CISCO SYSTEMS, INC., 10-Q filed on 5/26/2010
Quarterly Report
Document and Entity Information
May 20, 2010
9 Months Ended
May 1, 2010
Document Type
 
10-Q 
Amendment Flag
 
FALSE 
Document Period End Date
 
05/01/2010 
Trading Symbol
 
CSCO 
Document Fiscal Year Focus
 
2010 
Document Fiscal Period Focus
 
Q3 
Entity Registrant Name
 
CISCO SYSTEMS INC 
Entity Central Index Key
 
0000858877 
Current Fiscal Year End Date
 
07/28 
Entity Filer Category
 
Large Accelerated Filer 
Entity Common Stock, Shares Outstanding
5,711,151,107 
 
CONSOLIDATED BALANCE SHEETS (USD $)
In Millions
May 1, 2010
Jul. 25, 2009
ASSETS
 
 
Current assets:
 
 
Cash and cash equivalents
$ 3,961 
$ 5,718.0 
Investments
35,145 
29,283 
Accounts receivable, net of allowance for doubtful accounts of $216 at May 1, 2010 and July 25, 2009
4,078 
3,177 
Inventories
1,250 
1,074 
Deferred tax assets
2,277 
2,320 
Other current assets
3,047 
2,605 
Total current assets
49,758 
44,177 
Property and equipment, net
3,994 
4,043 
Goodwill
16,668 
12,925 
Purchased intangible assets, net
3,448 
1,702 
Other assets
5,424 
5,281 
TOTAL ASSETS
79,292 
68,128 
LIABILITIES AND EQUITY
 
 
Current liabilities:
 
 
Short-term debt
3,127.0 
0.0 
Accounts payable
902 
675 
Income taxes payable
167 
166 
Accrued compensation
2,709 
2,535 
Deferred revenue
7,154 
6,438 
Other current liabilities
4,380 
3,841 
Total current liabilities
18,439 
13,655 
Long-term debt
12,119 
10,295 
Income taxes payable
1,054 
2,007 
Deferred revenue
3,149 
2,955 
Other long-term liabilities
679 
539 
Total liabilities
35,440 
29,451 
Commitments and contingencies (Note 11)
 
 
Equity:
 
 
Cisco shareholders' equity:
 
 
Preferred stock, no par value: 5 shares authorized; none issued and outstanding
Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized; 5,722 and 5,785 shares issued and outstanding at May 1, 2010 and July 25, 2009, respectively
37,584 
34,344 
Retained earnings
5,570 
3,868 
Accumulated other comprehensive income
676 
435 
Total Cisco shareholders' equity
43,830 
38,647 
Noncontrolling interests
22 
30 
Total equity
43,852.0 
38,677.0 
TOTAL LIABILITIES AND EQUITY
$ 79,292 
$ 68,128 
CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)
In Millions, except Per Share data
May 1, 2010
Jul. 25, 2009
Accounts receivable, allowance for doubtful accounts
$ 216 
$ 216 
Preferred stock, par value
Preferred stock, shares authorized
Preferred stock, issued
Preferred stock, outstanding
Common stock, par value
0.001 
0.001 
Common stock, shares authorized
20,000 
20,000 
Common stock, shares issued
5,722 
5,785 
Common stock, shares outstanding
5,722 
5,785 
CONSOLIDATED STATEMENTS OF OPERATIONS (USD $)
In Millions, except Per Share data
3 Months Ended
May 1, 2010
9 Months Ended
May 1, 2010
3 Months Ended
Apr. 25, 2009
9 Months Ended
Apr. 25, 2009
NET SALES:
 
 
 
 
Product
$ 8,436 
$ 23,612 
$ 6,420 
$ 22,402 
Service
1,932 
5,592 
1,742 
5,180 
Total net sales
10,368 
29,204 
8,162 
27,582 
COST OF SALES:
 
 
 
 
Product
3,010 
8,311 
2,327 
8,045 
Service
728 
2,043 
606 
1,904 
Total cost of sales
3,738 
10,354 
2,933 
9,949 
GROSS MARGIN
6,630 
18,850 
5,229 
17,633 
OPERATING EXPENSES:
 
 
 
 
Research and development
1,411 
3,882 
1,243 
3,928 
Sales and marketing
2,260 
6,365 
1,956 
6,394 
General and administrative
497 
1,404 
302 
1,077 
Amortization of purchased intangible assets
117 
360 
121 
369 
In-process research and development
Total operating expenses
4,285 
12,011 
3,622 
11,771 
OPERATING INCOME
2,345 
6,839 
1,607 
5,862 
Interest income
158 
481 
194 
675 
Interest expense
(182)
(454)
(105)
(232)
Other income (loss), net
82 
131 
(9)
(145)
Interest and other income, net
58 
158 
80 
298 
INCOME BEFORE PROVISION FOR INCOME TAXES
2,403 
6,997 
1,687 
6,160 
Provision for income taxes
211 
1,165 
339 
1,107 
NET INCOME
2,192 
5,832 
1,348 
5,053 
Net income per share:
 
 
 
 
Basic
0.38 
1.01 
0.23 
0.86 
Diluted
0.37 
0.99 
0.23 
0.86 
Shares used in per-share calculation:
 
 
 
 
Basic
5,731 
5,746 
5,805 
5,844 
Diluted
5,869 
5,869 
5,818 
5,871 
CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $)
In Millions
9 Months Ended
May 1, 2010
Apr. 25, 2009
Cash flows from operating activities:
 
 
Net income
$ 5,832 
$ 5,053 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation, amortization and other noncash items
1,415 
1,244 
Share-based compensation expense
1,126 
901 
Provision for doubtful accounts
18 
36 
Deferred income taxes
(256)
(166)
Excess tax benefits from share-based compensation
(177)
(25)
In-process research and development
Net (gains) losses on investments
(147)
113 
Change in operating assets and liabilities, net of effects of acquisitions:
 
 
Accounts receivable
(662)
1,337 
Inventories
(86)
199 
Lease receivables, net
(263)
(127)
Accounts payable
160 
(198)
Income taxes payable
(204)
274 
Accrued compensation
138 
120 
Deferred revenue
740 
Other assets
(544)
(618)
Other liabilities
(149)
(243)
Net cash provided by operating activities
6,941 
7,912 
Cash flows from investing activities:
 
 
Purchases of investments
(35,263)
(31,865)
Proceeds from sales of investments
12,193 
17,291 
Proceeds from maturities of investments
17,474 
9,088 
Acquisition of property and equipment
(699)
(794)
Acquisition of businesses, net of cash and cash equivalents acquired
(4,950)
(338)
Change in investments in privately held companies
(68)
(78)
Other
80 
(54)
Net cash used in investing activities
(11,233)
(6,750)
Cash flows from financing activities:
 
 
Issuance of common stock
2,780 
486 
Repurchase of common stock
(5,440)
(2,807)
Issuance of long-term debt
4,944 
3,991 
Short-term borrowings, net
62.0 
0.0 
Repayment of long-term debt
0.0 
(500.0)
Settlements of interest rate derivatives related to long-term debt
23 
(42)
Excess tax benefits from share-based compensation
177 
25 
Other
(11)
(147)
Net cash provided by financing activities
2,535 
1,006 
Net (decrease) increase in cash and cash equivalents
(1,757)
2,168 
Cash and cash equivalents, beginning of period
5,718.0 
5,191.0 
Cash and cash equivalents, end of period
$ 3,961 
$ 7,359 
CONSOLIDATED STATEMENTS OF EQUITY (USD $)
In Millions
9 Months Ended
May 1, 2010
Apr. 25, 2009
Balance
$ 38,677.0 
$ 34,402.0 
Net income
5,832 
5,053 
Change in unrealized gains and losses on investments
225.0 
(195.0)
Change in derivative instruments
(4.0)
(136.0)
Change in cumulative translation adjustment and other
12.0 
(429.0)
Comprehensive income (loss)
6,065.0 
4,293.0 
Issuance of common stock
2,780.0 
486.0 
Repurchase of common stock
(5,588.0)
(2,817.0)
Tax benefits from employee stock incentive plans
710.0 
5.0 
Purchase acquisitions
82.0 
13.0 
Share-based compensation expense
1,126.0 
901.0 
Balance
43,852.0 
37,283.0 
Shares of Common Stock
 
 
Balance (in shares)
5,785.0 
5,893.0 
Issuance of common stock (in shares)
167.0 
39.0 
Repurchase of common stock (in shares)
(230.0)
(160.0)
Balance (in shares)
5,722.0 
5,772.0 
Common Stock and Additional Paid-In Capital
 
 
Balance
34,344.0 
33,505.0 
Issuance of common stock
2,780.0 
486.0 
Repurchase of common stock
(1,458.0)
(936.0)
Tax benefits from employee stock incentive plans
710.0 
5.0 
Purchase acquisitions
82.0 
13.0 
Share-based compensation expense
1,126.0 
901.0 
Balance
37,584.0 
33,974.0 
Retained Earnings
 
 
Balance
3,868.0 
120.0 
Net income
5,832.0 
5,053.0 
Repurchase of common stock
(4,130.0)
(1,881.0)
Balance
5,570.0 
3,292.0 
Accumulated Other Comprehensive Income (Loss)
 
 
Balance
435.0 
728.0 
Change in unrealized gains and losses on investments
233.0 
(173.0)
Change in derivative instruments
(4.0)
(136.0)
Change in cumulative translation adjustment and other
12.0 
(429.0)
Balance
676.0 
(10.0)
Total Cisco Shareholders' Equity
 
 
Balance
38,647.0 
34,353.0 
Net income
5,832.0 
5,053.0 
Change in unrealized gains and losses on investments
233.0 
(173.0)
Change in derivative instruments
(4.0)
(136.0)
Change in cumulative translation adjustment and other
12.0 
(429.0)
Comprehensive income (loss)
6,073.0 
4,315.0 
Issuance of common stock
2,780.0 
486.0 
Repurchase of common stock
(5,588.0)
(2,817.0)
Tax benefits from employee stock incentive plans
710.0 
5.0 
Purchase acquisitions
82.0 
13.0 
Share-based compensation expense
1,126.0 
901.0 
Balance
43,830.0 
37,256.0 
Noncontrolling Interests
 
 
Balance
30.0 
49.0 
Change in unrealized gains and losses on investments
(8.0)
(22.0)
Comprehensive income (loss)
(8.0)
(22.0)
Balance
$ 22.0 
$ 27.0 
Supplemental Information
Supplemental Information

Supplemental Information

In September 2001, the Company's Board of Directors authorized a stock repurchase program. As of May 1, 2010, the Company's Board of Directors had authorized an aggregate repurchase of up to $72 billion of common stock under this program with no termination date. For additional information regarding stock repurchases, see Note 12 to the Consolidated Financial Statements. The stock repurchases since the inception of this program and the related impact on Cisco shareholders' equity are summarized in the table below (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

   3,028    $ 12,113    $ 50,569       $ 62,682
Basis of Presentation
Basis of Presentation
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 2010 is a 53-week fiscal year and fiscal 2009 was a 52-week fiscal year. The third quarter of fiscal 2010 consisted of 14 weeks, one week more than a typical quarter. 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 following theaters: United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan. The Emerging Markets theater consists of Eastern Europe, Latin America, the Middle East and Africa, and Russia and the Commonwealth of Independent States.

