10-Q 1 d10q.htm FORM 10-Q 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 January 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 February 17, 2011: 5,527,994,846

 

 

 


Table of Contents

Cisco Systems, Inc.

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

INDEX

 

              Page  
Part I.   

Financial Information

     3   
  Item 1.   

Financial Statements (Unaudited)

     3   
    

Consolidated Balance Sheets at January 29, 2011 and July 31, 2010

     3   
    

Consolidated Statements of Operations for the three and six months ended January 29, 2011 and January 23, 2010

     4   
    

Consolidated Statements of Cash Flows for the six months ended January 29, 2011 and January 23, 2010

     5   
    

Consolidated Statements of Equity for the six months ended January 29, 2011 and January 23, 2010

     6   
    

Notes to Consolidated Financial Statements

     7   
  Item 2.   

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

     37   
  Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     65   
  Item 4.   

Controls and Procedures

     68   
Part II.   

Other Information

     68   
  Item 1.   

Legal Proceedings

     68   
  Item 1A.   

Risk Factors

     69   
  Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     84   
  Item 3.   

Defaults Upon Senior Securities

     84   
  Item 5.   

Other Information

     84   
  Item 6.   

Exhibits

     85   
    

Signature

     86   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

CISCO SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(in millions, except par value)

(Unaudited)

 

     January 29,
2011
     July 31,
2010
 

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 4,924       $ 4,581   

Investments

     35,305         35,280   

Accounts receivable, net of allowance for doubtful accounts of $205 at January 29, 2011 and $235 at July 31, 2010

     4,620         4,929   

Inventories

     1,602         1,327   

Deferred tax assets

     2,054         2,126   

Other current assets

     3,561         3,178   
                 

Total current assets

     52,066         51,421   

Property and equipment, net

     4,031         3,941   

Goodwill

     16,746         16,674   

Purchased intangible assets, net

     2,799         3,274   

Other assets

     6,339         5,820   
                 

TOTAL ASSETS

   $ 81,981       $ 81,130   
                 

LIABILITIES AND EQUITY

     

Current liabilities:

     

Short-term debt

   $ 3,089       $ 3,096   

Accounts payable

     796         895   

Income taxes payable

     163         90   

Accrued compensation

     2,607         3,129   

Deferred revenue

     7,878         7,664   

Other current liabilities

     3,972         4,359   
                 

Total current liabilities

     18,505         19,233   

Long-term debt

     12,152         12,188   

Income taxes payable

     968         1,353   

Deferred revenue

     3,929         3,419   

Other long-term liabilities

     741         652   
                 

Total liabilities

     36,295         36,845   
                 

Commitments and contingencies (Note 11)

     

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; 5,533 and 5,655 shares issued and outstanding at January 29, 2011 and July 31, 2010, respectively

     38,302         37,793   

Retained earnings

     6,363         5,851   

Accumulated other comprehensive income

     976         623   
                 

Total Cisco shareholders’ equity

     45,641         44,267   

Noncontrolling interests

     45         18   
                 

Total equity

     45,686         44,285   
                 

TOTAL LIABILITIES AND EQUITY

   $ 81,981       $ 81,130   
                 

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     Six Months Ended  
     January 29,
2011
    January 23,
2010
    January 29,
2011
    January 23,
2010
 

NET SALES:

        

Product

   $ 8,236      $ 7,976      $ 16,936      $ 15,176   

Service

     2,171        1,839        4,221        3,660   
                                

Total net sales

     10,407        9,815        21,157        18,836   
                                

COST OF SALES:

        

Product

     3,382        2,815        6,631        5,301   

Service

     764        668        1,510        1,315   
                                

Total cost of sales

     4,146        3,483        8,141        6,616   
                                

GROSS MARGIN

     6,261        6,332        13,016        12,220   

OPERATING EXPENSES:

        

Research and development

     1,478        1,247        2,909        2,471   

Sales and marketing

     2,444        2,126        4,846        4,136   

General and administrative

     452        451        910        876   

Amortization of purchased intangible assets

     203        138        316        243   
                                

Total operating expenses

     4,577        3,962        8,981        7,726   
                                

OPERATING INCOME

     1,684        2,370        4,035        4,494   

Interest income

     156        155        316        323   

Interest expense

     (161     (158     (327     (272

Other income (loss), net

     51        (12 )     131        49   
                                

Interest and other income (loss), net

     46        (15 )     120        100   
                                

INCOME BEFORE PROVISION FOR INCOME TAXES

     1,730        2,355        4,155        4,594   

Provision for income taxes

     209        502        704        954   
                                

NET INCOME

   $ 1,521      $ 1,853      $ 3,451      $ 3,640   
                                

Net income per share:

        

Basic

   $ 0.27      $ 0.32      $ 0.62      $ 0.63   
                                

Diluted

   $ 0.27      $ 0.32      $ 0.61      $ 0.62   
                                

Shares used in per-share calculation:

        

Basic

     5,531        5,741        5,563        5,754   
                                

Diluted

     5,587        5,862        5,630        5,866   
                                

See Notes to Consolidated Financial Statements.

 

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CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)

 

     Six Months Ended  
     January 29,
2011
    January 23,
2010
 

Cash flows from operating activities:

    

Net income

   $ 3,451      $ 3,640   

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

    

Depreciation, amortization, and other noncash items

     1,240        942   

Share-based compensation expense

     837        692   

Provision for doubtful accounts

     —          36   

Deferred income taxes

     64        (117

Excess tax benefits from share-based compensation

     (45     (49

Net gains on investments

     (154     (84

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

    

Accounts receivable

     343        (994

Inventories

     (270     (80

Lease receivables, net

     (247     (137

Accounts payable

     (105     58   

Income taxes payable

     (317     (68

Accrued compensation

     (568     (346

Deferred revenue

     686        190   

Other assets

     (393     (202

Other liabilities

     (246     493   
                

Net cash provided by operating activities

     4,276        3,974   
                

Cash flows from investing activities:

    

Purchases of investments

     (17,632     (23,020

Proceeds from sales of investments

     9,394        6,282   

Proceeds from maturities of investments

     8,357        11,278   

Acquisition of property and equipment

     (652     (408

Acquisition of businesses, net of cash and cash equivalents acquired

     (94     (2,308

Change in investments in privately held companies

     (50     (69

Other

     28        60   
                

Net cash used in investing activities

     (649     (8,185
                

Cash flows from financing activities:

    

Issuance of common stock

     1,158        1,436   

Repurchase of common stock

     (4,550     (3,244

Issuance of debt

     —          4,944   

Short-term borrowings (repayments), net

     23        —     

Settlements of interest rate derivatives related to long-term debt

     —          23   

Excess tax benefits from share-based compensation

     45        49   

Other

     40        (5
                

Net cash (used in) provided by financing activities

     (3,284     3,203   
                

Net increase (decrease) in cash and cash equivalents

     343        (1,008

Cash and cash equivalents, beginning of period

     4,581        5,718   
                

Cash and cash equivalents, end of period

   $ 4,924      $ 4,710   
                

Cash paid for:

    

Interest

   $ 388      $ 305   

Income taxes

   $ 957      $ 1,138   

See Notes to Consolidated Financial Statements.

