<PAGE> 1
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 MAY 1, 1999
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 June 9, 1999, 1,611,543,199 shares of the Registrant's common stock were
outstanding.
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CISCO SYSTEMS, INC.
FORM 10-Q FOR THE QUARTER ENDED MAY 1, 1999
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Facing sheet 1
Index 2
Part I. Financial information
Item 1. Financial Statements and Supplementary Data
a) Consolidated statements of operations for the three
and nine months ended May 1, 1999 and April 25, 1998 3
b) Consolidated balance sheets at May 1, 1999
and July 25, 1998 4
c) Consolidated statements of cash flows for the nine
months ended May 1, 1999 and April 25, 1998 5
d) Notes to consolidated financial statements 6
Item 2. Management's discussion and analysis of financial
condition and results of operations 12
Part II. Other information 34
Signature 35
Exhibit Exhibit 27, Financial data schedule 36
</TABLE>
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PART I.
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------- ----------------------
May 1, April 25, May 1, April 25,
1999 1998 1999 1998
------ --------- ------ ---------
(Unaudited)
<S> <C> <C> <C> <C>
Net sales $3,147 $2,184 $8,562 $6,069
Cost of sales 1,102 750 2,981 2,099
------ ------ ------ ------
Gross margin 2,045 1,434 5,581 3,970
Operating expenses:
Research and development 418 263 1,102 726
Sales and marketing 647 412 1,731 1,109
General and administrative 105 67 279 181
Purchased research and development -- 419 390 546
------ ------ ------ ------
Total operating expenses 1,170 1,161 3,502 2,562
------ ------ ------ ------
Operating income 875 273 2,079 1,408
Realized gain on sale of investment -- -- -- 5
Interest and other income, net 90 52 235 133
------ ------ ------ ------
Income before provision for income taxes 965 325 2,314 1,546
Provision for income taxes 319 260 862 687
------ ------ ------ ------
Net income $ 646 $ 65 $1,452 $ 859
====== ====== ====== ======
Net income per share--basic $ .40 $ .04 $ .92 $ .56
====== ====== ====== ======
Net income per share--diluted $ .38 $ .04 $ .86 $ .54
====== ====== ====== ======
Shares used in per-share
calculation--basic 1,601 1,541 1,585 1,526
====== ====== ====== ======
Shares used in per-share
calculation--diluted 1,696 1,614 1,679 1,598
====== ====== ====== ======
</TABLE>
See notes to consolidated financial statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
<TABLE>
<CAPTION>
May 1, July 25,
1999 1998
------ --------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 690 $ 535
Short-term investments 1,161 1,157
Accounts receivable, net of allowance for doubtful
accounts of $30 at May 1, 1999 and
$40 at July 25, 1998 1,275 1,298
Inventories, net 621 362
Deferred income taxes 490 345
Prepaid expenses and other current assets 89 65
------- ------
Total current assets 4,326 3,762
Investments 5,840 3,463
Restricted investments 804 554
Property and equipment, net 701 595
Other assets, net 1,037 543
------- ------
Total assets $12,708 $8,917
======= ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 348 $ 249
Income taxes payable 522 410
Accrued payroll and related expenses 466 391
Other accrued liabilities 1,076 717
------- ------
Total current liabilities 2,412 1,767
Minority interest 44 43
Shareholders' equity:
Preferred stock, no par value, 5 shares authorized:
none issued or outstanding at May 1, 1999
and July 25, 1998
Common stock and additional paid-in capital,
$0.001 par value, 2,700 shares authorized:
1,607 shares issued and outstanding at
May 1, 1999 and 1,563 at July 25, 1998 4,847 3,220
Retained earnings 5,280 3,828
Accumulated comprehensive income 125 59
------- ------
Total shareholders' equity 10,252 7,107
------- ------
Total liabilities and shareholders' equity $12,708 $8,917
======= ======
</TABLE>
See notes to consolidated financial statements.
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CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
<TABLE>
<CAPTION>
Nine Months Ended
------------------------
May 1, April 25,
1999 1998
------- ---------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,452 $ 859
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 334 229
Deferred income taxes (164) (89)
Tax benefits from employee stock plans 679 282
Purchased research and development from acquisitions 298 426
Change in operating assets and liabilities:
Accounts receivable 29 (94)
Inventories (259) (52)
Prepaid expenses and other current assets (22) 31
Income taxes payable 110 107
Accounts payable 96 47
Accrued payroll and related expenses 75 79
Other accrued liabilities 328 159
------- -------
Net cash provided by operating activities 2,956 1,984
------- -------
Cash flows from investing activities:
Purchases of short-term investments (833) (1,099)
Proceeds from sales and maturities of short-term investments 1,179 1,373
Purchases of investments (3,977) (2,015)
Proceeds from sales of investments 1,338 821
Purchases of restricted investments (661) (325)
Proceeds from sales and maturities of restricted investments 408 202
Acquisition of property and equipment (377) (282)
Acquisition of Selsius Systems, net of
purchased research and development (19)
Increase in lease receivables (175) (106)
Other (208) 9
------- -------
Net cash used in investing activities (3,325) (1,422)
------- -------
Cash flows from financing activities:
Issuance of common stock 519 343
Other 5 (4)
------- -------
Net cash provided by financing activities 524 339
------- -------
Net increase in cash and equivalents 155 901
Cash and equivalents, beginning of period 535 270
------- -------
Cash and equivalents, end of period $ 690 $ 1,171
======= =======
</TABLE>
See notes to consolidated financial statements.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Cisco Systems, Inc. (the "Company") provides networking solutions that connect
computing devices and computer networks, allowing people to access or transfer
information without regard to differences in time, place or type of computer
system. The Company sells its products in approximately 105 countries through a
combination of direct sales and reseller and distribution channels.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
The Company's fiscal year is the 52- or 53-week period ending on the last
Saturday in July. Fiscal year 1999 is a 53-week year while 1998 was a 52-week
year.
Basis of Presentation
The accompanying financial data as of May 1, 1999 and July 25, 1998, and for the
three and nine month periods ended May 1, 1999 and April 25, 1998, have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The July 25, 1998 balance sheet was
derived from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles. However, the Company
believes that the disclosures are adequate to make the information presented not
misleading. These consolidated financial statements should be read in
conjunction with the financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the year ended July 25, 1998.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations, and cash flows as of May 1, 1999 and for the three and
nine month periods ended May 1, 1999 and April 25, 1998, have been made. The
results of operations for the period ended May 1, 1999 are not necessarily
indicative of the operating results for the full year.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Advertising Costs
The Company expenses all advertising costs as they are incurred.
Software Development Costs
Software development costs which are required to be capitalized pursuant to
Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," have not
been material to the Company to date.
