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Notes
to Consolidated Financial Statements
1. Description of Business
Cisco Systems, Inc. (the "Company" or "Cisco")
manufactures and sells networking and communications products and
provides services associated with that equipment and its use. Its
products are installed at corporations, public institutions, and telecommunication
companies, and are also found in small and medium-sized commercial
enterprises. Cisco provides a broad line of products for transporting
data, voice, and video within buildings, across campuses, or around
the world.
2. Summary of Significant Accounting Policies
Fiscal Year The Company's fiscal year is the 52 or 53 weeks
ending on the last Saturday in July. Fiscal 2002, 2001, and 2000 were
52-week fiscal years.
Principles of Consolidation The Consolidated Financial Statements
include the accounts of Cisco Systems, Inc. and its subsidiaries.
All significant intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents The Company considers all highly
liquid investments purchased with an original or remaining maturity
of less than three months at the date of purchase to be cash equivalents.
Cash and cash equivalents are maintained with several financial institutions.
Investments The Company's investments are primarily comprised
of U.S. government notes and bonds; corporate notes and bonds; and
publicly traded corporate equity securities. Investments with original
or remaining maturities of greater than three months and less than
one year are considered to be short-term. Investments are custodied
with a major financial institution. The specific identification method
is used to determine the cost basis of notes and bonds disposed of.
The weighted-average method is used to determine the cost basis of
corporate equity securities disposed of. At July 27, 2002 and July
28, 2001, substantially all of the Company's investments were classified
as available for sale. These investments are recorded on the Consolidated
Balance Sheets at fair value. Unrealized gains and losses on these
investments are included as a separate component of accumulated other
comprehensive income (loss), net of any related tax effect. The Company
recognizes an impairment charge when the decline in the fair value
of its investments below the cost basis is judged to be other-than-temporary.
The Company also has minority investments in privately held companies.
These investments are included in other assets on the Company's Consolidated
Balance Sheets and are generally carried at cost. The Company monitors
these investments for impairment and makes appropriate reductions
in carrying values.
Inventories Inventories are stated at the lower of cost or
market. Cost is computed using standard cost, which approximates actual
cost, on a first-in, first-out basis. The Company provides inventory
allowances based on excess and obsolete inventories determined primarily
by future demand forecasts.
Restricted Investments Restricted investments consisted of
U.S. government notes and bonds with maturities of more than one year.
These investments were carried at fair value and were restricted as
collateral for specified obligations under certain lease agreements.
In fiscal 2002, the Company elected to purchase all of the land and
buildings, as well as sites under construction, under these lease
agreements. As a result, all restricted investments were liquidated
and the Company no longer has any sites under such lease agreements.
Fair Value of Financial Instruments Fair value of certain of
the Company's financial instruments, including cash and cash equivalents,
accrued compensation, and other accrued liabilities, approximate cost
because of their short maturities. The fair value of investments is
determined using quoted market prices for those securities or similar
financial instruments.
Concentrations Cash and cash equivalents are maintained with
several financial institutions. Deposits held with banks may exceed
the amount of insurance provided on such deposits. Generally, these
deposits may be redeemed upon demand.
The Company performs ongoing credit evaluations of its customers and,
with the exception of certain financing transactions, does not require
collateral from its customers. The Company's customers are primarily
in the service provider and enterprise markets.
The Company receives certain of its components from sole suppliers.
Additionally, the Company relies on a limited number of contract manufacturers
and suppliers to provide manufacturing services for its products.
The inability of any contract manufacturer or supplier to fulfill
supply requirements of the Company could materially impact future
operating results.
Revenue Recognition The Company generally recognizes product
revenue when persuasive evidence of an arrangement exists, delivery
has occurred, the fee is fixed or determinable, and collectibility
is probable. 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. Service revenue is generally
deferred and, in most cases, recognized ratably over the service period
obligations, which are typically one to three years. Cash payments
received in advance of product or service revenue are recorded as
deferred revenue.
The Company makes certain sales to two-tier distribution channels.
These distributors are given privileges to return a portion of inventory,
receive credits for changes in selling prices, and participate in
various cooperative marketing programs. The Company recognizes revenue
to two-tier distributors based on information provided by its distributors
and also maintains accruals and allowances for all cooperative marketing
and other programs. The Company accrues for warranty costs, sales
returns, and other allowances based on its historical experience.
Lease Receivables The Company provides a variety of lease financing
services to its customers to build, maintain, and upgrade their networks.
Lease receivables primarily represent the principal balance remaining
in sales-type and direct-financing leases under these programs, net
of reserves. These leases typically have two- to three-year terms
and are usually collateralized by a security interest in the underlying
assets.
Advertising Costs The Company expenses all advertising costs
as incurred.
Software Development Costs Software development costs required
to be capitalized pursuant to Statement of Financial Accounting Standards
No. 86, "Accounting for the Costs of Computer Software to Be
Sold, Leased, or Otherwise Marketed," have not been material
to date. Software development costs for internal use required to be
capitalized pursuant to Statement of Position No. 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal
Use," have also not been material to date.