 

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CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(in millions)

(Unaudited)

 

Six Months Ended January 23, 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 25, 2009

    5,785      $ 34,344      $ 3,868      $ 435       $ 38,647      $ 30      $ 38,677   

Net income

    —          —          3,640        —           3,640        —          3,640   

Change in:

              

Unrealized gains and losses on investments

    —          —          —          205         205        (10     195   

Derivative instruments

    —          —          —          15         15        —          15   

Cumulative translation adjustment and other

    —          —          —          84         84        —          84   
                                

Comprehensive income (loss)

             3,944        (10 )     3,934   
                                

Issuance of common stock

    91        1,436        —          —           1,436        —          1,436   

Repurchase of common stock

    (142 )     (902     (2,422 )     —           (3,324 )     —          (3,324 )

Tax benefits from employee stock incentive plans

    —          35        —          —           35        —          35   

Purchase acquisitions

    —          82        —          —           82        —          82   

Share-based compensation expense

    —          692        —          —           692        —          692   
                                                        

BALANCE AT JANUARY 23, 2010

    5,734      $ 35,687      $ 5,086      $ 739       $ 41,512      $ 20      $ 41,532   
                                                        

Six Months Ended January 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 31, 2010

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

Net income

    —          —          3,451        —           3,451        —          3,451   

Change in:

              

Unrealized gains and losses on investments

    —          —          —          89         89        27        116   

Derivative instruments

    —          —          —          19         19        —          19   

Cumulative translation adjustment and other

    —          —          —          245         245        —          245   
                                

Comprehensive income

             3,804        27        3,831   
                                

Issuance of common stock

    87        1,158        —          —           1,158        —          1,158   

Repurchase of common stock

    (209     (1,489     (2,939     —           (4,428     —          (4,428

Tax benefits from employee stock incentive plans

    —          (3     —          —           (3     —          (3

Purchase acquisitions

    —          6        —          —           6        —          6   

Share-based compensation expense

    —          837        —          —           837        —          837   
                                                        

BALANCE AT JANUARY 29, 2011

    5,533      $ 38,302      $ 6,363      $ 976       $ 45,641      $ 45      $ 45,686   
                                                        

Supplemental Information

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of January 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 12 to the Consolidated Financial Statements. The stock repurchases since the inception of this program and the related impacts 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

     3,329       $ 14,111       $ 55,162       $ 69,273   

See Notes to Consolidated Financial Statements.

 

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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 2011 is a 52-week fiscal year and fiscal 2010 was a 53-week fiscal year with the extra week included in the third quarter of fiscal 2010. 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. In the first quarter of fiscal 2011, in order to achieve operational efficiencies, the Company combined its Asia Pacific and Japan operations. Following this change, the Company is organized into the following four geographic segments: United States and Canada, European Markets, Emerging Markets, and Asia Pacific Markets. The Company has reclassified the geographic segment data for the prior period to conform to the current period’s presentation. The Emerging Markets segment remains unchanged and includes Eastern Europe, Latin America, the Middle East and Africa, and Russia and the Commonwealth of Independent States.

The accompanying financial data as of January 29, 2011 and for the three and six months ended January 29, 2011 and January 23, 2010 have 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 31, 2010 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 31, 2010.

The Company consolidates its investment in a venture fund managed by SOFTBANK Corp. and its affiliates (“SOFTBANK”) subject to the applicable accounting guidance. 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 (loss), 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 January 29, 2011, and results of operations for the three and six months ended January 29, 2011 and January 23, 2010, cash flows, and equity for the six months ended January 29, 2011 and January 23, 2010, as applicable, have been made. The results of operations for the three and six months ended January 29, 2011 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

In addition to the segment reporting change referred to above, the Company has made certain reclassifications to prior period amounts in order to conform to the current period presentation. These items include reclassifications to prior period amounts related to net sales for similar groups of products, gross margin by geographic segment, and the allocation of share-based compensation expense within operating expenses due to the refinement of these respective categories.

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

 

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2. Summary of Significant Accounting Policies

New Accounting Standards or Updates Recently Adopted

In June 2009, the Financial Accounting Standards Board (“FASB”) issued revised guidance for the consolidation of variable interest entities. In February 2010, the FASB issued amendments to the consolidation requirements, exempting certain investment funds from the June 2009 guidance for the consolidation of variable interest entities. The June 2009 guidance for the consolidation of variable interest entities replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits from the entity that could be potentially significant to the variable interest entity. The accounting guidance also requires an ongoing reassessment of whether an enterprise is the primary beneficiary and requires additional disclosures about an enterprise’s involvement in variable interest entities. This accounting guidance was effective for the Company beginning in the first quarter of fiscal 2011. The application of the revised guidance for the consolidation of variable interest entities did not have a material impact to the Company’s Consolidated Financial Statements.

In June 2009, the FASB issued revised guidance for the accounting of transfers of financial assets. This guidance eliminates the concept of a qualifying special-purpose entity, removes the scope exception for qualifying special-purpose entities when applying the accounting guidance related to the consolidation of variable interest entities, changes the requirements for derecognizing financial assets, and requires enhanced disclosure. This accounting guidance was effective for the Company beginning in the first quarter of fiscal 2011. The application of the revised guidance for the accounting of transfers of financial assets did not have a material impact to the Company’s Consolidated Financial Statements.

In July 2010, the FASB issued an accounting standard update to provide guidance to enhance disclosure related to the credit quality of a company’s financing receivables portfolio and the associated allowance for credit loss. Pursuant to this accounting update, a company is required to provide a greater level of disaggregated information about its financing receivables portfolio and its allowance for credit loss with the objective of facilitating users’ evaluation of the nature of credit risk inherent in the company’s portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit loss, and the changes and reasons for those changes in the allowance for credit loss. Effective in the second quarter of fiscal 2011, the Company has included in Note 6 the expanded disclosure related to both the period end balances and activities during the reporting period as well as the related accounting policies.

 

3. Business Combinations

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

 

     Shares Issued      Purchase
Consideration
     Net
Liabilities
Assumed
    Purchased
Intangible
Assets
     Goodwill  

Total acquisitions

     —         $ 105       $ (1   $ 36       $ 70   

The total purchase consideration related to the Company’s business combinations completed during the six months ended January 29, 2011 consisted of either cash consideration or vested share-based awards assumed, or both. Total cash and cash equivalents acquired from these business combinations were $3 million.

Total transaction costs related to business combination activities for the six months ended January 29, 2011 were $13 million, which were expensed as incurred and recorded as general and administrative (“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 six months ended January 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 from the date of acquisition. Pro forma results of operations for the acquisitions completed during the six months ended January 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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4. Goodwill and Purchased Intangible Assets

(a) Goodwill

In the first quarter of fiscal 2011, in order to achieve operational efficiencies, the Company combined its Asia Pacific and Japan operations. Following this change, the Company is organized into the following four geographic segments: United States and Canada, European Markets, Emerging Markets, and Asia Pacific Markets. The goodwill of the former Asia Pacific and Japan geographic segments as of July 31, 2010 was allocated to the combined segment Asia Pacific Markets.

