Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 29, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 0-18225

 

 

CISCO SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

 

California   77-0059951

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

170 West Tasman Drive

San Jose, California 95134

(Address of principal executive office and zip code)

(408) 526-4000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x

  Accelerated filer  ¨   Non-accelerated filer  ¨   Smaller reporting company  ¨
   

(Do not check if a smaller

reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

Number of shares of the registrant’s common stock outstanding as of November 15, 2011: 5,375,863,983

 

 

 


Table of Contents

Cisco Systems, Inc.

FORM 10-Q for the Quarter Ended October 29, 2011

INDEX

 

          Page  
Part I.    Financial Information      3   

Item 1.

   Financial Statements (Unaudited)      3   
   Consolidated Balance Sheets at October 29, 2011 and July 30, 2011      3   
   Consolidated Statements of Operations for the three months ended October 29, 2011 and October 30, 2010      4   
   Consolidated Statements of Cash Flows for the three months ended October 29, 2011 and October 30, 2010      5   
   Consolidated Statements of Equity for the three months ended October 29, 2011 and October 30, 2010      6   
   Notes to Consolidated Financial Statements      7   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      34   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      56   

Item 4.

   Controls and Procedures      58   
Part II.    Other Information      59   

Item 1.

   Legal Proceedings      59   

Item 1A.

   Risk Factors      60   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      73   

Item 3.

   Defaults Upon Senior Securities      74   

Item 5.

   Other Information      74   

Item 6.

   Exhibits      75   
   Signature      76   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

CISCO SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(in millions, except par value)

(Unaudited)

 

          October 29,
2011
     July 30,
2011
 

ASSETS

        

Current assets:

        

Cash and cash equivalents

      $ 4,747       $ 7,662   

Investments

        39,641         36,923   

Accounts receivable, net of allowance for doubtful accounts of $180 at October 29, 2011 and $204 at July 30, 2011

        4,300         4,698   

Inventories

        1,622         1,486   

Financing receivables, net

        3,300         3,111   

Deferred tax assets

        2,158         2,410   

Other current assets

        1,499         941   
     

 

 

    

 

 

 

Total current assets

        57,267         57,231   

Property and equipment, net

        3,753         3,916   

Financing receivables, net

        3,209         3,488   

Goodwill

        16,823         16,818   

Purchased intangible assets, net

        2,369         2,541   

Other assets

        3,543         3,101   
     

 

 

    

 

 

 

TOTAL ASSETS

      $ 86,964       $ 87,095   
     

 

 

    

 

 

 

LIABILITIES AND EQUITY

        

Current liabilities:

        

Short-term debt

      $ 589       $ 588   

Accounts payable

        908         876   

Income taxes payable

        455         120   

Accrued compensation

        2,557         3,163   

Deferred revenue

        8,444         8,025   

Other current liabilities

        4,508         4,734   
     

 

 

    

 

 

 

Total current liabilities

        17,461         17,506   

Long-term debt

   16,264         16,234   

Income taxes payable

   1,501         1,191   

Deferred revenue

   3,952         4,182   

Other long-term liabilities

   572         723   
     

 

 

    

 

 

 

Total liabilities

   39,750         39,836   
     

 

 

    

 

 

 

Commitments and contingencies (Note 12)

     

Equity:

     

Cisco shareholders’ equity:

     

Preferred stock, no par value: 5 shares authorized; none issued and outstanding

   —           —     

Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized; 5,371 and 5,435 shares issued and outstanding at October 29, 2011 and July 30, 2011, respectively

   38,297         38,648   

Retained earnings

   7,910         7,284   

Accumulated other comprehensive income

   981         1,294   
     

 

 

    

 

 

 

Total Cisco shareholders’ equity

   47,188         47,226   

Noncontrolling interests

   26         33   
     

 

 

    

 

 

 

Total equity

   47,214         47,259   
     

 

 

    

 

 

 

TOTAL LIABILITIES AND EQUITY

   $86,964       $ 87,095   
     

 

 

    

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per-share amounts)

(Unaudited)

 

     Three Months Ended  
     October 29,
2011
    October 30,
2010
 

NET SALES:

    

Product

   $ 8,952      $ 8,700   

Service

     2,304        2,050   
  

 

 

   

 

 

 

Total net sales

     11,256        10,750   
  

 

 

   

 

 

 

COST OF SALES:

    

Product

     3,563        3,249   

Service

     803        746   
  

 

 

   

 

 

 

Total cost of sales

     4,366        3,995   
  

 

 

   

 

 

 

GROSS MARGIN

     6,890        6,755   

OPERATING EXPENSES:

    

Research and development

     1,375        1,431   

Sales and marketing

     2,452        2,402   

General and administrative

     552        458   

Amortization of purchased intangible assets

     99        113   

Restructuring and other charges

     202        —     
  

 

 

   

 

 

 

Total operating expenses

     4,680        4,404   
  

 

 

   

 

 

 

OPERATING INCOME

     2,210        2,351   

Interest income

     164        160   

Interest expense

     (148     (166

Other income, net

     19        80   
  

 

 

   

 

 

 

Interest and other income, net

     35        74   
  

 

 

   

 

 

 

INCOME BEFORE PROVISION FOR INCOME TAXES

     2,245        2,425   

Provision for income taxes

     468        495   
  

 

 

   

 

 

 

NET INCOME

   $ 1,777      $ 1,930   
  

 

 

   

 

 

 

Net income per share:

    

Basic

   $ 0.33      $ 0.34   
  

 

 

   

 

 

 

Diluted

   $ 0.33      $ 0.34   
  

 

 

   

 

 

 

Shares used in per-share calculation:

    

Basic

     5,394        5,595   
  

 

 

   

 

 

 

Diluted

     5,407        5,675   
  

 

 

   

 

 

 

Cash dividends declared per common share

   $ 0.06      $ —     
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)

 

     Three Months Ended  
     October 29,
2011
    October 30,
2010
 

Cash flows from operating activities:

    

Net income

   $ 1,777      $ 1,930   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation, amortization and other

     621        553   

Share-based compensation expense

     341        407   

Provision for doubtful accounts

     (22 )     (22

Deferred income taxes

     109        338   

Excess tax benefits from share-based compensation

     (21 )     (28

Net gains on investments

     (13 )     (108

Change in operating assets and liabilities, net of effects of acquisitions and divestitures:

    

Accounts receivable

     399        506   

Inventories

     (168 )     (193

Financing receivables, net

     —          (78

Other assets

     (374     (30

Accounts payable

     36        45   

Income taxes, net

     (38 )     (408

Accrued compensation

     (548 )     (678

Deferred revenue

     232        (367

Other liabilities

     2        (200
  

 

 

   

 

 

 

Net cash provided by operating activities

     2,333        1,667   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of investments

     (11,770 )     (9,569

Proceeds from sales of investments

     7,721        6,232   

Proceeds from maturities of investments

     1,179        3,574   

Acquisition of property and equipment

     (265 )     (326

Acquisition of businesses, net of cash and cash equivalents acquired

     (38 )     (69 )

Change in investments in privately held companies

     (95 )     (28

Other

     77        19   
  

 

 

   

 

 

 

Net cash used in investing activities

     (3,191 )     (167 )
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Issuances of common stock

     203        374   

Repurchases of common stock

     (1,881 )     (2,701

Short-term borrowings, maturities less than 90 days, net

     —          (16 )

Excess tax benefits from share-based compensation

     21        28   

Dividends paid

     (322     —     

Other

     (78 )     30   
  

 

 

   

 

 

 

Net cash used in financing activities

     (2,057 )     (2,285
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (2,915 )     (785

Cash and cash equivalents, beginning of period

     7,662        4,581   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 4,747      $ 3,796   
  

 

 

   

 

 

 

Cash paid for:

    

Interest

   $ 220      $ 270   

Income taxes

   $ 398      $ 565   

See Notes to Consolidated Financial Statements.

 

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Table of Contents

CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(in millions)

(Unaudited)

 

Three Months Ended October 29, 2011

   Shares of
Common
Stock
    Common Stock
and  Additional
Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Total Cisco
Shareholders’
Equity
    Noncontrolling
Interests
    Total
Equity
 

BALANCE AT JULY 30, 2011

     5,435      $ 38,648      $ 7,284      $ 1,294      $ 47,226      $ 33      $ 47,259   

Net income

         1,777          1,777          1,777   

Change in:

              

Unrealized gains and losses on investments

           (52 )     (52 )     (7 )     (59 )

Derivative instruments

           (50 )     (50 )       (50 )

Cumulative translation adjustment and other

           (211 )     (211 )       (211 )
          

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

             1,464        (7 )     1,457   
          

 

 

   

 

 

   

 

 

 

Issuance of common stock

     45        203            203          203   

Repurchase of common stock

     (109 )     (852 )     (829 )       (1,681 )       (1,681 )

Cash dividends declared

         (322       (322       (322 )

Tax effects from employee stock incentive plans

       (43 )         (43 )       (43 )

Share-based compensation expense

       341            341          341   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT OCTOBER 29, 2011

     5,371      $ 38,297      $ 7,910      $ 981      $ 47,188      $ 26      $ 47,214   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended October 30, 2010

   Shares of
Common
Stock
    Common Stock
and Additional
Paid-In

Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Total Cisco
Shareholders’
Equity
    Noncontrolling
Interests
    Total
Equity
 

BALANCE AT JULY 31, 2010

     5,655      $ 37,793      $ 5,851      $ 623      $ 44,267      $ 18      $ 44,285   

Net income

         1,930          1,930          1,930   

Change in:

              

Unrealized gains and losses on investments

           40        40        2        42   

Derivative instruments

           49        49          49   

Cumulative translation adjustment and other

           238        238          238   
          

 

 

   

 

 

   

 

 

 

Comprehensive income

             2,257        2        2,259   
          

 

 

   

 

 

   

 

 

 

Issuance of common stock

     41        374            374          374   

Repurchase of common stock

     (119 )     (880 )     (1,747 )       (2,627 )       (2,627 )

Tax effects from employee stock incentive plans

       (9 )         (9 )       (9 )

Purchase acquisitions

       6            6          6   

Share-based compensation expense

       407            407          407   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT OCTOBER 30, 2010

     5,577      $ 37,691      $ 6,034      $ 950      $ 44,675      $ 20      $ 44,695   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of October 29, 2011, the Company’s Board of Directors had authorized an aggregate repurchase of up to $82 billion of common stock under this program with no termination date. For additional information regarding stock repurchases, see Note 13 to the Consolidated Financial Statements. The stock repurchases since the inception of this program and the related impact on Cisco shareholders’ equity are summarized in the following table (in millions):

 

     Shares of
Common
Stock
     Common Stock
and Additional
Paid-In
Capital
     Retained
Earnings
     Total Cisco
Shareholders’
Equity
 

Repurchases of common stock under the repurchase program

     3,578       $ 15,866       $ 57,451       $ 73,317   

See Notes to Consolidated Financial Statements.