Computation of Net Income Per Share
Basic net income per common share is computed using the weighted average number
of common shares outstanding during the period. Diluted net income per share is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist of stock options.
Share and per share data presented reflect the three-for-two stock splits
effective September 1998 and December 1997. The data does not give effect to the
two-for-one stock split that will be effective June 21, 1999.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information" and in
June 1998, issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", implementation of which has recently been delayed. Readers
are referred to the "Recent Accounting Pronouncements" section of the Company's
1998 Annual Report to Shareholders for further discussion.
The Company adopted Statement of Position (SOP) No. 97-2, "Software Revenue
Recognition," in the first quarter of fiscal year 1999 and its adoption had no
material impact on the Company's results from operations or financial position.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. BUSINESS COMBINATIONS
Purchase Combinations
The Company has made a number of purchase acquisitions. The consolidated
financial statements include the operating results of each business from the
date of acquisition. Pro forma results of operations have not been presented
because the effects of these acquisitions were not material on either an
individual or an aggregated basis.
The amounts allocated to purchased research and development were determined
based on appraisals completed by an independent third party using established
valuation techniques in the high-technology communications industry and were
expensed upon acquisition, because technological feasibility had not been
established and no future alternative uses existed. Research and development
costs to bring the products from the acquired companies to technological
feasibility are not expected to have a material impact on the Company's future
results of operations or cash flows. Amounts allocated to goodwill and other
intangibles are amortized on a straight-line basis over periods not exceeding
five years.
In November, the Company completed its purchase of Summa Four, Inc. ("Summa
Four"), a provider of programmable switch products. The Company's acquired
technology consists of two existing programmable switch products and one
programmable switch currently under development. Also in November, the Company
completed its purchase of Clarity Wireless, Inc.("Clarity"), a developer of
high-bandwidth wireless access technology for the computer networking and
Internet access markets. The Company's acquired technology consists of two
high-bandwidth access projects currently under development, patents and patents
pending. Also in November, the Company completed its purchase of Selsius
Systems, Inc.("Selsius"), a developer of voice over data network products. The
Company's acquired technology consists of the core technology in Selsius'
existing public broadcast exchange (PBX) system and technology currently under
development for an enterprise-wide PBX system. Selsius' technology is focused on
developing products that will deliver voice over data network solutions. In
December, the Company acquired PipeLinks, Inc.("PipeLinks"), a developer of
SONET/SDH routers. The Company's acquired technology consists of
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
two research and development projects in process which are expected to result in
the ability to transport both voice and IP(Internet Protocol) traffic over the
same network.
Total purchased research and development expense was $390 million for the nine
months ending May 1, 1999. The purchased research and development expense that
was attributable to stock purchase acquisitions for the nine month period was
$298 million and the purchased research and development expense attributable to
the cash purchase transaction, consisting of Selsius only, was $92 million for
the nine month period ended May 1, 1999.
Each of the completed purchase acquisition transactions is further outlined
below:
Summary of purchase transactions (in millions):
<TABLE>
<CAPTION>
Purchased
Research & Form of Consideration and Other Notes to
Entity Name Consideration Development Charge Acquisition
----------- ------------- ------------------ ----------------------------------------
<S> <C> <C> <C>
Quarter Ended -
October 24, 1998
- -----------------------
American Internet Corp. $ 56 $41 Common stock and options assumed; goodwill and
other intangibles recorded of $18
Quarter Ended -
January 23, 1999
- ----------------------
Summa Four, Inc. $129 $64 Common stock and options assumed, $16 in
liabilities assumed; goodwill and other
intangibles recorded of $29
Clarity Wireless, Inc. $153 $94 Common stock and options assumed; goodwill and
other intangibles recorded of $73
Selsius Systems, Inc. $134 $92 $111 in cash; options assumed; goodwill and
other intangibles recorded of $41
PipeLinks, Inc. $118 $99 Common stock and options assumed; goodwill and
other intangibles recorded of $11
</TABLE>
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In April 1999, the Company announced a definitive agreement to acquire Amteva
Technologies, Inc., a leading developer of middleware, which provides a unified
means for enabling voicemail, fax and e-mail messages over an IP-based network.
Under the terms of the agreement, shares of the Company's common stock and cash
with an aggregate value of approximately $170 million will be exchanged for all
outstanding shares and options of Amteva. This acquisition is expected to be
completed in the fourth quarter.
Pooling of Interests Combinations
In April 1999, the Company announced a definitive agreement to acquire Fibex
Systems("Fibex"), a developer in Integrated Access Digital Loop Carrier (IADLC)
products, devices that combine traditional voice services with data services
using Asynchronous Transfer Mode ("ATM") as the underlying architecture. Also in
April, the Company announced a definitive agreement to acquire Sentient
Networks, Inc.("Sentient"), a developer of high density ATM Circuit Emulation
Service (CES) Gateway, which is capable of transporting circuit-based private
line services across packet-based ATM networks. Under terms of the agreement,
shares of the Company's common stock with an aggregate value of approximately
$320 million and $125 million will be exchanged for all outstanding shares and
options of Fibex and Sentient, respectively.
Also in April, the Company announced a definitive agreement to acquire GeoTel
Communications Corp.("GeoTel"), a provider of software solutions for distributed
voice call centers for enterprise and service provider customers. Under terms of
the agreement, shares of the Company's common stock with an aggregate value of
approximately $2 billion will be exchanged for all outstanding shares and
options of GeoTel. These acquisitions are expected to be completed in the fourth
quarter, subject to regulatory clearance and shareholder approval of the
acquired companies.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. BALANCE SHEET DETAIL
(In millions)
<TABLE>
<CAPTION>
Inventories: May 1, July 25,
1999 1998
----- --------
(Unaudited)
<S> <C> <C>
Raw materials $ 118 $ 76
Work in process 232 143
Finished goods 230 111
Demonstration systems 41 32
----- -----
$ 621 $ 362
===== =====
</TABLE>
<TABLE>
<CAPTION>
Intangible Assets: May 1, July 25,
1999 1998
----- --------
(Unaudited)
<S> <C> <C>
Gross intangible assets $ 415 $ 200
Less: accumulated amortization (71) (30)
===== =====
$ 344 $ 170
===== =====
</TABLE>
Amortization expense for the three- and nine-month periods ended May 1, 1999 and
April 25, 1998 was $19 million, $41 million, $4 million and $12 million,
respectively.
5. COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income", as of the first quarter of fiscal 1999.
SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components, however, it has no impact on the
Company's net income or total shareholders' equity.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of comprehensive income, net of tax, are as follows (in
millions):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- --------------------
May 1, Apr. 25, May 1, Apr. 25,
1999 1998 1999 1998
------ -------- ------ --------
<S> <C> <C> <C> <C>
Net income $ 646 $65 $1,452 $ 859
Other comprehensive income (loss):
Change in unrealized gain(loss) on
investments, net (30) 20 62 13
Change in accumulated translation
adjustments (6) 0 5 (5)
----- --- ------ -----
Total comprehensive income $ 610 $85 $1,519 $ 867
===== === ====== =====
</TABLE>
6. INCOME TAXES
The Company paid income taxes of $221 million in the nine months ended May 1,
1999 and $389 million in the nine months ended April 25, 1998. The Company's
income taxes currently payable for federal, state and foreign purposes have been
reduced by the tax benefits of disqualifying dispositions of stock options. This
benefit totaled $679 million in the first nine months of fiscal 1999, and was
credited directly to shareholders' equity.
7. SHAREHOLDERS' EQUITY AND STOCK SPLIT
All references to share and per-share data for all periods presented have been
adjusted to give effect to the three-for-two stock splits effective September
1998 and December 1997. In May 1999, the Company's Board of Directors approved a
two-for-one split of the Company's common stock that was applicable to
shareholders of record on May 24, 1999 and is expected to be effective on June
21, 1999. Share and per-share data have not been adjusted to give effect to this
latest stock split.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-Q, including,
without limitation, statements containing the words "believes", "anticipates",
"estimates", "expects", and words of similar import, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995.
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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 SEC.
Net sales grew to $3.15 billion in the third quarter of 1999 from $2.18 billion
in the third quarter of 1998. Net sales for the first nine months of 1999 were
$8.56 billion, compared to $6.07 billion in the first nine months of 1998. The
44.1% increase in net sales between the two three-month periods and the 41.1%
increase in net sales between the two nine-month periods was primarily a result
of increasing unit sales of LAN switching products such as the Catalyst(R) 5000
family and the Catalyst(R) 2900 series of switches for smaller enterprise
networks, access servers such as the Cisco 2600 and 3600 families, growth in the
sales of add-on boards that provide increased functionality, and increased
maintenance service contract sales. The sales growth rate for lower-priced
access and switching products targeted toward small and medium-sized businesses
has increased faster than that of the Company's high-end core router products.
However, these products typically carry lower average selling prices.
Additionally, sales of some of the Company's more established product lines,
such as the Cisco 2500 and Cisco 4000 product families, have decreased as a
percentage of total revenue. Sales to international customers increased to 42.5%
in the third quarter of 1999 versus 41.8% for the third quarter of 1998. The
increase reflects sales growth in certain international markets, particularly
Germany and the United Kingdom. Sales growth in other markets, including Japan
and certain countries in Latin America and Eastern Europe, have been negatively
impacted by certain factors including weaker economic conditions, delayed
government spending, a stronger dollar versus the local currencies, and slower
adoption of networking technologies.
Gross margins decreased slightly to 65.0% in the third quarter of 1999 from
65.6% in the third quarter of 1998. Gross margins for the first nine months of
1999 were 65.2%, which also decreased slightly compared to the same period in
1998. The decrease in the quarterly period is due principally to the Company's
continued shift in revenue mix towards its lower-margin products and the
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continued pricing pressure seen from competitors in certain product areas. The
prices of component parts have fluctuated in the recent past, and the Company
expects that this trend may continue. An increase in the price of component
parts may have a material adverse impact on gross margins. The Company expects
that gross margins will continue to decrease in the future, because it believes
that the market for lower-margin remote access and switching products for small
to medium-sized businesses will continue to increase at a faster rate than the
market for the Company's higher-margin router and high-performance switching
products. Additionally, as the Company focuses on new market opportunities, it
faces increasing competitive pressure from large telecommunications equipment
suppliers and well funded start-up companies, which may materially adversely
affect gross margins. The Company is attempting to mitigate this trend through
various means, such as increasing the functionality of its products, continued
value engineering, controlling royalty costs, and improving manufacturing
efficiencies. There can be no assurance that any efforts made by the Company in
these and other areas will successfully offset decreasing margins.
Research and development expenses increased by $155 million in the third quarter
of 1999 over the third quarter of 1998, an increase to 13.3% from 12.0% of net
sales. Research and development expenses increased by $376 million in the first
nine months of 1999 over the first nine months of 1998, an increase to 12.9%
from 12.0% of net sales. The increase reflects the Company's ongoing research
and development efforts in a wide variety of areas such as voice, video, and
data integration, Digital Subscriber Line (DSL) technologies, cable modem
technology, wireless access, dial access, enterprise switching, security,
network management, and high-end routing technologies, among others. A
significant portion of the increase was due to the addition of new personnel,
partly through acquisitions, as well as higher expenditures on prototypes and
depreciation on additional lab equipment. For the near future, research and
development expenses are expected to increase at a rate similar to or slightly
greater than the sales growth rate, as the Company invests in technology to
address potential market opportunities. The Company also continues to purchase
technology in order to bring a broad range of products to the market in a timely
fashion. If the Company believes that it is unable to enter a particular market
in a timely manner, with internally developed products, it may license
technology from other businesses or acquire other businesses as an alternative
to internal research and development. All of the Company's research and
development costs are expensed as incurred.
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Sales and marketing expenses increased by $235 million in the third quarter of
1999 over the third quarter of 1998, and increased $622 million in the first
nine months of 1999 over the first nine months of 1998. This represents an
increase from 18.9% to 20.6% of net sales for the quarter to quarter period and
from 18.3% to 20.2% for the first nine months of each fiscal year. The increase
is due principally to an increase in the size of the Company's direct sales
force and its commissions, additional marketing and advertising costs associated
with the introduction of new products and the expansion of distribution
channels. The increase also reflects the Company's efforts to invest in certain
key areas such as expansion of its end-to-end strategy and service provider
coverage in order to position itself to take advantage of future market
opportunities.
General and administrative expenses rose $38 million between the third quarters
of 1999 and 1998, an increase to 3.3% from 3.1% of net sales. These expenses
increased $98 million in the first nine months of 1999 over the first nine
months of 1998, representing an increase from 3.0% to 3.3% of net sales. The
increase primarily reflects increased levels of amortization for acquisition-
related intangible assets. It is management's intent to keep general and
administrative costs relatively constant as a percentage of net sales; however,
this is dependent upon the level of acquisition activity and amortization of the
resulting intangible assets, among other factors.
The amount expensed to purchased research and development in the first nine
months of fiscal 1999 arose from the completed acquisitions of American
Internet, Summa Four, Clarity, Selsius and PipeLinks (See also Note 3).
