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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 25, 1998
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 (I.R.S. Employer Identification
of Number)
incorporation or organization)
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 June 1, 1998, 1,036,548,848 shares of the Registrant's common stock were
outstanding.
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CISCO SYSTEMS, INC.
FORM 10-Q FOR THE QUARTER ENDED APRIL 25, 1998
INDEX
Page
----
Facing sheet 1
Index 2
Part I. Financial information
Item 1. Financial statements and supplementary data
a) Consolidated statements of operations for the three and nine months
ended April 25, 1998 and April 26, 1997 3
b) Consolidated balance sheets at April 25, 1998 and July 26, 1997 4
c) Consolidated statements of cash flows for the nine months
ended April 25, 1998 and April 26, 1997 5
d) Notes to consolidated financial statements 6
Item 2. Management's discussion and analysis of financial
condition and results of operations 10
Part II. Other information 18
Signature 19
Exhibit Exhibit 27, Financial data schedule 20
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PART I.
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per-share amounts)
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
Apr. 25, Apr. 26, Apr. 25, Apr. 26,
1998 1997 1998 1997
---------- ---------- ---------- ----------
(Unaudited)
Net sales $2,183,756 $1,647,871 $6,068,788 $4,675,074
Cost of sales 749,727 571,339 2,098,682 1,625,338
---------- ---------- ---------- ----------
Gross margin 1,434,029 1,076,532 3,970,106 3,049,736
---------- ---------- ---------- ----------
Operating expenses:
Research and development 263,064 183,714 726,071 496,077
Sales and marketing 412,241 299,339 1,109,066 846,790
General and administrative 67,329 54,349 181,411 148,236
Purchased research and development 418,659 -- 545,850 217,792
---------- ---------- ---------- ----------
Total operating expenses 1,161,293 537,402 2,562,398 1,708,895
---------- ---------- ---------- ----------
Operating income 272,736 539,130 1,407,708 1,340,841
Realized gain on sale of investment -- 32,288 5,411 134,695
Interest and other income, net 52,047 29,093 132,921 77,635
---------- ---------- ---------- ----------
Income before provision for income taxes 324,783 600,511 1,546,040 1,553,171
Provision for income taxes 260,205 222,190 687,645 655,449
---------- ---------- ---------- ----------
Net income $ 64,578 $ 378,321 $ 858,395 $ 897,722
========== ========== ========== ==========
Net income per share--Basic $ .06 $ .38 $ .84 $ .91
========== ========== ========== ==========
Net income per share--Diluted $ .06 $ .37 $ .81 $ .87
========== ========== ========== ==========
Shares used in per-share
calculation-- -- Basic 1,027,215 996,017 1,017,239 987,539
========== ========== ========== ==========
Shares used in per-share
calculation-- -- Diluted 1,076,327 1,032,677 1,065,127 1,030,941
========== ========== ========== ==========
See notes to consolidated financial statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
April 25, July 26,
1998 1997
----------- -----------
(Unaudited)
ASSETS
Current assets:
Cash and equivalents $ 1,170,585 $ 269,608
Short-term investments 942,475 1,005,977
Accounts receivable, net of allowance for doubtful
accounts of $30,849 at April 25, 1998 and
$22,340 at July 26, 1997 1,272,958 1,170,401
Inventories, net 308,276 254,677
Deferred income taxes 390,855 312,132
Prepaid expenses and other current assets 57,496 88,471
----------- -----------
Total current assets 4,142,645 3,101,266
Investments 2,259,289 1,267,174
Restricted investments 486,347 363,216
Property and equipment, net 545,661 466,352
Other assets 464,195 253,976
----------- -----------
Total assets $ 7,898,137 $ 5,451,984
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 268,168 $ 207,178
Income taxes payable 362,840 256,224
Accrued payroll and related expenses 343,068 263,269
Other accrued liabilities 572,632 393,438
----------- -----------
Total current liabilities 1,546,708 1,120,109
Minority interest 42,960 42,253
Shareholders' equity:
Preferred stock, no par value, 5,000 shares authorized:
none issued or outstanding at April 25, 1998
and July 26, 1997
Common stock and additional paid-in capital, $.001 par value(no par value -
July 26, 1997), 1,800,000 shares authorized: 1,035,207 shares issued and
outstanding at April 25, 1998
and 1,006,168 at July 26, 1997 2,924,246 1,763,200
Retained earnings 3,336,546 2,487,058
Unrealized gain on investments 62,312 49,628
Cumulative translation adjustments (14,635) (10,264)
----------- -----------
