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 April 30, 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 May 18, 2011: 5,500,184,916

 

 

 


Table of Contents

Cisco Systems, Inc.

FORM 10-Q for the Quarter Ended April 30, 2011

INDEX

 

              Page  
Part I.   

Financial Information

     3   
  Item 1.   

Financial Statements (Unaudited)

     3   
    

Consolidated Balance Sheets at April 30, 2011 and July 31, 2010

     3   
    

Consolidated Statements of Operations for the three and nine months ended April 30, 2011 and May 1, 2010

     4   
    

Consolidated Statements of Cash Flows for the nine months ended April 30, 2011 and May 1, 2010

     5   
    

Consolidated Statements of Equity for the nine months ended April 30, 2011 and May 1, 2010

     6   
    

Notes to Consolidated Financial Statements

     7   
  Item 2.   

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

     39   
  Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

     66   
  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

     85   
  Item 5.   

Other Information

     85   
  Item 6.   

Exhibits

     86   
    

Signature

     87   

 

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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)

 

     April 30,
2011
     July 31,
2010
 

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 6,635       $ 4,581   

Investments

     36,732         35,280   

Accounts receivable, net of allowance for doubtful accounts of $200 at April 30, 2011 and $235 at July 31, 2010

     4,413         4,929   

Inventories

     1,442         1,327   

Deferred tax assets

     2,120         2,126   

Other current assets

     3,862         3,178   
                 

Total current assets

     55,204         51,421   

Property and equipment, net

     4,023         3,941   

Goodwill

     16,880         16,674   

Purchased intangible assets, net

     2,702         3,274   

Other assets

     6,541         5,820   
                 

TOTAL ASSETS

   $ 85,350       $ 81,130   
                 

LIABILITIES AND EQUITY

     

Current liabilities:

     

Short-term debt

   $ 581       $ 3,096   

Accounts payable

     799         895   

Income taxes payable

     78         90   

Accrued compensation

     2,964         3,129   

Deferred revenue

     7,771         7,664   

Other current liabilities

     3,917         4,359   
                 

Total current liabilities

     16,110         19,233   

Long-term debt

     16,168         12,188   

Income taxes payable

     1,166         1,353   

Deferred revenue

     3,928         3,419   

Other long-term liabilities

     772         652   
                 

Total liabilities

     38,144         36,845   
                 

Commitments and contingencies (Note 12)

     

Equity:

     

Cisco shareholders’ equity:

     

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

     —           —     

Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized; 5,501 and 5,655 shares issued and outstanding at April 30, 2011 and July 31, 2010, respectively

     38,639         37,793   

Retained earnings

     7,217         5,851   

Accumulated other comprehensive income

     1,307         623   
                 

Total Cisco shareholders’ equity

     47,163         44,267   

Noncontrolling interests

     43         18   
                 

Total equity

     47,206         44,285   
                 

TOTAL LIABILITIES AND EQUITY

   $ 85,350       $ 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     Nine Months Ended  
     April  30,
2011
    May 1,
2010
    April  30,
2011
    May 1,
2010
 

NET SALES:

        

Product

   $ 8,669      $ 8,436      $ 25,605      $ 23,612   

Service

     2,197        1,932        6,418        5,592   
                                

Total net sales

     10,866        10,368        32,023        29,204   
                                

COST OF SALES:

        

Product

     3,437        3,010        10,068        8,311   

Service

     770        728        2,280        2,043   
                                

Total cost of sales

     4,207        3,738        12,348        10,354   
                                

GROSS MARGIN

     6,659        6,630        19,675        18,850   

OPERATING EXPENSES:

        

Research and development

     1,430        1,411        4,339        3,882   

Sales and marketing

     2,446        2,278        7,292        6,414   

General and administrative

     466        479        1,376        1,355   

Amortization of purchased intangible assets

     103        117        419        360   

Restructuring and other charges

     31        —          31        —     
                                

Total operating expenses

     4,476        4,285        13,457        12,011   
                                

OPERATING INCOME

     2,183        2,345        6,218        6,839   

Interest income

     161        158        477        481   

Interest expense

     (153 )     (182 )     (480 )     (454 )

Other income, net

     12        82        143        131   
                                

Interest and other income, net

     20        58        140        158   
                                

INCOME BEFORE PROVISION FOR INCOME TAXES

     2,203        2,403        6,358        6,997   

Provision for income taxes

     396        211        1,100        1,165   
                                

NET INCOME

   $ 1,807      $ 2,192      $ 5,258      $ 5,832   
                                

Net income per share:

        

Basic

   $ 0.33      $ 0.38      $ 0.95      $ 1.01   
                                

Diluted

   $ 0.33      $ 0.37      $ 0.94      $ 0.99   
                                

Shares used in per-share calculation:

        

Basic

     5,508        5,731        5,545        5,746   
                                

Diluted

     5,537        5,869        5,596        5,869   
                                

Cash dividends declared per common share

   $ 0.06      $ —        $ 0.06      $ —     
                                

See Notes to Consolidated Financial Statements.

 

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CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)

 

     Nine Months Ended  
     April  30,
2011
    May 1,
2010
 

Cash flows from operating activities:

    

Net income

   $ 5,258      $ 5,832   

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

    

Depreciation, amortization, and other

     1,813        1,415   

Share-based compensation expense

     1,237        1,126   

Provision for doubtful accounts

     (1     18   

Deferred income taxes

     (37 )     (256 )

Excess tax benefits from share-based compensation

     (65 )     (177 )

Net gains on investments

     (185 )     (147 )

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

    

Accounts receivable

     603        (662 )

Inventories

     (105 )     (86 )

Lease receivables, net

     (332 )     (263 )

Accounts payable

     (103 )     160   

Income taxes payable

     (192 )     (204 )

Accrued compensation

     (265 )     138   

Deferred revenue

     537        740   

Other assets

     (567 )     (544 )

Other liabilities

     (341 )     (149 )
                

Net cash provided by operating activities

     7,255        6,941   
                

Cash flows from investing activities:

    

Purchases of investments

     (30,303 )     (35,263 )

Proceeds from sales of investments

     14,942        12,193   

Proceeds from maturities of investments

     14,134        17,474   

Acquisition of property and equipment

     (930 )     (699 )

Acquisition of businesses, net of cash and cash equivalents acquired

     (266 )     (4,950 )