 

6


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The fiscal year for Cisco Systems, Inc. (the “Company” or “Cisco”) is the 52 or 53 weeks ending on the last Saturday in July. Fiscal 2012 and fiscal 2011 are each 52-week fiscal years. The Consolidated Financial Statements include the accounts of Cisco and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company conducts business globally and is primarily managed on a geographic basis. Beginning in fiscal 2012, the Company is organized into the following three geographic segments: the Americas; Europe, Middle East, and Africa (“EMEA”); and Asia Pacific, Japan, and China (“APJC”). In fiscal 2011, the Company was organized into four geographic segments, which consisted of United States and Canada, European Markets, Emerging Markets, and Asia Pacific Markets. As a result of this geographic segment change in fiscal 2012, countries within the former Emerging Markets segment were consolidated into either EMEA or the Americas segment depending on their respective geographic locations. The Company has reclassified the geographic segment data for the prior period to conform to the current period’s presentation.

The accompanying financial data as of October 29, 2011 and for the three months ended October 29, 2011 and October 30, 2010 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The July 30, 2011 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 30, 2011.

The Company consolidates its investment in a venture fund managed by SOFTBANK Corp. and its affiliates (“SOFTBANK”) as the Company is the primary beneficiary. The noncontrolling interests attributed to SOFTBANK are presented as a separate component from the Company’s equity in the equity section of the Consolidated Balance Sheets. SOFTBANK’s share of the earnings in the venture fund is not presented separately in the Consolidated Statements of Operations and is included in other income, net, as this amount is not material for any of the fiscal periods presented.

In the opinion of management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present fairly the statement of financial position as of October 29, 2011 and results of operations, cash flows, and equity for the three months ended October 29, 2011 and October 30, 2010, as applicable, have been made. The results of operations for the three months ended October 29, 2011 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

In addition to the geographic segment change referred to above, certain other reclassifications have been made to prior period amounts in order to conform to the current period’s presentation.

The Company has evaluated subsequent events through the date that the financial statements were issued.

 

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Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

2. Summary of Significant Accounting Policies

Recent Accounting Standards or Updates Not Yet Effective

In May 2011, the Financial Accounting Standards Board (FASB) issued an accounting standard update to provide guidance on achieving a consistent definition of and common requirements for measurement of and disclosure concerning fair value as between U.S. GAAP and International Financial Reporting Standards. This accounting standard update is effective for the Company beginning in the third quarter of fiscal 2012. The Company is currently evaluating the impact of this accounting standard update on its Consolidated Financial Statements but does not expect it will have a material impact.

In June 2011, the FASB issued an accounting standard update to provide guidance on increasing the prominence of items reported in other comprehensive income. This accounting standard update eliminates the option to present components of other comprehensive income as part of the statement of equity and requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This accounting standard update is effective for the Company beginning in the first quarter of fiscal 2013.

In August 2011, the FASB approved a revised accounting standard update intended to simplify how an entity tests goodwill for impairment. The amendment will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting standard update will be effective for the Company beginning in the first quarter of fiscal 2013 and early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its Consolidated Financial Statements.

3. Business Combinations

The Company completed two business combinations during the three months ended October 29, 2011. A summary of the allocation of the total purchase consideration is presented as follows (in millions):

 

     Shares Issued      Purchase
Consideration
     Net
Liabilities
Assumed
    Purchased
Intangible
Assets
     Goodwill  

Total acquisitions

     —         $ 38       $ (2   $ 19       $ 21   

The total purchase consideration related to the Company’s business combinations completed during the three months ended October 29, 2011 consisted of either cash consideration or cash consideration along with vested share-based awards assumed. Total transaction costs related to business combination activities for the three months ended October 29, 2011 and October 30, 2010 were $2 million and $8 million, respectively, which were expensed as incurred and recorded as G&A expenses.

The Company continues to evaluate certain assets and liabilities related to business combinations completed during the recent periods. Additional information, which existed as of the acquisition date but was at that time unknown to the Company, may become known to the Company during the remainder of the measurement period, a period not to exceed 12 months from the acquisition date. Changes to amounts recorded as assets or liabilities may result in a corresponding adjustment to goodwill.

The goodwill generated from the Company’s business combinations completed during the three months ended October 29, 2011 is primarily related to expected synergies. The goodwill is not deductible for U.S. federal income tax purposes.

The Consolidated Financial Statements include the operating results of each business combination from the date of acquisition. Pro forma results of operations for the acquisitions completed during the three months ended October 29, 2011 have not been presented because the effects of the acquisitions, individually and in the aggregate, were not material to the Company’s financial results.

 

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Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

4. Goodwill and Purchased Intangible Assets

(a) Goodwill

Beginning in fiscal 2012, the Company’s reportable segments were changed to the following segments: the Americas, EMEA, and APJC. As a result, the Company reallocated the goodwill at July 30, 2011 to these reportable segments. The following table presents the goodwill allocated to the Company’s reportable segments as of and during the three months ended October 29, 2011 (in millions):

 

     Balance at
July 30,  2011
     Acquisitions      Other     Balance at
October 29, 2011
 

Americas

   $ 11,627       $ 12       $ (4   $ 11,635   

EMEA

     3,272         6         (12     3,266   

APJC

     1,919         3         —          1,922   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 16,818       $ 21       $ (16   $ 16,823   
  

 

 

    

 

 

    

 

 

   

 

 

 

In the preceding table, “Other” includes foreign currency translation and purchase accounting adjustments.

(b) Purchased Intangible Assets

The following table presents details of the Company’s intangible assets acquired through business combinations completed during the three months ended October 29, 2011 (in millions, except years):

 

     FINITE LIVES      INDEFINITE
LIVES
        
     TECHNOLOGY      CUSTOMER
RELATIONSHIPS
     OTHER      In-Process
Research &
Development
     TOTAL  
     Weighted-
Average
Useful Life
(in Years)
     Amount      Weighted-
Average
Useful Life
(in Years)
     Amount      Weighted-
Average
Useful Life
(in Years)
     Amount      Amount      Amount  

Total

     3.7       $ 19         —         $ —           —         $ —         $ —         $ 19   

The following tables present details of the Company’s purchased intangible assets (in millions):

 

October 29, 2011

   Gross      Accumulated
Amortization
    Net  

Purchased intangible assets with finite lives:

       

Technology

   $ 2,128       $ (642 )   $ 1,486   

Customer relationships

     2,269         (1,425 )     844   

Other

     123         (97 )     26   
  

 

 

    

 

 

   

 

 

 

Total purchased intangible assets with finite lives

     4,520         (2,164 )     2,356   

In-process research & development, with indefinite lives

     13         —          13   
  

 

 

    

 

 

   

 

 

 

Total

   $ 4,533       $ (2,164 )   $ 2,369   
  

 

 

    

 

 

   

 

 

 

 

July 30, 2011

   Gross      Accumulated
Amortization
    Net  

Purchased intangible assets with finite lives:

       

Technology

   $ 1,961       $ (561 )   $ 1,400   

Customer relationships

     2,277         (1,346 )     931   

Other

     123         (91 )     32   
  

 

 

    

 

 

   

 

 

 

Total purchased intangible assets with finite lives

     4,361         (1,998 )     2,363   

In-process research & development, with indefinite lives

     178         —          178   
  

 

 

    

 

 

   

 

 

 

Total

   $ 4,539       $ (1,998 )   $ 2,541   
  

 

 

    

 

 

   

 

 

 

Purchased intangible assets include intangible assets acquired through business combinations as well as through direct purchases or licenses.

 

9


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

The following table presents the amortization of purchased intangible assets (in millions):

 

     Three Months Ended  
     October 29, 2011      October 30, 2010  

Amortization of purchased intangible assets:

     

Cost of sales

   $ 96       $ 106   

Operating expenses

     99         113   
  

 

 

    

 

 

 

Total

   $ 195       $ 219   
  

 

 

    

 

 

 

The estimated future amortization expense of purchased intangible assets with finite lives as of October 29, 2011 is as follows (in millions):

 

Fiscal Year

   Amount  

2012 (remaining nine months)

   $ 580   

2013

     659   

2014

     474   

2015

     404   

2016

     187   

Thereafter

     52   
  

 

 

 

Total

   $ 2,356   
  

 

 

 

 

10


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

5. Restructuring and Other Charges

In fiscal 2011, the Company initiated a number of key, targeted actions to address several areas in its business model. These actions are intended to simplify and focus the Company’s organization and operating model; align the Company’s cost structure given transitions in the marketplace; divest or exit underperforming operations; and deliver value to the Company’s shareholders. The Company is taking these actions to align its business based on its five foundational priorities: leadership in its core business (routing, switching, and associated services) which includes comprehensive security and mobility solutions; collaboration; data center virtualization and cloud; video; and architectures for business transformation. The Company announced in July 2011 that it would incur pretax charges, which are not expected to exceed $1.3 billion, as part of these expense reduction actions. In connection with the July announcement, the Company has incurred cumulative charges of approximately $925 million through October 29, 2011 (included as part of the charges discussed below). The Company expects to complete these restructuring actions by the end of fiscal 2012 with the corresponding restructuring charges recognized during the remainder of fiscal 2012.

During the three months ended October 29, 2011, the Company incurred total restructuring charges of $202 million consisting of $174 million of employee severance charges and $28 million of other restructuring charges. The employee severance charges consisted of $212 million of charges primarily related to impacted employees in the Company’s international locations, partially offset by a reduction of $38 million related to a change in estimate regarding certain employee severance charges incurred in the fourth quarter of fiscal 2011. Other charges incurred during the three months ended October 29, 2011 were primarily for the consolidation of excess facilities, as well as an incremental charge related to the sale of the Company’s Juarez, Mexico manufacturing operations, which sale was completed in the first quarter of fiscal 2012.

The following table summarizes the activity related to the restructuring and other charges related to the Company’s July 2011 announcement and the realignment and restructuring of the Company’s consumer product lines announced during the third quarter of fiscal 2011 (in millions):

 

     Voluntary Early
Retirement Program
    Employee
Severance
    Goodwill  and
Intangible
Assets
    Other     Total  

Initial charges in fiscal 2011

   $ 453      $ 247      $ 71     $ 28      $ 799   

Cash payments

     (436     (13     —          —          (449 )

Non-cash items

     —          —          (71     (17     (88 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of July 30, 2011

     17       234        —          11        262   

Charges

     —          174        —          28        202   

Cash payments

     (17     (276     —          (4     (297 )

Non-cash items

     —          —          —          (18     (18 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of October 29, 2011

   $ —        $ 132      $ —        $ 17      $ 149   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

11


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

6. Balance Sheet Details

The following tables provide details of selected balance sheet items (in millions):

 

     October 29,
2011
    July 30,
2011
 

Inventories:

    

Raw materials

   $ 193      $ 219   

Work in process

     43        52   

Finished goods:

    

Distributor inventory and deferred cost of sales

     684        631   

Manufactured finished goods

     437        331   
  

 

 

   

 

 

 

Total finished goods

     1,121        962   
  

 

 

   

 

 

 

Service-related spares

     195        182   

Demonstration systems

     70        71   
  

 

 

   

 

 

 

Total

   $ 1,622      $ 1,486   
  

 

 

   

 

 

 

Property and equipment, net:

    

Land, buildings, and building & leasehold improvements

   $ 4,616      $ 4,760   

Computer equipment and related software

     1,410        1,429   

Production, engineering, and other equipment

     5,075        5,093   

Operating lease assets (1)

     293        293   

Furniture and fixtures

     486        491   
  

 

 

   

 

 

 
     11,880        12,066   

Less accumulated depreciation and amortization (1)

     (8,127     (8,150
  

 

 

   

 

 

 

Total

   $ 3,753      $ 3,916   
  

 

 

   

 

 

 

 

(1)         Accumulated depreciation related to operating lease assets was $171 and $169 as of October 29, 2011 and July 30, 2011, respectively.

