Edgar Filing: CISCO SYSTEMS INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

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

For the quarterly period ended May 1, 2010

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

For the transition period from to

Commission file number 0-18225

CISCO SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

California

77-0059951

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

170 West Tasman Drive

San Jose, California 95134

(Address of principal executive office and zip code)

(408) 526-4000

(Registrant’s telephone number, including area code)

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

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

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


Large accelerated filer x	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

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

As of May 20, 2010, 5,711,151,107 shares of the registrant’s common stock were outstanding.

Cisco Systems, Inc.

FORM 10-Q for the Quarter Ended May 1, 2010

INDEX


		Page

Part I.	Financial Information	3
Item 1.	Financial Statements (Unaudited)	3
	Consolidated Balance Sheets at May 1, 2010 and July 25, 2009	3
	Consolidated Statements of Operations for the three and nine months ended May 1, 2010 and April 25, 2009	4
	Consolidated Statements of Cash Flows for the nine months ended May 1, 2010 and April 25, 2009	5
	Consolidated Statements of Equity for the nine months ended May 1, 2010 and April 25, 2009	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	66
Item 4.	Controls and Procedures	69
Part II.	Other Information	69
Item 1.	Legal Proceedings	69
Item 1A.	Risk Factors	70
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	86
Item 3.	Defaults Upon Senior Securities	86
Item 4.	Reserved	87
Item 5.	Other Information	87
Item 6.	Exhibits	87
	Signature	88

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements (Unaudited)

CISCO SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(in millions, except par value)

(Unaudited)


	May 1, 2010		July 25, 2009
ASSETS
Current assets:
Cash and cash equivalents	$	3,961	$	5,718
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	$	—
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		38,677


TOTAL LIABILITIES AND EQUITY	$	79,292	$	68,128

See Notes to Consolidated Financial Statements.

CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per-share amounts)

(Unaudited)


	Three Months Ended						Nine Months Ended
	May 1, 2010			April 25, 2009			May 1, 2010			April 25, 2009
NET SALES:
Product	$	8,436		$	6,420		$	23,612		$	22,402
Service		1,932			1,742			5,592			5,180

Total net sales		10,368			8,162			29,204			27,582

COST OF SALES:
Product		3,010			2,327			8,311			8,045
Service		728			606			2,043			1,904

Total cost of sales		3,738			2,933			10,354			9,949

GROSS MARGIN		6,630			5,229			18,850			17,633

OPERATING EXPENSES:
Research and development		1,411			1,243			3,882			3,928
Sales and marketing		2,260			1,956			6,365			6,394
General and administrative		497			302			1,404			1,077
Amortization of purchased intangible assets		117			121			360			369
In-process research and development		—			—			—			3

Total operating expenses		4,285			3,622			12,011			11,771


OPERATING INCOME		2,345			1,607			6,839			5,862
Interest income		158			194			481			675
Interest expense		(182	)		(105	)		(454	)		(232	)
Other income (loss), net		82			(9	)		131			(145	)

Interest and other income, net		58			80			158			298

INCOME BEFORE PROVISION FOR INCOME TAXES		2,403			1,687			6,997			6,160
Provision for income taxes		211			339			1,165			1,107

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


Net income per share:
Basic	$	0.38		$	0.23		$	1.01		$	0.86

Diluted	$	0.37		$	0.23		$	0.99		$	0.86


Shares used in per-share calculation:
Basic		5,731			5,805			5,746			5,844

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

See Notes to Consolidated Financial Statements.

CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)


	Nine Months Ended
	May 1, 2010			April 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		—			3
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			9
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			—
Repayment of long-term debt		—			(500	)
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			5,191


Cash and cash equivalents, end of period	$	3,961		$	7,359

See Notes to Consolidated Financial Statements.