Change in investments in privately held companies

     (86 )     (68 )

Other

     48        80   
                

Net cash used in investing activities

     (2,461 )     (11,233 )
                

Cash flows from financing activities:

    

Issuances of common stock

     1,516        2,780   

Repurchases of common stock

     (5,564 )     (5,440 )

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

     392        62   

Issuances of debt, maturities greater than 90 days

     4,109        4,944   

Repayments of debt, maturities greater than 90 days

     (3,000     —     

Settlements of interest rate derivatives related to long-term debt

     —          23   

Excess tax benefits from share-based compensation

     65        177   

Dividends paid

     (329 )     —     

Other

     71        (11 )
                

Net cash (used in) provided by financing activities

     (2,740     2,535   
                

Net increase (decrease) in cash and cash equivalents

     2,054        (1,757 )

Cash and cash equivalents, beginning of period

     4,581        5,718   
                

Cash and cash equivalents, end of period

   $ 6,635      $ 3,961   
                

Cash paid for:

    

Interest

   $ 658      $ 575   

Income taxes

   $ 1,328      $ 1,624   

See Notes to Consolidated Financial Statements.

 

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CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(in millions)

(Unaudited)

 

Nine Months Ended April 30, 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

     —          —          5,258        —          5,258        —          5,258   

Change in:

              

Unrealized gains and losses on investments

     —          —          —          153        153        25        178   

Derivative instruments

     —          —          —          37        37        —          37   

Cumulative translation adjustment and other

     —          —          —          494        494        —          494   
                                

Comprehensive income

             5,942        25        5,967   
                                

Issuance of common stock

     110        1,516        —          —          1,516        —          1,516   

Repurchase of common stock

     (264 )     (1,879 )     (3,563 )     —          (5,442 )     —          (5,442 )

Cash dividends declared ($0.06 per common share)

     —          —          (329 )     —          (329 )     —          (329 )

Tax effects from employee stock incentive plans

     —          (40 )     —          —          (40 )     —          (40 )

Purchase acquisitions

     —          12        —          —          12        —          12   

Share-based compensation expense

     —          1,237        —          —          1,237        —          1,237   
                                                        

BALANCE AT APRIL 30, 2011

     5,501      $ 38,639      $ 7,217      $ 1,307      $ 47,163      $ 43      $ 47,206   
                                                        

Nine Months Ended May 1, 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

     —          —          5,832        —          5,832        —          5,832   

Change in:

              

Unrealized gains and losses on investments

     —          —          —          233        233        (8 )     225   

Derivative instruments

     —          —          —          (4 )     (4 )     —          (4

Cumulative translation adjustment and other

     —          —          —          12        12        —          12   
                                

Comprehensive income (loss)

             6,073        (8 )     6,065   
                                

Issuance of common stock

     167        2,780        —          —          2,780        —          2,780   

Repurchase of common stock

     (230 )     (1,458 )     (4,130     —          (5,588     —          (5,588

Tax benefits from employee stock incentive plans, including transfer pricing adjustments

     —          710        —          —          710        —          710   

Purchase acquisitions

     —          82        —          —          82        —          82   

Share-based compensation expense

     —          1,126        —          —          1,126        —          1,126   
                                                        

BALANCE AT MAY 1, 2010

     5,722      $ 37,584      $ 5,570      $ 676      $ 43,830      $ 22      $ 43,852   
                                                        

Supplemental Information

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of April 30, 2011, the Company’s Board of Directors had authorized an aggregate repurchase of up to $82 billion of common stock under this program with no termination date. For additional information regarding stock repurchases, see Note 13 to the Consolidated Financial Statements. The stock repurchases since the inception of this program and the related 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

     3,383       $ 14,487       $ 55,786       $ 70,273   

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 April 30, 2011 and for the three and nine months ended April 30, 2011 and May 1, 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 Current Report on Form 8-K filed March 9, 2011.

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, 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 April 30, 2011, and results of operations for the three and nine months ended April 30, 2011 and May 1, 2010, and cash flows and equity for the nine months ended April 30, 2011 and May 1, 2010, as applicable, have been made. The results of operations for the three and nine months ended April 30, 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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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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 7 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 six business combinations during the nine months ended April 30, 2011. A summary of the allocation of the total purchase consideration is presented as follows (in millions):

 

     Shares Issued      Purchase
Consideration
     Net
Liabilities
Assumed
    Purchased
Intangible
Assets
     Goodwill  

Total acquisitions

     —         $ 288       $ (10 )   $ 114       $ 184   

The total purchase consideration related to the Company’s business combinations completed during the nine months ended April 30, 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 $7 million.

Total transaction costs related to business combination activities for the nine months ended April 30, 2011 were $10 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 nine months ended April 30, 2011 is primarily related to expected synergies. The goodwill is not deductible for U.S. federal income tax purposes.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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 nine months ended April 30, 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.

 

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 nine months ended April 30, 2011 (in millions):

 

     Balance at
July 31, 2010
     Acquisitions      Other     Balance at
April 30, 2011
 

United States and Canada

   $ 11,289       $ 121       $ (14   $ 11,396   

European Markets

     2,729         35         35        2,799   

Emerging Markets

     762         4         1       767   

Asia Pacific Markets

     1,894         24         —          1,918   
                                  

Total

   $ 16,674       $ 184       $ 22      $ 16,880   
                                  

In the preceding table, “Other” includes foreign currency translation, purchase accounting adjustments, and an adjustment related to a divestiture.

(b) Purchased Intangible Assets

The following table presents details of the Company’s intangible assets acquired through business combinations completed during the nine months ended April 30, 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

     4.8       $ 92         6.4       $ 16         2.5       $ 1       $ 5       $ 114   

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

 

April 30, 2011

   Gross      Accumulated
Amortization
    Net  

Purchased intangible assets with finite lives:

       

Technology

   $ 2,365       $ (902 )   $ 1,463   

Customer relationships

     2,278         (1,263 )     1,015   

Other

     124         (86 )     38   
                         

Total purchased intangible assets with finite lives

     4,767         (2,251 )     2,516   

IPR&D, with indefinite lives

     186         —          186   
                         

Total

   $ 4,953       $ (2,251 )   $ 2,702   
                         

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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.