The accompanying financial data as of May 1, 2010 and for the three and nine months ended May 1, 2010 and April 25, 2009 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States ("GAAP") have been condensed or omitted pursuant to such rules and regulations. The July 25, 2009 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Company's Annual Report on Form 10-K for the fiscal year ended July 25, 2009.

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 May 1, 2010, and results of operations for the three and nine months ended May 1, 2010 and April 25, 2009, cash flows, and equity for the nine months ended May 1, 2010 and April 25, 2009, as applicable, have been made. The results of operations for the three and nine months ended May 1, 2010 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

The Company has made certain reclassifications to prior period amounts relating to net sales for similar groups of products, and gross margin by theater, due to refinement of the respective categories. The Company has made certain other reclassifications to prior period amounts in order to conform to the current period's presentation.

The Company has evaluated subsequent events through the date that the financial statements were issued based on the accounting guidance for subsequent events.

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies
2. Summary of Significant Accounting Policies

(a) New Accounting Standards Recently Adopted

Revenue Recognition for Arrangements with Multiple Deliverables

In October 2009, the Financial Accounting Standards Board (FASB) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance, tangible products containing software components and nonsoftware components that function together to deliver the product's essential functionality. In October 2009, the FASB also amended the accounting standards for multiple-deliverable revenue arrangements to:

 

  (i) provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

  (ii) require an entity to allocate revenue in an arrangement using estimated selling prices (ESP) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (VSOE) or third-party evidence of selling price (TPE); and

 

  (iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

The Company elected to early adopt this accounting guidance at the beginning of its first quarter of fiscal 2010 on a prospective basis for applicable transactions originating or materially modified after July 25, 2009.

This guidance does not generally change the units of accounting for the Company's revenue transactions. Most products and services qualify as separate units of accounting. Products are typically considered delivered upon shipment. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met. Technical support services revenue is deferred and recognized ratably over the period during which the services are to be performed, which is typically from one to three years. Consulting services for specific customer networking needs, which the Company refers to as advanced services, are recognized upon delivery or completion of performance. Advanced service arrangements are typically short term in nature and are largely completed within 90 days from the start of service. The Company's arrangements generally do not include any provisions for cancellation, termination, or refunds that would significantly impact recognized revenue.

Many of the Company's products have both software and nonsoftware components that function together to deliver the products' essential functionality. The Company's product offerings fall into the following categories: routing, switching, advanced technologies, and other products, which include emerging technologies. In addition to its product offerings, the Company provides a broad range of technical support and advanced services, as discussed above. The Company has a broad customer base that encompasses virtually all types of public and private entities, including enterprise businesses, service providers, commercial customers, and consumers. The Company and its sales force are not organized by product divisions and all of the above described products and services can be sold standalone or together in various combinations across the Company's geographic segments or customer markets. For example, service provider arrangements are typically larger in scale with longer deployment schedules and involve the delivery of a variety of product technologies, including high-end routing, video and network management software, among others, along with technical support and advanced services. The Company's enterprise and commercial arrangements are typically unique for each customer and smaller in scale and may include network infrastructure products such as routers and switches or collaboration technologies such as Unified Communications and Cisco TelePresence systems along with technical support services. Consumer products, including Linksys wireless routers and Pure Digital video recorders, are sold in standalone arrangements directly to distributors and retailers without support, as customers generally only require repair or replacement of defective products or parts under warranty.

The Company enters into revenue arrangements that may consist of multiple deliverables of its product and service offerings due to the needs of its customers. For example, a customer may purchase routing products along with a contract for technical support services. This arrangement would consist of multiple elements, with the products delivered in one reporting period and the technical support services delivered across multiple reporting periods. Another customer may purchase networking products along with advanced service offerings, in which all the elements are delivered within the same reporting period. In addition, distributors and retail partners purchase products or services on a standalone basis for the purpose of stocking for resale to an end user, and these transactions would not result in a multiple element arrangement.

 

For transactions entered into prior to the first quarter of fiscal 2010, the Company primarily recognized revenue based on software revenue recognition guidance. For the vast majority of the Company's arrangements involving multiple deliverables, such as sales of products with services, the entire fee from the arrangement was allocated to each respective element based on its relative selling price, using VSOE. In the limited circumstances when the Company was not able to determine VSOE for all of the deliverables of the arrangement, but was able to obtain VSOE for any undelivered elements, revenue was allocated using the residual method. Under the residual method, the amount of revenue allocated to delivered elements equaled the total arrangement consideration less the aggregate selling price of any undelivered elements, and no revenue was recognized until all elements without VSOE had been delivered. If VSOE of any undelivered items did not exist, revenue from the entire arrangement was initially deferred and recognized at the earlier of (i) delivery of those elements for which VSOE did not exist or (ii) when VSOE can be established. However, in limited cases where technical support services were the only undelivered element without VSOE, the entire arrangement fee was recognized ratably as a single unit of accounting over the technical services contractual period. The residual and ratable revenue recognition methods were generally used in a limited number of arrangements containing advanced and emerging technologies, such as Cisco TelePresence systems. Several of these technologies are sold as solution offerings whereby products or services are not sold on a standalone basis.

In many instances, products are sold separately in standalone arrangements as customers may support the products themselves or purchase support on a time and materials basis. Advanced services are sold in standalone engagements such as general consulting, network management, or security advisory projects. Also, technical support services are sold separately through renewals of annual contracts. As a result, for substantially all of the arrangements with multiple deliverables pertaining to routing and switching products and related services, as well as most arrangements containing advanced and emerging technologies, the Company has used and intends to continue using VSOE to allocate the selling price to each deliverable. Consistent with its methodology under previous accounting guidance, the Company determines VSOE based on its normal pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, the Company requires that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range, generally evidenced by approximately 80% of such historical standalone transactions falling within plus or minus 15% of the median rates. In addition, the Company considers the geographies in which the products or services are sold, major product and service groups and customer classifications, and other environmental or marketing variables in determining VSOE.

In certain limited instances, the Company is not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be due to the Company infrequently selling each element separately, not pricing products within a narrow range, or only having a limited sales history, such as in the case of certain advanced and emerging technologies. When VSOE cannot be established, the Company attempts to establish selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, the Company's go-to-market strategy differs from that of its peers and its offerings contain a significant level of customization and differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitor products' selling prices are on a standalone basis. Therefore, the Company is typically not able to determine TPE.

When the Company is unable to establish selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a standalone basis. ESP is generally used for new or highly customized offerings and solutions or offerings not priced within a narrow range, and it applies to a small proportion of the Company's arrangements with multiple deliverables.

The Company determines ESP for a product or service by considering multiple factors, including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives, and pricing practices. The determination of ESP is made through consultation with and formal approval by the Company's management, taking into consideration the go-to-market strategy.

The Company regularly reviews VSOE, TPE, and ESP and maintains internal controls over the establishment and updates of these estimates. There were no material impacts during the quarter nor does the Company currently expect a material impact in the near term from changes in VSOE, TPE, or ESP.

Net sales as reported and the Company's estimate of the pro forma net sales that would have been reported during the three and nine months ended May 1, 2010, if the transaction entered into or materially modified after July 25, 2009 were subject to previous accounting guidance, are shown in the following table (in millions):

 

     Three Months Ended May 1, 2010    Nine Months Ended May 1, 2010
     As Reported    Pro Forma Basis
as if the
Previous
Accounting
Guidance Were
in Effect
   As Reported    Pro Forma Basis
as if the
Previous
Accounting
Guidance Were
in Effect

Net sales

   $ 10,368    $ 10,288    $ 29,204    $ 29,051

 

The estimated impact to net sales of the accounting standard was primarily to net product sales.

The new accounting standards for revenue recognition if applied in the same manner to the year ended July 25, 2009 would not have had a material impact on net sales for that fiscal year. In terms of the timing and pattern of revenue recognition, the new accounting guidance for revenue recognition is not expected to have a significant effect on net sales in periods after the initial adoption when applied to multiple-element arrangements based on current go-to-market strategies due to the existence of VSOE across most of the Company's product and service offerings. However, the Company expects that this new accounting guidance will facilitate the Company's efforts to optimize its offerings due to better alignment between the economics of an arrangement and the accounting. This may lead to the Company engaging in new go-to-market practices in the future. In particular, the Company expects that the new accounting standards will enable it to better integrate products and services without VSOE into existing offerings and solutions. As these go-to-market strategies evolve, the Company may modify its pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP. As a result, the Company's future revenue recognition for multiple-element arrangements could differ materially from the results in the current period. The Company is currently unable to determine the impact that the newly adopted accounting guidance could have on its revenue as these go-to-market strategies evolve.

The Company's arrangements with multiple deliverables may have a standalone software deliverable that is subject to the existing software revenue recognition guidance. The revenue for these multiple-element arrangements is allocated to the software deliverable and the nonsoftware deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the new revenue accounting guidance. In the limited circumstances where the Company cannot determine VSOE or TPE of the selling price for all of the deliverables in the arrangement, including the software deliverable, ESP is used for the purposes of performing this allocation.

