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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 JANUARY 27, 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 February 23, 2001, 7,276,393,789 shares of the registrant's common stock
were outstanding.
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CISCO SYSTEMS, INC.
FORM 10-Q FOR THE QUARTER ENDED JANUARY 27, 2001
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
a) Consolidated Statements of Operations for the three and six months
ended January 27, 2001 and January 29, 2000 3
b) Consolidated Balance Sheets at January 27, 2001 and July 29, 2000 4
c) Consolidated Statements of Cash Flows for the six months ended
January 27, 2001 and January 29, 2000 5
d) Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds 33
Item 6. Exhibits and Reports on Form 8-K 34
Signature 35
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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 Six Months Ended
-------------------------- --------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
NET SALES $ 6,748 $ 4,357 $ 13,267 $ 8,275
Cost of sales 2,581 1,539 4,959 2,927
---------- ---------- ---------- ----------
GROSS MARGIN 4,167 2,818 8,308 5,348
Operating expenses:
Research and development 1,012 602 1,959 1,143
Sales and marketing 1,434 933 2,796 1,751
General and administrative 196 147 392 259
Amortization of goodwill and
purchased intangible assets 256 47 481 71
In-process research and development 237 43 746 424
---------- ---------- ---------- ----------
Total operating expenses 3,135 1,772 6,374 3,648
---------- ---------- ---------- ----------
OPERATING INCOME 1,032 1,046 1,934 1,700
Net gains realized on minority investments - 31 190 31
Interest and other income, net 275 120 505 222
---------- ---------- ---------- ----------
INCOME BEFORE PROVISION
FOR INCOME TAXES 1,307 1,197 2,629 1,953
Provision for income taxes 433 381 957 722
---------- ---------- ---------- ----------
NET INCOME $ 874 $ 816 $ 1,672 $ 1,231
========== ========== ========== ==========
Net income per share--basic $ 0.12 $ 0.12 $ 0.23 $ 0.18
========== ========== ========== ==========
Net income per share--diluted $ 0.12 $ 0.11 $ 0.22 $ 0.17
========== ========== ========== ==========
Shares used in per-share calculation--basic 7,144 6,911 7,121 6,872
========== ========== ========== ==========
Shares used in per-share calculation--diluted 7,556 7,387 7,567 7,338
========== ========== ========== ==========
See Notes to Consolidated Financial Statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT PAR VALUE)
(UNAUDITED)
January 27, July 29,
2001 2000
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 3,994 $ 4,234
Short-term investments 788 1,291
Accounts receivable, net of allowance for doubtful accounts
of $89 at January 27, 2001 and $43 at July 29, 2000 3,512 2,299
Inventories, net 2,533 1,232
Deferred tax assets 1,162 1,091
Lease receivables 454 588
Prepaid expenses and other current assets 469 375
---------- ----------
Total current assets 12,912 11,110
Investments 12,007 13,688
Restricted investments 1,162 1,286
Property and equipment, net 2,211 1,426
Goodwill and purchased intangible assets, net 4,696 4,087
Lease receivables 516 527
Other assets 2,377 746
---------- ----------
TOTAL ASSETS $ 35,881 $ 32,870
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 942 $ 739
Income taxes payable 287 233
Accrued compensation 1,312 1,317
Deferred revenue 1,994 1,386
Other accrued liabilities 1,800 1,521
---------- ----------
Total current liabilities 6,335 5,196
Deferred tax liabilities - 1,132
Minority interest 48 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; 7,241 and 7,138 shares issued and
outstanding at January 27, 2001 and July 29, 2000, respectively 18,203 14,609
Retained earnings 10,030 8,358
Accumulated other comprehensive income 1,265 3,530
---------- ----------
Total shareholders' equity 29,498 26,497
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 35,881 $ 32,870
========== ==========
See Notes to Consolidated Financial Statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
Six Months Ended
---------------------------
January 27, January 29,