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

 

     Three Months Ended      Nine Months Ended  
     April 30,
2011
     May 1,
2010
     April 30,
2011
     May 1,
2010
 

Amortization of purchased intangible assets:

           

Cost of sales

   $ 110       $ 69       $ 387       $ 178   

Operating expenses:

           

Amortization of purchased intangible assets

     103         117         419         360   

Restructuring and other charges

     8         —           8         —     
                                   

Total

   $ 221       $ 186       $ 814       $ 538   
                                   

Amortization of purchased intangible assets for the three months ended April 30, 2011 included impairment charges of approximately $9 million primarily recorded under restructuring and other charges (see Note 5). Amortization of purchased intangible assets for the nine months ended April 30, 2011 included impairment charges of approximately $164 million, $64 million of which was recorded under product cost of sales, $92 million of which was recorded under amortization of purchased intangible assets, and $8 million of which was recorded under restructuring and other charges. These charges were categorized as $97 million impairment in technology assets, $40 million impairment in customer relationships, and $27 million impairment in other. These impairment charges were primarily due to the declines in the second quarter of fiscal 2011 of the estimated fair value of intangible assets associated with the Company’s certain consumer products as a result of reductions in expected future cash flows associated with such consumer products and the Company’s decision in the third quarter of fiscal 2011 to exit its Flip Video cameras product line. The fair value for purchased intangible assets for which the carrying amount was not deemed to be recoverable was determined using the future discounted cash flows that the assets were expected to generate. For the three and nine months ended May 1, 2010, the amortization of purchased intangible assets under operating expenses included impairment charges of $5 million and $13 million, respectively, primarily related to technology assets.

The estimated future amortization expense of purchased intangible assets with finite lives as of April 30, 2011 is as follows (in millions):

 

Fiscal Year

   Amount  

2011 (remaining three months)

   $ 202   

2012

     725   

2013

     610   

2014

     423   

2015

     355   

Thereafter

     201   
        

Total

   $ 2,516   
        

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

5. Restructuring and Other Charges

In April 2011, the Company initiated the first of what it expects to be a number of key, targeted actions to address several areas in its business model. These actions are intended to accomplish the following: to simplify and focus the Company’s organization and operating model; to align the Company’s cost structure given transitions in the marketplace; to divest or exit underperforming operations; and to deliver value to the Company’s shareholders. The Company is taking these actions to align its business based on its five company priorities: leadership in its core business (routing, switching, and associated services) which includes comprehensive security and mobility solutions; collaboration; data center, virtualization, and cloud; video; and architectures for business transformation.

The first of these actions, which was implemented in the third quarter of fiscal 2011, involved the realignment and restructuring of the Company’s consumer business, most notably exiting the Flip Video cameras product line. Restructuring and other charges for the three and nine months ended April 30, 2011 are summarized as follow (in millions):

 

Three and Nine Months Ended April 30, 2011

   Restructuring and Other Charges  

Cost of sales:

  

Excess inventories and purchase commitments with contract manufacturers and suppliers

   $ 115   

Other

     5   
        

Total cost of sales

     120   
        

Operating expenses:

  

Workforce reduction

     18   

Impairment of purchased intangible assets

     8   

Other

     5   
        

Total operating expenses

     31   
        

Total restructuring and other charges

   $ 151   
        

The majority of the workforce reduction charge (350 employees) reflected in the table above is expected to be paid in the fourth quarter of fiscal 2011. The Company expects to incur additional charges in the fourth quarter of fiscal 2011 related to the restructuring of its consumer business.

The Company announced its intent to realign its sales, services, and engineering organizations in order to simplify its operating model and focus on its key areas of growth. The Company expects to complete this realignment in fiscal 2012. As part of simplifying its operating model, the Company intends to consolidate its four geographic operating segments into three geographic operating segments, beginning in fiscal 2012. The Company plans to also undertake certain cost control initiatives, such as a voluntary early retirement program, additional workforce reductions, and other restructuring activities. The Company expects to record a pretax charge in the fourth quarter of fiscal 2011 of between $0.5 billion and $1.1 billion in connection with the voluntary early retirement program, which amounts will be paid in the fourth quarter of fiscal 2011. The Company cannot currently quantify the amount of other restructuring charges that it expects to record in future periods as it is currently evaluating these activities.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

6. Balance Sheet Details

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

 

     April 30,
2011
    July 31,
2010
 

Inventories:

    

Raw materials

   $ 283      $ 217   

Work in process

     28        50   

Finished goods:

    

Distributor inventory and deferred cost of sales

     612        587   

Manufactured finished goods

     278        260   
                

Total finished goods

     890        847   
                

Service-related spares

     181        161   

Demonstration systems

     60        52   
                

Total

   $ 1,442      $ 1,327   
                

Property and equipment, net:

    

Land, buildings, and building & leasehold improvements

   $ 4,773      $ 4,470   

Computer equipment and related software

     1,420        1,405   

Production, engineering, and other equipment

     4,977        4,702   

Operating lease assets

     281        255   

Furniture and fixtures

     488        476   
                
     11,939        11,308   

Less accumulated depreciation and amortization

     (7,916 )     (7,367
                

Total

   $ 4,023      $ 3,941   
                

Other assets:

    

Deferred tax assets

   $ 2,034      $ 2,079   

Investments in privately held companies

     837        756   

Lease receivables, net (1)

     1,412        1,176   

Financed service contracts & other, net (1)

     1,225        763   

Loan receivables, net (1)

     667        675   

Other

     366        371   
                

Total

   $ 6,541      $ 5,820   
                

Deferred revenue:

    

Service

   $ 8,010      $ 7,428   

Product:

    

Unrecognized revenue on product shipments and other deferred revenue

     2,898        2,788   

Cash receipts related to unrecognized revenue from two-tier distributors

     791        867   
                

Total product deferred revenue

     3,689        3,655   
                

Total

   $ 11,699      $ 11,083   
                

Reported as:

    

Current

   $ 7,771      $ 7,664   

Noncurrent

     3,928        3,419   
                

Total

   $ 11,699      $ 11,083   
                

 

(1) 

Amounts represent the noncurrent portions of the respective balances. See Note 7 for the current portions of the respective balances, which are included in other current assets.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

7. 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.