Fair Value Measures

Effective as of the first quarter of fiscal 2010, the Company adopted revised accounting guidance for the fair value measurement and disclosure of its nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of this accounting guidance did not have a material impact on the Company's financial position or results of operations. In January 2010, the FASB issued revised guidance intended to improve disclosures related to fair value measurements. This guidance requires new disclosures as well as clarifies certain existing disclosure requirements. New disclosures under this guidance require separate information about significant transfers in and out of Level 1 and Level 2 fair value measurement categories and the reason for such transfers and also require purchases, sales, issuances, and settlements information for Level 3 measurements to be included in the rollforward of activity on a gross basis. The guidance also clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and the requirement to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. This accounting guidance was effective for the Company beginning in the third quarter of fiscal 2010, except for the rollforward of activity on a gross basis for Level 3 fair value measurement, which will be effective for the Company in the first quarter of fiscal 2012. The Company adopted the applicable portions of this guidance beginning in the third quarter of fiscal 2010, and it is currently evaluating the impact that the adoption of the remainder of this guidance might have on its financial statement disclosures in the first quarter of fiscal 2012.

Business Combinations and Noncontrolling Interests

Effective the first quarter of fiscal 2010, the Company adopted the revised accounting guidance for business combinations, which changed its previous accounting practices regarding business combinations. The more significant changes include an expanded definition of a business and a business combination; recognition of assets acquired, liabilities assumed and noncontrolling interests (including goodwill) measured at fair value at the acquisition date; recognition of acquisition-related expenses and restructuring costs separately from the business combination; recognition of assets acquired and liabilities assumed at their acquisition-date fair values with subsequent changes recognized in earnings; and capitalization of in-process research and development (IPR&D) at fair value as an indefinite-lived intangible asset. Such IPR&D will be assessed for impairment until completion and, following completion, will be amortized. The guidance also amends and clarifies the application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The impact of this accounting guidance and its relevant updates on the Company's results of operations or financial position will vary depending on each specific business combination or asset purchase. See Note 3.

 

Effective in the first quarter of fiscal 2010, the Company adopted revised accounting guidance which requires noncontrolling interests (formerly minority interest) to be presented as a separate component from the Company's equity in the equity section of the Consolidated Balance Sheets. The net income attributable to the noncontrolling interests was not significant to the Company's consolidated operating results and was not presented separately in the Consolidated Statements of Operations. In accordance with the adoption of this accounting guidance, the Company has expanded disclosures on noncontrolling interests in its consolidated financial statements where applicable, and the relevant presentation and disclosures have been applied retrospectively for all periods presented. The adoption of this accounting guidance had no impact on the Company's results of operations and did not have a material impact on the Company's financial position.

(b) Recent Accounting Standards Not Yet Effective

In June 2009, the FASB issued revised guidance for the accounting of variable interest entities. This revised guidance 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 is effective for the Company beginning in the first quarter of fiscal 2011. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements. In February 2010, the FASB issued amendments to the consolidation requirements for certain investment funds. The amendments specify the attributes that qualify an entity for deferral of the application of Consolidations: Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. The amendments include guidance on the nature and characteristics, and on the applicable disclosure requirements, for entities that qualify for the deferral. The amendments further provide that if an entity that initially met the deferral requirements ceases to qualify for the deferral as a result of a change in facts and circumstances, the reporting entity shall initially measure the assets, liabilities, and noncontrolling interests of the variable interest entity as of the date the entity ceased to qualify for the deferral. The amendments also clarify that when performing an analysis on whether or not the fees paid to a legal entity's decision maker or service provider are variable interests, a related party's interest should be considered as though it were the reporting entity's own interest. These amendments are effective for the Company beginning in the first quarter of fiscal 2011. The Company is currently evaluating the impact that the adoption of these amendments will have on its 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 is effective for the Company beginning in the first quarter of fiscal 2011. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.

Business Combinations
Business Combinations
3. Business Combinations

(a) Business Combinations Completed During the Period

A summary of the business combinations completed during the nine months ended May 1, 2010 is as follows (in millions):

 

     Purchase
Consideration
   Net Tangible Assets
Acquired/(Liabilities
Assumed) (1)
    Purchased
Intangible
Assets
   Goodwill

ScanSafe, Inc.

   $ 154    $ 2     $ 31    $ 121

Starent Networks, Corp.

     2,636      (17 )     1,274      1,379

Tandberg ASA

     3,268      17        980      2,271

Other

     3      (5 )     6      2
                            

Total

   $ 6,061    $ (3 )   $ 2,291    $ 3,773
                            

 

(1)

Net liabilities assumed for business combinations completed during the nine months ended May 1, 2010 primarily consist of net deferred tax liabilities, partially offset by $748 million of cash and cash equivalents acquired.

 

The Company continues to evaluate certain assets and liabilities related to business combinations completed during the period. 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.

 

   

In December 2009, the Company acquired ScanSafe, Inc., a provider of hosted web security to help build a borderless network security architecture that combines network and cloud-based services for advanced security enforcement.

 

   

In December 2009, the Company acquired Starent Networks, Corp. ("Starent"), a provider of IP-based mobile infrastructure for mobile and converged carriers, to enhance the Company's portfolio of products to provide an integrated architecture to offer rich, quality multimedia experiences to mobile subscribers.

 

   

In April 2010, the Company acquired Tandberg ASA ("Tandberg"), a leader in video communications. With this acquisition, the Company expects that it will be able to combine innovations with multivendor interoperability capabilities to provide a platform significantly more attractive to its customers and partners.

The total purchase consideration related to the Company's business combinations completed during the nine months ended May 1, 2010, consisted of approximately $6.0 billion in cash and $82 million in vested share-based awards assumed. For the April 2010 acquisition of Tandberg, of the total consideration of $3.3 billion, approximately $281 million (based on exchange rates in effect as of May 1, 2010) relating to the compulsory acquisition of non-tendered shares is expected to be paid during the fourth quarter of fiscal 2010.

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 May 1, 2010 have not been presented because the effects of the acquisitions, individually and in the aggregate, were not material to the Company's financial results. For the three and nine months ended May 1, 2010, the Company recorded business combination-related transaction costs of $10 million and $33 million, respectively, within general and administrative expenses.

(b) Cash Compensation Expense Related to Acquisitions and Investments

In connection with the Company's business combinations and asset purchases, the Company has agreed to pay certain amounts contingent upon the achievement of certain agreed-upon technology, development, product, or other milestones or the continued employment with the Company of certain employees of the acquired entities.

The following table presents the cash compensation expense related to acquisitions and investments (in millions):

 

     Three Months Ended    Nine Months Ended
     May 1,
2010
   April 25,
2009
   May 1,
2010
   April 25,
2009

Cash compensation expense

   $ 19    $ 98    $ 85    $ 257
                           

The Company may be required to recognize future compensation expense pursuant to these agreements of up to $206 million, which includes the remaining potential amount of compensation expense related to Nuova Systems, Inc., as discussed below.

During fiscal 2008, the Company purchased the remaining interests in Nuova Systems, Inc. ("Nuova Systems") not previously held by the Company, representing approximately 20% of Nuova Systems. Under the terms of the merger agreement, the former noncontrolling interest holders of Nuova Systems are eligible to receive up to three milestone payments based on agreed-upon formulas totaling up to a maximum of $678 million. During the first nine months of fiscal 2010, the Company recorded $65 million of compensation expense, and through May 1, 2010, the Company has recorded aggregate compensation expense of $487 million related to the fair value of amounts that are expected to be earned by the former noncontrolling interest holders pursuant to a vesting schedule. Of this compensation, approximately $261 million was paid during the third quarter of fiscal 2010, and the remainder is expected to be paid primarily in fiscal 2011 and fiscal 2012. Actual amounts payable to the former noncontrolling interest holders of Nuova Systems will depend upon achievement under the agreed-upon formulas and vesting.

Goodwill and Purchased Intangible Assets
Goodwill and Purchased Intangible Assets
4. Goodwill and Purchased Intangible Assets

(a) Goodwill

The following table presents the goodwill allocated to the Company's reportable segments as of and during the nine months ended May 1, 2010 (in millions):

 

     Balance at
July 25, 2009
   Acquisitions    Other     Balance at
May 1,  2010

United States and Canada

   $ 9,512    $ 1,788    $ (5   $ 11,295

European Markets

     1,669      1,087      (26     2,730

Emerging Markets

     437      322      1        760

Asia Pacific

     506      462      —          968

Japan

     801      114      —          915
                            

Total

   $ 12,925    $ 3,773    $ (30   $ 16,668
                            

In the table above, "Other" primarily includes foreign currency translation.

(b) Purchased Intangible Assets

The following table presents details of the Company's purchased intangible assets acquired through business combinations during the nine months ended May 1, 2010 (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

ScanSafe, Inc.

   5.0    $ 14    6.0    $ 11    3.0    $ 6    $ —      $ 31

Starent Networks, Corp.

   6.0      691    7.0      434    0.3      35      114      1,274

Tandberg ASA

   5.0      709    7.0      179    3.0      21      71      980

Other

   —        —      —        —      —        —        6      6
                                           

Total

      $ 1,414       $ 624       $ 62    $ 191    $ 2,291
                                           
                       

 

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

 

May 1, 2010

   Gross    Accumulated
Amortization
    Net

Intangible assets with finite lives:

       

Technology

   $ 2,361    $ (563   $ 1,798

Customer relationships

     2,331      (966     1,365

Other

     207      (113     94
                     

Total intangible assets with finite lives

     4,899      (1,642     3,257

IPR&D, with indefinite lives

     191      —          191
                     

Total intangible assets

   $ 5,090    $ (1,642   $ 3,448
                     

July 25, 2009

   Gross    Accumulated
Amortization
    Net

Intangible assets with finite lives:

       

Technology

   $ 1,469    $ (803   $ 666

Customer relationships

     1,730      (768     962

Other

     184      (110     74
                     

Total intangible assets

   $ 3,383    $ (1,681   $ 1,702
                     

Purchased intangible assets include technology intangible assets acquired through business combinations as well as through technology licenses.

Effective the first quarter of fiscal 2010, with the adoption of revised accounting guidance for business combinations, IPR&D has been capitalized at fair value as an intangible asset with an indefinite life and will be assessed for impairment thereafter. Upon completion of the development of the underlying marketable products, the capitalized IPR&D asset will be amortized over its estimated useful life. Prior to the adoption of the revised accounting guidance, IPR&D was expensed upon acquisition if it had no alternative future use.

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

 

     Three Months Ended    Nine Months Ended
     May 1,
2010
   April 25,
2009
   May 1,
2010
   April 25,
2009

Amortization of purchased intangible assets:

           

Cost of sales

   $ 69    $ 48    $ 178    $ 166

Operating expenses

     117      121      360      369
                           

Total

   $ 186    $ 169    $ 538    $ 535
                           

The Company recorded impairment charges of $5 million and $13 million during the three and nine months ended May 1, 2010, respectively, and $11 million and $34 million during the three and nine months ended April 25, 2009, respectively. These impairment charges were due to reductions in expected future cash flows related to certain technologies and were recorded as amortization of purchased intangible assets.

