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FORM 10-K/A
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark one)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended July 31, 1999
[ ] 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
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
170 West Tasman Drive
San Jose, California 95134
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (408) 526-4000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock Nasdaq National Market
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 such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of September 20, 1999, the approximate aggregate market value of voting stock
held by non-affiliates of the registrant was $235,936,179,459 (based upon the
closing price for shares of the Registrant's Common Stock as reported by the
National Market System of the National Association of Securities Dealers
Automated Quotation System on that date). Shares of Common Stock held by each
officer, director, and holder of 5% or more of the outstanding Common Stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes. As of September 20, 1999, 3,297,512,440 shares of
registrant's common stock were outstanding.
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PORTIONS AMENDED
The Registrant hereby amends Items 7 and 8 contained in the Registrant's Report
on Form 10-K for the fiscal year ended July 31, 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 7 and 8
below, no other changes are made to the Registrant's Report on Form 10-K for the
fiscal year ended July 31, 1999.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
All historical financial information and analysis have been restated to reflect
the acquisition of GeoTel in June 1999, which was accounted for as a pooling of
interests.
Forward-Looking Statements
Certain statements contained in this Annual Report, 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 risks faced by us
described in this Annual Report and in the Risk Factors sections, among others,
included in the documents Cisco files with the SEC, specifically Cisco's most
recent reports on Form 10-K and form 10-Q.
Comparison of 1999 and 1998
Net sales grew to $12.2 billion in 1999 from $8.5 billion in 1998. The 43.2%
increase in net sales during the year was primarily a result of increasing unit
sales of LAN switching products such as the Catalyst(R) 5000 family, the
Catalyst 2900 series of switches for smaller enterprise networks, access servers
such as the Cisco 2600 and 3600 families, high-performance WAN switching and
routing products including the IGX(TM) and BPX(R) switches, and the Cisco 12000
gigabit switch router (GSR) and increased maintenance service contract sales.
These increases were partially offset by lower unit sales of some of our more
established product lines, such as the Cisco 4000 and Cisco 2500 product
families. The Company is managed on four geographic theaters: the Americas;
Europe, Middle East and Africa (EMEA); Asia/Pacific; and Japan. Sales in 1999
grew 40.8% in the Americas, 52.1% in EMEA, 54.2% in Asia/Pacific and 23.3% in
Japan from 1998. The strong growth in the Americas, EMEA, and Asia/Pacific is
primarily being driven by market demand and deployment of Internet technologies
and business solutions, as well as the overall economic health within these
regions. The slower growth in Japan can be attributed to weaker economic
conditions, delayed government spending, and a stronger dollar versus the yen.
Gross margins decreased slightly to 65.1% during 1999 from 65.6% in 1998.
Standard margins for the Americas, EMEA, Asia/Pacific and Japan were 72.3%,
74.0%, 71.0% and 77.0%, respectively, for fiscal 1999 compared to 74.3%, 74.0%,
73.8% and 74.1%, respectively, for fiscal 1998 (see Note 11 of Consolidated
Financial Statements.) 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 66.4% of our revenues were derived in 1999,
decreased by 2.0% during 1999 as compared to 1998. The decrease in overall gross
margin and standard margins for the Americas was due primarily to our continued
shift in revenue mix towards our lower-margin products and the continued pricing
pressure seen from competitors in certain product areas. Standard margins for
EMEA, where 26.5% of our revenues were derived in 1999, remained constant as
compared to 1998. 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 also
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
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equipment suppliers and well-funded startup 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, continuing
value engineering, controlling royalty costs, and improving manufacturing
efficiencies. There can be no assurance that any efforts we make in these and
other areas will successfully offset decreasing margins.
Research and development expenses increased by $568 million in 1999 compared
with 1998 expenditures, an increase to 13.1% of net sales from 12.1% in 1998.
The increase reflects our ongoing research and development efforts in a wide
variety of areas such as data, voice and video integration, digital subscriber
line (DSL) technologies, cable modem technology, wireless access, dial access,
enterprise switching, 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 we continue
to 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 $875 million in fiscal 1999 over
fiscal 1998, an increase to 20.1% of net sales in 1999 from 18.5% in fiscal
1998. The increase is due principally to an increase in the size of our direct
sales force and its commissions, our recent television advertising campaign to
build brand awareness, 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 be positioned to take advantage of future market opportunities.
General and administrative expenses rose by $156 million in fiscal 1999 over
fiscal 1998, an increase to 3.4% from 3.1% of net sales. The increase primarily
reflects increased levels of amortization for acquisition-related intangible
assets and $16 million of costs associated with the acquisition of GeoTel. We
intend to keep general and administrative costs relatively constant as a
percentage of net sales; however, this depends on the level of acquisition
activity and amortization of the resulting intangible assets, among other
factors.
The amount expensed to purchased research and development in fiscal 1999 arose
from the purchase acquisitions of American Internet Corporation, Summa Four,
Inc., Clarity Wireless Corporation, Selsius Systems, Inc., PipeLinks, Inc., and
Amteva Technologies, Inc. (see Note 3 to the financial statements).
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 9.5% for acquisitions in the current year. 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 six to
nine months after integration. However, development of these technologies
remains a significant risk due to the remaining effort to achieve technical
viability, rapidly changing customer markets, uncertain standards for new
products, and significant competitive threats from numerous companies. The
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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 1998, research and
development efforts are substantially complete and actual results to date have
been consistent, in all material respects, with our assumptions at the time of
the acquisitions. The assumptions primarily consist of an expected completion
date for the in-process projects, estimated costs to complete the projects, and
revenue and expense projections once the products have entered the market.
Products from these 1998 acquisitions have been introduced to the market in the
last nine to twelve months. 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 life cycle. 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.
The following table summarizes the significant assumptions underlying the
valuations in 1999 and 1998 and the development costs we incurred in the periods
after the respective acquisition date (in millions, except percentages):
<TABLE>
<CAPTION>
Acquisition Assumptions Approximate Development
Costs Incurred to
Estimated Cost to Complete Risk-Adjusted Discount Date after Acquisition on
ENTITY NAME Technology at Time of Acquisition Rate for In-Process R&D Acquired In-Process Technology
- ------------------------------------------------------------------------------------------------------------------------
1999 PURCHASE ACQUISITIONS
<S> <C> <C> <C>
American Internet Corporation $ 1 25% $ 1
Summa Four, Inc. $ 5 25% $ 5
Clarity Wireless, Inc. $42 32% $10
Selsius Systems, Inc. $15 31% $ 4
PipeLinks, Inc. $ 5 31% $10
Amteva Technologies, Inc. $ 4 35% $ 1
- ------------------------------------------------------------------------------------------------------------------------
1998 PURCHASE ACQUISITIONS
Dagaz Technologies $10 35% $10
LightSpeed International, Inc. $13 26% $15
WheelGroup Corporation $ 8 24% $ 8
NetSpeed International, Inc. $12 32% $16
CLASS Data Systems $ 3 24% $ 2
</TABLE>
Interest and other income, net, was $332 million in 1999 and $196 million in
1998. Interest income rose as a result of additional investment income on our
increasing investment balances.
Our effective tax rate for fiscal 1999 was 33% excluding the 3.8% impact of
nondeductible purchased research and development. Our future effective tax rate
could be adversely affected if earnings are lower than anticipated in countries
where we have lower effective rates, or by unfavorable changes in tax laws and
regulations.
Comparison of 1998 and 1997
Net sales grew to $8.5 billion in 1998 from $6.5 billion in 1997. The 31.6%
increase in net sales during 1998 was primarily a result of increasing unit
sales of high-end switches such as the Catalyst 5500, access servers such as the
Cisco 3600 family, Internet and intranet access products for small offices such
as the Cisco 1600 series router, and increased service contract sales. The sales
growth rate in 1998 for lower-priced access and switching products targeting
small and medium-sized businesses increased faster than that of the Company's
high-end core router products. However, because these products carried lower
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average selling prices, the 1998 growth rate slowed compared with 1997.
Additionally, some of our more established product lines, such as the Cisco 2500
product family and the Cisco 4000, experienced decelerating growth rates. Sales
in 1998 grew 44.4% in the Americas, 36.3% in EMEA, and 18.1% in Asia/Pacific
versus 1997, but decreased 21.8% in Japan from 1997 levels.