Depreciation and Amortization Property and equipment are stated
at cost less accumulated depreciation and amortization. Depreciation
and amortization are computed using the straight-line method over
the estimated useful lives of the assets. Estimated useful lives of
25 years are used for buildings. Estimated useful lives of 30 to 36
months are used for computer equipment and related software and 5
years for furniture and fixtures. Estimated useful lives of up to
five years are used for production, engineering, and other equipment.
Depreciation of operating lease assets is computed based on the respective
lease terms, which range up to three years. Depreciation and amortization
of leasehold improvements are computed using the shorter of the remaining
lease terms or five years.
Goodwill and Purchased Intangible Assets In July 2001, the
Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 142 requires
goodwill to be tested for impairment on an annual basis and between
annual tests in certain circumstances, and written down when impaired,
rather than being amortized as previous accounting standards required.
Furthermore, SFAS 142 requires purchased intangible assets other than
goodwill to be amortized over their useful lives unless these lives
are determined to be indefinite.
SFAS 142 is effective for fiscal years beginning after December 15,
2001; however, the Company elected to early-adopt the accounting standard
effective the beginning of fiscal 2002. In accordance with SFAS 142,
the Company ceased amortizing goodwill totaling $3.2 billion as of
the beginning of fiscal 2002, including $55 million of acquired workforce
intangible previously classified as purchased intangible assets, net
of related deferred tax liabilities. Based on the impairment tests
performed, there was no impairment of goodwill in fiscal 2002. There
can be no assurance that future goodwill impairment tests will not
result in a charge to earnings.
Purchased intangible assets are carried at cost less accumulated amortization.
Amortization is computed over the estimated useful lives of the respective
assets, generally two to five years.
The following table presents the impact of SFAS 142 on net income
(loss) and net income (loss) per share had the accounting standard
been in effect for fiscal 2001 and 2000 (in millions, except per-share
amounts):
Income Taxes Income tax expense is based on pre-tax financial
accounting income. Deferred tax assets and liabilities are recognized
for the expected tax consequences of temporary differences between
the tax bases of assets and liabilities and their reported amounts.
Computation of Net Income (Loss) per Share Basic net income
(loss) per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted net income per
share is computed using the weighted-average number of common shares
and dilutive potential common shares outstanding during the period.
Diluted net loss per share is computed using the weighted-average
number of common shares and excludes dilutive potential common shares
outstanding, as their effect is antidilutive. Dilutive potential common
shares consist of employee stock options and restricted common stock.
Foreign Currency Translation Assets and liabilities of non-U.S.
subsidiaries that operate in a local currency environment are translated
to U.S. dollars at exchange rates in effect at the balance sheet date
with the resulting translation adjustments directly recorded as a
separate component of accumulated other comprehensive income (loss).
Income and expense accounts are translated at average exchange rates
during the year. Where the U.S. dollar is the functional currency,
translation adjustments are recorded in other income (loss).
Derivatives The Company recognizes derivatives as either assets
or liabilities on the Consolidated Balance Sheets and measures those
instruments at fair value. The accounting for changes in the fair
value of a derivative depends on the intended use of the derivative
and the resulting designation.
For a derivative designated as a fair value hedge, the gain or loss
is recognized in earnings in the period of change together with the
offsetting loss or gain on the hedged item attributed to the risk
being hedged. For a derivative designated as a cash flow hedge, the
effective portion of the derivative's gain or loss is initially reported
as a component of accumulated other comprehensive income (loss) and
subsequently reclassified into earnings when the hedged exposure affects
earnings. The ineffective portion of the gain or loss is reported
in earnings immediately.
The Company uses derivatives to manage exposures to foreign currency
and securities price risk. The Company's objective for holding derivatives
is to minimize the volatility of earnings and cash flows associated
with changes in foreign currency and security prices.
Certain forecasted transactions and foreign currency assets and liabilities
expose the Company to foreign currency risk. The Company purchases
currency options and designates these currency options as cash flow
hedges of foreign currency forecasted transactions related to certain
operating expenses. The Company enters into foreign exchange forward
contracts to minimize the short-term impact of currency fluctuations
on certain foreign currency receivables, investments, and payables.
The foreign exchange forward contracts are not designated as accounting
hedges and all changes in fair value are recognized in earnings in
the period of change.
The fair value of derivative instruments as of July 27, 2002 and changes
in fair value during fiscal 2002 were not material. During fiscal
2002, there were no significant gains or losses recognized in earnings
for hedge ineffectiveness. The Company did not discontinue any hedges
because it was probable that the original forecasted transaction would
not occur.
Minority Interest Minority interest represents the preferred
stockholders' proportionate share of the equity of Cisco Systems,
K.K. (Japan). At July 27, 2002, the Company owned all issued and outstanding
common stock amounting to 92.4% of the voting rights. Each share of
preferred stock is convertible into one share of common stock at any
time at the option of the holder.
Use of Estimates The preparation of financial statements and
related disclosures in conformity with accounting principles generally
accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the Consolidated
Financial Statements and accompanying notes. Estimates are used for,
but not limited to, the accounting for the allowance for doubtful
accounts and sales returns, inventory allowances, warranty costs,
investment impairments, goodwill impairments, contingencies, restructuring
costs and other special charges, and taxes. Actual results could differ
materially from these estimates.
Impairment of Long-Lived Assets Long-lived assets and certain
identifiable intangible assets to be held and used are reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amount of such assets may not be recoverable. Determination
of recoverability is based on an estimate of undiscounted future cash
flows resulting from the use of the asset and its eventual disposition.