The following table presents the goodwill allocated to the Company’s reportable segments as of and during the six months ended January 29, 2011 (in millions):

 

     Balance at
July 31, 2010
     Acquisitions      Other     Balance at
January 29, 2011
 

United States and Canada

   $ 11,289       $ 39       $ (14   $ 11,314   

European Markets

     2,729         17         16        2,762   

Emerging Markets

     762         —           —          762   

Asia Pacific Markets

     1,894         14         —          1,908   
                                  

Total

   $ 16,674       $ 70       $ 2      $ 16,746   
                                  

In the preceding table, “Other” primarily 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 six months ended January 29, 2011 (in millions, except years):

 

     FINITE LIVES      INDEFINITE
LIVES
        
     TECHNOLOGY      CUSTOMER
RELATIONSHIPS
     OTHER      IPR&D      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

     5.1       $ 35         —         $ —           3.0       $ 1       $ —         $ 36   

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

 

January 29, 2011

   Gross      Accumulated
Amortization
    Net  

Purchased intangible assets with finite lives:

       

Technology

   $ 2,299       $ (812   $ 1,487   

Customer relationships

     2,268         (1,191     1,077   

Other

     163         (110     53   
                         

Total purchased intangible assets with finite lives

     4,730         (2,113     2,617   

IPR&D, with indefinite lives

     182         —          182   
                         

Total

   $ 4,912       $ (2,113   $ 2,799   
                         

July 31, 2010

   Gross      Accumulated
Amortization
    Net  

Purchased intangible assets with finite lives:

       

Technology

   $ 2,396       $ (686 )   $ 1,710   

Customer relationships

     2,326         (1,045 )     1,281   

Other

     172         (85 )     87   
                         

Total purchased intangible assets with finite lives

     4,894         (1,816 )     3,078   

IPR&D, with indefinite lives

     196         —          196   
                         

Total

   $ 5,090       $ (1,816 )   $ 3,274   
                         

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

 

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

 

     Three Months Ended      Six Months Ended  
     January 29,
2011
     January 23,
2010
     January 29,
2011
     January 23,
2010
 

Amortization of purchased intangible assets:

           

Cost of sales

   $ 171       $ 60       $ 277       $ 109   

Operating expenses

     203         138         316         243   
                                   

Total

   $ 374       $ 198       $ 593       $ 352   
                                   

The amortization of purchased intangible assets for the three and six months ended January 29, 2011 included impairment charges of approximately $155 million, of which $63 million was recorded to product cost of sales and $92 million was recorded to operating expenses. The fair value for purchased intangible assets for which the carrying amount was not deemed to be recoverable was determined using the future undiscounted cash flows that the assets are expected to generate. The impairment of purchased intangible assets was categorized as $96 million in technology, $40 million in customer relationships, and $19 million in other. These impairment charges were primarily due to declines in estimated fair value as a result of reductions in expected future cash flows associated with certain of the Company’s consumer products. For the three and six months ended January 23, 2010, the Company had impairment charges of $8 million primarily related to technology.

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

 

Fiscal Year

   Amount  

2011 (remaining six months)

   $ 402   

2012

     706   

2013

     586   

2014

     402   

2015

     337   

Thereafter

     184   
        

Total

   $ 2,617   
        

 

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5. Balance Sheet Details

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

 

     January 29,
2011
    July 31,
2010
 

Inventories:

    

Raw materials

   $ 326      $ 217   

Work in process

     29        50   

Finished goods:

    

Distributor inventory and deferred cost of sales

     602        587   

Manufactured finished goods

     403        260   
                

Total finished goods

     1,005        847   
                

Service-related spares

     178        161   

Demonstration systems

     64        52   
                

Total

   $ 1,602      $ 1,327   
                

Property and equipment, net:

    

Land, buildings, and building & leasehold improvements

   $ 4,555      $ 4,470   

Computer equipment and related software

     1,434        1,405   

Production, engineering, and other equipment

     5,016        4,702   

Operating lease assets

     261        255   

Furniture and fixtures

     481        476   
                
     11,747        11,308   

Less accumulated depreciation and amortization

     (7,716     (7,367 )
                

Total

   $ 4,031      $ 3,941   
                

Other assets:

    

Deferred tax assets

   $ 2,060      $ 2,079   

Investments in privately held companies

     824        756   

Lease receivables, net (1)

     1,343        1,176   

Financed service contracts & other, net (1)

     1,120        763   

Loan receivables, net (1)

     655        675   

Other

     337        371   
                

Total

   $ 6,339      $ 5,820   
                

Deferred revenue:

    

Service

   $ 8,048      $ 7,428   

Product:

    

Unrecognized revenue on product shipments and other deferred revenue

     2,877        2,788   

Cash receipts related to unrecognized revenue from two-tier distributors

     882        867   
                

Total product deferred revenue

     3,759        3,655   
                

Total

   $ 11,807      $ 11,083   
                

Reported as:

    

Current

   $ 7,878      $ 7,664   

Noncurrent

     3,929        3,419   
                

Total

   $ 11,807      $ 11,083   
                

 

(1)

Amounts represent the noncurrent portions of the respective balances. See Note 6 for the current portions of the respective balances, which are included in other current assets.

 

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6. Financing Receivables and Guarantees

(a) Financing Receivables Summary

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. Both the lease receivables and loan receivables consist of arrangements with, on average, terms of 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. As of January 29, 2011, the deferred service revenue related to these technical support services was $1,757 million.

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

 

January 29, 2011

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts & Other
    Total Financing
Receivables
 

Gross

   $ 2,738      $ 1,294      $ 2,285      $ 6,317   

Unearned income

     (225     —          —          (225

Allowance for credit loss

     (233     (84     (27     (344
                                

Total, net

   $ 2,280      $ 1,210      $ 2,258      $ 5,748   
                                

Reported as:

        

Current

   $ 937      $ 555      $ 1,138      $ 2,630   

Noncurrent

     1,343        655        1,120        3,118   
                                

Total, net

   $ 2,280      $ 1,210      $ 2,258      $ 5,748   
                                

July 31, 2010

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts & Other
    Total Financing
Receivables
 

Gross

   $ 2,411      $ 1,249      $ 1,773      $ 5,433   

Unearned income

     (215 )     —          —          (215

Allowance for credit loss

     (207 )     (73 )     (21 )     (301
                                

Total, net

   $ 1,989      $ 1,176      $ 1,752      $ 4,917   
                                

Reported as:

        

Current

   $ 813      $ 501      $ 989      $ 2,303   

Noncurrent

     1,176        675        763        2,614   
                                

Total, net

   $ 1,989      $ 1,176      $ 1,752      $ 4,917   
                                

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

 

Fiscal Year

   Amount  

2011 (remaining six months)

   $ 626   

2012

     927   

2013

     648   

2014

     363   

Thereafter

     174   
        

Total

   $ 2,738   
        

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

 

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(b) Credit Quality of Financing Receivables

The Company determines the adequacy of its allowance for credit loss by assessing the risks and losses inherent in its financing receivables that are disaggregated by portfolio segment and class. The portfolio segment is based on the type of financing transactions: lease receivables, loan receivables, and financed service contracts and other. These financing receivables are further disaggregated by class based on their risk characteristics. The two classes that the Company has identified are Established Markets and Growth Markets. The Growth Markets class consists of countries in the Company’s Emerging Markets segment as well as China and India, and the Established Markets class consists of the remaining geographies in which the Company has financing receivables.

In determining the allowance for credit loss for financing receivables, the Company applies the applicable loss factors to such receivables by class. The loss factors that the Company applies to the financing receivables for a given internal credit risk rating are developed using external data as benchmarks, such as the external long-term historical loss rates and expected default rates that are published annually, most recently in February 2010, by a major third party credit rating agency.

The internal credit risk rating for individual customers is derived by taking into consideration various customer specific factors and macroeconomic conditions. These factors include the strength of the customer’s business and financial performance, the quality of the customer’s banking relationships, the Company’s specific historical experience with the customer, the performance and outlook of the customer’s industry, the customer’s legal and regulatory environment, the potential sovereign risk of the geographic locations in which the customer is operating, and independent third party evaluations. Such factors are updated regularly or when facts and circumstances indicate that an update is deemed necessary.