            

 

Other assets:

    

Deferred tax assets

   $ 1,895      $ 1,864   

Investments in privately held companies

     898        796   

Other

     750        441   
  

 

 

   

 

 

 

Total

   $ 3,543      $ 3,101   
  

 

 

   

 

 

 

Deferred revenue:

    

Service

   $ 8,321      $ 8,521   

Product:

    

Unrecognized revenue on product shipments and other deferred revenue

     3,209        3,003   

Cash receipts related to unrecognized revenue from two-tier distributors

     866        683   
  

 

 

   

 

 

 

Total product deferred revenue

     4,075        3,686   
  

 

 

   

 

 

 

Total

   $ 12,396      $ 12,207   
  

 

 

   

 

 

 

Reported as:

    

Current

   $ 8,444      $ 8,025   

Noncurrent

     3,952        4,182   
  

 

 

   

 

 

 

Total

   $ 12,396      $ 12,207   
  

 

 

   

 

 

 

 

12


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

7. Financing Receivables and Guarantees

(a) Financing Receivables

Financing receivables primarily consist of lease receivables, loan receivables, and financed service contracts and other. Lease receivables represent sales-type and direct-financing leases resulting from the sale of the Company’s and complementary third-party products and are typically collateralized by a security interest in the underlying assets. Lease receivables consist of arrangements with terms of four years on average while loan receivables generally have terms of up to three years. The financed service contracts and other category includes financing receivables related to technical support and other services, as well as an insignificant amount of receivables related to financing of certain indirect costs associated with leases. Revenue related to the technical support services is typically deferred and included in deferred service revenue and is recognized ratably over the period during which the related services are to be performed, which typically ranges from one to three years.

A summary of the Company’s financing receivables is presented as follows (in millions):

 

October 29, 2011

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts & Other (1)
    Total Financing
Receivables
 

Gross

   $ 3,086      $ 1,468      $ 2,557      $ 7,111   

Unearned income

     (237 )     —          —          (237 )

Allowance for credit loss

     (233 )     (103     (29 )     (365 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Total, net

   $ 2,616      $ 1,365      $ 2,528      $ 6,509   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reported as:

        

Current

   $ 1,054      $ 861      $ 1,385      $ 3,300   

Noncurrent

     1,562        504        1,143        3,209   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total, net

   $ 2,616      $ 1,365      $ 2,528      $ 6,509   
  

 

 

   

 

 

   

 

 

   

 

 

 

July 30, 2011

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts & Other (1)
    Total Financing
Receivables
 

Gross

   $ 3,111      $ 1,468      $ 2,637      $ 7,216   

Unearned income

     (250 )     —          —          (250 )

Allowance for credit loss

     (237 )     (103     (27 )     (367 )
  

 

 

   

 

 

   

 

 

   

 

 

 

Total, net

   $ 2,624      $ 1,365      $ 2,610      $ 6,599   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reported as:

        

Current

   $ 1,087      $ 673      $ 1,351      $ 3,111   

Noncurrent

     1,537        692        1,259        3,488   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total, net

   $ 2,624      $ 1,365      $ 2,610      $ 6,599   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

As of October 29, 2011 and July 30, 2011, the deferred service revenue related to financed service contracts and other was $1,940 million and $2,044 million, respectively.

Contractual maturities of the gross lease receivables at October 29, 2011 are summarized as follows (in millions):

 

Fiscal Year

   Amount  

2012 (remaining nine months)

   $ 978   

2013

     988   

2014

     677   

2015

     325   

2016

     109   

Thereafter

     9   
  

 

 

 

Total

   $ 3,086   
  

 

 

 

Actual cash collections may differ from the contractual maturities due to early customer buyouts, refinancings, or defaults.

 

13


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(b) Credit Quality of Financing Receivables

Financing receivables categorized by the Company’s internal credit risk rating for each portfolio segment and class as of October 29, 2011 and July 30, 2011 are summarized as follows (in millions):

 

     INTERNAL CREDIT RISK
RATING
                      

October 29, 2011

   1 to 4      5 to 6      7 and Higher      Total      Residual
Value
     Gross Receivables,
Net of Unearned
Income
 

Established Markets

                 

Lease receivables

   $ 1,193       $ 1,190       $ 20       $ 2,403       $ 291       $ 2,694   

Loan receivables

     206         258         6         470         —           470   

Financed service contracts & other

     1,610         870         49         2,529         —           2,529   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Established Markets

   $ 3,009       $ 2,318       $ 75       $ 5,402       $ 291       $ 5,693   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Growth Markets

                 

Lease receivables

   $ 51       $ 90       $ 10       $ 151       $ 4       $ 155   

Loan receivables

     428         554         16         998         —           998   

Financed service contracts & other

     5         19         4         28         —           28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Growth Markets

   $ 484       $ 663       $ 30       $ 1,177       $ 4       $ 1,181   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,493       $ 2,981       $ 105       $ 6,579       $ 295       $ 6,874   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     INTERNAL CREDIT RISK
RATING
                      

July 30, 2011

   1 to 4      5 to 6      7 and Higher      Total      Residual
Value
     Gross Receivables,
Net of Unearned
Income
 

Established Markets

                 

Lease receivables

   $ 1,214       $ 1,182       $ 23       $ 2,419       $ 292       $ 2,711   

Loan receivables

     204         187         4         395         —           395   

Financed service contracts & other

     1,622         939         52         2,613         —           2,613   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Established Markets

   $ 3,040       $ 2,308       $ 79       $ 5,427       $ 292       $ 5,719   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Growth Markets

                 

Lease receivables

   $ 35       $ 93       $ 18       $ 146       $ 4       $ 150   

Loan receivables

     458         580         35         1,073         —           1,073   

Financed service contracts & other

     1         19         4         24         —           24   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Growth Markets

   $ 494       $ 692       $ 57       $ 1,243       $ 4       $ 1,247   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,534       $ 3,000       $ 136       $ 6,670       $ 296       $ 6,966   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s internal credit risk ratings of 1 through 4 correspond to investment-grade ratings, while credit risk ratings of 5 and 6 correspond to non-investment-grade ratings. Credit risk ratings of 7 and higher correspond to substandard ratings and constitute a relatively small portion of the Company’s financing receivables.

The financing receivables are disaggregated into two classes: the Established Markets and Growth Markets . The Growth Markets class primarily consists of emerging countries including Brazil, Russia, India, China and Mexico, among others. The Established Markets class consists of countries other than the emerging countries in which the Company has financing receivables.

In circumstances when collectability is not deemed reasonably assured, the associated revenue is deferred in accordance with the Company’s revenue recognition policies, and the related allowance for credit loss, if any, is included in deferred revenue. The Company also records deferred revenue associated with financing receivables when there are remaining performance obligations, as it does for financed service contracts. Total allowances for credit loss and deferred revenue as of October 29, 2011 and July 30, 2011 were $2,644 million and $2,793 million, respectively and they were associated with financing receivables (net of unearned income) of $6,874 million, and $6,966 million as of their respective period ends. The losses that the Company has incurred historically as well as in the periods presented with respect to its financing receivables have been immaterial and consistent with the performance of an investment-grade portfolio.

As of October 29, 2011 and July 30, 2011, the portion of the portfolio that was deemed to be impaired, generally with a credit risk rating of 8 or higher, was immaterial. The total net write-offs of financing receivables were not material for the first quarter of fiscal 2012. During the first quarter of fiscal 2012, the Company did not modify any financing receivables.

 

14


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

The following table presents the aging analysis of financing receivables by portfolio segment and class as of October 29, 2011 and July 30, 2011 (in millions):

 

October 29, 2011

   31-60 Days
Past Due (1)
     61-90 Days
Past Due (1)
     Greater than 90 Days
Past Due (1) (2)
     Total
Past Due
     Current      Gross Receivables,
Net of Unearned
Income
     Non-Accrual
Financing
Receivables
     Impaired
Financing
Receivables
 

Established Markets

                       

Lease receivables

   $ 103       $ 75       $ 127       $ 305       $ 2,389       $ 2,694       $ 18       $ 6   

Loan receivables

     3         4         9         16         454         470         2         2   

Financed service contracts & other

     64         97         241         402         2,127         2,529         14         6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Established Markets

   $ 170       $ 176       $ 377       $ 723       $ 4,970       $ 5,693       $ 34       $ 14   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Growth Markets

                                                       

Lease receivables

   $ 4       $ 5       $ 2       $ 11       $ 144       $ 155       $ 9       $ 9   

Loan receivables

     2         —           3         5         993         998         4         3   

Financed service contracts & other

     —           —           —           —           28         28         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Growth Markets

   $ 6       $ 5       $ 5       $ 16       $ 1,165       $ 1,181       $ 13       $ 12   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 176       $ 181       $ 382       $ 739       $ 6,135       $ 6,874       $ 47       $ 26   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

July 30, 2011

   31-60 Days
Past Due (1)
     61-90 Days
Past Due (1)
     Greater than 90 Days
Past Due (1) (2)
     Total
Past Due
     Current      Gross Receivables,
Net of Unearned
Income
     Non-Accrual
Financing
Receivables
     Impaired
Financing
Receivables
 

Established Markets

                       

Lease receivables

   $ 85       $ 33       $ 139       $ 257       $ 2,454       $ 2,711       $ 16       $ 6   

Loan receivables

     6         1         9         16         379         395         1         1   

Financed service contracts & other

     68         33         265         366         2,247         2,613         17         6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Established Markets

   $ 159       $ 67       $ 413       $ 639       $ 5,080       $ 5,719       $ 34       $ 13   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Growth Markets

                                                       

Lease receivables

   $ 4       $ 2       $ 13       $ 19       $ 131       $ 150       $ 18       $ 18   

Loan receivables

     2         6         12         20         1,053         1,073         3         3   

Financed service contracts & other

     —           —           —           —           24         24         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Growth Markets

   $ 6       $ 8       $ 25       $ 39       $ 1,208       $ 1,247       $ 21       $ 21   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 165       $ 75       $ 438       $ 678       $ 6,288       $ 6,966       $ 55       $ 34   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Past due financing receivables are those that are 31 days or more past due according to their contractual payment terms. The data in the preceding tables are presented by contract and the aging classification of each contract is based on the oldest outstanding receivable, and therefore past due amounts also include unbilled and current receivables within the same contract. The preceding aging tables also exclude pending adjustments on billed tax assessment in certain international markets.

