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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 OCTOBER 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 November 24, 2001, 7,334,911,767 shares of the registrant's common stock
were outstanding.
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CISCO SYSTEMS, INC.
FORM 10-Q FOR THE QUARTER ENDED OCTOBER 27, 2001
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
a) Consolidated Statements of Operations for the three months ended
October 27, 2001 and October 28, 2000 3
b) Consolidated Balance Sheets at October 27, 2001 and July 28, 2001 4
c) Consolidated Statements of Cash Flows for the three months ended
October 27, 2001 and October 28, 2000 5
d) Consolidated Statements of Shareholders' Equity for the three
months ended October 27, 2001 and October 28, 2000 6
e) Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 45
Part II. Other Information
Item 1. Legal Proceedings 46
Item 2. Changes in Securities and Use of Proceeds 46
Item 4. Submission of Matters to a Vote of Security Holders 47
Item 6. Exhibits and Reports on Form 8-K 48
Signature 49
2
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
-----------------------------
October 27, October 28,
2001 2000
------------ ------------
NET SALES:
Product $ 3,656 $ 5,911
Services 792 608
------------ ------------
Total net sales 4,448 6,519
------------ ------------
COST OF SALES:
Product 1,500 2,122
Services 256 256
------------ ------------
Total cost of sales 1,756 2,378
------------ ------------
GROSS MARGIN 2,692 4,141
OPERATING EXPENSES:
Research and development 917 947
Sales and marketing 1,096 1,362
General and administrative 151 196
Amortization of goodwill -- 144
Amortization of purchased intangible assets 146 81
In-process research and development 37 509
------------ ------------
Total operating expenses 2,347 3,239
------------ ------------
OPERATING INCOME 345 902
Interest and other income (losses), net (688) 420
------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES (343) 1,322
Provision for (benefit from) income taxes (75) 524
------------ ------------
NET INCOME (LOSS) $ (268) $ 798
============ ============
Net income (loss) per share--basic $ (0.04) $ 0.11
============ ============
Net income (loss) per share--diluted $ (0.04) $ 0.11
============ ============
Shares used in per-share calculation--basic 7,307 7,093
============ ============
Shares used in per-share calculation--diluted 7,307 7,580
============ ============
See Notes to Consolidated Financial Statements.
3
CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT PAR VALUE)
(UNAUDITED)
October 27, July 28,
2001 2001
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,487 $ 4,873
Short-term investments 2,873 2,034
Accounts receivable, net of allowance for doubtful accounts
of $311 at October 27, 2001 and $288 at July 28, 2001 1,181 1,466
Inventories, net 1,301 1,684
Deferred tax assets 2,271 1,809
Lease receivables, net 395 405
Prepaid expenses and other current assets 513 564
------------ ------------
Total current assets 13,021 12,835
Investments 10,570 10,346
Restricted investments 1,150 1,264
Property and equipment, net 2,585 2,591
Goodwill 3,300 3,189
Purchased intangible assets, net 1,366 1,470
Lease receivables, net 98 253
Other assets 3,450 3,290
------------ ------------
TOTAL ASSETS $ 35,540 $ 35,238
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 459 $ 644
Income taxes payable 276 241
Accrued compensation 1,180 1,058
Deferred revenue 2,784 2,470
Other accrued liabilities 2,304 2,553
Restructuring liabilities 316 386
------------ ------------
Total current liabilities 7,319 7,352
Deferred revenue 751 744
------------ ------------
Total liabilities 8,070 8,096
------------ ------------
Minority interest 20 22
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; 7,328 and 7,324 shares issued and
outstanding at October 27, 2001 and July 28, 2001, respectively 20,372 20,051
Retained earnings 6,800 7,344
Accumulated other comprehensive income (loss) 278 (275)
------------ ------------
Total shareholders' equity 27,450 27,120
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 35,540 $ 35,238
============ ============
See Notes to Consolidated Financial Statements.
4
CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
Three Months Ended
-----------------------------
October 27, October 28,
2001 2000
------------ ------------
Cash flows from operating activities:
Net income (loss) $ (268) $ 798
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 459 434
Provision for doubtful accounts 26 14
Provision for (benefit from) inventory (29) 143
Deferred income taxes (540) (292)
Tax benefits from employee stock option plans 43 985
In-process research and development 25 476
Net (gains) losses on investments and provision for losses 971 37
Change in operating assets and liabilities:
Accounts receivable 259 (601)
Inventories 229 (867)
Prepaid expenses and other current assets 70 (349)
Accounts payable (185) 259
Income taxes payable 34 23
Accrued compensation 122 (234)
Deferred revenue 321 311
Other accrued liabilities (83) 226
Restructuring liabilities (70) --
------------ ------------
Net cash provided by operating activities 1,384 1,363
------------ ------------
Cash flows from investing activities:
Purchases of short-term investments (2,327) (1,524)
Proceeds from sales and maturities of short-term investments 1,724 2,143
Purchases of investments (2,790) (4,134)
Proceeds from sales and maturities of investments 2,040 4,116
Purchases of restricted investments (19) (51)
Proceeds from sales and maturities of restricted investments 161 10
Acquisition of property and equipment (292) (524)
Acquisition of businesses, net of cash and cash equivalents 14 31
Change in lease receivables, net 165 106
Purchases of investments in privately held companies (19) (317)
Lease deposits (73) --
Purchase of minority interest of Cisco Systems, K.K. (Japan) (37) --
Other (138) (234)
------------ ------------
Net cash used in investing activities (1,591) (378)
------------ ------------
Cash flows from financing activities:
Issuance of common stock 171 338
Repurchase of common stock (350) --
Other -- (19)
------------ ------------
Net cash provided by (used in) financing activities (179) 319
------------ ------------
Net increase (decrease) in cash and cash equivalents (386) 1,304
Cash and cash equivalents, beginning of period 4,873 4,234
------------ ------------
Cash and cash equivalents, end of period $ 4,487 $ 5,538
============ ============
See Notes to Consolidated Financial Statements.
5
CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN MILLIONS)
(UNAUDITED)
Common Stock Accumulated
Common Stock and Other Total
Three Months Number of Additional Retained Comprehensive Shareholders'
Ended October 28, 2000 Shares Paid-In Capital Earnings Income Equity
---------------------- -------------- -------------- -------------- -------------- --------------
BALANCE AT JULY 29, 2000 7,138 $ 14,609 $ 8,358 $ 3,530 $ 26,497
Net income -- -- 798 -- 798
Change in unrealized gains and losses
on investments -- -- -- (1,129) (1,129)
Other -- -- -- (19) (19)
--------------
Comprehensive loss -- -- -- -- (350)
--------------
Issuance of common stock 35 338 -- -- 338
Tax benefits from employee stock
option plans -- 106 -- -- 106
Purchase acquisitions 17 1,027 -- -- 1,027
Amortization of deferred stock-based
compensation -- 23 -- -- 23
-------------- -------------- -------------- -------------- --------------
BALANCE AT OCTOBER 28, 2000 7,190 $ 16,103 $ 9,156 $ 2,382 $ 27,641
============== ============== ============== ============== ==============
Common Stock Accumulated
Common Stock and Other Total
Three Months Number of Additional Retained Comprehensive Shareholders'
Ended October 27, 2001 Shares Paid-In Capital Earnings Income Equity
---------------------- -------------- -------------- -------------- -------------- --------------
BALANCE AT JULY 28, 2001 7,324 $ 20,051 $ 7,344 $ (275) $ 27,120
Net loss -- -- (268) -- (268)
Change in unrealized gains and losses
on investments -- -- -- 555 555
Other -- -- -- (2) (2)
--------------
Comprehensive income -- -- -- -- 285
--------------
Issuance of common stock 23 171 -- -- 171
Repurchase of common stock (27) (74) (276) -- (350)
Tax benefits from employee stock
option plans -- 43 -- -- 43
Purchase acquisitions 8 128 -- -- 128
Amortization of deferred stock-based
compensation -- 53 -- -- 53
-------------- -------------- -------------- -------------- --------------
BALANCE AT OCTOBER 27, 2001 7,328 $ 20,372 $ 6,800 $ 278 $ 27,450
============== ============== ============== ============== ==============
See Notes to Consolidated Financial Statements.
6
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. DESCRIPTION OF BUSINESS
Cisco Systems, Inc. (the "Company" or "Cisco") is the worldwide leader in
networking for the Internet. Cisco Internet Protocol ("IP")-based networking
solutions are the foundation of the Internet and are installed at corporations,
public institutions, telecommunication companies, and in a growing number of
medium-sized commercial enterprises. Cisco provides a broad line of solutions
for transporting data, voice, and video within buildings, across campuses, or
around the world. Cisco solutions allow networks, both public and private, to
operate with flexibility, security, and performance.
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 2002 and 2001 are 52-week fiscal years.
Basis of Presentation
The accompanying financial data as of October 27, 2001 and for the three months
ended October 27, 2001 and October 28, 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 28, 2001 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 28, 2001.
In the opinion of management, all adjustments (which include normal recurring
adjustments except as disclosed herein) necessary to present a fair statement of
financial position as of October 27, 2001, results of operations, cash flows,
and shareholders' equity for the three months ended October 27, 2001 and October
28, 2000 have been made. The results of operations for the three months ended
October 27, 2001 are not necessarily indicative of the operating results for the
full fiscal year or any future periods.