2001 2000
---------- ----------
Cash flows from operating activities:
Net income $ 1,672 $ 1,231
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 974 308
Provision for doubtful accounts 52 13
Provision for inventory reserves 338 154
Deferred income taxes (661) (113)
Tax benefits from employee stock plans 1,662 697
Adjustment to conform fiscal year ends of pooled acquisitions - (18)
In-process research and development 637 424
Net gains on minority investments and provision for losses 43 -
Change in operating assets and liabilities:
Accounts receivable (1,261) (477)
Inventories (1,637) (195)
Prepaid expenses and other current assets (93) (43)
Accounts payable 193 (33)
Income taxes payable 54 91
Accrued compensation (5) 133
Deferred revenue 608 222
Other accrued liabilities 250 303
---------- ----------
Net cash provided by operating activities 2,826 2,697
---------- ----------
Cash flows from investing activities:
Purchases of short-term investments (1,975) (417)
Sales and maturities of short-term investments 2,818 1,227
Purchases of investments (9,866) (5,988)
Sales and maturities of investments 7,793 5,800
Purchases of restricted investments (489) (158)
Sales and maturities of restricted investments 705 123
Acquisition of property and equipment (1,208) (414)
Acquisition of businesses, net of cash and cash equivalents (24) (11)
Net change in lease receivables 145 (262)
Purchases of minority investments (806) (125)
Other (855) (310)
---------- ----------
Net cash used in investing activities (3,762) (535)
---------- ----------
Cash flows from financing activities:
Issuance of common stock 698 669
Other (2) 6
---------- ----------
Net cash provided by financing activities 696 675
---------- ----------
Net increase (decrease) in cash and cash equivalents (240) 2,837
Cash and cash equivalents, beginning of period 4,234 913
---------- ----------
Cash and cash equivalents, end of period $ 3,994 $ 3,750
========== ==========
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
advantage 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 January 27, 2001 and for the three and six
months ended January 27, 2001 and January 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 January 27, 2001, results of operations for the three and six
months ended January 27, 2001 and January 29, 2000, and cash flows for the six
months ended January 27, 2001 and January 29, 2000 have been made. The results
of operations for the three and six months ended January 27, 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 per Share
Basic net income per 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 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. BUSINESS COMBINATIONS
Purchase Combinations
During the first six 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 six
months of fiscal 2001 (in millions):
In-Process Form of Consideration
Acquired Company Consideration R&D Expense and Other Notes to Acquisition
- ---------------- ------------- ----------- ------------------------------------------------
IPmobile, Inc. $ 422 $ 181 Cash of $4; common stock and options
assumed; goodwill and other intangibles recorded
of $157
NuSpeed, Inc. $ 463 $ 164 Cash of $4; common stock and options
assumed; goodwill and other intangibles recorded
of $214
IPCell Technologies, Inc. $ 213 $ 75 Cash of $16; common stock and options
assumed; $5 in liabilities assumed; goodwill and
other intangibles recorded of $102
PixStream Incorporated $ 395 $ 67 Common stock and options assumed; $2 in
liabilities assumed; goodwill and other intangibles
recorded of $315
Other $ 756 $ 259 Cash of $181; common stock and options
assumed; $22 in liabilities assumed;
goodwill and other intangibles recorded of $308
Other Purchase Combinations Completed as of January 27, 2001
During the six months ended January 27, 2001, the Company acquired Netiverse,
Inc.; HyNEX, Ltd.; Komodo Technology, Inc.; Vovida Networks, Inc.; and the
broadband subscriber management business of CAIS Software Solutions, Inc. for a
total purchase price of $756 million, paid in common stock and cash. Total
in-process R&D related to these acquisitions amounted to $259 million.