The Company’s internal credit risk ratings applied for individual customers are categorized as 1 through 10 with the lowest credit risk rating representing the highest quality receivables in the portfolio. Credit risk ratings of 1 through 4 generally 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 sub-standard ratings and constitute a relatively small portion of the Company’s financing receivables. The credit risk profile of the Company’s financing receivables as of January 29, 2011 is not materially different than the credit risk profile as of July 31, 2010. Financing receivables categorized by the Company’s internal credit risk rating for each portfolio segment and class as of January 29, 2011 are summarized as follows (in millions):

 

     ESTABLISHED MARKETS      GROWTH MARKETS      TOTAL  

Internal Credit Risk Rating

   Lease
Receivables
     Loan
Receivables
     Financed Service
Contracts &
Other
     Total      Lease
Receivables
     Loan
Receivables
     Financed Service
Contracts &
Other
     Total         

1 to 4

   $ 995       $ 181       $ 1,426       $ 2,602       $ 17       $ 292       $ —         $ 309       $ 2,911   

5 to 6

     1,076         121         807         2,004         92         643         —           735         2,739   

7 and higher

     26         1         52         79         23         56         —           79         158   
                                                                                

Total

     2,097         303         2,285         4,685         132         991         —           1,123         5,808   

Residual value

     280         —           —           280         4         —           —           4         284   
                                                                                

Gross receivables, net of unearned income

   $ 2,377       $ 303       $ 2,285       $ 4,965       $ 136       $ 991       $ —         $ 1,127       $ 6,092   
                                                                                

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. The total of the allowances for credit loss and the deferred revenue associated with total financing receivables as of January 29, 2011, was $2,526 million, compared with a gross financing receivables balance (net of unearned income) of $6,092 million. The losses that the Company has incurred historically with respect to its financing receivables have been immaterial, consistent with the performance of an investment grade portfolio.

If a customer’s financial condition deteriorates to a risk rating of 8 or higher, all receivables due from the customer are deemed to be impaired. When evaluating lease and loan receivables and the earned portion of financed service contracts for possible impairment, the Company considers historical experience, credit quality, the age of the receivable balances, and economic conditions that may affect a customer’s ability to pay. The Company considers a financing receivable to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the financing agreement, including scheduled interest payments. When an individual loan receivable, lease receivable, or the earned portion of financed service contracts has been identified as being impaired, all the outstanding amounts due from the customer, including any accrued interest, are fully reserved. As of January 29, 2011, the portion of the portfolio that was deemed to be impaired was immaterial. Financing receivables are written off at the point when they are considered uncollectible. Total net write-offs of financing receivables were not material for the six months ended January 29, 2011. The Company does not typically have any partially written-off financing receivables. During the six months ended January 29, 2011, the Company did not modify any financing receivables.

 

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

 

     CLASS         

PORTFOLIO SEGMENT

   Established
Markets
     Growth
Markets
     Total  

Lease Receivables:

        

31 – 60 days past due(1)

   $ 155       $ 4       $ 159   

61 – 90 days past due(1)

     51         6         57   

Greater than 90 days past due(1) (2)

     157         22         179   
                          

Total past due

     363         32         395   

Current

     2,014         104         2,118   
                          

Total lease receivables

   $ 2,377       $ 136       $ 2,513   
                          

Non-accrual lease receivables

   $ 9       $ 20       $ 29   

Impaired lease receivables

   $ 9       $ 20       $ 29   

Loan Receivables:

        

31 – 60 days past due(1)

   $ 10       $ 124       $ 134   

61 – 90 days past due(1)

     —           3         3   

Greater than 90 days past due(1) (2)

     5         155         160   
                          

Total past due

     15         282         297   

Current

     288         709         997   
                          

Total loan receivables

   $ 303       $ 991       $ 1,294   
                          

Non-accrual loan receivables

   $ 1       $ 7       $ 8   

Impaired loan receivables

   $ —         $ 7       $ 7   

Financed Service Contracts & Other:

        

31 – 60 days past due (1)

   $ 75       $ —         $ 75   

61 – 90 days past due(1)

     57         —           57   

Greater than 90 days past due(1) (2)

     240         —           240   
                          

Total past due

     372         —           372   

Current

     1,913         —           1,913   
                          

Total financed service contracts & other

   $ 2,285       $ —         $ 2,285   
                          

Non-accrual financed service contracts & other

   $ 7       $ —         $ 7   

Impaired financed service contracts & other

   $ 7       $ —         $ 7   

 

(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 table above is 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.

(2)

The balance 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 was $152 million, $151 million, and $206 million as of January 29, 2011, respectively.

The aging profile of the Company’s financing receivables as of January 29, 2011 is not materially different than that of July 31, 2010. The Company does not accrue interest on financing receivables which are more than 90 days past due unless either the receivable has not been collected due to administrative reasons or the receivable is well secured. The Company also does not accrue interest on financing receivables which are considered impaired. As of January 29, 2011, the Company had financing receivables of $55 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. Financing receivables may be placed on non-accrual status earlier if in management’s opinion, a timely collection of the full principal and interest becomes uncertain. After a financing receivable has been categorized as non-accrual, interest will be recognized when cash is received. Any previously earned but uncollected interest income on such financing receivables is reversed and charged against earnings. A financing receivable may be returned to accrual status after all of the customer’s delinquent balances of principal and interest have been settled and the customer remains current for an appropriate period.

 

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Table of Contents

(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  

Six Months Ended January 29, 2011

   Lease
Receivables
    Loan
Receivables
     Financed Service
Contracts & Other
    Total  

Allowance for credit loss as of July 31, 2010

   $ 207      $ 73       $ 21      $ 301   

Provisions

     21        9         7        37   

Write-offs, net

     (1 )     —           (1 )     (2 )

Foreign exchange and other

     6        2         —          8   
                                 

Allowance for credit loss as of January 29, 2011

   $ 233      $ 84       $ 27      $ 344   
                                 

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

   $ 2,513      $ 1,294       $ 2,285      $ 6,092   

The Company’s write-offs associated with financing receivables for fiscal 2010 and 2009 were not material. Financing receivables which were individually evaluated for impairment during the six months ended January 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 that are generally for various third-party financing arrangements extended to channel partners and end-user customers.

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 $4.5 billion and $4.0 billion for the three months ended January 29, 2011 and January 23, 2010, respectively, and $9.0 billion and $7.8 billion for the six months ended January 29, 2011 and January 23, 2010, respectively. The balance of the channel partner financing subject to guarantees was $1.3 billion and $1.4 billion as of January 29, 2011 and July 31, 2010, respectively. For the periods presented, payments under these guarantee arrangements were not material.

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 on which the Company has provided guarantees was $278 million and $155 million for the three months ended January 29, 2011 and January 23, 2010, respectively, and $561 million and $410 million for the six months ended January 29, 2011 and January 23, 2010, respectively. For the periods presented, payments under these guarantee arrangements were not material.

Financing Guarantee Summary

The aggregate amount of financing guarantees outstanding at January 29, 2011 and July 31, 2010, representing the total maximum potential future payments under financing arrangements with third parties, and the related deferred revenue are summarized in the following table (in millions):

 

     January 29,
2011
    July 31,
2010
 

Maximum potential future payments relating to financing guarantees:

    

Channel partner

   $ 383      $ 448   

End user

     300        304   
                

Total

   $ 683      $ 752   
                

Deferred revenue associated with financing guarantees:

    

Channel partner

   $ (258   $ (277

End user

     (273     (272
                

Total

   $ (531   $ (549
                

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

   $ 152      $ 203   
                

 

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Table of Contents
7. Investments

(a) Summary of Available-for-Sale Investments

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

 

January 29, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Fixed income securities:

          

U.S. government securities

   $ 17,659       $ 22       $ (11   $ 17,670   

U.S. government agency securities (1)

     10,731         32         (3     10,760   

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

     1,876         13         (2     1,887   

Corporate debt securities

     3,292         55         (18     3,329   

Asset-backed securities

     133         9         (4     138   
                                  

Total fixed income securities

     33,691         131         (38     33,784   

Publicly traded equity securities

     916         609         (4     1,521   
                                  

Total

   $ 34,607       $ 740       $ (42   $ 35,305   
                                  

July 31, 2010

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Fixed income securities:

          

U.S. government securities

   $ 16,570       $ 42       $ —        $ 16,612   

U.S. government agency securities (1)

     13,511         68         —          13,579   

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

     1,452         15         —          1,467   

Corporate debt securities

     2,179         64         (21 )     2,222   

Asset-backed securities

     145         9         (5 )     149   
                                  

Total fixed income securities

     33,857         198         (26 )     34,029   

Publicly traded equity securities

     889         411         (49 )     1,251   
                                  

Total

   $ 34,746       $ 609       $ (75 )   $ 35,280   
                                  

 

(1)

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

(2)

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

 

     Three Months Ended      Six Months Ended  
     January 29, 2011      January 23, 2010      January 29, 2011      January 23, 2010  

Net gains on investments in publicly traded equity securities

   $ 11       $ 17       $ 30       $ 28   

Net gains on investments in fixed income securities

     6         14         77         20   
                                   

Total

   $ 17       $ 31       $ 107       $ 48   
                                   

There were no impairment charges on available-for-sale investments for either the six months ended January 29, 2011 or the six months ended January 23, 2010.