Measurement of an impairment loss for long-lived assets and certain
identifiable intangible assets that management expects to hold and
use is based on the fair value of the asset. Long-lived assets and
certain identifiable intangible assets to be disposed of are reported
at the lower of carrying amount or fair value less costs to sell.
Recent Accounting Pronouncements In October 2001, the FASB
issued Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 establishes a single accounting model, based
on the framework established in Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS
121"), for long-lived assets to be disposed of by sale, and resolves
implementation issues related to SFAS 121. The Company is required
to adopt SFAS 144 no later than the first quarter of fiscal 2003.
The Company does not expect the adoption of SFAS 144 to have a material
impact on its operating results or financial position.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS 146"). SFAS 146 requires that a
liability for costs associated with an exit or disposal activity be
recognized and measured initially at fair value only when the liability
is incurred. SFAS 146 is effective for exit or disposal activities
that are initiated after December 31, 2002. The Company does not expect
the adoption of SFAS 146 to have a material impact on its operating
results or financial position.
Reclassifications Certain reclassifications have been made
to prior year balances in order to conform to the current year presentation.
3. Business Combinations
Purchase Combinations
During the year ended July 27, 2002, the Company completed a number
of purchase acquisitions which are summarized as follows (in millions):
The Company acquired Allegro Systems, Inc. to enhance its existing
virtual private network (VPN) and security solutions. The Company
acquired AuroraNetics, Inc. to enhance its development of high-end
routing technologies in the metropolitan network environment. The
Company acquired Hammerhead Networks, Inc. to augment its Internet
Protocol aggregation portfolio consisting of cable, broadband, and
leased-line products. The Company acquired Navarro Networks, Inc.
to complement its continued development of Ethernet switching solutions.
In connection with the acquisition of AuroraNetics, Inc., the Company
may be required to pay certain additional amounts of up to $100 million,
payable in common stock and to be accounted for under the purchase
method, contingent upon the company achieving certain agreed-upon
technology and other milestones.
A summary of the purchase transactions completed in fiscal 2001 and
2000 is outlined as follows (in millions):
The purchase price was also allocated to tangible assets and deferred
stock-based compensation. At July 27, 2002 and July 28, 2001, the
total unamortized deferred stock-based compensation balance was $182
million and $293 million, respectively, and was reflected as a debit
to additional paid-in capital in the Consolidated Statements of Shareholders'
Equity.
The amounts allocated to in-process research and development ("in-process
R&D") were determined through established valuation techniques
in the high-technology communications equipment industry and were
expensed upon acquisition because technological feasibility had not
been established and no future alternative uses existed. Total in-process
R&D expense in fiscal 2002, 2001, and 2000 was $65 million, $855
million, and $1.4 billion, respectively. The in-process R&D expense
that was attributable to common stock consideration for the same periods
was $53 million, $739 million, and $1.3 billion, respectively.
The following table presents details of the purchased intangible assets
acquired during fiscal 2002 (in millions, except number of years):
The Consolidated Financial Statements include the operating results
of each business from the date of acquisition. Pro forma results of
operations have not been presented because the effects of these acquisitions
were not material on either an individual or aggregate basis.
The following tables present details of the Company's total purchased
intangible assets (in millions):
The following table presents details of the amortization expense of
purchased intangible assets (excluding the impairment of purchased
intangible assets included in restructuring costs and other special
charges for fiscal 2001) as reported in the Consolidated Statements
of Operations (in millions):
The estimated future amortization expense of purchased intangible
assets as of July 27, 2002 was as follows (in millions):
The following table presents the changes in goodwill allocated to
the Company's reportable segments during fiscal 2002 (in millions):
In fiscal 2002, the Company purchased a portion of the minority interest
of Cisco Systems, K.K. (Japan). As a result, the Company increased
its ownership to 92.4% of the voting rights of Cisco Systems, K.K.
(Japan) and recorded goodwill of $108 million. The adjustments during
fiscal 2002 were due to the reclassification of acquired workforce
intangible and the related deferred tax liabilities to goodwill as
a result of the adoption of SFAS 142.
Pooling of Interests Combinations
There were no transactions accounted for as pooling of interests in
fiscal 2001. In fiscal 2000, the Company acquired StratumOne Communications,
Inc.; TransMedia Communications, Inc.; Cerent Corporation; WebLine
Communications Corporation; SightPath, Inc.; InfoGear Technology Corporation;
and ArrowPoint Communications, Inc. These transactions were accounted
for as pooling of interests and the historical financial information
for all periods presented prior to fiscal 2000 was restated. In addition,
the historical financial information for all periods presented prior
to fiscal 2000 was restated to reflect the acquisition of Fibex Systems,
which was completed in the fourth quarter of fiscal 1999 and accounted
for as a pooling of interests. As a result of these transactions,
354 million shares of common stock were exchanged and stock options
were assumed for a fair value of $15.2 billion.
In fiscal 2000, the Company also acquired Cocom A/S; V-Bits, Inc.;
Growth Networks, Inc.; Altiga Networks, Inc.; and Compatible Systems
Corporation. As a result of these transactions, 20 million shares
of common stock were exchanged and stock options were assumed for
a fair value of $1.1 billion. These transactions were accounted for
as pooling of interests. The historical operations of these entities
were not material to the Company's consolidated operations on either
an individual or aggregate basis; therefore, prior period financial
statements were not restated for these acquisitions.