(2) 

The balances of either unbilled or current financing receivables included in the greater-than-90 days past due category for lease receivables, loan receivables, and financed service contracts and other were $102 million, $10 million, and $212 million, respectively, as of October 29, 2011. Such balances for the same category of receivables were $116 million, $15 million, and $230 million, respectively, as of July 30, 2011.

As of October 29, 2011, the Company had financing receivables of $48 million, net of unbilled or current receivables from the same contract, that were in the greater-than 90 days past due category but remained on accrual status. Such balance was $50 million as of July 30, 2011. A financing receivable may be placed on non-accrual status earlier if, in management’s opinion, a timely collection of the full principal and interest becomes uncertain.

 

15


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(c) Allowance for Credit Loss Rollforward

The allowances for credit loss and the related financing receivables are summarized as follows (in millions):

 

     CREDIT LOSS ALLOWANCES  

Three Months Ended October 29, 2011

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts and Other
     Total  

Allowance for credit loss as of July 30, 2011

   $ 237      $ 103      $ 27       $ 367   

Provisions

     2        5        2         9   

Foreign exchange and other

     (6 )     (5 )     —           (11 )
  

 

 

   

 

 

   

 

 

    

 

 

 

Allowance for credit loss as of October 29, 2011

   $ 233      $ 103      $ 29       $ 365   
  

 

 

   

 

 

   

 

 

    

 

 

 

Gross receivables as of October 29, 2011, net of unearned income

   $ 2,849      $ 1,468      $ 2,557       $ 6,874   

Financing receivables that were individually evaluated for impairment during the three month period ended October 29, 2011 were not material and therefore are not presented separately in the preceding table.

(d) Financing Guarantees

In the ordinary course of business, the Company provides financing guarantees for various third-party financing arrangements extended to channel partners and end-user customers. Payments under these financing guarantee arrangements were not material for the periods presented.

Channel Partner Financing Guarantees The Company facilitates arrangements for third-party financing extended to channel partners, consisting of revolving short-term financing, generally with payment terms ranging from 60 to 90 days. These financing arrangements facilitate the working capital requirements of the channel partners and, in some cases, the Company guarantees a portion of these arrangements. The volume of channel partner financing was $5.3 billion and $4.5 billion for the three months ended October 29, 2011 and October 30, 2010, respectively. The balance of the channel partner financing subject to guarantees was $1.5 billion as of October 29, 2011 and $1.4 billion as of July 30, 2011.

End-User Financing Guarantees The Company also provides financing guarantees for third-party financing arrangements extended to end-user customers related to leases and loans that typically have terms of up to three years. The volume of financing provided by third parties for leases and loans for the three months ended October 29, 2011 and October 30, 2010 was $411 million and $283 million, respectively. The volume of financing for which the Company has provided guarantees was $35 million for each of the respective periods.

Financing Guarantee Summary The aggregate amount of financing guarantees outstanding at October 29, 2011 and July 30, 2011, representing the total maximum potential future payments under financing arrangements with third parties along with the related deferred revenue are summarized in the following table (in millions):

 

     October 29,
2011
    July 30,
2011
 

Maximum potential future payments relating to financing guarantees:

    

Channel partner

   $ 349      $ 336   

End user

     259        277   
  

 

 

   

 

 

 

Total

   $ 608      $ 613   
  

 

 

   

 

 

 

Deferred revenue associated with financing guarantees:

    

Channel partner

   $ (261   $ (248

End user

     (234     (248
  

 

 

   

 

 

 

Total

   $ (495   $ (496
  

 

 

   

 

 

 

Maximum potential future payments relating to financing guarantees, net of associated deferred revenue

   $ 113      $ 117   
  

 

 

   

 

 

 

 

16


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

8. Investments

(a) Summary of Available-for-Sale Investments

The following tables summarize the Company’s available-for-sale investments (in millions):

 

October 29, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Fixed income securities:

          

U.S. government securities

   $ 20,206       $ 53       $ (5 )   $ 20,254   

U.S. government agency securities (1)

     10,026         27         (4     10,049   

Non-U.S. government and agency securities (2)

     3,516         12         (3     3,525   

Corporate debt securities

     4,299         44         (23 )     4,320   

Asset-backed securities

     116         4         (4 )     116   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed income securities

     38,163         140         (39 )     38,264   

Publicly traded equity securities

     777         603         (3 )     1,377   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 38,940       $ 743       $ (42 )   $ 39,641   
  

 

 

    

 

 

    

 

 

   

 

 

 

July 30, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Fixed income securities:

          

U.S. government securities

   $ 19,087       $ 52       $ —        $ 19,139   

U.S. government agency securities (1)

     8,742         35         (1     8,776   

Non-U.S. government and agency securities (2)

     3,119         14         (1     3,132   

Corporate debt securities

     4,333         65         (4 )     4,394   

Asset-backed securities

     120         5         (4 )     121   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed income securities

     35,401         171         (10 )     35,562   

Publicly traded equity securities

     734         639         (12 )     1,361   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 36,135       $ 810       $ (22 )   $ 36,923   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) 

Includes corporate debt securities that are guaranteed by the Federal Deposit Insurance Corporation (FDIC).

(2) 

Includes agency and corporate debt securities that are guaranteed by non-U.S. governments.

(b) Gains and Losses on Available-for-Sale Investments

The following table presents the net realized gains (losses) related to the Company’s available-for-sale investments (in millions):

 

Three Months Ended

   October 29, 2011     October 30, 2010  

Net realized gains (losses):

    

Publicly traded equity securities

   $ (16 )   $ 19   

Fixed income securities

     25        71   
  

 

 

   

 

 

 

Total

   $ 9      $ 90   
  

 

 

   

 

 

 

There were no material impairment charges on available-for-sale investments for the three months ended October 29, 2011 and October 30, 2010.

The following table summarizes the activity related to credit losses for fixed income securities (in millions):

 

     October 29, 2011     October 30, 2010  

Balance at beginning of period

   $ (23 )   $ (95 )

Sales of other-than-temporarily impaired fixed income securities

     —          27   
  

 

 

   

 

 

 

Balance at end of period

   $ (23 )   $ (68 )
  

 

 

   

 

 

 

 

17


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

The following tables present the breakdown of the available-for-sale investments with gross unrealized losses and the duration that those losses had been unrealized at October 29, 2011 and July 30, 2011 (in millions):

 

     UNREALIZED LOSSES
LESS THAN 12 MONTHS
    UNREALIZED LOSSES
12 MONTHS OR GREATER
    TOTAL  

October 29, 2011

   Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair
Value
     Gross
Unrealized
Losses
 

Fixed income securities:

               

U.S. government securities

   $ 4,767       $ (5   $ —         $ —        $ 4,767       $ (5 )

U.S. government agency securities (1)

     2,490         (4     —           —          2,490         (4 )

Non-U.S. government and agency securities (2)

     1,603         (3     —           —          1,603         (3

Corporate debt securities

     1,528         (19     68         (4     1,596         (23

Asset-backed securities

     —           —          101         (4 )     101         (4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed income securities

     10,388         (31     169         (8     10,557         (39

Publicly traded equity securities

     25         (3     —           —          25         (3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 10,413       $ (34   $ 169       $ (8   $ 10,582       $ (42
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     UNREALIZED LOSSES
LESS THAN 12 MONTHS
    UNREALIZED LOSSES
12 MONTHS OR GREATER
    TOTAL  

July 30, 2011

   Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair
Value
     Gross
Unrealized
Losses
 

Fixed income securities:

               

U.S. government agency securities (1)

   $ 2,310       $ (1   $ —         $ —        $ 2,310       $ (1 )

Non-U.S. government and agency securities (2)

     875         (1     —           —          875         (1

Corporate debt securities

     548         (2     56         (2     604         (4

Asset-backed securities

     —           —          105         (4 )     105         (4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed income securities

     3,733         (4     161         (6     3,894         (10

Publicly traded equity securities

     112         (12     —           —          112         (12
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 3,845       $ (16   $ 161       $ (6   $ 4,006       $ (22
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

Includes corporate debt securities that are guaranteed by the FDIC.

(2) 

Includes agency and corporate debt securities that are guaranteed by non-U.S. governments.

For fixed income securities that have unrealized losses as of October 29, 2011, the Company has determined that (i) it does not have the intent to sell any of these investments and (ii) it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis. In addition, as of October 29, 2011, the Company anticipates that it will recover the entire amortized cost basis of such fixed income securities and has determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three months ended October 29, 2011.

The Company has evaluated its publicly traded equity securities as of October 29, 2011 and has determined that there was no indication of other-than-temporary impairments in the respective categories of unrealized losses. This determination was based on several factors, which include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the issuer, and the Company’s intent and ability to hold the publicly traded equity securities for a period of time sufficient to allow for any anticipated recovery in market value.

(c) Maturities of Fixed Income Securities

The following table summarizes the maturities of the Company’s fixed income securities at October 29, 2011 (in millions):

 

     Amortized Cost      Fair Value  

Less than 1 year

   $ 18,989       $ 19,017   

Due in 1 to 2 years

     11,927         11,971   

Due in 2 to 5 years

     7,045         7,069   

Due after 5 years

     202         207   
  

 

 

    

 

 

 

Total

   $ 38,163       $ 38,264   
  

 

 

    

 

 

 

Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations.

 

18


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(d) Securities Lending

The Company periodically engages in securities lending activities with certain of its available-for-sale investments. These transactions are accounted for as a secured lending of the securities, and the securities are typically loaned only on an overnight basis. The average balance of securities lending for the three months ended October 29, 2011 and October 30, 2010 was $1.7 billion and $2.1 billion, respectively. The Company requires collateral equal to at least 102% of the fair market value of the loaned security in the form of cash or liquid, high-quality assets. The Company engages in these secured lending transactions only with highly creditworthy counterparties, and the associated portfolio custodian has agreed to indemnify the Company against any collateral losses. The Company did not experience any losses in connection with the secured lending of securities during the periods presented. As of October 29, 2011 and July 30, 2011, the Company had no outstanding securities lending transactions.

 

9. Fair Value

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact, and it considers assumptions that market participants would use when pricing the asset or liability.

(a) Fair Value Hierarchy

The accounting guidance for fair value measurement requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard establishes a fair value hierarchy based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows

Level 1 Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.

Level 2 Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

Level 3 Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

(b) Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis as of October 29, 2011 and July 30, 2011 were as follows (in millions):

 

     OCTOBER 29, 2011
FAIR VALUE MEASUREMENTS
     JULY 30, 2011
FAIR VALUE MEASUREMENTS
 
     Level 1      Level 2      Level 3      Total
Balance
     Level 1      Level 2      Level 3      Total
Balance
 

Assets

                       

Cash equivalents:

                       

Money market funds

   $ 3,136       $ —         $ —         $ 3,136       $ 5,852       $ —         $ —         $ 5,852   

U.S. government agency securities (1)

     —           —           —           —           —           1         —           1   

Available-for-sale investments:

                       

U.S. government securities

     —           20,254         —           20,254         —           19,139         —           19,139   

U.S. government agency securities (1)

     —           10,049         —           10,049         —           8,776         —           8,776   

Non-U.S. government and agency securities (2)

     —           3,525         —           3,525         —           3,132         —           3,132   

Corporate debt securities

     —           4,320         —           4,320         —           4,394         —           4,394   

Asset-backed securities

     —           —           116         116         —           —           121         121   

Publicly traded equity securities

     1,377         —           —           1,377         1,361         —           —           1,361   

Derivative assets

     —           242         1         243         —           220         2         222   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,513       $ 38,390       $ 117       $ 43,020       $ 7,213       $ 35,662       $ 123       $ 42,998   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

                       

Derivative liabilities

   $ —         $ 42       $ —         $ 42       $ —         $ 24       $ —         $ 24   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ 42       $ —         $ 42       $ —         $ 24       $ —         $ 24   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Includes corporate debt securities that are guaranteed by the FDIC.