CISCO SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(in millions)

(Unaudited)


Nine Months Ended April 25, 2009	Shares of Common Stock		Common Stock and Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Cisco Shareholders’ Equity			Noncontrolling Interests			Total Equity
BALANCE AT JULY 26, 2008	5,893		$	33,505		$	120		$	728		$	34,353		$	49		$	34,402
Net income	—			—			5,053			—			5,053			—			5,053
Change in unrealized gains and losses on investments	—			—			—			(173	)		(173	)		(22	)		(195	)
Change in derivative instruments	—			—			—			(136	)		(136	)		—			(136	)
Change in cumulative translation adjustment and other	—			—			—			(429	)		(429	)		—			(429	)

Comprehensive income (loss)													4,315			(22	)		4,293

Issuance of common stock	39			486			—			—			486			—			486
Repurchase of common stock	(160	)		(936	)		(1,881	)		—			(2,817	)		—			(2,817	)
Tax benefits from employee stock incentive plans	—			5			—			—			5			—			5
Purchase acquisitions	—			13			—			—			13			—			13
Share-based compensation expense	—			901			—			—			901			—			901

BALANCE AT APRIL 25, 2009	5,772		$	33,974		$	3,292		$	(10	)	$	37,256		$	27		$	37,283


Nine Months Ended May 1, 2010	Shares of Common Stock		Common Stock and Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total Cisco Shareholders’ Equity			Noncontrolling Interests			Total Equity
BALANCE AT JULY 25, 2009	5,785		$	34,344		$	3,868		$	435		$	38,647		$	30		$	38,677
Net income	—			—			5,832			—			5,832			—			5,832
Change in unrealized gains and losses on investments	—			—			—			233			233			(8	)		225
Change in derivative instruments	—			—			—			(4	)		(4	)		—			(4	)
Change in cumulative translation adjustment and other	—			—			—			12			12			—			12

Comprehensive income (loss)													6,073			(8	)		6,065

Issuance of common stock	167			2,780			—			—			2,780			—			2,780
Repurchase of common stock	(230	)		(1,458	)		(4,130	)		—			(5,588	)		—			(5,588	)
Tax benefits from employee stock incentive plans, including transfer pricing adjustments	—			710			—			—			710			—			710
Purchase acquisitions	—			82			—			—			82			—			82
Share-based compensation expense	—			1,126			—			—			1,126			—			1,126

BALANCE AT MAY 1, 2010	5,722		$	37,584		$	5,570		$	676		$	43,830		$	22		$	43,852

Supplemental Information

In September 2001, the Company’s Board of Directors authorized a stock repurchase program. As of 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

See Notes to Consolidated Financial Statements.

CISCO SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	Basis of Presentation

The fiscal year for Cisco Systems, Inc. (the “Company” or “Cisco”) is the 52 or 53 weeks ending on the last Saturday in July. Fiscal 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.

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.

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.

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

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.

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

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.

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.

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.

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.

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.

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

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.

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.

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

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.

Item 2.

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “endeavors,” “strives,” “may,” variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below, under “Part II, Item 1A. Risk Factors,” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.

Overview

A summary of our results is as follows (in millions, except percentages and per-share amounts):


	Three Months Ended								Nine Months Ended
	Fiscal 2010			Fiscal 2009			Variance		Fiscal 2010			Fiscal 2009			Variance
Net sales	$	10,368		$	8,162		27.0	%	$	29,204		$	27,582		5.9	%
Gross margin percentage		63.9	%		64.1	%	(0.2	)%		64.5	%		63.9	%	0.6	%
Net income	$	2,192		$	1,348		62.6	%	$	5,832		$	5,053		15.4	%
Earnings per share—diluted	$	0.37		$	0.23		60.9	%	$	0.99		$	0.86		15.1	%

Our results for the third quarter of fiscal 2010 represent the fourth consecutive quarter of positive sequential revenue growth and the second consecutive quarter of positive year-over-year revenue growth. Our results for the third quarter of fiscal 2010 reflect balanced growth across our geographic theaters, product categories, and customer markets and a return to more normal sequential revenue trends. Net income in the third quarter of fiscal 2010 increased by 63% compared with the third quarter of fiscal 2009, while for the first nine months of fiscal 2010, net income increased by 15% compared with the first nine months of fiscal 2009. In the third quarter of fiscal 2010, net income per diluted share increased by 61% compared with the third quarter of fiscal 2009, primarily due to higher revenue and lower operating expenses as a percentage of revenue. A tax benefit of $158 million during the third quarter of fiscal 2010 also contributed to the increase in net income and net income per diluted share for both periods in fiscal 2010. In addition, the third quarter of fiscal 2010 had 14 weeks, compared with 13 weeks in the third quarter of fiscal 2009, thus our operating results for the third quarter and the first nine months of fiscal 2010 reflect an extra week compared with the corresponding periods in fiscal 2009, the estimated impacts of which are discussed below.