Total in-process R&D expense for the six months ended January 27, 2001 and
January 29, 2000 was $746 million and $424 million, respectively. The in-process
R&D expense that was attributable to stock consideration for the same periods
was $637 million and $424 million, respectively.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. BALANCE SHEET DETAIL
The following tables provide details of selected balance sheet items (in
millions):
January 27, July 29,
2001 2000
---------- ----------
Inventories, net:
Raw materials $ 941 $ 145
Work in process 902 472
Finished goods 610 496
Demonstration systems 80 119
---------- ----------
Total $ 2,533 $ 1,232
========== ==========
Goodwill and purchased intangible assets, net:
Goodwill $ 3,645 $ 2,937
Purchased intangible assets 1,950 1,558
---------- ----------
5,595 4,495
Less, accumulated amortization (899) (408)
---------- ----------
Total $ 4,696 $ 4,087
========== ==========
Other assets:
Minority investments, net $ 765 $ 181
Inventory financing 645 25
Lease deposit 320 -
Structured loans, net 186 205
Other 461 335
---------- ----------
Total $ 2,377 $ 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 Six Months Ended
--------------------------- --------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Reported as:
Cost of sales $ 6 $ 6 $ 10 $ 12
Operating expenses 256 47 481 71
---------- ---------- ---------- ----------
Total $ 262 $ 53 $ 491 $ 83
========== ========== ========== ==========
5. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, are as follows (in
millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net income $ 874 $ 816 $ 1,672 $ 1,231
Other comprehensive income (loss):
Change in net unrealized gains
on investments (1,134) 999 (2,263) 1,519
Change in accumulated translation
adjustments 17 (2) (2) 4
---------- ---------- ---------- ----------
Total $ (243) $ 1,813 $ (593) $ 2,754
========== ========== ========== ==========
6. INCOME TAXES
The Company received net income tax refunds of $118 million for the six months
ended January 27, 2001 and paid income taxes of $174 million for the six months
ended January 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. This benefit totaled $1.66 billion and $697 million in the
first six months of fiscal 2001 and 2000, respectively, and was 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 $479 million in the first six months of
fiscal 2001 and was reflected as a debit to shareholders' equity.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. 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 segment for the three and six months ended
January 27, 2001 and January 29, 2000, as taken from the internal management
system discussed above, is as follows (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net sales:
Americas $ 4,197 $ 2,879 $ 8,829 $ 5,541
EMEA 1,991 1,082 3,836 2,102
Asia Pacific 731 351 1,400 634
Japan 434 182 918 339
Sales adjustments (605) (137) (1,716) (341)
---------- ---------- ---------- ----------
Total $ 6,748 $ 4,357 $ 13,267 $ 8,275
========== ========== ========== ==========
Gross margin:
Americas $ 3,003 $ 2,117 $ 6,376 $ 4,057
EMEA 1,513 801 2,897 1,566
Asia Pacific 504 259 986 467
Japan 334 144 721 269
---------- ---------- ---------- ----------
Standard margin 5,354 3,321 10,980 6,359
Sales adjustments (605) (137) (1,716) (341)
Cost of sales adjustments 63 72 356 125
Production overhead (147) (106) (301) (189)
Manufacturing variances and other
related costs (498) (332) (1,011) (606)
---------- ---------- ---------- ----------
Total $ 4,167 $ 2,818 $ 8,308 $ 5,348
========== ========== ========== ==========
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 Six Months Ended
--------------------------- ---------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Routers $ 2,375 $ 1,688 $ 5,193 $ 3,286
Switches 3,283 1,702 6,092 3,278
Access 616 507 1,426 982
Other 1,079 597 2,272 1,070
Sales adjustments (605) (137) (1,716) (341)
---------- ---------- ---------- ----------
Total $ 6,748 $ 4,357 $ 13,267 $ 8,275
========== ========== ========== ==========
Substantially all of the Company's assets at January 27, 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 six months ended January 27, 2001 and
January 29, 2000.