Total shareholders' equity 6,308,469 4,289,622
----------- -----------
Total liabilities and shareholders' equity $ 7,898,137 $ 5,451,984
=========== ===========
See notes to consolidated financial statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
------------------------------
April 25, April 26,
1998 1997
----------- -----------
(Unaudited)
Cash flows from operating activities:
Net income $ 858,395 $ 897,722
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 230,162 151,044
Deferred income taxes (88,831) (82,459)
Tax benefits from employee stock plans 282,668 140,547
Adjustment to conform StrataCom fiscal year -- (11,020)
Purchased research and development from acquisitions 426,038 43,203
Change in operating assets and liabilities:
Accounts receivable (94,434) (514,374)
Inventories (52,107) 70,229
Prepaid expenses and other current assets 31,145 23,692
Income taxes payable 106,616 75,973
Accounts payable 46,987 64,152
Accrued payroll and related expenses 78,736 28,912
Other accrued liabilities 158,971 70,228
----------- -----------
Net cash provided by operating activities 1,984,346 957,849
----------- -----------
Cash flows from investing activities:
Purchases of short-term investments (1,098,872) (1,045,272)
Proceeds from sales and maturities of short-term
investments 1,373,092 919,396
Purchases of investments (2,015,530) (1,335,381)
Proceeds from sales and maturities of investments 821,160 850,949
Purchases of restricted investments (324,613) (259,668)
Proceeds from sales and maturities of restricted
investments 202,323 155,017
Acquisition of property and equipment (282,156) (270,240)
Acquisition of Telebit Corporation, net of
purchased research and development -- (25,189)
Other (97,597) (26,980)
----------- -----------
Net cash used in investing activities (1,422,193) (1,037,368)
----------- -----------
Cash flows from financing activities:
Issuance of common stock 343,195 152,531
Other (4,371) (7,215)
----------- -----------
Net cash provided by financing activities 338,824 145,316
----------- -----------
Net increase in cash and equivalents 900,977 65,797
Cash and equivalents, beginning of period 269,608 279,695
----------- -----------
Cash and equivalents, end of period $ 1,170,585 $ 345,492
=========== ===========
See notes to consolidated financial statements.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Cisco Systems, Inc. (the "Company") provides networking solutions that connect
computing devices and computer networks, allowing people to access or transfer
information without regard to differences in time, place or type of computer
system. The Company sells its products in approximately 105 countries through a
combination of direct sales and reseller and distribution channels.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
The Company's fiscal year is the 52 or 53 weeks ending on the last Saturday in
July. Fiscal years 1998 and 1997 are both 52 week years. Fiscal year 1999 will
be a 53 week year.
Basis of Presentation
The accompanying financial data as of April 25, 1998 and July 26, 1997, and for
the three and nine month periods ended April 25, 1998 and April 26, 1997, have
been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. 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 26, 1997 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 financial statements and the notes thereto included in
the Company's Annual Report on Form 10-K for the year ended July 26, 1997.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations, and cash flows as of April 25, 1998 and for the three and
nine month periods ended April 25, 1998 and April 26, 1997, have been made. The
results of operations for the periods ended April 25, 1998 are not necessarily
indicative of the operating results for the full year.
Computation of Net Income Per Share
The Company has adopted Statement of Financial Accounting Standards (SFAS) No.
128. This Statement requires the presentation of basic and diluted net income
per share. Basic net income per common share is computed using the weighted
average number of common shares outstanding during the period. Diluted net
income per share is computed using the weighted average number of common and
dilutive common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of stock options (see Note 7). The Company has
restated all prior period per share data presented as required by SFAS No. 128.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Restated numbers as computed using the diluted method under SFAS No. 128
approximate those computed using the previous method as defined in Accounting
Principals Board Opinion No. 15.