Strategy and Focus Areas

Our strategy centers on the increasing role of intelligent networks, collaboration and Web 2.0 technologies, the United States and selected emerging countries, the network as the platform, and resource management and realignment. Consistent with our strategy during the fiscal 2009 economic downturn, we will continue to seek to expand our share of our customers’ information technology spending. We will endeavor to achieve this objective by focusing on our core networking capabilities while continuing to expand into product markets similar, related, or adjacent to those in which we currently are active, which we refer to as market adjacencies. We have continued our focus on our core networking capabilities and have expanded our movement into market adjacencies, primarily through the realignment of resources, while simultaneously reducing our operating expenses as a percentage of revenue.

We refer to the evolutionary process by which adjacencies arise as market transitions. Specifically, we believe the key market transitions currently taking place in our industry pertain to virtualization, video, and collaboration. Virtualization is the process of aggregating the current siloed data center resources into unified, shared resource pools that can be dynamically delivered to applications on demand, thus providing the ability to move content and applications between devices and the network. Due to changing technology trends such as the increasing adoption of virtualization and the rise in scalable processing, a significant market transition appears to be under way in the enterprise data center market. We believe the market is at an inflection point, as awareness grows that intelligent networks are becoming the platform for productivity improvement and global competitiveness. We further believe that disruption in the enterprise data center market will accelerate in the next several months. This market transition is being brought about through the convergence of networking, computing, storage, and software technologies. We are seeking to capitalize on this market transition through, among other things, our Cisco Unified Computing System and Cisco Nexus product families, which are designed to integrate the previously siloed technologies in the enterprise data center with a unified architecture.

The competitive landscape in our markets has changed, and we expect there will be a new class of very large, well-financed and aggressive competitors, each bringing its own new class of products to address this new enterprise data center market. Despite the increased competition, we continue to believe that, with respect to this new enterprise data center market, the network will be the intersection of innovation through an open ecosystem and standards. We expect to see acquisitions, industry consolidation, and new alliances among companies as they seek to serve the enterprise data center market. As we enter this next market phase, we expect to continue and strengthen certain strategic alliances, as we have already done, and compete more with certain strategic alliances and partners, and perhaps also encounter new competitors, in our attempt to deliver the best solutions for our customers.

Other market transitions on which we are focusing attention include those related to the increased role of video and collaboration across our customer markets. The key market transitions relative to the convergence of video and collaboration, which we believe will drive productivity and growth in network loads, appear to be evolving even faster than we had anticipated earlier this year. Cisco TelePresence systems are one example of our product offerings that have incorporated video and collaboration as customers evolve their communications and business models. During the third quarter of fiscal 2010, we completed our acquisition of Tandberg. We plan to integrate Tandberg with our Cisco TelePresence business in order to enhance multiproduct and multivendor interoperability and to encourage faster customer adoption.

We believe that the architectural approach that has served us well in our core networking technologies in the communications and information technology industry will be adaptable to other markets. Examples of market adjacencies where we aim to apply this approach are the consumer market and electrical services infrastructure market. We believe that our approach of focusing on our core networking technologies and moving into market adjacencies has contributed to the growth we experienced in the past. Recently we have delivered several new products, and we are pleased with the breadth and depth of our innovation across almost all aspects of our business and the impact that we believe this innovation will have on our long-term prospects. We are currently undergoing product transitions within several of our product families, and we believe that many of these product transitions are gaining momentum based on the strong year-over-year product revenue growth across these product families. We believe that our strategy and our ability to innovate and execute may enable us to improve our relative competitive position in difficult business conditions and may continue to provide us with long-term growth opportunities.