The fair value of the existing products and patents as well as the technology
currently under development was determined by using the income approach, which
discounts expected future cash flows to present value. The discount rates used
in the present value calculations were typically derived from a weighted average
cost of capital analysis, adjusted upward to reflect additional risks inherent
in the development life cycle. These risk factors have increased the overall
discount rate between 4% and 7.5% for acquisitions in the current year. The
Company expects that the pricing model for products related to these
acquisitions will be considered standard within the high-technology
communications industry. However, the Company does 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
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savings. The Company expects that products incorporating the acquired technology
from these acquisitions will be completed and begin to generate cash flows over
the 6 to 9 months after integration. However, development of these technologies
remains a significant risk to the Company due to the remaining effort to achieve
technical viability, rapidly changing customer markets, uncertain standards for
new products and significant competitive threats from numerous companies. The
nature of the efforts to develop the acquired technology into commercially
viable products consists principally of planning, designing and testing
activities necessary to determine that the product can meet market expectations,
including functionality and technical requirements. Failure to bring these
products to market in a timely manner could result in a loss of market share, or
a lost opportunity to capitalize on emerging markets, and could have a material
adverse impact on the Company's business and operating results.
Regarding the Company's purchase acquisitions completed in fiscal 1998, actual
results to date have been consistent, in all material respects, with the
assumptions of the Company at the time of the acquisitions as they relate to the
value of purchased in-process research and development. The assumptions
primarily consist of an expected completion date for the in-process projects,
estimated costs to complete the projects and revenue and expense projections
once the products have entered the market. Products from these 1998 acquisitions
have been introduced to the market in the last 6 - 9 months. Shipment volumes of
products from acquired technologies are not material to the Company's overall
position at the present time, therefore, it is difficult to determine the
accuracy of overall revenue projections early in the technology or product
lifecycle. Failure to achieve the expected levels of revenues and net income
from these products will negatively impact the return on investment expected at
the time that the acquisition was completed and potentially result in impairment
of any other assets related to the development activities.
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The following table summarizes the significant assumptions underlying the
valuations in 1998 and 1999 and the development costs incurred by the Company in
the periods after the respective acquisition date (in millions, except
percentages):
<TABLE>
<CAPTION>
Approximate
Development
Acquisition Assumptions Costs
--------------------------------------------- Incurred to
Estimated Cost Date After
to Complete Acquisition
Technology at Risk Adjusted on Acquired
Time of Discount Rate In-Process
Entity Name Acquisition In-Process R&D Technology
----------- -------------- -------------------- ------------
<S> <C> <C> <C>
1998 Purchase Acquisitions
- --------------------------
DAGAZ Technologies $10 35% $10
Lightspeed International, Inc. $13 26% $15
WheelGroup Corp. $ 8 24% $ 6
NetSpeed International, Inc. $12 32% $16
CLASS Data Systems $ 3 24% $ 2
1999 Purchase Acquisitions
- --------------------------
American Internet Corp. $ 1 24.9% $ 1
Summa Four, Inc. $ 5 25.5% $ 4
Clarity Wireless, Inc. $42 32% $ 6
Selsius Systems, Inc. $15 31% $ 3
PipeLinks, Inc. $ 5 31% $ 6
</TABLE>
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information" and in
June 1998, issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", implementation of which has recently been delayed. Readers
are referred to the
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"Recent Accounting Pronouncements" section of the Company's 1998 Annual Report
to Shareholders for further discussion.
The Company adopted Statement of Position (SOP) No. 97-2, "Software Revenue
Recognition," in the first quarter of fiscal year 1999 and its adoption had no
material impact on the Company's results from operations or financial position.
Liquidity and Capital Resources
Cash and equivalents, short-term investments, and investments were $7.7 billion
at May 1, 1999 an increase of $2.5 billion from July 25, 1998. The increase is
primarily a result of cash generated by operations and financing activities,
primarily the exercise of employee stock options. These cash flows were
partially offset by cash outflows from operating activities including tax
payments of approximately $221 million, and cash outflows from investing
activities including capital expenditures of approximately $377 million.
Accounts receivable decreased 1.8% from July 25, 1998 to May 1, 1999. Days sales
outstanding in receivables improved to 40 days at May 1, 1999 from 49 days at
July 25, 1998. Inventories increased 71.5% between July 25, 1998 and May 1,
1999, which reflects the Company's new product introductions and continued
growth in the Company's two-tiered distribution system. Inventory management
remains an area of focus as the Company balances the need to maintain strategic
inventory levels to ensure competitive lead times versus the risk of inventory
obsolescence because of rapidly changing technology and customer requirements.
Accounts payable increased by 39.8% at May 1, 1999 over July 25, 1998 primarily
due to increasing levels of raw material purchases. Other accrued liabilities
increased by 50.1% primarily due to higher deferred revenue on service
contracts.
At May 1, 1999, the Company had a line of credit totaling $500 million, which
expires July 2002. There have been no borrowings under this facility.
The Company has entered into certain lease arrangements in San Jose, California,
and Research Triangle Park, North Carolina, where it has established its
headquarters operations and certain research and development and customer
support activities. In connection with these transactions, the Company pledged
$804 million of its investments as collateral for certain obligations of the
leases. The Company anticipates that it will occupy more leased property in the
future that will require similar pledged securities; however, the Company does
not expect the impact of this activity to be material to liquidity.
The Company's management believes that its current cash and equivalents,
short-term investments, line of credit, and cash generated from operations will
satisfy its expected working capital and capital expenditure requirements
through fiscal 1999.
RISK FACTORS
CISCO IS EXPOSED TO FLUCTUATIONS IN THE EXCHANGE RATES OF FOREIGN CURRENCY
As a global concern, Cisco faces exposure to adverse movements in foreign
currency exchange rates. These exposures may change over time as business
practices evolve and could have a material adverse impact on Cisco's financial
results. Historically, Cisco's primary exposures related to nondollar-
denominated sales in Japan, Canada, and Australia and nondollar-denominated
operating expenses in Europe, Latin America, and Asia where it sells primarily
in U.S. dollars. Additionally, Cisco has recently seen its exposures to emerging
market currencies, such as the Brazilian Real and Russian Ruble, among others,
increase because of Cisco's expanding presence in these markets and the extreme
currency volatility. Cisco currently does not hedge against these or any other
emerging market currencies and could suffer unanticipated gains or losses as a
result.
The increasing use of the Euro as a common currency for members of the European
Union could impact Cisco's foreign exchange exposure. Cisco is prepared to hedge
against fluctuations in the Euro if this exposure becomes material. Cisco will
continue to evaluate the impact of the Euro on its foreign exchange exposure as
well as on its internal systems.