Certain reclassifications have been made to prior period balances in order to
conform to the current period presentation.
7
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Computation of Net Income (Loss) per Share
Basic net income (loss) per share is computed using the weighted-average number
of common shares outstanding during the period. Diluted net income per share is
computed using the weighted-average number of common shares and dilutive
potential common shares outstanding during the period. Diluted net loss per
share is computed using the weighted-average number of common shares and
excludes dilutive potential common shares outstanding, as their effect is
antidilutive. Dilutive potential common shares primarily consist of employee
stock options.
Goodwill and Purchased Intangible Assets
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141")
and Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 141 requires all business combinations to
be accounted for using the purchase method of accounting and that certain
intangible assets acquired in a business combination shall be recognized as
assets apart from goodwill. SFAS 141 was effective for all business combinations
initiated after June 30, 2001. SFAS 142 requires goodwill to be tested for
impairment under certain circumstances, and written down when impaired, rather
than being amortized as previous standards required. Furthermore, SFAS 142
requires purchased intangible assets other than goodwill to be amortized over
their useful lives unless these lives are determined to be indefinite. Purchased
intangible assets are carried at cost less accumulated amortization.
Amortization is computed over the useful lives of the respective assets,
generally two to five years.
SFAS 142 is effective for fiscal years beginning after December 15, 2001;
however, the Company has elected to early-adopt the standard effective the
beginning of fiscal 2002. In accordance with SFAS 142, the Company ceased
amortizing goodwill totaling $3.2 billion as of the beginning of fiscal 2002,
including $55 million of acquired workforce intangible previously classified as
purchased intangible assets, net of related deferred tax liabilities. As a
result, in the first quarter of fiscal 2002, the Company did not recognize $199
million of goodwill amortization expense that would have been recognized had the
previous standards been in effect.
8
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table presents the impact of SFAS 142 on net income (loss) and net
income (loss) per share had the standard been in effect for the first quarter of
fiscal 2001 (in millions, except per-share amounts):
Three Months Ended
-----------------------------
October 27, October 28,
2001 2000
------------ ------------
Reported net income (loss) $ (268) $ 798
Adjustments:
Amortization of goodwill -- 144
Amortization of acquired workforce intangible
previously classified as purchased intangible assets -- 2
Income tax effect -- (20)
------------ ------------
Net adjustments -- 126
------------ ------------
Adjusted net income (loss) $ (268) $ 924
============ ============
Reported net income (loss) per share--basic $ (0.04) $ 0.11
Adjusted net income (loss) per share--basic $ (0.04) $ 0.13
Reported net income (loss) per share--diluted $ (0.04) $ 0.11
Adjusted net income (loss) per share--diluted $ (0.04) $ 0.12
There was no impairment of goodwill upon adoption of SFAS 142. The Company is
required to perform goodwill impairment tests on an annual basis and between
annual tests in certain circumstances. There can be no assurance that future
goodwill impairment tests will not result in a charge to earnings.
9
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Recent Accounting Pronouncement
In October 2001, the FASB issued Statement of Financial Accounting Standard No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 establishes a single accounting model, based on the framework
established in Statement of Financial Accounting Standard No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" ("SFAS 121"), for long-lived assets to be disposed of by sale, and resolves
significant implementation issues related to SFAS 121. The Company is currently
assessing the impact of SFAS 144 on its operating results and financial
condition. The Company is required to adopt SFAS 144 no later than the first
quarter of fiscal 2003.
3. BUSINESS COMBINATIONS
During the first quarter of fiscal 2002, the Company completed the acquisitions
of Allegro Systems, Inc. ("Allegro") and AuroraNetics, Inc. ("AuroraNetics").
The Company acquired Allegro to enhance its existing Virtual Private Network
("VPN") and security solutions with added performance capabilities to meet the
growing security requirements of organizations connecting remote offices,
employees, and customers to corporate networks and the Internet. The Company
acquired AuroraNetics to enhance its development of innovative high-end routing
technologies designed to address the rapid growth of data traffic in the
metropolitan network environment. A summary of the purchase transactions is
outlined as follows (in millions):
Consideration
Including Purchased
Assumed In-Process Intangible
Acquired Company Liabilities R&D Expense Goodwill Assets
---------------- -------------- -------------- -------------- --------------
Allegro $ 138 $ 28 $ 5 $ 105
AuroraNetics 51 9 16 14
-------------- -------------- -------------- --------------
Total $ 189 $ 37 $ 21 $ 119
============== ============== ============== ==============
In connection with the above purchase acquisitions, the Company may be required
to pay certain additional amounts of up to $145 million contingent upon Allegro
and AuroraNetics achieving certain agreed upon milestones.
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. Total in-process R&D expense for
10
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
the first quarter of fiscal 2002 and 2001 was $37 million and $509 million,
respectively. The in-process R&D expense that was attributable to stock
consideration for the same periods was $25 million and $476 million,
respectively.
The following table presents details of the purchased intangible assets acquired
during the first quarter of fiscal 2002 (in millions):
Allegro AuroraNetics
---------------------------- ----------------------------
Estimated Estimated
Useful Life Amount Useful Life Amount
------------ ------------ ------------ ------------
Technology 4.1 $ 98 -- $ --
Patents -- -- 5.0 3
Other 2.0 7 2.0 11
------------ ------------ ------------ ------------
4.0 $ 105 2.6 $ 14
============ ============ ============ ============
The remaining purchase price was primarily allocated to tangible assets and
deferred stock-based compensation. At October 27, 2001 and July 28, 2001, the
total unamortized deferred stock-based compensation was $266 million and $293
million, respectively, and was reflected as a debit to additional paid-in
capital in the Consolidated Statements of Shareholders' Equity.
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 aggregate basis.
11
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following tables present details of the Company's total purchased intangible
assets (in millions):
Accumulated
October 27, 2001 Gross Amortization Net
---------------- ------------ ------------ ------------
Technology $ 1,096 $ (279) $ 817
Technology licenses 523 (225) 298
Patents 222 (51) 171
Other 135 (55) 80
------------ ------------ ------------
Total $ 1,976 $ (610) $ 1,366
============ ============ ============
Accumulated
July 28, 2001 Gross Amortization Net
------------- ------------ ------------ ------------
Technology $ 1,053 $ (240) $ 813
Technology licenses 523 (191) 332
Patents 232 (44) 188
Acquired workforce 91 (20) 71
Other 117 (51) 66
------------ ------------ ------------
Total $ 2,016 $ (546) $ 1,470
============ ============ ============
The following table presents details of the amortization expense of purchased
intangible assets as reported in the Consolidated Statements of Operations (in
millions):
Three Months Ended
----------------------------
October 27, October 28,
2001 2000
------------ ------------
Reported as:
Cost of sales $ 6 $ 4
Operating expenses 146 81
------------ ------------
Total $ 152 $ 85
============ ============
12
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The estimated future amortization expense of purchased intangible assets is as
follows (in millions):
Fiscal year Amount
----------- -------------
2002 (remaining nine months) $ 410
2003 $ 416
2004 $ 291
2005 $ 199
2006 $ 49
2007 $ 1
The following table presents the changes in goodwill allocated to the reportable
segments during the first quarter of fiscal 2002 (in millions):
Balance at Balance at
July 28, October 27,
2001 Acquired Adjustments 2001
------------- ------------- ------------- -------------
Americas $ 2,177 $ 11 $ 38 $ 2,226
EMEA 531 6 12 549
Asia Pacific 110 2 4 116
Japan 371 37 1 409
------------- ------------- ------------- -------------
Total $ 3,189 $ 56 $ 55 $ 3,300
============= ============= ============= =============
In the first quarter of fiscal 2002, the Company purchased a portion of the
minority interest of Cisco Systems, K.K. (Japan). As a result, the Company
increased its ownership to 89.3% of the voting rights of Cisco Systems, K.K.
(Japan) and recorded goodwill of $35 million. The adjustments during the first
quarter of fiscal 2002 were due to the reclassification of acquired workforce
intangible and the related deferred tax liabilities to goodwill as a result of
the adoption of SFAS 142.
13
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES AND PROVISION FOR
INVENTORY
On April 16, 2001, due to macroeconomic and capital spending issues affecting
the networking industry, the Company announced a restructuring program to
prioritize its initiatives around high-growth areas of its business, focus on
profit contribution, reduce expenses, and improve efficiency. This restructuring
program included a worldwide workforce reduction, consolidation of additional
excess facilities, and restructuring of certain business functions.
In fiscal 2001, the Company recorded restructuring costs and other special
charges classified as operating expenses and an additional excess inventory
charge classified as cost of sales as a result of the restructuring program and
decline in forecasted revenue. The following paragraphs provide detailed
information relating to the status of the restructuring liabilities and
additional excess inventory reserve during the first quarter of fiscal 2002.
Worldwide Workforce Reduction, Consolidation of Excess Facilities, and Other
Special Charges
The following table summarizes the activity related to the restructuring
liabilities during the first quarter of fiscal 2002 (in millions):
Balance at Cash Balance at
July 28, 2001 Reclassification Payments October 27, 2001
------------- ---------------- -------------- ----------------
Workforce reduction $ 61 $ (31) $ (19) $ 11
Consolidation of excess
facilities and other charges 325 31 (51) 305
-------------- -------------- -------------- --------------
Total $ 386 $ -- $ (70) $ 316
============== ============== ============== ==============
In the first quarter of fiscal 2002, due to changes in previous estimates, the
Company reclassified $31 million of restructuring liabilities related to the
workforce reduction charges to consolidation of excess facilities and other
charges.