Gross margins increased slightly to 65.6% during 1998 from 65.2% in 1997. This
increase was due principally to our improvements in value-engineering efforts
and material cost reductions, partially offset by a continued shift in product
mix to our lower-margin products and pricing pressure from competitors in
certain product areas.
Research and development expenses increased by $324 million in 1998 compared
with 1997 expenditures, an increase to 12.1% of net sales from 10.9% in 1997.
The increase reflected our ongoing research and development efforts in a wide
variety of areas such as data, voice and video integration, DSL technologies,
dial access, enterprise switch routers, security, network management, and
high-end routing technologies, among others. A significant portion of the
increase was due to the addition of new personnel, partly through acquisitions,
as well as higher expenditures on prototypes and depreciation on additional lab
equipment.
Sales and marketing expenses increased by $408 million in fiscal 1998 over
fiscal 1997, an increase to 18.5% of net sales in 1998 from 18.0% in fiscal
1997. The increase was due principally to an increase in the size of our direct
sales force and related commissions, additional marketing and advertising costs
associated with the introduction of new products, and the expansion of
distribution channels. The increase also reflected our efforts to invest in
certain key areas such as expansion of our end-to-end strategy and service
provider coverage in order to be positioned to take advantage of future market
opportunities.
General and administrative expenses rose by $56 million in fiscal 1998 over
fiscal 1997, a decrease to 3.1% from 3.2% of net sales. The dollar increase
reflected increased personnel costs necessary to support our business
infrastructure, including those associated with our European Logistics Center,
the further development of our information systems, as well as increased levels
of amortization for acquisition-related intangible assets.
The amount expensed to purchased research and development in fiscal 1998 arose
from the purchase acquisitions of Dagaz Technologies, LightSpeed International,
Inc., WheelGroup Corporation, NetSpeed International, Inc., and CLASS Data
Systems (see Note 3 to the financial statements).
Interest and other income, net, was $196 million in 1998 and $110 million in
1997. Interest income rose as a result of additional investment income on our
increasing investment balances. In fiscal 1997, we began selling our holdings in
a publicly traded company at amounts significantly above the cost basis of the
investment. Also in 1997, we established the Cisco Systems Foundation ("the
Foundation"). As part of this initiative, we donated a portion of this
investment, along with other equity securities, to the Foundation, with a
combined cost basis of approximately $2 million and an approximate market value
of $72 million at July 26, 1997. The realized gains on the sale of this
investment, net of the amounts donated to the Foundation, were $152 million in
fiscal 1997 (see Note 5 to the financial statements).
Recent Accounting Pronouncements
In June 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
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. We do not believe this will have a material effect on the our
operations. Implementation of this standard has recently been delayed by the
FASB for a 12-month period. The Company will now adopt SFAS 133 as required for
its first quarterly filing of fiscal year 2001.
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Liquidity and Capital Resources
Cash, short-term investments, and investments were $9.0 billion at July 31,
1999, an increase of $3.8 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
$301 million and cash outflows from investing activities including capital
expenditures of approximately $584 million.
Accounts receivable decreased 4.7% during 1999. Days sales outstanding in
receivables improved to 32 days as of July 31, 1999, from 49 days as of July 25,
1998. Inventories increased 80.1% between July 31, 1999, and July 25, 1998,
which reflects new product introductions, continued growth in our two-tiered
distribution system, and the need to maintain shorter lead times on certain
products. Inventory management remains an area of focus as we balance the need
to maintain strategic inventory levels to ensure competitive lead times with the
risk of inventory obsolescence due to rapidly changing technology and customer
requirements.
Accounts payable increased by 44.4% during 1999 primarily due to increasing
levels of raw material purchases. Other accrued liabilities increased by 83.2%
primarily due to higher deferred revenue on service contracts.
At July 31, 1999, we had a line of credit totaling $500 million, which expires
in July 2002. There have been no borrowings under this agreement (see Note 6 to
the financial statements).
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 have 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 our liquidity position.
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, capital expenditure, and investment requirements through fiscal 2000.
Risk Factors
Set forth below and elsewhere in this Annual Report and in the other documents
we file with the SEC, including our most recent Form 10-K and Form 10-Q, are
risks and uncertainties that could cause actual results to differ materially
from the results contemplated by the forward-looking statements contained in
this Annual 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
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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 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 FAIR 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.
The following table presents the hypothetical changes in fair values in the
financial instruments we held at July 31, 1999, that are sensitive to changes in
interest rates. These instruments are not leveraged and are held for purposes
other than trading. The modeling technique used measures the change in fair
values arising from selected potential changes in interest rates. Market changes
reflect immediate hypothetical parallel shifts in the yield curve of plus or
minus 50 basis points (BPS), 100 BPS, and 150 BPS over a 12-month time horizon.
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Beginning fair values represent the market principal plus accrued interest,
dividends, and certain interest rate-sensitive securities considered cash and
equivalents for financial reporting purposes at July 31, 1999. Ending fair
values are the market principal plus accrued interest, dividends, and
reinvestment income at a 12-month time horizon. This table estimates the fair
value of the portfolio at a 12-month time horizon (in millions):
<TABLE>
<CAPTION>
Valuation of securities No change Valuation of Securities
of securities given an interest rate in interest given an Interest rate increase
decrease of X basis points rates rate of X basis points
Issuer (150 BPS) (100 BPS) (50 BPS) 50 BPS 100 BPS 150 BPS
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Government notes and bonds $2,440 $2,426 $2,411 $2,393 $2,376 $2,354 $2,341
State, municipal, and county
government notes and bonds 5,513 5,444 5,386 5,315 5,248 5,166 5,113
Corporate notes and bonds 1,297 1,287 1,277 1,268 1,259 1,241 1,241
- -----------------------------------------------------------------------------------------------------------------------------------
Total $9,250 $9,157 $9,074 $8,976 $8,883 $8,761 $8,695
===================================================================================================================================
</TABLE>
A 50-BPS move in the Federal Funds Rate has occurred in nine of the last ten
years; a 100-BPS move in the Federal Funds Rate has occurred in six of the last
ten years; and a 150-BPS move in the Federal Funds Rate has occurred in four of
the last ten years.
The following analysis 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 12-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 each
stock price July 31, 1999 stock's price
(50%) (35%) (15%) 15% 35% 50%
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Corporate equities $ 438 $ 570 $ 745 $ 877 $1,009 $1,184 $1,315
========================================================================================================================
</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 shown a 15% movement in each 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 also are exposed to interest rate risk associated with leases on its
facilities whose payments are tied to the London Interbank Offered Rate (LIBOR)
and has evaluated the hypothetical change in lease obligations held at July 31,
1999 due to changes in the LIBOR. The modeling technique used measured
hypothetical changes in lease obligations arising from selected hypothetical
changes in the LIBOR. Market changes reflected immediate hypothetical parallel
shifts in the LIBOR curve of plus or minus 50 BPS, 100 BPS, and 150 BPS over a
12-month period. The results of this analysis were not material to our financial
results.
We enter into forward foreign exchange contracts to offset the impact of
currency fluctuations on certain nonfunctional currency assets and liabilities,
primarily denominated in euro, Japanese, Canadian, Australian, and certain
European currencies.
We generally enter into forward currency contracts that have original
maturities of one to three months, with none having a maturity greater than one
year in length. The total notional values of forward contracts purchased and
forward contracts sold were $211 million and $180 million, respectively. We do
not expect gains or losses on these contracts to have a material impact on our
financial results (see Note 7 to the financial statements).
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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 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
9
<PAGE> 10
costs associated with these new 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 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 has 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.
10
<PAGE> 11
- - 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 its 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 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 phases I and II of our review of our supplier bases and,
in the third phase of the compliance approach, are in the process of reviewing
the state of readiness of our supplier base. This exercise includes compliance
inquiries and reviews that will continue throughout calendar 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
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 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 us with
11
<PAGE> 12
an adequate level of support. These plans are being developed, refined, and
tested in the last six months of calendar 1999.
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.
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.