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

 

April 30, 2011

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

Gross

   $ 2,885      $ 1,373      $ 2,495      $ 6,753   

Unearned income

     (237 )     —          —          (237 )

Allowance for credit loss

     (236 )     (111 )     (25 )     (372 )
                                

Total, net

   $ 2,412      $ 1,262      $ 2,470       $ 6,144   
                                

Reported as:

        

Current

   $ 1,000      $ 595      $ 1,245      $ 2,840   

Noncurrent

     1,412        667        1,225        3,304   
                                

Total, net

   $ 2,412      $ 1,262      $ 2,470      $ 6,144   
                                

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   
                                

 

(1) 

As of April 30, 2011, the deferred service revenue related to financed service contracts and other was $1,996 million.

Contractual maturities of the gross lease receivables at April 30, 2011 are summarized as follows (in millions):

 

Fiscal Year

   Amount  

2011 (remaining three months)

   $ 373   

2012

     1,076   

2013

     740   

2014

     449   

Thereafter

     247   
        

Total

   $ 2,885   
        

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

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(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 2011, 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 substandard 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 April 30, 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 April 30, 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

   $ 1,054       $ 216       $ 1,549       $ 2,819       $ 20       $ 334       $ —         $ 354       $ 3,173   

5 to 6

     1,144         163         892         2,199         91         584         2        677         2,876   

7 and higher

     26         1         52         79         20         75         —           95         174   
                                                                                

Total

     2,224         380         2,493         5,097         131         993         2         1,126         6,223   

Residual value

     288         —           —           288         5         —           —           5         293   
                                                                                

Gross receivables, net of unearned income

   $ 2,512       $ 380       $ 2,493       $ 5,385       $ 136       $ 993       $ 2      $ 1,131       $ 6,516   
                                                                                

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 April 30, 2011 was $2,784 million, compared with a gross financing receivables balance (net of unearned income) of $6,516 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.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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, 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 April 30, 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 nine months ended April 30, 2011. The Company does not typically have any partially written-off financing receivables. During the nine months ended April 30, 2011, the Company did not modify any financing receivables.

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

 

ESTABLISHED MARKETS

   31-60 Days
Past Due  (1)
     61-90 Days
Past Due  (1)
     Greater than 90 Days
Past Due (1) (2)
     Total
Past Due
     Current      Total
Financing
Receivables
     Non-Accrual
Financing
Receivables
     Impaired
Financing
Receivables
 

Lease receivables

   $ 89       $ 40       $ 117       $ 246       $ 2,266       $ 2,512       $ 12      $ 8   

Loan receivables

     2         1         6         9         371         380         1        1   

Financed service contracts & other

     93         33         238         364         2,129         2,493         9         7   
                                                                       

Total Established Markets

   $ 184       $ 74       $ 361       $ 619       $ 4,766       $ 5,385       $ 22      $ 16   
                                                                       

GROWTH MARKETS

                                                       

Lease receivables

   $ 4       $ 1       $ 12       $ 17       $ 119       $ 136       $ 18      $ 18   

Loan receivables

     150         11         50         211         782         993         9        9   

Financed service contracts & other

     —           —           —           —           2         2         —           —     
                                                                       

Total Growth Markets

   $ 154       $ 12       $ 62       $ 228       $ 903       $ 1,131       $ 27      $ 27   
                                                                       

Total

   $ 338       $ 86       $ 423       $ 847       $ 5,669       $ 6,516       $ 49      $ 43   
                                                                       

 

(1) 

Past due financing receivables are those that are 31 days or more past due according to their contractual payment terms. The data in the preceding table 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 $96 million, $46 million, and $214 million as of April 30, 2011, respectively.

The aging profile of the Company’s financing receivables as of April 30, 2011 is not materially different than that of July 31, 2010. The Company does not accrue interest on financing receivables that 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 that are considered impaired. As of April 30, 2011, the Company had financing receivables of $57 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

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(c) Allowance for Credit Loss Rollforward

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

 

     CREDIT LOSS ALLOWANCES  

Three Months Ended April 30, 2011

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts & Other
    Total  

Allowance for credit loss as of January 29, 2011

   $ 233      $ 84      $ 27      $ 344   

Provisions

     3        26        (2 )     27   

Write-offs, net

     (5     (2     (1     (8

Foreign exchange and other

     5        3        1        9   
                                

Allowance for credit loss as of April 30, 2011

   $ 236      $ 111      $ 25      $ 372   
                                

Nine Months Ended April 30, 2011

   Lease
Receivables
    Loan
Receivables
    Financed Service
Contracts & Other
    Total  

Allowance for credit loss as of July 31, 2010

   $ 207      $ 73      $ 21      $ 301   

Provisions

     24        35        5        64   

Write-offs, net

     (6     (2     (2     (10

Foreign exchange and other

     11        5        1        17   
                                

Allowance for credit loss as of April 30, 2011

   $ 236      $ 111      $ 25      $ 372   
                                

Gross receivables as of April 30, 2011, net of unearned income

   $ 2,648      $ 1,373      $ 2,495      $ 6,516   

The Company’s write-offs associated with financing receivables for fiscal 2010 and 2009 were not material. Financing receivables that were individually evaluated for impairment during the three and nine months ended April 30, 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 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 $4.4 billion for each of the three months ended April 30, 2011 and May 1, 2010, and $13.4 billion and $12.3 billion for the nine months ended April 30, 2011 and May 1, 2010, respectively. The balance of the channel partner financing subject to guarantees was $1.3 billion and $1.4 billion as of April 30, 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 $371 million and $215 million for the three months ended April 30, 2011 and May 1, 2010, respectively, and $932 million and $625 million for the nine months ended April 30, 2011 and May 1, 2010, respectively. For the periods presented, payments under these guarantee arrangements were not material.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

Financing Guarantee Summary

The aggregate amount of financing guarantees outstanding at April 30, 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):

 

     April 30,
2011
    July 31,
2010
 

Maximum potential future payments relating to financing guarantees:

    

Channel partner

   $ 314      $ 448   

End user

     276        304   
                

Total

   $ 590      $ 752   
                

Deferred revenue associated with financing guarantees:

    

Channel partner

   $ (216 )   $ (277 )

End user

     (244 )     (272 )
                

Total

   $ (460 )   $ (549 )
                

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

   $ 130      $ 203   
                

 

8. Investments

(a) Summary of Available-for-Sale Investments

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

 