14
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following is a summary of the restructuring liabilities at October 27, 2001
(in millions):
Total Non-Cash Cash Balance at
Charge Reclassification Charges Payments October 27, 2001
-------------- ---------------- -------------- -------------- ----------------
Workforce reduction $ 397 $ (31) $ (71) $ (284) $ 11
Consolidation of excess
facilities and other charges 484 31 (141) (69) 305
Impairment of goodwill and
purchased intangible assets 289 -- (289) -- --
-------------- -------------- -------------- -------------- --------------
Total $ 1,170 $ -- $ (501) $ (353) $ 316
============== ============== ============== ============== ==============
The worldwide workforce reduction program started in the third quarter of fiscal
2001. As of October 27, 2001, approximately 5,300 regular employees have been
terminated and paid. Amounts related to the net lease expense due to the
consolidation of facilities will be paid over the respective lease terms through
fiscal 2007.
Provision for Inventory
In the third quarter of fiscal 2001, the Company recorded an additional excess
inventory charge of $2.2 billion. This additional excess inventory charge was
subsequently reduced in the fourth quarter of fiscal 2001 by a $187 million
benefit primarily related to lower settlement charges for purchase commitments.
In the first quarter of fiscal 2002, this additional excess inventory charge was
further reduced by a $290 million benefit primarily related to inventory used to
manufacture products sold and for internal use in research and development and
was credited to the provision for inventory.
The following is a summary of the additional excess inventory reserve during the
first quarter of fiscal 2002 (in millions):
Excess Inventory Excess Inventory
Reserve Benefit
-------------- --------------
Reserve balance as of July 28, 2001 $ 1,677 $ --
Usage:
Inventory scrapped (450) --
Sale of inventory (32) 4
Inventory utilized (234) 234
Settlement of purchase commitments (118) 52
-------------- --------------
(834) $ 290
==============
--------------
Remaining reserve balance as of October 27, 2001 $ 843
==============
15
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following is a summary of the additional excess inventory reserve at October
27, 2001 (in millions):
Excess Inventory Excess Inventory
Reserve Benefit
-------------- --------------
Initial additional excess inventory charge $ 2,249 $ --
Usage:
Inventory scrapped (555) --
Sale of inventory (121) 13
Inventory utilized (283) 283
Settlement of purchase commitments (447) 181
-------------- --------------
(1,406) $ 477
==============
--------------
Remaining reserve balance as of October 27, 2001 $ 843
==============
5. BALANCE SHEET DETAILS
The following tables provide details of selected balance sheet items (in
millions):
October 27, July 28,
2001 2001
-------------- --------------
Inventories, net:
Raw materials $ 521 $ 662
Work in process 100 260
Finished goods 594 669
Demonstration systems 86 93
-------------- --------------
Total $ 1,301 $ 1,684
============== ==============
Other assets:
Deferred tax assets $ 1,220 $ 1,314
Investments in privately held companies, net 781 775
Income tax receivable 443 443
Lease deposits 393 320
Structured loans, net 112 84
Other 501 354
-------------- --------------
Total $ 3,450 $ 3,290
============== ==============
16
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. LEGAL PROCEEDINGS
The Company is subject to legal proceedings, claims, and litigation arising in
the ordinary course of business. While the outcome of these matters is currently
not determinable, management does not expect that the ultimate costs to resolve
these matters will have a material adverse effect on the Company's consolidated
financial position, results of operations, or cash flows.
Beginning on April 20, 2001, a number of purported shareholder class action
lawsuits have been filed in the United States District Court for the Northern
District of California against the Company and certain of its officers and
directors. The lawsuits are essentially identical, and purport to bring suit on
behalf of those who purchased the Company's publicly traded securities between
August 10, 1999 and April 16, 2001. Plaintiffs allege that defendants made false
and misleading statements, purport to assert claims for violations of the
federal securities laws, and seek unspecified compensatory damages and other
relief. The Company believes the claims are without merit and intends to defend
the actions vigorously.
In addition, beginning on April 23, 2001, a number of purported shareholder
derivative lawsuits have been filed in the Superior Court of California, County
of Santa Clara, against the Company (as a nominal defendant), its directors and
certain officers. At least two purported derivative suits have also been filed
in the United States District Court for the Northern District of California, and
another has been filed in the Superior Court of California, County of San Mateo.
The complaints in the various derivative actions include claims for breach of
fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment and
violations of the California Corporations Code, seek compensatory and other
damages, disgorgement and other relief, and are based on essentially the same
allegations as the class actions.
7. SHAREHOLDERS' EQUITY
Stock Repurchase Program
In September 2001, the Board of Directors authorized a stock repurchase program
to acquire outstanding common stock in the open market or negotiated
transactions. Under the program, up to $3 billion of Cisco common stock could be
reacquired over the next two years. During the first quarter of fiscal 2002, the
Company repurchased and retired approximately 27 million shares of Cisco common
stock for an aggregate purchase price of $350 million.
17
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, are as follows (in
millions):
Three Months Ended
---------------------------
October 27, October 28,
2001 2000
----------- -----------
Net income (loss) $ (268) $ 798
Other comprehensive income (loss)
Change in unrealized gains and losses on investments,
net of tax 555 (1,129)
Other (2) (19)
---------- -----------
Total $ 285 $ (350)
========== ===========
During the first quarter of fiscal 2002, the Company recorded a charge of $858
million related to the impairment on certain publicly traded securities in its
investment portfolio in accordance with Statement of Financial Accounting
Standard No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The impairment charge was related to the decline in the fair value
of the Company's publicly traded equity investments below the cost basis that
are considered to be other-than-temporary. The change in the unrealized gains
and losses on investments during the first quarter of fiscal 2002 was primarily
related to this impairment charge, net of tax.
8. INCOME TAXES
The Company paid net income taxes of $390 million for the first quarter of
fiscal 2002 and received net income tax refunds of $219 million for the first
quarter of fiscal 2001. The Company's income taxes currently payable for federal
and state purposes have been reduced by the tax benefits of employee stock
option transactions. These benefits totaled $43 million and $985 million in the
first quarter of fiscal 2002 and 2001, respectively, and were reflected as a
credit to additional paid-in capital in the Consolidated Statements of
Shareholders' Equity. In the first quarter of fiscal 2001, the Company's
valuation allowance against gross deferred tax assets attributable to employee
stock option transactions increased by $879 million and was reflected as a debit
to additional paid-in capital in the Consolidated Statements of Shareholders'
Equity.
18
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. 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 and WANs into complete end-to-end
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 in this internal management system, as
management does not use the information to measure the performance of the
operating segments. Management does not believe that allocating these expenses
is significant in evaluating a geographic theater's performance. Based on
established criteria, the Company has four reportable segments: the Americas;
Europe, the Middle East, and Africa ("EMEA"); Asia Pacific; and Japan.
19
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Summarized financial information by theater for the first quarter of fiscal 2002
and 2001, as taken from the internal management system previously discussed, is
as follows (in millions):
Three Months Ended
--------------------------------
October 27, October 28,
2001 2000
------------- -------------
Net sales:
Americas $ 3,007 $ 4,632
EMEA 1,197 1,845
Asia Pacific 400 669
Japan 325 484
Revenue adjustments (151) (608)
Revenue deferrals (330) (503)
------------- -------------
Total $ 4,448 $ 6,519
============= =============
Gross margin:
Americas $ 2,197 $ 3,373
EMEA 934 1,384
Asia Pacific 312 482
Japan 254 387
------------- -------------
Standard margin 3,697 5,626
Revenue adjustments (151) (608)
Revenue deferrals (330) (503)
Deferred cost of sales 75 293
Production overhead (191) (154)
Manufacturing variances and other related costs (408) (513)
------------- -------------
Total $ 2,692 $ 4,141
============= =============
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 revenue adjustments, revenue deferrals, deferred cost
of sales, production overhead, and manufacturing variances and other related
costs to the theaters. Revenue adjustments primarily relate to reserves for
accounts receivable, leases, and structured loans which are not allocated to
geographical or product categories. Revenue deferrals primarily relate to
two-tier distribution, sales that contain contract terms requiring revenue
deferral, and other timing differences which are not allocated to geographical
or product categories. 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.
20
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
-------------------------------
October 27, October 28,
2001 2000
------------- -------------
Net sales:
Routers $ 1,607 $ 2,818
Switches 1,993 2,809
Access 316 810
Service 792 608
Other 479 642
Revenue adjustments (1) (409) (665)
Revenue deferrals (330) (503)
------------- -------------
Total $ 4,448 $ 6,519
============= =============
Note 1: Also includes credit memos related to customer incentives and other
discounts not allocated to specific product categories but allocated to
geographical categories totaling $258 million and $57 million in the first
quarter of fiscal 2002 and 2001, respectively.
Substantially all of the Company's assets at October 27, 2001 and July 28, 2001
were attributable to U.S. operations. In the first quarter of fiscal 2002 and
2001, no single customer accounted for 10% or more of the Company's net sales.