4. Restructuring Costs and Other Special
Charges and Provision for Inventory
On April 16, 2001, due to macroeconomic and capital spending issues
affecting the networking industry, the Company announced a restructuring
program to prioritize its initiatives around a focus on profit contribution,
high-growth areas of its business, reduction of expenses, and improved
efficiency. This restructuring program included a worldwide workforce
reduction, consolidation of excess facilities, and restructuring of
certain business functions.
As a result of the restructuring program and decline in forecasted
revenue in the third quarter of fiscal 2001, the Company recorded
restructuring costs and other special charges of $1.2 billion and
an additional excess inventory charge of $2.2 billion. The following
discussion provides detailed information relating to the status of
the restructuring liabilities and additional excess inventory reserve
as of July 27, 2002.
Worldwide Workforce Reduction, Consolidation
of Excess Facilities, and Other Special Charges
The following table summarizes the activity related to the restructuring
liabilities (in millions):
Note 1: Due to changes in previous estimates, the Company reclassified
$35 million of restructuring liabilities related to the workforce
reduction charges to consolidation of excess facilities and other
charges. The initial estimated workforce reduction was approximately
6,000 regular employees. Approximately 5,400 regular employees have
been terminated and the liability has been paid. In addition, during
the third quarter of fiscal 2002, the Company increased the restructuring
liabilities related to the consolidation of excess facilities and
other charges by $93 million due to changes in real estate market
conditions. The increase in the restructuring liabilities related
to the consolidation of excess facilities and other charges was recorded
as research and development ($39 million), sales and marketing ($42
million), general and administrative ($8 million) expenses and cost
of sales ($4 million) in the Consolidated Statements of Operations.
Note 2: Amounts related to the net lease expense due to the consolidation
of excess facilities will be paid over the respective lease terms
through fiscal 2010.
Provision for Inventory
The following is a summary of the change in the additional excess
inventory reserve (in millions):
5. Balance Sheet and Cash Flow Details
The following tables provide details of selected balance sheet items
(in millions):
The following table presents supplemental cash flow information of
significant noncash investing and financing activities (in millions):
6. Lease Receivables, Net
Lease receivables represent sales-type and direct-financing leases
resulting from the sale of the Company's and complementary third-party
products and services. These lease arrangements typically have terms
from two to three years and are usually collateralized by a security
interest in the underlying assets. The net lease receivables are summarized
as follows (in millions):
Contractual maturities of the gross lease receivables at July 27,
2002 were $613 million in fiscal 2003, $348 million in fiscal 2004,
$234 million in fiscal 2005, and $19 million in fiscal 2006. Actual
cash collections may differ from the contractual maturities due to
early customer buyouts or refinancings.
7. Investments
The following tables summarize the Company's investments (in millions):
The following table summarizes the maturities of the U.S. government
and corporate notes and bonds at July 27, 2002 (in millions):
8. Commitments and Contingencies
Leases
The Company leases office space in U.S. locations, as well as locations
in the Americas; Europe, the Middle East, and Africa ("EMEA");
Asia Pacific; and Japan. Rent expense totaled $265 million, $381 million,
and $229 million in fiscal 2002, 2001, and 2000, respectively. Future
annual minimum lease payments under all noncancelable operating leases
with an initial term in excess of one year as of July 27, 2002 were
as follows (in millions):
The Company had entered into several agreements to lease sites in
San Jose, California, where its headquarters is located, and certain
other facilities, both completed and under construction, in the surrounding
areas of San Jose, California; Boxborough, Massachusetts; Salem, New
Hampshire; Richardson, Texas; and Research Triangle Park, North Carolina.
Under these agreements, the Company could, at its option, purchase
the land or both land and buildings. The Company could purchase the
buildings at approximately the amount expended by the lessors to construct
the buildings. As part of the lease agreements, the Company had restricted
certain of its investment securities as collateral for specified obligations
of the lessors.
In fiscal 2002, the Company elected to purchase all of the land and
buildings, as well as sites under construction, under these lease
agreements. The total purchase price was approximately $1.9 billion
and was primarily funded by the liquidation of restricted investments
and lease deposits. As a result, the Company no longer has any sites
under such lease agreements.
Derivative Instruments
The Company conducts business on a global basis in several currencies.
As such, it is exposed to adverse movements in foreign currency exchange
rates. The Company enters into foreign exchange forward contracts
to minimize the short-term impact of foreign currency fluctuations
on certain foreign currency receivables, investments, and payables.
The gains and losses on the foreign exchange forward contracts offset
the transaction gains and losses on certain foreign currency receivables,
investments, and payables recognized in earnings.
The Company does not enter into foreign exchange forward contracts
for trading purposes. Gains and losses on the contracts are included
in other income (loss), net, in the Company's Consolidated Statements
of Operations and offset foreign exchange gains or losses from the
revaluation of intercompany balances or other current assets, investments,
and liabilities denominated in currencies other than the functional
currency of the reporting entity. The Company's foreign exchange forward
contracts related to current assets and liabilities generally range
from one to three months in original maturity. Additionally, the Company
has entered into foreign exchange forward contracts related to long-term
customer financings with maturities of up to two years. The foreign
exchange contracts related to investments generally have maturities
of less than one year.
