EXHIBIT 13.01
SELECTED FINANCIAL DATA
Five Years Ended July 25, 1998 (in thousands, except per-share amounts)
(*) Reflects the three-for-two stock split effective September 1998.
(1) Net income and net income per share include purchased research and
development expenses of $594 million and realized gains on the sale of a
minority stock investment of $5 million. Pro forma net income and
diluted net income per share, excluding these nonrecurring items net of
tax, would have been $1,878,988 and $1.17, respectively.
(2) Net income and net income per share include purchased research and
development expenses of $508 million and realized gains on the sale of a
minority stock investment of $153 million. Pro forma net income and
diluted net income per share, excluding these nonrecurring items net of
tax, would have been $1,413,893 and $0.91, respectively.
(3) Net income and net income per share include purchased research and
development expenses of $96 million. Pro forma net income and diluted
net income per share, excluding these nonrecurring items net of tax,
would have been $515,723 and $0.36, respectively.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report including, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," and words of similar import, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Readers are referred to the "Financial Risk Management" and "Potential
Volatility in Operating Results" sections contained herein, as well as the
"Future Growth Subject to Risks" and "Other Risk Factors" sections, among
others, included in the Form 10-K for the fiscal year ended July 25, 1998, which
identify important risk factors that could cause actual results to differ from
those contained in the forward-looking statements.
COMPARISON OF 1998 AND 1997
Net sales grew to $8.5 billion in 1998 from $6.4 billion in 1997. The 31.3%
increase in net sales during the year was primarily a result of increasing unit
sales of high-end switches such as the Catalyst(R) 5500, access servers such as
the Cisco 3600 family, Internet and intranet access products for small offices
such as the Cisco 1600 series router, and increased service contract sales. The
sales growth rate for lower-priced access and switching products targeted toward
small and medium-sized businesses has increased faster than that of the
Company's high-end core router products. However, these products typically carry
lower average selling prices, and thus have slowed the Company's growth rate
compared with last year. Additionally, some of the Company's more established
product lines, such as the Cisco 2500 product family and the Catalyst 1400,
experienced decelerating growth rates. Sales to international customers
decreased to 40.9% of net sales in 1998 from 43.5% in 1997. The decrease
reflects slower sales growth in certain Asian countries, particularly Japan and
Korea. The Company anticipates that sales in Asia will remain weak for the near
future, with the exception of the Greater China markets. Sales growth in these
markets has been impacted by certain factors including weaker economic
conditions, delayed government spending, a stronger dollar versus the local
currencies, and slower adoption of networking technologies.
Gross margins increased slightly to 65.5% during 1998 from 65.2% in 1997.
This increase is due principally to the Company's improvements in
value-engineering efforts and material cost reductions, partially offset by a
continued shift in product mix to the Company's lower-margin products. The
prices of component parts have fluctuated in the recent past, and the Company
expects that this trend may continue. An increase in the price of component
parts may have a material adverse impact on gross margins. The Company continues
to expect that gross margins will decrease in the future, because it believes
that the market for lower-margin remote access and switching products for small
to medium-sized businesses will continue to increase at a faster rate than the
market for the Company's higher-margin router and high-performance switching
products. Additionally, as the Company focuses on new market opportunities, it
faces increasing competitive pressure from large telecommunications equipment
suppliers and well-funded startup companies, which may materially adversely
affect gross margins. The Company is attempting to mitigate this trend through
various means, such as increasing the functionality of its products, continued
value engineering, controlling royalty costs, and improving manufacturing
efficiencies. There can be no assurance that any efforts made by the Company in
these and other areas will successfully offset decreasing margins.
Research and development expenses increased by $322 million in 1998 compared
with 1997 expenditures, an increase to 12.1% of net sales from 10.8% in 1997.
The increase reflects the Company's ongoing research and development efforts in
a wide variety of areas such as voice, video, and data integration, Digital
Subscriber Line (DSL) technologies, dial access, enterprise switch routers,
security, network management, and high-end routing technologies, among others. A
significant portion
20
of the increase was due to the addition of new personnel, partly through
acquisitions, as well as higher expenditures on prototypes and depreciation on
additional lab equipment. For the near future, research and development expenses
are expected to increase at a greater rate than the sales growth rate as the
Company invests in technology to address potential market opportunities. The
Company also continues to purchase technology in order to bring a broad range of
products to the market in a timely fashion. If the Company believes that it is
unable to enter a particular market in a timely manner, it may license
technology from other businesses or acquire other businesses as an alternative
to internal research and development. All of the Company's research and
development costs are expensed as incurred.
