<PAGE> 1
FORM 10-Q/A
(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 30, 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 December 13, 1999, 3,421,222,492 shares of the Registrant's common stock
were outstanding.
1
<PAGE> 2
PORTIONS AMENDED
The Registrant hereby amends Part I - Items 1 and 2 contained in the
Registrant's Report on Form 10-Q for the quarterly period ended October 30, 1999
to provide additional information relating to FAS 131 "Disclosures about
Segments of an Enterprise and Related Information" and to provide additional
disclosure in the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section in each case, as set forth below. Except as
set forth in Items 1 and 2 below, no other changes are made to the Company's
Report on Form 10-Q for the quarterly period ended October 30, 1999.
2
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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
---------------------------
October 30, October 24,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Net sales $3,877 $2,597
Cost of sales 1,364 897
------ ------
Gross margin 2,513 1,700
Operating expenses:
Research and development 519 333
Sales and marketing 803 518
General and administrative 101 76
Amortization of goodwill and purchased
intangible assets 24 11
Purchased research and development 381 41
------ ------
Total operating expenses 1,828 979
------ ------
Operating income 685 721
Interest and other income, net 106 66
------ ------
Income before provision for income taxes 791 787
Provision for income taxes 353 275
------ ------
Net income $ 438 $ 512
====== ======
Net income per share--basic $ .13 $ .16
====== ======
Net income per share--diluted $ .13 $ .15
====== ======
Shares used in per-share
calculation--basic 3,301 3,179
====== ======
Shares used in per-share
calculation--diluted 3,500 3,351
====== ======
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
CISCO SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
<TABLE>
<CAPTION>
October 30, July 31,
1999 1999
----------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 1,251 $ 838
Short-term investments 514 1,215
Accounts receivable, net of allowance for doubtful
accounts of $27 at October 30, 1999 and
$27 at July 31, 1999 1,391 1,242
Inventories, net 655 652
Deferred income taxes 604 545
Prepaid expenses and other current assets 477 168
------- -------
Total current assets 4,892 4,660
Investments 8,884 7,032
Restricted investments 1,079 1,080
Property and equipment, net 898 806
Other assets, net 1,654 1,194
------- -------
Total assets $17,407 $14,772
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 484 $ 363
Income taxes payable 475 630
Accrued payroll and related expenses 576 678
Other accrued liabilities 1,494 1,339
------- -------
Total current liabilities 3,029 3,010
Deferred income taxes 452 --
Minority interest 44 44
Shareholders' equity:
Preferred stock, no par value, 5 shares authorized:
none issued or outstanding at October 30, 1999
and July 31, 1999
Common stock and additional paid-in capital,
$0.001 par value,
10,000 shares authorized: 3,315 shares
issued and outstanding at October 30, 1999
and 3,284 at July 31, 1999 6,794 5,578
Retained earnings 6,264 5,842
Accumulated comprehensive income 824 298
------- -------
Total shareholders' equity 13,882 11,718
------- -------
Total liabilities and shareholders' equity $17,407 $14,772
======= =======
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
CISCO SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
<TABLE>
<CAPTION>
Three Months Ended
----------------------------
October 30, October 24,
1999 1998
---------- -----------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 438 $ 512
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 144 113
Deferred income taxes (21) 38
Tax benefits from employee stock plans 390 116
Adjustment to conform fiscal year ends of pooled
acquisitions (3) 1
Purchased research and development from acquisitions 381 41
Change in operating assets and liabilities:
Accounts receivable (148) (36)
Inventories (3) (14)
Prepaid expenses and other current assets 1 (31)
Income taxes payable (155) (7)
Accounts payable 106 33
Accrued payroll and related expenses (107) (10)
Other accrued liabilities 153 90
------- -------
Net cash provided by operating activities 1,176 846
------- -------
Cash flows from investing activities:
Purchases of short-term investments (297) (131)
Proceeds from sales and maturities of short-term
investments 825 462
Purchases of investments (3,104) (1,048)
Proceeds from sales of investments 2,262 427
Purchases of restricted investments (70) (133)
Proceeds from sales and maturities of restricted
investments 69 54
Acquisition of property and equipment (193) (125)
Increase in lease receivables (119) (39)
Other (411) (25)
------- -------
Net cash used in investing activities (1,038) (558)
------- -------
Cash flows from financing activities:
Issuance of common stock 269 129
Other 6 11
------- -------
Net cash provided by financing activities 275 140
------- -------
Net increase in cash and equivalents 413 428
Cash and equivalents, beginning of period 838 598
------- -------
Cash and equivalents, end of period $ 1,251 $ 1,026
======= =======
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
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 2000 is a 52-week year while 1999 was a 53-week
year.
Basis of Presentation
All historical financial information has been restated to reflect the
acquisitions of StratumOne Communications, Inc.("StratumOne") and TransMedia
Communications, Inc.("TransMedia") in the first quarter of fiscal 2000 which
were accounted for as poolings of interests. In addition, the historical
financial information has been restated to reflect the acquisition of Fibex
Systems which was completed in the fourth quarter of 1999 and accounted for as a
pooling of interests.