At the present time, Cisco hedges only those currency exposures associated with
certain assets and liabilities denominated in nonfunctional currencies and does
not generally hedge anticipated foreign currency cash flows. The hedging
activity undertaken by Cisco is intended to offset the impact of currency
fluctuations on certain nonfunctional currency assets and liabilities. The
success of this activity depends upon estimations of intercompany balances
denominated in various currencies, primarily the Japanese yen, Canadian dollar,
Australian dollar and certain European currencies. To the extent that these
forecasts are over- or understated during periods of currency volatility, Cisco
could experience unanticipated currency gains or losses.
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CISCO IS EXPOSED TO THE CREDIT RISK OF SOME OF ITS CUSTOMERS AND TO CREDIT
EXPOSURES IN WEAKENED MARKETS
Cisco is experiencing a greater proportion of its sales activity through its
partners in two-tier distribution channels. These customers are generally given
privileges to return inventory, receive credits for changes in Cisco's selling
prices and participate in cooperative marketing programs. Cisco maintains
appropriate accruals and allowances for such exposures. However, such partners
tend to have access to more limited financial resources than other resellers and
end user customers and therefore represent potential sources of increased credit
risk. Cisco is experiencing increased demands for customer financing and leasing
solutions, particularly to competitive local exchange carriers ("CLEC's").
CLEC's typically finance significant networking infrastructure deployments
through alternative forms of financing, including leasing, through Cisco.
Although Cisco has programs in place to monitor and mitigate the associated
risk, there can no assurance that such programs will alleviate all credit risk
to the Company. Cisco also continues to monitor increased credit exposures
because of the weakened financial conditions in Asia, and other emerging market
regions, and the impact that such conditions may have on the worldwide economy.
Although Cisco has not experienced significant losses due to customers failing
to meet their obligations to date, such losses, if incurred, could harm our
business and financial position.
CISCO IS EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF ITS PORTFOLIO
INVESTMENTS AND IN INTEREST RATES
Cisco maintains investment portfolio holdings of various issuers, types and
maturities. These securities are generally classified as available for sale, and
consequently, are recorded on the balance sheet at fair value with unrealized
gains or losses reported as a separate component of accumulated comprehensive
income, net of tax. Part of this portfolio includes minority equity investments
in several publicly-traded companies, the values of which are subject to market
price volatility. Cisco has also invested in numerous privately-held companies,
many of which can still be considered in the start-up or development stage.
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. This could result in Cisco losing up to its entire initial
investment. Cisco also has certain real estate lease commitments with payments
tied to short-term interest rates. At any time, a sharp rise in interest rates
could have a material adverse impact on the fair value of Cisco's investment
portfolio
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while increasing the costs associated with its lease commitments. Conversely,
declines in interest rates could have a material impact on interest earnings for
Cisco's investment portfolio. Cisco does not currently hedge these interest rate
exposures.
CISCO EXPECTS TO MAKE FUTURE ACQUISITIONS WHERE ADVISABLE AND ACQUISITIONS
INVOLVE NUMEROUS RISKS.
The networking business is highly competitive, and as such, Cisco's growth is
dependent upon market growth and its ability to enhance its existing products
and introduce new products on a timely basis. One of the ways Cisco has
addressed and will continue to address the need to develop new products is
through acquisitions of other companies. Acquisitions involve numerous risks,
including the following:
o difficulties in integration of the operations, technologies, and
products of the acquired companies;
o the risk of diverting management's attention from normal daily
operations of the business;
o potential difficulties in completing projects associated with purchased
in process research and development;
o risks of entering markets in which Cisco has no or limited direct prior
experience and where competitors in such markets have stronger market
positions; and
o the potential loss of key employees of the acquired company.
Mergers and acquisitions of high-technology companies are inherently risky, and
no assurance can be given that Cisco's previous or future acquisitions will be
successful and will not adversely affect Cisco's financial condition or results
of operations.
Cisco must also maintain its ability to manage any such growth effectively.
Failure to manage growth effectively and successfully integrate acquisitions
made by Cisco could harm Cisco's business and operating results.
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SINCE CISCO'S GROWTH RATE MAY SLOW, OPERATING RESULTS FOR A PARTICULAR QUARTER
ARE DIFFICULT TO PREDICT
Cisco expects that in the future, its net sales may grow at a slower rate than
was experienced in previous periods, and that on a quarter-to-quarter basis,
Cisco's growth in net sales may be significantly lower than its historical
quarterly growth rate. As a consequence, operating results for a particular
quarter are extremely difficult to predict. Cisco's ability to meet financial
expectations could be hampered if the nonlinear sales pattern seen in past
quarters reoccurs in future periods. Cisco generally has had one quarter of the
fiscal year when backlog has been reduced. Although such reductions have not
occurred consistently in recent years, they are difficult to predict and may
occur in the future. In addition, in response to customer demand, Cisco
continues to attempt to reduce its product manufacturing lead times, which may
result in corresponding reductions in order backlog. A decline in backlog levels
could result in more variability and less predictability in Cisco's
quarter-to-quarter net sales and operating results going forward. On the other
hand, for certain products, lead times are longer than Cisco's goal. If Cisco
cannot reduce manufacturing lead times for such products, Cisco's customers may
cancel orders or not place further orders if shorter lead times are available
from other manufacturers, thus creating additional variability.
As a result of recent unfavorable economic conditions, sales to certain
countries in the Pacific Rim, Eastern Europe, and Latin America, have declined
as a percentage of Cisco's total revenue. If the economic conditions in these
markets, or other markets which recently experienced unfavorable conditions
worsen, or if these unfavorable conditions result in a wider regional or global
economic slowdown, this decline may have a material adverse impact on Cisco's
business, operations and financial condition.
Recent actions and comments from the Securities and Exchange Commission have
indicated they are reviewing the current valuation methodology of purchased
in-process research and development
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related to business combinations. The Commission is concerned that some
companies are writing off more of the value of an acquisition than is
appropriate. Cisco believes it is in compliance with all of the rules and
related guidance as they currently exist. However, there can be no assurance
that the Commission will not seek to reduce the amount of purchased in-process
research and development previously expensed by Cisco. This would result in the
restatement of previously filed financial statements of Cisco and could have a
material negative impact on financial results for the periods subsequent to
acquisitions. Additionally, the Financial Accounting Standards Board ("FASB")
has announced that it plans to rescind the pooling of interests method of
acquisition accounting. If this occurs, it could alter Cisco's acquisition
strategy and potentially impair its ability to acquire companies. The FASB has
also announced that it is reviewing the current accounting rules associated with
stock options. The FASB is concerned that current practice, as outlined in
Accounting Principles Board No. 25 (APB25), does not accurately reflect
appropriate compensation expense under a variety of scenarios, including the
assumption of option plans from acquired companies. The changes proposed could
alter Cisco's practices of annual stock option grants and the assumption of
stock option plans of acquired companies. Any change in these business practices
could make it more difficult to attract and retain qualified personnel.