Share and per share data presented reflect a three-for-two stock split, which
was effective on December 16, 1997.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131 "Disclosures about Segments
of an Enterprise and Related Information." Readers are referred to the "Recent
Accounting Pronouncements" section of the Company's 1997 Annual Report to
Shareholders for further discussion.
3. BUSINESS COMBINATIONS
PURCHASE COMBINATIONS
In August 1997, the Company completed its purchase of Dagaz Technologies, Inc.
("Dagaz"), a wholly owned subsidiary of Integrated Network Corporation, and its
xDSL technology. Under the terms of the agreement the Company paid cash of $108
million, exchanged stock worth $18 million and assumed net liabilities of $1
million in exchange for all of the outstanding common stock of Dagaz. The
Company recorded purchased research and development related to this transaction
of $127 million.
In February 1998, the Company completed its purchase of LightSpeed
International, Inc. ("LightSpeed"), a privately-held innovator in voice
signaling translation technology. Under the terms of the agreement, the Company
exchanged 2.5 million shares of its common stock for all outstanding shares of
LightSpeed. The Company also assumed remaining outstanding LightSpeed stock
options which were converted to options to purchase approximately .5 million
shares of the Company's common stock. As part of this transaction, the Company
recorded approximately $143 million in purchased research and development
expense in the third quarter of fiscal year 1998.
In March 1998, the Company completed its purchase of WheelGroup Corporation
("WheelGroup"), a privately-held innovator of network security software
products. Under the terms of the agreement, the Company issued 1.5 million
shares of its common stock for all outstanding shares of WheelGroup. The Company
also assumed remaining outstanding WheelGroup stock options which were converted
to options to purchase approximately .4 million shares of the Company's common
stock. As part of this transaction, the Company recorded approximately $97
million in purchased research and development expense in the third quarter of
fiscal year 1998.
In April 1998, the Company completed its purchase of NetSpeed Inc. ("NetSpeed"),
a privately-held developer of Digital Subscriber Line technology. Under the
terms of the agreement, the Company exchanged 3.0 million shares of its common
stock for all outstanding shares of NetSpeed. The Company also assumed remaining
outstanding NetSpeed
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
stock options which were converted to options to purchase approximately .5
million shares of the Company's common stock. As part of this transaction, the
Company recorded approximately $179 million in purchased research and
development expense in the third quarter of fiscal year 1998.
The historical operations of Dagaz, LightSpeed, WheelGroup and NetSpeed are not
material to the Company's consolidated operations and financial position on
either an individual or an aggregate basis, therefore, pro forma summaries are
not presented. The amounts allocated to purchased research and development were
determined through established valuation techniques in the high technology
communications industry, and were expensed upon acquisition, because
technological feasibility had not been established and no future alternative
uses existed. Research and development costs to bring the Dagaz, LightSpeed,
WheelGroup and NetSpeed products to technological feasibility are not expected
to have a material impact on the Company's future results of operations, cash
flows or liquidity.
Purchase Combination Announced Subsequent to Quarter-End
In May 1998, the Company announced a definitive agreement to purchase CLASS Data
Systems ("CLASS Data"), a privately-held developer of software solutions which
enable policy-based quality of service in Internet Protocol (IP) networks. Under
terms of the agreement, a combination of the Company's common stock and cash
with an aggregate value of $50 million will be exchanged for all outstanding
shares and options of CLASS Data. The acquisition is expected to be completed in
the fourth quarter.
POOLING OF INTERESTS COMBINATION
In April 1998, the Company completed its acquisition of Precept Software, Inc.