Revenue

For the third quarter of fiscal 2010, our total revenue increased by 27% on a year-over-year basis, which included revenue increases in all of our geographic theaters, reflecting what we believe to be an improving economic environment across all of our geographic theaters. From a customer market perspective, during the third quarter of fiscal 2010 we saw an improved environment for capital expenditures across our enterprise, commercial, and service provider markets. Our net product sales increased on a year-over-year basis across all of our categories of similar products in the third quarter of fiscal 2010, while our net product sales for the first nine months of fiscal 2010 increased on a year-over-year basis across almost all categories of similar products, except for sales of our advanced technologies which were relatively unchanged. In the third quarter and first nine months of fiscal 2010, our revenue from routing products increased by 23% and 1%, respectively, compared with the corresponding periods of fiscal 2009. In the third quarter and first nine months of fiscal 2010, our revenue from switching products increased by 40% and 7%, respectively, compared with the corresponding periods of fiscal 2009. Sales of our advanced technologies for the third quarter of fiscal 2010 increased 18% on a year-over-year basis. The year-over-year revenue increase in the other product revenue category was driven primarily by sales of cable products, the Cisco Unified Computing System within our Emerging Technologies, and sales of Flip Video cameras from our acquisition of Pure Digital Technologies, Inc. (“Pure Digital”), which we acquired in the fourth quarter of fiscal 2009. While we cannot quantify with precision the impact to revenue of the extra week in the third quarter of fiscal 2010, we believe the extra week added approximately 4% to 5% to our year-over-year revenue growth for the third quarter of fiscal 2010.

Gross Margin

In the third quarter of fiscal 2010, our gross margin percentage decreased by approximately 0.2 percentage points compared with the corresponding period of fiscal 2009. This decrease in gross margin percentage for the third quarter of fiscal 2010 was the result of a decline in our service gross margin percentage partially offset by our higher product gross margin. The year-over-year increase in our product gross margin percentage during the third quarter of fiscal 2010 was primarily due to higher shipment volume, lower overall manufacturing costs, and a favorable product mix, partially offset by unfavorable impacts attributable to sales discounts, rebates and product pricing. For the first nine months of fiscal 2010, our gross margin percentage increased by 0.6 percentage points, driven primarily by our higher product gross margin percentage.

Operating Expenses

For the third quarter and first nine months of fiscal 2010, operating expenses increased in absolute dollars compared with the corresponding periods of fiscal 2009, but decreased as a percentage of revenue. The increase in absolute dollar terms was attributable to higher headcount-related expenses, including variable compensation expenses, and higher discretionary expenses. The extra week in the third quarter of fiscal 2010 also contributed approximately $150 million to the year-over-year increase in total operating expenses during the third quarter and first nine months of fiscal 2010.

Other Key Financial Measures

The following is a summary of our other financial measures for the third quarter and first nine months of fiscal 2010:

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We generated cash flows from operations of $3.0 billion and $6.9 billion during the third quarter and first nine months of fiscal 2010, respectively. Our cash and cash equivalents, together with our investments, were $39.1 billion at the end of the third quarter of fiscal 2010, compared with $35.0 billion at the end of fiscal 2009.

•

Our deferred revenue at the end of the third quarter of fiscal 2010 was $10.3 billion, compared with $9.4 billion at the end of fiscal 2009.

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We repurchased 87 million shares of our common stock under our stock repurchase program for $2.25 billion during the third quarter of fiscal 2010, and we repurchased 226 million shares of our common stock for $5.5 billion during the first nine months of fiscal 2010. As of the end of the third quarter of fiscal 2010, the remaining authorized repurchase amount under this program was $9.3 billion with no termination date.

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Days sales outstanding in accounts receivable (“DSO”) at the end of the third quarter of fiscal 2010 was 39 days, compared with 34 days at the end of fiscal 2009.