April 30, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

Fixed income securities:

          

U.S. government securities

   $ 19,785       $ 38       $ (6 )   $ 19,817   

U.S. government agency securities (1)

     8,197         30         (2 )     8,225   

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

     2,721         14         (1 )     2,734   

Corporate debt securities

     4,351         64         (9 )     4,406   

Asset-backed securities

     126         7         (3 )     130   
                                  

Total fixed income securities

     35,180         153         (21 )     35,312   

Publicly traded equity securities

     758         666         (4 )     1,420   
                                  

Total

   $ 35,938       $ 819       $ (25 )   $ 36,732   
                                  

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.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(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      Nine Months Ended  
     April 30, 2011      May 1, 2010      April 30, 2011      May 1, 2010  

Net gains on investments in publicly traded equity securities

   $ 42       $ 36       $ 72       $ 64   

Net gains on investments in fixed income securities

     7         35         84         55   
                                   

Total

   $ 49       $ 71       $ 156       $ 119   
                                   

There were no impairment charges on available-for-sale investments for either the nine months ended April 30, 2011 or the nine months ended May 1, 2010.

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

 

Nine Months Ended

   April 30, 2011     May 1, 2010  

Balance at beginning of period

   $ (95 )   $ (153 )

Sales of other-than-temporarily impaired fixed income securities

     52        20   
                

Balance at end of period

   $ (43 )   $ (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 April 30, 2011 and July 31, 2010 (in millions):

 

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

April 30, 2011

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

Fixed income securities:

               

U.S. government securities

   $ 2,090       $ (6 )   $ —         $ —        $ 2,090       $ (6 )

U.S. government agency securities (1)

     819         (2 )     —           —          819         (2 )

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

     305         (1 )     —           —          305         (1 )

Corporate debt securities

     606         (2 )     211         (7 )     817         (9 )

Asset-backed securities

     —           —          109         (3 )     109         (3 )
                                                   

Total fixed income securities

     3,820         (11 )     320         (10 )     4,140         (21 )

Publicly traded equity securities

     52         (4 )     2         —          54         (4 )
                                                   

Total

   $ 3,872       $ (15 )   $ 322       $ (10 )   $ 4,194       $ (25 )
                                                   
     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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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

For fixed income securities that have unrealized losses as of April 30, 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 April 30, 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 nine months ended April 30, 2011.

The Company has evaluated its publicly traded equity securities as of April 30, 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 April 30, 2011 (in millions):

 

     Amortized
Cost
     Fair
Value
 

Less than 1 year

   $ 13,718       $ 13,744   

Due in 1 to 2 years

     15,189         15,250   

Due in 2 to 5 years

     5,933         5,961   

Due after 5 years

     340         357   
                 

Total

   $ 35,180       $ 35,312   
                 

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 April 30, 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.

 

9. Fair Value

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

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(a) Fair Value Hierarchy

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

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

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

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

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

Assets and liabilities measured at fair value on a recurring basis as of April 30, 2011 and July 31, 2010 were as follows (in millions):

 

     APRIL 30, 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

   $ 4,995       $ —         $ —         $ 4,995       $ 2,521       $ —         $ —         $ 2,521   

U.S. government securities

     —           —           —           —           —           235         —           235   

U.S. government agency securities (1)

     —           76         —           76         —           40         —           40   

Corporate debt securities

     —           —           —           —           —           1         —           1   

Available-for-sale investments:

                       

U.S. government securities

     —           19,817         —           19,817         —           16,612         —           16,612   

U.S. government agency securities (1)

     —           8,225         —           8,225         —           13,579         —           13,579   

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

     —           2,734         —           2,734         —           1,467         —           1,467   

Corporate debt securities

     —           4,406         —           4,406         —           2,222         —           2,222   

Asset-backed securities

     —           —           130         130         —           —           149         149   

Publicly traded equity securities

     1,420         —           —           1,420         1,251         —           —           1,251   

Derivative assets

     —           183         2         185         —           160         3         163   
                                                                       

Total

   $ 6,415       $ 35,441       $ 132       $ 41,988       $ 3,772       $ 34,316       $ 152       $ 38,240   
                                                                       

Liabilities:

                       

Derivative liabilities

   $ —         $ 22       $ —         $ 22       $ —         $ 19       $ —         $ 19   
                                                                       

Total

   $ —         $ 22       $ —         $ 22       $ —         $ 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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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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 nine months ended April 30, 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 nine months ended April 30, 2011 and May 1, 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 other income, net

     3        —          3   

Included in operating expense

     —          (1 )     (1 )

Included in other comprehensive income

     (1 )     —          (1 )

Purchases, sales and maturities

     (21 )     —          (21 )
                        

Balance at April 30, 2011

   $ 130      $ 2      $ 132   
                        

Losses attributable to assets still held as of April 30, 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, net

     (6 )     —          (6 )

Included in operating expenses

     —          (2 )     (2 )

Included in other comprehensive income

     33        —          33   

Purchases, sales and maturities

     (96 )     —          (96 )
                        

Balance at May 1, 2010

   $ 154      $ 2      $ 156   
                        

(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
April 30, 2011
    Level 1     Level 2     Level 3     Total Losses for the
Three Months Ended
April 30, 2011
    Total Losses for  the
Nine Months Ended
April 30, 2011
 

Investments in privately held companies

  $ 11      $ —        $ —        $ 11      $ (1 )   $ (6

Purchased intangible assets

  $ —        $ —        $ —        $ —          (9 )     (164 )
                       

Total losses for nonrecurring measurements

          $ (10 )   $ (170 )
                       

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

          FAIR VALUE MEASUREMENTS              
    Net Carrying
Value as of
May 1, 2010
    Level 1     Level 2     Level 3     Total Losses for  the
Three Months Ended
May 1, 2010
    Total Gains
(Losses)  for the
Nine Months Ended
May 1, 2010
 

Investments in privately held companies

  $ 27      $ —        $ —        $ 27      $ (3 )   $ (17

Purchased intangible assets

  $ —        $ —        $ —        $ —          (5 )     (13 )

Property held for sale

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

Gains on assets no longer held as of May 1, 2010

            —          2   
                       

Total losses for nonrecurring measurements

          $ (18 )   $ (38 )
                       

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 fair value during the three and nine months ended April 30, 2011 and May 1, 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, net.