The Company periodically hedges foreign currency forecasted transactions
related to certain operating expenses with currency options. These
transactions are designated as cash flow hedges. These currency option
contracts generally have maturities of less than one year. The Company
does not purchase currency options for trading purposes. Foreign exchange
forward and option contracts as of July 27, 2002 are summarized as
follows (in millions):
The Company's foreign exchange forward and option contracts expose
the Company to credit risk to the extent that the counterparties may
be unable to meet the terms of the agreement. The Company minimizes
such risk by limiting its counterparties to major financial institutions.
In addition, the potential risk of loss with any one party resulting
from this type of credit risk is monitored. Management does not expect
any material losses as a result of default by counterparties.
Legal Proceedings
The Company is subject to legal proceedings, claims, and litigation
arising in the ordinary course of business. While the outcome of these
matters is currently not determinable, management does not expect
that the ultimate costs to resolve these matters will have a material
adverse effect on the Company's consolidated financial position, results
of operations, or cash flows.
Beginning on April 20, 2001, a number of purported shareholder class
action lawsuits were filed in the United States District Court for
the Northern District of California against Cisco and certain of its
officers and directors. The lawsuits have been consolidated, and the
consolidated action is purportedly brought on behalf of those who
purchased the Company's publicly traded securities between August
10, 1999 and February 6, 2001. Plaintiffs allege that defendants have
made false and misleading statements, purport to assert claims for
violations of the federal securities laws, and seek unspecified compensatory
damages and other relief. Cisco believes the claims are without merit
and intends to defend the actions vigorously.
In addition, beginning on April 23, 2001, a number of purported shareholder
derivative lawsuits were filed in the Superior Court of California,
County of Santa Clara and in the Superior Court of California, County
of San Mateo. There is a procedure in place for the coordination of
such actions. Two purported derivative suits have also been filed
in the United States District Court for the Northern District of California,
and those federal court actions have been consolidated. The complaints
in the various derivative actions include claims for breach of fiduciary
duty, waste of corporate assets, mismanagement, unjust enrichment,
and violations of the California Corporations Code; seek compensatory
and other damages, disgorgement, and other relief; and are based on
essentially the same allegations as the class actions.
Certain Investments in Privately Held Companies
Cisco has entered into investment agreements with two privately held
companies, AYR Networks, Inc. ("AYR") and Andiamo Systems,
Inc. ("Andiamo").
On July 25, 2002, Cisco announced a definitive agreement to acquire
the remaining interests of AYR for a purchase price of approximately
$113 million payable in common stock. This acquisition will be accounted
for under the purchase method and is expected to close in the first
quarter of fiscal 2003.
In the case of Andiamo, as of July 27, 2002, Cisco had an option to
acquire the remaining interests not owned by Cisco for consideration
consisting of shares of its common stock. In addition, Andiamo had
a put option enabling them to require Cisco to acquire the remaining
interests not owned by Cisco, subject to the fulfillment of various
conditions, including the achievement of specified technology and
other milestones. As of July 27, 2002, Cisco funded $63 million of
its $84 million investment commitment to Andiamo. Upon full funding
of the commitment and based on certain terms and conditions, Cisco
will hold a promissory note that is convertible into approximately
44% of the equity of Andiamo. Cisco is also committed to provide additional
funding to Andiamo through the closing of the acquisition of approximately
$100 million. Since making its initial investment in the third quarter
of fiscal 2001, Cisco has expensed the entire amount funded as research
and development costs, as if such expenses constituted the development
costs of the Company.
On August 19, 2002, the Company entered into a definitive agreement
to acquire Andiamo, which represents the Company's exercise of its
rights (see Note 14 to the Consolidated Financial Statements).
Purchase Commitments with Contract Manufacturers
and Suppliers
The Company uses several contract manufacturers and suppliers to provide
manufacturing services for its products. During the normal course
of business, in order to reduce manufacturing lead times and ensure
adequate component supply, the Company enters into agreements with
certain contract manufacturers and suppliers that allow them to procure
inventory based upon criteria as defined by the Company. As of July
27, 2002, the Company has purchase commitments for inventory of approximately
$800 million.
Other Commitments
In fiscal 2001, the Company entered into an agreement to invest approximately
$1.0 billion in venture funds managed by SOFTBANK Corp. and its affiliates
("SOFTBANK"). These venture funds are required to be funded
upon demand by SOFTBANK. As of July 27, 2002, the Company has funded
$100 million of this investment commitment.
The Company provides structured financing to certain qualified customers
to be used for the purchase of equipment and other needs through its
wholly-owned subsidiary, Cisco Systems Capital Corporation. At July
27, 2002, the outstanding loan commitments were approximately $948
million, subject to the customer achieving certain financial covenants,
of which approximately $209 million was eligible for draw down. These
loan commitments may be funded over a two- to three-year period provided
that these customers achieve specific business milestones and financial
covenants.
The Company has entered into several agreements to purchase or construct
real estate, subject to the satisfaction of certain conditions. As
of July 27, 2002, the total amount of commitments, if certain conditions
are met, was approximately $491 million.