Sales and marketing expenses increased by $404 million in fiscal 1998 over
fiscal 1997, an increase to 18.5% of net sales in 1998 from 18.0% in fiscal
1997. The increase is due principally to an increase in the size of the
Company's direct sales force and related commissions, additional marketing and
advertising costs associated with the introduction of new products, and the
expansion of distribution channels. The increase also reflects the Company's
efforts to invest in certain key areas such as expansion of its end-to-end
strategy and service provider coverage in order to position itself to take
advantage of future market opportunities.
General and administrative expenses rose by $54 million in fiscal 1998 over
fiscal 1997, a decrease to 3.1% from 3.2% of net sales. The dollar increase
reflects increased personnel costs necessary to support the Company's business
infrastructure, including those associated with its European Logistics Center,
the further development of its information systems, as well as increased levels
of amortization for acquisition-related intangible assets. It is management's
intent to keep general and administrative costs relatively constant as a
percentage of net sales; however, this goal depends upon the level of
acquisition activity and amortization of the resulting intangible assets, among
other factors.
The amount expensed to purchased research and development in fiscal 1998
arose from the purchase acquisitions of DAGAZ Technologies, LightSpeed
International, Inc., WheelGroup Corporation, NetSpeed Inc., and CLASS Data
Systems (see Note 3).
Interest and other income, net, was $193 million in 1998 and $109 million in
1997. Interest income rose as a result of additional investment income on the
Company's increasing investment balances. In fiscal 1997, the Company began
selling its holdings in a publicly traded company at amounts significantly above
the cost basis of the investment. Also in 1997, the Company established the
Cisco Systems Foundation ("the Foundation"). As part of this initiative, the
Company donated a portion of this investment, along with other equity
securities, to the Foundation, with a combined cost basis of approximately $2
million and an approximate market value of $72 million at July 26, 1997. The
realized gains on the sale of this investment, net of the amounts donated to the
Foundation, were $153 million in fiscal 1997 (see Note 5).
COMPARISON OF 1997 AND 1996
Net sales grew to $6.4 billion in 1997 from $4.1 billion in 1996. The 57.2%
increase in net sales during the year was primarily the result of increasing
unit sales of LAN switching products such as the Catalyst 5000, high-end routers
such as the Cisco 7500 product family, modular access routers such as the Cisco
4700, and growth in the sales of add-on boards that provide increased
functionality. These increases were partially offset by decreasing unit sales of
the Company's older product lines, consisting of the Cisco 7000 and Cisco 4000.
The sales growth rate for lower-priced access and switching products targeted
toward small and medium-sized businesses increased faster than that of the
Company's high-end core router products. These products typically carry lower
average selling prices, thereby contributing to the slowdown in the Company's
overall growth rate in 1997 versus 1996. Additionally, some of the Company's
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
more established product lines, such as the Cisco 2500 series, experienced
decelerating growth rates. Sales to international customers decreased to 43.5%
of net sales in 1997 from 48.2% for 1996. The decrease was attributed to slower
sales growth in certain international markets, particularly Japan, France, and
Germany. Sales growth in these markets was impacted by certain factors including
weaker economic conditions, delayed government spending, a stronger dollar
versus the local currencies, and slower adoption of networking technologies.
Gross margins decreased slightly to 65.2% during 1997 from 65.6% in 1996.
This decrease was due to several factors, including the continued shift in
revenue mix to the Company's lower-margin products consisting primarily of
access and workgroup products for small to medium-sized businesses. These
products traditionally have fewer features and less software functionality than
the Company's service provider and enterprise offerings.
Research and development expenses increased by $299 million in 1997 compared
with 1996 expenditures, an increase to 10.8% of net sales from 9.7% in 1996. The
increase reflected the Company's ongoing research and development efforts in a
wide variety of areas such as voice, video, and data integration, Digital
Subscriber Line (DSL) technologies, dial access, enterprise switching, security,
network management, and high-end routing technologies, among others. A
significant portion of the increase was due to the addition of new personnel, as
well as higher expenditures on prototypes and depreciation on new equipment.