21
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
10. NET INCOME (LOSS) PER SHARE
The following table presents the calculation of basic and diluted net income
(loss) per share (in millions, except per-share amounts):
Three Months Ended
-------------------------------
October 27, October 28,
2001 2000
------------- -------------
Net income (loss) $ (268) $ 798
============= =============
Weighted-average shares -- basic 7,307 7,093
Effect of dilutive securities:
Employee stock options -- 487
------------- -------------
Weighted-average shares -- diluted 7,307 7,580
============= =============
Net income (loss) per share -- basic $ (0.04) $ 0.11
============= =============
Net income (loss) per share -- diluted $ (0.04) $ 0.11
============= =============
The dilutive potential common shares that were antidilutive for the first
quarter of fiscal 2002 amounted to 159 million shares.
22
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.
The net sales and gross margin for the first quarter of fiscal 2002 and 2001
were as follows (in millions, except percentages):
Net Sales Gross Margin
------------------------------ -------------------------------
October 27, October 28, October 27, October 28,
Three Months Ended 2001 2000 2001 2000
------------------ ------------- ------------- ------------- -------------
Product $ 3,656 $ 5,911 59.0% 64.1%
Service 792 608 67.7% 57.9%
------------- ------------- ------------- -------------
Total $ 4,448 $ 6,519 60.5% 63.5%
============= ============= ============= =============
Net product revenue in the first quarter of fiscal 2002 decreased by 38.1% from
the first quarter of fiscal 2001. The decrease in net product revenue was
primarily a result of decreased unit sales of router, switch, and access
products due to the unfavorable economic conditions and capital spending
environment compared to the period a year ago. Net product revenue in the first
quarter of fiscal 2002 increased by 2.2% compared with net product revenue of
$3.6 billion in the fourth quarter of fiscal 2001.
Product gross margin in the first quarter of fiscal 2002 decreased to 59.0% from
64.1% in the first quarter of fiscal 2001 primarily due to lower shipment
volumes and related manufacturing overhead; shifts in product mix; and higher
production-related costs partially offset by a benefit from the additional
excess inventory reserve as discussed below. Excluding the benefit from the
additional excess inventory reserve in both periods, product gross margin was
51.0% in the first quarter of fiscal 2002 compared with 49.1% in the fourth
quarter of fiscal 2001.
The provision for (benefit from) inventory was ($29) million in the first
quarter of fiscal 2002 compared with $143 million in the first quarter of fiscal
2001. In the third quarter of fiscal 2001, we recorded an additional excess
inventory charge of $2.2 billion. This additional excess inventory charge was
subsequently reduced in the fourth quarter of fiscal 2001 by a $187 million
benefit primarily related to lower settlement charges for purchase commitments.
In the first quarter of fiscal 2002, this additional excess inventory charge was
further reduced by a $290 million benefit primarily related to inventory used to
manufacture products sold and for internal use in research and development and
was credited to the provision for inventory. As of October 28, 2001, the
remaining additional excess inventory reserve balance was $843 million. For
additional information regarding the additional excess inventory reserve, see
Note 4
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
"Restructuring Costs and Other Special Charges and Provision for
Inventory" of the Notes to Consolidated Financial Statements.
Inventory purchases and commitments are based upon future demand forecasts. Due
to a sudden and significant decrease in demand for our products in the third
quarter of fiscal 2001, inventory levels exceeded our estimated requirements
based on demand forecasts and the additional excess inventory charge was
recorded in accordance with our accounting policy. We do not currently
anticipate the additional excess inventory subject to this provision will be
used significantly at a later date based on our current demand forecast.
Net service revenue in the first quarter of fiscal 2002 increased by 30.3% from
the first quarter of fiscal 2001. Service revenue is generally deferred and, in
most cases, recognized ratably over the service period obligations, which are
typically one to three years. The increase in net service revenue was primarily
related to the increased installed base of equipment needing maintenance
support. Net service revenue in the first quarter of fiscal 2002 increased by
9.8% compared with net service revenue of $721 million in the fourth quarter of
fiscal 2001.
Net service margin in the first quarter of fiscal 2002 increased to 67.7% from
57.9% in the first quarter of fiscal 2001. The increase in service margin was
primarily due to cost efficiencies in our technical assistance centers. Service
margin was 68.5% in the fourth quarter of fiscal 2001. Service margins will
typically experience some variability over time due to various factors such as
the changes in mix between support and professional services, as well as the
timing of support contract renewals.
We manage our business based on four geographic theaters: the Americas; Europe,
the Middle East, and Africa ("EMEA"); Asia Pacific; and Japan. Financial
information by theater for the first quarter of fiscal 2002 and 2001 is
summarized in the following table (in millions, except percentages):
Amounts Percentage of Net Sales
--------------------------------- ----------------------------------
October 27, October 28, October 27, October 28,
Three Months Ended 2001 2000 2001 2000
------------------- -------------- -------------- -------------- --------------
Net sales:
Americas $ 3,007 $ 4,632 67.6% 71.1%
EMEA 1,197 1,845 26.9% 28.3%
Asia Pacific 400 669 9.0% 10.2%
Japan 325 484 7.3% 7.4%
Revenue adjustments (151) (608) (3.4%) (9.3%)
Revenue deferrals (330) (503) (7.4%) (7.7%)
-------------- -------------- -------- ---------
Total $ 4,448 $ 6,519 100.0% 100.0%
============== ============== ======== =========
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following table shows the standard margins for each theater and the total
gross margin (in millions, except percentages):
Amounts Standard Margin
------------------------------- -------------------------------
October 27, October 28, October 27, October 28,
Years Ended 2001 2000 2001 2000
----------- ------------- ------------- ------------- -------------
Gross margin:
Americas $ 2,197 $ 3,373 73.1% 72.8%
EMEA 934 1,384 78.0% 75.0%
Asia Pacific 312 482 78.0% 72.0%
Japan 254 387 78.2% 80.0%
------------- ------------- ------------- -------------
Standard margin 3,697 5,626 75.0% 73.7%
Revenue adjustments (151) (608)
Revenue deferrals (330) (503)
Deferred cost of sales 75 293
Production overhead (191) (154)
Manufacturing variances and
other related costs (408) (513)
------------- -------------
Total $ 2,692 $ 4,141
============= =============
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 revenue adjustments, revenue deferrals, deferred cost of sales,
production overhead, and manufacturing variances and other related costs to the
theaters. Standard margins vary due to a number of reasons including, but not
limited to, shifts in product mix, sales discounts, and sales channels. Revenue
adjustments primarily relate to reserves for accounts receivable, leases, and
structured loans which are not allocated to geographical or product categories.
Revenue deferrals primarily relate to two-tier distribution, sales that contain
contract terms requiring revenue deferral, and other timing differences which
are not allocated to geographical or product categories.
Gross margin may be adversely affected in the future by increases in material or
labor costs, excess inventory, obsolescence charges, changes in shipment volume,
loss of cost savings, price competition, and changes in channels of distribution
or in the mix of products sold. If product or related warranty costs associated
with our products are greater than we have experienced, gross margin may also be
adversely affected. 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.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Research and development ("R&D"), sales and marketing, and general and
administrative ("G&A") expenses are summarized in the following table (in
millions, except percentages):
Amounts Percentage of Net Sales
------------------------------ -------------------------------
October 27, October 28, October 27, October 28,
Three Months Ended 2001 2000 2001 2000
------------------ ------------- ------------- ------------- -------------
Research and development $ 917 $ 947 20.6% 14.5%
Sales and marketing $ 1,096 $ 1,362 24.6% 20.9%
General and administrative $ 151 $ 196 3.4% 3.0%
In the third quarter of fiscal 2001, we announced a restructuring program to
prioritize our initiatives around high-growth areas of our business, focus on
profit contribution, reduce expenses, and improve efficiency. This restructuring
program included a worldwide workforce reduction, consolidation of additional
excess facilities, and restructuring of certain business functions. For
additional information regarding the restructuring program, see Note 4
"Restructuring Costs and Other Special Charges and Provision for Inventory" of
the Notes to Consolidated Financial Statements.
R&D, sales and marketing, and G&A expenses as a percentage of net sales for the
first quarter of fiscal 2002 have increased compared with the first quarter of
fiscal 2001 primarily due to the decline in net sales. R&D, sales and marketing,
and G&A expenses decreased in absolute dollars from the first quarter of the
prior year primarily due to the impact of the restructuring program and cost
control measures to contain hiring and reduce discretionary spending. As a
result, operating expenses have been reduced on a quarterly basis by
approximately $500 million compared to the high point of fiscal 2001.
R&D expenses in the first quarter of fiscal 2002 decreased by 3.2% from the
first quarter of fiscal 2001. A significant portion of the decrease was due to
lower expenditures on prototypes and lab equipment and the reduction of
discretionary spending. R&D includes efforts in a wide variety of areas such as
data, voice, and video over IP; advanced access technologies; enterprise
switching; optical transport; storage networking; content networking; security;
network management; advanced routing and switching technologies; cable; and
other broadband technologies, among others. We have 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 have been expensed as incurred.
Sales and marketing expenses in the first quarter of fiscal 2002 decreased by
19.5% from the first quarter of fiscal 2001. The decrease in sales and marketing
expenses was principally due to the decrease in the size of our direct sales
force and related commissions, reduced marketing and
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
advertising investments associated with existing and new product introductions,
the reduction of distribution channels and markets, and reduced investments in
general corporate branding. However, we have continued 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.