(2)

Includes agency and corporate debt securities that are guaranteed by non-U.S. governments.

 

19


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

Level 2 fixed income securities are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. The Company uses inputs such as actual trade data, benchmark yields, broker/dealer quotes, and other similar data, which are obtained from quoted market prices, independent pricing vendors, or other sources, to determine the ultimate fair value of these assets and liabilities. The Company uses such pricing data as the primary input to make its assessments and determinations as to the ultimate valuation of its investment portfolio and has not made, during the periods presented, any material adjustments to such inputs. The Company is ultimately responsible for the financial statements and underlying estimates. The Company’s derivative instruments are primarily classified as Level 2, as they are not actively traded and are valued using pricing models that use observable market inputs. The Company did not have any transfers between Level 1 and Level 2 fair value measurements during the periods presented.

Level 3 assets include asset-backed securities and certain derivative instruments, the values of which are determined based on discounted cash flow models using inputs that the Company could not corroborate with market data.

The following tables present a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended October 29, 2011 and October 30, 2010 (in millions):

 

     Asset-Backed
Securities
    Derivative
Assets
    Total  

Balance at July 30, 2011

   $ 121      $ 2      $ 123   

Total gains and losses (realized and unrealized):

      

Included in other income, net

     —          (1     (1 )

Sales and maturities

     (5 )     —          (5
  

 

 

   

 

 

   

 

 

 

Balance at October 29, 2011

   $ 116      $ 1      $ 117   
  

 

 

   

 

 

   

 

 

 

Losses attributable to assets still held as of October 29, 2011

   $ —        $ (1 )   $ (1
     Asset-Backed
Securities
    Derivative
Assets
    Total  

Balance at July 31, 2010

   $ 149      $ 3      $ 152   

Total gains and losses (realized and unrealized):

      

Included in other income, net

     —          (1     (1 )

Included in other comprehensive income

     (1 )     —          (1

Sales and maturities

     (6 )     —          (6
  

 

 

   

 

 

   

 

 

 

Balance at October 30, 2010

   $ 142      $ 2      $ 144   
  

 

 

   

 

 

   

 

 

 

Losses attributable to assets still held as of October 30, 2010

   $ —        $ (1 )   $ (1

(c) Assets Measured at Fair Value on a Nonrecurring Basis

The following tables present the Company’s financial instruments and nonfinancial assets that were measured at fair value on a nonrecurring basis during the indicated periods and the related recognized gains and losses for the periods (in millions):

 

            FAIR VALUE MEASUREMENTS USING         
     Net Carrying
Value as of
October 29, 2011
     Level 1      Level 2      Level 3      Total Losses
for the Three Months
Ended
October 29, 2011
 

Investments in privately held companies

   $ 1       $ —         $ —         $ 1       $ 1   

Property held for sale

   $ 24       $ —         $ —         $ 24         89   
              

 

 

 

Total

               $ 90   
              

 

 

 
            FAIR VALUE MEASUREMENTS USING         
     Net Carrying
Value as of
October 30, 2010
     Level 1      Level 2      Level 3      Total Losses
for the Three Months
Ended
October 30, 2010
 

Investments in privately held companies

   $ 9       $ —         $ —         $ 9       $ 3   

The assets in the preceding tables were classified as Level 3 assets because the Company used unobservable inputs to value them, reflecting the Company’s assessment of the assumptions market participants would use in pricing these assets due to the absence of quoted market prices and the inherent lack of liquidity. These assets were measured at fair value due to events or circumstances the Company identified as having significantly impacted the fair value during the respective indicated periods.

The fair value for investments in privately held companies was measured using financial metrics, comparison to other private and public companies, and analysis of the financial condition and near-term prospects of the issuers, including recent financing activities and their capital structure as well as other economic variables. The impairment as a result of the evaluation for the investments in privately held companies was recorded to other income, net.

The fair value of property held for sale was measured using discounted cash flow techniques.

(d) Other

The fair value of certain of the Company’s financial instruments that are not measured at fair value, including accounts receivable, accounts payable, accrued compensation and other current liabilities, approximates the carrying amount because of their short maturities. In addition, the fair value of the Company’s loan receivables and financed service contracts also approximates the carrying amount. The fair value of the Company’s debt is disclosed in Note 10 and was determined using quoted market prices for those securities.

 

20


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

10. Borrowings

(a) Short-Term Debt

The following table summarizes the Company’s short-term debt (in millions, except percentages):

 

     October 29, 2011     July 30, 2011  
     Amount      Weighted-Average
Interest Rate
    Amount      Weighted-Average
Interest Rate
 

Commercial paper

   $ 500         0.13  %   $ 500         0.14  %

Other notes and borrowings

     89         6.12  %     88         4.59 
  

 

 

      

 

 

    

Total short-term debt

   $ 589         $ 588      
  

 

 

      

 

 

    

In fiscal 2011, the Company established a short-term debt financing program of up to $3.0 billion through the issuance of commercial paper notes. The Company used the proceeds from the issuance of commercial paper notes for general corporate purposes, including repayment of matured debt, if applicable. The outstanding commercial paper as of October 29, 2011 and July 30, 2011 had maturity dates of approximately three months or less.

Other notes and borrowings in the preceding table consist of notes and credit facilities established with a number of financial institutions that are available to certain foreign subsidiaries of the Company. These notes and credit facilities are subject to various terms and foreign currency market interest rates pursuant to individual financial arrangements between the financing institution and the applicable foreign subsidiary.

As of October 29, 2011, the estimated fair value of the short-term debt approximates its carrying value due to the short maturities.

(b) Long-Term Debt

The following table summarizes the Company’s long-term debt (in millions, except percentages):

 

     October 29, 2011     July 30, 2011  
     Amount     Effective Rate     Amount     Effective Rate  

Senior Notes:

        

Floating-rate notes, due 2014

   $ 1,250        0.69  %   $ 1,250        0.60  %

2.90% fixed-rate notes, due 2014

     500        3.11  %     500        3.11  %

1.625% fixed-rate notes, due 2014

     2,000        0.67  %     2,000        0.58  %

5.50% fixed-rate notes, due 2016

     3,000        3.08  %     3,000        3.06  %

3.15% fixed-rate notes, due 2017

     750        0.91  %     750        0.81  %

4.95% fixed-rate notes, due 2019

     2,000        5.08  %     2,000        5.08  %

4.45% fixed-rate notes, due 2020

     2,500        4.50      2,500        4.50 

5.90% fixed-rate notes, due 2039

     2,000        6.11  %     2,000        6.11  %

5.50% fixed-rate notes, due 2040

     2,000        5.67      2,000        5.67 
  

 

 

     

 

 

   

Total

     16,000          16,000     

Unaccreted discount

     (72       (73  

Hedge accounting adjustment

     336          307     
  

 

 

     

 

 

   

Total long-term debt

   $ 16,264        $ 16,234     
  

 

 

     

 

 

   

To achieve its interest rate risk management objectives, the Company entered into interest rate swaps with an aggregate notional amount of $4.25 billion designated as fair value hedges of certain fixed-rate senior notes. In effect, these swaps convert the fixed interest rates of the fixed-rate notes to floating interest rates based on the London InterBank Offered Rate (“LIBOR”). The gains and losses related to changes in the fair value of the interest rate swaps substantially offset changes in the fair value of the hedged portion of the underlying debt that are attributable to the changes in market interest rates. See Note 11.

The effective rates for the fixed-rate debt include the interest on the notes, the accretion of the discount, and, if applicable, adjustments related to hedging. Based on market prices, the fair value of the Company’s long-term debt was $17.9 billion as of October 29, 2011.

 

21


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

Interest is payable semiannually on each class of the senior fixed-rate notes and payable quarterly on the floating-rate notes. Each of the senior fixed-rate notes is redeemable by the Company at any time, subject to a make-whole premium.

The senior notes rank at par with the issued commercial paper notes, as well as any other commercial paper notes that may be issued in the future pursuant to the short-term debt financing program, as discussed earlier under “Short-Term Debt.” The Company was in compliance with all debt covenants as of October 29, 2011.

Future principal payments for long-term debt as of October 29, 2011 are summarized as follows (in millions):

 

Fiscal Year

   Amount  

2014

   $ 3,250   

2015

     500   

2016

     3,000   

Thereafter

     9,250   
  

 

 

 

Total

   $ 16,000   
  

 

 

 

(c) Credit Facility

The Company has a credit agreement with certain institutional lenders providing for a $3.0 billion unsecured revolving credit facility that is scheduled to expire on August 17, 2012. Any advances under the credit agreement will accrue interest at rates that are equal to, based on certain conditions, either (i) the higher of the Federal Funds rate plus 0.50% or Bank of America’s “prime rate” as announced from time to time or (ii) LIBOR plus a margin that is based on the Company’s senior debt credit ratings as published by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc. The credit agreement requires the Company to comply with certain covenants, including that it maintain an interest coverage ratio as defined in the agreement. The Company was in compliance with the required interest coverage ratio and the other covenants as of October 29, 2011.

The Company may also, upon the agreement of either the then-existing lenders or additional lenders not currently parties to the agreement, increase the commitments under the credit facility by up to an additional $1.9 billion and/or extend the expiration date of the credit facility up to August 15, 2014. As of October 29, 2011, the Company had not borrowed any funds under the credit facility.

 

11. Derivative Instruments

(a) Summary of Derivative Instruments

The Company uses derivative instruments primarily to manage exposures to foreign currency exchange rate, interest rate, and equity price risks. The Company’s primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates, interest rates, and equity prices. The Company’s derivatives expose it to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company does, however, seek to mitigate such risks by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.