 

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Table of Contents

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

 

Six Months Ended

   January 29, 2011     January 23, 2010  

Balance at beginning of period

   $ (95   $ (153

Sales of other-than-temporarily impaired fixed income securities

     45        20   
                

Balance at end of period

   $ (50   $ (133
                

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 January 29, 2011 and July 31, 2010 (in millions):

 

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

January 29, 2011

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

Fixed income securities:

               

U.S. government securities

   $ 3,886       $ (11   $ —         $ —        $ 3,886       $ (11

U.S. government agency securities (1)

     1,206         (3     —           —          1,206         (3

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

     547         (2     —           —          547         (2

Corporate debt securities

     1,137         (8     228         (10     1,365         (18

Asset-backed securities

     2         —          110         (4     112         (4
                                                   

Total fixed income securities

     6,778         (24     338         (14     7,116         (38

Publicly traded equity securities

     60         (4     1         —          61         (4
                                                   

Total

   $ 6,838       $ (28   $ 339       $ (14   $ 7,177       $ (42
                                                   
     UNREALIZED LOSSES
LESS THAN 12 MONTHS
    UNREALIZED LOSSES
12 MONTHS OR GREATER
    TOTAL  

July 31, 2010

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

Fixed income securities:

               

Corporate debt securities

   $ 140       $ (1 )   $ 304       $ (20 )   $ 444       $ (21 )

Asset-backed securities

     2         —          115         (5 )     117         (5 )
                                                   

Total fixed income securities

     142         (1 )     419         (25 )     561         (26 )

Publicly traded equity securities

     168         (12 )     393         (37 )     561         (49 )
                                                   

Total

   $ 310       $ (13 )   $ 812       $ (62 )   $ 1,122       $ (75 )
                                                   

 

(1)

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

(2)

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

 

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For fixed income securities that have unrealized losses as of January 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 January 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 and six months ended January 29, 2011.

The Company has evaluated its publicly traded equity securities as of January 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 January 29, 2011 (in millions):

 

     Amortized
Cost
     Fair
Value
 

Less than 1 year

   $ 17,698       $ 17,720   

Due in 1 to 2 years

     10,984         11,034   

Due in 2 to 5 years

     4,705         4,716   

Due after 5 years

     304         314   
                 

Total

   $ 33,691       $ 33,784   
                 

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

(d) Securities Lending

The Company periodically engages in securities lending activities with certain of its available-for-sale investments. These transactions, with a daily balance averaging less than 25% of the Company’s total available-for-sale investments portfolio, are accounted for as a secured lending of the securities, and the securities are typically loaned only on an overnight basis. 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. As of January 29, 2011 and July 31 2010, the Company had no outstanding securities lending transactions. The Company did not experience any losses in connection with the secured lending of securities during the periods presented.

 

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8. Fair Value

Pursuant to the accounting guidance for fair value measurements and its subsequent updates, 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 also 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 January 29, 2011 and July 31, 2010 were as follows (in millions):

 

     JANUARY 29, 2011      JULY 31, 2010  
     FAIR VALUE MEASUREMENTS      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

   $ 2,982       $ —         $ —         $ 2,982       $ 2,521       $ —         $ —         $ 2,521   

U.S. government securities

     —           24         —           24         —           235         —           235   

U.S. government agency securities (1)

     —           49         —           49         —           40         —           40   

Corporate debt securities

     —           1         —           1         —           1         —           1   

Available-for-sale investments:

                       

U.S. government securities

     —           17,670         —           17,670         —           16,612         —           16,612   

U.S. government agency securities (1)

     —           10,760         —           10,760         —           13,579         —           13,579   

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

     —           1,887         —           1,887         —           1,467         —           1,467   

Corporate debt securities

     —           3,329         —           3,329         —           2,222         —           2,222   

Asset-backed securities

     —           —           138         138         —           —           149         149   

Publicly traded equity securities

     1,521         —           —           1,521         1,251         —           —           1,251   

Derivative assets

     —           151         2         153         —           160         3         163   
                                                                       

Total

   $ 4,503       $ 33,871       $ 140       $ 38,514       $ 3,772       $ 34,316       $ 152       $ 38,240   
                                                                       

Liabilities:

                       

Derivative liabilities

   $ —         $ 12       $ —         $ 12       $ —         $ 19       $ —         $ 19   
                                                                       

Total

   $ —         $ 12       $ —         $ 12       $ —         $ 19       $ —         $ 19   
                                                                       

 

(1)

Includes corporate debt securities that are guaranteed by the FDIC.

(2)

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

 

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Level 2 fixed income securities are priced using quoted market prices for similar instruments; nonbinding market prices that are corroborated by observable market data; or, in limited circumstances, discounted cash flow techniques. 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 three and six months ended January 29, 2011.

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 six months ended January 29, 2011 and January 23, 2010 (in millions):

 

     Asset-Backed
Securities
    Derivative Assets     Total  

Balance at July 31, 2010

   $ 149      $ 3      $ 152   

Total gains and losses (realized and unrealized):

      

Included in operating expenses

     —          (1 )     (1 )

Included in other comprehensive income

     —          —          —     

Purchases, sales and maturities

     (11     —          (11
                        

Balance at January 29, 2011

   $ 138      $ 2      $ 140   
                        

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

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

Balance at July 25, 2009

   $ 223     $ 4     $ 227  

Total gains and losses (realized and unrealized):

      

Included in other income (loss), net

     (6     —          (6

Included in operating expenses

     —          (2     (2

Included in other comprehensive income

     29        —          29   

Purchases, sales and maturities

     (72     —          (72
                        

Balance at January 23, 2010

   $ 174      $ 2      $ 176   
                        

 

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Table of Contents

(c) Assets and Liabilities 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              
    Net Carrying
Value as of
January 29, 2011
    Level 1     Level 2     Level 3     Total Losses for  the
Three Months Ended
January 29, 2011
    Total Losses for the
Six Months Ended
January 29, 2011
 

Investments in privately held companies

  $ 11      $ —        $ —        $ 11      $ (2   $ (5 )

Purchased intangible assets

  $ 8     $ —        $ —        $ 8        (155     (155
                       

Total losses for nonrecurring measurements

          $ (157   $ (160
                       
          FAIR VALUE MEASUREMENTS              
    Net Carrying
Value as of
January 23, 2010
    Level 1     Level 2     Level 3     Total Losses for the
Three Months Ended
January 23, 2010
    Total Gains
(Losses) for the
Six Months Ended
January 23, 2010
 

Investments in privately held companies

  $ 24      $ —        $ —        $ 24      $ (4   $ (14 )

Purchased intangible assets

  $ —        $ —        $ —        $ —          (8     (8

Property held for sale

  $ 12      $ —        $ —        $ 12        (10     (10

Gains on assets no longer held as of January 23, 2010

            —          2   
                       

Total losses for nonrecurring measurements

          $ (22   $ (30
                       

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 inherent lack of liquidity. These assets were measured at fair value due to events or circumstances the Company identified that significantly impacted the fair value of these investments during the three and six months ended January 29, 2011 and January 23, 2010.