12
<PAGE> 13
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Statements of Operations
(in millions, except per-share amounts)
<TABLE>
<CAPTION>
YEARS ENDED July 31, 1999 July 25, 1998 July 26, 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
NET SALES $12,154 $ 8,488 $ 6,452
Cost of sales 4,240 2,924 2,243
- ---------------------------------------------------------------------------------------------
Gross margin 7,914 5,564 4,209
- ---------------------------------------------------------------------------------------------
Expenses:
Research and development 1,594 1,026 702
Sales and marketing 2,447 1,572 1,164
General and administrative 418 262 206
Purchased research and development 471 594 508
- ---------------------------------------------------------------------------------------------
Total operating expenses 4,930 3,454 2,580
- ---------------------------------------------------------------------------------------------
OPERATING INCOME 2,984 2,110 1,629
Realized gains on sale of investment 5 152
Interest and other income, net 332 196 110
- ---------------------------------------------------------------------------------------------
Income before provision for income taxes 3,316 2,311 1,891
Provision for income taxes 1,220 956 840
- ---------------------------------------------------------------------------------------------
NET INCOME $ 2,096 $ 1,355 $ 1,051
=============================================================================================
Net income per common share--basic $ 0.65 $ 0.44 $ 0.35
- ---------------------------------------------------------------------------------------------
Net income per common share--diluted $ 0.62 $ 0.42 $ 0.34
- ---------------------------------------------------------------------------------------------
Shares used in per-share calculation--basic 3,213 3,094 2,990
- ---------------------------------------------------------------------------------------------
Shares used in per-share calculation--diluted 3,398 3,245 3,128
- ---------------------------------------------------------------------------------------------
</TABLE>
See notes to consolidated financial statements.
13
<PAGE> 14
Consolidated Balance Sheets
(in millions, except par value)
<TABLE>
<CAPTION>
July 31, 1999 July 25, 1998
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 827 $ 580
Short-term investments 1,189 1,157
Accounts receivable, net of allowances for doubtful
accounts of $27 in 1999 and $40 in 1998 1,242 1,303
Inventories, net 652 362
Deferred income taxes 537 345
Prepaid expenses and other current assets 168 67
- ----------------------------------------------------------------------------------------------------
Total current assets 4,615 3,814
Investments 7,032 3,463
Restricted investments 1,080 554
Property and equipment, net 801 599
Other assets 1,197 542
- ----------------------------------------------------------------------------------------------------
TOTAL ASSETS $14,725 $ 8,972
====================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 361 $ 250
Income taxes payable 630 411
Accrued payroll and related expenses 678 392
Other accrued liabilities 1,334 728
- ----------------------------------------------------------------------------------------------------
Total current liabilities 3,003 1,781
Commitments and contingencies (Note 7)
Minority interest 44 43
Shareholders' equity:
Preferred stock, no par value, 5 shares authorized:
none issued or outstanding in 1999 and 1998 (Note 8)
Common stock and additional paid-in capital, $0.001 par value
5,400 shares authorized: 3,271 shares issued and outstanding in
1999 and 3,152 shares in 1998 5,524 3,262
Retained earnings 5,856 3,828
Accumulated other comprehensive income (Note 8) 298 58
- ----------------------------------------------------------------------------------------------------
Total shareholders' equity 11,678 7,148
- ----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $14,725 $ 8,972
====================================================================================================
</TABLE>
See notes to consolidated financial statements.
14
<PAGE> 15
Consolidated Statement of Cash Flows
(in millions)
<TABLE>
<CAPTION>
YEARS ENDED July 31, 1999 July 25, 1998 July 26, 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,096 $ 1,355 $ 1,051
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 486 328 214
Provision for doubtful accounts 19 43 13
Provision for inventory allowances 151 161 123
Deferred income taxes (207) (60) (186)
Tax benefits from employee stock plans 837 422 274
Adjustment to conform fiscal year ends
of pooled acquisitions 2 (11)
Purchased research and development
from acquisitions 379 436 273
Change in operating assets and liabilities:
Accounts receivable 54 (166) (559)
Inventories (434) (266) (74)
Prepaid expenses and other current assets (97) 22 6
Accounts payable 102 28 53
Income taxes payable 218 154 86
Accrued payroll and related expenses 282 127 67
Other accrued liabilities 550 306 118
- -------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 4,438 2,890 1,448
- -------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of short-term investments (1,250) (1,611) (1,431)
Proceeds from sales and maturities
of short-term investments 1,660 1,751 1,276
Purchases of investments (5,632) (3,561) (1,762)
Proceeds from sales and maturities
of investments 1,994 1,107 1,052
Purchases of restricted investments (1,101) (527) (351)
Proceeds from sales and maturities
of restricted investments 560 337 219
Acquisition of property and equipment (584) (417) (332)
Acquisition of businesses, net of cash acquired
and purchased research and development (19) (19)
Net investment in leases (310) (171) (20)
Other (255) (3) (39)
- -------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (4,937) (3,095) (1,407)
- -------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Issuance of common stock 740 489 308
Common stock repurchases (323)
Other 6 (10) (5)
- -------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 746 479 (20)
- -------------------------------------------------------------------------------------------------
Net increase in cash and equivalents 247 274 21
Cash and equivalents, beginning of year 580 306 285
- -------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS, END OF YEAR $ 827 $ 580 $ 306
=================================================================================================
Non-cash investing and financing activities:
Transfers of securities to restricted investments $ -- $ -- $ 3,586
=================================================================================================
</TABLE>
See notes to consolidated financial statements.
15
<PAGE> 16
Consolidated Statements of Shareholders' Equity (in millions)
<TABLE>
<CAPTION>
Common Stock and
Additional
Common Stock Paid-In Capital Accumulated
Other Total
Retained Comprehensive Shareholders
Number of Shares Amount Earnings Income Equity
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AS OF JULY 28, 1996 2,927 $ 900 $ 1,770 $ 154 $ 2,824
Net income 1,051 1,051
Change in unrealized gain on investments (109) (109)
Translation adjustment (5) (5)
-----------
Comprehensive income 937
Issuance of common stock 107 308 308
Tax benefit from employee stock plans 274 274
Common stock repurchases (22) (10) (313) (323)
Pooling of interest acquisitions 17 7 (15) (8)
Purchase acquisitions 17 324 324
Adjustment to conform fiscal year
ends of pooled acquisitions (11) (11)
- -----------------------------------------------------------------------------------------------------------------
BALANCE AS OF JULY 26, 1997 3,046 1,803 2,482 40 4,325
Net income 1,355 1,355
Change in unrealized gain on investments 28 28
Translation adjustment (10) (10)
-----------
Comprehensive income 1,373
Issuance of common stock 82 489 489
Tax benefit from employee stock plans 422 422
Pooling of interest acquisitions 3 12 (9) 3
Purchase acquisitions 21 536 536
- -----------------------------------------------------------------------------------------------------------------
BALANCE AS OF JULY 25, 1998 3,152 3,262 3,828 58 7,148
Net income 2,096 2,096
Change in unrealized gain on investments 234 234
Translation adjustment 6 6
-----------
Comprehensive income 2,336
Issuance of common stock 98 740 740
Tax benefit from employee stock plans 837 837
Pooling of interest acquisitions 8 115 (70) 45
Purchase acquisitions 13 570 570
Adjustment to conform fiscal year
ends of pooled acquisitions 2 2
- -----------------------------------------------------------------------------------------------------------------
BALANCE AS OF JULY 31, 1999 3,271 $ 5,524 $ 5,856 $ 298 $11,678
=================================================================================================================
</TABLE>
See notes to consolidated financial statements.
16
<PAGE> 17
1. Description of Business
Cisco Systems, Inc. (the "Company") provides networking solutions that connect
computing devices and computer networks, allowing people to access or transfer
information without regard to differences in time, place, or type of computer
system. The Company sells its products in approximately 105 countries through a
combination of direct sales and reseller and distribution channels.
2. Summary of Significant Accounting Policies
FISCAL YEAR. The Company's fiscal year is the 52 or 53 weeks ending on the last
Saturday in July. The fiscal year ended July 31, 1999, was a 53-week year. The
fiscal years ended July 25, 1998, and July 26, 1997, were 52-week years.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the
accounts of Cisco Systems, Inc. and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
CASH AND EQUIVALENTS. The Company considers cash and all highly liquid
investments purchased with an original or remaining maturity of less than three
months at the date of purchase to be cash equivalents. Substantially all of its
cash and equivalents are custodied with three major financial institutions.
INVESTMENTS. The Company's investments comprise U.S., state, and municipal
government obligations and foreign and public corporate equity securities.