("Precept") a developer of multimedia network software. Under the terms of the
agreement, the Company exchanged approximately 1.0 million shares for all of the
outstanding shares of Precept. The Company also assumed remaining outstanding
Precept stock options which were converted to options to purchase approximately
.1 million shares of the Company's common stock. The historical operations of
Precept are not material to the Company's consolidated operations and financial
position, therefore prior period statements have not been restated.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. BALANCE SHEET DETAIL
(In thousands)
Inventories: April 25, July 26,
1998 1997
----------- ---------
(Unaudited)
Raw materials $ 68,225 $ 89,226
Work in process 123,290 114,724
Finished goods 81,483 21,733
Demonstration systems 35,278 28,994
-------- --------
$308,276 $254,677
======== ========
5. INCOME TAXES
The Company paid income taxes of $389 million in the nine months ended April 25,
1998 and $514 million in the nine months ended April 26, 1997. The Company's
effective tax rate for the fiscal year 1997 has been affected by the purchased
research and development from the acquisitions of LightSpeed, WheelGroup and
NetSpeed. The Company's income taxes currently payable for both federal and
state purposes have been reduced by the tax benefit of disqualifying
dispositions of stock options. This benefit totaled $283 million in the first
nine months of fiscal 1998, and was credited directly to shareholders' equity.
6. SHAREHOLDERS' EQUITY AND STOCK SPLIT
At the Annual Meeting of Shareholders held on November 13, 1997, the
shareholders approved an amendment to the Articles of Incorporation changing the
par value of the Company's Common Stock from zero to $.001 per share. As a
result, the Company has transferred the additional paid-in capital to a separate
account; however, for financial statement purposes, the additional paid-in
capital account has been combined with the common stock account and reflected on
the balance sheet as "Common stock and additional paid-in capital."
In November 1997, the Company announced that its Board of Directors approved a
three-for-two split of the Company's common stock that was applicable to
shareholders of record on November 18, 1997 and effective on December 16, 1997.
Share and per-share data for all periods presented have been adjusted to give
effect to this three-for-two stock split.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. EARNINGS PER SHARE
(In thousands, except per-share amounts)
The following table presents the calculation of basic and diluted earnings per
share as required under SFAS 128:
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
April 25, April 26, April 25, April 26,
1998 1997 1998 1997
---------- ---------- ---------- ----------
(Unaudited)
Net income $ 64,578 $ 378,321 $ 858,395 $ 897,722
========== ========== ========== ==========
Weighted average shares -- basic 1,027,215 996,017 1,017,239 987,539
Effect of dilutive securities:
Employee stock options 49,112 36,660 47,888 43,402
---------- ---------- ---------- ----------
Weighted average shares--diluted 1,076,327 1,032,677 1,065,127 1,030,941
========== ========== ========== ==========
Net income per share--Basic $ .06 $ .38 $ .84 $ .91
========== ========== ========== ==========
Net income per share--Diluted $ .06 $ .37 $ .81 $ .87
========== ========== ========== ==========
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", and words of similar import, constitute forward looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Readers are referred to the "Acquisitions, Investments and Alliances",
"Competition", "Research and Development", "Manufacturing", "Patents,
Intellectual Property and Licensing" and "Other Risk Factors" sections contained
in the Company's 1997 Form 10-K filed on October 22, 1997, and to the "Financial
Risk Management" and "Future Growth Subject to Risks" sections contained herein
which identify important risk factors that could cause actual results to differ
from those contained in the forward looking statements.
Net sales grew to $2,184 million in the third quarter of 1998 from $1,648
million in the third quarter of 1997. Net sales for the first nine months of
1998 were $6,069 million, compared to $4,675 million in the first nine months of
1997. The 32.5% increase in net sales between the two three month periods and
the 29.8% increase in net sales between the two nine month periods was primarily
a result of increasing unit sales of LAN switching products such as the
Catalyst(R) 5000 family, access servers such as the Cisco 3600 family, and
increased service contract sales. The sales growth rate for lower-priced access
and
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switching products targeted toward small and medium-sized businesses has
increased faster than that of the Company's high-end core router products. These
products typically carry lower average selling prices, and thus have slowed the
Company's growth rate versus last year. Additionally, some of the Company's more
established product lines, such as the Cisco 2500 product family and the
Catalyst(R) 1400, have experienced decelerating growth rates. Sales to
international customers declined to 41.8% in the third quarter of 1998, from
49.6% for the third quarter of 1997. International sales in the first nine
months of 1998 were 40.9% of net sales compared with 48.7% of net sales for the
same period in 1997. The decrease reflects slower sales in international
markets, particularly certain countries in Asia. The Company anticipates that
sales in Asia will remain weak for the foreseeable future. Sales growth in these
markets has generally been impacted by a variety of factors including weaker
economic conditions, delayed government spending, a stronger dollar versus the
local currencies, and slower adoption of networking technologies.