The fair values of the Company’s derivative instruments and the line items on the Consolidated Balance Sheets to which they were recorded are summarized as follows (in millions):

 

    

DERIVATIVE ASSETS

    

DERIVATIVE LIABILITIES

 
    

Balance Sheet Line Item

   October 29,
2011
     July 30, 2011     

Balance Sheet Line Item

   October 29,
2011
     July 30, 2011  

Derivatives designated as hedging instruments:

                 

Foreign currency derivatives

   Other current assets    $ 32       $ 67       Other current liabilities    $ 30       $ 12   

Interest rate derivatives

   Other assets      180         146       Other long-term liabilities      —           —     
     

 

 

    

 

 

       

 

 

    

 

 

 

Total

      $ 212       $ 213          $ 30       $ 12   
     

 

 

    

 

 

       

 

 

    

 

 

 

Derivatives not designated as hedging instruments:

                 

Foreign currency derivatives

   Other current assets    $ 30       $ 7       Other current liabilities    $ 12       $ 12   

Equity derivatives

   Other assets      1         2       Other long-term liabilities      —           —     
     

 

 

    

 

 

       

 

 

    

 

 

 

Total

        31         9            12         12   
     

 

 

    

 

 

       

 

 

    

 

 

 

Total

      $ 243       $ 222          $ 42       $ 24   
     

 

 

    

 

 

       

 

 

    

 

 

 

 

22


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

The effects of the Company’s cash flow hedging instruments on other comprehensive income (OCI) and the Consolidated Statements of Operations are summarized as follows (in millions):

 

GAINS (LOSSES) RECOGNIZED

IN OCI ON DERIVATIVES FOR THE

THREE MONTHS ENDED (EFFECTIVE PORTION)

    

GAINS (LOSSES) RECLASSIFIED
FROM AOCI INTO INCOME FOR THE

THREE MONTHS ENDED

 

Derivatives Designated as Cash

Flow Hedging Instruments

   October 29,
2011
    October 30,
2010
    

Line Item in Statements

of Operations

   October 29,
2011
     October 30,
2010
 

Foreign currency derivatives

   $ (50 )   $ 55       Operating expenses    $ —         $ 6   
        Cost of sales–service      —           1   
  

 

 

   

 

 

       

 

 

    

 

 

 

Total

   $ (50 )   $ 55          $ —         $ 7   
  

 

 

   

 

 

       

 

 

    

 

 

 

During the three months ended October 29, 2011 and October 30, 2010, the amounts recognized in earnings on derivative instruments designated as cash flow hedges related to the ineffective portion were not material, and the Company did not exclude any component of the changes in fair value of the derivative instruments from the assessment of hedge effectiveness. As of October 29, 2011, the Company estimates that approximately $32 million of net derivative losses related to its cash flow hedges included in AOCI will be reclassified into earnings within the next 12 months.

The effect on the Consolidated Statements of Operations of derivative instruments designated as fair value hedges and the underlying hedged items is summarized as follows (in millions):

 

          GAINS (LOSSES) ON
DERIVATIVES INSTRUMENTS
FOR THE THREE MONTHS ENDED
     GAINS (LOSSES) RELATED TO
HEDGED ITEMS FOR THE

THREE MONTHS ENDED
 

Derivatives Designated as

Fair Value Hedging Instruments

  

Line Item in Statements

of Operations

   October  29,
2011
     October  30,
2010
     October 29,
2011
    October 30,
2010
 

Interest rate derivatives

   Interest expense    $ 35       $ 30       $ (36   $ (32
     

 

 

    

 

 

    

 

 

   

 

 

 

The effect on the Consolidated Statements of Operations of derivative instruments not designated as hedges is summarized as follows (in millions):

 

          GAINS (LOSSES) FOR THE
THREE MONTHS ENDED
 

Derivatives Not Designated as

Hedging Instruments

  

Line Item in Statements

of Operations

   October 29, 2011     October 30, 2010  

Foreign currency derivatives

   Other income, net    $ (57   $ 114   

Total return swaps-deferred compensation

   Operating expenses      (20 )     11   

Equity derivatives

   Other income, net      7        5   
     

 

 

   

 

 

 

Total

      $ (70   $ 130   
     

 

 

   

 

 

 

The notional amounts of the Company’s outstanding derivatives are summarized as follows (in millions):

 

     October 29,
2011
     July 30,
2011
 

Derivatives designated as hedging instruments:

     

Foreign currency derivatives–cash flow hedges

   $ 2,707       $ 3,433   

Interest rate derivatives

     4,250         4,250   

Net investment hedging instruments

     68         73   

Derivatives not designated as hedging instruments:

     

Foreign currency derivatives

     5,220         4,565   

Total return swaps

     262         262   
  

 

 

    

 

 

 

Total

   $ 12,507       $ 12,583   
  

 

 

    

 

 

 

(b) Foreign Currency Exchange Risk

The Company conducts business globally in numerous currencies. Therefore, it is exposed to adverse movements in foreign currency exchange rates. To limit the exposure related to foreign currency changes, the Company enters into foreign currency contracts. The Company does not enter into such contracts for trading purposes.

The Company hedges foreign currency forecasted transactions related to certain operating expenses and service cost of sales with currency options and forward contracts. These currency option and forward contracts, designated as cash flow hedges, generally have maturities of less than 18 months. The Company assesses effectiveness based on changes in total fair value of the derivatives. The effective portion of the derivative instrument’s gain or loss is initially reported as a component of AOCI and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion, if any, of the gain or loss is reported in earnings immediately. During the fiscal years presented, the Company did not discontinue any cash flow hedge for which it was probable that a forecasted transaction would not occur.

 

23


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

The Company enters into foreign exchange forward and option contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables, including long-term customer financings, investments, and payables. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in other income, net, and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances or other current assets, investments, or liabilities denominated in currencies other than the functional currency of the reporting entity.

The Company hedges certain net investments in its foreign subsidiaries with forward contracts, which generally have maturities of up to six months. The Company recognized a loss of $4 million and $5 million in OCI for the effective portion of its net investment hedges for the three months ended October 29, 2011 and October 30, 2010, respectively.

(c) Interest Rate Risk

Interest Rate Derivatives, Investments The Company’s primary objective for holding fixed income securities is to achieve an appropriate investment return consistent with preserving principal and managing risk. To realize these objectives, the Company may utilize interest rate swaps or other derivatives designated as fair value or cash flow hedges. As of October 29, 2011 and July 30, 2011 the Company did not have any outstanding interest rate derivatives related to its fixed income securities.

Interest Rate Derivatives Designated as Fair Value Hedge, Long-Term Debt In fiscal 2011, the Company entered into interest rate swaps designated as fair value hedges related to fixed-rate senior notes that were issued in March 2011 and are due in 2014 and 2017. In fiscal 2010, the Company entered into interest rate swaps designated as fair value hedges for a portion of senior fixed-rate notes that were issued in 2006 and are due in 2016. Under these interest rate swaps, the Company receives fixed-rate interest payments and makes interest payments based on LIBOR plus a fixed number of basis points. The effect of such swaps is to convert the fixed interest rates of the senior fixed-rate notes to floating interest rates based on LIBOR. The gains and losses related to changes in the fair value of the interest rate swaps are included in interest expense and substantially offset changes in the fair value of the hedged portion of the underlying debt that are attributable to the changes in market interest rates. The fair value of the interest rate swaps was reflected in other assets.

(d) Equity Price Risk

The Company may hold equity securities for strategic purposes or to diversify its overall investment portfolio. The publicly traded equity securities in the Company’s portfolio are subject to price risk. To manage its exposure to changes in the fair value of certain equity securities, the Company may enter into equity derivatives that are designated as fair value hedges. The changes in the value of the hedging instruments are included in other income (loss), net, and offset the change in the fair value of the underlying hedged investment. In addition, the Company periodically manages the risk of its investment portfolio by entering into equity derivatives that are not designated as accounting hedges. The changes in the fair value of these derivatives were also included in other income (loss), net. The Company did not have any equity derivatives outstanding related to its investment portfolio at October 29, 2011 and July 30, 2011.

The Company is also exposed to variability in compensation charges related to certain deferred compensation obligations to employees. Although not designated as accounting hedges, the Company utilizes derivatives such as total return swaps to economically hedge this exposure. The fair value of such derivative instruments was negligible as of October 29, 2011.

(e) Credit-Risk-Related Contingent Features

Certain derivative instruments are executed under agreements that have provisions requiring the Company and the counterparty to maintain a specified credit rating from certain credit rating agencies. If the Company’s or the counterparty’s credit rating falls below a specified credit rating, either party has the right to request collateral on the derivatives’ net liability position. Such provisions did not affect the Company’s financial position as of October 29, 2011 and July 30, 2011.

 

24


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

12. Commitments and Contingencies

(a) Operating Leases

The Company leases office space in several U.S. locations. Outside the United States, larger leased sites include sites in Australia, Belgium, China, Germany, India, Israel, Italy, Japan, Norway, and the United Kingdom. The Company also leases equipment and vehicles. Future minimum lease payments under all noncancelable operating leases with an initial term in excess of one year as of October 29, 2011 are as follows (in millions):

 

Fiscal Year

   Amount  

2012 (remaining nine months)

   $ 253   

2013

     256   

2014

     189   

2015

     155   

2016

     67   

Thereafter

     267   
  

 

 

 

Total

   $ 1,187   
  

 

 

 

(b) Purchase Commitments with Contract Manufacturers and Suppliers

The Company purchases components from a variety of suppliers and uses several contract manufacturers to provide manufacturing services for its products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, the Company enters into agreements with contract manufacturers and suppliers that either allow them to procure inventory based upon criteria as defined by the Company or that establish the parameters defining the Company’s requirements. A significant portion of the Company’s reported purchase commitments arising from these agreements consists of firm, noncancelable, and unconditional commitments. In certain instances, these agreements allow the Company the option to cancel, reschedule, and adjust the Company’s requirements based on its business needs prior to firm orders being placed. As of October 29, 2011 and July 30, 2011, the Company had total purchase commitments for inventory of $4.178 billion and $4.313 billion, respectively.

The Company records a liability for firm, noncancelable, and unconditional purchase commitments for quantities in excess of its future demand forecasts consistent with the valuation of the Company’s excess and obsolete inventory. As of October 29, 2011 and July 30, 2011, the liability for these purchase commitments was $164 million and $168 million, respectively, and was included in other current liabilities.

(c) Other Commitments

In connection with the Company’s business combinations and asset purchases, the Company has agreed to pay certain additional amounts contingent upon the achievement of certain agreed-upon-technology, development, product, or other milestones or the continued employment with the Company of certain employees of the acquired entities. The Company recognized such compensation expense of $14 million and $37 million during the three months ended October 29, 2011 and October 30, 2010, respectively. The largest component of this compensation expense during both periods was related to milestone payments made to former noncontrolling interest holders of Nuova Systems, Inc., the remaining interest of which the Company purchased in fiscal 2008. As of October 29, 2011, the Company estimated that future compensation expense and contingent consideration of up to $53 million may be required to be recognized pursuant to the applicable business combination and asset purchase agreements.

The Company also has certain funding commitments, primarily related to its investments in privately held companies and venture funds, some of which are based on the achievement of certain agreed-upon milestones, and some of which are required to be funded on demand. The funding commitments were $145 million and $192 million as of October 29, 2011 and July 30, 2011, respectively.

(d) Variable Interest Entities

In the ordinary course of business, the Company has investments in privately held companies and provides financing to certain customers. These privately held companies and customers may be considered to be variable interest entities. The Company evaluates on an ongoing basis its investments in these privately held companies and its customer financings and has determined that as of October 29, 2011 there were no material unconsolidated variable interest entities.

VCE is a joint venture that the Company formed in fiscal 2010 with EMC Corporation (“EMC”), with investments from VMware, Inc. (“VMware”) and Intel Corporation. VCE helps organizations leverage best-in-class technologies and disciplines from Cisco, EMC and VMware to enable the transformation to cloud computing.