Investments with maturities of less than one year are considered short term and
are carried at fair value. Nearly all investments are held in the Company's name
and custodied with two major financial institutions. The specific identification
method is used to determine the cost of securities disposed of, with realized
gains and losses reflected in other income and expense. At July 31, 1999, and
July 25, 1998, substantially all of the Company's investments were classified as
available for sale. Unrealized gains and losses on these investments are
included as a separate component of shareholders' equity, net of any related tax
effect. The Company also has certain investments in nonpublicly traded
companies. These investments are included in "Other Assets" in the Company's
balance sheet and are generally carried at cost. The Company monitors these
investments for impairment and makes appropriate reductions in carrying values
when necessary.
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is
computed using standard cost, which approximates actual cost on a first-in,
first-out basis.
RESTRICTED INVESTMENTS. Restricted investments consist of U.S. governmental
obligations with maturities of more than one year. These investments are carried
at fair value and are restricted as to withdrawal (see Note 7). Restricted
investments are held in the Company's name and custodied with two major
financial institutions.
FAIR VALUE OF FINANCIAL INSTRUMENTS. Carrying amounts of certain of the
Company's financial instruments, including cash and equivalents, accrued
payroll, and other accrued liabilities, approximate fair value because of their
short maturities. The fair values of investments are determined using quoted
market prices for those securities or similar financial instruments (see Note
5).
CONCENTRATIONS. Cash and equivalents are, for the most part, maintained with
several major financial institutions in the United States. Deposits held with
banks may exceed the amount of insurance provided on such deposits. Generally
these deposits may be redeemed upon demand and therefore, bear minimal risk.
The Company performs ongoing credit evaluations of its customers and, with the
exception of certain financing transactions, does not require collateral from
its customers.
The Company receives certain of its custom semiconductor chips for some of its
products from sole suppliers. Additionally, the Company relies on a limited
number of hardware manufacturers. The inability of any supplier or manufacturer
17
<PAGE> 18
to fulfill supply requirements of the Company could impact future results.
REVENUE RECOGNITION. The Company generally recognizes product revenue upon
shipment of product unless there are significant post-delivery obligations or
collection is not considered probable at the time of sale. When significant
post-delivery obligations exist, revenue is deferred until such obligations are
fulfilled. Revenue from service obligations is deferred and generally recognized
ratably over the period of the obligation. The Company makes certain sales to
partners in two-tier distribution channels. These customers are generally given
privileges to return a portion of inventory and participate in various
cooperative marketing programs. The Company recognizes revenues to two-tier
distributors based on management estimates to approximate the point that
products have been sold by the distributors and also maintains appropriate
accruals and allowances for all other programs. The Company accrues for warranty
costs, sales returns, and other allowances at the time of shipment based on its
experience.
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 operating results or financial position.
NET INVESTMENT IN LEASES. Net investment in leases represents sales-type and
direct-financing leases. These leases typically have terms of two to five years
and are usually collateralized by a security interest in the underlying assets.
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.
DEPRECIATION AND AMORTIZATION. Property and equipment are stated at cost and
depreciated on a straight-line basis over the estimated useful lives of the
assets. Such lives vary from two and one-half to five years. Goodwill and other
intangible assets are included in other assets and are carried at cost less
accumulated amortization, which is being provided on a straight-line basis over
the economic lives of the respective assets, generally three to five years.
INCOME TAXES. Income tax expense is based on pretax financial accounting income.
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities and their reported amounts.
COMPUTATION OF NET INCOME PER COMMON 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 common share is computed using the weighted
average number of common and dilutive common equivalent shares outstanding
during the period. Dilutive common equivalent shares consist of stock options
(see Note 12). Share and per-share data presented reflect the two-for-one stock
split effective June 1999 and the three-for-two stock splits effective September
1998 and December 1997.
FOREIGN CURRENCY TRANSLATION. Substantially all of the Company's international
subsidiaries use their local currency as their functional currency. For those
subsidiaries using the local currency as their functional currency, assets and
liabilities are translated at exchange rates in effect at the balance sheet date
and income and expense accounts at average exchange rates during the year.
Resulting translation adjustments are recorded directly to a separate component
of shareholders' equity. Where the U.S. dollar is the functional currency,
translation adjustments are recorded in income.
DERIVATIVES. The Company enters into forward exchange contracts to minimize the
short-term impact of foreign currency fluctuations on assets and liabilities
denominated in currencies other than the functional currency of the reporting
entity. All foreign exchange forward contracts are highly inversely correlated
18
<PAGE> 19
to the hedged items and are designated as, and considered, effective as hedges
of the underlying assets or liabilities. Gains and losses on the contracts are
included in interest and other income, net and offset foreign exchange gains or
losses from the revaluation of intercompany balances, or other current assets
and liabilities denominated in currencies other than the functional currency of
the reporting entity. Fair values of exchange contracts are determined using
published rates. If a derivative contract terminates prior to maturity, the
investment is shown at its fair value with the resulting gain or loss reflected
in interest and other income, net.
MINORITY INTEREST Minority interest represents the preferred stockholders'
proportionate share of the equity of Nihon Cisco Systems, K.K. At July 31, 1999,
the Company owned all issued and outstanding common stock, amounting to 73.2% of
the voting rights. Each share of preferred stock is convertible into one share
of common stock at any time at the option of the holder.
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Estimates are used for, but not limited to, the accounting for doubtful
accounts, inventory reserves, depreciation and amortization, sales returns,
warranty costs, taxes, and contingencies. Actual results could differ from these
estimates.
COMPREHENSIVE INCOME In the first quarter of fiscal 1999, the Company adopted
SFAS No. 130 "Reporting Comprehensive Income". Under SFAS 130 the Company is
required to report comprehensive income, which includes the Company's net
income, as well as changes in equity from other sources. In the Company's case,
the other changes in equity included in comprehensive income comprise unrealized
gains and losses on other available-for-sale investments and the foreign
currency cumulative translation adjustment. The adoption of SFAS 130 had no
impact on the Company's net income, balance sheet, or shareholders' equity.
SEGMENT INFORMATION In 1999, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 131 "Disclosures about Segments of an Enterprise
and Related Information". SFAS 131 supercedes SFAS No. 14, "Financial Reporting
for Segments of a Business Enterprise". Under the new standard the Company is
required to use the "management" approach to reporting its segments. The
management approach designates that the internal organization that is used by
management for making operating decisions and assessing performance as the
source of the Company's segments. The adoption of SFAS 131 had no impact on the
Company's net income, balance sheet, or shareholders' equity.
RECENT ACCOUNTING PRONOUNCEMENT In June 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 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 12-month period. The
Company will now adopt SFAS 133 as required for its first quarterly filing of
fiscal year 2001.
3. Business Combinations
Pooling of Interests Combinations
On June 24, 1999, the Company acquired GeoTel Communications Corporation
("GeoTel"). Under the terms of the agreement, 1.0276 shares of the Company's
common stock were exchanged for each outstanding share of GeoTel. Approximately
28 million shares of common stock were issued to acquire GeoTel. The Company
also assumed remaining outstanding stock options that were converted to options
to purchase approximately six million shares of the Company's common stock. The
19
<PAGE> 20
transaction was accounted for as a pooling of interests in fiscal year 1999;
therefore, all prior periods presented have been restated.
Prior to the merger, GeoTel used a calendar year end. Restated financial
statements of the Company combine the July 31, 1999, July 25, 1998, and July 26,
1997, results of the Company with the July 31, 1999, June 30, 1998, and June 30,
1997, results of GeoTel, respectively. No adjustments were necessary to conform
accounting policies of the entities. However, GeoTel's historical results have
been adjusted to reflect an increase in income taxes because of the elimination
of a previously provided valuation allowance on its deferred tax assets. There
were no intercompany transactions requiring elimination in any period presented.
In order for both companies to operate on the same fiscal year for 1999,
GeoTel's operations for the one-month period ending July 31, 1998, which are not
significant to the Company, have been reflected as an adjustment to retained
earnings in fiscal 1999.