Gross margins increased slightly to 65.7% in the third quarter of 1998 from
65.3% in the third quarter of 1997. Gross margins for the first nine months of
1998 were 65.4% compared with 65.2% for the same period in 1997. The increase is
due principally to the Company's improvements in value engineering efforts and
material cost reductions. The prices of component parts have fluctuated in the
recent past, and the Company expects that this trend may continue. An increase
in the price of component parts may have a material adverse impact on gross
margins. The Company expects that gross margins will decrease in the future,
because it believes that the market for lower-margin remote access and switching
products for small to medium-sized businesses will increase at a faster rate
than the market for the Company's higher-margin router and high-performance
switching products. Additionally, as the Company focuses on new market
opportunities, it faces increasing competitive pressure from large
telecommunications equipment suppliers and well funded start-up companies, which
may materially adversely effect gross margins. The Company is attempting to
mitigate these trends through various means, such as increasing the
functionality of its products, continued value engineering efforts, controlling
royalty costs, and improving manufacturing efficiencies. There can be no
assurance that any efforts made by the Company in these and other areas will
successfully offset decreasing margins.
Research and development expenses increased by $79 million in the third quarter
of 1998 over the third quarter of 1997, and increased $230 million in the first
nine months of 1998 versus the first nine months of 1997. This represents an
increase from 11.1% to 12.0% of net sales in the quarter to quarter period and
from 10.6% to 12.0% of net sales for the first nine months of each fiscal year.
The increase reflects the Company's ongoing research and development efforts in
a wide variety of areas such as voice, video, and data integration, Digital
Subscriber Line (DSL) technologies, dial access, enterprise switch routers,
security, network management, and high-end routing technologies, among others. A
significant portion of the increase was due to the addition of new personnel, as
well as higher expenditures on prototypes and depreciation on new equipment. For
the near future, research and development expenses are expected to increase at a
greater rate than the sales growth rate, as the Company invests in technology to
address potential market opportunities. The Company also continues to purchase
technology in order to bring a broad range of products to the market in a timely
fashion. If the Company believes it is unable to enter a particular market in a
timely manner, it may acquire other
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businesses or license technology from other businesses as an alternative to
internal research and development. All of the Company's research and development
costs are expensed as incurred.
Sales and marketing expenses increased by $113 million between the third quarter
of 1998 and the third quarter of 1997, and increased $262 million from the first
nine months of 1997 to the first nine months of 1998. This represents an
increase from 18.2% of net sales to 18.9% for the quarter to quarter period and
from 18.1% to 18.3% for the first nine months of each fiscal year. The dollar
increase is due principally to an increase in the size of the Company's direct
sales force and its commissions, additional marketing and advertising costs
associated with the introduction of new products and the expansion of
distribution channels. The increase in percentage terms also reflects the
Company's efforts to invest in certain key areas such as expansion of its
end-to-end strategy and service provider coverage in order to position itself to
take advantage of future market opportunities.
General and administrative expenses rose $13 million between the third quarters
of 1998 and 1997, and decreased to 3.1% from 3.3% of net sales in the third
quarter of 1998 and 1997, respectively. These expenses increased $33 million in
the first nine months of 1998 compared to the same period in 1997, representing
a decrease to 3.0% from 3.2% of net sales for the comparable nine month periods.
The dollar increase reflects increased personnel costs necessary to support the
Company's business infrastructure, including those associated with its European
Logistics Center, as well as further development of its information systems. It
is management's intent to keep general and administrative costs relatively
constant as a percentage of net sales; however, this goal is dependent upon the
level of acquisition activity and the amortization of resulting intangible
assets, among other factors.
The amount expensed to purchased research and development in the first nine
months of fiscal 1998 related to the acquisitions of Dagaz, LightSpeed,
WheelGroup and NetSpeed (See Note 3).
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 130, "Reporting Comprehensive Income,"
and SFAS No. 131 "Disclosures about Segments of an Enterprise and Related
Information." Readers are referred to the "Recent Accounting Pronouncements"
section of the Company's 1997 Annual Report to Shareholders for further
discussion.