The estimated future amortization expense of purchased intangible assets with finite lives as of May 1, 2010 is as follows (in millions):

 

Fiscal Year

   Amount

2010 (remaining three months)

   $ 208

2011

     827

2012

     711

2013

     600

2014

     408

Thereafter

     503
      

Total

   $ 3,257
      

 

Balance Sheet Details
Balance Sheet Details
5. Balance Sheet Details

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

 

     May 1,
2010
    July 25,
2009
 

Inventories:

    

Raw materials

   $ 204      $ 165   

Work in process

     43        33   

Finished goods:

    

Distributor inventory and deferred cost of sales

     530        382   

Manufactured finished goods

     280        310   
                

Total finished goods

     810        692   
                

Service-related spares

     143        151   

Demonstration systems

     50        33   
                

Total

   $ 1,250      $ 1,074   
                

Property and equipment, net:

    

Land, buildings, and building & leasehold improvements

   $ 4,527      $ 4,618   

Computer equipment and related software

     1,489        1,823   

Production, engineering, and other equipment

     4,891        5,075   

Operating lease assets

     256        227   

Furniture and fixtures

     474        465   
                
     11,637        12,208   

Less accumulated depreciation and amortization

     (7,643     (8,165
                

Total

   $ 3,994      $ 4,043   
                

Other assets:

    

Deferred tax assets

   $ 1,800      $ 2,122   

Investments in privately held companies

     763        709   

Lease receivables, net(1)

     1,126        966   

Financed service contracts, net(1)

     692        676   

Loan receivables, net(1)

     744        537   

Other

     299        271   
                

Total

   $ 5,424      $ 5,281   
                

Deferred revenue:

    

Service

   $ 6,838      $ 6,496   

Product:

    

Unrecognized revenue on product shipments and other deferred revenue

     2,737        2,490   

Cash receipts related to unrecognized revenue from two-tier distributors

     728        407   
                

Total product deferred revenue

     3,465        2,897   
                

Total

   $ 10,303      $ 9,393   
                

Reported as:

    

Current

   $ 7,154      $ 6,438   

Noncurrent

     3,149        2,955   
                

Total

   $ 10,303      $ 9,393   
                

 

(1)

Amounts represent the noncurrent portions of the respective balances. See Note 6 for the current portions of the respective balances.

 

Financing Receivables and Guarantees
Financing Receivables and Guarantees
6. Financing Receivables and Guarantees

(a) Lease Receivables

Lease receivables represent sales-type and direct-financing leases resulting from the sale of the Company's and complementary third-party products. These lease arrangements typically have terms of up to three years and are generally collateralized by a security interest in the underlying assets. The net lease receivables are summarized as follows (in millions):

 

     May 1,
2010
    July 25,
2009
 

Gross lease receivables

   $ 2,294      $ 1,996   

Unearned income

     (215     (191

Allowances

     (199     (213
                

Lease receivables, net

   $ 1,880      $ 1,592   
                

Reported as:

    

Current

   $ 754      $ 626   

Noncurrent

     1,126        966   
                

Lease receivables, net

   $ 1,880      $ 1,592   
                

Contractual maturities of the gross lease receivables at May 1, 2010 are as follows (in millions):

 

Fiscal Year

   Amount

2010 (remaining three months)

   $ 280

2011

     850

2012

     590

2013

     366

2014

     170

Thereafter

     38
      

Total

   $ 2,294
      

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

(b) Financed Service Contracts

Financed service contracts are summarized as follows (in millions):

 

     May 1,
2010
    July 25,
2009
 

Gross financed service contracts

   $ 1,676      $ 1,642   

Allowances

     (19     (26
                

Financed service contracts, net

   $ 1,657      $ 1,616   
                

Reported as:

    

Current

   $ 965      $ 940   

Noncurrent

     692        676   
                

Financed service contracts, net

   $ 1,657      $ 1,616   
                

The revenue related to financed service contracts, which primarily relates to technical support services, is deferred and included in deferred service revenue. The revenue is recognized ratably over the period during which the related services are to be performed, which is typically from one to three years.

 

(c) Loan Receivables

Loan receivables are summarized as follows (in millions):

 

     May 1,
2010
    July 25,
2009
 

Gross loan receivables

   $ 1,271      $ 861   

Allowances

     (104     (88
                

Loan receivables, net

   $ 1,167      $ 773   
                

Reported as:

    

Current

   $ 423      $ 236   

Noncurrent

     744        537   
                

Loan receivables, net

   $ 1,167      $ 773   
                

A portion of the revenue related to loan receivables is deferred and included in deferred product revenue based on revenue recognition criteria.

(d) Financing Guarantees

In the ordinary course of business, the Company provides financing guarantees that are generally for various third-party financing arrangements extended to channel partners and end-user customers.

Channel Partner Financing Guarantees

The Company facilitates arrangements for third-party financing extended to channel partners, consisting of revolving short-term financing, generally with payment terms ranging from 60 to 90 days. These financing arrangements facilitate the working capital requirements of the channel partners, and, in some cases, the Company guarantees a portion of these arrangements. During the three and nine months ended May 1, 2010, the volume of channel partner financing was $4.4 billion and $12.3 billion, respectively, compared with $3.0 billion and $10.7 billion for the three and nine months ended April 25, 2009, respectively. As of May 1, 2010 and July 25, 2009, the balance of the channel partner financing subject to guarantees was $1.4 billion and $1.1 billion, respectively.

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. During the three and nine months ended May 1, 2010, the volume of financing provided by third parties for leases and loans on which the Company has provided guarantees was $215 million and $625 million, respectively, compared with $316 million and $960 million for the three and nine months ended April 25, 2009, respectively.

Financing Guarantee Summary

The aggregate amount of financing guarantees outstanding at May 1, 2010 and July 25, 2009, 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):

 

     May 1,
2010
   July 25,
2009

Maximum potential future payments relating to financing guarantees:

     

Channel partner

   $ 423    $ 334

End user

     313      405
             

Total

   $ 736    $ 739
             

Deferred revenue associated with financing guarantees:

     

Channel partner

   $ 263    $ 218

End user

     287      378
             

Total

   $ 550    $ 596
             

 

Investments
Investments
7. Investments

(a) Summary of Available-for-Sale Investments

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

 

May 1, 2010

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value

Fixed income securities:

          

Government securities

   $ 19,402    $ 26    $ (3   $ 19,425

Government agency securities (1)

     12,153      70      (2     12,221

Corporate debt securities

     2,061      65      (18     2,108

Asset-backed securities

     151      9      (6     154
                            

Total fixed income securities

     33,767      170      (29     33,908

Publicly traded equity securities

     887      353      (3     1,237
                            

Total

   $ 34,654    $ 523    $ (32   $ 35,145
                            

July 25, 2009

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value

Fixed income securities:

          

Government securities

   $ 10,266    $ 23    $ (5   $ 10,284

Government agency securities (1)

     16,029      116      (2     16,143

Corporate debt securities

     1,740      51      (86     1,705

Asset-backed securities

     252      5      (34     223
                            

Total fixed income securities

     28,287      195      (127     28,355

Publicly traded equity securities

     824      193      (89     928
                            

Total

   $ 29,111    $ 388    $ (216   $ 29,283
                            

(1)

In Note 7 and Note 8, government agency securities as of May 1, 2010 and July 25, 2009 include bank-issued securities that are guaranteed by the Federal Deposit Insurance Corporation (FDIC).

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

The following table summarizes the realized net gains (losses) associated with the Company's available-for-sale investments (in millions):

 

     Three Months Ended     Nine Months Ended  
     May 1,
2010
   April 25,
2009
    May 1,
2010
   April 25,
2009
 

Net gains (losses) on investments in publicly traded equity securities

   $ 36    $ (10 )   $ 64    $ 58   

Net gains (losses) on investments in fixed income securities

     35      36        55      (123
                              

Net gains (losses) on available-for-sale investments

   $ 71    $ 26      $ 119    $ (65
                              

There were no impairment charges on investments in fixed income securities and publicly traded equity securities during the third quarter and first nine months of fiscal 2010. For the third quarter and first nine months of fiscal 2009, net gains (losses) on investments in fixed income securities included impairment charges of $17 million and $219 million, respectively, and net gains (losses) on investments in publicly traded equity securities included impairment charges of $4 million and $39 million, respectively. All such impairment charges were due to a decline in the fair value of the investments below their cost basis that were judged to be other than temporary and were recorded as a reduction to the amortized cost of the respective investments.

 

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

 

     Three Months Ended
May 1, 2010
    Nine Months Ended
May 1, 2010
 

Balance at beginning of period

   $ (133   $ (153 )

Sales of other-than-temporarily-impaired fixed income securities

     —          20   
                

Balance at end of period

   $ (133   $ (133 )
                

The following tables present the breakdown of the available-for-sale investments with gross unrealized losses and the duration that those losses have been unrealized at May 1, 2010 and July 25, 2009 (in millions):

 

     LESS THAN
12 MONTHS
    12 MONTHS
OR GREATER
    TOTAL  

May 1, 2010

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

Fixed income securities:

               

Government securities

   $ 5,461    $ (3   $ —      $ —        $ 5,461    $ (3

Government agency securities (1)

     2,734      (2 )     —        —          2,734      (2 )

Corporate debt securities

     335      (1 )     306      (17 )     641      (18 )

Asset-backed securities

     3      —          116      (6 )     119      (6 )
                                             

Total fixed income securities

     8,533      (6 )     422      (23 )     8,955      (29 )

Publicly traded equity securities

     36      (1 )     409      (2 )     445      (3 )
                                             

Total

   $ 8,569    $ (7 )   $ 831    $ (25 )   $ 9,400    $ (32 )
                                             

July 25, 2009

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

Fixed income securities:

               

Government securities

   $ 1,850    $ (5 )   $ —      $ —        $ 1,850    $ (5 )

Government agency securities (1)

     1,362      (2 )     5      —          1,367      (2 )

Corporate debt securities

     123      (10 )     613      (76 )     736      (86 )

Asset-backed securities

     41      (11 )     141      (23 )     182      (34 )
                                             

Total fixed income securities

     3,376      (28 )     759      (99 )     4,135      (127 )

Publicly traded equity securities

     25      (3 )     328      (86 )     353      (89 )
                                             

Total

   $ 3,401    $ (31 )   $ 1,087    $ (185 )   $ 4,488    $ (216 )
                                             

For fixed income securities that have unrealized losses as of May 1, 2010, 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 May 1, 2010, 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 May 1, 2010.