G&A expenses in the first quarter of fiscal 2002 decreased by 23.0% from the
first quarter of fiscal 2001. The decrease in G&A expenses was primarily related
to the reduction of investments in infrastructure and discretionary spending.
We have elected to early-adopt Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142") effective the beginning
of fiscal 2002. In accordance with SFAS 142, we ceased amortizing goodwill.
There was no impairment of goodwill upon adoption of SFAS 142. We are required
to perform goodwill impairment tests on an annual basis and between annual tests
in certain circumstances. There can be no assurance that future goodwill
impairment tests will not result in a charge to earnings. For additional
information regarding SFAS 142, see Note 2 "Summary of Significant Accounting
Policies" of the Notes to Consolidated Financial Statements.
Amortization of purchased intangible assets included in operating expenses was
$146 million in the first quarter of fiscal 2002, compared with $81 million in
the first quarter of fiscal 2001. The increase in the amortization of purchased
intangible assets was primarily related to the accelerated amortization for
certain technology and patent intangibles due to a reduction in their useful
lives. For additional information regarding purchased intangible assets, see
Note 3 "Business Combinations" of the Notes to Consolidated Financial
Statements.
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 purchased technology 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. 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 efforts 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 these
technologies into commercially viable products consists principally of planning,
designing, experimenting, and testing activities necessary to determine that the
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
technologies can meet market expectations, including functionality and technical
requirements. Failure to bring these products to market in a timely manner could
result in a loss of market share or a lost opportunity to capitalize on emerging
markets and could have a material adverse impact on our business and operating
results.
The following table summarizes the key assumptions underlying the valuations for
our significant purchase acquisitions completed in the first quarter of fiscal
2002 (in millions, except percentages):
Estimated Cost to Risk-Adjusted
Complete Technology at Discount Rate for
Acquired Company Time of Acquisition In-Process R&D
---------------- ---------------------- -----------------
Allegro Systems, Inc. $ 5 52.5%
AuroraNetics, Inc. $ 2 35.0%
Regarding our purchase acquisitions, actual results to date have been
consistent, in all material respects, with our assumptions at the time of
acquisitions except for certain purchase acquisitions where the purchased
intangible assets have been impaired and written-down as reflected in the
Consolidated Statements of Operations. 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 assuming the products
have entered the market. Failure to achieve the expected levels of revenue and
net income from these products will negatively impact the return on investment
expected at the time that the acquisitions were completed and may result in
impairment charges.
Interest and other income (losses), net, were ($688) million in the first
quarter of fiscal 2002, compared with $420 million in the first quarter of
fiscal 2001. The decrease was primarily due to a charge of $858 million related
to the impairment on certain publicly traded securities in our investment
portfolio. In accordance with Statement of Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt and Equity Securities," we have
recorded an impairment charge related to the declines in the fair value of our
publicly traded equity investments below the cost basis that are considered to
be other-than-temporary.
For the first quarter of fiscal 2002, the effective tax rate was 21.9%. The
effective tax rate differs from the statutory rate primarily due to the impact
of nondeductible in-process R&D, acquisition-related costs, research and
experimentation tax credits, and the tax impact of foreign operations. Our
future effective tax rates could be adversely affected if earnings are lower
than anticipated in countries where we have lower effective rates or by
unfavorable changes in tax laws and regulations.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and total investments were $19.1 billion at October
27, 2001, an increase of $563 million from July 28, 2001. The increase was
primarily a result of cash provided by operating activities of $1.4 billion and
cash provided by the issuance of common stock of $171 million. This increase was
partially offset by cash used in capital expenditures of $292 million, cash used
for the repurchase of common stock of $350 million, and a net decrease of $151
million in the fair value of investments.
Accounts receivable decreased 19.4% from July 28, 2001 to October 27, 2001. Days
sales outstanding in receivables decreased to 24 days at October 27, 2001 from
31 days at July 28, 2001. The decrease in accounts receivable and days sales
outstanding were primarily due to shipment linearity and process improvements
surrounding billing and collections.
Inventories decreased 22.7% from July 28, 2001 to October 27, 2001. Inventory
turns, excluding the additional excess inventory benefit previously discussed
were 5.5 for the first quarter of fiscal 2002 and 4.6 for the fourth quarter of
fiscal 2001. The inventory levels and inventory turns reflected the improvement
in shipment linearity. Inventory management remains an area of focus as we
balance the need to maintain strategic inventory levels to ensure competitive
lead times versus the risk of inventory obsolescence because of rapidly changing
technology and customer requirements.
We have entered into several agreements to lease sites in San Jose, California
(where our headquarters are established) and surrounding areas; Boxborough,
Massachusetts; Salem, New Hampshire; Richardson, Texas; and Research Triangle
Park, North Carolina where we have pledged $1.1 billion of our investments as
collateral for certain obligations of the leases. We anticipate that we may
occupy more leased property in the future that will require similar pledged
securities; however, we do not expect the impact of this activity to be material
to our liquidity position. We also lease office space in other U.S. locations,
as well as locations in the Americas, EMEA, Asia Pacific, and Japan.
In September 2001, the Board of Directors authorized a stock repurchase program
to acquire outstanding common stock in the open market or negotiated
transactions. Under the program, up to $3 billion of Cisco common stock could be
reacquired over the next two years. During the first quarter of fiscal 2002, we
repurchased and retired approximately 27 million shares of Cisco common stock
for an aggregate purchase price of $350 million.
We believe that our current cash and cash equivalents, short-term investments,
and cash generated from operations will satisfy our expected working capital
needs, capital expenditures, investment requirements, stock repurchases, and
commitments through at least the next 12 months. Amounts related to the net
lease expense due to the consolidation of facilities will be paid over the
respective lease terms through fiscal 2007.
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
PRO FORMA CONSOLIDATED DATA
We provide pro forma net income and pro forma net income per share data as an
alternative for understanding our operating results. These measures are not in
accordance with, or an alternative for, generally accepted accounting principles
and may be different from pro forma measures used by other companies. Pro forma
net income and pro forma net income per share -- diluted are calculated as
follows (in millions, except per-share amounts):
Three Months Ended
-------------------------------
October 27, October 28,
2001 2000
------------- -------------
Net income (loss) $ (268) $ 798
In-process research and development 37 509
Payroll tax on stock option exercises (1) 3 22
Amortization of deferred stock-based compensation (2) 50 6
Amortization of goodwill -- 144
Amortization of purchased intangible assets 146 81
Net (gains) losses on investments 858 (190)
Excess inventory benefit (290) --
Income tax effect (204) (7)
------------- -------------
Pro forma net income $ 332 $ 1,363
============= =============
Pro forma net income per share -- diluted $ 0.04 $ 0.18
============= =============
Shares used in per-share calculation -- diluted (3) 7,466 7,580
============= =============
Note 1: Payroll tax on stock option exercises of $3 million for the first
quarter of fiscal 2002 was allocated to R&D ($1 million) and sales and marketing
($2 million) expenses in the Consolidated Statements of Operations. Payroll tax
on stock option exercises of $22 million for the first quarter of fiscal 2001
was allocated to R&D ($8 million), sales and marketing ($12 million), and G&A
($2 million) expenses in the Consolidated Statements of Operations.
Note 2: Amortization of deferred stock-based compensation related to purchase
acquisitions of $50 million for the first quarter of fiscal 2002 was allocated
to R&D ($41 million), sales and marketing ($8 million), and G&A ($1 million)
expenses in the Consolidated Statements of Operations. Amortization of deferred
stock-based compensation related to purchase acquisitions of $6 million for the
first quarter of fiscal 2001 was allocated to R&D ($5 million) and G&A ($1
million) expenses in the Consolidated Statements of Operations.
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Note 3: Diluted net income per share is computed using the weighted-average
number of common shares and dilutive potential common shares outstanding during
the period. Diluted net loss per share is computed using the weighted-average
number of common shares and excludes dilutive potential common shares, as their
effect is antidilutive. The dilutive potential common shares that were
antidilutive for the first quarter of fiscal 2002 amounted to 159 million
shares.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
Set forth below and elsewhere in this Quarterly Report and in the other
documents we file with the SEC are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the
forward-looking statements contained in this Quarterly Report.
YOU SHOULD EXPECT THAT OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS
The results of operations for any quarter or fiscal year are not necessarily
indicative of results to be expected in future periods. Our operating results
have in the past been, and will continue to be, subject to quarterly and annual
fluctuations as a result of a number of factors. These factors include:
- Overall information technology spending
- Changes in general economic conditions and specific market conditions in
the communications and networking industries
- Fluctuations in demand for our products and services
- The effects of terrorist activity and armed conflict, such as disruptions
in general economic activity, changes in logistics and security
arrangements, and reduced customer demand for our products and services
- The long sales and implementation cycle for our products and the reduced
visibility into our customers' spending plans and associated revenue
- Inventory levels exceeding our requirements based upon future demand
forecasts
- Existing network capacity, sharing of existing network capacity, and
network capacity utilization rates of our customers
- Price and product competition in the networking industry
- The overall trend toward industry consolidation
- The introduction and market acceptance of new technologies and products,
as well as the adoption of new networking standards
- Variations in sales channels, product costs, or mix of products sold
- The timing of orders, timing of shipments, and the ability to satisfy all
contractual obligations in customer contracts
- Manufacturing lead times
- The impact of acquired businesses and technologies
- The geographical mix of our revenue and the associated impact on gross
margin
- Our ability to achieve targeted cost reductions
- Adverse changes in the public and private equity and debt markets
- The ability of our customers and suppliers to obtain financing or to fund
capital expenditures
- The trend toward sales of integrated network solutions
- The timing and amount of employer payroll tax to be paid on employees'
gains on stock options exercised
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
As a consequence, operating results for a particular future period are difficult
to predict, especially in recent periods. Any of the foregoing factors, or any
other factors discussed elsewhere herein, could have a material adverse effect
on our business, results of operations, and financial condition.