Sales and marketing expenses increased by $434 million in fiscal 1997 over
fiscal 1996, an increase to 18.0% of net sales in 1997 from 17.7% in fiscal
1996. The increase in these expenses resulted from an increase in the size of
the Company's direct sales force and related commissions, additional marketing
programs to support the launch of new products, the entry into new markets, and
expanding distribution channels.
General and administrative expenses rose by $45 million in fiscal 1997 over
fiscal 1996, a decrease to 3.2% from 3.9% of net sales. The dollar increase
reflected increased personnel costs necessary to support the Company's business
infrastructure, including those associated with its new European Logistics
Center, as well as the further development of its information systems. The
percentage decrease reflects management's continued efforts to control
discretionary spending.
The amount expensed to purchased research and development in fiscal 1997
arose from the purchase acquisitions of Telebit Corporation, Netsys
Technologies, Skystone Systems Corporation, Ardent Communications, and Global
Internet Software Group (see Note 3).
Interest and other income, net, was $109 million in 1997 and $64 million in
1996. Interest income rose as a result of additional investment income on the
Company's increasing investment balances.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
130, "Reporting Comprehensive Income," which establishes standards for reporting
and display of comprehensive income and its components (revenue, expenses,
gains, and losses) in a full set of general-purpose financial statements. The
Company will adopt SFAS No. 130 as required for its first quarterly filing of
fiscal year 1999.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information," which changes the way public companies
report information about operating segments. SFAS No. 131, which is based on the
management approach to segment reporting, establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers, and the material countries in
which the entity holds assets and reports revenue. Management is in the process
of evaluating the effects of this change on its reporting of segment
information.
22
The Company will adopt SFAS No. 131 as required for its annual report on fiscal
year 1999.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
Management has not yet evaluated the effects of this change on its operations.
The Company will adopt SFAS No. 133 as required for its first quarterly filing
of fiscal year 2000.
Financial Risk Management
The following discussion about the Company's risk management activities includes
"forward-looking statements" that involve risks and uncertainties. Actual
results could differ materially from those projected in the forward-looking
statements.
As a global concern, the Company faces exposure to adverse movements in
foreign currency exchange rates. These exposures may change over time as
business practices evolve and could have a material adverse impact on the
Company's financial results. Historically, the Company's primary exposures have
related to nondollar-denominated sales in Japan, Canada, and Australia and
nondollar-denominated operating expenses in Europe, Latin America, and Asia
where the Company sells primarily in U.S. dollars. The introduction of the Euro
as a common currency for members of the European Monetary Union is scheduled to
take place in the Company's fiscal year 1999. The Company has not determined
what impact, if any, the Euro will have on foreign exchange exposure. The
Company is prepared to hedge against fluctuations in the Euro if this exposure
becomes material. At the present time, the Company hedges only those currency
exposures associated with certain assets and liabilities denominated in
nonfunctional currencies and does not generally hedge anticipated foreign
currency cash flows. The hedging activity undertaken by the Company is intended
to offset the impact of currency fluctuations on certain nonfunctional currency
assets and liabilities. The success of this activity depends upon estimation of
intercompany balances denominated in various currencies, primarily the Japanese
yen, Canadian dollar, Australian dollar, and certain European currencies. To the
extent that these forecasts are over- or understated during periods of currency
volatility, the Company could experience unanticipated currency gains or losses.
The Company is experiencing a greater proportion of its sales activity
through its partners in two-tier distribution channels. These customers are
generally given privileges to return inventory, receive credits for changes in
the Company's selling prices, and participate in cooperative marketing programs.
The Company maintains appropriate reserves and allowances for such exposures.
However, such partners tend to have access to more limited financial resources
than other resellers and end-user customers and therefore represent potential
sources of increased credit risk. Additionally, the Company is experiencing
increased demands for customer financing and leasing solutions. The Company also
continues to monitor increased credit exposures because of the weakened
financial conditions in Asia and the impact that such conditions may have on the
worldwide economy. Although the Company has not experienced significant losses
because of customers failing to meet their obligations to date, such losses, if
incurred, could have a material adverse impact on the Company's business,
operating results, and financial position.