The accompanying financial data as of October 30, 1999 and July 31, 1999, and
for the three months ended October 30, 1999 and October 24, 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 31, 1999 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
6
<PAGE> 7
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the notes thereto included in the Company's Annual Report on Form 10-K for the
year ended July 31, 1999.
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 October 30, 1999 and for the three
months ended October 30, 1999 and October 24, 1998, have been made. The results
of operations for the period ended October 30, 1999 are not necessarily
indicative of the operating results for the full year.
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.
Recent Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board (FASB) issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. Management does not believe this will have a material effect on
the Company's operations. Implementation of this standard has recently been
delayed by the FASB for a twelve-month period. The Company will now be required
to adopt SFAS 133 for its first quarterly filing of fiscal 2001.
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 aggregate basis.
7
<PAGE> 8
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amounts allocated to purchased research and development were determined
through established valuation techniques in the high-technology communications
industry and were expensed upon acquisition because technological feasibility
had not been established and no future alternative uses existed. Research and
development costs to bring the 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 September 1999, the Company completed its purchase of Monterey Networks, Inc.
("Monterey"), a developer of infrastructure-class, optical cross-connect
technology that is used to increase network capacity at the core of an optical
network. The Company's acquired technology consists of one product currently
under development which will result in a wavelength router that would
intelligently route signals over long-haul optical pipes created by dense wave
division multiplexing (DWDM). Also in September 1999, the Company completed its
purchase of MaxComm Technologies, Inc. ("MaxComm"), a developer of broadband
Internet technology that brings data and multiple voice lines to consumers. The
Company's acquired technology consists of one product currently under
development which will allow the end user to create an easily adaptable home LAN
(local area network) utilizing their existing in home wiring, to support up to
four separate phone lines with different numbers.
8
<PAGE> 9
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Each of the completed purchase acquisition transactions is further outlined
below:
Summary of purchase transactions (in millions):
<TABLE>
<CAPTION>
Purchased
Research &
Development Form of Consideration and
Entity Name Consideration Charge Other Notes to Acquisition
----------- ------------- ----------- --------------------------
<S> <C> <C> <C>
Quarter Ended -
October 30, 1999
- ----------------------
Monterey Networks, Inc. $517 $354 Common stock and options assumed; $14
in liabilities assumed; goodwill and
other intangibles recorded of $154
MaxComm Technologies, Inc. $ 73 $ 27 Common stock and options assumed;
goodwill and other intangibles
recorded of $41
</TABLE>
Total purchased research and development expense for the three months ending
October 30, 1999 and October 24, 1998 was $381 million and $41 million,
respectively. The purchased research and development expense for both periods
was attributable to stock consideration.
Pooling of Interests Combinations
In September 1999, the Company acquired StratumOne, a developer of highly
integrated, high-performance semiconductor technology and TransMedia, a provider
of Media Gateway technology that unites the multiple networks of public voice
communications. Under the terms of the agreements, approximately 12.3 million
shares of common stock were issued to acquire StratumOne and TransMedia, and
options to purchase an additional 1.4 million shares were assumed. Also in
September 1999, the Company acquired Cocom A/S, ("Cocom"), a European developer
of high-speed Internet access solutions over cable, satellite and wireless
networks based on international standards. Under the terms of the agreement,
approximately 1 million shares of common stock were issued to acquire Cocom. All
historical financial information contained herein has been restated to reflect
the acquisitions of StratumOne and TransMedia. The historical operations of
Cocom were not material to the Company's consolidated operations, therefore
prior period statements have not been restated for this acquisition.
9
<PAGE> 10
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquisitions Pending or Completed After First Quarter Ended October 30, 1999
In November 1999, the Company acquired Calista Inc. ("Calista") and Tasmania
Network Systems, Inc. ("Tasmania"). Calista is a developer of Internet
technology that allows different business phone systems to work together over an
open Internet-based infrastructure. Tasmania is a leading developer of network
caching software technology. The total purchase price for these two acquisitions
was approximately $80 million and was paid in common stock. Calista and Tasmania
were both accounted for as purchases. Pro forma results of operations have not
been presented because the effects of these acquisitions were not material on
either an individual or an aggregate basis.