At July 27, 2002, the Company has a commitment of approximately $190
million to purchase the remaining portion of the minority interest
of Cisco Systems, K.K. (Japan).
The Company also has certain other funding commitments of approximately
$152 million at July 27, 2002 related to its privately held investments.
9. Shareholders' Equity
Stock Repurchase Program
In September 2001, the Board of Directors authorized a stock repurchase
program to acquire outstanding common stock in the open market or
negotiated transactions. Under the program, up to $3 billion of Cisco
common stock could be reacquired over two years. In August 2002, the
Board of Directors increased Cisco's stock repurchase program by $5
billion to a total of $8 billion of Cisco common stock available for
repurchase through September 12, 2003.
During fiscal 2002, the Company repurchased and retired approximately
124 million shares of Cisco common stock for an aggregate purchase
price of approximately $1.9 billion. Including the amount approved
by the Board of Directors in August 2002 as discussed above, the remaining
authorized amount for stock repurchase is $6.1 billion.
Shareholders' Rights Plan
In June 1998, the Board of Directors approved a Shareholders' Rights
Plan ("Rights Plan"). The Rights Plan is intended to protect
shareholders' rights in the event of an unsolicited takeover attempt.
It is not intended to prevent a takeover of the Company on terms that
are favorable and fair to all shareholders and will not interfere
with a merger approved by the Board of Directors. Each right entitles
shareholders to buy a unit equal to a portion of a new share of Series
A Preferred Stock of the Company. The rights will be exercisable only
if a person or a group acquires or announces a tender or exchange
offer to acquire 15% or more of the Company's common stock.
In the event the rights become exercisable, the Rights Plan allows
for Cisco shareholders to acquire, at an exercise price of $108 per
right owned, stock of the surviving corporation having a market value
of $217, whether or not Cisco is the surviving corporation. The rights,
which expire in June 2008, are redeemable for $0.00017 per right at
the approval of the Board of Directors.
Preferred Stock
Under the terms of the Company's Articles of Incorporation, the Board
of Directors may determine the rights, preferences, and terms of the
Company's authorized but unissued shares of preferred stock.
Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, are as
follows (in millions):
The change in net unrealized gains and losses on investments during
fiscal 2002 was primarily related to the recognition of a charge of
$858 million, pre-tax, in the first quarter attributable to the impairment
of certain publicly traded equity securities, partially offset by
a net decrease of approximately $500 million in the fair value of
investments. The impairment charge was related to the decline in the
fair value of the Company's publicly traded equity investments below
the cost basis that was judged to be other-than-temporary.
10. Employee Benefit Plans
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan (the "Purchase
Plan") under which 222 million shares of common stock have been
reserved for issuance. Eligible employees may purchase a limited number
of shares of the Company's common stock at a discount of up to 15%
of the market value at certain plan-defined dates. The Purchase Plan
terminates on January 3, 2005. In fiscal 2002, 2001, and 2000, 22
million, 13 million, and 7 million shares, respectively, were issued
under the Purchase Plan. At July 27, 2002, 88 million shares were
available for issuance under the Purchase Plan.
Employee Stock Option Plans
The Company has two main stock option plans: the 1987 Stock Option
Plan (the "Predecessor Plan") and the 1996 Stock Incentive
Plan (the "1996 Plan").
The Predecessor Plan was terminated in 1996. All outstanding options
under the Predecessor Plan were transferred to the 1996 Plan. However,
all outstanding options under the Predecessor Plan continue to be
governed by the terms and conditions of the existing option agreements
for those grants.
The maximum number of shares issuable over the term of the 1996 Plan
is limited to 2.5 billion shares. Such share reserve consists of the
620 million shares originally transferred from the Predecessor Plan
plus the number of shares added to the reserve pursuant to the automatic
share increases effected annually beginning in December 1996 and expired
in December 2001. The share reserve will automatically increase on
the first trading day of each December by an amount equal to 4.75%
of the outstanding shares on the last trading day of the immediately
preceding November.
Although the Board of Directors has the authority to set other terms,
the options will 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. Options granted under the 1996
Plan have an exercise price equal to the fair market value of the
underlying stock on the grant date and expire no later than nine years
from the grant date.
In 1997, the Company adopted a Supplemental Stock Incentive Plan (the
"Supplemental Plan") under which options can be granted
or shares can be directly issued to eligible employees. Officers and
members of the Company's Board of Directors are not eligible to participate
in the Supplemental Plan. Nine million shares have been reserved for
issuance under the Supplemental Plan, of which three million shares
are subject to outstanding options, and one million shares have been
issued in fiscal 2002. All option grants have an exercise price equal
to the fair market value of the option shares on the grant date.
The Company has, in connection with the acquisitions of various companies,
assumed the stock option plans of each acquired company. During fiscal
2002, a total of approximately two million shares of the Company's
common stock has been reserved for issuance under the assumed plans
and the related options are included in the following table.
A summary of option activity follows (in millions, except per-share
amounts):
The following table summarizes information concerning outstanding
and exercisable options at July 27, 2002 (in millions, except number
of years and per-share amounts):
At July 28, 2001 and July 29, 2000, 505 million and 418 million outstanding
options, respectively, were exercisable. The weighted-average exercise
prices for exercisable options were $17.62 and $9.22 at July 28, 2001
and July 29, 2000, respectively.