8. NET INCOME PER SHARE
The following table presents the calculation of basic and diluted net income per
share (in millions, except per-share amounts):
Three Months Ended Six Months Ended
-------------------------- --------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net income $ 874 $ 816 $ 1,672 $ 1,231
========== ========== ========== ==========
Weighted-average shares--basic 7,144 6,911 7,121 6,872
Effect of dilutive securities 412 476 446 466
---------- ---------- ---------- ----------
Weighted-average shares--diluted 7,556 7,387 7,567 7,338
========== ========== ========== ==========
Net income per share--basic $ 0.12 $ 0.12 $ 0.23 $ 0.18
========== ========== ========== ==========
Net income per share--diluted $ 0.12 $ 0.11 $ 0.22 $ 0.17
========== ========== ========== ==========
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. SUBSEQUENT EVENTS
Business Combinations
In February 2001, the Company acquired Active Voice Corporation; Radiata, Inc.;
and ExiO Communications, Inc. for a total purchase price of approximately $746
million, payable in common stock and cash. These acquisitions will be accounted
for using the purchase method.
Investment in KPMG Consulting, Inc.
In January 2000, the Company purchased five million shares of Series A
Mandatorily Redeemable Convertible Preferred Stock ("Preferred Stock") in KPMG
Consulting, Inc. totaling $1.05 billion. In February 2001, 1.4 million shares of
Preferred Stock were repurchased by KPMG LLP for $378 million and 2.5 million
shares of Preferred Stock were repurchased by KPMG Consulting, Inc. for $525
million. The remaining portion of the Preferred Stock was converted to 9.9% of
the outstanding common stock of KPMG Consulting, Inc. upon the completion of its
initial public offering.
Minority Interest
In February 2001, the Company purchased a portion of the minority interest of
Cisco Systems, K.K. (Japan) for approximately $275 million. As a result, the
Company has increased its ownership to 84.2% of the voting rights.
Workforce Reduction
In March 2001, the Company announced measures to reduce its workforce. As a
result of this workforce reduction, the Company expects to incur a one-time
charge of $300 to $400 million by the end of the fourth quarter of fiscal 2001.
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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.
Net sales in the second quarter of fiscal 2001 were $6.75 billion, compared with
$4.36 billion in the second quarter of fiscal 2000, an increase of 54.9%. Net
sales in the first six months of fiscal 2001 were $13.27 billion, compared with
$8.27 billion in the first six months of fiscal 2000, an increase of 60.3%. The
increases in net sales were primarily a result of increased unit sales of
switch, router, 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 (see Note 7 to the
Consolidated Financial Statements). Net sales in the second quarter of fiscal
2001 were $6.75 billion, compared with $6.52 billion in the first quarter of
fiscal 2001, an increase of 3.5%.
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 six months of fiscal 2001 and
2000 is summarized in the following table (in millions):
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net sales:
Americas $ 4,197 $ 2,879 $ 8,829 $ 5,541
EMEA 1,991 1,082 3,836 2,102
Asia Pacific 731 351 1,400 634
Japan 434 182 918 339
Sales adjustments (605) (137) (1,716) (341)
---------- ---------- ---------- ----------
Total $ 6,748 $ 4,357 $ 13,267 $ 8,275
========== ========== ========== ==========
Gross margin in the second quarter of fiscal 2001 was 61.8%, compared with 64.7%
in the second quarter of fiscal 2000. Gross margin in the first six months of
fiscal 2001 was 62.6%, compared with 64.6% in the first six months of fiscal
2000.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following table shows the standard margins for each theater:
Three Months Ended Six Months Ended
--------------------------- ---------------------------
January 27, January 29, January 27, January 29,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Standard margin:
Americas 71.6% 73.5% 72.2% 73.2%
EMEA 76.0% 74.0% 75.5% 74.5%
Asia Pacific 68.9% 73.8% 70.4% 73.7%
Japan 77.0% 79.1% 78.5% 79.4%
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 for three geographic theaters as compared with the
second quarter and first six months of fiscal 2000. The decreases in the overall
gross margin were primarily due to shifts in product mix; introduction of new
products, which generally have lower margins when first released; higher
production-related costs and inventory 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 expect gross margin may be adversely affected by increases in material or
labor costs, heightened price competition, increasing levels of services, higher
inventory balances, inventory financing, 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. We believe gross
margin may be additionally impacted due to constraints relating to certain
component shortages that exist or have existed in the supply chain.