Cisco also expects that gross margins may be adversely affected by increases in
material or labor costs, heightened price competition, and changes in channels
of distribution or in the mix of products sold. For example, Cisco believes that
gross margins may decline over time, because the markets for lower-margin access
products targeted toward small to medium-sized customers have continued to grow
at a faster rate than the markets for Cisco's higher-margin router and
high-performance switching products targeted toward enterprise and service
provider customers. Cisco has recently introduced several new products with
additional new products scheduled to be released in the near future. If warranty
costs associated with these new products are greater than Cisco has experienced
historically, gross margins may be adversely affected. Cisco's gross margins may
also be impacted by geographic mix, as well as the mix of configurations within
each product group. Cisco continues to expand into third-party or indirect
distribution channels, which generally results in lower gross margins. In
addition, increasing third-party and indirect distribution channels generally
results in greater difficulty in forecasting the mix of Cisco's products, and to
a certain degree, the timing of its orders.
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Cisco also expects that its operating margins may decrease as it continues to
hire additional personnel and increases other operating expenses to support its
business. Cisco plans its operating expense levels based primarily on forecasted
revenue levels. Because these expenses are relatively fixed in the short term, a
shortfall in revenue could lead to operating results being below expectations.
YOU SHOULD EXPECT THAT CISCO'S OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS
The results of operations for any quarter are not necessarily indicative of
results to be expected in future periods. Cisco's operating results have in the
past been, and will continue to be, subject to quarterly fluctuations as a
result of a number of factors. These factors include:
o the integration of people, operations, and products from acquired
businesses and technologies;
o increased competition in the networking industry;
o the overall trend toward industry consolidation;
o the introduction and market acceptance of new technologies and
standards, including switch routers, Gigabit Ethernet switching, Tag
Switching (currently also known as multiprotocol label switching (MPLS))
and voice, video and data capabilities;
o variations in sales channels, product costs, or mix of products sold;
o the timing of orders and manufacturing lead times; and
o changes in general economic conditions and specific economic conditions
in the computer and networking industries.
Any of the factors could have a material adverse impact on Cisco's operations
and financial results. For example, Cisco from time to time has made
acquisitions that result in purchased research and development expenses being
charged in an individual quarter. These charges may occur in any particular
quarter resulting in variability in Cisco's quarterly earnings. Additionally,
the dollar amounts of large orders for Cisco's products have been increasing,
and therefore the operating results for a quarter could be materially adversely
affected if a number of large orders are either not received or are delayed, due
for example, to cancellations, delays or deferrals by customers.
THE YEAR 2000 PROBLEM MAY HAVE AN ADVERSE EFFECT ON CISCO'S OPERATIONS AND
ABILITY TO OFFER PRODUCTS AND SERVICES WITHOUT INTERRUPTION
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Cisco is continuing to assess the impact of the Year 2000 issue on its current
and future products, internal information systems and non-information technology
systems (equipment and systems) and has begun, and in many cases completed,
corrective efforts in these areas.
Cisco is using a four phase approach to address the issue.
o The first phase consists of the inventorying of all potential business
disruption problems, including those with products and systems, as well
as potential disruption from suppliers and other third parties.
o The second phase consists of the prioritization of all the potential
problems to allocate the appropriate level of resources to the most
critical areas.
o The third phase addresses the remediation programs to solve or mitigate
any identified Year 2000 problems.
o The fourth phase, if necessary, will be to develop contingency plans if
it appears Cisco or its key suppliers will not be Year 2000 compliant,
and such noncompliance is expected to have a material adverse impact on
Cisco's operations.
Cisco has largely completed the implementation of Year 2000 compliant internal
computer applications for its main financial, manufacturing and order processing
systems. The systems are being tested for compliance and Cisco does not
currently expect any significant issues to be identified during this review.
However, the failure of any internal system to achieve Year 2000 readiness could
result in material disruption to Cisco's operations.
Cisco has also conducted extensive work regarding the status of its currently
available, developing and installed base of products. Cisco believes that its
current products are largely Year 2000 compliant. There can be no assurance that
certain previous releases of Cisco's products which are no longer under support
will prove to be Year 2000 compliant with customers' systems or within an
existing network. Further information about Cisco's products is available on its
Year 2000 Internet web site. Cisco has developed programs for customers who have
indicated a need to upgrade components of their systems. However, the inability
of any of Cisco's products to properly manage and manipulate data in the year
2000 could result in increased warranty costs, customer satisfaction issues,
potential lawsuits and other material costs and liabilities.
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Cisco has completed phases I and II of its review of its supplier bases and, in
the third phase of the compliance approach, is in the process of reviewing the
state of readiness of its supplier base. This exercise includes compliance
inquiries and reviews that will continue throughout 1999. Where issues are
identified with a particular supplier, contingency plans will be developed as
discussed below. Even where assurances are received from third parties there
remains a risk that failure of systems and products of other companies on which
Cisco relies could have a material adverse effect on Cisco. Further, if these
suppliers fail to adequately address the Year 2000 issue for the products they
provide to Cisco, critical materials, products and services may not be delivered
timely and Cisco may not be able to manufacture sufficient product to meet sales
demand.
Based on the work done to date, Cisco has not incurred material costs and does
not expect to incur future material costs in the work to address the Year 2000
problem for its systems (as a result of relatively new legacy information
systems) and products.
Cisco has taken and will continue to take corrective action to mitigate any
significant Year 2000 problems with its systems and products and believes that
the Year 2000 issue for information systems will not have a material impact on
its operations or financial results. However, there can be no assurance that
Cisco will not experience significant business disruptions or loss of business
due to an inability to adequately address the Year 2000 issue. Cisco is
concerned that many enterprises will be devoting a substantial portion of their
information systems spending to addressing the Year 2000 issue. This expense may
result in spending being diverted from networking solutions in the near future.
This diversion of information technology spending could have a material adverse
impact on Cisco's future sales volume.
Contingency plans are being developed in certain key areas, in particular
surrounding third party manufacturers and other suppliers, to ensure that any
potential business interruptions caused by the Year 2000 issue are mitigated.
Such contingency plans include identification of alternative sources of supply
and test exercises to ensure that such alternatives are able to provide Cisco
with an adequate level of support. These plans are expected to be developed by
the end of June 1999 and will be tested in the six months beginning in July
1999, prior to the year 2000.