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 losses for the investments in privately held companies were recorded to other income (loss), net.

The fair value for purchased intangible assets for which the carrying amount was not deemed to be recoverable was determined using the future undiscounted cash flows that the assets are expected to generate. The difference between the estimated fair value and the carrying value of the assets was recorded as an impairment charge and included in product cost of sales and operating expenses as indicated in Note 3.

The fair values for property held for sale were measured using discounted cash flow techniques. The net losses for property held for sale were included in G&A expenses.

(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 9 and was determined using quoted market prices for those securities.

 

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9. Borrowings

(a) Debt

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

 

     January 29, 2011     July 31, 2010  
     Amount     Effective
Rate
    Amount     Effective
Rate
 

Senior notes:

        

5.25% fixed-rate notes, due 2011 (“2011 Notes”)

   $ 3,000        3.12   $ 3,000        3.12

2.90% fixed-rate notes, due 2014 (“2014 Notes”)

     500        3.11     500        3.11

5.50% fixed-rate notes, due 2016 (“2016 Notes”)

     3,000        3.07     3,000        3.18 %

4.95% fixed-rate notes, due 2019 (“2019 Notes”)

     2,000        5.08     2,000        5.08

4.45% fixed-rate notes, due 2020 (“2020 Notes”)

     2,500        4.50 %     2,500        4.50 %

5.90% fixed-rate notes, due 2039 (“2039 Notes”)

     2,000        6.11     2,000        6.11

5.50% fixed-rate notes, due 2040 (“2040 Notes”)

     2,000        5.67 %     2,000        5.67 %
                    

Total senior notes

     15,000          15,000     

Other notes and borrowings

     84          59     

Unaccreted discount

     (71       (73  

Hedge accounting adjustment

     228          298     
                    

Total

   $ 15,241        $ 15,284     
                    

Reported as:

        

Short-term debt

   $ 3,089        $ 3,096     

Long-term debt

     12,152          12,188     
                    

Total

   $ 15,241        $ 15,284     
                    

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 senior notes was $16.0 billion and $16.3 billion as of January 29, 2011 and July 31, 2010, respectively. Interest is payable semiannually on each class of the senior fixed-rate notes. The notes are redeemable by the Company at any time, subject to a make-whole premium. The Company was in compliance with all covenants on the senior notes and other notes and borrowings as of January 29, 2011. Other notes and borrowings include notes and credit facilities with a number of financial institutions that are available to certain foreign subsidiaries of the Company.

On January 31, 2011, the Company announced that it had established a short-term debt financing program of up to $3.0 billion through the issuance of commercial paper notes. As of February 22, 2011, the Company had issued commercial paper notes for an aggregate principal amount of $2.0 billion under this program. The Company intends to use the proceeds from the issuance of commercial paper notes for general corporate purposes, which may include the repayment of other maturing debt. On February 22, 2011 the Company repaid the 2011 Notes upon their maturity for an aggregate principal amount of $3.0 billion.

(b) 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) the London Interbank Offered Rate (“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 January 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 January 29, 2011, the Company had not borrowed any funds under the credit facility.

 

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10. 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     January 29,
2011
    July 31,
2010
   

Balance Sheet Line Item

  January 29,
2011
    July 31,
2010
 

Derivatives designated as hedging instruments:

           

Foreign currency derivatives

    Other current assets      $ 89      $ 82      Other current liabilities   $ 5      $ 7   

Interest rate derivatives

    Other assets        49        72      Other long-term liabilities     —          —     
                                   

Total

      138        154          5        7   
                                   

Derivatives not designated as hedging instruments:

           

Foreign currency derivatives

    Other current assets        13        6      Other current liabilities     7        12   

Equity derivatives

    Other current assets        —          1      Other current liabilities     —          —     

Equity derivatives

    Other assets        2        2      Other long-term liabilities     —          —     
                                   

Total

      15        9          7        12   
                                   

Total

    $ 153      $ 163        $ 12      $ 19   
                                   

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):

 

Three Months Ended

Derivatives Designated as Cash Flow

Hedging Instruments

  GAINS (LOSSES) RECOGNIZED IN OCI
ON DERIVATIVES
(EFFECTIVE PORTION)
   

GAINS (LOSSES) RECLASSIFIED FROM AOCI INTO
INCOME

(EFFECTIVE PORTION)

 
  January 29,
2011
    January 23,
2010
   

Line Item in Statements of Operations

  January 29,
2011
    January 23,
2010
 

Foreign currency derivatives

  $ (10   $ (35 )   Operating expenses   $ 17      $ 13   
      Cost of sales-service     3        2   

Interest rate derivatives

    —          8     Interest expense     —          —     
                                 

Total

  $ (10   $ (27 )     $ 20      $ 15   
                                 

Six Months Ended

Derivatives Designated as Cash Flow

Hedging Instruments

  GAINS (LOSSES) RECOGNIZED IN OCI
ON DERIVATIVES
(EFFECTIVE PORTION)
   

GAINS (LOSSES) RECLASSIFIED FROM AOCI INTO
INCOME

(EFFECTIVE PORTION)

 
  January  29,
2011
    January  23,
2010
   

Line Item in Statements of Operations

  January 29,
2011
    January 23,
2010
 

Foreign currency derivatives

  $ 45      $ 9      Operating expenses   $ 23      $ 7   
      Cost of sales-service     4        1   

Interest rate derivatives

    —          23      Interest expense     —          —     
                                 

Total

  $ 45      $ 32        $ 27      $ 8   
                                 

During the three and six months ended January 29, 2011 and January 23, 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 January 29, 2011, the Company estimates that approximately $58 million of net derivative gains related to its cash flow hedges included in accumulated other comprehensive income (AOCI) will be reclassified into earnings within the next 12 months.

 

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Table of Contents

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):

 

Three Months Ended

       GAINS (LOSSES) ON
DERIVATIVE INSTRUMENTS
    GAINS (LOSSES) RELATED  TO
HEDGED ITEMS
 

Derivatives Designated as

Fair Value Hedging Instruments

 

Line Item in Statements

of Operations

   January 29,
2011
    January 23,
2010
    January 29,
2011
    January 23,
2010
 

Equity derivatives

  Other income (loss), net    $ —        $ (1   $ —        $ 1   

Interest rate derivatives

  Interest expense      (53     —          55        —     
                                  

Total

     $ (53   $ (1   $ 55      $ 1   
                                  

Six Months Ended

       GAINS (LOSSES) ON
DERIVATIVE INSTRUMENTS
    GAINS (LOSSES) RELATED  TO
HEDGED ITEMS
 

Derivatives Designated as

Fair Value Hedging Instruments

 

Line Item in Statements

of Operations

   January 29, 2011     January 23, 2010     January 29,
2011
    January 23,
2010
 

Equity derivatives

  Other income (loss), net    $ —        $ (1   $ —        $ 1   

Interest rate derivatives

  Interest expense      (23 )     —          23        —     
                                  

Total

     $ (23 )   $ (1   $ 23      $ 1   
                                  

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
    GAINS (LOSSES) FOR  THE
SIX MONTHS ENDED
 

Derivatives Not Designated as

Hedging Instruments

 

Line Item in Statements

of Operations

  January 29,
2011
    January 23,
2010
    January 29,
2011
    January 23,
2010
 

Foreign currency derivatives

  Other income (loss), net   $ 16      $ (77   $ 130      $ 49   

Equity derivatives

  Operating expenses     13        5        24        18   

Equity derivatives

  Other income (loss), net     3        3        8        7   
                                 

Total

    $ 32      $ (69 )   $ 162      $ 74   
                                 

(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 option 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. The Company did not discontinue any hedges during any of the periods presented because it was probable that the original forecasted transaction would not occur.