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Our inventory balance was $1.3 billion at the end of the third quarter of fiscal 2010, compared with $1.1 billion at the end of fiscal 2009. Annualized inventory turns were 11.5 in the third quarter of fiscal 2010 and were 11.7 in the fourth quarter of fiscal 2009.

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Our purchase commitments with contract manufacturers and suppliers were $4.3 billion at the end of the third quarter of fiscal 2010, compared with $2.2 billion at the end of fiscal 2009.

We believe that in any rapidly shifting supply and demand environment such as the one we are currently experiencing, shifts in lead times, inventory levels, purchase commitments, and manufacturing outputs will occur. For the third quarter of fiscal 2010, we experienced a higher percentage of our total quarterly shipments in the last month of the quarter compared with the corresponding month in the fourth quarter of fiscal 2009, which resulted in an increase to our accounts receivable and DSO. Similar to the first half of fiscal 2010, we experienced longer than normal lead times on several of our products. This was attributable in part to increasing demand driven by the improvement in our overall markets. In addition, and similar to what is happening throughout the industry, the longer than normal lead time extensions also stemmed from supplier constraints based upon their labor and other actions taken during the global economic downturn. While we may continue to experience longer than normal lead times, our lead times improved on most products throughout the third quarter of fiscal 2010. If lead times for key components lengthen further as the economic environment continues to improve, our operating results for a particular future period could be adversely affected.

Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended July 25, 2009, as updated where applicable in Note 2 herein, describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements.

The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies.

Revenue Recognition

Revenue is recognized when all of the following criteria have been met:

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When persuasive evidence of an arrangement exists. Contracts, Internet commerce agreements, and customer purchase orders are generally used to determine the existence of an arrangement.

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Delivery has occurred. Shipping documents and customer acceptance, when applicable, are used to verify delivery.

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The fee is fixed or determinable. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.

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Collectibility is reasonably assured. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.

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. When a sale involves multiple deliverables, such as sales of products that include services, the entire fee from the arrangement is allocated to each respective element based on its relative selling price and recognized when revenue recognition criteria for each element are met.

In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and nonsoftware components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. 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)

(iii)

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

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

The amount of product and service revenue recognized in a given period is affected by our judgment as to whether an arrangement includes multiple deliverables and, if so, our determinations surrounding whether VSOE exists. In the certain limited circumstances when VSOE does not exist, we then apply judgment with respect to whether we can obtain TPE. Generally, we are not able to determine TPE because our go-to-market strategy differs from that of our peers. In the limited number of circumstances in which we are unable to establish selling price using VSOE or TPE, we will use ESP in our allocation of arrangement consideration. We determine VSOE based on its normal pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, we require 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 determining ESP, we apply significant judgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. We typically arrive at an ESP for a product or service that is not sold separately by considering company-specific factors such as geographies, competitive landscape, internal costs, gross margin objectives, pricing practices used to establish bundled pricing, and existing portfolio pricing and discounting. There were no material impacts during the quarter nor do we currently expect a material impact in future periods from changes in VSOE, TPE, or ESP.

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 subsequent 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 our product and service offerings. However, we expect that this new accounting guidance will facilitate our efforts to optimize our offerings due to better alignment between the economics of an arrangement and the accounting. This may lead to us engaging in new go-to-market practices in the future. In particular, we expect that the new accounting standards will enable us to better integrate products and services without VSOE into existing offerings and solutions. As these go-to-market strategies evolve, we may modify our pricing practices in the future, which could result in changes in selling prices, including both VSOE and ESP. As a result, our future revenue recognition for multiple-element arrangements could differ materially from the results in the current period. We are currently unable to determine the impact that the newly adopted accounting guidance could have on our revenue as these go-to-market strategies evolve.

Revenue deferrals relate to the timing of revenue recognition for specific transactions based on financing arrangements, service, support, and other factors. Financing arrangements may include sales-type, direct-financing, and operating leases, loans, and guarantees of third-party financing. Our deferred revenue for products was $3.5 billion and $2.9 billion as of May 1, 2010 and July 25, 2009, respectively. Technical support services revenue is deferred and recognized ratably over the period during which the services are to be performed, which typically is from one to three years. Advanced services revenue is recognized upon delivery or completion of performance. Our deferred revenue for services was $6.8 billion and $6.5 billion as of May 1, 2010 and July 25, 2009, respectively.