In November 1999, the Company completed the acquisitions of Cerent Corporation
("Cerent") and Webline Communications Corporation ("Webline"). Cerent is a
developer of next-generation optical transport products, and Webline is a
provider of customer interaction management software for Internet customer
service and e-commerce. Under the terms of the agreements, approximately 98.1
million and 3.7 million shares of common stock were issued to acquire Cerent and
Webline, respectively. The Company also assumed outstanding options that were
converted into options to purchase approximately 2.5 million shares of the
Company's stock. As of the announcement date, the purchase prices for Cerent and
Webline were approximately $6.9 billion and $325 million, respectively. The
transactions were accounted for as poolings of interests; all prior periods'
financial information will be restated as a result of these transactions. The
following table shows the pro forma historical results of the Company, Cerent,
and Webline for the periods prior to the consummation of the mergers of the
entities (in millions):
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------
October 30, October 24,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Revenues:
Cisco $3,877 $2,597
Cerent 36 --
Webline 1 1
------ ------
Total $3,914 $2,598
====== ======
</TABLE>
10
<PAGE> 11
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C> <C>
Net income:
Cisco $ 438 $ 512
Cerent (15) (2)
Webline (3) (1)
------ ------
Total $ 420 $ 509
====== ======
</TABLE>
In November 1999, the Company announced a definitive agreement to acquire
Aironet Wireless Communications, Inc. ("Aironet") for approximately $799 million
payable in common stock. Aironet is a leading developer of standards-based, high
speed wireless LAN (local area network) products. In December, 1999, the Company
acquired V-Bits, Inc. ("V-Bits") for approximately $128 million, which was paid
in common stock. V-Bits is a provider of standards-based digital video
processing systems for cable television service providers. Aironet will be
accounted for as a purchase while V-Bits will be accounted for as a pooling of
interests.
4. BALANCE SHEET DETAIL
(In millions)
<TABLE>
<CAPTION>
Inventories: October 30, July 31,
1999 1999
----------- --------
(Unaudited)
<S> <C> <C>
Raw materials $ 79 $ 143
Work in process 263 198
Finished goods 265 276
Demonstration systems 48 35
------ ------
Total $ 655 $ 652
====== ======
</TABLE>
<TABLE>
<CAPTION>
Other Assets October 30, July 31,
1999 1999
----------- --------
(Unaudited)
<S> <C> <C>
Goodwill- gross $ 299 $ 157
Other intangible assets- gross 738 395
Less: accumulated amortization (122) (92)
------ ------
Intangibles, net 915 460
Investments in nonpublic
companies 277 196
Net investment in leases 310 500
Other assets 152 38
------ ------
Total $1,654 $1,194
====== ======
</TABLE>
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<PAGE> 12
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amortization expense for the three month period ended October 30, 1999 and
October 24, 1998 was $30 million and $11 million, respectively.
5. COMPREHENSIVE INCOME
The following table presents the calculation of comprehensive income as required
by SFAS 130. Comprehensive income has no impact on the Company's net income,
balance sheet or shareholders' equity. The components of comprehensive income,
net of tax, are as follows (in millions):
<TABLE>
<CAPTION>
Three Months Ended
-----------------------
October 30, October 24,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Net income $438 $512
Other comprehensive income:
Change in unrealized gain/(loss) on
investments, net 520 17
Change in accumulated translation
adjustments 6 11
---- ----
Total comprehensive income $964 $540
==== ====
</TABLE>
6. INCOME TAXES
The Company paid income taxes of $135 million in the three months ended October
30, 1999 and $125 million in the three months ended October 24, 1998. The
Company's income taxes currently payable for federal and state purposes have
been reduced by the tax benefits of disqualifying dispositions of stock options.
This benefit totaled $390 million and $116 million in the first three months of
fiscal 2000 and 1999, respectively, and was credited directly to shareholders'
equity.
7. SHAREHOLDERS' EQUITY
Increase in Authorized Common Stock
On November 10, 1999, the shareholders of the Company approved an increase to
the authorized number of shares of Common Stock from 5.4 billion to 10 billion
shares.
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CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. SEGMENT INFORMATION AND MAJOR CUSTOMERS
The Company's operations involve the design, development, manufacture,
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, dialup access servers, and network
management software. These products, integrated by the Cisco IOS(R) software,
link geographically dispersed LANs, WANs, and IBM networks.
The Company conducts business globally and is managed geographically. The
Company's management relies on an internal management accounting system. This
system includes 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 system. The Company does not
allocate marketing, engineering or administrative expenses to geographical
segments as management does not use this information to measure the performance
of the operating segments. Management does not believe that allocating these
expenses is material in evaluating a geographical segment's performance.
Information from this internal management system differs from the amounts
reported under generally accepted accounting principles due to certain corporate
level adjustments. These corporate level adjustments are primarily sales
adjustments relating to credit memos and returns. Based on the criteria set
forth in SFAS No. 131, the Company has four reportable segments: the Americas,
EMEA, Asia/Pacific, and Japan.
13
<PAGE> 14
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summarized financial information by segment for the first quarter of fiscal
years 2000 and 1999, as taken from the internal management information system
discussed above, is as follows (in millions):
<TABLE>
<CAPTION>
Three Months Ended
----------------------------
October 30, October 24,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Net sales:
U.S./Americas $2,621 $1,787
EMEA 1,020 665
Asia/Pacific 284 163
Japan 157 127
Sales adjustments (205) (145)
------ ------
Total--Net Sales $3,877 $2,597
====== ======
Standard Margin:
U.S./Americas $1,924 $1,304
EMEA 765 485
Asia/Pacific 207 123
Japan 125 94
Sales adjustments (205) (145)
Production overhead (82) (55)
Manufacturing variances
and other related costs (221) (106)
------ ------
Total--Gross Margin $2,513 $1,700
====== ======
</TABLE>
The standard margins by geographical segment differ from the amounts recognized
under generally accepted accounting principles because the Company does not
allocate certain sales adjustments, production overhead and manufacturing
variances and other related costs to the segments. The above table reconciles
the net sales and standard margins by geographic segment to net sales and gross
margins as reported on the statements of operations by including such
adjustments.