The Company maintains investment portfolio holdings of various issuers,
types, and maturities. These securities are generally classified as available
for sale, and consequently, are recorded on the balance sheet at fair value with
unrealized gains or losses reported as a separate component of shareholders'
equity, net of tax. Part of this portfolio includes minority equity investments
in several publicly traded companies, the values of which are subject
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
to market price volatility. The Company also has certain real estate lease
commitments with payments tied to short-term interest rates. At any time, a
sharp rise in interest rates could have a material adverse impact on the fair
value of the Company's investment portfolio while increasing the costs
associated with its lease commitments. Conversely, declines in interest rates
could have a material impact on interest earnings for the Company's investment
portfolio. The Company does not currently hedge these interest rate exposures.
The following table presents the hypothetical changes in fair values in the
financial instruments held by the Company at July 25, 1998 that are sensitive to
changes in interest rates. These instruments are not leveraged and are held for
purposes other than trading. The modeling technique used measures the change in
fair values arising from selected potential changes in interest rates. Market
changes reflect immediate hypothetical parallel shifts in the yield curve of
plus or minus 50 basis points (BPS), 100 BPS, and 150 BPS over a twelve-month
time horizon. Beginning fair values represent the market principal plus accrued
interest, dividends, and certain interest rate-sensitive securities considered
cash and equivalents for financial reporting purposes at July 25, 1998. Ending
fair values comprise the market principal plus accrued interest, dividends, and
reinvestment income at a twelve-month time horizon. This table estimates the
fair value of the portfolio at a twelve-month time horizon (in millions):
A 50-BPS move in the Federal Funds Rate has occurred in 9 of the last 10 years;
a 100-BPS move in the Federal Funds Rate has occurred in 6 of the last 10 years;
and a 150-BPS move in the Federal Funds Rate has occurred in 4 of the last 10
years.
The following analysis presents the hypothetical change in fair values of
public equity investments held by the Company that are sensitive to changes in
the stock market. These equity securities are held for purposes other than
trading. The modeling technique used measures the hypothetical change in fair
values arising from selected hypothetical changes in each stock's price. Stock
price fluctuations of plus or minus 15%, plus or minus 35%, and plus or minus
50% were selected based on the probability of their occurrence.
This table estimates the fair value of the publicly traded corporate
equities at a twelve-month time horizon (in millions):
24
Within the Company's public equity investment portfolio, a 15% movement in
the stock price has occurred in 82% of the annual periods since the shares were
initially offered or in the last three years; a 35% movement in the stock price
has occurred in 36% of the annual periods since the shares were initially
offered or in the last three years; and a 50% movement in the stock price has
occurred in 36% of the annual periods since the shares were initially offered or
in the last three years.
The Company also is exposed to interest rate risk associated with leases on
its facilities whose payments are tied to the London Interbank Offered Rate
(LIBOR), and has evaluated the hypothetical change in lease obligations held at
July 25, 1998 due to changes in the LIBOR rate. The modeling technique used for
analysis measured hypothetical changes in lease obligations arising from
selected hypothetical changes in the LIBOR rate. Market changes reflected
immediate hypothetical parallel shifts in the LIBOR curve of plus or minus 50
BPS, 100 BPS, and 150 BPS over a twelve-month period. The results of this
analysis were not material to the Company's financial results.
The Company enters into forward foreign exchange contracts to offset the
impact of currency fluctuations on certain nonfunctional currency assets and
liabilities, primarily denominated in Japanese, Canadian, Australian, and
certain European currencies.
The Company generally enters into forward currency contracts that have
original maturities of one to three months, with none having a maturity greater
than one year in length. The total notional values of forward contracts
purchased and forward contracts sold were $166 million and $153 million,
respectively. The net unrealized gain on forward exchange contracts was $0.1
million. Management does not expect gains or losses on these contracts to have a
material impact on the Company's financial results (see Note 7).
POTENTIAL VOLATILITY IN OPERATING RESULTS
The Company expects that in the future, its net sales may grow at a slower rate
than was experienced in previous periods, and that on a quarter-to-quarter
basis, the Company's growth in net sales may be significantly lower than its
historical quarterly growth rate. As a consequence, operating results for any
particular quarter are extremely difficult to predict. The Company's ability to
meet financial expectations could be hampered if the nonlinear sales pattern
seen in recent quarters continues in future periods. The Company generally has
had one quarter of the fiscal year when backlog has been reduced. Although such
reductions have not occurred consistently in recent years, they are difficult to
predict and may occur in the future. In addition, in response to customer
demand, the Company continues to attempt to reduce its product manufacturing
lead times, which may result in corresponding reductions in order backlog. A
decline in backlog levels could result in more variability and less
predictability in the Company's quarter-to-quarter net sales and operating
results going forward. On the other hand, for certain products, lead times are
longer than the Company's goal. If the Company cannot reduce manufacturing lead
times for such products, the Company's customers may cancel orders or not place
further orders if shorter lead times are available from other manufacturers,
thus creating additional variability.