The fair value for purchased intangible assets for which the carrying amount was not deemed to be recoverable was determined using the future discounted 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, which was included in product cost of sales and operating expenses as indicated in Note 4. The impairment charge of $9 million that was recognized during the three months ended April 30, 2011 was related to the restructuring activities as discussed in Note 5.

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

(d) Other

The fair value of certain of the Company’s financial instruments that are not measured at fair value, including accounts receivable, accounts payable, accrued compensation, short-term debt, 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 long-term debt is disclosed in Note 10 and was determined using quoted market prices for those securities.

 

10. Borrowings

(a) Short-Term Debt

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

 

     April 30, 2011     July 31, 2010  
     Amount      Weighted-Average
Interest Rate
    Amount      Weighted-Average
Interest Rate
 

Commercial paper

   $ 513         0.26 %   $ —           —     

Current portion of long-term debt

     —           —          3,037         3.12

Other notes and borrowings

     68         6.34 %     59         4.21
                      

Total short-term debt

   $ 581         $ 3,096      
                      

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

In the third quarter of fiscal 2011, the Company established a short-term debt financing program of up to $3.0 billion through the issuance of commercial paper notes. The Company continues to use the proceeds from the issuance of commercial paper notes for general corporate purposes, including repayment of matured debt. The outstanding commercial paper as of April 30, 2011 matures at various dates through May 2011.

The Company repaid senior fixed-rate notes upon their maturity in February 2011 for an aggregate principal amount of $3.0 billion. Other notes and borrowings in the preceding table related to notes and credit facilities with a number of financial institutions that are available to certain foreign subsidiaries of the Company. These notes and credit facilities are subject to various terms and foreign currency market interest rates pursuant to individual financial arrangements between the financing institution and the applicable foreign subsidiary.

As of April 30, 2011, the estimated fair value of the short-term debt approximates its carrying value due to the short maturities.

(b) Long-Term Debt

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

 

     April 30, 2011     July 31, 2010  
     Amount     Effective
Rate
    Amount     Effective
Rate
 

Senior Notes:

        

Floating-rate notes, due 2014

   $ 1,250        0.56 %   $ —          —     

5.25% fixed-rate notes, due 2011

     —          —          3,000        3.12

2.90% fixed-rate notes, due 2014

     500        3.11 %     500        3.11

1.625% fixed-rate notes, due 2014

     2,000        0.64 %     —          —     

5.50% fixed-rate notes, due 2016

     3,000        3.09 %     3,000        3.18

3.15% fixed-rate notes, due 2017

     750        0.86 %     —          —     

4.95% fixed-rate notes, due 2019

     2,000        5.08 %     2,000        5.08

4.45% fixed-rate notes, due 2020

     2,500        4.50     2,500        4.50

5.90% fixed-rate notes, due 2039

     2,000        6.11 %     2,000        6.11

5.50% fixed-rate notes, due 2040

     2,000        5.67     2,000        5.67
                    

Total

     16,000          15,000     

Unaccreted discount

     (74       (73  

Hedge accounting adjustment

     242          298     
                    

Total

   $ 16,168        $ 15,225     

Less: current portion

     —            (3,037  
                    

Total long-term debt

   $ 16,168        $ 12,188     
                    

In March 2011, the Company issued senior notes for an aggregate principal amount of $4.0 billion, including $1.25 billion of senior floating interest rate notes due 2014, $2.0 billion of 1.625% fixed-rate senior notes due 2014, and $750 million of 3.15% fixed-rate senior notes due 2017. To achieve its interest rate risk management objectives, the Company entered into interest rate swaps with a notional amount of $2.75 billion designated as fair value hedges of the fixed-rate senior notes. In effect, these swaps convert the fixed interest rates of the fixed-rate notes to floating interest rates based on the London InterBank Offered Rate (“LIBOR”). The gains and losses related to changes in the fair value of the interest rate swaps substantially offset changes in the fair value of the hedged portion of the underlying debt that are attributable to the changes in market interest rates. See Note 11.

The effective rates for the fixed-rate debt include the interest on the notes, the accretion of the discount, and, if applicable, adjustments related to hedging. Based on market prices, the fair value of the Company’s senior notes was $17.0 billion as of April 30, 2011. Interest is payable semiannually on each class of the senior fixed-rate notes and payable quarterly on the floating-rate notes. Each of the senior fixed-rate notes is redeemable by the Company at any time, subject to a make-whole premium.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

The senior notes rank at par with the issued commercial paper notes, as well as any other commercial paper notes that may be issued in the future pursuant to the short-term debt financing program, as discussed earlier under “Short-Term Debt”. The Company was in compliance with all debt covenants as of April 30, 2011.

(c) Credit Facility

The Company has a credit agreement with certain institutional lenders providing for a $3.0 billion unsecured revolving credit facility that is scheduled to expire on August 17, 2012. Any advances under the credit agreement will accrue interest at rates that are equal to, based on certain conditions, either (i) the higher of the Federal Funds rate plus 0.50% or Bank of America’s “prime rate” as announced from time to time or (ii) the 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 April 30, 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 April 30, 2011, the Company had not borrowed any funds under the credit facility.

 

11. Derivative Instruments

(a) Summary of Derivative Instruments

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

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

 

   

DERIVATIVE ASSETS

   

DERIVATIVE LIABILITIES

 
   

Balance Sheet Line Item

  April  30,
2011
    July  31,
2010
   

Balance Sheet Line Item

  April  30,
2011
    July  31,
2010
 

Derivatives designated as hedging instruments:

           

Foreign currency derivatives

  Other current assets   $ 100      $ 82      Other current liabilities   $ 14      $ 7   

Interest rate derivatives

  Other assets     75        72      Other long-term liabilities     —          —     
                                   

Total

      175        154          14        7   
                                   

Derivatives not designated as hedging instruments:

           

Foreign currency derivatives

  Other current assets     8        6      Other current liabilities     8        12   

Total return swaps-deferred compensation

  Other current assets     —          1      Other current liabilities     —          —     

Equity derivatives

  Other assets     2        2      Other long-term liabilities     —          —     
                                   

Total

      10        9          8        12   
                                   

Total

    $ 185      $ 163        $ 22      $ 19   
                                   

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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

 

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)
 