The following table shows the historical results of the Company and GeoTel for
the periods prior to the consummation of the merger of the two entities (in
millions):
<TABLE>
<CAPTION>
Nine Months Ended Year Ended
May 1, 1999 July 25, 1998 July 26, 1997
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Cisco $ 8,562 $ 8,459 $ 6,440
GeoTel 44 29 12
- -------------------------------------------------------------------------------------
Total $ 8,606 $ 8,488 $ 6,452
- -------------------------------------------------------------------------------------
Net income:
Cisco as previously reported $ 1,452 $ 1,350 $ 1,049
GeoTel as previously reported 9 8 2
- -------------------------------------------------------------------------------------
Total 1,461 1,358 1,051
Adjustment to reflect elimination
of valuation allowances (3)
- -------------------------------------------------------------------------------------
Net income, as restated $ 1,461 $ 1,355 $ 1,051
- -------------------------------------------------------------------------------------
</TABLE>
The Company has also completed a number of other pooling transactions. The
historical operations of these entities were not material to the Company's
consolidated operations on either an individual or an aggregate basis;
therefore, prior period statements have not been restated for these
acquisitions. These transactions are summarized as follows (in millions of
shares):
<TABLE>
<CAPTION>
Total Shares of
Fiscal Year Acquired Companies Cisco Stock Issued
- ----------------------------------------------------------------------
<S> <C> <C>
1997 Nashoba Networks 7
Granite Systems, Inc. 10
1998 Precept Software, Inc. 3
1999 Fibex Systems 6
Sentient Networks, Inc. 2
</TABLE>
In conjunction with these poolings, the Company also assumed the outstanding
options of these companies, which were converted to options to purchase
approximately nine million shares of the Company's common stock.
Purchase Combinations
During the three years ended July 31, 1999, the Company 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.
The amounts allocated to purchased research and development were determined
through established valuation techniques in the high-technology communications
20
<PAGE> 21
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. Each transaction is outlined as follows:
Summary of Purchase Transactions (in millions)
<TABLE>
<CAPTION>
Purchased Research and Form of Consideration
Acquired Companies Consideration Date Development Charge and Other Notes to Acquisition
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL 1999
American Internet Corporation $ 58 Oct. 1998 $ 41 Common stock and options assumed; goodwill and
other intangibles recorded of $18
Summa Four, Inc. $129 Nov. 1998 $ 64 Common stock and options assumed, $16 in
liabilities assumed; goodwill and other
intangibles recorded of $29
Clarity Wireless, Inc. $153 Nov. 1998 $ 94 Common stock and options assumed; goodwill and
other intangibles recorded of $73
Selsius Systems, Inc. $134 Nov. 1998 $ 92 $111 in cash; options assumed; goodwill and other
intangibles recorded of $41
PipeLinks, Inc. $118 Dec. 1998 $ 99 Common stock and options assumed; goodwill and
other intangibles recorded of $11
Amteva Technologies, Inc. $159 June 1999 $ 81 Common stock and options assumed; goodwill
and other intangibles recorded of $85;
liabilities assumed of $9
- ---------------------------------------------------------------------------------------------------------------------------------
FISCAL 1998
Dagaz Technologies, Inc. $130 Aug. 1997 $127 $108 in cash, $18 in common stock, and
assumed liabilities of $4
LightSpeed International, Inc. $161 Feb. 1998 $143 Common stock and options assumed; other
intangibles recorded of $15
WheelGroup Corporation $124 March 1998 $ 97 Common stock and options assumed; goodwill
and other intangibles recorded of $38
NetSpeed International, Inc. $252 April 1998 $179 $222 in common stock and options assumed,
$12 cash and assumed liabilities of $18;
goodwill and other intangibles recorded of $76
CLASS Data Systems $ 51 June 1998 $ 48 Cash of $38 and options assumed
- ---------------------------------------------------------------------------------------------------------------------------------
FISCAL 1997
Telebit Corporation $200 Oct. 1996 $174 Cash
Netsys Technologies $ 85 Nov. 1996 $ 43 $81 in common stock and $4 in liabilities
assumed; goodwill and other intangibles
recorded of $42
Skystone Systems Corporation $ 92 July 1997 $ 89 $69 in common stock and $23 in cash
Ardent Communications $165 July 1997 $164 Common stock
Global Internet Software Group $ 40 July 1997 $ 38 Cash
</TABLE>
Total purchased research and development expense in 1999, 1998, and 1997 was
$471 million, $594 million, and $508 million, respectively. The purchased
research and development expense that was attributable to stock consideration in
purchase acquisitions for the same periods was $379 million, $436 million, and
$273 million, respectively.
Pending Business Combinations (unaudited)
In June 1999, the Company announced definitive agreements to purchase TransMedia
Communications, Inc. ("TransMedia") and StratumOne Communications, Inc.
("StratumOne"). TransMedia provides Media Gateway technology that unites the
multiple networks of public voice communications. StratumOne is a developer of
highly integrated, high-performance semiconductor technology.
In August 1999, the Company announced definitive agreements to purchase Calista
Inc. ("Calista"); MaxComm Technologies, Inc. ("MaxComm"); Cerent Corporation
("Cerent"); and Monterey Networks, Inc. ("Monterey"). Calista is a developer of
Internet technology that allows different business phone systems to work
together over an open Internet-based infrastructure for the first time. MaxComm
is a developer of broadband Internet technology that brings data and
21
<PAGE> 22
multiple voice lines to consumers. Cerent is a developer of next-generation
optical transport products, and Monterey is a developer of infrastructure-class,
optical cross-connect technology that is used to increase network capacity at
the core of an optical network.
The terms of the pending business combinations are as follows (in millions):
<TABLE>
<CAPTION>
Entity Name Consideration Accounting Treatment
- ----------------------------------------------------------------------
<S> <C> <C>
TransMedia Communications, Inc. $ 407 Pooling of interests
StratumOne Communications, Inc. 435 Pooling of interests
Calista, Inc. 55 Purchase
MaxComm Technologies, Inc. 143 Purchase
Cerent Corporation 6,900 Pooling of interests
Monterey Networks, Inc. 500 Purchase
</TABLE>
Consideration for each of the above transactions will be the Company's common
stock.
4. Balance Sheet Detail (in millions)
<TABLE>
<CAPTION>
July 31, 1999 July 25, 1998
- ---------------------------------------------------------------------
<S> <C> <C>
INVENTORIES, NET:
Raw materials $ 143 $ 76
Work in process 198 143
Finished goods 276 111
Demonstration systems 35 32
- ---------------------------------------------------------------------
Total $ 652 $ 362
=====================================================================
PROPERTY AND
EQUIPMENT, NET:
Leasehold improvements $ 282 $ 154
Computer equipment and
related software 628 537
Production and engineering
equipment 238 139
Office equipment, furniture,
fixtures, and other 676 441
- ---------------------------------------------------------------------
1,824 1,271
Less accumulated depreciation
and amortization (1,023) (672)
- ---------------------------------------------------------------------
Total $ 801 $ 599
=====================================================================
OTHER ASSETS, NET:
Goodwill--gross $ 157 $ 57
Other intangibles--gross 395 143
Accumulated amortization
of intangible assets (92) (30)
- ---------------------------------------------------------------------
Intangibles, net 460 170
Investments in nonpublic
companies 196 90
Net investment in leases 500 190
Other assets 41 92
- ---------------------------------------------------------------------
Total $ 1,197 $ 542
=====================================================================
ACCRUED PAYROLL AND RELATED EXPENSES:
Accrued wages, paid time
off, and related expenses $ 318 $ 172
Accrued commissions 138 83
Accrued bonuses 222 137
- ---------------------------------------------------------------------
Total $ 678 $ 392
=====================================================================
OTHER ACCRUED LIABILITIES:
Deferred revenue $ 724 $ 339
Accrued warranties 67 48
Other liabilities 543 341
- ---------------------------------------------------------------------
Total $ 1,334 $ 728
=====================================================================
</TABLE>
22
<PAGE> 23
Amortization expense of intangible assets for the fiscal years ended July 31,
1999, July 25, 1998, and July 26, 1997, was $62 million, $23 million, and $11
million, respectively.