The Company follows APB Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"), in accounting for
its employee stock options. Under APB 25, because the exercise price
of the Company's employee stock options equals the market price of
the underlying stock on the date of grant, no compensation expense
is recognized in the Company's Consolidated Statements of Operations.
The Company is required under Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), to disclose pro forma information regarding option grants
made to its employees based on specified valuation techniques that
produce estimated compensation charges.
Pro forma information under SFAS 123 is as follows (in millions, except
per-share amounts):
The value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions:
The Black-Scholes option pricing model was developed for use in estimating
the value of traded options that have no vesting restrictions and
are fully transferable. In addition, option pricing models require
the input of highly subjective assumptions including the expected
stock price volatility. The Company uses projected data for expected
volatility and expected life of its stock options based upon historical
and other economic data trended into future years. Because the Company's
employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective
input assumptions can materially affect the estimate, in management's
opinion, the existing models do not provide a reliable single measure
of the fair value of the Company's options. Under the Black-Scholes
option pricing model, the weighted-average estimated values of employee
stock options granted during fiscal 2002, 2001, and 2000 were $8.60,
$13.31, and $19.44 per share, respectively.
Basic and diluted shares outstanding for the year ended July 27, 2002
were 7.3 billion and 7.4 billion shares, respectively. Diluted shares
outstanding include the dilutive impact of in-the-money options which
is calculated based on the average share price for each fiscal year
using the treasury stock method. Under the treasury stock method,
the tax-effected proceeds that would be hypothetically received from
the exercise of all in-the-money options are assumed to be used to
repurchase shares. In fiscal 2002, the dilutive impact of in-the-money
employee stock options was approximately 130 million shares or approximately
2% of the average shares outstanding based on Cisco's average share
price of $16.68. The Cisco share price at the end of fiscal 2002 was
$11.82; the dilutive impact of in-the-money stock options would be
80 million shares or approximately 1% of the average shares outstanding
in fiscal 2002.
Employee 401(k) Plans
The Company sponsors the Cisco Systems, Inc. 401(k) Plan (the "Plan")
to provide retirement benefits for its employees. As allowed under
Section 401(k) of the Internal Revenue Code, the Plan provides tax-deferred
salary deductions for eligible employees. The Company also has other
401(k) plans that it sponsors. These plans arose from acquisitions
of other companies and are not material to the Company on either an
individual or aggregate basis.
Through December 31, 2001, employees could contribute from 1% to 15%
of their annual compensation to the Plan. Effective January 1, 2002,
the employee contribution limit was increased to 25% of their annual
compensation. Employee contributions are limited to a maximum annual
amount as set periodically by the Internal Revenue Service. The Company
matches employee contributions dollar for dollar up to a maximum of
$1,500 per year per person. All matching contributions vest immediately.
The Company's matching contributions to the Plan totaled $35 million,
$45 million, and $34 million in fiscal 2002, 2001, and 2000, respectively.
Effective January 1, 2003, the new matching structure will be 50%
of the first 6% of eligible earnings that are contributed by employees.
Therefore, the maximum matching contribution that the Company may
allocate to each participant's account will not exceed $6,000 for
the 2003 calendar year due to the $200,000 annual limit on eligible
earnings imposed by the Internal Revenue Service.
In addition, the Plan provides for discretionary profit sharing contributions
as determined by the Board of Directors. Such contributions to the
Plan are allocated among eligible participants in the proportion of
their salaries to the total salaries of all participants. There were
no discretionary profit sharing contributions made in fiscal 2002,
2001, or 2000. In fiscal 2002, the Plan provided for a one-time discretionary
matching contribution of $11 million based on $500 per eligible employee.
11. Income Taxes
The provision for income taxes consisted of the following (in millions):
The Company paid income taxes of $909 million, $48 million, and $327
million in fiscal 2002, 2001, and 2000, respectively.
Income (loss) before provision for income taxes consisted of
the following (in millions):
The items accounting for the difference between income taxes computed
at the federal statutory rate and the provision for income taxes consisted
of the following:
U.S. income taxes and foreign withholding taxes were not provided
for on a cumulative total of $1.2 billion of undistributed earnings
for certain non-U.S. subsidiaries. The Company intends to reinvest
these earnings indefinitely in operations outside the United States.
The components of the deferred tax assets (liabilities) are as follows
(in millions):
The following table presents the breakdown between current and non-current
deferred tax assets (in millions):
The non-current portion of the deferred tax assets is included in
other assets.
At July 29, 2000, the Company provided a valuation allowance on certain
of its deferred tax assets because of uncertainty regarding their
realizability due to expectation of future employee stock option exercises.
As of July 28, 2001, the Company had removed the valuation allowance
because it believed it was more likely than not that all deferred
tax assets would be realized in the foreseeable future and was reflected
as a credit to shareholders' equity.
As of July 27, 2002, the Company's federal and state net operating
loss carryforwards for income tax purposes were $83 million and $14
million, respectively. If not utilized, the federal net operating
loss carryforwards will begin to expire in fiscal 2010 and the state
net operating loss carryforwards will begin to expire in fiscal 2003.