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 (loss), 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.

 

 

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During the six months ended January 23, 2010, the Company entered into foreign exchange forward and options contracts denominated in Norwegian kroner to hedge against a portion of the foreign currency exchange risk associated with the purchase consideration for Tandberg ASA (“Tandberg”). These contracts were not designated as hedging instruments and were substantially settled in the third quarter of fiscal 2010 in connection with the close of the acquisition.

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 $5 million in OCI for the effective portion of its net investment hedges for the six months ended January 29, 2011. The Company’s net investment hedges are not included in the preceding tables.

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

 

     January 29,
2011
     July 31,
2010
 

Cash flow hedging instruments

   $ 2,560       $ 2,611   

No hedge designation

     3,930         4,619   

Net investment hedging instruments

     111         105   
                 

Total

   $ 6,601       $ 7,335   
                 

(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 January 29, 2011 and July 31, 2010, 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 the fourth quarter of fiscal 2010, the Company entered into interest rate swaps with a $1.5 billion notional amount that are designated as fair value hedges for a portion of the 2016 Notes. 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 these swaps is to convert fixed-rate interest expense on a portion of the 2016 Notes to a floating rate interest expense. 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 hedged debt. The fair value of the interest rate swaps was $49 million and $72 million as of January 29, 2011 and July 31, 2010, respectively, and was reflected in other assets.

Interest Rate Derivatives Designated as Cash Flow Hedges, Long-Term Debt

During the six months ended January 23, 2010, the Company entered into $3.7 billion of interest rate derivatives designated as cash flow hedges to hedge against interest rate movements in connection with the anticipated issuance of senior notes in November 2009. The effective portion of these hedges was recorded to AOCI, net of tax, and is amortized to interest expense over the respective lives of the notes. These derivative instruments were settled in connection with the actual issuance of the senior notes in November 2009.

(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. As of January 29, 2011 and July 31, 2010, the Company did not have any equity derivatives outstanding related to its investment portfolio.

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 equity derivatives to economically hedge this exposure. As of January 29, 2011 and July 31, 2010, the notional amount of the derivative instruments used to hedge such liabilities was $237 million and $169 million, respectively.

(e) Credit-Risk-Related Contingent Features

Certain derivative instruments are executed under agreements that have provisions requiring the Company and counterparty to maintain a specified credit rating from certain credit rating agencies. If the Company’s or 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 January 29, 2011 and July 31, 2010.

 

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11. 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 January 29, 2011 are as follows (in millions):

 

Fiscal Year

   Amount  

2011 (remaining six months)

   $ 193   

2012

     291   

2013

     193   

2014

     136   

Thereafter

     394   
        

Total

   $ 1,207   
        

(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 January 29, 2011 and July 31, 2010, the Company had total purchase commitments for inventory of $3,875 million and $4,319 million, 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 January 29, 2011 and July 31, 2010, the liability for these purchase commitments was $124 million and $135 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 upon the continued employment with the Company of certain employees of the acquired entities. The Company recognized such compensation expense of $58 million and $32 million during the three months ended January 29, 2011 and January 23, 2010 respectively, and $95 million and $66 million during the six months ended January 29, 2011 and January 23, 2010, respectively. As of January 29, 2011, the Company estimated that future compensation expense and contingent consideration of up to $101 million may be recognized pursuant to these 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 $298 million and $279 million as of January 29, 2011 and July 31, 2010, respectively.

(d) Variable Interest Entities

In the ordinary course of business, the Company makes 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 January 29, 2011 there were no material unconsolidated variable interest entities. Additionally, the Company’s potential maximum exposure to loss with these investments was not material.

 

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(e) Product Warranties and Guarantees

The following table summarizes the activity related to the product warranty liability during the six months ended January 29, 2011 and January 23, 2010 (in millions):

 

     Six Months Ended  
     January 29,
2011
    January 23,
2010
 

Balance at beginning of period

   $ 360      $ 321   

Provision for warranties issued

     229        219   

Payments

     (236     (212
                

Balance at end of period

   $ 353      $ 328   
                

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 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 6. The Company’s other guarantee arrangements as of January 29, 2011 and July 31, 2010 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 $480 million for the alleged evasion of import taxes, approximately $535 million for interest, and approximately $2.2 billion for various penalties, all determined using an exchange rate as of January 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.

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.

 

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12. Shareholders’ Equity

(a) Stock Repurchase Program

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of January 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 $12.7 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):

 

Six Months Ended January 29, 2011

   Shares
Repurchased
     Weighted-
Average Price
per Share
     Amount
Repurchased
 

Cumulative balance at July 31, 2010

     3,127       $ 20.78       $ 64,982   

Repurchase of common stock under the stock repurchase program

     202         21.27         4,291   
                    

Cumulative balance at January 29, 2011

     3,329       $ 20.81       $ 69,273   
                    

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) Other Repurchases of Common Stock

For the six months ended January 29, 2011 and January 23, 2010, the Company repurchased approximately 7 million and 3 million shares, or $140 million and $72 million of common stock, respectively, in settlement of employee tax withholding obligations due upon the vesting of restricted stock or stock units.

(c) Comprehensive Income

The components of comprehensive income are as follows (in millions):

 

     Three Months Ended     Six Months Ended  
     January 29,
2011
    January 23,
2010
    January 29,
2011
    January 23,
2010
 

Net income

   $ 1,521      $ 1,853      $ 3,451      $ 3,640   

Other comprehensive income:

        

Change in unrealized gains and losses on investments, net of tax benefit (expense) of $(30) and $(47), for the three and six months ended January 29, 2011, respectively and $4 and $(26) for the corresponding periods of fiscal 2010

     74        15        116        195   

Change in derivative instruments, net of tax expense of $3 and $9 for the three and six months ended January 23, 2010, respectively

     (30     (46     19        15   

Change in cumulative translation adjustment and other, net of tax benefit (expense) of $(5) and $(15), for the three and six months ended January 29, 2011, respectively and $3 and $(17) for the corresponding periods of fiscal 2010

     7        (79     245        84   
                                

Comprehensive income

     1,572        1,743        3,831        3,934   

Comprehensive (income) loss attributable to noncontrolling interests

     (25 )     4        (27     10   
                                

Comprehensive income attributable to Cisco Systems, Inc.

   $ 1,547      $ 1,747      $ 3,804      $ 3,944   
                                

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

 

     January 29,
2011
     July 31,
2010
 

Net unrealized gains on investments

   $ 422       $ 333   

Net unrealized gains on derivative instruments

     46         27   

Cumulative translation adjustment and other

     508         263   
                 

Total

   $ 976       $ 623   
                 

 

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13. Employee Benefit Plans

(a) 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 January 29, 2011. Effective July 1, 2009, 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. Prior to July 1, 2009 the offering period was six months. The Purchase Plan is scheduled to terminate on January 3, 2020. The Company issued 17 million and 14 million shares under the Purchase Plan during the six months ended January 29, 2011 and January 23, 2010, respectively. As of January 29, 2011, 139 million shares were available for issuance under the Purchase Plan.

(b) Employee Stock Incentive Plans

Stock Incentive Plan Program Description As of January 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.