We recently introduced several new products, with additional new products
scheduled to be released in the future. Increase in demand would result in
increased manufacturing capacity, which in turn could result in higher inventory
balances. In addition, certain portions of our vendor base are or have been
capacity-constrained and this has resulted in increased cost pressure on certain
components and increased levels of inventories due to longer term purchase
commitments, which we have entered into to maintain or reduce lead times. We
also provide inventory financing to certain of our suppliers. Inventory
purchases and commitments are based upon future sales forecast. Due to the
current slow down 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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
Research and development ("R&D") expenses in the second quarter of fiscal 2001
were $1.01 billion, compared with $602 million in the second quarter of fiscal
2000, an increase of 68.1%. R&D expenses, as a percentage of net sales,
increased to 15.0% in the second quarter of fiscal 2001, compared with 13.8% in
the second quarter of fiscal 2000. R&D expenses in the first six months of
fiscal 2001 were $1.96 billion, compared with $1.14 billion in the first six
months of fiscal 2000, an increase of 71.4%. R&D expenses, as a percentage of
net sales, increased to 14.8% in the first six months of fiscal 2001, compared
with 13.8% in the first six months of fiscal 2000. The increases reflected our
ongoing R&D efforts in a wide variety of areas such as data, voice, and video
integration, digital subscriber line ("DSL") technologies, cable modem
technology, wireless access, dial access, enterprise switching, optical
transport, content networking, security, network management, and high-end
routing and switching 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. We expect that R&D expenses will continue to increase in absolute
dollars as we continue to invest in technology to address potential market
opportunities in future periods.
Sales and marketing expenses in the second quarter of fiscal 2001 were $1.43
billion, compared with $933 million in the second quarter of fiscal 2000, an
increase of 53.7%. Sales and marketing expenses, as a percentage of net sales,
remained relatively constant at 21.3% in the second quarter of fiscal 2001,
compared with 21.4% in the second quarter of fiscal 2000. Sales and marketing
expenses in the first six months of fiscal 2001 were $2.80 billion, compared
with $1.75 billion in the first six months of fiscal 2000, an increase of 59.7%.
Sales and marketing expenses, as a percentage of net sales, remained relatively
constant at 21.1% in the first six months of fiscal 2001, compared with 21.2% in
the first six months of fiscal 2000. The increases in sales and marketing
expense 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We expect that sales and marketing expenses will continue to increase in
absolute dollars in future periods.
General and administrative ("G&A") expenses in the second quarter of fiscal 2001
were $196 million, compared with $147 million in the second quarter of fiscal
2000, an increase of 33.3%. G&A expenses, as a percentage of net sales,
decreased to 2.9% in the second quarter of fiscal 2001, compared with 3.4% in
the second quarter of fiscal 2000. G&A expenses in the first six months of
fiscal 2001 were $392 million, compared with $259 million in the first six
months of fiscal 2000, an increase of 51.4%. G&A expenses, as a percentage of
net sales, decreased to 3.0% in the first six months of fiscal 2001, compared
with 3.1% in the first six 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. We intend to keep G&A expenses relatively
constant as a percentage of net sales; however, this depends on the level of
acquisition activity and our growth, among other factors.
Amortization of goodwill and purchased intangible assets included in operating
expenses was $256 million in the second quarter of fiscal 2001, compared with
$47 million in the second quarter of fiscal 2000. Amortization of goodwill and
purchased intangible assets included in operating expenses was $481 million in
the first six months of fiscal 2001, compared with $71 million in the first six
months of fiscal 2000. Amortization of goodwill and purchased intangible assets
primarily relates to various purchase acquisitions (see Note 3 and Note 4 to the
Consolidated Financial Statements). We expect amortization of goodwill and
purchased intangibles assets to continue to increase as 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 3 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 have
increased the overall discount rate for acquisitions 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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
opportunity to capitalize on emerging markets and could have a material adverse
impact on our business and operating results.