The Company has evaluated its publicly traded equity securities as of May 1, 2010 and has determined that there were no unrealized losses that indicate an other-than-temporary impairment. 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 and 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 May 1, 2010 (in millions):

 

     Amortized
Cost
   Fair
Value

Less than 1 year

   $ 22,953    $ 22,984

Due in 1 to 2 years

     6,018      6,077

Due in 2 to 5 years

     4,425      4,477

Due after 5 years

     371      370
             

Total

   $ 33,767    $ 33,908
             

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

 

Fair Value
Fair Value
8. Fair Value

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

(a) Fair Value Hierarchy

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

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

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

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

 

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

Assets and liabilities measured at fair value on a recurring basis as of May 1, 2010 and July 25, 2009 were as follows (in millions):

 

     May 1, 2010    July 25, 2009
     Fair Value Measurements    Fair Value Measurements
     Level 1    Level 2    Level 3    Total
Balance
   Level 1    Level 2    Level 3    Total
Balance

Assets:

                       

Money market funds

   $ 2,058    $ —      $ —      $ 2,058    $ 4,514    $ —      $ —      $ 4,514

Government securities

     —        19,524      —        19,524      —        10,345      —        10,345

Government agency securities(1)

     —        12,423      —        12,423      —        16,455      —        16,455

Corporate debt securities

     —        2,135      —        2,135      —        1,741      —        1,741

Asset-backed securities

     —        —        154      154      —        —        223      223

Publicly traded equity securities

     1,237      —        —        1,237      928      —        —        928

Derivative instruments and other assets (2)

     —        27      14      41      —        109      4      113
                                                       

Total

   $ 3,295    $ 34,109    $ 168    $ 37,572    $ 5,442    $ 28,650    $ 227    $ 34,319
                                                       

Liabilities:

                       

Derivative liabilities

   $ —      $ 8    $ —      $ 8    $ —      $ 66    $ —      $ 66
                                                       

Total

   $ —      $ 8    $ —      $ 8    $ —      $ 66    $ —      $ 66
                                                       

 

(1)

Government agency securities as of May 1, 2010 and July 25, 2009 include bank-issued securities that are guaranteed by the FDIC.

(2)

Derivative instruments and other assets as of May 1, 2010 include derivative assets and property held for sale.

Government securities, government agency securities and corporate debt securities include an aggregate of $328 million and $409 million of cash equivalents as of May 1, 2010 and July 25, 2009, respectively.

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 inputs to make its assessments and determinations as to the ultimate valuation of its investment portfolio and has not made, during the periods presented, any material adjustments to such inputs. The Company is ultimately responsible for the financial statements and underlying estimates. The Company's derivative instruments are primarily classified as Level 2, as they are not actively traded and are valued using pricing models that use observable market inputs. The Company did not have any transfers between Level 1 and Level 2 fair value measurements during the three or nine months ended May 1, 2010.

Level 3 assets include asset-backed securities, certain derivative instruments, and property held for sale, whose values 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 May 1, 2010 and April 25, 2009 (in millions):

 

     Asset-Backed
Securities
    Derivative Instruments
and Other Assets (1)
    Total  

Balance at July 25, 2009

   $ 223      $ 4      $ 227   

Transfers into Level 3

     —          22        22   

Total gains and losses (realized and unrealized):

      

Included in other income (loss), net

     (6 )     —          (6

Included in operating expenses

     —          (12     (12

Included in other comprehensive income

     33        —          33   

Purchases, sales and maturities

     (96     —          (96
                        

Balance at May 1, 2010

   $ 154      $ 14      $ 168   
                        

Losses attributable to assets still held as of May 1, 2010

   $ —        $ (10   $ (10
                        
     Asset-Backed
Securities
    Derivative Instruments
and Other Assets
    Total  

Balance at July 27, 2008

   $ —        $ —        $ —     

Transfers into Level 3

     618        6       624   

Total gains and losses (realized and unrealized):

      

Included in other income (loss), net

     (28 )     —          (28

Included in other comprehensive income

     (12 )     —          (12

Purchases, sales and maturities

     (340 )     —          (340
                        

Balance at April 25, 2009

   $ 238      $ 6     $ 244   
                        

Losses attributable to assets still held as of April 25, 2009

   $ (14   $ —        $ (14
                        

 

(1)

Derivative instruments and other assets as of May 1, 2010 include derivative assets and property held for sale.

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

The following table presents the Company's financial instruments and non-financial assets that were measured at fair value on a nonrecurring basis and the losses recorded for the periods presented (in millions):

 

     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 Losses for the
Nine Months Ended
May 1, 2010
 

Investments in privately held companies

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

Purchased intangible assets

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

Total losses for nonrecurring measurements

               $ (8   $ (30
                            

 

The following table presents the Company's financial instruments that were measured at fair value on a nonrecurring basis and the losses recorded for the periods presented (in millions):

 

     FAIR VALUE MEASUREMENTS  
     Net Carrying
Value as of
April 25, 2009
   Level 1    Level 2    Level 3    Total Losses for the
Three Months Ended
April 25, 2009
    Total Losses for the
Nine Months Ended
April 25, 2009
 

Investments in privately held companies

   $ 37    $ —      $ —      $ 37    $ (15   $ (66

Losses on assets no longer held

                 —          (2
                            

Total losses for nonrecurring measurements

               $ (15   $ (68
                            

The losses for the investments in privately held companies were recorded to other income (loss), net, and the losses for purchased intangible assets were included in amortization of purchased intangible assets.

The assets in the preceding tables were measured at fair value due to events or circumstances the Company identified that significantly impacted the fair value of these assets during the periods presented. The Company measured the fair value for investments in privately held companies using financial metrics, comparison to other private and public companies, and analysis of the financial condition and near-term prospects of the issuer, including recent financing activities and their capital structure as well as other economic variables. These investments 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 investments due to the absence of quoted market prices and inherent lack of liquidity. The Company measured the fair value for these purchased intangible assets using discounted cash flow techniques, and these assets 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 valuing these purchased intangible assets.

(d) Other

The fair value of certain of the Company's financial instruments that are not measured at fair value, including accounts receivable, accounts payable, accrued compensation, and other current liabilities, approximates the carrying amount because of their short maturities. In addition, the fair value of the Company's loan receivables and financed service contracts also approximates the carrying amount. The fair value of the Company's debt is disclosed in Note 9 and was determined using quoted market prices for those securities.

Borrowings
Borrowings
9. Borrowings

(a) Debt

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

 

     May 1, 2010     July 25, 2009  
     Amount     Effective
Rate
    Amount     Effective
Rate
 

Senior notes:

        

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

   $ 3,000      3.12 %   $ 3,000      3.12 %

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

     500      3.11 %     —        —     

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

     3,000      3.71     3,000      4.34

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

     2,000      5.08 %     2,000      5.08 %

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

     2,500      4.50     —        —     

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

     2,000      6.11 %     2,000      6.11 %

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

     2,000      5.67     —        —     
                    

Total senior notes

     15,000          10,000     

Other notes and borrowings

     73          2     

Unaccreted discount

     (74 )       (21  

Hedge accounting adjustment

     247          314     
                    

Total

   $ 15,246        $ 10,295     
                    

Reported as:

        

Short-term debt

   $ 3,127        $ —       

Long-term debt

     12,119          10,295     
                    

Total

   $ 15,246        $ 10,295     
                    

In November 2009, the Company issued senior unsecured notes in an aggregate principal amount of $5.0 billion. Of these notes, $500 million will mature in 2014 and bear interest at a fixed rate of 2.90% per annum (the "2014 Notes"), $2.5 billion will mature in 2020 and bear interest at a fixed rate of 4.45% per annum (the "2020 Notes"), and $2.0 billion will mature in 2040 and bear interest at a fixed rate of 5.50% per annum (the "2040 Notes"). To achieve its interest rate risk management objectives, during the three months ended May 1, 2010, the Company entered into a $750 million notional amount interest rate swap designated as a fair value hedge of a portion of the 2016 Notes. Subsequent to May 1, 2010, the Company entered into an additional $750 million notional amount interest rate swap, designated as a fair value hedge of an additional portion of the 2016 Notes. In effect, these swaps convert the fixed interest rates of a portion of the 2016 Notes to floating interest rates based on the London InterBank Offered Rate ("LIBOR") plus a fixed number of basis points. Gains and losses in the value of the interest rate swaps substantially offset changes in the fair value of the hedged portion of the underlying debt.

The effective rates for the fixed-rate debt include the interest on the notes, the accretion of the discount, and adjustments related to hedging, if applicable. Based on market prices, the fair value of the Company's senior notes was $15.8 billion and $10.5 billion as of May 1, 2010 and July 25, 2009, respectively. Interest is payable semiannually on each class of the senior fixed-rate notes. The notes are redeemable by the Company at any time, subject to a make-whole premium. The Company was in compliance with all debt covenants as of May 1, 2010.

Interest expense and cash paid for interest are summarized as follows (in millions):

 

     Three Months Ended    Nine Months Ended
     May 1,
2010
   April
25, 2009
   May 1,
2010
   April 25,
2009

Interest expense

   $ 182    $ 105    $ 454    $ 232

Cash paid for interest

   $ 270    $ 164    $ 575    $ 333

 

(b) Credit Facility

The Company has a credit agreement with certain institutional lenders providing for a $3.0 billion unsecured revolving credit facility that is scheduled to expire on August 17, 2012. Any advances under the credit agreement will accrue interest at rates that are equal to, based on certain conditions, either (i) the higher of the Federal Funds rate plus 0.50% or Bank of America's "prime rate" as announced from time to time or (ii) 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 that the Company comply with certain covenants, including that it maintains an interest coverage ratio as defined in the agreement.

The Company may also, upon the agreement of either the then-existing lenders or of 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 May 1, 2010, the Company was in compliance with the required interest coverage ratio and the other covenants, and the Company had not borrowed any funds under the credit facility.