We make sales to distributors and retail partners and recognize revenue based on a sell-through method using information provided by them. Our distributors and retail partners participate in various cooperative marketing and other programs, and we maintain estimated accruals and allowances for these programs. If actual credits received by our distributors and retail partners under these programs were to deviate significantly from our estimates, which are based on historical experience, our revenue could be adversely affected.

Allowances for Receivables and Sales Returns

The allowances for receivables were as follows (in millions, except percentages):


	May 1, 2010			July 25, 2009
Allowance for doubtful accounts	$	216		$	216
Percentage of gross accounts receivable		5.0	%		6.4	%
Allowance for lease receivables	$	199		$	213
Percentage of gross lease receivables		8.7	%		10.7	%
Allowance for loan receivables	$	104		$	88
Percentage of gross loan receivables		8.2	%		10.2	%

The allowances are based on our assessment of the collectibility of customer accounts. We regularly review the adequacy of these allowances by considering factors such as historical experience, credit quality, age of the receivable balances, and economic conditions that may affect a customer’s ability to pay. In addition, we perform credit reviews and statistical portfolio analysis to assess the credit quality of our receivables. We also consider the concentration of receivables outstanding with a particular customer in assessing the adequacy of our allowances. If a major customer’s creditworthiness deteriorates, or if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our revenue.

A reserve for future sales returns is established based on historical trends in product return rates. The reserve for future sales returns as of May 1, 2010 and July 25, 2009 was $78 million and $75 million, respectively, and was recorded as a reduction of our accounts receivable. If the actual future returns were to deviate from the historical data on which the reserve had been established, our revenue could be adversely affected.

Inventory Valuation and Liability for Purchase Commitments with Contract Manufacturers and Suppliers

Our inventory balance was $1.3 billion and $1.1 billion as of May 1, 2010 and July 25, 2009, respectively. Inventory is written down based on excess and obsolete inventories determined primarily by future demand forecasts. Inventory write-downs are measured as the difference between the cost of the inventory and market, based upon assumptions about future demand, and are charged to the provision for inventory, which is a component of our cost of sales. At the point of the loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

We record a liability for firm, noncancelable, and unconditional purchase commitments with contract manufacturers and suppliers for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of May 1, 2010, the liability for these purchase commitments was $148 million, compared with $175 million as of July 25, 2009, and was included in other current liabilities.

Our provision for inventory was $56 million and $64 million for the first nine months of fiscal 2010 and 2009, respectively. The provision for the liability related to purchase commitments with contract manufacturers and suppliers was $7 million and $77 million for the first nine months of fiscal 2010 and 2009, respectively. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, we could be required to increase our inventory write-downs and our liability for purchase commitments with contract manufacturers and suppliers and gross margin could be adversely affected. Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility to help ensure competitive lead times with the risk of inventory obsolescence.

Warranty Costs

The liability for product warranties, included in other current liabilities, was $342 million as of May 1, 2010, compared with $321 million as of July 25, 2009. See Note 11 to the Consolidated Financial Statements. Our products are generally covered by a warranty for periods ranging from 90 days to five years, and for some products we provide a limited lifetime warranty. We accrue for warranty costs as part of our cost of sales based on associated material costs, technical support labor costs, and associated overhead. Material cost is estimated based primarily upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the equipment. Technical support labor cost is estimated based primarily upon historical trends in the rate of customer cases and the cost to support the customer cases within the warranty period. Overhead cost is applied based on estimated time to support warranty activities.

The provision for product warranties issued during the first nine months of fiscal 2010 and 2009 was $342 million and $282 million, respectively. If we experience an increase in warranty claims compared with our historical experience, or if the cost of servicing warranty claims is greater than expected, our gross margin could be adversely affected.