The foregoing statements are based upon management's best estimates at the
present time, which were derived utilizing numerous assumptions of future
events, including the continued availability
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of certain resources, third party modification plans and other factors. There
can be no guarantee that these estimates will be achieved and actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences include, but are not limited to:
o the availability and cost of personnel trained in this area;
o the ability to locate and correct all relevant computer codes;
o the nature and amount of programming required to upgrade or replace each
of the affected programs; and
o the rate and magnitude of related labor and consulting costs and the
success of Cisco's external customers and suppliers in addressing the
Year 2000 issue.
Cisco's evaluation is on-going and it expects that new and different information
will become available to it as that evaluation continues. Consequently, there is
no guarantee that all material elements will be Year 2000 ready in time.
CISCO COMPETES IN THE HIGHLY COMPETITIVE TELECOMMUNICATIONS EQUIPMENT MARKET
Cisco competes in the telecommunications equipment market, providing solutions
for transporting data, voice and video traffic across intranets, extranets, and
the Internet. The market is characterized by rapid growth, converging
technologies, and a conversion to new solutions that offer superior advantages.
These market factors represent both an opportunity and a competitive threat to
Cisco. Cisco competes with numerous vendors in each product category. Cisco
expects that the overall number of competitors providing niche product solutions
will increase due to the market's attractive growth. On the other hand, Cisco
expects the number of vendors supplying end-to-end telecommunications solutions
will decrease, due to the rapid pace of acquisitions in the industry. Ultimately
Cisco believes only a few larger suppliers of end-to-end telecommunication
equipment solutions will become its primary competitors.
Cisco's competitors include Lucent, Nortel, Ericsson, 3Com, Cabletron, Fore and
IBM. Some of Cisco's competitors compete across many of Cisco's product lines,
while others do not offer as wide a breadth of solutions. Several of Cisco's
current and potential competitors have greater financial, marketing and
technical resources than Cisco.
The principal competitive factors in the markets in which Cisco presently
competes and may compete in the future are:
o price;
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o performance;
o the ability to provide end-to-end solutions and support;
o conformance to standards;
o the ability to provide added value features such as security,
reliability, and investment protection; and
o market presence.
Cisco also faces competition from customers it licenses technology to and
suppliers from whom it transfers technology. Networking's inherent nature
requires interoperability. As such, Cisco must cooperate, and at the same time
compete, with these companies. Cisco's inability to effectively manage these
complicated relationships with customers and suppliers could have a material
adverse effect on Cisco's business, operating results, and financial condition.
CISCO'S BUSINESS DEPENDS UPON ITS PROPRIETARY RIGHTS, AND THERE IS A RISK OF
INFRINGEMENT
Cisco's success is dependent upon its proprietary technology. Cisco generally
relies upon patents, copyrights, trademarks and trade secret laws to establish
and maintain its proprietary rights in its technology and products. Cisco has a
program to file applications for and obtain patents in the United States and in
selected foreign countries where a potential market for Cisco's products exists.
Cisco has 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 Cisco. 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
Cisco's technology. In addition, the laws of some foreign countries may not
permit the protection of Cisco's proprietary rights to the same extent as do the
laws of the United States. Although Cisco believes the protection afforded by
its patents, patent applications, copyrights and trademarks has value, the
rapidly changing technology in the networking industry makes Cisco's future
success dependent primarily on the innovative skills, technological expertise
and management abilities of its employees rather than on patent, copyright and
trademark protection.
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Many of Cisco's 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 its products, Cisco
believes that based upon past experience and standard industry practice, such
licenses generally could be obtained on commercially reasonable terms. Because
of the existence of a large number of patents in the networking field and the
rapid rate of issuance of new patents, it is not economically practical to
determine in advance whether a product or any of its components infringe patent
rights of others. From time to time, Cisco receives notices from or is sued by
third parties regarding patent claims. If infringement is alleged, Cisco
believes 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 Cisco's business, operating results and financial condition.
Nevertheless, there can be no assurance that the necessary licenses would be
available on acceptable terms, if at all, or that Cisco would prevail in any
such challenge. The inability to obtain certain licenses or other rights or to
obtain such licenses or rights on favorable terms, or the need to engage in
litigation could have a material adverse effect on Cisco's business, operating
results and financial condition.
CISCO FACES 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. Cisco could be materially adversely affected by
regulation in any country where Cisco operates, on such technology as voice over
the Internet, encryption technology and access charges for Internet service
providers, as well as the continuing deregulation of the telecommunication
industry. The adoption of such measures could decrease demand for Cisco's
products, and at the same time increase Cisco's cost of selling its products.
Changes in laws or regulations governing the Internet and Internet commerce
could have a material adverse effect on Cisco's business, operating results and
financial condition.
THE ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES OUR BUSINESS AND OPERATIONS
TO RISKS.
As Cisco focuses on new market opportunities, such as transporting voice, video,
and data traffic across the same network, it will increasingly compete with
large telecommunications equipment suppliers such as Lucent, Ericsson and
Nortel, among others, and several well funded start-up companies. Several of
Cisco's current and potential competitors have greater financial, marketing and
technical resources than Cisco. Additionally, as customers in these markets
complete infrastructure deployments, they may require greater levels of service,
support and financing than Cisco has experienced in the past. Cisco has not
entered into a material amount of labor intensive service contracts which
require significant production or customization. However, Cisco expects that
demand for these types of service contracts will increase in the future. There
can be no assurance that Cisco can provide products, service, support and
financing to effectively compete for these market opportunities. Further,
provision of greater levels of services by Cisco may result in less favorable
name recognition treatment than has historically been experienced.
CISCO IS DEPENDENT UPON THE ABILITY OF SUPPLIERS TO DELIVER PARTS ON TIME
Cisco's growth and ability to meet customer demands also depend in part on its
ability to obtain timely deliveries of parts from its suppliers. Cisco has
experienced component shortages in the past that have adversely affected its
operations. Although Cisco works
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closely with its suppliers to avoid these types of shortages, there can be no
assurances that Cisco will not encounter these problems in the future.
THE LOCATION OF OUR FACILITIES SUBJECTS CISCO TO THE RISK OF EARTHQUAKES AND
FLOODS
Cisco's corporate headquarters, including most of its research and development
operations and its manufacturing facilities, are located in the Silicon Valley
area of Northern California, a region known for seismic activity. Additionally,
one of Cisco's manufacturing facilities is located near a river that has
experienced flooding in the past. A significant natural disaster, such as an
earthquake or a flood, could have a material adverse impact on Cisco's business,
financial condition and operating results.
CISCO DEPENDS UPON THE DEVELOPMENT OF NEW PRODUCTS AND IS SUBJECT TO RAPID
CHANGES IN TECHNOLOGY AND THE MARKET
Cisco's operating results will depend to a significant extent on its ability to
reduce the costs to produce existing products. In particular, Cisco broadened
its product line by introducing network access products. Sales of these
products, which are generally lower priced and carry lower margins than Cisco's
core products, have increased more rapidly than sales of Cisco's core products.