Other notes and borrowings include notes and credit facilities with a number of financial institutions that are available to certain foreign subsidiaries of the Company. The amount of borrowings outstanding under these arrangements was $72 million and $2 million at May 1, 2010 and July 25, 2009, respectively.

Derivative Instruments
Derivative Instruments

10. Derivative Instruments

(a) Summary of Derivative Instruments

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

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

 

    

DERIVATIVE ASSETS

  

DERIVATIVE LIABILITIES

     Balance Sheet Line Item    May 1,
    2010    
   July 25,
    2009    
       Balance Sheet Line Item        May 1,
    2010    
   July 25,
    2009    

Derivatives designated as hedging instruments:

                 

Foreign currency derivatives

   Other current assets    $ 18    $ 87   

Other current liabilities

   $ 6    $ 36

Interest rate derivatives

   Other assets      1      —     

Other long-term liabilities

     —        —  
                                 

Total

        19      87         6      36
                                 

Derivatives not designated as hedging instruments:

                 

Foreign currency derivatives

   Other current assets      8      22   

Other current liabilities

     2      30

Equity derivatives

   Other current assets      —        2   

Other current liabilities

     —        —  

Equity derivatives

  

Other assets

     2      2   

Other long-term liabilities

     —        —  
                                 

Total

        10      26         2      30
                                 

Total

      $ 29    $ 113       $ 8    $ 66
                                 

 

The effect of the Company's cash flow hedging instruments on other comprehensive income (OCI) and the Consolidated Statement of Operations is summarized as follows (in millions):

 

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

GAINS (LOSSES) RECLASSIFIED FROM

AOCI INTO INCOME

(EFFECTIVE PORTION)

 

Three Months Ended

   May 1,
2010
    April 25,
2009
         May 1,
2010
    April 25,
2009
 

Derivatives Designated as Cash Flow Hedging Instruments

      

Line Item in Statements of Operations

    

Foreign currency derivatives

   $ (21 )   $ 16     

Operating expenses

   $ (2   $ (38 )
      

Cost of sales-service

       (5 )

Interest rate derivatives

     —          (42 )  

Interest expense

     —          —     

Other derivatives

     —          (2  

Operating expenses

     —          (1
                                   

Total

   $ (21 )   $ (28 )      $ (2   $ (44 )
                                   
     GAINS (LOSSES) RECOGNIZED IN  OCI
ON DERIVATIVES
(EFFECTIVE PORTION)
   

GAINS (LOSSES) RECLASSIFIED FROM

AOCI INTO INCOME

(EFFECTIVE PORTION)

 

Nine Months Ended

   May 1,
2010
    April 25,
2009
         May 1,
2010
    April 25,
2009
 

Derivatives Designated as Cash Flow Hedging Instruments

      

Line Item in Statements of Operations

    

Foreign currency derivatives

   $ (12 )   $ (174 )  

Operating expenses

   $ 5      $ (73 )
      

Cost of sales-service

     1        (10 )

Interest rate derivatives

     23        (42 )  

Interest expense

     —          —     

Other derivatives

     —          (2  

Operating expenses

     —          (1
                                   

Total

   $ 11      $ (218 )      $ 6      $ (84 )
                                   

During the three and nine months ended May 1, 2010 and April 25, 2009, 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 May 1, 2010, the Company estimates that approximately $13 million of net derivative losses 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 Statement of Operations of derivative instruments designated as fair value hedges is summarized as follows (in millions):

 

          Gains (Losses) for the  Three
Months Ended
   Gains (Losses) for the  Nine
Months Ended
 

Derivatives Designated as

Fair Value Hedging Instruments

  

Line Item in Statements

of Operations

   May 1,
2010
   April 25,
2009
   May 1,
2010
   April 25,
2009
 

Equity derivatives

   Other income (loss), net    $ 3    $ —      $ 2    $ 16   

Interest rate derivatives

   Other income (loss), net      —        —        —        (7

Interest rate derivatives

   Interest expense      1      —        1      —     
                                

Total

      $ 4    $ —      $ 3    $ 9   
                                

 

The effect on the Consolidated Statement 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

   May 1,
2010
    April 25,
2009
    May 1,
2010
    April 25,
2009
 

Foreign currency derivatives

  

Other income (loss), net

   $ (118   $ (20 )   $ (69   $ (134

Equity derivatives

  

Operating expenses

     5        —          23        (22

Equity derivatives

  

Other income (loss), net

     5        2        12        4   
                                   

Total

      $ (108   $ (18   $ (34   $ (152
                                   

(b) Foreign Currency Exchange Risk

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

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

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

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 the acquisition of Tandberg. These contracts were not designated as hedging instruments. Gains and losses on such contracts are included in other income (loss), net. 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 $4 million in OCI for the effective portion of its net investment hedges for the nine months ended May 1, 2010. The Company's net investment hedges are not included in the preceding tables.

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

 

     May 1,
2010
   July 25,
2009

Derivatives designated as cash flow hedging instruments

   $ 1,720    $ 2,965

Derivatives not designated as hedging instruments

     3,280      4,423

Derivatives designated as net investment hedging instruments

     107      103
             

Total

   $ 5,107    $ 7,491
             

(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 May 1, 2010 and July 25, 2009, the Company did not have any outstanding interest rate derivatives related to its fixed income securities.

 

Interest Rate Derivatives, 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 being 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.

During the third quarter of fiscal 2010, the Company entered into a $750 million notional amount interest rate swap designated as a fair value hedge of a portion of the 2016 Notes. Subsequent to May 1, 2010, the Company entered into an additional $750 million notional amount interest rate swap, designated as a fair value hedge of an additional portion of the 2016 Notes. Under these interest rate swap contracts, the Company receives fixed-rate interest payments and makes interest payments based on LIBOR plus a fixed number of basis points. The effect of these swaps is to convert fixed-rate interest expense on a portion of the 2016 Notes to a floating rate interest expense. The gains and losses related to changes in the fair value of the interest rate swaps are included in interest expense in the Consolidated Statements of Operations and substantially offset changes in the fair value of the hedged portion of the underlying hedged debt. As of May 1, 2010 the fair value of the interest rate swaps was $1 million and was reflected in other assets in the Consolidated Balance Sheet.

(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 or cash flow hedges. The changes in the value of the hedging instruments are included in other income (loss), net, and offset the change in the fair value of the underlying hedged investment. The Company did not have any equity derivatives outstanding as of May 1, 2010 and July 25, 2009.

In addition, the Company periodically manages the risk of its investment portfolio by entering into equity derivatives that are not designated as accounting hedges. The changes in the fair value of these derivatives were also included in other income (loss), net. The Company is also exposed to variability in compensation charges related to certain deferred compensation obligations to employees. Although not designated as accounting hedges, the Company utilizes equity derivatives to economically hedge this exposure. As of May 1, 2010 and July 25, 2009, the notional amount of the derivative instruments used to hedge such liabilities was $167 million and $91 million, respectively.

(e) Credit-Risk-Related Contingent Features

Certain derivative instruments are executed under agreements that have provisions requiring the Company and counterparty to maintain a specified credit rating from certain credit rating agencies. If the Company's or counterparty's credit rating falls below a specified credit rating, either party has the right to request collateral on the derivatives' net liability position. Such provisions did not affect the Company's financial position as of May 1, 2010 and July 25, 2009.

 

Commitments and Contingencies
Commitments and Contingencies
11. Commitments and Contingencies

(a) Operating Leases

The Company leases office space in several U.S. locations. Outside the United States, larger leased sites include sites in Australia, Belgium, China, France, Germany, India, Israel, Italy, Japan, 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 May 1, 2010 are as follows (in millions):

 

Fiscal Year

   Amount

2010 (remaining three months)

   $ 81

2011

     324

2012

     216

2013

     150

2014

     111

Thereafter

     399
      

Total

   $ 1,281
      

 

(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 May 1, 2010 and July 25, 2009, the Company had total purchase commitments for inventory of $4.3 billion and $2.2 billion, respectively.

The Company records a liability for firm, noncancelable, and unconditional purchase commitments for quantities in excess of its future demand forecasts consistent with the valuation of the Company's excess and obsolete inventory. As of May 1, 2010 and July 25, 2009, the liability for these purchase commitments was $148 million and $175 million, respectively, and was included in other current liabilities.

(c) Other Commitments

In connection with the Company's business combinations and asset purchases, the Company has agreed to pay certain additional amounts contingent upon the achievement of certain agreed-upon technology, development, product, or other milestones or the continued employment with the Company of certain employees of acquired entities. See Note 3.

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 approximately $299 million and $313 million as of May 1, 2010 and July 25, 2009, respectively.

(d) Variable Interest Entities

In the ordinary course of business, the Company has investments in privately held companies and provides financing to certain customers. These privately held companies and customers may be considered to be variable interest entities. The Company has evaluated its investments in these privately held companies and its customer financings and has determined that there were no significant unconsolidated variable interest entities as of May 1, 2010.

(e) Product Warranties and Guarantees

The following table summarizes the activity related to the product warranty liability during the nine months ended May 1, 2010 and April 25, 2009 (in millions):

 

     Nine Months Ended  
     May 1,
2010
    April 25,
2009
 

Balance at beginning of period

   $ 321      $ 399   

Provision for warranties issued

     342        282   

Payments

     (328 )     (343 )

Fair value of warranty liability acquired

     7        —     
                

Balance at end of period

   $ 342      $ 338   
                

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

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

 

The Company also provides financing guarantees, which are generally for various third-party financing arrangements to channel partners and other end-user customers. See Note 6. The Company's other guarantee arrangements as of May 1, 2010 and July 25, 2009 that are subject to recognition and disclosure requirements were not material.

(f) Legal Proceedings

Brazilian authorities have investigated the Company's Brazilian subsidiary and certain of its current and former employees, as well as a Brazilian importer of the Company's products, and its affiliates and employees, relating to alleged evasion of import taxes and alleged improper transactions involving the subsidiary and the importer. Brazilian 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. The claims are for calendar years 2003 through 2007 and aggregate to approximately $190 million for the alleged evasion of import taxes, $85 million for interest, and approximately $1.6 billion for various penalties, all determined using an exchange rate as of May 1, 2010. 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.

The Company has investigated the alleged improper transactions referred to above. The Company communicated with United States authorities to provide information and report on its findings and the United States authorities have investigated such allegations.