Share-Based Compensation Expense

Total share-based compensation expense for the nine months ended May 1, 2010 and April 25, 2009 was $1.1 billion and $901 million, respectively. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. For employee stock options and employee stock purchase rights, these variables include, but are not limited to, the expected stock price volatility over the term of the awards, risk-free interest rate, and expected dividends. For employee stock options, we used the implied volatility for two-year traded options on our stock as the expected volatility assumption required in the lattice-binomial model. For employee stock purchase rights, we used the implied volatility for traded options (with lives corresponding to the expected life of the employee stock purchase rights) on our stock. The selection of the implied volatility approach was based upon the availability of actively traded options on our stock and our assessment that implied volatility is more representative of future stock price trends than historical volatility. The valuation of employee stock options is also impacted by kurtosis and skewness, which are technical measures of the distribution of stock price returns, and the actual and projected employee stock option exercise behaviors.

Because share-based compensation expense recognized in the Consolidated Statements of Operations is based on awards ultimately expected to vest, it has been reduced for forfeitures. If factors change and we employ different assumptions in the application of our option-pricing model in future periods or if we experience different forfeiture rates, the compensation expense that is derived may differ significantly from what we have recorded in the current period.

Fair Value Measurements of Investments

Our fixed income and publicly traded equity securities, collectively, are reflected in the Consolidated Balance Sheets at a fair value of $35.1 billion as of May 1, 2010, compared with $29.3 billion as of July 25, 2009. Our fixed income investment portfolio consists primarily of high-quality investment-grade securities and as of May 1, 2010 had a weighted-average credit rating exceeding AA. See Note 7 to the Consolidated Financial Statements.

As described more fully in Note 8 to the Consolidated Financial Statements, a valuation hierarchy was established based on the level of independent, objective evidence available regarding the value of the investments. It encompasses three classes of investments: Level 1 consists of securities for which there are quoted prices in active markets for identical securities; Level 2 consists of securities for which observable inputs other than Level 1 inputs are used, such as prices for similar securities in active markets or for identical securities in less active markets and model-derived valuations for which the variables are derived from, or corroborated by, observable market data; and Level 3 consists of securities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value.

Our Level 2 securities are valued using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques in limited circumstances. We use inputs such as actual trade data, benchmark yields, broker/dealer quotes, and other similar data, which are obtained from independent pricing vendors, quoted market prices, or other sources to determine the ultimate fair value of our assets and liabilities. We use such pricing data as the primary input, to which we have not made any material adjustments during the periods presented, to make our assessments and determinations as to the ultimate valuation of our investment portfolio. We are ultimately responsible for the financial statements and underlying estimates.

The inputs and fair value are reviewed for reasonableness, may be further validated by comparison to publicly available information and could be adjusted based on market indices or other information that management deems material to their estimate of fair value. In the current market environment, the assessment of fair value can be difficult and subjective. However, given the relative reliability of the inputs we use to value our investment portfolio, and because substantially all of our valuation inputs are obtained using quoted market prices for similar or identical assets, we do not believe that the nature of estimates and assumptions affected by levels of subjectivity and judgment was material to the valuation of the investment portfolio as of May 1, 2010. Level 3 assets do not represent a significant portion of our total investment portfolio as of May 1, 2010.

Other-than-Temporary Impairments

We recognize an impairment charge when the declines in the fair values of our fixed income or publicly traded equity securities below their cost basis are judged to be other than temporary. The ultimate value realized on these securities, to the extent unhedged, is subject to market price volatility until they are sold.

Effective at the beginning of the fourth quarter of fiscal 2009, we were required to evaluate our fixed income securities for other-than-temporary impairments subject to new accounting guidance. Pursuant to this accounting guidance, if the fair value of a debt security is less than its amortized cost, we assess whether the impairment is other than temporary. An impairment is considered other than temporary if (i) we have the intent to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovery of its entire amortized cost basis, or (iii) we do not expect to recover the entire amortized cost basis of the security. If an impairment is considered other than temporary based on (i) or (ii) described above, the entire difference between the amortized cost basis and the fair value of the security is recognized in earnings. If an impairment is considered other than temporary based on condition (iii), the amount representing credit losses, defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security, will be recognized in earnings and the amount relating to all other factors will be recognized in other comprehensive income (OCI). In estimating the amount and timing of cash flows expected to be collected, we consider all available information, including past events, current conditions, the remaining payment terms of the security, the financial condition of the issuer, expected defaults, and the value of underlying collateral.