As a result of recent unfavorable economic conditions, sales to certain
countries in Asia and the Pacific Rim have declined as a percentage of the
Company's total revenue. If the economic conditions in these markets worsen, or
if these unfavorable conditions result in a wider regional or global
economic slowdown, this decline may have a material adverse impact on the
Company's business, operations, and financial condition.
Many computer systems were not designed to handle any dates beyond the year
1999, and therefore, computer hardware and software will need to be modified
prior to the year 2000 in order to remain
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
functional. The Company is concerned that many enterprises will be devoting a
substantial portion of their information systems spending to resolving this
upcoming Year 2000 problem. This expense may result in spending being diverted
from networking solutions in the near future. The Company is still assessing the
impact of the Year 2000 issue on its products and internal information systems
and has begun, and in many cases completed, corrective efforts in these areas.
The Company does not anticipate that addressing the Year 2000 problem for its
internal information systems and current and future products will have a
material impact on its operations or financial results. However, there can be no
assurance that these costs will not be greater than anticipated, or that
corrective actions undertaken will be completed before any Year 2000 problems
could occur. The Year 2000 issue could lower demand for the Company's products
while increasing the Company's costs. These combining factors, while not
quantified, could have a material adverse impact on the Company's financial
results.
The Company has certain key relationships with suppliers. If these suppliers
fail to adequately address the Year 2000 issue for the products they provide to
the Company, this could have a material adverse impact on the Company's
operations and financial results. The Company is still assessing the effect the
Year 2000 issue will have on its suppliers and at this time, cannot determine
the impact it will have.
Contingency plans will be developed if it appears the Company or its key
suppliers will not be Year 2000 compliant, and such noncompliance is expected to
have a material adverse impact on the Company's operations.
The Company also expects that gross margins may be adversely affected by
increases in material or labor costs, heightened price competition, and changes
in channels of distribution or in the mix of products sold. For example, the
Company believes that gross margins may decline over time, because the markets
for lower-margin access products targeted toward small to medium-sized customers
have continued to grow at a faster rate than the markets for the Company's
higher-margin router and high-performance switching products targeted toward
enterprise and service provider customers. The Company recently introduced new
products, and several additional new products are scheduled to be released in
the near future. If warranty costs associated with these new products are
greater than the Company has experienced historically, gross margins may be
adversely affected. The Company's gross margins may also be impacted by
geographic mix, as well as the mix of configurations within each product group.
The Company continues to expand into third-party or indirect distribution
channels, which generally results in lower gross margins. In addition,
increasing third-party and indirect distribution channels generally results in
greater difficulty in forecasting the mix of the Company's products, and to a
certain degree, the timing of its orders.
The Company also expects that its operating margins may decrease as it
continues to hire additional personnel and increases other operating expenses to
support its business. The Company plans its operating expense levels based
primarily on forecasted revenue levels. Because these expenses are relatively
fixed in the short term, a shortfall in revenue could lead to operating results
being below expectations. The results of operations for 1998 are not necessarily
indicative of results to be expected in future periods, and the Company's
operating results may be subject to quarterly fluctuations as a result of
several factors. These factors include the integration of people, operations,
and products from acquired businesses and technologies; increased competition in
the networking industry; the overall trend toward industry consolidation; the
introduction and market acceptance of new technologies and standards, including
switch routers, Gigabit Ethernet switching, Tag Switching (currently also known
as multiprotocol label switching [MPLS]), and voice, video, and data
capabilities; variations in sales channels, product costs,
26
or mix of products sold; the timing of orders and manufacturing lead times; and
changes in general economic conditions, any of which could have a material
adverse impact on operations and financial results.
LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents, short-term investments, and investments were $5.2 billion
at July 25, 1998, an increase of $2.6 billion from 1997. The increase is
primarily a result of cash generated by operations, and to a lesser extent,
through financing activities, mainly the exercise of employee stock options,
which generated $488 million in cash. These cash flows were partially offset by
cash outflows from operating activities, including tax payments of approximately
$438 million; cash flows from investing activities including capital
expenditures of approximately $415 million; and cash payments of $108 million
and $38 million related to the acquisitions of DAGAZ Technologies and CLASS Data
Systems, respectively.