The Company and other defendants are also subject to patent claims asserted by Network-1 Security Solutions, Inc. on February 7, 2008 in the Federal District Court for the Eastern District of Texas. Network-1 alleges that various Cisco products implement a method for remotely powering equipment that infringes U.S. Patent No. 6,218,930. Network-1 seeks monetary damages. The trial on these claims is scheduled to begin in July 2010. The Company believes it has strong arguments that its products do not use the technology described in the patent and that the patent is, in any case, invalid. If the jury were to find that Cisco's products infringe this patent and find that the patent is valid, the Company believes damages are not likely to be material given the limited contribution it believes is played by the technology the plaintiff claims is covered by the patent. However, due to the uncertainty surrounding the litigation process, the Company is unable to reasonably estimate the ultimate outcome of this litigation at this time.

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.

 

Shareholders' Equity
Shareholders' Equity
12. Shareholders' Equity

(a) Stock Repurchase Program

In September 2001, the Company's Board of Directors authorized a stock repurchase program. As of May 1, 2010, the Company's Board of Directors had authorized an aggregate repurchase of up to $72 billion of common stock under this program and the remaining authorized repurchase amount was $9.3 billion with no termination date. The stock repurchase activity under the stock repurchase program during the nine months ended May 1, 2010 is summarized as follows (in millions, except per-share amounts):

 

Nine Months Ended May 1, 2010

   Shares
Repurchased
   Weighted-
Average Price
per Share
   Amount
Repurchased

Cumulative balance at July 25, 2009

   2,802    $ 20.41    $ 57,179

Repurchase of common stock under the stock repurchase program

   226      24.33      5,503
              

Cumulative balance at May 1, 2010

   3,028    $ 20.70    $ 62,682
              

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

(b) Other Repurchases of Common Stock

For the nine months ended May 1, 2010 and April 25, 2009, the Company repurchased approximately 3.7 million and 0.8 million shares, respectively, in settlement of employee tax withholding obligations due upon the vesting of restricted stock or stock units.

 

(c) Comprehensive Income

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

 

     Three Months Ended     Nine Months Ended  
     May 1,
2010
    April 25,
2009
    May 1,
2010
    April 25,
2009
 

Net income

   $ 2,192      $ 1,348      $ 5,832      $ 5,053   

Other comprehensive income:

        

Change in unrealized gains and losses on investments, net of tax benefit (expense) of $(67) and $(93), for the three and nine months ended May 1, 2010, respectively, and $(8) and $86 for the corresponding periods of fiscal 2009

     30        (19     225        (195 )

Change in derivative instruments

     (19     17        (4     (136

Change in cumulative translation adjustment and other

     (72 )     5        12        (429 )
                                

Comprehensive income

     2,131        1,351        6,065        4,293   

Comprehensive (income) loss attributable to noncontrolling interests

     (2     (9 )     8        22   
                                

Comprehensive income attributable to Cisco Systems, Inc.

   $ 2,129      $ 1,342      $ 6,073      $ 4,315   
                                

The Company consolidates its investment in a venture fund managed by SOFTBANK Corp. and its affiliates ("SOFTBANK") as the Company is the primary beneficiary. As a result, SOFTBANK's interest in the change in the unrealized gains and losses on the investments in the venture fund is shown as comprehensive income attributable to noncontrolling interests.

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

 

     May 1,
2010
    July 25,
2009
 

Net unrealized gains on investments

   $ 371      $ 138   

Net unrealized losses on derivative instruments

     (25 )     (21 )

Cumulative translation adjustment and other

     330        318   
                

Total

   $ 676      $ 435   
                

 

Employee Benefit Plans
Employee Benefit Plans
13. Employee Benefit Plans

(a) Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan, which includes its subplan, the International Employee Stock Purchase Plan (together, the "Purchase Plan"), under which 471.4 million shares of the Company's common stock had been reserved for issuance as of May 1, 2010. 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. For the nine months ended both May 1, 2010 and April 25, 2009, the Company issued 14 million shares under the Purchase Plan. As of May 1, 2010, 169 million shares were available for issuance under the Purchase Plan.

 

(b) Employee Stock Incentive Plans

Stock Incentive Plan Program Description

As of May 1, 2010, the Company had five stock incentive plans: the 2005 Stock Incentive Plan (the "2005 Plan"); the 1996 Stock Incentive Plan (the "1996 Plan"); the 1997 Supplemental Stock Incentive Plan (the "Supplemental Plan"); the Cisco Systems, Inc. SA Acquisition Long-Term Incentive Plan (the "SA Acquisition Plan"); and the Cisco Systems, Inc. WebEx Acquisition Long-Term Incentive Plan (the "WebEx Acquisition Plan"). In addition, the Company has, in connection with the acquisitions of various companies, assumed the share-based awards granted under stock incentive plans of the acquired companies or issued share-based awards in replacement thereof. Share-based awards are designed to reward employees for their long-term contributions to the Company and provide incentives for them to remain with the Company. The number and frequency of share-based awards are based on competitive practices, operating results of the Company, government regulations, and other factors. Since the inception of the stock incentive plans, the Company has granted share-based awards to a significant percentage of its employees, and the majority has been granted to employees below the vice president level. The Company's primary stock incentive plans are summarized as follows:

2005 Plan

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

Prior to November 12, 2009, the number of shares available for issuance under the 2005 Plan was reduced by 2.5 shares for each share awarded as a stock grant or stock unit. Pursuant to an amendment approved by the Company's shareholders on November 12, 2009, following that amendment the number of shares available for issuance under the 2005 Plan is reduced by 1.5 shares for each share awarded as a stock grant or a stock unit, and any shares underlying awards outstanding under the 1996 Plan, the SA Acquisition Plan, and the WebEx Acquisition Plan that expire unexercised at the end of their maximum terms become available for reissuance under the 2005 Plan. The 2005 Plan permits the granting of stock options, stock, stock units, and stock appreciation rights to employees (including employee directors and officers), consultants of the Company and its subsidiaries and affiliates, and non-employee directors of the Company. Stock options and stock appreciation rights granted under the 2005 Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and prior to November 12, 2009 have an expiration date no later than nine years from the grant date. The expiration date for stock options and stock appreciation rights granted subsequent to the amendment approved on November 12, 2009 shall be no later than ten years from the grant date. The stock options will generally become exercisable for 20% or 25% of the option shares one year from the date of grant and then ratably over the following 48 or 36 months, respectively. Stock grants and stock units will generally vest with respect to 20% or 25% of the shares covered by the grant on each of the first through fifth or fourth anniversaries of the date of the grant, respectively. The Compensation and Management Development Committee of the Board of Directors has the discretion to use different vesting schedules. Stock appreciation rights may be awarded in combination with stock options or stock grants, and such awards shall provide that the stock appreciation rights will not be exercisable unless the related stock options or stock grants are forfeited. Stock grants may be awarded in combination with non-statutory stock options, and such awards may provide that the stock grants will be forfeited in the event that the related non-statutory stock options are exercised.

1996 Plan

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

Supplemental Plan

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

 

Acquisition Plans

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

General Share-Based Award Information

Stock Option Awards

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

 

     STOCK OPTIONS OUTSTANDING
     Number
Outstanding
    Weighted-
Average
Exercise Price
per Share

BALANCE AT JULY 26, 2008

   1,199      $ 27.83

Granted and assumed

   14        19.01

Exercised

   (33 )     14.67

Canceled/forfeited/expired

   (176 )     49.79
        

BALANCE AT JULY 25, 2009

   1,004        24.29

Granted and assumed

   15        13.23

Exercised

   (141 )     17.92

Canceled/forfeited/expired

   (126 )     47.61
        

BALANCE AT MAY 1, 2010

   752      $ 21.36
        

The following table summarizes significant ranges of outstanding and exercisable stock options as of May 1, 2010 (in millions, except years and share prices):

 

     STOCK OPTIONS OUTSTANDING    STOCK OPTIONS EXERCISABLE

Range of Exercise Prices

   Number
Outstanding
   Weighted-
Average
Remaining
Contractual
Life

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

$  0.01 – 15.00

   73    2.76    $ 10.59    $ 1,191    66    $ 10.89    $ 1,036

  15.01 – 18.00

   142    3.37      17.33      1,363    128      17.29      1,234

  18.01 – 20.00

   185    3.06      19.27      1,415    179      19.27      1,371

  20.01 – 25.00

   191    4.51      22.47      849    140      22.39      634

  25.01 – 35.00

   160    6.26      30.61      32    86      30.54      16

  35.01 – 68.56

   1    0.54      56.68      —      1      56.68      —  
                                

   Total

   752    4.13    $ 21.36    $ 4,850    600    $ 20.42    $ 4,291
                                

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Company's closing stock price of $26.93 as of April 30, 2010, which would have been received by the option holders had those option holders exercised their stock options as of that date. The total number of in-the-money stock options exercisable as of May 1, 2010 was 529 million. As of July 25, 2009, 768 million outstanding stock options were exercisable and the weighted-average exercise price was $24.16.

 

Restricted Stock and Stock Unit Awards

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

 

     Restricted
Stock/Stock
Units
    Weighted-
Average Grant
Date Price per
Share
   Aggregated
Fair Market
Value

BALANCE AT JULY 26, 2008

   10      $ 24.27   

Granted and assumed

   57        20.90   

Vested

   (4 )     23.56    $ 69

Canceled/forfeited

   (1 )     22.76   
           

BALANCE AT JULY 25, 2009

   62      $ 21.25   

Granted and assumed

   47        23.47   

Vested

   (11 )     22.43    $ 252

Canceled/forfeited

   (3 )     22.33   
           

BALANCE AT MAY 1, 2010

   95      $ 22.18   
           

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 26, 2008

   362   

Options granted and assumed

   (14 )

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

   (140 )

Share-based awards canceled/forfeited

   38   

Additional shares reserved

   7   
      

BALANCE AT JULY 25, 2009

   253   

Options granted and assumed

   (15

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

   (71

Share-based awards canceled/forfeited/expired

   118   

Additional shares reserved

   14   
      

BALANCE AT MAY 1, 2010

   299   
      

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

 

Expense and Valuation Information for Share-Based Awards

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 compensation related to acquisitions or investments. The following table summarizes share-based compensation expense (in millions):

 

     Three Months Ended    Nine Months Ended
     May 1,
2010
   April 25,
2009
   May 1,
2010
   April 25,
2009

Cost of sales – product

   $ 16    $ 12    $ 43    $ 33

Cost of sales – service

     47      31      121      94
                           

Share-based compensation expense in cost of sales

     63      43      164      127
                           

Research and development

     129      94      336      283

Sales and marketing

     153      103      395      321

General and administrative

     89      59      231      170
                           

Share-based compensation expense in operating expenses

     371      256      962      774
                           

Total share-based compensation expense

   $ 434    $ 299    $ 1,126    $ 901
                           

As of May 1, 2010, the total compensation cost related to unvested share-based awards not yet recognized was $3.6 billion, which is expected to be recognized over approximately 2.6 years on a weighted-average basis. The income tax benefit for share-based compensation expense was $118 million and $304 million for the three and nine months ended May 1, 2010, respectively, and $79 million and $238 million for the three and nine months ended April 25, 2009, respectively.