FINANCIAL RISK MANAGEMENT
As a global concern, the Company faces 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 the Company's
financial results. Historically, the Company's primary exposures related to
nondollar-denominated sales in Japan, Canada, and Australia and
nondollar-denominated operating expenses in Europe, Latin America, and Asia
where the Company sells primarily in U.S. dollars. The Company has recently
expanded its business activities in Europe. As a result, the Company expects to
see an increase over time in exposures related to nondollar-denominated sales in
several European currencies. At the present time, the Company hedges only those
currency exposures associated with certain assets and liabilities denominated in
nonfunctional currencies and does not
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generally hedge anticipated foreign currency cash flows. The hedging activity
undertaken by the Company is intended to offset the impact of currency
fluctuations on certain nonfunctional currency assets and liabilities. The
success of this activity depends upon forecasts of transaction activity
denominated in various currencies, primarily the Japanese yen, Canadian dollar,
Australian dollar, and certain European currencies. To the extent that these
forecasts are over- or understated during periods of currency volatility, the
Company could experience unanticipated currency gains or losses.
The Company has experienced increased activity with partners in its two-tier
distributor channel, as well as an increase in leasing activity. The Company is
also closely monitoring credit risk with its customers in Asia. Although to date
the Company has not experienced significant losses due to customers failing to
meet their obligations, such losses, if incurred, could have a material adverse
impact on the Company's business, operating results, and financial position.
The Company maintains investment portfolio holdings of various issuers, types,
and maturities. These securities are generally classified as available for sale,
and consequently, are recorded on the balance sheet at fair value with
unrealized gains or losses reported as a separate component of shareholders'
equity, net of tax. Part of this portfolio includes minority equity investments
in several publicly-traded companies, the value of which are subject to market
price volatility. The Company also has 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 the
Company's investment portfolio while increasing the costs associated with its
lease commitments. Conversely, declines in interest rates could have a material
impact on interest earnings for the Company's investment portfolio. The Company
does not currently hedge these interest rate exposures. Readers are referred to
pages 26-27 of the Company's 1997 Annual Report to Shareholders for further
discussion of the Company's interest rate exposures.
FUTURE GROWTH SUBJECT TO RISKS
The networking business is highly competitive, and as such, the Company's growth
is dependent upon market growth and its ability to enhance its existing products
and introduce new products on a timely basis. One of the ways the Company has
addressed and will continue to address the need to develop new products is
through acquisitions of other companies. Acquisitions involve numerous risks,
including difficulties in integration of the operations, technologies, and
products of the acquired companies; the risk of diverting management's attention
from normal daily operations of the business; risks of entering markets in which
the Company has no or limited direct prior experience and where competitors in
such markets have stronger market positions; and the potential loss of key
employees of the acquired company. The Company must also maintain its ability to
manage any such growth effectively. Failure to manage growth effectively and
successfully integrate acquisitions made by the Company could materially
adversely affect the Company's business and operating results.
There are currently few laws or regulations that apply directly to access or
commerce on the Internet. The Company could be materially adversely affected by
proposed regulation on voice over the Internet, encryption technology and access
charges for Internet service
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providers, as well as the continuing deregulation of the telecommunications
industry. The adoption of such measures could decrease demand for the Company's
products, and at the same time increase the Company's cost of selling its
products. Changes in laws or regulations governing the Internet and Internet
commerce could have a material adverse effect on the Company's business,
operating results and financial condition.
The markets for the Company's 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 the Company will successfully identify new product opportunities and
develop and bring new products to market in a timely manner, or that products
and technologies developed by others will not render the Company's products or
technologies obsolete or noncompetitive.
As the Company focuses on new market opportunities, such as transporting voice,
video, and data traffic across the same networks, it will increasingly compete
with large telecommunications equipment suppliers, and well funded start-up
companies. Additionally, as customers in these markets complete infrastructure
deployments, they may require greater levels of service, support and financing
than the Company has experienced in the past. There can be no assurance that the
Company can provide products, service, support and financing to effectively
compete for these market opportunities. Readers are referred to the
"Competition" section of the Company's Form 10-K filed on October 22, 1997 for
further discussion.
