to defend
the actions vigorously.
In addition, beginning on April 23, 2001, a number of purported shareholder
derivative lawsuits have been filed in the Superior Court of California, County
of Santa Clara, against the Company (as a nominal defendant), its directors and
certain officers. At least one purported derivative suit has also been filed in
the United States District Court for the Northern District of California, and
another has been filed in the Superior Court of California, County of San Mateo.
The complaints in the various derivative actions include claims for breach of
fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment and
violations of the California Corporations Code, seek compensatory and other
damages, disgorgement and other relief, and are based on essentially the same
allegations as the class actions.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) During the quarter ended April 28, 2001, the Company issued an aggregate
of approximately 16.3 million shares of its common stock in connection
with the purchase of the capital stock of Active Voice Corporation;
Radiata, Inc.; and ExiO Communications, Inc. The shares were issued
pursuant to exemptions under Section 3(a)(10) and 4(2) of the Securities
Act of 1933, as amended. In the case of issuances in reliance on Section
3(a)(10), an appropriate governmental authority approved the terms of the
issuance following a fairness hearing. In the case of issuances in
reliance on Section 4(2), the issuances were effected without general
solicitation or advertising, and each purchaser was an accredited
investor or a sophisticated investor with access to information regarding
the Company, its business, and its common stock.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Reports on Form 8-K
The Company filed four reports on Form 8-K during the quarter ended April 28,
2001. Information regarding the items reported on is as follows:
Date Item Reported On
- ---- ----------------
February 7, 2001 The Company announced the completion of the acquisition of Radiata,
Inc.
February 8, 2001 The Company reported its second quarter results for the period ending January
27, 2001.
February 15, 2001 The Company announced the completion of the acquisition of Active
Voice Corporation.
February 26, 2001 The Company announced the completion of the acquisition of ExiO
Communications, Inc.
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SIGNATURE
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: May 31, 2001 By /s/ Larry R. Carter
------------------------------------
Larry R. Carter, Senior Vice
President, Finance and
Administration, Chief Financial
Officer and Secretary
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