14
<PAGE> 15
CISCO SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents external net sales for groups of similar products
and services (in millions):
<TABLE>
<CAPTION>
Three Months Ended
----------------------------
October 30, October 24,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Routers $1,608 $1,169
Switches 1,572 1,129
Access 465 193
Other 437 251
Sales adjustments (205) (145)
------ ------
Total--Net Sales $3,877 $2,597
====== ======
</TABLE>
Substantially all of the Company's assets at October 30, 1999 and October 24,
1998 were attributable to U.S. operations.
9. NET INCOME PER COMMON SHARE
The following table presents the calculation of basic and diluted earnings per
share as required under SFAS 128 (in millions except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended
--------------------------
October 30, October 24,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Numerator
Net income $ 438 $ 512
------ ------
Denominator:
Denominator for basic earnings per
share--weighted-average shares 3,301 3,179
Effect of dilutive securities:
Employee stock options 199 172
------ ------
Denominator for diluted earnings per
share 3,500 3,351
====== ======
Net income per share--Basic $ .13 $ .16
====== ======
Net income per share--Diluted $ .13 $ .15
====== ======
</TABLE>
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<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
All historical financial information has been restated to reflect the
acquisitions of StratumOne Communications, Inc. and TransMedia Communications,
Inc. in the first quarter of fiscal 2000 which were accounted for as poolings of
interests. In addition, the historical financial information has been restated
to reflect the acquisition of Fibex Systems which was completed in the fourth
quarter of 1999 and accounted for as a pooling of interests.
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." 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 $3.9 billion in the first quarter of fiscal 2000 from $2.6
billion in the first quarter of 1999. The 49.3% increase in net sales between
the two three-month periods was primarily a result of increasing unit sales of
LAN switching products such as the Catalyst(R) 6000 family and the Catalyst 2900
series of switches for smaller enterprise networks, the Cisco 12000 gigabit
switch router (GSR), 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 our high-end core
router products. Additionally, sales of some of our more established product
lines such as the Catalyst 5000, Cisco 2500 and Cisco 4000 product families have
decreased as a percentage of total revenue. Sales in the first quarter of fiscal
2000 grew 46.7% in the Americas, 53.4% in EMEA, 74.2% in Asia and 23.6% in Japan
compared to the first quarter of fiscal 1999 (See Note 8). Market demand and
deployment of Internet technologies and business solutions, as well as the
overall economic health within these regions, are primarily driving the strong
growth in the Americas, EMEA and Asia/Pacific. The slower growth in Japan can be
attributed to weaker economic conditions and delayed government spending.
16
<PAGE> 17
Gross margins decreased to 64.8% in the first quarter of 2000 from 65.5% in the
first quarter of 1999. Standard margins for the Americas, EMEA, Asia/Pacific and
Japan were 73.4%, 75.0%, 72.9% and 79.6%, respectively, for the first quarter of
2000 compared to 73.0%, 72.9%, 75.5%, and 74.0%, respectively, for the first
quarter of 1999 (see Note 8) The standard margins by geographical segment differ
from the amounts recognized under generally accepted accounting principles
because the Company does not allocate certain sales adjustments, production
overhead and manufacturing variances and other related costs to the segments.
Standard margins for the Americas, where 67.6% of our revenues were derived in
the first quarter of 2000, remained relatively constant as compared to the first
quarter of 1999. Standard margins for EMEA, where 26.3% of our revenues were
derived in first quarter of 2000, increased by 2.1% as compared to the first
quarter of 1999. The increase in EMEA's standard margin was due to a shift in
revenue mix for the quarter. The decrease in the overall gross margin for the
quarterly period was due primarily to our continued shift in revenue mix towards
our lower-margin products, other production related costs and the continued
pricing pressure seen from competitors in certain product areas. The prices of
component parts have fluctuated in the recent past, and we expect that this
trend may continue. An increase in the price of component parts may have a
material adverse impact on gross margins. We expect that gross margins will
continue to decrease in the future, because we believe 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 our
higher-margin router and high-performance switching products. Additionally, as
we focus on new market opportunities, we face increasing competitive pressure
from large telecommunications equipment suppliers and well funded start-up
companies, which may materially adversely affect gross margins. We are
attempting to mitigate this trend through various means, such as increasing the
functionality of our products, continued value engineering, controlling royalty
costs, and improving manufacturing efficiencies. There can be no assurance that
any efforts made by us in these and other areas will successfully offset
decreasing margins.
Research and development expenses increased by $186 million in the first quarter
of 2000 over the first quarter of 1999, an increase to 13.4% from 12.8% of net
sales. The increase reflects our 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,
17
<PAGE> 18
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 we invest in technology to address
potential market opportunities. We also continue 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 other businesses as an alternative to internal research and
development. All of our research and development costs are expensed as incurred.