The Company expects that in the future, its net sales may grow at a slower rate
than was experienced in previous periods, and that on a quarter-to-quarter
basis, the Company's growth in net sales may be significantly lower than its
historical quarterly growth rate. As a consequence, operating results for a
particular quarter are extremely difficult to predict. The Company's ability to
meet financial expectations could be hampered if the nonlinear sales pattern
seen in past quarters reoccurs in future periods. The Company generally has had
one quarter of the fiscal year when backlog has been reduced. Although such
reductions have not occurred consistently in recent years, they are difficult to
predict and may occur in the future. In addition, in response to customer
demand, the Company continues to attempt to reduce its 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 the Company's quarter-to-quarter net sales and operating
results going forward. On the other hand, for certain products, lead times are
longer than the Company's goal. If the Company cannot reduce manufacturing lead
times for such products, the Company's customers may cancel orders or not place
further orders if shorter lead times are available from other manufacturers,
thus creating additional variability.
As a result of recent unfavorable economic conditions, sales to certain
countries in Asia and the Pacific Rim have declined as a percentage of the
Company's total revenue. If the economic conditions in these markets worsen, or
if these unfavorable conditions result in a wider regional or global economic
slowdown, this may have a material adverse impact on the Company's business,
operations and financial condition.
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Many computer systems were not designed to handle any dates beyond the year
1999, and therefore computer hardware and software will need to be modified
prior to the year 2000 in order to remain functional. The Company is concerned
that many enterprises will be devoting a substantial portion of their
information systems spending to resolving this upcoming year 2000 problem. This
may result in spending being diverted from networking solutions over the next
two years. The Company is still assessing the impact of the year 2000 issue on
its products and internal information systems and has begun, and in many cases
completed, corrective efforts in these areas. The Company does not anticipate
that addressing the year 2000 problem for its internal information systems and
current and future products will have a material impact on its operations or
financial results. However, there can be no assurance that these costs will not
be greater than anticipated, or that corrective actions undertaken will be
completed before any year 2000 problems could occur. The year 2000 issue could
lower demand for the Company's products while increasing the Company's costs.
These combining factors, while not quantified, could have a material adverse
impact on the Company's financial results.
The Company has certain key relationships with suppliers. If these suppliers
fail to adequately address the year 2000 issue for the products they provide the
Company, this could have a material adverse impact on the Company's operations
and financial results. The Company is still assessing the effect the year 2000
issue will have on its suppliers and, at this time, cannot determine the impact
it will have.
The Company also expects that gross margins may be adversely affected by
increases in material or labor costs, heightened price competition, and changes
in channels of distribution or in the mix of products sold. For example, the
Company believes that gross margins may decline over time, because the markets
for lower-margin access products targeted toward small to medium-sized customers
have continued to grow at a faster rate than the markets for the Company's
higher-margin router and high-performance switching products targeted toward
enterprise and service provider customers. The Company has recently introduced
new products with several new products scheduled to be released in the near
future. If warranty costs associated with these new products are greater than
the Company has experienced historically, gross margins may be adversely
affected. The Company's gross margins may also be impacted by geographic mix, as
well as the mix of configurations within each product group. The Company
continues to expand into third-party or indirect distribution channels, which
generally results in lower gross margins. In addition, increasing third-party
and indirect distribution channels generally results in greater difficulty in
forecasting the mix of the Company's products, and to a certain degree, the
timing of its orders.
The Company's growth and ability to meet customer demands also depend in part on
its ability to obtain timely deliveries of parts from its suppliers. The Company
has experienced component shortages in the past that have adversely affected its
operations. Although the Company works closely with its suppliers to avoid these
types of shortages, there can be no assurance that the Company will not
encounter these problems in the future.
The Company also expects that its operating margins may decrease as it continues
to hire additional personnel and increases other operating expenses to support
its business. The Company plans its operating expense levels based primarily on
forecasted revenue levels. Because
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these expenses are relatively fixed in the short term, a shortfall in revenue
could lead to operating results being below expectations.