In response to changes in industry and market conditions, we may strategically
realign our resources and consider restructuring, disposing of, or otherwise
exiting businesses. Any decision to limit investment in or to dispose of or
otherwise exit businesses may result in the recording of accrued liabilities for
special one-time charges, such as workforce reduction costs. Additionally,
estimates with respect to the useful life or ultimate recoverability of our
carrying basis of assets, including goodwill and purchased intangible assets,
could change as a result of such assessments and decisions.
WE ARE EXPOSED TO GENERAL ECONOMIC AND MARKET CONDITIONS
Our business is subject to the effects of general economic conditions in the
United States and globally, and, in particular, market conditions in the
communications and networking industries. In recent quarters, our operating
results have been adversely affected as a result of unfavorable economic
conditions and reduced capital spending in the United States, Europe, and Asia.
In particular, sales to service providers, e-commerce and Internet businesses,
and the manufacturing industry in the United States has been adversely affected.
If the economic conditions in the United States and globally do not improve, or
if we experience a worsening in the global economic slowdown, we may continue to
experience material adverse impacts on our business, operating results, and
financial condition.
OPERATING RESULTS FOR A PARTICULAR QUARTER ARE DIFFICULT TO PREDICT
As a result of a variety of factors discussed herein, operating results for a
particular quarter are extremely difficult to predict. Our net sales may grow at
a slower rate than experienced in previous periods and, in particular periods,
may decline. Our ability to meet financial expectations could also be adversely
affected if the nonlinear sales pattern seen in certain of our recent quarters
recurs in future periods. We generally have had at least one quarter of the
fiscal year when backlog has been reduced. Although such reductions have not
occurred consistently in recent years, they are difficult to predict and may
occur in the future. In addition, in response to customer demand, we continue to
attempt to reduce our product manufacturing lead times, which may result in
corresponding reductions in order backlog. A decline in backlog levels could
result in more variability and less predictability in our quarter-to-quarter net
sales and operating results going forward. On the other hand, for certain
products, lead times are longer than our goal. If we cannot reduce manufacturing
lead times for such products, our customers may place the same orders within our
various sales channels, cancel orders, or not place further orders if shorter
lead times are available from other manufacturers.
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
As a result of our growth in past periods, our fixed costs have increased. With
increased levels of spending and the impact of long-term commitments, an
inability to meet expected revenue levels in a particular quarter could have a
material adverse impact on our operating results for that period as we may not
be able to quickly reduce these fixed expenses in response to short-term
business changes.
Any of the above factors could have a material adverse impact on our operations
and financial results. For example, from time to time, we have made acquisitions
that result in in-process research and development expenses being charged in an
individual quarter. These charges may occur in any particular quarter resulting
in variability in our quarterly earnings. Additionally, the operating results
for a quarter could be materially adversely affected if a number of large orders
are either not received or are delayed, for example, due to cancellations,
delays, or deferrals by customers.
WE EXPECT GROSS MARGIN VARIABILITY OVER TIME
We expect gross margin may be adversely affected in the future by increases in
material or labor costs, excess inventory, obsolescence charges, changes in
shipment volume, loss of cost savings, price competition, and changes in
channels of distribution or in the mix of products sold. If product or related
warranty costs associated with our products are greater than we have
experienced, gross margin may also be adversely affected. 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 products, and to a certain
degree, the timing of orders from our customers.
We plan our operating expense levels primarily based 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
capability 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.
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
While our suppliers have performed effectively and have been relatively flexible
to date, we believe that we may 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
- 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. We use several supply partners to manufacture our products.
During the normal course of business, in order to reduce manufacturing lead
times and ensure adequate component supply, we enter into agreements with
certain supply partners which allow these partners to procure inventory based
upon criteria as defined by us. For additional information regarding our
purchase commitments, see Note 9, "Commitments and Contingencies" on pages 36 to
38 of our 2001 Annual Report to Shareholders. A reduction or interruption in
supply, a significant increase in the price of one or more components, or a
decrease in demand of products could materially adversely affect our business,
operating results and financial condition and could materially damage customer
relationships.
WE COMPETE IN THE HIGHLY COMPETITIVE TELECOMMUNICATIONS EQUIPMENT MARKET
We compete in the Internet infrastructure market, providing solutions for
transporting data, voice, and video traffic across intranets, extranets, and the
Internet. The market is characterized by rapid change, 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. The overall number of
competitors providing niche product solutions may 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 consolidations
in and accompanying economic pressure upon the industry. We believe our primary
competition comes from nimble start-ups and young companies offering innovative
niche solutions.
Our competitors include Alcatel, Ciena, Ericsson, Extreme Networks, Foundry
Networks, Juniper, Lucent, Nortel Networks, Redback Networks, Siemens AG, and
Sycamore Networks, among others. 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 resources,
including technical and engineering resources, than we do.
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
The principal competitive factors in the markets in which we presently compete
and may compete in the future are:
- The ability to provide end-to-end networking solutions and support
- Performance
- Price
- The ability to provide new technologies and products
- The ability to provide value-added features such as security, reliability,
and investment protection
- Conformance to standards
- Market presence
- The ability to provide financing
We also face competition from customers to whom we license technology and
suppliers from whom we transfer technology. The inherent nature of networking
requires interoperability. As such, we must cooperate and at the same time
compete with these companies. Our inability to effectively manage these
complicated relationships with customers and suppliers, or the uncontrollable
and unpredictable acts of others, could have a material adverse effect on our
business, operating results, and financial condition.
WE HAVE INVESTED IN AND WILL CONTINUE TO INVEST IN NEW AND EXISTING MARKET
OPPORTUNITIES
We have made investments in headcount, inventory, manufacturing capacity, and
product development through internal efforts and acquisitions, as a result of
growth in existing opportunities and new or emerging opportunities in our target
markets over the past years. We will continue to invest in these markets either
through additional investments or through re-alignment of existing resources. If
we are unable to meet expected revenue levels in a particular quarter, it 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.
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 may depend on our ability to develop and introduce new
products into existing and emerging markets and to reduce the costs to produce
existing products. The success of new products is dependent on several factors,
including proper new product definition, product cost, timely completion and
introduction of new products, differentiation of new products from those of our
competitors, and market acceptance of these products. The markets for our
products are characterized by rapidly changing technology, evolving industry
standards, new product introductions, and evolving methods of building and
operating networks. There can
36
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
be no assurance that we will successfully identify new product opportunities,
develop and bring new products to market in a timely manner, and achieve market
acceptance of our products, or that products and technologies developed by
others will not render our products or technologies obsolete or noncompetitive.
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND
INTERNET-BASED SYSTEMS
A substantial portion of our business and revenue depends on the continued
growth of the Internet and on the deployment of our products by customers that
depend on the growth of the Internet. As a result of the economic slowdown and
the reduction in capital spending, spending on Internet infrastructure has
declined, which has had a material adverse effect on our business. To the extent
that the economic slowdown and reduction in capital spending continue to
adversely affect spending on Internet infrastructure, we could continue to
experience material adverse effects on our business, operating results, and
financial condition.
We believe that there will be certain performance problems with Internet
communications in the future, which could receive a high degree of publicity and
visibility. As we are a large supplier of networking products, we may be
materially adversely affected, regardless of whether or not these problems are
due to the performance of our products. Such an event could also result in a
material adverse effect on the market price of our common stock and could
materially adversely affect our business, operating results, and financial
condition.
WE EXPECT TO MAKE FUTURE ACQUISITIONS WHERE ADVISABLE AND ACQUISITIONS INVOLVE
NUMEROUS RISKS
The networking business is highly competitive, and as such, our growth is
dependent upon market growth, our ability to enhance our existing products, and
our ability to introduce new products on a timely basis. One of the ways we have
addressed and will continue to address the need to develop new products is
through acquisitions of other companies and technologies. Acquisitions involve
numerous risks, including the following:
- Difficulties in integrating the operations, technologies, and products of
the acquired companies
- The risk of diverting management's attention from normal daily operations
of the business
- Potential difficulties in completing projects associated with in-process
research and development
- Risks of entering markets in which we have no or limited direct prior
experience and where competitors in such markets have stronger market
positions
- Initial dependence on unfamiliar supply chains or relatively small supply
partners
- Insufficient revenues to offset increased expenses associated with
acquisitions
- The potential loss of key employees of the acquired companies
37
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
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
make could harm our business and operating results in a material way.
THE ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES OUR BUSINESS AND OPERATIONS
TO RISKS
As we focus on new market opportunities, such as transporting data, voice, and
video traffic across the same network, we will increasingly compete with large
telecommunications equipment suppliers such as Alcatel, Ericsson, Lucent,
Nortel, and Siemens AG, among others, and several startup companies. Several of
our current and potential competitors may have greater resources, including
technical and engineering resources, than we do. Additionally, as customers in
these markets complete infrastructure deployments, they may require greater
levels of service, support, and financing than we have experienced in the past.