Valuation of Share-Based Awards

The valuation of employee stock options is summarized as follows:

 

     Nine Months Ended  
     May 1,
2010
    April 25,
2009
 

Number of options granted (in millions)

     4        5   

Weighted-average assumptions:

    

Expected volatility

     30.5     37.7

Risk-free interest rate

     2.3     2.9

Expected dividend

     0.0     0.0

Kurtosis

     4.1        4.6   

Skewness

     0.20        (0.27

Weighted-average expected life (in years)

     5.1        5.9   

Weighted-average estimated grant date fair value (per option share)

   $ 6.50      $ 6.81   

The Company estimates the fair value of employee stock options on the date of grant using a lattice-binomial option-pricing model and measures the fair value of restricted stock and restricted stock units as if the awards were vested and issued on the grant date.

 

The determination of the fair value of employee stock options on the date of grant using the lattice-binomial model is impacted by the Company's stock price as well as assumptions regarding a number of highly complex and subjective variables. The weighted-average assumptions were determined as follows:

 

   

For employee stock options, the Company used the implied volatility for two-year traded options on the Company's stock as the expected volatility assumption required in the lattice-binomial model.

 

   

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of the Company's employee stock options.

 

   

The dividend yield assumption is based on the history and expectation of dividend payouts.

 

   

The estimated kurtosis and skewness are technical measures of the distribution of stock price returns, which affect expected employee exercise behaviors, and are based on the Company's stock price return history as well as consideration of various academic analyses.

The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and is a derived output of the lattice-binomial model. The expected life of employee stock options is impacted by all of the underlying assumptions and calibration of the Company's model. The lattice-binomial model assumes that employees' exercise behavior is a function of the option's remaining vested life and the extent to which the option is in-the-money. The lattice-binomial model estimates the probability of exercise as a function of these two variables based on the entire history of exercises and cancellations on all past option grants made by the Company.

Accuracy of Fair Value Estimates

The Company uses third-party analyses to assist in developing the assumptions used in, as well as calibrating, its lattice-binomial 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.

 

Income Taxes
Income Taxes
14. Income Taxes

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

 

     Three Months Ended     Nine Months Ended  
     May 1,
2010
    April 25,
2009
    May 1,
2010
    April 25,
2009
 

Effective tax rate

     8.8     20.1     16.6     18.0

Cash paid for income taxes

   $ 486      $ 406      $ 1,624      $ 999   

In the third quarter of fiscal 2010, the U.S. Court of Appeals for the Ninth Circuit affirmed a 2005 U.S. Tax Court ruling in Xilinx, Inc. v. Commissioner. The decision affirmed the tax treatment of share-based compensation expenses for the purpose of determining intangible development costs under a company's research and development cost sharing arrangement. While the Company was not a party to the case, as a result of this ruling, the Company recognized tax benefits as an increase in additional paid-in capital of $566 million and as a reduction to the provision for income taxes of $158 million during the three months ended May 1, 2010.

During the nine months ended April 25, 2009, the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 reinstated the U.S. federal research and development (R&D) tax credit, retroactive to January 1, 2008. As a result, the effective tax rate for the nine months ended April 25, 2009 reflected a $106 million tax benefit related to fiscal 2008 R&D expenses. The U.S. federal R&D tax credit expired on December 31, 2009.

In the third quarter of fiscal 2010, as a result of the U.S. Court of Appeals decision in Xilinx Inc. v. Commissioner as discussed above, the Company decreased the amount of unrecognized tax benefits by approximately $220 million. The Company also decreased the amount of accrued interest by approximately $218 million. As of May 1, 2010, the Company had $2.6 billion of unrecognized tax benefits, of which $2.3 billion, if recognized, would favorably impact the effective tax rate. Although timing of the resolution of audits is highly uncertain, the Company does not believe it is reasonably possible that the total amount of unrecognized tax benefits as of May 1, 2010 will materially change in the next 12 months.

Segment Information and Major Customers
Segment Information and Major Customers
15. Segment Information and Major Customers

The Company's operations involve the design, development, manufacturing, marketing, and technical support of networking and other products and services related to the communications and information technology industry. Cisco products include routers, switches, advanced technologies, and other products. These products, primarily integrated by Cisco IOS Software, link geographically dispersed local-area networks (LANs), metropolitan-area networks (MANs), and wide-area networks (WANs).

(a) Net Sales and Gross Margin by Theater

The Company conducts business globally and is primarily managed on a geographic basis. The Company's management makes financial decisions and allocates resources based on the information it receives from its internal management system. Sales are attributed to a geographic theater based on the ordering location of the customer.

The Company does not allocate research and development, sales and marketing, or general and administrative expenses to its geographic theaters in this internal management system because management does not include the information in its measurement of the performance of the operating segments. In addition, the Company does not allocate amortization of acquisition-related intangible assets, share-based compensation expense, and certain other items to the gross margin for each theater because management does not include this information in its measurement of the performance of the operating segments.

Summarized financial information by theater for the three and nine months ended May 1, 2010 and April 25, 2009, based on the Company's internal management system and as utilized by the Company's Chief Operating Decision Maker (CODM), is as follows (in millions):

 

     Three Months Ended     Nine Months Ended  
     May 1,
2010
    April 25,
2009
    May 1,
2010
    April 25,
2009
 

Net sales:

        

United States and Canada (1)

   $ 5,555      $ 4,308      $ 15,869      $ 14,593   

European Markets

     2,134        1,848        5,895        6,009   

Emerging Markets

     1,140        880        3,107        3,198   

Asia Pacific

     1,141        808        3,175        2,753   

Japan

     398        318        1,158        1,029   
                                

Total

   $ 10,368      $ 8,162      $ 29,204      $ 27,582   
                                

Gross margin (2):

        

United States and Canada

   $ 3,595      $ 2,832      $ 10,339      $ 9,538   

European Markets

     1,444        1,233        4,007        3,993   

Emerging Markets

     717        532        1,986        1,960   

Asia Pacific

     718        498        2,009        1,718   

Japan

     283        220        835        702   
                                

Theater total

     6,757        5,315        19,176        17,911   

Unallocated corporate items (3)

     (127     (86     (326     (278
                                

Total

   $ 6,630      $ 5,229      $ 18,850      $ 17,633   
                                

(1)

Net sales in the United States were $5.2 billion and $4.1 billion for the three months ended May 1, 2010 and April 25, 2009, respectively. Net sales in the United States were $14.9 billion and $13.8 billion for the nine months ended both May 1, 2010 and April 25, 2009, respectively.

 

(2)

Certain reclassifications have been made to prior period amounts to conform to the current period's presentation.

 

(3)

The unallocated corporate items include the effects of amortization of acquisition-related intangible assets and share-based compensation expense.

 

(b) Net Sales for Groups of Similar Products and Services

The following table presents net sales for groups of similar products and services (in millions):

 

     Three Months Ended    Nine Months Ended
     May 1,
2010
   April 25,
2009
   May 1,
2010
   April 25,
2009

Net sales (1):

           

Routers

   $ 1,713    $ 1,388    $ 4,846    $ 4,813

Switches

     3,658      2,604      9,962      9,276

Advanced technologies

     2,435      2,060      7,089      7,091

Other

     630      368      1,715      1,222
                           

Product

     8,436      6,420      23,612      22,402

Service

     1,932      1,742      5,592      5,180
                           

Total

   $ 10,368    $ 8,162    $ 29,204    $ 27,582
                           

(1)

Certain reclassifications have been made to prior period amounts to conform to the current period's presentation.

The Company refers to some of its products and technologies as advanced technologies. As of May 1, 2010, the Company had identified the following advanced technologies for particular focus: application networking services, home networking, security, storage area networking, unified communications, video systems, and wireless technology. The Company continues to identify additional advanced technologies for focus and investment in the future. The Company's investments in some previously identified advanced technologies may be curtailed or eliminated depending on market developments.

(c) Other Segment Information

The majority of the Company's assets, excluding cash and cash equivalents and investments, as of May 1, 2010 and July 25, 2009 were attributable to its U.S. operations. The Company's total cash and cash equivalents and investments held outside of the United States in various foreign subsidiaries as of May 1, 2010 were $30.8 billion, and the remaining $8.3 billion was held in the United States. For the three and nine months ended May 1, 2010 and April 25, 2009, no single customer accounted for 10% or more of the Company's net sales.

Property and equipment information is based on the physical location of the assets. The following table presents property and equipment information for geographic areas (in millions):

 

     May 1,
2010
   July 25,
2009

Property and equipment, net:

     

United States

   $ 3,313    $ 3,330

International

     681      713
             

Total

   $ 3,994    $ 4,043
             

 

Net Income per Share
Net Income per Share
16. Net Income per Share

The following table presents the calculation of basic and diluted net income per share (in millions, except per-share amounts):

 

     Three Months Ended    Nine Months Ended
     May 1,
2010
   April 25,
2009
   May 1,
2010
   April 25,
2009

Net income

   $ 2,192    $ 1,348    $ 5,832    $ 5,053
                           

Weighted-average shares—basic

     5,731      5,805      5,746      5,844

Effect of dilutive potential common shares

     138      13      123      27
                           

Weighted-average shares—diluted

     5,869      5,818      5,869      5,871
                           

Net income per share—basic

   $ 0.38    $ 0.23    $ 1.01    $ 0.86
                           

Net income per share—diluted

   $ 0.37    $ 0.23    $ 0.99    $ 0.86
                           

Antidilutive employee share-based awards, excluded

     197      977      358      1,008

Employee equity share options, unvested shares, and similar equity instruments granted by the Company are treated as potential common shares outstanding in computing diluted earnings per share. Diluted shares outstanding include the dilutive effect of in-the-money options and nonvested restricted stock and restricted stock units which is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.