Sales and marketing expenses increased by $285 million in the first quarter of
2000 over the first quarter of 1999. This represents an increase from 19.9% to
20.7% of net sales for the quarter to quarter period. The increase is due
principally to an increase in the size of our 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 our efforts to invest in certain key areas such as
expansion of our end-to-end strategy and service provider coverage in order to
position ourselves to take advantage of future market opportunities.
General and administrative expenses rose $25 million between the first quarters
of 2000 and 1999, a decrease to 2.6% from 2.9% of net sales. The decrease in
general and administrative expenses as a percentage of sales primarily relates
to the increase in sales. 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 growth of the
Company, among other factors.
Amortization of goodwill and purchased intangible assets increased by $13
million. Amortization of goodwill and purchased intangible assets includes the
amortization of goodwill and other purchased intangible assets relating to
various purchase acquisitions (See Note 4).
The amount expensed to purchased research and development in the first three
months of fiscal 2000 arose from the completed acquisitions of Monterey and
MaxComm (See also Note 4).
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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 5% to 10% for acquisitions in the current quarter. We
expect that the pricing model for products related to these acquisitions will be
considered standard within the high-technology communications 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. We
expect 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 us 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 our business and operating results.
Regarding our purchase acquisitions completed in fiscal 1999, 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 acquisitions are being introduced to the
market 6 to 9 months after the acquisition. Shipment volumes of products from
acquired technologies are not material to our 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
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and potentially result in impairment of any other assets related to the
development activities.
The following table summarizes the significant assumptions underlying the
valuations in 1999 and 2000 and the development costs incurred by us in the
periods after the respective acquisition date (in millions, except percentages):
<TABLE>
<CAPTION>
Approximate
Acquisition Assumptions Development
---------------------------------- Costs Incurred
Estimated Cost to Date After
to Complete Risk Adjusted Acquisition on
Technology at Discount Acquired
Time of Rate In- In-Process
Entity Name Acquisition Process R&D Technology
----------- ------------- ------------- --------------
<S> <C> <C> <C>
1999 Purchase Acquisitions
- --------------------------
American Internet Corp. $ 1 25% $ 1
Summa Four, Inc. $ 5 25% $12
Clarity Wireless, Inc. $42 32% $14
Selsius Systems, Inc. $15 31% $ 8
PipeLinks, Inc. $ 5 31% $15
Amteva Technologies, Inc. $ 4 35% $ 2
2000 Purchase Acquisitions
- --------------------------
Monterey Networks, Inc. $ 4 30% $ 1
MaxComm Technologies, Inc. $ 2 25% $ 1
</TABLE>
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Liquidity and Capital Resources
Cash and equivalents, short-term investments, and investments were $10.6 billion
at October 30, 1999, an increase of $1.6 billion from July 31, 1999. The
increase is primarily a result of unrealized gains on publicly held investments,
cash generated by operations and the exercise of employee stock options. These
cash flows were partially offset by cash outflows from operating activities
including tax payments of approximately $135 million, and cash outflows from
investing activities including capital expenditures of approximately $193
million.
Accounts receivable increased 12.0% from July 31, 1999 to October 30, 1999. Days
sales outstanding in receivables increased to 33 days at October 30, 1999 from
32 days at July 31, 1999. Inventories increased 0.5% between July 31, 1999 and
October 30, 1999. Inventory level remained relatively constant between the two
periods; however, inventory management remains an area of focus as we balance
the need to maintain strategic inventory levels to ensure competitive lead times
versus the risk of inventory obsolescence because of rapidly changing technology
and customer requirements.
At October 30, 1999, we had a line of credit totaling $500 million, which
expires July 2002. There have been no borrowings under this facility.
We have entered into certain lease arrangements in San Jose, California, and
Research Triangle Park, North Carolina, where we have established our
headquarters operations and certain research and development and customer
support activities. In connection with these transactions, we pledged $1.1
billion of our investments as collateral for certain obligations of the leases.
We anticipate that we will occupy more leased property in the future that will
require similar pledged securities; however, we do not expect the impact of this
activity to be material to liquidity.
We believe that our current cash and equivalents, short-term investments, line
of credit, and cash generated from operations will satisfy our expected working
capital and capital expenditure requirements through fiscal 2000.
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
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results contemplated by the forward looking statements contained in this
Quarterly Report.
CISCO IS 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 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 recently seen our exposures to emerging market currencies,
such as the Brazilian real, Korean won, and Russian ruble, among others,
increase because of our expanding presence in these markets and the extreme
currency volatility. We currently do 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 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 do
not 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. The success of this
activity depends upon estimations of intercompany balances denominated in
various currencies, primarily the euro, Japanese yen, Canadian dollar,
Australian dollar, and certain other European currencies. To the extent that
these forecasts are over- or understated during periods of currency volatility,
we could experience unanticipated currency gains or losses.