For publicly traded equity securities, we consider various factors in determining whether we should recognize an impairment charge, including the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the issuer, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

There were no impairment charges on investments in fixed income securities and publicly traded equity securities that were recognized in earnings in the first nine months of fiscal 2010, while such impairment charges for the first nine months of 2009 were $258 million. Our ongoing consideration of all the factors described above could result in additional impairment charges in the future, which could adversely affect our net income.

We also have investments in privately held companies, some of which are in the startup or development stages. As of May 1, 2010, our investments in privately held companies were $763 million, compared with $709 million as of July 25, 2009, and were included in other assets. See Note 5 to the Consolidated Financial Statements. We monitor these investments for events or circumstances indicative of potential impairment and will make appropriate reductions in carrying values if we determine that an impairment charge is required, based primarily on the financial condition and near-term prospects of these companies. These investments are inherently risky because the markets for the technologies or products these companies are developing are typically in the early stages and may never materialize. Our impairment charges on investments in privately held companies were $17 million and $68 million during the first nine months of fiscal 2010 and 2009, respectively.

Goodwill Impairments

Our methodology for allocating the purchase price relating to purchase acquisitions is determined through established valuation techniques. Goodwill is measured as a residual as of the acquisition date which, in most cases, results in measuring goodwill as an excess of the purchase consideration transferred plus the fair value of any noncontrolling interest in the acquiree over the fair value of net assets acquired, including any contingent consideration. We perform goodwill impairment tests on an annual basis in the fourth fiscal quarter and between annual tests in certain circumstances for each reporting unit. Effective in fiscal 2010, the assessment of fair value for goodwill and other long-lived intangible assets is based on factors that market participants would use in an orderly transaction in accordance with the new accounting guidance for the fair value measurement of nonfinancial assets.

The goodwill recorded in the Consolidated Balance Sheets as of May 1, 2010 and July 25, 2009 was $16.7 billion and $12.9 billion, respectively. In response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill. There was no impairment of goodwill in the first nine months of fiscal 2010 and 2009, respectively.

Income Taxes

We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective tax rates differ from the statutory rate, primarily due to the tax impact of state taxes, foreign operations, R&D tax credits, tax audit settlements, nondeductible compensation, international realignments, and transfer pricing adjustments. Our effective tax rate was 8.8% and 20.1% in the third quarter of fiscal 2010 and fiscal 2009, respectively. The effective tax rate was 16.6% and 18.0% for the first nine months of fiscal 2010 and 2009, respectively.

Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.

Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by expiration of or lapses in the R&D tax credit laws; by transfer pricing adjustments, including the effect of acquisitions on our intercompany R&D cost sharing arrangement and legal structure; by tax effects of nondeductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by changes in tax laws and regulations, including possible U.S. changes to the taxation of earnings of our foreign subsidiaries, the deductibility of expenses attributable to foreign income, or the foreign tax credit rules. Significant judgment is required to determine the recognition and measurement attributes prescribed in the accounting guidance for uncertainty in income taxes. The accounting guidance for uncertainty in income taxes applies to all income tax positions, including the potential recovery of previously paid taxes, which if settled unfavorably could adversely impact our provision for income taxes or additional paid-in capital. Further, as a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries is subject to reduced tax rates and in some cases is wholly exempt from tax. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.

Loss Contingencies

We are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.

Third parties, including customers, have in the past and may in the future assert claims or initiate litigation related to exclusive patent, copyright, trademark, and other intellectual property rights to technologies and related standards that are relevant to us. These assertions have increased over time as a result of our growth and the general increase in the pace of patent claims assertions, particularly in the United States. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results, and financial condition could be materially and adversely affected.

Net Sales

The following table presents the breakdown of net sales between product and service revenue (in millions, except percentages):