We have not entered into a material amount of labor-intensive service contracts,
which require significant production or customization. However, we expect that
demand for these types of service contracts may increase in the future. There
can be no assurance that we can provide products, service, support, and
financing to effectively compete for these market opportunities. Further,
provision of greater levels of services by us may result in less favorable
timing of revenue recognition than we have historically experienced.
SALES TO THE SERVICE PROVIDER MARKET ARE SUBJECT TO VARIATION
Sales to the service provider market have been characterized by large and often
sporadic purchases. Sales activity in this industry depends upon the stage of
completion of expanding network infrastructures, the availability of funding,
and the extent that service providers are affected by regulatory, economic, and
business conditions in the country of operations. A decline or delay in sales
orders from this industry could have a material adverse effect on our business,
operating results, and financial condition. The slowdown in the general economy,
changes in the service provider market, and the constraints on capital
availability have had a material adverse effect on many of our service provider
customers, with a number of such customers going out of business or
substantially reducing their expansion plans. These conditions have had a
material adverse effect on our business and operating results, and we expect
that these conditions may continue for the foreseeable future.
THE INDUSTRY IN WHICH WE COMPETE IS SUBJECT TO CONSOLIDATION
There has been a trend toward industry consolidation for several years. We
expect this trend toward industry consolidation to continue as companies attempt
to strengthen or hold their market positions in an evolving industry. We believe
that industry consolidation may result in stronger competitors that are better
able to compete as sole-source vendors for customers. This
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
could lead to more variability in operating results as we compete to be a single
vendor solution and could have a material adverse effect on our business,
operating results, and financial condition.
OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS
We conduct business globally. Accordingly, our future results could be
materially adversely affected by a variety of uncontrollable and changing
factors including, among others, foreign currency exchange rates; regulatory,
political, or economic conditions in a specific country or region; trade
protection measures and other regulatory requirements; service provider and
government spending patterns; and natural disasters. Any or all of these factors
could have a material adverse impact on our future international business.
WE ARE EXPOSED TO FLUCTUATIONS IN THE EXCHANGE RATES OF FOREIGN CURRENCY
As a global concern, we face exposure to adverse movements in foreign currency
exchange rates. These exposures may change over time as business practices
evolve and could have a material adverse impact on our financial results.
Historically, our primary exposures have related to nondollar-denominated sales
in Japan, Canada, and Australia and nondollar-denominated operating expenses in
Europe, Latin America, and Asia where we sell primarily in U.S. dollars.
Additionally, we have exposures to emerging market currencies which can have
extreme currency volatility. We will continue to monitor our exposures 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 resellers in two-tier distribution
channels. These resellers/customers are generally given privileges to return
inventory, receive credits for changes in selling prices, and participate in
cooperative marketing programs. We maintain estimated accruals and allowances
for such exposures. However, such resellers tend to have access to more limited
financial resources than other resellers and end-user customers and therefore
represent potential sources of increased credit risk. We have experienced
increased demands for
39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
customer financing, including loan financing and leasing solutions. We expect
demands for customer financing may continue. We believe customer financing is a
competitive factor in obtaining business, particularly in supplying customers
involved in significant infrastructure projects. Our loan financing arrangements
may include not only financing the acquisition of our products but also
providing additional funds for soft costs associated with network installation
and integration of our products and for working capital purposes. Due to the
current slowdown in the economy, the credit risks relating to these
resellers/customers have increased. Although we have programs in place to
monitor and mitigate the associated risk, there can be no assurance that such
programs will be effective in reducing our credit risks. We also continue to
monitor credit exposures from weakened financial conditions in certain
geographic regions, and the impact that such conditions may have on the
worldwide economy. We have experienced losses due to customers failing to meet
their obligations. Although these losses have not been significant, future
losses, if incurred, could harm our business and have a material adverse effect
on our operating results and financial condition.
OUR BUSINESS DEPENDS UPON OUR PROPRIETARY RIGHTS AND THERE IS A RISK OF
INFRINGEMENT
Our success is dependent upon our proprietary technology. We generally rely upon
patents, copyrights, trademarks, and trade secret laws to establish and maintain
our proprietary rights in our technology and products. We have a program to file
applications for and obtain patents in the United States and in selected foreign
countries where a potential market for our products exists. We have been issued
a number of patents; other patent applications are currently pending. There can
be no assurance that any of these patents will not be challenged, invalidated,
or circumvented, or that any rights granted thereunder will provide competitive
advantages to us. In addition, there can be no assurance that patents will be
issued from pending applications, or that claims allowed on any future patents
will be sufficiently broad to protect our technology. 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 our patents, patent applications, copyrights, and
trademarks has value, the rapidly changing technology in the networking industry
makes our future success dependent primarily on the innovative skills,
technological expertise, and management abilities of our employees rather than
on patent, copyright, and trademark protection.
The industry in which we compete is characterized by the existence of a large
number of patents and frequent claims and related litigation regarding patent
and other intellectual property rights. From time to time, third parties have
asserted exclusive patent, copyright, trademark and other intellectual property
rights to technologies and related standards that are important to us. These
claims have increased recently as a result of our acquisitions of businesses and
technologies. Such parties have pursued and may in the future assert claims or
initiate litigation against us or our manufacturers, suppliers, or customers
alleging infringement of their proprietary rights with respect to our existing
or future products. Regardless of the merit of these claims, they could be
time-consuming, result in costly litigation and diversion of technical
management personnel, or
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
require us to develop a non-infringing technology or enter into royalty or
license agreements. If any infringement or other intellectual property claim
made against us by any third party is successful, or if we fail to develop
non-infringing technology or license the proprietary rights, our business could
be materially and adversely affected.
Many of our products are designed to include software or other intellectual
property licensed from third parties. While it may be necessary in the future to
seek or renew licenses relating to various aspects of our products, we believe
that based upon past experience and standard industry practice, such licenses
generally could be obtained on commercially reasonable terms. Because of the
existence of a large number of patents in the networking field and the rapid
rate of issuance of new patents, it is not economically practical to determine
in advance whether a product or any of our components infringe patent rights of
others. From time to time, we receive notices from or are sued by third parties
regarding patent infringement claims. If infringement claims are found to have
merit, 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 financial condition. Nevertheless, there can be
no assurance that the necessary licenses would be available on acceptable terms,
if at all. 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
regarding these matters 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 technology such as voice over the Internet, encryption technology, and access
charges for Internet service providers. Our business could be materially
adversely affected by the changes in the regulations surrounding the
telecommunications industry. The adoption of regulation of the Internet and
Internet commerce could decrease demand for our products, and at the same time
increase the cost of selling our products, which could have a material adverse
effect on our business, operating results, and financial condition.
OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO RETAIN AND RECRUIT KEY PERSONNEL
Our success has always depended in large part on our ability to attract and
retain highly skilled technical, managerial, sales, and marketing personnel. In
spite of the economic slowdown, competition for these personnel is intense,
especially in the Silicon Valley area of Northern California. Volatility or lack
of positive performance in our stock price may also adversely affect our ability
to retain key employees, all of whom have been granted stock options. The loss
of services of any of our key personnel, the inability to retain and attract
qualified personnel in
41
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
the future, or delays in hiring required personnel, particularly engineers and
sales personnel, could make it difficult to meet key objectives, such as timely
product introductions. In addition, companies in the networking industry whose
employees accept positions with competitors frequently claim that competitors
have engaged in improper hiring practices. We have received these claims in the
past and may receive additional claims to this effect in the future.
WE FACE CERTAIN LITIGATION RISKS
We are a party to lawsuits in the normal course of our business. Litigation can
be expensive, lengthy and disruptive to normal business operations. Moreover,
the results of complex legal proceedings are difficult to predict. An
unfavorable resolution of a particular lawsuit could have a material adverse
effect on our business, results of operations, or financial condition. For
additional information regarding certain of the lawsuits in which we are
involved, see Note 6, "Legal Proceedings" of the Notes to Consolidated Financial
Statements.
OUR BUSINESS IS SUBJECT TO THE RISKS OF EARTHQUAKES, FLOODS, AND OTHER
CATASTROPHIC EVENTS
Our corporate headquarters, including certain of our research and development
operations and our manufacturing facilities, are located in the Silicon Valley
area of Northern California, a region known for seismic activity. Additionally,
certain of our facilities, which include one of our manufacturing facilities,
are located near rivers that have experienced flooding in the past. A
significant natural disaster, such as an earthquake or a flood, could have a
material adverse impact on our business, operating results, and financial
condition. In addition, despite our implementation of network security measures,
our servers are vulnerable to computer viruses, break-ins, and similar
disruptions from unauthorized tampering with our computer systems. Any such
event could have a material adverse effect on our business, operating results,
and financial condition. In addition, the effects of war or acts of terrorism
could have a material adverse effect on our business, operating results, and
financial condition. The recent terrorist attacks in New York and Washington,
D.C. on September 11, 2001 disrupted commerce throughout the world and
intensified the uncertainty of the U.S. economy and other economies around the
world. The continued threat of terrorism and heightened security and military
action in response to this threat, or any future acts of terrorism, may cause
further disruptions to these economies and create further uncertainties. To the
extent that such disruptions or uncertainties result in delays or cancellations
of customer orders, or the manufacture or shipment of our products, our
business, operating results and financial condition could be materially and
adversely affected.