CISCO IS EXPOSED TO THE CREDIT RISK OF SOME OF ITS CUSTOMERS AND TO CREDIT
EXPOSURES IN WEAKENED MARKETS
We are experiencing a greater proportion of our sales activity through our
partners in two-tier distribution channels. These customers are generally given
privileges to return inventory, receive credits for changes in selling prices,
and participate in
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<PAGE> 23
cooperative marketing programs. We maintain appropriate accruals and allowances
for such exposures. However, such partners tend to have access to more limited
financial resources than other resellers and end-user customers and therefore
represent potential sources of increased credit risk. We are experiencing
increased demands for customer financing and leasing solutions, particularly to
competitive local exchange carriers ("CLECs"). CLECs typically finance
significant networking infrastructure deployments through alternative forms of
financing, including leasing, through Cisco. Although we have programs in place
to monitor and mitigate the associated risk, there can be no assurance that such
programs will alleviate all of our credit risk. We also continue 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 we have 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
We maintain 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 other
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. We have also invested in numerous privately
held companies, many of which can still be considered in the startup 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 28-29 of our 1999 Annual Report to Shareholders
for a more detailed discussion of quantitative and qualitative disclosures about
market risk. The following analysis
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presents the hypothetical change in fair values of public equity investments we
held that are sensitive to changes in the stock market. These equity securities
are held for purposes other than trading. The modeling technique used measures
the hypothetical change in fair values arising from selected hypothetical
changes in each stock's price. Stock price fluctuations of plus or minus 15%,
plus or minus 35%, and plus or minus 50% were selected based on the probability
of their occurrence.
This table estimates the fair value of the publicly traded corporate equities at
a twelve-month time horizon (in millions):
<TABLE>
<CAPTION>
Valuation of security Fair value Valuation of security
given X% decrease in each as of given X% increase in
stock's price October 31, each stock's price
-------------------------- ------------ ----------------------------
(50%) (35%) (15%) 1999 15% 35% 50%
----- ------ ------ ----------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Corporate Equities $924 $1,201 $1,571 $1,848 $2,125 $2,495 $2,772
</TABLE>
Our equity portfolio consists of securities with characteristics that most
closely match the S&P Index or companies traded on the NASDAQ Exchange. The
NASDAQ Composite Index has occurrence of a 15% movement in all of the last three
years, a 35% movement in one of the last three years, and a 50% movement in none
of the last three years.
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 and our ability to enhance our existing products
and introduce new products on a timely basis. One of the ways we have addressed
and will continue to address the need to develop new products is through
acquisitions of other companies. Acquisitions involve numerous risks, including
the following:
- - difficulties in integration of the operations, technologies, and products of
the acquired companies;
- - the risk of diverting management's attention from normal daily operations of
the business;
- - potential difficulties in completing projects associated with purchased
in-process research and development;
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- - risks of entering markets in which we have no or limited direct prior
experience and where competitors in such markets have stronger market
positions; and
- - the potential loss of key employees of the acquired company.
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 maintain our ability to manage any such growth effectively. Failure
to manage growth effectively and successfully integrate acquisitions made by us
could harm our business and operating results.
SINCE CISCO'S GROWTH RATE MAY SLOW, OPERATING RESULTS FOR A PARTICULAR QUARTER
ARE DIFFICULT TO PREDICT
We expect that in the future, our net sales may grow at a slower rate than
experienced in previous periods, and that on a quarter-to-quarter basis, our
growth in net sales may be significantly lower than our historical quarterly
growth rate. As a consequence, operating results for a particular quarter are
extremely difficult to predict. Our ability to meet financial expectations could
be hampered if the nonlinear sales pattern seen in past quarters reoccurs in
future periods. We generally have 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, 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 cancel orders or not place further orders if
shorter lead times are available from other manufacturers, thus creating
additional variability.
CISCO IS EXPOSED TO UNFAVORABLE ECONOMIC CONDITIONS WORLDWIDE
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 our total revenue. If the economic conditions in these markets,
or other markets that
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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 our business, operations, and financial
condition.
CISCO CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC
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 related to business combinations. The
Commission is concerned that some companies are writing off more of the value of
an acquisition than is appropriate. We believe we are 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 us. This would result
in the restatement of our previously filed financial statements 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 our acquisition strategy
and potentially impair our 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
make it more difficult to attract and retain qualified personnel and could
unfavorably impact operating results.
CISCO EXPECTS GROSS MARGINS TO DECLINE OVER TIME
We expect 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, we believe 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 our higher-margin router and
high-performance switching products targeted toward enterprise and service
provider customers. We have recently introduced several new products, with
additional new products scheduled to be released in the near future. If warranty
costs associated with these new
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products are greater than we have experienced historically, gross margins may be
adversely affected. Our gross margins 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 lower gross margins. 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 its orders.
We also expect that our operating margins may decrease as we continue to hire
additional personnel and increases other operating expenses to support our
business. We plan our operating expense levels based primarily on forecasted
revenue levels. Because these expenses are relatively fixed in the short term, a
shortfall in revenue could lead to operating results being below expectations.