Prior to November 12, 2009, the number of shares available for issuance under the 2005 Plan was reduced by 2.5 shares for each share awarded as a stock grant or stock unit. Pursuant to an amendment approved by the Company’s shareholders on November 12, 2009, following that amendment the number of shares available for issuance under the 2005 Plan is 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, has the discretion to use a different vesting schedule and has 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.

 

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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.

General Share-Based Award Information

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 25, 2009

     1,004      $ 24.29   

Granted and assumed

     15        13.23   

Exercised

     (158 )     17.88   

Canceled/forfeited/expired

     (129 )     47.31   
          

BALANCE AT JULY 31, 2010

     732        21.39   

Exercised

     (50     17.87   

Canceled/forfeited/expired

     (14     26.22   
          

BALANCE AT JANUARY 29, 2011

     668      $ 21.55   
          

The following table summarizes significant ranges of outstanding and exercisable stock options as of January 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

     66         2.03       $ 10.62       $ 677         62       $ 10.79       $ 622   

  15.01 – 18.00

     119         2.99         17.47         410         118         17.48         405   

  18.01 – 20.00

     170         2.41         19.29         279         168         19.29         273   

  20.01 – 25.00

     160         4.31         22.76         8         136         22.76         6   

  25.01 – 35.00

     153         5.56         30.63         —           104         30.57         —     
                                            

Total

     668         3.65       $ 21.55       $ 1,374         588       $ 20.87       $ 1,306   
                                            

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Company’s closing stock price of $20.93 as of January 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 January 29, 2011 was 367 million. As of July 31, 2010, 606 million outstanding stock options were exercisable and the weighted-average exercise price was $20.51.

 

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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 Price per
Share
     Aggregated
Fair Market
Value
 

BALANCE AT JULY 25, 2009

     62      $ 21.25      

Granted and assumed

     54        23.40      

Vested

     (16 )     21.56       $ 378   

Canceled/forfeited

     (3 )     22.40      
             

BALANCE AT JULY 31, 2010

     97      $ 22.35      

Granted and assumed

     46        21.85      

Vested

     (20     23.28       $ 403   

Canceled/forfeited

     (3     22.10      
             

BALANCE AT JANUARY 29, 2011

     120      $ 22.01      
             

Certain of the restricted stock units awarded in fiscal 2011 are contingent on the future achievement of financial performance metrics. The performance measures for these performance-based restricted stock units are revenue and earnings per share with pre-established adjustments.

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 25, 2009

     253   

Options granted and assumed

     (15 )

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

     (81 )

Share-based awards canceled/forfeited/expired

     123   

Additional shares reserved

     15   
        

BALANCE AT JULY 31, 2010

     295   

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

     (68

Share-based awards canceled/forfeited/expired

     17   

Additional shares reserved

     1   
        

BALANCE AT JANUARY 29, 2011

     245   
        

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 beginning November 15, 2007 and prior to November 12, 2009, an equivalent of 2.5 shares was deducted from the available share-based award balance. Effective as of November 12, 2009, the equivalent number of shares was revised to 1.5 shares for each share awarded as restricted stock or subject to a restricted stock unit award under the 2005 Plan beginning on such date.

 

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Expense and Valuation Information for Share-Based Awards

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

 

     Three Months Ended      Six Months Ended  
     January 29,
2011
     January 23,
2010
     January 29,
2011
     January 23,
2010
 

Cost of sales – product

   $ 16       $ 15       $ 31       $ 27   

Cost of sales – service

     48         41         91         74   
                                   

Share-based compensation expense in cost of sales

     64         56         122         101   
                                   

Research and development

     132         110         253         207   

Sales and marketing

     167         145         331         273   

General and administrative

     67         60         131         111   
                                   

Share-based compensation expense in operating expenses

     366         315         715         591   
                                   

Total share-based compensation expense

   $ 430       $ 371       $ 837       $ 692   
                                   

As of January 29, 2011, total compensation cost related to unvested share-based awards not yet recognized was $3.4 billion, which is expected to be recognized over approximately 2.5 years on a weighted-average basis. The income tax benefit for share-based compensation expense was $119 million and $228 million for the three and six months ended January 29, 2011, respectively, and $100 million and $185 million for the three and six months ended January 23, 2010, respectively.

Valuation of Share-Based Awards

The fair value of restricted stock and restricted stock units was measured as if awards were vested and issued on the grant date. The Company estimates the value of employee stock options on the date of grant using a lattice-binomial model and estimates the value of employee stock purchase rights on the date of grant using the Black-Scholes model. The lattice-binomial model is more capable 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 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 did not grant a material number of options during the six months ended January 29, 2011 or January 23, 2010.

Accuracy of Fair Value Estimates

The Company uses third-party analyses to assist in developing the assumptions used in, as well as calibrating, its lattice-binomial and Black-Scholes models. 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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14. Income Taxes

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

 

     Three Months Ended     Six Months Ended  
     January 29,
2011
    January 23,
2010
    January 29,
2011
    January 23,
2010
 

Income before provision for income taxes

   $ 1,730      $ 2,355      $ 4,155      $ 4,594   

Provision for income taxes

   $ 209      $ 502      $ 704      $ 954   

Effective tax rate

     12.1     21.3     16.9     20.8

During the three months ended January 29, 2011, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 reinstated the U.S. federal R&D tax credit, retroactive to January 1, 2010. As a result, the effective tax rate for the three and six months ended January 29, 2011 reflected a tax benefit of $53 million related to the current fiscal year R&D expenses and a tax benefit of $65 million related to fiscal 2010 R&D expenses.

As of January 29, 2011, the Company had $2.8 billion of unrecognized tax benefits, of which $2.4 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 January 29, 2011 could be reduced by approximately $275 million in the next 12 months.

 

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15. Segment Information and Major Customers

The Company designs, manufactures, and sells Internet Protocol (IP)-based networking and other products related to the communications and IT industry and provides services associated with these products and their use. Cisco products include Routers, Switches, New Products, and Other. These products, primarily integrated by Cisco IOS Software, link geographically dispersed local-area networks (LANs), metropolitan-area networks (MANs) and wide-area networks (WANs).

(a) Net Sales and Gross Margin by Segment

The Company conducts business globally and is primarily managed on a geographic basis. In the first quarter of fiscal 2011, in order to achieve operational efficiencies, the Company combined its Asia Pacific and Japan operations. Following this change, the Company is organized into the following four geographic segments: United States and Canada, European Markets, Emerging Markets, and Asia Pacific Markets.

The Company’s management makes financial decisions and allocates resources based on the information it receives from its internal management system. Sales are attributed to a geographic segment based on the ordering location of the customer. The Company does not allocate research and development, sales and marketing, or general and administrative expenses to its geographic segments in this internal management system because management does not include the information in its measurement of the performance of the operating segments. In addition, the Company does not allocate amortization of acquisition-related intangible assets, share-based compensation expense, charges related to asset impairments and restructurings, and certain other charges to the gross margin for each segment because management does not include this information in its measurement of the performance of the operating segments.

Summarized financial information by segment for the three and six months ended January 29, 2011 and January 23, 2010, based on the Company’s internal management system and as utilized by the Company’s Chief Operating Decision Maker (CODM), is as follows (in millions):

 

     Three Months Ended     Six Months Ended  
     January 29,
2011
    January 23,
2010
    January 29,
2011
    January 23,
2010
 

Net sales:

        

United States and Canada (1)

   $ 5,546      $ 5,324      $ 11,424      $ 10,314   

European Markets

     2,112        1,939        4,130        3,761   

Emerging Markets

     1,188        1,104        2,403        1,967   

Asia Pacific Markets

     1,561        1,448        3,200        2,794   
                                

Total

   $