During the three months ended October 29, 2011, the Company invested an additional $96 million in VCE. As of October 29, 2011, the Company’s cumulative investment in VCE entity was approximately $205 million. The Company’s ownership percentage has remained unchanged since inception at approximately 35% of the outstanding equity of VCE. The Company accounts for its investment in VCE under the equity method, and accordingly its carrying value in VCE as of October 29, 2011 was $95 million, reflecting its cumulative share of VCE’s losses. Over the next 12 months, as VCE scales its operations, the Company expects that it will make additional investments in VCE and may incur additional losses proportionate with the Company’s ownership percentage.

 

25


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(e) Product Warranties and Guarantees

The following table summarizes the activity related to product warranty liability during the three months ended October 29, 2011 and October 30, 2010 (in millions):

 

     Three Months Ended  
     October 29, 2011     October 30, 2010  

Balance at beginning of period

   $ 342      $ 360   

Provision for warranties issued

     151        110   

Payments

     (132     (120
  

 

 

   

 

 

 

Balance at end of period

   $ 361      $ 350   
  

 

 

   

 

 

 

The Company accrues for warranty costs as part of its cost of sales based on associated material product costs, labor costs for technical support staff, and associated overhead. The Company’s products are generally covered by a warranty for periods ranging from 90 days to five years, and for some products the Company provides a limited lifetime warranty.

In the normal course of business, the Company indemnifies other parties, including customers, lessors, and parties to other transactions with the Company, with respect to certain matters. The Company has agreed to hold the other parties harmless against losses arising from a breach of representations or covenants or out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, the Company has entered into indemnification agreements with its officers and directors, and the Company’s Amended and Restated Bylaws contain similar indemnification obligations to the Company’s agents. It is not possible to determine the maximum potential amount under these indemnification agreements due to the Company’s limited history with prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on the Company’s operating results, financial position, or cash flows.

The Company also provides financing guarantees, which are generally for various third-party financing arrangements to channel partners and other end-user customers. See Note 7. The Company’s other guarantee arrangements as of October 29, 2011 that are subject to recognition and disclosure requirements were not material.

(f) Legal Proceedings

Brazilian authorities have investigated the Company’s Brazilian subsidiary and certain of its current and former employees, as well as a Brazilian importer of the Company’s products, and its affiliates and employees, relating to alleged evasion of import taxes and alleged improper transactions involving the subsidiary and the importer. Brazilian tax authorities have assessed claims against the Company’s Brazilian subsidiary based on a theory of joint liability with the Brazilian importer for import taxes and related penalties. In addition to claims asserted during prior fiscal years by Brazilian federal tax authorities, tax authorities from the Brazilian state of Sao Paulo asserted similar claims on the same legal basis during the second quarter of fiscal 2011.

The asserted claims by Brazilian federal tax authorities are for calendar years 2003 through 2007 and the asserted claims by the tax authorities from the state of Sao Paulo are for calendar years 2005 through 2007. The total asserted claims by Brazilian state and federal tax authorities aggregated to approximately $483 million for the alleged evasion of import taxes, approximately $929 million for interest, and approximately $2.2 billion for various penalties, all determined using an exchange rate as of October 29, 2011. The Company has completed a thorough review of the matter and believes the asserted tax claims against it are without merit, and the Company intends to defend the claims vigorously. While the Company believes there is no legal basis for its alleged liability, due to the complexities and uncertainty surrounding the judicial process in Brazil and the nature of the claims asserting joint liability with the importer, the Company is unable to determine the likelihood of an unfavorable outcome against it and is unable to reasonably estimate a range of loss, if any. The Company does not expect a final judicial determination for several years.

On March 31, 2011, a purported shareholder class action lawsuit was filed in the United States District Court for the Northern District of California against the Company and certain of its officers and directors. A second lawsuit with substantially similar allegations was filed with the same court on April 12, 2011 against the Company and certain of its officers and directors. The lawsuits are purportedly brought on behalf of those who purchased the Company’s publicly traded securities between May 12, 2010 and February 9, 2011, and between February 3, 2010 and February 9, 2011, respectively. Plaintiffs allege that defendants made false and misleading statements during quarterly earnings calls, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. The Company believes the claims are without merit and intends to defend the actions vigorously. While the Company believes there is no legal basis for liability, due to the uncertainty surrounding the litigation process, the Company is unable to reasonably estimate a range of loss, if any, at this time.

Beginning in April 2011, purported shareholder derivative lawsuits were filed in both the United States District Court for the Northern District of California and the California Superior Court for the County of Santa Clara against the Company’s Board of Directors and several of its officers alleging that the Board allowed management to make allegedly false statements during earnings calls. The Company’s management of its stock repurchase program is also alleged to have breached a fiduciary duty. The complaints include claims for violation of the federal securities laws, breach of fiduciary duty, aiding and abetting breaches of fiduciary duty, waste of corporate assets, unjust enrichment, and violations of the California Corporations Code. The complaint seeks compensatory damages, disgorgement, and other relief.

In addition, the Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business, including intellectual property litigation. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

26


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

13. Shareholders’ Equity

(a) Stock Repurchase Program

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of October 29, 2011, the Company’s Board of Directors had authorized an aggregate repurchase of up to $82 billion of common stock under this program and the remaining authorized repurchase amount was $8.7 billion with no termination date. A summary of the stock repurchase activity under the stock repurchase program, reported based on the trade date, is summarized as follows (in millions, except per-share amounts):

 

     Shares
Repurchased
     Weighted-
Average Price
per Share
     Amount
Repurchased
 

Cumulative balance at July 30, 2011

     3,478       $ 20.64       $ 71,773   

Repurchase of common stock under the stock repurchase program

     100         15.37         1,544   
  

 

 

       

 

 

 

Cumulative balance at October 29, 2011

     3,578       $ 20.49       $ 73,317   
  

 

 

       

 

 

 

The purchase price for the shares of the Company’s stock repurchased is reflected as a reduction to shareholders’ equity. The Company is required to allocate the purchase price of the repurchased shares as (i) a reduction to retained earnings until retained earnings are zero and then as an increase to accumulated deficit and (ii) a reduction of common stock and additional paid-in capital. Issuance of common stock and the tax benefit related to employee stock incentive plans are recorded as an increase to common stock and additional paid-in capital.

(b) Cash Dividends on Shares of Common Stock

During the three months ended October 29, 2011, cash dividends of $0.06 per share, or $322 million were declared and paid on the Company’s outstanding common stock. Any future dividends will be subject to the approval of the Company’s Board of Directors.

(c) Other Repurchases of Common Stock

For the three months ended October 29, 2011 and October 30, 2010, the Company repurchased approximately 9 million and 6 million shares, or $137 million and $127 million of common stock, respectively, in settlement of employee tax withholding obligations due upon the vesting of restricted stock or stock units.

(d) Comprehensive Income

The components of comprehensive income for the three months ended October 29, 2011 and October 30, 2010 are as follows (in millions):

 

     Three Months Ended  
     October 29,
2011
    October 30,
2010
 

Net income

   $ 1,777      $ 1,930   

Other comprehensive income:

    

Change in unrealized gains and losses on investments, net of tax benefit (expense) of $28 and ($17) for the first quarters of fiscal 2012 and 2011, respectively

     (59 )     42   

Change in derivative instruments

     (50 )     49   

Change in cumulative translation adjustment and other, net of tax benefit (expense) of $21 and ($10) for the first quarters of fiscal 2012 and 2011, respectively

     (211 )     238   
  

 

 

   

 

 

 

Comprehensive income

     1,457        2,259   

Comprehensive loss (income) attributable to noncontrolling interests

     7        (2 )
  

 

 

   

 

 

 

Comprehensive income attributable to Cisco

   $ 1,464      $ 2,257   
  

 

 

   

 

 

 

The components of AOCI, net of tax, are summarized as follows (in millions):

 

     October 29,
2011
    July 30,
2011
 

Net unrealized gains on investments

   $ 435      $ 487   

Net unrealized (losses) gains on derivative instruments

     (44 )     6   

Cumulative translation adjustment and other

     590        801   
  

 

 

   

 

 

 

Total

   $ 981      $ 1,294   
  

 

 

   

 

 

 

 

27


Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

14. Employee Stock Benefit Plans

(a) Employee Stock Incentive Plans

Stock Incentive Plan Program Description As of October 29, 2011, the Company had five stock incentive plans: the 2005 Stock Incentive Plan (the “2005 Plan”); the 1996 Stock Incentive Plan (the “1996 Plan”); the 1997 Supplemental Stock Incentive Plan (the “Supplemental Plan”); the Cisco Systems, Inc. SA Acquisition Long-Term Incentive Plan (the “SA Acquisition Plan”); and the Cisco Systems, Inc. WebEx Acquisition Long-Term Incentive Plan (the “WebEx Acquisition Plan”). In addition, the Company has, in connection with the acquisitions of various companies, assumed the share-based awards granted under stock incentive plans of the acquired companies or issued share-based awards in replacement thereof. Share-based awards are designed to reward employees for their long-term contributions to the Company and provide incentives for them to remain with the Company. The number and frequency of share-based awards are based on competitive practices, operating results of the Company, government regulations, and other factors. Since the inception of the stock incentive plans, the Company has granted share-based awards to a significant percentage of its employees, and the majority has been granted to employees below the vice president level. The Company’s primary stock incentive plans are summarized as follows:

2005 Plan As amended on November 15, 2007, the maximum number of shares issuable under the 2005 Plan over its term is 559 million shares plus the amount of any shares underlying awards outstanding on November 15, 2007 under the 1996 Plan, the SA Acquisition Plan, and the WebEx Acquisition Plan that are forfeited or are terminated for any other reason before being exercised or settled. If any awards granted under the 2005 Plan are forfeited or are terminated for any other reason before being exercised or settled, then the shares underlying the awards will again be available under the 2005 Plan.

Pursuant to an amendment approved by the Company’s shareholders on November 12, 2009, the number of shares available for issuance under the 2005 Plan was reduced by 1.5 shares for each share awarded as a stock grant or a stock unit, and any shares underlying awards outstanding under the 1996 Plan, the SA Acquisition Plan, and the WebEx Acquisition Plan that expire unexercised at the end of their maximum terms become available for reissuance under the 2005 Plan. The 2005 Plan permits the granting of stock options, stock, stock units, and stock appreciation rights to employees (including employee directors and officers), consultants of the Company and its subsidiaries and affiliates, and non-employee directors of the Company. Stock options and stock appreciation rights granted under the 2005 Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and prior to November 12, 2009 have an expiration date no later than nine years from the grant date. The expiration date for stock options and stock appreciation rights granted subsequent to the amendment approved on November 12, 2009 shall be no later than ten years from the grant date. The stock options will generally become exercisable for 20% or 25% of the option shares one year from the date of grant and then ratably over the following 48 or 36 months, respectively. Stock grants and stock units will generally vest with respect to 20% or 25% of the shares covered by the grant on each of the first through fifth or fourth anniversaries of the date of the grant, respectively. The Compensation and Management Development Committee of the Board of Directors has the discretion to use different vesting schedules. Stock appreciation rights may be awarded in combination with stock options or stock grants, and such awards shall provide that the stock appreciation rights will not be exercisable unless the related stock options or stock grants are forfeited. Stock grants may be awarded in combination with non-statutory stock options, and such awards may provide that the stock grants will be forfeited in the event that the related non-statutory stock options are exercised.