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. Our operating results have in the past
been, and will continue to be, subject to quarterly fluctuations as a result of
a number of factors. These factors include:
- - The integration of people, operations, and products from acquired businesses
and technologies
- - Increased competition in the networking industry
- - The overall trend toward industry consolidation
- - The introduction and market acceptance of new technologies and standards,
including switch routers, Gigabit Ethernet switching, Tag Switching (currently
also known as multiprotocol label switching [MPLS]) and data, voice and video
capabilities
- - Variations in sales channels, product costs, or mix of products sold
- - The timing of orders and manufacturing lead times
- - The trend toward sales of integrated network solutions
- - Changes in general economic conditions and specific economic conditions in the
computer and networking industries
Any of these above factors could have a material adverse impact on our
operations and financial results. For example, we from time to time have made
acquisitions that result in purchased research and development expenses being
charged in an individual quarter. These
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charges may occur in any particular quarter resulting in variability in our
quarterly earnings. Additionally, the dollar amounts of large orders for our
products have been increasing, and therefore the operating results for a quarter
could be materially adversely affected if a number of large orders are either
not received or are delayed, for example, due to cancellations, delays, or
deferrals by customers.
THE YEAR 2000 PROBLEM MAY HAVE AN ADVERSE EFFECT ON CISCO'S OPERATIONS AND
ABILITY TO OFFER PRODUCTS AND SERVICES WITHOUT INTERRUPTION
We are continuing to assess the impact of the year 2000 issue on our current and
future products, internal information systems, and noninformation technology
systems (equipment and systems) and have begun, and in many cases completed,
corrective efforts in these areas.
We are using a four-phased approach to address the issue:
- - 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.
- - The second phase consists of the prioritization of all the potential problems
to allocate the appropriate level of resources to the most critical areas.
- - The third phase addresses the remediation programs to solve or mitigate any
identified year 2000 problems.
- - The fourth phase consists of the development of contingency plans to address
potential year 2000 problems that may arise with Cisco, our customers, and our
suppliers.
We have largely completed the implementation of year 2000-compliant internal
computer applications for our main financial, manufacturing, and order
processing systems. The systems are being tested for compliance, and we do 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 our operations.
We have also conducted extensive work regarding the status of our currently
available, developing, and installed base of products. We believe that our
current products are largely year 2000-compliant. There can be no assurance that
certain previous releases of our products that are no longer under support will
prove to be year 2000 compliant with customers' systems or within an existing
network. Further information about our products is available on our
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<PAGE> 29
Year 2000 Internet Web site. We have developed programs for customers who have
indicated a need to upgrade components of their systems. However, the inability
of any of our 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.
We have completed our review of our supplier base. This exercise included
compliance inquiries and reviews that will continue throughout calendar 1999.
Where issues were identified with a particular supplier, contingency plans have
been 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 we rely could have a material adverse effect on us. Further,
if these suppliers fail to adequately address the year 2000 issue for the
products they provide to us, critical materials, products, and services may not
be delivered in a timely manner and we may not be able to manufacture sufficient
product to meet sales demand.
Based on the work done to date, we have not incurred material costs and do not
expect to incur future material costs in the work to address the year 2000
problem for our systems (as a result of relatively new legacy information
systems) and products.
We have taken and will continue to take corrective action to mitigate any
significant year 2000 problems with our systems and products and believe that
the year 2000 issue for information systems will not have a material impact on
our operations or financial results. However, there can be no assurance that we
will not experience significant business disruptions or loss of business due to
an inability to adequately address the year 2000 issue. We are 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 our future sales volume.
Contingency plans have been 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 us with
an adequate level of support.
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The foregoing statements are based upon our best estimates at the present time,
which were derived utilizing numerous assumptions of future events, including
the continued availability 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:
- The availability and cost of personnel trained in this area
- The ability to locate and correct all relevant computer codes
- The nature and amount of programming required to upgrade or replace each
of the affected programs
- 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
Our evaluation is ongoing and we expect that new and different information will
become available to us 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 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
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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:
- price;
- performance;
- the ability to provide end-to-end solutions and support;
- conformance to standards;
- the ability to provide added value features such as security, reliability,
and investment protection; and
- 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
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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.
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.
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 in any country where we operate, 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 our products,
and at the same time increase our cost of selling our products. Changes in laws
or regulations governing the Internet and Internet commerce could have a
material adverse effect on our business, operating results and financial
condition.
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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 Lucent, Ericsson and Nortel,
among others, and several well-funded start-up companies. Several of our current
and potential competitors have greater financial, marketing and technical
resources than we do. Additionally, as customers in these markets complete
infrastructure deployments, they may require greater levels of service, support
and financing than we have experienced in the past. We have not entered into a
material amount of labor intensive service contracts which require significant
production or customization. However, we expect that demand for these types of
service contracts will increase in the future. There can be no assurance that we
can provide products, service, support and financing to effectively compete for
these market opportunities. Further, provision of greater levels of services by
us may result in less favorable timing of revenue recognition than we have
historically experienced.