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 %
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. 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 potentially result
in impairment of any other assets related to the development activities.
There were no net gains realized on minority investments in the second quarter
of fiscal 2001, compared with $31 million in the second quarter of fiscal 2000.
Net gains realized on minority investments were $190 million in the first six
months of fiscal 2001, compared with $31 million in the first six months of
fiscal 2000.
Interest and other income, net, was $275 million in the second quarter of fiscal
2001, compared with $120 million in the second quarter of fiscal 2000. Interest
and other income, net, was $505 million in the first six months of fiscal 2001,
compared with $222 million in the first six 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 33.1% for the second quarter of fiscal 2001 and 36.4%
for the first six months of fiscal 2001, which included the impact of
nondeductible in-process R&D and
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
acquisition-related costs. 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.
Liquidity and Capital Resources
Cash and cash equivalents, short-term investments, and investments were $17.95
billion at January 27, 2001, a decrease of $2.55 billion from July 29, 2000. The
decrease was primarily a result of a net unrealized loss on publicly held
investments of $3.51 billion ($2.26 billion, net of tax). Cash used in investing
activities of $3.76 billion, which includes $1.21 billion in capital
expenditures and $806 million in purchases of minority investments, was
essentially offset by cash provided by operating activities of $2.83 billion and
financing activities of $696 million.
Accounts receivable increased 52.8% from July 29, 2000 to January 27, 2001. Days
sales outstanding in receivables increased to 47 days at January 27, 2001 from
37 days at July 29, 2000. The increase in accounts receivable and days sales
outstanding was due, in part, to growth in net sales and non-linear shipments
combined with conditions in a number of markets resulting in longer payment
terms.
Inventories increased 105.6% from July 29, 2000 to January 27, 2001. Inventory
turns decreased to 4.6 times at January 27, 2001 from 7.8 times at July 29,
2000. The increase in inventory levels reflected new product introductions and
increased purchases to secure the supply 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.
At January 27, 2001, we had a line of credit totaling $500 million, which
expires in July 2002. There have been no borrowings under this agreement.
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
$1.16 billion of our investments as collateral for certain obligations of the
leases. We anticipate that we will occupy more leased property in the future
that will require similar pledged securities; however, we do not expect the
impact of this activity to be material to our liquidity position.
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, capital expenditure, and investment requirements at least
through the next 12 months.
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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 are not necessarily indicative of
results to be expected in future periods. Our operating results have in the past
been, and will continue to be, subject to quarterly fluctuations as a result of
a number of factors. These factors include:
- - The integration of people, operations, and products from acquired
businesses and technologies;
- - Increased competition in the networking industry;
- - The overall trend toward industry consolidation;
- - The introduction and market acceptance of new technologies and
standards, including switch routers, Gigabit Ethernet switching, Tag
Switching (currently also known as multiprotocol label switching
["MPLS"]), optical transport, Packet over SONET, VSR optics, Dynamic
Packet Transport, wireless, content networking, and data, voice, and
video capabilities;
- - Variations in sales channels, product costs, or mix of products sold;
- - The timing of orders and manufacturing lead times;
- - The trend towards sales of integrated network solutions;
- - The timing and amount of employer payroll tax to be paid on employees'
gains on stock options exercised;
- - Overall information technology spending, especially service provider
capital spending in the data or IP segment; and
- - Changes in general economic conditions and specific economic conditions
in the computer and networking industries.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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 year. We will continue to invest in these
markets either through additional investments or through re-alignment of
existing resources.
With increased levels of spending, an inability to meet expected revenue levels
in a particular quarter could have a material, negative impact on our operating
results for that period as we will not be able to react quickly enough to scale
back expenses.