1996 Plan The 1996 Plan expired on December 31, 2006, and the Company can no longer make equity awards under the 1996 Plan. The maximum number of shares issuable over the term of the 1996 Plan was 2.5 billion shares. Stock options granted under the 1996 Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and expire no later than nine years from the grant date. The stock options generally become exercisable for 20% or 25% of the option shares one year from the date of grant and then ratably over the following 48 or 36 months, respectively. Certain other grants have utilized a 60-month ratable vesting schedule. In addition, the Board of Directors, or other committees administering the plan, have the discretion to use a different vesting schedule and have done so from time to time.

Supplemental Plan The Supplemental Plan expired on December 31, 2007, and the Company can no longer make equity awards under the Supplemental Plan. Officers and members of the Company’s Board of Directors were not eligible to participate in the Supplemental Plan. Nine million shares were reserved for issuance under the Supplemental Plan.

Acquisition Plans In connection with the Company’s acquisitions of Scientific-Atlanta, Inc. (“Scientific-Atlanta”) and WebEx Communications, Inc. (“WebEx”), the Company adopted the SA Acquisition Plan and the WebEx Acquisition Plan, respectively, each effective upon completion of the applicable acquisition. These plans constitute assumptions, amendments, restatements, and renamings of the 2003 Long-Term Incentive Plan of Scientific-Atlanta and the WebEx Communications, Inc. Amended and Restated 2000 Stock Incentive Plan, respectively. The plans permit the grant of stock options, stock, stock units, and stock appreciation rights to certain employees of the Company and its subsidiaries and affiliates who had been employed by Scientific-Atlanta or its subsidiaries or WebEx or its subsidiaries, as applicable. As a result of the shareholder approval of the amendment and extension of the 2005 Plan, as of November 15, 2007, the Company will no longer make stock option grants or direct share issuances under either the SA Acquisition Plan or the WebEx Acquisition Plan.

 

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Table of Contents

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(b) Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan, which includes its subplan, the International Employee Stock Purchase Plan (together, the “Purchase Plan”), under which 471.4 million shares of the Company’s common stock have been reserved for issuance as of October 29, 2011. Eligible employees are offered shares through a 24-month offering period, which consists of four consecutive 6-month purchase periods. Employees may purchase a limited number of shares of the Company’s stock at a discount of up to 15% of the lesser of the market value at the beginning of the offering period or the end of each 6-month purchase period. The Purchase Plan is scheduled to terminate on January 3, 2020. No shares were issued under the Purchase Plan during the three months ended October 29, 2011 and October 30, 2010. As of October 29, 2011, 122 million shares were available for issuance under the Purchase Plan.

(c) Summary of Share-Based Compensation Expense

Share-based compensation expense consists primarily of expenses for stock options, stock purchase rights, restricted stock, and restricted stock units granted to employees. The following table summarizes share-based compensation expense (in millions):

 

      Three Months Ended  
     October 29,
2011
     October 30,
2010
 

Cost of sales – product

   $ 13       $ 15   

Cost of sales – service

     37         43   
  

 

 

    

 

 

 

Share-based compensation expense in cost of sales

     50         58   
  

 

 

    

 

 

 

Research and development

     101         121   

Sales and marketing

     142         164   

General and administrative

     48         64   
  

 

 

    

 

 

 

Share-based compensation expense in operating expenses

     291         349   
  

 

 

    

 

 

 

Total share-based compensation expense

   $ 341       $ 407   
  

 

 

    

 

 

 

As of October 29, 2011, total compensation cost related to unvested share-based awards not yet recognized was $2.7 billion, which is expected to be recognized over approximately 2.2 years on a weighted-average basis. The income tax benefit for share-based compensation expense was $90 million and $109 million for the three months ended October 29, 2011 and October 30, 2010, respectively.

The fair value of restricted stock units was measured based on the grant-date share price adjusted for expected dividend yield. The Company estimates the fair value of employee stock options on the date of grant using a lattice-binomial model. The lattice-binomial model is more capable than the Black-Scholes model of incorporating the features of the Company’s employee stock options, such as the vesting provisions and various restrictions, including restrictions on transfer and hedging, among others, and the fact that options are often exercised prior to their contractual maturity. The use of the lattice-binomial model also requires extensive actual employee exercise behavior data for the relative probability estimation purpose and a number of complex assumptions, including expected volatility, risk-free interest rate, expected dividends, kurtosis, and skewness.

The Company uses third-party analyses to assist in developing the assumptions used in, as well as calibrating, its lattice-binomial model. The Company is responsible for determining the assumptions used in estimating the fair value of its share-based payment awards. The Company’s determination of the fair value of share-based payment awards is affected by assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company’s employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value or be indicative of the fair value that would be observed in a willing buyer/willing seller market for the Company’s employee stock options.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(d) Share-Based Awards Available for Grant

A summary of share-based awards available for grant is as follows (in millions):

 

     Share-
Based
Awards
Available
for Grant
 

BALANCE AT JULY 31, 2010

     295   

Restricted stock, stock units, and other share-based awards granted and assumed

     (84

Share-based awards canceled/forfeited/expired

     42   

Additional shares reserved

     2   
  

 

 

 

BALANCE AT JULY 30, 2011

     255   

Restricted stock, stock units, and other share-based awards granted and assumed

     (17

Share-based awards canceled/forfeited/expired

     23   

Other

     (6
  

 

 

 

BALANCE AT OCTOBER 29, 2011

     255   
  

 

 

 

As reflected in the preceding table, for each share awarded as restricted stock or subject to a restricted stock unit award under the 2005 Plan, an equivalent of 1.5 shares was deducted from the available share-based award balance. For restricted stock units that were awarded with vesting contingent upon the achievement of future financial performance metrics, the maximum awards that can be achieved upon full vesting of such awards were reflected in the preceding table.

(e) Restricted Stock and Stock Unit Awards

A summary of the restricted stock and stock unit activity is as follows (in millions, except per-share amounts):

 

     Restricted Stock/
Stock  Units
    Weighted-
Average Grant-
Date Fair Value per

Share
     Vest-Date
Fair Value
in Aggregate
 

BALANCE AT JULY 31, 2010

     97      $ 22.35      

Granted and assumed

     56        20.62      

Vested

     (27     22.54       $ 529   

Canceled/forfeited

     (10     22.04      
  

 

 

      

BALANCE AT JULY 30, 2011

     116        21.50      

Granted and assumed

     11        15.68      

Vested

     (25     22.87       $ 400   

Canceled/forfeited

     (8     21.70      
  

 

 

      

BALANCE AT OCTOBER 29, 2011

     94      $ 20.41      
  

 

 

      

Certain of the restricted stock units awarded in fiscal 2012 are contingent on the future achievement of financial performance metrics.

Prior to the initial declaration of a quarterly cash dividend on March 17, 2011, the fair value of restricted stock units was measured based on the grant date share price reduced by the present value of the dividend using an expected dividend yield of 0%, as the Company did not historically pay cash dividends on its common stock. For awards granted on or subsequent to March 17, 2011, the Company used an annualized dividend yield based on the per-share dividends declared by its Board of Directors.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(f) Stock Option Awards

A summary of the stock option activity is as follows (in millions, except per-share amounts):

 

     STOCK OPTIONS OUTSTANDING  
     Number
Outstanding
    Weighted-
Average
Exercise  Price

per Share
 

BALANCE AT JULY 31, 2010

     732      $ 21.39   

Exercised

     (80     16.55   

Canceled/forfeited/expired

     (31     25.91   
  

 

 

   

BALANCE AT JULY 30, 2011

     621        21.79   

Exercised

     (19     10.23   

Canceled/forfeited/expired

     (11     22.95   
  

 

 

   

BALANCE AT OCTOBER 29, 2011

     591      $ 22.14   
  

 

 

   

The following table summarizes significant ranges of outstanding and exercisable stock options as of October 29, 2011 (in millions, except years and share prices):

 

     STOCK OPTIONS OUTSTANDING      STOCK OPTIONS EXERCISABLE  

Range of Exercise Prices

   Number
Outstanding
     Weighted-
Average
Remaining
Contractual
Life (in Years)
     Weighted-
Average
Exercise
Price per
Share
     Aggregate
Intrinsic
Value
     Number
Exercisable
     Weighted-
Average
Exercise
Price per
Share
     Aggregate
Intrinsic
Value
 

$  0.01 – 15.00

     36         1.85       $ 10.86       $ 275         34       $ 10.98       $ 260   

  15.01 – 18.00

     96         2.78         17.72         80         96         17.73         80   

  18.01 – 20.00

     166         1.66         19.29         1         166         19.29         1   

  20.01 – 25.00

     151         3.62         22.75         —           146         22.76         —     

  25.01 – 35.00

     142         4.84         30.65         —           119         30.63         —     
  

 

 

          

 

 

    

 

 

       

 

 

 

Total

     591         3.12       $ 22.14       $ 356         561       $ 21.83       $ 341   
  

 

 

          

 

 

    

 

 

       

 

 

 

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Company’s closing stock price of $18.56 as of October 28, 2011, which would have been received by the option holders had those option holders exercised their stock options as of that date. The total number of in-the-money stock options exercisable as of October 29, 2011 was 136 million. As of July 30, 2011, 575 million outstanding stock options were exercisable and the weighted-average exercise price was $21.37.

 

15. Income Taxes

The following table provides details of income taxes (in millions, except percentages):

 

     Three Months Ended  
     October 29,
2011
    October 30,
2010
 

Income before provision for income taxes

   $ 2,245      $ 2,425   

Provision for income taxes

   $ 468      $ 495   

Effective tax rate

     20.8     20.4

As of October 29, 2011, the Company had $3.0 billion of unrecognized tax benefits, of which $2.6 billion, if recognized, would favorably impact the effective tax rate. The Company regularly engages in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. It is reasonably possible that certain federal, foreign, and state tax matters may be concluded in the next 12 months. Specific positions that may be resolved include issues involving transfer pricing and various other matters. The Company estimates that the unrecognized tax benefits at October 29, 2011 could be reduced by approximately $400 million in the next 12 months.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

16. Segment Information and Major Customers

(a) Net Sales and Gross Margin by Segment

The Company conducts business globally and is primarily managed on a geographic basis. As of October 29, 2011, the Company has three geographic segments: the Americas; EMEA; and APJC. In fiscal 2011, the Company was organized into four geographic segments, which consisted of United States and Canada, European Markets, Emerging Markets, and Asia Pacific Markets. As a result of this geographic segment change in fiscal 2012, countries within the former Emerging Markets segment were consolidated into either EMEA or the Americas segment depending on their respective geographic locations. The Company has reclassified the geographic segment data for the prior period to conform to the current period’s presentation.

The Company’s management makes financial decisions and allocates resources based on the information it receives from its internal management system. Sales are