5. Investments
The following tables summarize the Company's investments in securities (in
millions):
<TABLE>
<CAPTION>
Amortized Gross Unrealized Gross Unrealized Fair
July 31, 1999 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government notes and bonds $2,187 $ $ (29) $2,158
State, municipal, and county
government notes and bonds 5,177 5 (44) 5,138
Corporate notes and bonds 1,145 (17) 1,128
Corporate equity securities 288 615 (26) 877
- ----------------------------------------------------------------------------------------------------------
Total $8,797 $ 620 $ (116) $9,301
==========================================================================================================
Reported as:
Short-term investments $1,189
Investments 7,032
Restricted investments 1,080
- ----------------------------------------------------------------------------------------------------------
Total $9,301
==========================================================================================================
Amortized Gross Unrealized Gross Unrealized Fair
July 25, 1998 Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------
U.S. government notes and bonds $ 978 $ 3 $ (1) $ 980
State, municipal, and county
government notes and bonds 3,216 11 (3) 3,224
Foreign government notes and bonds 31 31
Corporate notes and bonds 768 1 (1) 768
Corporate equity securities 55 137 (21) 171
- ----------------------------------------------------------------------------------------------------------
Total $5,048 $152 $(26) $5,174
==========================================================================================================
Reported as:
Short-term investments $1,157
Investments 3,463
Restricted investments 554
- ----------------------------------------------------------------------------------------------------------
Total $5,174
==========================================================================================================
</TABLE>
The following table summarizes debt maturities (including restricted
investments) at July 31, 1999 (in millions):
<TABLE>
<CAPTION>
Amortized Cost Fair Value
- -----------------------------------------------------------------------
<S> <C> <C>
Less than one year $1,403 $1,397
Due in 1-2 years 1,447 1,442
Due in 2-5 years 5,064 5,005
Due after 5 years 595 580
- -----------------------------------------------------------------------
Total $8,509 $8,424
=======================================================================
</TABLE>
During fiscal year 1997, the Company began to sell its minority equity position
in a publicly traded company, which was completed in fiscal year 1998. Also, in
fiscal 1997, the Company established the Cisco Systems Foundation ("the
Foundation"). As part of this initiative, the Company donated a portion of the
equity investment, along with other equity securities to the Foundation, with a
combined cost basis of approximately $2 million and an approximate fair value of
$72 million at July 26, 1997. The realized gains reported on the sale of this
investment, net of the 1997 donation to the Foundation, were $152 million in
fiscal 1997 and $5 million in fiscal 1998.
6. Line of Credit
As of July 31, 1999, the Company had a syndicated credit agreement under the
23
<PAGE> 24
terms of which a group of banks committed a maximum of $500 million on an
unsecured, revolving basis for cash borrowings of various maturities. The
commitments made under this agreement expire on July 1, 2002. Under the terms of
the agreement, borrowings bear interest at a spread over the London Interbank
Offered Rate based on certain financial criteria and third-party rating
assessments. As of July 31, 1999, this spread was 20 basis points. From this
spread, a commitment fee of seven basis points is assessed against any undrawn
amounts. The agreement includes a single financial covenant that places a
variable floor on tangible net worth, as defined, if certain leverage ratios are
exceeded. There have been no borrowings under this agreement.
7. Commitments and Contingencies
Leases
The Company has entered into several agreements to lease 448 acres of land
located in San Jose, California, where it has established its headquarters
operations, and 45 acres of land located in Research Triangle Park, North
Carolina, where it has expanded certain research and development and customer
support activities. All of the leases have initial terms of five to seven years
and options to renew for an additional three to five years, subject to certain
conditions. At any time during the terms of these land leases, the Company may
purchase the land. If the Company elects not to purchase the land at the end of
each of the leases, the Company has guaranteed a residual value of $592 million.
The Company has also entered into agreements to lease certain buildings to
be constructed on the land described above. The lessors of the buildings have
committed to fund up to a maximum of $993 million (subject to reductions based
on certain conditions in the respective leases) for the construction of the
buildings, with the portion of the committed amount actually used to be
determined by the Company. Rent obligations for the buildings commenced on
various dates and will expire at the same time as the land leases.
The Company has an option to renew the building leases for an additional
three to five years, subject to certain conditions. The Company may, at its
option, purchase the buildings during or at the ends of the terms of the leases
at approximately the amount expended by the lessors to construct the buildings.
If the Company does not exercise the purchase options by the ends of the leases,
the Company will guarantee a residual value of the buildings as determined at
the lease inception date of each agreement (approximately $569 million at July
31, 1999).
As part of the above lease transactions, the Company restricted $1.1
billion of its investment securities as collateral for specified obligations of
the lessors under the leases. These investment securities are restricted as to
withdrawal and are managed by a third party subject to certain limitations under
the Company's investment policy. In addition, the Company must maintain a
minimum consolidated tangible net worth, as defined, of $2.8 billion.
The Company also leases office space in Santa Clara, California; Chelmsford,
Massachusetts; and for its various U.S. and international sales offices.
Future annual minimum lease payments under all noncancelable operating
leases as of July 31, 1999, are as follows (in millions):
<TABLE>
<S> <C>
- -------------------------------------------
2000 $ 156
2001 143
2002 122
2003 109
2004 97
Thereafter 448
- --------------------------------------------
Total minimum lease payments $1,075
============================================
</TABLE>
Rent expense totaled $121 million, $90 million, and $65 million for 1999, 1998,
and 1997, respectively.
24
<PAGE> 25
Forward Exchange Contracts
The Company conducts business on a global basis in several major international
currencies. As such, it is exposed to adverse movements in foreign currency
exchange rates. The Company enters into forward foreign exchange contracts to
reduce certain currency exposures. These contracts hedge exposures associated
with nonfunctional currency assets and liabilities denominated in Japanese,
Canadian, Australian, and several European currencies, including the euro. At
the present time, the Company hedges only those currency exposures associated
with certain nonfunctional currency assets and liabilities and does not
generally hedge anticipated foreign currency cash flows.
The Company does not enter into forward exchange contracts for trading
purposes. Gains and losses on the contracts are included in interest and other
income, net and offset foreign exchange gains or losses from the revaluation of
intercompany balances or other current assets and liabilities denominated in
currencies other than the functional currency of the reporting entity. The
Company's forward currency contracts generally range from one to three months in
original maturity. Forward exchange contracts outstanding and their unrealized
gains and (losses) as of July 31, 1999, are summarized as follows (in millions):
<TABLE>
<CAPTION>
Notional
Value Notional Unrealized
Purchased Value Sold Gain/(Loss)
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Japanese yen $ $ (49) $
Australian dollar (58)
Canadian dollar (73)
Euro 150
British pound
sterling 33
Other European
currencies 12
Other Asian
currencies 16
- -----------------------------------------------------------------------------
Total $ 211 $(180) $ --
=============================================================================
</TABLE>
The Company's forward exchange contracts contain credit risk in that its banking
counterparties may be unable to meet the terms of the agreements. The Company
minimizes such risk by limiting its counterparties to major financial
institutions. In addition, the potential risk of loss with any one party
resulting from this type of credit risk is monitored. Management does not expect
any material losses as a result of default by other parties.
Legal Proceedings
The Company and its subsidiaries are subject to legal proceedings, claims, and
litigation arising in the ordinary course of business. The Company's management
does not expect that the ultimate costs to resolve these matters will have a
material adverse effect on the Company's consolidated financial position,
results of operations, or cash flows.
8. Shareholders' Equity
Par Value At the Annual Meeting of Shareholders held on November 13, 1997, the
shareholders approved an amendment to the Articles of Incorporation changing the
par value of the Company's Common Stock from zero to $0.001 per share. As a
result, the Company has transferred the additional paid-in capital to a separate
account; however, for financial statement purposes, the additional paid-in
capital account has been combined with the common stock account and reflected on
the balance sheet as "Common stock and additional paid-in capital."
Stock Splits 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 effective on June 21, 1999. All
references to share and per-share data for all periods presented have been
adjusted to give effect to this two-for-one stock split and the two
three-for-two stock splits effective September 1998 and December 1997.
25
<PAGE> 26
Shareholder Rights Plan In June 1998, the Company's Board of Directors approved
a Shareholders' Rights Plan. This plan is intended to protect shareholders'
rights in the event of an unsolicited takeover attempt. It is not intended to
prevent a takeover of the Company on terms that are favorable and fair to all
shareholders and will not interfere with a merger approved by the Board of
Directors. Each right entitles shareholders to buy a "unit" equal to one
thirty-thousandth of a new share of Series A Preferred Stock of the Company. The
rights will be exercisable only if a person or a group acquires or announces a
tender or exchange offer to acquire 15% or more of the Company's common stock.
In the event the rights become exercisable, the rights plan allows for Cisco
shareholders to acquire, at an exercise price of $216 per right owned, stock of
the surviving corporation having a market value of $433, whether or not Cisco is
the surviving corporation. The dividend was distributed to shareholders of
record in June 1998. The rights, which expire June 2008, are redeemable for
$0.00033 per right at the approval of the Company's Board of Directors.