Accounts receivable increased 10.9% during 1998, while sales grew by 31.3%.
Days sales outstanding in receivables decreased to 49 days as of July 25, 1998
from 60 days at July 26,1997. Inventories increased 42.1% during 1998. The
increase in inventories was primarily because of the shift toward a two-tier
distribution model and the need to maintain shorter lead times on certain
products. Inventory management remains an area of focus as the Company balances
the need to maintain strategic inventory levels to ensure competitive lead times
with the risk of inventory obsolescence due to rapidly changing technology and
customer requirements.
Accounts payable increased by 20.1% during 1998 because of material
purchases to support the growth in net sales. Other accrued liabilities
increased by 82.3%, primarily because of higher deferred revenue on service
contracts.
At July 25, 1998, the Company had a line of credit totaling $500 million,
which expires in July 2002. There have been no borrowings under this agreement
(see Note 6).
The Company has entered into certain lease arrangements in San Jose,
California, and Research Triangle Park, North Carolina, where it has established
its headquarters operations and certain research and development and customer
support activities, respectively. In connection with these transactions, the
Company restricted $554 million of its investments as collateral for certain
obligations of the leases. The Company anticipates that it will occupy more
leased property in the future that will require similar restricted securities;
however, the Company does not expect the impact of this activity to be material
to liquidity.
The Company's management believes that its current cash and equivalents,
short-term investments, line of credit, and cash generated from operations will
satisfy its expected working capital and capital expenditure requirements
through fiscal 1999.
27
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per-share amounts)
See notes to consolidated financial statements
28
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
See notes to consolidated financial statements.
29
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
See notes to consolidated financial statements.
30
(This Page Intentionally Left Blank)
31
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See notes to consolidated financial statements.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Cisco Systems, Inc. (the "Company") provides networking solutions that connect
computing devices and computer networks, allowing people to access or transfer
information without regard to differences in time, place, or type of computer
system. The Company sells its products in approximately 105 countries through a
combination of direct sales and reseller and distribution channels.
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. The fiscal years ended July 25, 1998, July 26, 1997, and July
28, 1996 all comprised 52-week years. Prior to fiscal year 1997, the Company's
fiscal year was the 52- or 53-week period ending on the last Sunday in July.
Fiscal year 1999 will be a 53-week year.
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 Equivalents The Company considers cash and 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. Substantially all of its
cash and equivalents are custodied with three major financial institutions.
Investments The Company's investments comprise U.S., state, and municipal
government obligations and foreign and corporate securities. Investments with
maturities of less than one year are considered short term and are carried at
fair value. Nearly all investments are held in the Company's name and custodied
with two major financial institutions. The specific identification method is
used to determine the cost of securities disposed of, with realized gains and
losses reflected in other income and expense. At July 25, 1998 and July 26,
1997, substantially all of the Company's investments were classified as
available for sale. Unrealized gains and losses on these investments are
included as a separate component of shareholders' equity, net of any related tax
effect.
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.
Restricted Investments Restricted investments consist of U.S. governmental
obligations with maturities of more than one year. These investments are carried
at fair value and are restricted as to withdrawal (see Note 7). Restricted
investments are held in the Company's name and custodied with two major
financial institutions.
Fair Value of Financial Instruments Carrying amounts of certain of the Company's
financial instruments, including cash and equivalents, accrued payroll, and
other accrued liabilities, approximate fair value because of their short
maturities. The fair values of investments are determined using quoted market
prices for those securities or similar financial instruments (see Note 5).
Concentrations Cash and equivalents are, for the most part, maintained with
several major financial institutions in the United States. Deposits held with
banks may exceed the amount of insurance provided on such deposits. Generally
these deposits may be redeemed upon demand and therefore, bear minimal risk.
The Company performs ongoing credit evaluations of its customers and
generally does not require collateral from its customers.
The Company receives certain of its custom semi-conductor chips for some of
its products from sole suppliers. Additionally, the Company relies on a limited
number of hardware manufacturers. The inability of any supplier or manufacturer
to fulfill supply requirements of the Company could impact future results.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Recognition The Company generally recognizes product revenue upon
shipment of product. Revenue from service obligations is deferred and recognized
over the lives of the contracts. The Company accrues for warranty costs, sales
returns, and other allowances at the time of shipment based on its experience.