As of July 27, 2002, the Company's federal and state tax credit carryforwards
for income tax purposes were $255 million and $164 million, respectively.
If not utilized, the federal tax credit carryforwards will begin to
expire in fiscal 2005 and state tax credit carryforwards will begin
to expire in fiscal 2003.
The Company's income taxes payable for federal, state, and foreign
purposes have been reduced, and the deferred tax assets increased,
by the tax benefits associated with dispositions of employee stock
options. The Company receives an income tax benefit calculated as
the difference between the fair market value of the stock issued at
the time of exercise and the option price, tax effected. These benefits
were credited directly to shareholders' equity and amounted to $61
million, $1.8 billion, and $3.1 billion in fiscal 2002, 2001, and
2000, respectively. Benefits reducing taxes payable amounted to $61
million, $1.4 billion, and $2.5 billion in fiscal 2002, 2001, and
2000, respectively. Benefits increasing gross deferred tax assets
amounted to $358 million and $582 million in fiscal 2001 and 2000,
respectively.
The Company's federal income tax returns for fiscal years ended July
31, 1999 and July 25, 1998 are under examination and the Internal
Revenue Service has proposed certain adjustments. Management believes
that adequate amounts have been reserved for any adjustments that
may ultimately result from these examinations.
12. Segment Information and Major Customers
The Company's operations involve the design, development, manufacturing,
marketing, and technical support of networking and communications
products and services. Cisco products include routers, switches, access,
and other networking equipment. These products, integrated by the
Cisco IOS® Software, link geographically dispersed LANs and WANs
into networks.
The Company conducts business globally and is managed geographically.
The Company's management relies on an internal management system that
provides sales and standard cost information by geographic theater.
Sales are attributed to a theater based on the ordering location of
the customer. The Company's management makes financial decisions and
allocates resources based on the information it receives from this
internal management system. 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,
as management does not use the information to measure the performance
of the operating segments. Management does not believe that allocating
these expenses is significant in evaluating a geographic theater's
performance. Based on established criteria, the Company has four reportable
segments: the Americas; EMEA; Asia Pacific; and Japan.
Summarized financial information by theater for fiscal 2002, 2001,
and 2000, as taken from the internal management system previously
discussed, is as follows (in millions):
The Americas theater included non-U.S. net sales of $886 million,
$1.0 billion, and $848 million for fiscal 2002, 2001, and 2000, respectively.
Property and equipment information is based on the physical location
of the assets. The following table presents property and equipment
information by geographic area (in millions):
The following table presents net sales for groups of similar products
and services (in millions):
The majority of the Company's assets at July 27, 2002 and July 28,
2001 were attributable to its U.S. operations. In fiscal 2002, 2001,
and 2000, no single customer accounted for 10% or more of the Company's
net sales.
13. Net Income (Loss) per Share
The following table presents the calculation of basic and diluted
net income (loss) per share (in millions, except per-share amounts):
Dilutive potential common shares consist of employee stock options
and restricted common stock. The weighted-average dilutive potential
common shares, which were antidilutive for fiscal 2001, amounted to
348 million shares. Employee stock options to purchase approximately
712 million shares in fiscal 2002 and 426 million shares in fiscal
2001 were outstanding, but were not included in the computation of
diluted earnings per share because the exercise price of the stock
options was greater than the average share price of the common shares
and, therefore, the effect would have been antidilutive. The antidilutive
employee stock options were not material in fiscal 2000.
14. Subsequent Event
On August 19, 2002, Cisco entered into a definitive agreement to acquire
privately held Andiamo Systems, Inc. ("Andiamo"). As disclosed
in Note 8, Cisco entered into agreements with Andiamo under which
Cisco was granted the right to acquire Andiamo. This definitive agreement
represented Cisco's exercise of this right. The acquisition of Andiamo
is expected to close in the third quarter of fiscal year 2004 (February
to April 2004), but no later than July 31, 2004.
Under the terms of the agreement, common stock of Cisco will be exchanged
for all outstanding shares and options of Andiamo not owned by Cisco
at the closing of the acquisition. The amount of the purchase price
for the remaining equity interests in Andiamo not then held by Cisco
is not determinable at this time, but will be based primarily upon
a valuation of Andiamo to be determined by applying a multiple to
the actual, annualized revenue generated from sales by Cisco of products
attributable to Andiamo during a three-month period shortly preceding
the closing. Under its agreements with Andiamo, Cisco is the exclusive
manufacturer and distributor of all Andiamo products. The multiple
will be equal to Cisco's average market capitalization during a specified
period divided by Cisco's annualized revenue for a three-month period
prior to closing, subject to adjustment as follows: (i) if the multiple
so calculated is less than 10, then the multiple to be used for purposes
of determining the transaction price shall be the midpoint between
10 and the multiple so calculated; (ii) if the multiple so calculated
is greater than 15, then the multiple to be used for purposes of determining
the transaction price shall be the midpoint between 15 and the multiple
so calculated. There is no minimum purchase price, and the maximum
purchase price is limited to approximately $2.5 billion in shares
of Cisco common stock valued at the time of closing.
The acquisition has received the required approvals from both companies
and is subject to various closing conditions and approvals, including
stockholder approval by Andiamo. In connection with this acquisition,
Cisco filed a Current Report on Form 8-K.
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