SINCE OUR GROWTH RATE MAY SLOW, OPERATING RESULTS FOR A PARTICULAR QUARTER ARE
DIFFICULT TO PREDICT
We expect that in the future, our net sales may grow at a slower rate than
experienced in previous periods and that on a quarter-to-quarter basis, our
growth in net sales may be significantly lower than our historical quarterly
growth rate. As a consequence, operating results for a particular quarter are
extremely difficult to predict. Our ability to meet financial expectations could
be hampered if the non-linear sales pattern seen in our second quarter of fiscal
2001 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.
WE EXPECT GROSS MARGIN TO DECLINE 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, inventory financing, 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. We believe gross
margin may be additionally impacted due to constraints relating to certain
component shortages that exist or have existed in the supply chain.
We recently introduced several new products, with additional new products
scheduled to be released in the future. Increase in demand would result in
increased manufacturing capacity,
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
which in turn could result in higher inventory balances. In addition, certain
portions of our vendor base are or have been capacity-constrained and this has
resulted in increased cost pressure on certain components and increased levels
of inventories due to longer term purchase commitments, which we have entered
into to maintain or reduce lead times. We also provide inventory financing to
certain of our suppliers. Inventory purchases and commitments are based upon
future sales forecast. Due to the current slow down 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.
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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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 the component supply constraints that exist or have
existed, we have built inventory levels for certain components with long lead
times, entered into certain longer term commitments for certain other components
and provided inventory financing. 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 ARE EXPOSED TO GENERAL ECONOMIC CONDITIONS
As a result of recent unfavorable economic conditions and reduced capital
spending, sales in the United States have declined as a percentage of our total
revenue. In particular, sales to service providers, e-commerce and Internet
businesses, and the manufacturing industry in the United States were impacted
during the second quarter of fiscal 2001. If the economic conditions in the
United States worsen or if a wider or global economic slowdown occurs, we may
experience a material adverse impact on our business, operating results, and
financial condition.
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. We believe our primary
competition comes from nimble start-ups and young companies offering innovative
niche solutions.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
Our competitors include Alcatel, Ciena, Ericsson, Extreme, Foundry, Juniper,
Lucent, Nortel, Redback, Siemens AG, and Sycamore. 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 have
greater financial, marketing, and technical resources than we do.
The principal competitive factors in the markets in which we presently compete
and may compete in the future are:
- - Price;
- - Ability to provide financing;
- - Performance;
- - The ability to provide end-to-end networking solutions and support;
- - Conformance to standards;
- - The ability to provide value-added features such as security,
reliability, and investment protection; and
- - Market presence.
We also face competition from customers we license technology to and suppliers
from whom we transfer technology. Networking's inherent nature requires
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 EXPECT TO MAKE FUTURE ACQUISITIONS WHERE ADVISABLE AND ACQUISITIONS INVOLVE
NUMEROUS RISKS
The networking business is highly competitive, and as such, our growth is
dependent upon market growth, our ability to enhance our existing products, and
our ability to introduce new products on a timely basis. One of the ways we have
addressed and will continue to address the need to develop new products is
through acquisitions of other companies. Acquisitions involve numerous risks,
including the following:
- - Difficulties in 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;
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
- - 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.
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 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 partners in two-tier distribution
channels. These partners/customers are generally given privileges to return
inventory, receive credits for changes in selling prices, and participate in
cooperative marketing programs. We maintain appropriate accruals and allowances
for such exposures. However, such partners tend to have access to more limited
financial resources than other resellers and end-user customers and therefore
represent potential sources of increased credit risk. We are experiencing
increased demands for customer financing, including loan financing and leasing
solutions. We expect demands for customer
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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 slow down in the
economy, the credit risks relating to these partners/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.
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 AND FASB
Recent actions and comments from the SEC have indicated they are reviewing the
current valuation methodology 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. Additionally,
FASB has announced that it plans to rescind the pooling of interests method of
acquisition accounting. If this occurs, it could alter our acquisition strategy
and impair our ability to acquire companies.
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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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. 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.