WE ARE DEPENDENT UPON THE ABILITY OF SUPPLIERS TO DELIVER PARTS ON TIME
Our growth and ability to meet customer demands also depend in part on our
ability to obtain timely deliveries of parts from our suppliers. We have
experienced component shortages in the past that have adversely affected our
operations. Although we work closely with our suppliers to avoid these types of
shortages, there can be no assurances that we will not encounter these problems
in the future.
THE LOCATION OF OUR FACILITIES SUBJECTS US TO THE RISK OF EARTHQUAKES AND FLOODS
Our corporate headquarters, including most of our research and development
operations and our manufacturing facilities, are located in the Silicon Valley
area of Northern California, a region known for seismic activity. Additionally,
one of our 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 our business, financial condition
and operating results.
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WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ARE SUBJECT TO RAPID CHANGES
IN TECHNOLOGY AND THE MARKET
Our operating results will depend to a significant extent on our ability to
reduce the costs to produce existing products. In particular, we broadened our
product line by introducing network access products. Sales of these products,
which are generally lower priced and carry lower margins than our core products,
have increased more rapidly than sales of our 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 our competitors and
market acceptance of these products. The markets for our products are
characterized by rapidly changing technology, evolving industry standards,
frequent new product introductions, and evolving methods of building and
operating networks. There can be no assurance that we will successfully identify
new product opportunities, develop and bring new products to market in a timely
manner, and achieve market acceptance of our products or that products and
technologies developed by others will not render our products or technologies
obsolete or noncompetitive.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH STRATEGIC ALLIANCES
We have 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 will be mutually beneficial and result in
industry growth. However, these alliances carry an element of risk because, in
most cases, we must compete in some business areas with a company with which we
have strategic alliances and, at the same time, cooperate with such company in
other business areas. Also, if these companies fail to perform, or if these
relationships fail to materialize as expected, we could suffer delays in product
development or other operational difficulties.
THE INDUSTRY IN WHICH WE COMPETE IS SUBJECT TO CONSOLIDATION
There has been a trend toward industry consolidation for several years. We
expect this trend toward industry consolidation to continue as companies attempt
to strengthen or hold their market positions in an evolving industry. We believe
that industry consolidation may provide stronger competitors that are better
able to compete as sole-source vendors for customers. This could lead to
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more variability in operating results as we compete to be a single vendor
solution and could have a material adverse effect on our business, operating
results and financial condition.
SALES IN THE SERVICE PROVIDER MARKET ARE SUBJECT TO VARIATION
Although sales to the service provider market have grown historically, 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 our business, operating results and financial
condition.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH THE MANUFACTURE OF PARTS AND COMPONENTS
OF OUR PRODUCTS
Although we generally use standard parts and components for our 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 our business, operating
results and financial condition and could materially damage customer
relationships.
WE FACE RISKS ASSOCIATED WITH CHANGES IN TELECOMMUNICATION REGULATION AND
TARIFFS
Changes in domestic and international telecommunication requirements could
affect the sales of our products. In particular, we believe it is possible that
there may be significant changes in domestic telecommunications regulation in
the near future that could slow the expansion of the service providers' network
infrastructures and materially adversely affect our business, operating results
and financial condition. Future changes in tariffs by regulatory agencies or
application of tariff requirements to currently untariffed services could affect
the sales of our products for certain classes of customers. Additionally, in the
U.S. our products must comply with various Federal Communication Commission
requirements and regulations. In countries outside of the U.S., 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.
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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; government spending
patterns; and natural disasters. In the first quarter of fiscal 2000, the sales
growth rate in Japan, as well as in certain other parts of Asia continued to be
slower than that in other areas. Any or all of these factors could have a
material adverse impact on our future international business in these or other
countries.
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND
INTERNET-BASED SYSTEMS
We believe that there will be performance problems with Internet communications
in the future which could receive a high degree of publicity and visibility. As
we are a large supplier of equipment for the Internet infrastructure, customers'
perceptions of our products and the marketplace's perception of us as a supplier
of networking products, may be materially adversely affected, regardless of
whether or not these problems are due to the performance of our products. Such
an event could also result in a material adverse effect on the market price of
our Common Stock and could materially adversely affect our business, operating
results and financial condition.
OUR STOCK PRICE MAY BE VOLATILE
Our Common Stock has experienced substantial price volatility, particularly as a
result of variations between our actual or anticipated financial results and 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
Cisco's Common Stock in the future.
OTHER
PricewaterhouseCoopers LLP ("PWC"), Cisco's independent accountants, has
notified Cisco that PWC is engaged in discussions with the Securities and
Exchange Commission following an internal review by PWC, pursuant to an
administrative settlement with the Commission, of PWC's compliance with auditor
independence guidelines. PWC has advised Cisco that Cisco is one of the
companies affected by such discussions. Cisco is not involved in the discussions
between the Commission and PWC and cannot predict the result of those
discussions.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Cisco Systems, Inc.
Date: February 3, 2000 By /s/ Larry R. Carter
----------------------------------
Larry R. Carter, Senior Vice
President, Finance and Administration,
Chief Financial Officer, and Secretary
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