Three Months Ended

  April 30,
2011
    May 1,
2010
    Line Item in Statements of Operations     April  30,
2011
    May 1,
2010
 
Foreign currency derivatives   $ 51      $ (21     Operating expenses      $ 28      $ (2
        Cost of sales-service        5        —     
Interest rate derivatives     —          —          Interest expense        1        —     
                                 

Total

  $ 51      $ (21     $ 34      $ (2
                                 

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)
 

Nine Months Ended

  April 30,
2011
    May 1,
2010
    Line Item in Statements of Operations     April 30,
2011
    May 1,
2010
 

Foreign currency derivatives

  $ 96      $ (12     Operating expenses      $ 51      $ 5   
        Cost of sales-service        9        1   

Interest rate derivatives

    —          23        Interest expense        1        —     
                                 

Total

  $ 96      $ 11        $ 61      $ 6   
                                 

During the three and nine months ended April 30, 2011 and May 1, 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 April 30, 2011, the Company estimates that approximately $76 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.

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

 

        GAINS (LOSSES) ON
DERIVATIVE INSTRUMENTS
    GAINS (LOSSES) RELATED  TO
HEDGED ITEMS
 
        Three Months Ended  

Derivatives Designated as

Fair Value Hedging Instruments

 

Line Item in Statements

of Operations

  April  30,
2011
    May 1,
2010
    April  30,
2011
    May 1,
2010
 

Equity derivatives

  Other income, net   $ —        $ 3      $ —        $ (3 )

Interest rate derivatives

  Interest expense     26        1        (27     (1 )
                                 

Total

    $ 26      $ 4      $ (27   $ (4 )
                                 

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

        GAINS (LOSSES) ON
DERIVATIVE INSTRUMENTS
    GAINS (LOSSES) RELATED  TO
HEDGED ITEMS
 
        Nine Months Ended  

Derivatives Designated as

Fair Value Hedging

Instruments

 

Line Item in Statements

of Operations

  April  30,
2011
    May 1,
2010
    April  30,
2011
    May 1,
2010
 

Equity derivatives

  Other income, net   $ —        $ 2      $ —        $ (2 )

Interest rate derivatives

  Interest expense     3        1        (4 )     (1
                                 

Total

    $ 3      $ 3      $ (4 )   $ (3 )
                                 

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
NINE MONTHS ENDED
 

Derivatives Not Designated as

Hedging Instruments

  

Line Item in Statements

of Operations

   April 30,
2011
     May 1,
2010
    April 30,
2011
     May 1,
2010
 

Foreign currency derivatives

   Other income, net    $ 114       $ (118 )   $ 244       $ (69 )

Total return swaps-deferred compensation

   Operating expenses      13         5        37         23   

Equity derivatives

   Other income, net      8         5        16         12   
                                     

Total

      $ 135       $ (108   $ 297       $ (34 )
                                     

(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, 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.

During the nine months ended May 1, 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 recognized net losses of $14 million and $10 million for the third quarter and first nine months of fiscal 2010, respectively, relating to such contracts denominated in Norwegian kroner.

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 $9 million in OCI for the effective portion of its net investment hedges for the nine months ended April 30, 2011. The Company’s net investment hedges are not included in the preceding tables.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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

 

     April  30,
2011
     July  31,
2010
 

Cash flow hedging instruments

   $ 2,137       $ 2,611   

No hedge designation

     3,382         4,619   

Net investment hedging instruments

     72         105   
                 

Total

   $ 5,591       $ 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 April 30, 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 third quarter of fiscal 2011, the Company entered into interest rate swaps for an aggregate notional amount of $2.75 billion designated as fair value hedges of fixed-rate senior notes that were issued in March 2011 and are due in 2014 and 2017. In fiscal 2010, the Company entered into interest rate swaps for an aggregate notional amount of $1.5 billion designated as fair value hedges for a portion of senior fixed-rate notes that were issued in 2006 and are due in 2016. Under these interest rate swaps, the Company receives fixed-rate interest payments and makes interest payments based on LIBOR plus a fixed number of basis points. The effect of such swaps is to convert the fixed interest rates of the senior fixed-rate notes to floating interest rates based on LIBOR. The gains and losses related to changes in the fair value of the interest rate swaps substantially offset changes in the fair value of the hedged portion of the underlying debt that are attributable to the changes in market interest rates. The fair value of the interest rate swaps was $75 million and $72 million as of April 30, 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 nine months ended May 1, 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, 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, net. As of April 30, 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 derivatives such as total return swaps to economically hedge this exposure. As of April 30, 2011 and July 31, 2010, the notional amount of the total return swaps used to hedge such liabilities was $260 million and $169 million, respectively.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(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 April 30, 2011 and July 31, 2010.

 

12. Commitments and Contingencies

(a) Operating Leases

The Company leases office space in several U.S. locations. Outside the United States, larger leased sites include sites in Australia, Belgium, China, Germany, India, Israel, Italy, Japan, Norway, and the United Kingdom. The Company also leases equipment and vehicles. Future minimum lease payments under all noncancelable operating leases with an initial term in excess of one year as of April 30, 2011 are as follows (in millions):

 

Fiscal Year

   Amount  

2011 (remaining three months)

   $ 94   

2012

     339   

2013

     214   

2014

     152   

Thereafter

     454   
        

Total

   $ 1,253   
        

(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 April 30, 2011 and July 31, 2010, the Company had total purchase commitments for inventory of $4,257 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 April 30, 2011 and July 31, 2010, the liability for these purchase commitments was $154 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 $18 million and $19 million during the three months ended April 30, 2011 and May 1, 2010 respectively, and $113 million and $85 million during the nine months ended April 30, 2011 and May 1, 2010, respectively. As of April 30, 2011, the Company estimated that future compensation expense and contingent consideration of up to $83 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 $204 million and $279 million as of April 30, 2011 and July 31, 2010, respectively.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(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 April 30, 2011 there were no material unconsolidated variable interest entities.