Preferred Stock Under the terms of the Company's Articles of Incorporation, the
Board of Directors may determine the rights, preferences, and terms of the
Company's authorized but unissued shares of preferred stock.
Comprehensive Income
The Company has adopted 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
had no impact on the Company's net income or total shareholders' equity.
The components of comprehensive income are as follows (in millions):
<TABLE>
<CAPTION>
July 31, 1999 July 25, 1998 July 26, 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $ 2,096 $ 1,355 $ 1,051
Other comprehensive income (loss):
Change in unrealized gain (loss) on investments, net of tax (provision)
benefit of ($144), ($17), and $9 in 1999, 1998, and 1997, respectively 234 25 (14)
Reclassification for unrealized gains previously included in net income, net
of tax (provision) benefit of ($2) and $57 in 1998 and 1997, respectively 3 (95)
- ----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gain (loss) 234 28 (109)
- ----------------------------------------------------------------------------------------------------------------------------------
Change in accumulated translation adjustments 6 (10) (5)
- ----------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income $ 2,336 $ 1,373 $ 937
==================================================================================================================================
</TABLE>
9. Employee Benefit Plans
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan ("the Purchase Plan") under
which 111 million shares of common stock have been reserved for issuance.
Eligible employees may purchase a limited number of shares of the Company's
stock at 85% of the market value at certain plan-defined dates.
In November 1997, the shareholders approved an amendment to the Purchase Plan,
which, among other changes, increased the maximum number of shares of Common
Stock authorized for issuance over the term of the Purchase Plan by 68 million
common shares, which is reflected in the number above, and extended the term of
the Plan from January 3, 2000, to January 3, 2005. In fiscal 1999, 1998, and
1997, five million, seven million, and six million shares, respectively, were
issued under the Purchase Plan. At July 31, 1999, 65 million shares were
available for issuance under the Purchase Plan.
Stock Option Plans
The Company has two main stock option plans: the 1987 Stock Option Plan (the
"Predecessor Plan") and the 1996 Stock Incentive Plan (the "1996 Plan"). All
outstanding options under the Predecessor Plan were transferred to the 1996
Plan. However, all outstanding options under the Predecessor Plan continue to be
26
<PAGE> 27
governed by the terms and conditions of the existing option agreements for those
grants. The maximum number of shares under the 1996 Plan was initially limited
to the 310 million shares transferred from the Predecessor Plan. However, under
the terms of the 1996 Plan, the share reserve increases each December for the
three fiscal years beginning with fiscal 1997, by an amount equal to 4.75% of
the outstanding shares on the last trading day of the immediately preceding
November. In fiscal year 1999, the Company's shareholders approved the extension
of the automatic share increase provision of the 1996 plan for an additional
three-year period. Although the Board has the authority to set other terms, the
options are generally 25% exercisable one year from the date of grant and then
ratably over the following 36 months. Options issued under the Predecessor Plan
generally had terms of five years. New options granted under the 1996 Plan
expire no later than nine years from the grant date.
A summary of option activity follows (in millions, except per-share amounts):
<TABLE>
<CAPTION>
Options Outstanding
Options Available Weighted Average
for Grant Options Exercise Price
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balances, July 28, 1996 76 312 $ 5.09
Granted and assumed (192) 192 10.83
Exercised (79) 2.84
Canceled 21 (21) 7.64
Additional shares reserved 143
- ------------------------------------------------------------------------------------
Balances, July 26, 1997 48 404 8.13
Granted and assumed (129) 129 21.72
Exercised (76) 5.31
Canceled 22 (22) 9.87
Additional shares reserved 147
- ------------------------------------------------------------------------------------
Balances, July 25, 1998 88 435 12.56
Granted and assumed (107) 107 49.58
Exercised (93) 6.85
Canceled 10 (10) 24.66
Additional shares reserved 165
- ------------------------------------------------------------------------------------
Balances, July 31, 1999 156 439 $ 22.52
====================================================================================
</TABLE>
The Company has, in connection with the acquisition of various companies,
assumed the stock option plans of each acquired company. A total of 30 million
shares of the Company's common stock have been reserved for issuance under the
assumed plans, and the related options are included in the preceding table.
The following tables summarize information concerning outstanding and
exercisable options at July 31, 1999 (in millions, except number of years and
per-share amounts):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted Average Weighted Average Weighted Average
Range of Number Remaining Contractual Exercise Price Number Exercise Price
Exercise Prices Outstanding Life (in Years) per Share Exercisable per Share
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.01 - 9.00 76 4.2 $ 5.34 66 $ 5.54
9.01 - 11.11 89 6.4 10.59 52 10.63
11.12 - 18.08 78 6.5 13.87 40 13.57
18.09 - 24.54 79 7.6 23.74 22 23.64
24.55 - 68.25 117 8.4 47.69 5 29.12
- -------------------------------------------------------------------------------------------------------------------------
Total 439 6.8 $22.52 185 $11.50
=========================================================================================================================
</TABLE>
At July 25, 1998, and July 26, 1997, approximately 156 million, and 112 million
outstanding options, respectively, were exercisable. The weighted average
exercise prices for options were $7.27 and $4.59 at July 25, 1998, and July 26,
1997, respectively.
SFAS No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123"),
27
<PAGE> 28
requires the Company to disclose pro forma information regarding option grants
made to its employees. SFAS 123 specifies certain valuation techniques that
produce estimated compensation charges that are included in the pro forma
results below. These amounts have not been reflected in the Company's Statement
of Operations, because APB 25, "Accounting for Stock Issued to Employees,"
specifies that no compensation charge arises when the price of the employees'
stock options equal the market value of the underlying stock at the grant date,
as in the case of options granted to the Company's employees.
SFAS 123 pro forma numbers are as follows (in millions, except per-share amounts
and percentages):
<TABLE>
<CAPTION>
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income--as reported under APB 25 $2,096 $1,355 $1,051
Net income--pro forma under SFAS 123 $1,598 $1,108 $ 899
Basic net income per common share--as reported under APB 25 $ 0.65 $ 0.44 $ 0.35
Diluted net income per common share--as reported under APB 25 $ 0.62 $ 0.42 $ 0.34
Basic net income per common share--pro forma under SFAS 123 $ 0.50 $ 0.36 $ 0.30
Diluted net income per common share--pro forma under SFAS 123 $ 0.47 $ 0.35 $ 0.29
</TABLE>
Under SFAS 123, the fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following weighted
average assumptions:
<TABLE>
<CAPTION>
Employee Stock Options Employee Stock Purchase Plan
---------------------- ----------------------------
1999 1998 1997 1999 1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Expected dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Risk-free interest rate 5.1% 5.7% 6.4% 4.9% 5.4% 5.3%
Expected volatility 40.2% 35.6% 32.8% 47.2% 44.8% 44.4%
Expected life (in years) 3.1 3.1 3.1 0.5 0.5 0.5
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of the Company's options. The weighted average estimated fair
values of employee stock options granted during fiscal 1999, 1998, and 1997 were
$16.79, $7.14, and $3.47 per share, respectively.
The above pro forma disclosures are also not likely to be representative of
the effects on net income and net income per common share in future years,
because they do not take into consideration pro forma compensation expense
related to grants made prior to the Company's fiscal year 1996.
Employee 401(k) Plans
The Company has adopted a plan known as the Cisco Systems, Inc. 401(k) Plan
("the Plan") to provide retirement and incidental benefits for its employees. As
allowed under Section 401(k) of the Internal Revenue Code, the Plan provides
tax-deferred salary deductions for eligible employees. The Company also has
other 401(k) plans which it administers. These plans arose from acquisitions of
other companies and are not material to the Company on either an individual or
aggregate basis.
Employees may contribute from 1% to 15% of their annual compensation to the
Plan, limited to a maximum annual amount as set periodically by the Internal
Revenue Service. The Company matches employee contributions dollar for dollar up
to a maximum of $1,500 per year per person. All matching contributions vest
immediately. In addition, the Plan provides for discretionary contributions as
determined by the Board of Directors. Such contributions to the Plan are
allocated among eligible participants in the proportion of their salaries to the
total salaries of all participants. Company matching contributions to the Plan
totaled $20 million in 1999, $15 million in 1998, and $13 million in 1997. No
discretionary contributions were made in 1999, 1998, or 1997.