The results of operations for the quarter ended April 25, 1998 are not
necessarily indicative of results to be expected in future periods, and the
Company's operating results may be subject to quarterly fluctuations as a result
of a number of factors. These factors include the integration of people,
operations, and products from acquired businesses and technologies; increased
competition in the networking industry; the overall trend toward industry
consolidation; the introduction and market acceptance of new technologies and
standards, including routing switches, Gigabit Ethernet Switching, Tag
Switching, currently also known as multiprotocol label switching (MPLS) and
voice, video and data products; variations in sales channels, product costs, or
mix of products sold; the timing of orders and manufacturing lead times; and
changes in general economic conditions, any of which could have a material
adverse impact on operations and financial results.
The Company's corporate headquarters, including most of its research and
development operations and its manufacturing facilities, are located in the
Silicon Valley area of Northern California, a region known for seismic activity.
Additionally, one of the Company's manufacturing facilities is located near a
river that has experienced flooding in the past. A significant natural disaster,
such as an earthquake or a flood, could have a material adverse impact on the
Company's business, financial condition and operating results.
Liquidity and Capital Resources
Cash and equivalents, short-term investments, and investments were $4.4 billion
at April 25, 1998, an increase of $1.8 billion from July 26, 1997. The increase
is primarily a result of cash generated by operations; and to a lesser extent,
through financing activities, primarily the exercise of employee stock options.
These cash flows were partially offset by cash outflows from operating
activities including tax payments of approximately $389 million, cash outflows
from investing activities, including capital expenditures of approximately $282
million, and a cash payment of $108 million related to the acquisition of Dagaz.
Accounts receivable increased 8.8% from July 26, 1997 to April 25, 1998. Days
sales outstanding in receivables improved to 53 days at April 25, 1998 from 60
days at July 26, 1997. Inventories increased 21.0% between July 26, 1997 and
April 25, 1998. The increase in inventories was due primarily to increased sales
through two-tier distribution channels, and the need to maintain shorter lead
times on certain products. Inventory management remains an area of focus as the
Company balances 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.
Accounts payable increased by 29.4% at April 25, 1998 over July 26, 1997 due to
material purchases to support the growth in net sales. Other accrued liabilities
increased by 45.5% primarily due to higher deferred revenue on service
contracts.
At April 25, 1998, the Company had a line of credit totaling $500 million, which
expires July 2002. There have been no borrowings under this facility.
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The Company has entered into certain lease arrangements in San Jose, California,
and Research Triangle Park, North Carolina, where it has established its
headquarters operations and certain research and development and customer
support activities. In connection with these transactions, the Company pledged
$486 million of its investments as collateral for certain obligations of the
leases. The Company anticipates that it will occupy more leased property in the
future that will require similar pledged securities; however, the Company does
not expect the impact of this activity to be material to its liquidity.
The Company's management believes that its current cash and equivalents,
short-term investments, line of credit, borrowing capacity, and cash generated
from operations will satisfy its expected working capital and capital
expenditure requirements through fiscal 1998.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter, the Company issued an aggregate of
7,930,827 million shares of its Common Stock in exchange
for the outstanding capital stock of LightSpeed
International, Inc., WheelGroup Corporation, NetSpeed,
Inc., and Precept Software, Inc. The shares were issued
pursuant to an exemption by reason of Section 4(2) of the
Securities Act of 1933. These sales were made without
general solicitation or advertising. Each purchaser was
an accredited investor or a sophisticated investor with
access to all relevant information necessary. The
Company has filed Registration Statements on Form S-3
covering the resale of such securities.
ITEM 6. EXHIBIT AND REPORTS ON FORM 8-K
(a)Exhibit
27 Financial data schedule
(b)Reports on Form 8-K
The Company filed one report on form 8-K during the third
quarter ended April 25, 1998. The report was filed on February
11, 1998 and reported on the February 1998 acquisition of
LightSpeed International, Inc.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Cisco Systems, Inc.
Date: June 5, 1998 By /s/ Larry R. Carter
-----------------------------
Larry R. Carter,
Senior Vice President Finance, and Chief
Financial Officer (Principal Financial and
Accounting Officer)
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