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, 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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
financial, marketing, and technical resources than we do. Additionally, as
customers in these markets complete infrastructure deployments, they may require
greater levels of service, support, and financing than we have experienced in
the past. We have not entered into a material amount of labor intensive service
contracts, which require significant production or customization. However, we
expect that demand for these types of service contracts will increase in the
future. There can be no assurance that we can provide products, service,
support, and financing to effectively compete for these market opportunities.
Further, provision of greater levels of services by us may result in less
favorable timing of revenue recognition than we have historically experienced.
THE LOCATION OF OUR FACILITIES SUBJECTS US TO THE RISK OF EARTHQUAKES AND FLOODS
Our corporate headquarters, including most of our research and development
operations and our manufacturing facilities, are located in the Silicon Valley
area of Northern California, a region known for seismic activity. Additionally,
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.
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
reduce the costs to produce existing products and to develop and introduce new
products into existing and emerging markets. 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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 some business areas with a company with which we have strategic
alliances 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.
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 provide stronger competitors that are better
able to compete as sole-source vendors for customers. This could lead to more
variability in operating results as we compete to be a single vendor solution
and could have a material adverse effect on our business, operating results, and
financial condition.
SALES 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 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.
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
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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 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.
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND
INTERNET-BASED SYSTEMS
We believe that there will be performance problems with Internet communications
in the future, which could receive a high degree of publicity and visibility. As
we are a large supplier of equipment for the Internet infrastructure, customers'
perceptions of our products and the marketplace's perception of us as a supplier
of networking products may be materially adversely affected, regardless of
whether or not these problems are due to the performance of our products. Such
an event could also result in a material adverse effect on the market price of
our common stock and could materially adversely affect our business, operating
results, and financial condition.
In addition, 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 this infrastructure will continue at these
historical rates. If there is a significant decrease in spending, we may
experience a material adverse impact 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 who 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
$2.26 billion after-tax unrealized loss during the first six 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
------------------------------------------ Jan. 27, ------------------------------------------
(50%) (35%) (15%) 2001 15% 35% 50%
---------- ---------- ---------- ---------- ---------- ---------- ----------
Corporate equities $ 1,780 $ 2,313 $ 3,025 $ 3,559 $ 4,093 $ 4,805 $ 5,339
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) During the quarter ended January 27, 2001, the Company issued an
aggregate of approximately 12.1 million shares of its common stock in
connection with the purchase of the capital stock of IPCell
Technologies, Inc.; PixStream Incorporated; and Vovida Networks, 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) Exhibits:
3.1 Restated Articles of Incorporation of Cisco Systems,
Inc., as currently in effect.
3.2 Amended and Restated Bylaws of Cisco Systems, Inc., as
currently in effect.
(b) Reports on Form 8-K
The Company filed eight reports on Form 8-K during the quarter ended January 27,
2001. Information regarding the items reported on is as follows:
Date Item Reported On
- ---- ----------------
November 6, 2000 The Company announced the completion of the
acquisition of IPCell Technologies, Inc.
November 7, 2000 The Company reported its first quarter results
for the period ending October 28, 2000.
November 13, 2000 The Company announced the completion of the
acquisition of Vovida Networks, Inc.
November 15, 2000 The Company announced the acquisition of Radiata,
Inc.
November 15, 2000 The Company announced the acquisition of Active
Voice Corporation.
December 19, 2000 The Company provided certain detail regarding its
provision for losses included in the cash flow
statement in its Quarterly Report on Form 10-Q
for its first quarter of fiscal 2001 ended
October 28, 2000 filed with the SEC on December
12, 2000.
December 21, 2000 The Company announced the acquisition of ExiO
Communications, Inc.
December 27, 2000 The Company announced the completion of the
acquisition of PixStream Incorporated.
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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: March 12, 2001 By /s/ Larry R. Carter
------------------------------------
Larry R. Carter, Senior Vice
President, Finance and
Administration, Chief Financial
Officer and Secretary
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EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
3.1 Restated Articles of Incorporation of Cisco Systems, Inc., as
currently in effect.
3.2 Amended and Restated Bylaws of Cisco Systems, Inc., as currently
in effect.