28
<PAGE> 29
10. Income Taxes
The provision (benefit) for income taxes consists of (in millions):
<TABLE>
<CAPTION>
1999 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal:
Current $ 1,164 $ 855 $ 845
Deferred (184) (39) (172)
- -------------------------------------------------------------------------------
980 816 673
===============================================================================
State:
Current 112 87 153
Deferred (21) (7) (15)
- -------------------------------------------------------------------------------
91 80 138
===============================================================================
Foreign:
Current 151 74 28
Deferred (2) (14) 1
- -------------------------------------------------------------------------------
149 60 29
- -------------------------------------------------------------------------------
Total provision for income taxes $ 1,220 $ 956 $ 840
===============================================================================
</TABLE>
The Company paid income taxes of $301 million, $440 million, and $659 million,
in fiscal 1999, 1998, and 1997, respectively.
Income (loss) before provision for income taxes consisted of (in millions):
<TABLE>
<CAPTION>
1999 1998 1997
- -----------------------------------------------------------
<S> <C> <C> <C>
U.S. $ 2,205 1,990 2,011
International 1,111 321 (120)
- -----------------------------------------------------------
$ 3,316 $ 2,311 $ 1,891
===========================================================
</TABLE>
The items accounting for the difference between income taxes computed at the
federal statutory rate and the provision for income taxes follow:
<TABLE>
<CAPTION>
1999 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal statutory rate 35.0% 35.0% 35.0%
Effect of:
State taxes, net of federal benefits 2.2 2.2 4.5
Foreign sales corporation (1.6) (2.4) (3.3)
Foreign income at other than U.S. rates (1.0)
Nondeductible purchased R&D 3.8 6.4 7.1
Tax-exempt interest (1.9) (1.6) (1.0)
Tax credits (1.2) (1.4) (1.3)
Other, net 1.5 3.2 3.4
- ----------------------------------------------------------------------------------------
36.8% 41.4% 44.4%
========================================================================================
</TABLE>
U.S. income taxes and foreign withholding taxes were not provided for on a
cumulative total of approximately $133 million of undistributed earnings for
certain non-U.S. subsidiaries. The Company intends to reinvest these earnings
indefinitely in operations outside the United States. The components of the
deferred income tax assets (liabilities) follow (in millions):
29
<PAGE> 30
<TABLE>
<CAPTION>
July 31, 1999 July 25 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Assets
Allowance for doubtful accounts and returns $ 225 $ 134
Other nondeductible accruals 200 131
Purchased research and development 75 92
Inventory allowances and capitalization 57 68
Depreciation 56 24
Accrued state franchise tax 32 28
- --------------------------------------------------------------------------------
Total deferred tax assets 645 477
================================================================================
Liabilities
Deferred revenue (5) (26)
Unrealized gain on investments (192) (48)
- --------------------------------------------------------------------------------
Total deferred tax liabilities (197) (74)
================================================================================
$ 448 $ 403
</TABLE>
The noncurrent portion of the deferred income tax (liabilities)/assets, which
totaled ($89) million at July 31, 1999, and $58 million at July 25, 1998, is
included in other assets.
The Company's income taxes payable for federal, state, and foreign purposes
have been reduced by the tax benefits of disqualifying dispositions of stock
options. The Company receives an income tax benefit calculated as the difference
between the market value of the stock issued at the time of exercise and the
option price, tax effected.
11. 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.
30
<PAGE> 31
Summarized financial information by segment for 1999, 1998, and 1997, as taken
from the internal management information system discussed above, is as follows
(in millions):
<TABLE>
<CAPTION>
1999 1998 1997
- ----------------------------------------------------------------------
<S> <C> <C> <C>
Net sales:
Americas $ 8,069 $ 5,731 $ 3,968
EMEA 3,216 2,114 1,551
Asia/Pacific 825 535 453
Japan 566 459 587
Sales adjustments (522) (351) (107)
- ----------------------------------------------------------------------
Total - Net Sales $ 12,154 $ 8,488 $ 6,452
======================================================================
Standard margin(1):
Americas $ 5,836 $ 4,260
EMEA 2,380 1,565
Asia/Pacific 586 395
Japan 436 340
Sales adjustments (522) (351)
Production overhead (255) (207)
Manufacturing variances and
other related costs (547) (438)
- ----------------------------------------------------------------------
Total - Gross Margin $ 7,914 $ 5,564
======================================================================
</TABLE>
(1) Standard margin by theater was not tracked by the Company prior to fiscal
year 1998.
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 consolidated statements of operations by including
such adjustments.
Enterprise-wide information is provided in accordance with SFAS 131. Geographic
sales information is based on the ordering location of the customer. Property
and equipment information is based on the physical location of the assets.
The following is net sales and property and equipment information for geographic
areas (in millions):
<TABLE>
<CAPTION>
1999 1998 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales:
U.S. $ 7,435 $ 5,231 $ 3,615
All other countries 5,241 3,608 2,944
Sales adjustments (522) (351) (107)
- -----------------------------------------------------------------------------------------
Total - Net Sales $ 12,154 $ 8,488 $ 6,452
- -----------------------------------------------------------------------------------------
Property and equipment, net:
U.S. $ 687 $ 527 $ 412
All other countries 114 72 56
- -----------------------------------------------------------------------------------------
Total $ 801 $ 599 $ 468
- -----------------------------------------------------------------------------------------
</TABLE>
The following table presents external net sales for groups of similar products
and services:
<TABLE>
<CAPTION>
1999 1998 1997 (1)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales:
Routers $ 5,196 $ 3,856
Switches 5,164 3,613
Access 1,127 630
Other 1,189 740
Sales adjustments (522) (351)
- -----------------------------------------------------------------------------------------
Total - Net Sales $ 12,154 $ 8,488
- -----------------------------------------------------------------------------------------
</TABLE>
(1)Information not available for fiscal year 1997.
Substantially all of the Company's assets at July 31, 1999 and July 25, 1998
were attributable to U.S. operations.
31
<PAGE> 32
In 1999, 1998, and 1997 no single customer accounted for 10% or more of the
Company's net sales.
12. Net Income per Common Share
The following table presents the calculation of basic and diluted net income per
common share as required under SFAS 128 (in millions, except per-share amounts):
<TABLE>
<CAPTION>
1999 1998 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $2,096 $1,355 $1,051
=========================================================================================
Weighted average shares--basic 3,213 3,094 2,990
Effect of dilutive securities: employee stock options 185 151 138
- -----------------------------------------------------------------------------------------
Weighted average shares--diluted 3,398 3,245 3,128
=========================================================================================
Net income per common share--basic $ 0.65 $ 0.44 $ 0.35
Net income per common share--diluted $ 0.62 $ 0.42 $ 0.34
=========================================================================================
</TABLE>
32
<PAGE> 33
To the Board of Directors and
Shareholders of Cisco Systems, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and of shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of Cisco
Systems, Inc. and its subsidiaries at July 31, 1999 and July 25, 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended July 31, 1999, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards, which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
San Jose, California
August 10, 1999
33
<PAGE> 34
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, in the City of San Jose, State of
California on this 3rd day of February, 2000.
Cisco Systems, Inc.
/s/ John T. Chambers
-----------------------------------
(John T. Chambers, President and
Chief Executive Officer)
34
<PAGE> 35
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- ------- -----------------------
<S> <C>
23.1 Consent of Independent Accountants
</TABLE>
35
<PAGE> 1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in this Registration
Statement on Form S-3 (Pre-Effective Amendment No.1) of Cisco Systems, Inc. of
our report dated August 10, 1999 relating to the consolidated financial
statements, which appears in Cisco Systems, Inc.'s 1999 Annual Report to
Shareholders, which is incorporated by reference in its Annual Report on Form
10-K/A for the year ended July 31, 1999. We also consent to the incorporation by
reference of our report dated August 10, 1999, relating to the financial
statement schedule, which appears in such Annual Report on Form 10-K/A. We also
consent to the incorporation by reference of our report dated August 10, 1999,
except as to the pooling of interest transactions as described in Note 3b which
is as of November 24, 1999, relating to the supplementary consolidated financial
statements of Cisco Systems, Inc. which appears in the Current Report on Form
8-K/A dated February 3, 2000. We also consent to the reference to us under the
heading "Experts" in such Registration Statement.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
February 3, 2000