THE ENERGY CRISIS IN CALIFORNIA COULD DISRUPT OUR BUSINESS AND THE BUSINESSES OF
OUR SUPPLIERS AND SUPPLY PARTNERS AND COULD INCREASE OUR EXPENSES
The western United States (and California in particular) has experienced
repeated episodes of diminished electrical power supply, and we anticipate that
this situation could continue or
42
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
worsen in the near future. As a result of these episodes, certain of our
operations or facilities have been and may continue to be subject to "rolling
blackouts" or other unscheduled interruptions of electrical power. The prospect
of such unscheduled interruptions may continue for the foreseeable future, and
we are unable to predict their occurrence or duration. Certain of our suppliers
and supply partners are also located in this area and their operations may also
be materially and adversely affected by such interruptions. These suppliers and
manufacturers may be unable to manufacture sufficient quantities of our products
to meet our demands, or they may increase the costs of such products, which in
turn could have a material adverse effect on our business or results of
operations.
WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS
AND IN INTEREST RATES
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 reported as a separate component of accumulated other
comprehensive income (loss), net of tax. Part of this portfolio includes equity
investments in several publicly traded companies, the values of which are
subject to market price volatility. Recent events have adversely affected the
public equities market and general economic conditions may continue to worsen.
As a result, we may recognize in earnings declines in fair value of our publicly
traded equity investments below the cost basis that are considered to be
other-than-temporary. For information regarding the sensitivity of and risks
associated with the market value of portfolio investments and interest rates,
see the section titled "Quantitative and Qualitative Disclosures About Market
Risk" contained in this Quarterly Report.
WE CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC
The SEC has been reviewing registrants' valuation methodologies of in-process
research and development related to business combinations. We believe we are in
compliance with all of the existing rules and related guidance as applicable to
our business operations. However, the SEC may change these rules or issue new
guidance applicable to our business in the future. There can be no assurance
that the SEC will not seek to reduce the amount of in-process research and
development previously expensed by us. This would result in the restatement of
our previously filed financial statements and could have a material adverse
effect on our operating results and financial condition for periods subsequent
to the acquisitions.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH STRATEGIC ALLIANCES
We have a number of 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 may be
mutually beneficial and result in industry growth. However, these
43
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK FACTORS
alliances carry an element of risk because, in most cases, we must compete in
some business areas with a company with which we have a strategic alliance and,
at the same time, cooperate with that company in other business areas. Also, if
these companies fail to perform or if these relationships fail to materialize as
expected, we could suffer delays in product development or other operational
difficulties.
WE FACE RISKS ASSOCIATED WITH CHANGES IN TELECOMMUNICATIONS REGULATION AND
TARIFFS
Changes in domestic and international telecommunications requirements could
affect the sales of our products. In particular, we believe it is possible that
there may be changes in domestic telecommunications regulation in the near
future that could slow the expansion of the service providers' network
infrastructures and materially adversely affect our business, operating results,
and financial condition. Future changes in tariffs by regulatory agencies or
application of tariff requirements to currently untariffed services could affect
the sales of our products for certain classes of customers. Additionally, in the
United States, our products must comply with various Federal Communications
Commission requirements and regulations. In countries outside of the United
States, our products must meet various requirements of local telecommunications
authorities. Changes in tariffs or failure by us to obtain timely approval of
products could have a material adverse effect on our business, operating
results, and financial condition.
OUR STOCK PRICE MAY BE VOLATILE
Our common stock has experienced substantial price volatility, particularly as a
result of variations between our actual and anticipated financial results, the
published expectations of analysts, and as a result of announcements by our
competitors and us. In addition, the stock market has experienced extreme price
and volume fluctuations that have affected the market price of many technology
companies, in particular, and that have often been unrelated to the operating
performance of these companies. These factors, as well as general economic and
political conditions, may materially adversely affect the market price of our
common stock in the future. Additionally, volatility or a lack of positive
performance in our stock price may adversely affect our ability to retain key
employees, all of whom have been granted stock options.
44
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 reported as a separate component of accumulated other
comprehensive income (loss), net of tax. Part of this portfolio includes equity
investments in several publicly traded companies, the values of which are
subject to market price volatility. During the first quarter of fiscal 2002, we
recorded a charge of $858 million related to the impairment on certain publicly
traded securities in our investment portfolio, in accordance with Statement of
Financial Accounting Standard No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The impairment charge was related to the declines
in the fair value of our publicly traded equity investments below the cost basis
that are considered to be other-than-temporary. 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 21 to 22 of the fiscal 2001 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 (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
-------------------------------------------- Oct. 27, ----------------------------------------
(75%) (50%) (25%) 2001 25% 50% 75%
---------- ---------- ---------- ---------- ---------- ---------- ----------
Corporate equities $ 295 $ 591 $ 886 $ 1,182 $ 1,477 $ 1,773 $ 2,068
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 25%, 50%, and 75% were selected based on the probability of their
occurrence. 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 25% and 50% movement in each of
the last three years and a 75% movement in at least one of the last three years.
45
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to legal proceedings, claims, and litigation arising in
the ordinary course of business. While the outcome of these matters is currently
not determinable, management does not expect that the ultimate costs to resolve
these matters will have a material adverse effect on the Company's consolidated
financial position, results of operations, or cash flows.
Beginning on April 20, 2001, a number of purported shareholder class action
lawsuits have been filed in the United States District Court for the Northern
District of California against the Company and certain of its officers and
directors. The lawsuits are essentially identical, and purport to bring suit on
behalf of those who purchased the Company's publicly traded securities between
August 10, 1999 and April 16, 2001. Plaintiffs allege that defendants made false
and misleading statements, purport to assert claims for violations of the
federal securities laws, and seek unspecified compensatory damages and other
relief. The Company believes the claims are without merit and intends to defend
the actions vigorously.
In addition, beginning on April 23, 2001, a number of purported shareholder
derivative lawsuits have been filed in the Superior Court of California, County
of Santa Clara, against the Company (as a nominal defendant), its directors and
certain officers. At least two purported derivative suits have also been filed
in the United States District Court for the Northern District of California, and
another has been filed in the Superior Court of California, County of San Mateo.
The complaints in the various derivative actions include claims for breach of
fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment and
violations of the California Corporations Code, seek compensatory and other
damages, disgorgement and other relief, and are based on essentially the same
allegations as the class actions.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) During the quarter ended October 27, 2001, the Company issued an
aggregate of eight million shares of its common stock in connection with
the purchase of the capital stock of Allegro Systems, Inc. and
AuroraNetics, Inc. The shares were issued pursuant to exemptions under
Section 3(a)(10), where an appropriate governmental authority approved
the terms of the issuance following a fairness hearing.
46
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Shareholders on November 13, 2001. At
such meeting, the following actions were voted upon:
(a) Election of Directors:
FOR AGAINST WITHHELD ABSTENTIONS NON-VOTES
---------------- ---------------- ----------------- ----------------- -----------------
Carol A. Bartz 5,969,818,259 - 60,971,607 - -
Larry R. Carter 5,962,266,097 - 68,523,769 - -
John T. Chambers 5,375,788,083 - 655,001,783 - -
Carleton S. Fiorina 5,967,574,173 - 63,215,693 - -
Dr. James F. Gibbons 5,970,662,836 - 60,127,030 - -
James C. Morgan 5,972,318,209 - 58,471,657 - -
John P. Morgridge 5,969,896,140 - 60,893,726 - -
Arun Sarin 5,971,893,257 - 58,896,609 - -
Donald T. Valentine 5,971,019,032 - 59,770,834 - -
Steven M. West 5,972,232,142 - 58,557,724 - -
Jerry Yang 5,970,963,415 - 59,826,451 - -
(b) Ratification of the appointment of PricewaterhouseCoopers LLP as the
Company's independent accountants for the fiscal year ending July 27,
2002:
FOR AGAINST WITHHELD ABSTENTIONS NON-VOTES
---------------- ---------------- ----------------- ----------------- -----------------
5,893,680,315 96,742,854 - 40,111,325 -
47
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 4.1 Second Amendment to the Rights Agreement and
Certification of Compliance with Section 27 Thereof by
and among Cisco Systems, Inc., Fleet National Bank (f/k/a
Bank Boston, N.A.), and EquiServe Trust Company, N.A.
(b) Reports on Form 8-K
The Company filed four reports on Form 8-K during the quarter ended October 27,
2001. Information regarding the items reported on is as follows:
Date Item Reported On
---- ----------------
July 30, 2001 The Company announced the acquisition of Allegro Systems,
Inc., which was completed on September 27, 2001.
August 24, 2001 The Company announced the completion of the acquisition
of AuroraNetics, Inc.
September 14, 2001 The Company announced a stock repurchase program.
September 28, 2001 The Company announced the completion of the acquisition
of Allegro Systems, Inc.
48
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: December 7, 2001 By /s/ Larry R. Carter
------------------------------------
Larry R. Carter, Senior Vice
President, Finance and
Administration, Chief Financial
Officer and Secretary
49
Exhibit Index
-------------
Exhibit 4.1 Second Amendment to the Rights Agreement and
Certification of Compliance with Section 27 Thereof by
and among Cisco Systems, Inc., Fleet National Bank (f/k/a
Bank Boston, N.A.), and EquiServe Trust Company, N.A.