In fiscal 2010, Cisco and EMC Corporation (“EMC”), together with VMware, Inc. (“VMware”) formed the Virtual Computing Environment coalition. Similarly, the Company’s investment in Acadia Enterprises LLC (“Acadia”), a joint venture with EMC in which VMware and Intel have also invested, is designed to pave the way for new delivery models in cloud computing solutions. During fiscal 2011, the Virtual Computing Environment coalition and Acadia were combined into a single entity and renamed The Virtual Computing Environment Company (“VCE”). As of April 30, 2011, the Company’s cumulative investment in the combined VCE entity was approximately $100 million and it owned approximately 35% of the outstanding equity. The Company accounts for its investment in VCE under the equity method, and accordingly the Company’s carrying value in VCE has been reduced by $40 million, which reflects its cumulative share of VCE’s losses. Over the next 12 months, as VCE scales its operations, the Company expects that it will make additional investments in VCE and may incur additional losses, proportionate with the Company’s ownership percentage.

(e) Product Warranties and Guarantees

The following table summarizes the activity related to the product warranty liability during the nine months ended April 30, 2011 and May 1, 2010 (in millions):

 

     Nine Months Ended  
     April 30,
2011
    May 1,
2010
 

Balance at beginning of period

   $ 360      $ 321   

Provision for warranties issued

     330        342   

Payments

     (356 )     (328 )

Fair value of warranty liability acquired

     —          7   
                

Balance at end of period

   $ 334      $ 342   
                

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 7. The Company’s other guarantee arrangements as of April 30, 2011 and July 31, 2010 that are subject to recognition and disclosure requirements were not material.

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(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 $515 million for the alleged evasion of import taxes, approximately $650 million for interest, and approximately $2.4 billion for various penalties, all determined using an exchange rate as of April 30, 2011. The Company has completed a thorough review of the matter and believes the asserted tax claims against it are without merit, and the Company intends to defend the claims vigorously. While the Company believes there is no legal basis for its alleged liability, due to the complexities and uncertainty surrounding the judicial process in Brazil and the nature of the claims asserting joint liability with the importer, the Company is unable to determine the likelihood of an unfavorable outcome against it and is unable to reasonably estimate a range of loss, if any. The Company does not expect a final judicial determination for several years.

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

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

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

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

13. Shareholders’ Equity

(a) Stock Repurchase Program

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of April 30, 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 $11.7 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):

 

Nine Months Ended April 30, 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

     256         20.66         5,291   
                    

Cumulative balance at April 30, 2011

     3,383       $ 20.77       $ 70,273   
                    

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) Cash Dividends on Shares of Common Stock

A quarterly dividend of $0.06 per share was declared on March 17, 2011 and was subsequently paid on April 20, 2011 to shareholders of record as of the close of business on March 31, 2011. Any future dividends will be subject to the approval of the Company’s Board of Directors.

(c) Other Repurchases of Common Stock

For the nine months ended April 30, 2011 and May 1, 2010, the Company repurchased approximately 8 million and 4 million shares, or $152 million and $86 million of common stock, respectively, in settlement of employee tax withholding obligations due upon the vesting of restricted stock or stock units.

(d) Comprehensive Income

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

 

     Three Months Ended     Nine Months Ended  
     April 30,
2011
     May 1,
2010
    April 30,
2011
    May 1,
2010
 

Net income

   $ 1,807       $ 2,192      $ 5,258      $ 5,832   

Changes in other comprehensive income:

         

Unrealized gains and losses on investments, net of tax expense of $34 and $81, for the three and nine months ended April 30, 2011, respectively and $67 and $93 for the corresponding periods of fiscal 2010

     62         30        178        225   

Derivative instruments, net of tax expense of $1 for the three and nine months ended April 30, 2011, and $0 and $9 for the three and nine months ended May 1, 2010, respectively

     18         (19 )     37        (4 )

Cumulative translation adjustment and other, net of tax expense of $17 and $32, for the three and nine months ended April 30, 2011, respectively and $1 and $18 for the corresponding periods of fiscal 2010

     249         (72 )     494        12   
                                 

Comprehensive income

     2,136         2,131        5,967        6,065   

Comprehensive loss (income) attributable to noncontrolling interests

     2         (2 )     (25 )     8   
                                 

Comprehensive income attributable to Cisco Systems, Inc.

   $ 2,138       $ 2,129      $ 5,942      $ 6,073   
                                 

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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

 

     April 30,
2011
     July 31,
2010
 

Net unrealized gains on investments

   $ 486       $ 333   

Net unrealized gains on derivative instruments

     64         27   

Cumulative translation adjustment and other

     757         263   
                 

Total

   $ 1,307       $ 623   
                 

 

14. Employee Stock Plans

(a) Employee Stock Incentive Plans

Stock Incentive Plan Program Description As of April 30, 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.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

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.

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 renaming 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.

(b) Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan, which includes its subplan, the International Employee Stock Purchase Plan (together, the “Purchase Plan”), under which 471.4 million shares of the Company’s common stock have been reserved for issuance as of April 30, 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 nine months ended April 30, 2011 and May 1, 2010, respectively. As of April 30, 2011, 139 million shares were available for issuance under the Purchase Plan. The Company estimates the value of employee stock purchase rights on the date of grant using the Black-Scholes model.

(c) Summary of Share-Based Compensation Expense

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

 

     Three Months Ended      Nine Months Ended  
     April 30,
2011
     May 1,
2010
     April 30,
2011
     May 1,
2010
 

Cost of sales – product

   $ 16       $ 16       $ 47       $ 43   

Cost of sales – service

     44         47         135         121   
                                   

Share-based compensation expense in cost of sales

     60         63         182         164   
                                   

Research and development

     120         129         373         336   

Sales and marketing

     160         171         491         444   

General and administrative

     60         71         191         182   
                                   

Share-based compensation expense in operating expenses

     340         371         1,055         962   
                                   

Total share-based compensation expense

   $ 400       $ 434       $ 1,237       $ 1,126   
                                   

 

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CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

As of April 30, 2011, there was approximately $2.9 billion of total unrecognized compensation cost related to unvested share-based awards. This compensation cost is expected to be recognized over a weighted-average life of approximately 2.4 years. The income tax benefit for share-based compensation expense was $107 million and $335 million for the three and nine months ended April 30, 2011, respectively, and $118 million and $304 million for the three and nine months ended May 1, 2010, respectively.

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

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

(d) Share-Based Awards Available for Grant

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

 

     Share-
Based
Awards
Available
for Grant
 

BALANCE AT JULY 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

     (72 )

Share-based awards canceled/forfeited/expired

     26   

Additional shares reserved

   <