The success of these and other new products is dependent on several factors,
including proper new product definition, product cost, timely completion and
introduction of new products, differentiation of new products from those of
Cisco's competitors and market acceptance of these products. The markets for
Cisco's products are characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions, and evolving methods of
building and operating networks. There can be no assurance that Cisco will
successfully identify new product opportunities, develop and bring new products
to market in a timely manner, and achieve market acceptance of its products or
that products and technologies developed by others will not render Cisco's
products or technologies obsolete or noncompetitive.
CISCO IS SUBJECT TO RISKS ASSOCIATED WITH STRATEGIC ALLIANCES
Cisco has a number of strategic alliances with companies including Microsoft,
Hewlett-Packard, EDS, Sprint and Motorola, among others. 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
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will be mutually beneficial and result in industry growth. However, these
alliances carry an element of risk because, in most cases, Cisco must compete in
some business areas with a company with which it has strategic alliances and, at
the same time, cooperate with such company in other business areas. Also, if
these companies fail to perform, or if these relationships fail to materialize
as expected, Cisco could suffer delays in product development or other
operational difficulties.
THE INDUSTRY IN WHICH CISCO COMPETES IS SUBJECT TO CONSOLIDATION
There has been a trend toward industry consolidation for several years, which
has continued during fiscal 1999. Cisco expects this trend toward industry
consolidation to continue as companies attempt to strengthen or hold their
market positions in an evolving industry. Cisco believes that industry
consolidation may provide stronger competitors that are better able to compete
as sole-source vendors for customers. This could lead to more variability in
operating results as Cisco competes to be a single vendor solution and could
have a material adverse effect on Cisco's business, operating results and
financial condition.
SALES IN THE SERVICE PROVIDER MARKET ARE SUBJECT TO VARIATION
Although sales to the service provider market have continued to grow, this
market is characterized by large, and often sporadic purchases. Sales activity
in this industry depends upon the stage of completion of expanding network
infrastructures, the availability of funding, and the extent that service
providers are affected by regulatory and business conditions in the country of
operations. A decline or delay in sales orders from this industry could have a
material adverse effect on Cisco's business, operating results and financial
condition.
CISCO IS SUBJECT TO RISKS ASSOCIATED WITH THE MANUFACTURE OF PARTS AND
COMPONENTS OF ITS PRODUCTS
Although Cisco generally uses standard parts and components for its products,
certain components are presently available only from a single source or limited
sources. A reduction or interruption in supply or a significant increase in the
price of one or more components would adversely affect Cisco's business,
operating results and financial condition and could damage customer
relationships.
CISCO FACES RISKS ASSOCIATED WITH CHANGES IN TELECOMMUNICATION REGULATION AND
TARIFFS
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Changes in domestic and international telecommunication requirements could
affect Cisco's sales of its products. In particular, Cisco believes it is
possible that there may be significant changes in domestic telecommunications
regulations in the near future that could slow the expansion of the service
providers' network infrastructures and adversely affect Cisco's 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 Cisco's products for certain
classes of customers. Additionally, in the U.S. Cisco's products must comply
with various Federal Communication Commission requirements and regulations. In
countries outside of the U.S., Cisco's products must meet various requirements
of local telecommunications authorities. Changes in tariffs, or failure by Cisco
to obtain timely approval of products could have a material adverse effect on
Cisco's business, operating results and financial condition.
CISCO'S BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS
Cisco conducts business globally. Accordingly, Cisco's future results could be
adversely affected by a variety of uncontrollable and changing factors including
foreign currency exchange rates; regulatory, political or economic conditions in
a specific country or region; trade protection measures and other regulatory
requirements; government spending patterns; and natural disasters, among other
factors. In fiscal 1998, Cisco experienced slower sales growth in Japan, as well
as in certain other parts of Asia. Any or all of these factors could have a
material adverse impact on Cisco's future international business in these or
other countries.
CISCO'S BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET
AND INTERNET-BASED SYSTEMS
Cisco's management believes that there will be performance problems with
Internet communications in the future which could receive a high degree of
publicity and visibility. As Cisco is a large supplier of equipment for the
Internet infrastructure, customers' perceptions of Cisco's products and the
marketplace's perception of Cisco as a supplier of networking products, may be
materially adversely affected, regardless of whether or not these problems are
due to the performance of Cisco's products. Such an event could also result in a
material adverse effect on the market price of Cisco's Common Stock and could
materially adversely affect Cisco's business, operating results and financial
condition.
31
<PAGE> 32
CISCO'S STOCK PRICE MAY BE VOLATILE
Cisco's Common Stock has experienced substantial price volatility, particularly
as a result of variations between Cisco's actual or anticipated financial
results and the published expectations of analysts and as a result of
announcements by Cisco and its competitors. 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 adversely affect the
market price of Cisco's Common Stock in the future.
32
<PAGE> 33
PART II. OTHER INFORMATION
ITEM 6. EXHIBIT AND REPORTS ON FORM 8-K
(a) Exhibit
27 Financial data schedule
(b) Reports on Form 8-K
None
34
<PAGE> 34
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Cisco Systems, Inc.
Date: June 11, 1999 By /s/ Larry R. Carter
-------------------------------------
Larry R. Carter,
Senior Vice President Finance, and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
35
<PAGE> 35
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
- -------
<S> <C>
27 Financial data schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF OPERATIONS INCLUDED IN
THE COMPANY'S FORM 10-Q FOR THE PERIOD ENDED MAY 1, 1999, AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1999
<PERIOD-START> JUL-26-1998
<PERIOD-END> MAY-01-1999
<CASH> 690
<SECURITIES> 7,805
<RECEIVABLES> 1,305
<ALLOWANCES> 30
<INVENTORY> 621
<CURRENT-ASSETS> 4,326
<PP&E> 1,618
<DEPRECIATION> 917
<TOTAL-ASSETS> 12,708
<CURRENT-LIABILITIES> 2,412
<BONDS> 0
0
0
<COMMON> 4,847
<OTHER-SE> 5,405
<TOTAL-LIABILITY-AND-EQUITY> 12,708
<SALES> 8,562
<TOTAL-REVENUES> 8,562
<CGS> 2,981
<TOTAL-COSTS> 6,483
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,314
<INCOME-TAX> 862
<INCOME-CONTINUING> 1,452
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,452
<EPS-BASIC> 0.92<F1>
<EPS-DILUTED> 0.86
<FN>
<F1>For purpose of this statement, primary means basic.
</FN>
</TABLE>