Depreciation and Amortization Property and equipment are stated at cost and
depreciated on a straight-line basis over the estimated useful lives of the
assets. Such lives vary from two and one-half to five years. Goodwill and other
intangible assets are included in other assets and are carried at cost less
accumulated amortization, which is being provided on a straight-line basis over
the economic lives of the respective assets, generally three to five years. The
Company applies the provisions of SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of," in evaluating
its fixed and intangible assets.
Income Taxes Income tax expense is based on pretax 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 per Common Share The Company adopted Statement of
Financial Accounting Standards (SFAS) No. 128 in 1998. This statement requires
the presentation of basic and diluted net income per share. Basic net income per
common 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 and dilutive common equivalent shares
outstanding during the period. Dilutive common equivalent shares consist of
stock options (see Note 12). The Company has restated all prior period per-share
data presented as required by SFAS No. 128.
Restated numbers as computed using the diluted method under SFAS No. 128
approximate those computed using the primary method as defined in Accounting
Principals Board Opinion No. 15.
Share and per-share data presented reflect the three-for-two stock splits
effective September 1998 and December 1997 and the two-for-one stock split
effective February 1996.
Foreign Currency Translation Substantially all of the Company's international
subsidiaries use their local currency as their functional currency. For those
subsidiaries using the local currency as their functional currency, assets and
liabilities are translated at exchange rates in effect at the balance sheet
date, and income and expense accounts at average exchange rates during the year.
Resulting translation adjustments are recorded directly to a separate component
of shareholders' equity. Where the U.S. dollar is the functional currency,
translation adjustments are recorded in income.
Derivatives The Company enters into forward exchange contracts to minimize the
short-term impact of foreign currency fluctuations on assets and liabilities
denominated in currencies other than the functional currency of the reporting
entity. All foreign exchange forward contracts are designated as and effective
as a hedge and are highly inversely correlated to the hedged item as required by
generally accepted accounting principles.
Gains and losses on the contracts are included in other income and offset
foreign exchange gains or losses from the revaluation of intercompany balances
or other current assets and liabilities denominated in currencies other than the
functional currency of the reporting entity. Fair values of exchange contracts
are determined using published rates. If a derivative contract terminates prior
to maturity, the investment is shown at its fair value with the resulting gain
or loss reflected in operating results.
34
Minority Interest Minority interest represents the preferred stockholders'
proportionate share of the equity of Nihon Cisco Systems, K.K. At July 25, 1998,
the Company owned all issued and outstanding common stock, amounting to 73.2% 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 in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Estimates are used for, but not limited to, the accounting for doubtful
accounts, depreciation and amortization, sales returns, warranty costs, taxes,
and contingencies. Actual results could differ from these estimates.
Recent Accounting Pronouncements In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
display of comprehensive income and its components (revenue, expenses, gains,
and losses) in a full set of general-purpose financial statements. The Company
will adopt SFAS No. 130 as required for its first quarterly filing of fiscal
year 1999.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information," which changes the way public companies
report information about operating segments. SFAS No. 131, which is based on the
management approach to segment reporting, establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers, and the material countries in
which the entity holds assets and reports revenue. Management is in the process
of evaluating the effects of this change on its reporting of segment
information. The Company will adopt SFAS No. 131 as required for its annual
report on fiscal year 1999.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
Management has not yet evaluated the effects of this change on its operations.
The Company will adopt SFAS No. 133 as required for its first quarterly filing
of fiscal year 2000.
3. BUSINESS COMBINATIONS
Pooling of Interests Combinations On July 9, 1996, the Company acquired
StrataCom, Inc. ("StrataCom"). Under the terms of the agreement, one share of
the Company's common stock was exchanged for each outstanding share of
StrataCom. Approximately 171.9 million shares of common stock were issued to
acquire StrataCom. The Company also assumed remaining outstanding StrataCom
stock options that were converted to options to purchase approximately 25.9
million shares of the Company's common stock. The transaction was accounted for
as a pooling of interests in fiscal year 1996; therefore, all prior periods
presented were restated. In order for both companies to operate on the same
fiscal year for 1997, StrataCom's operations for the one-month period ended July
28, 1996, which are not material to the Company, have been reflected as an
adjustment to retained earnings in the first quarter of fiscal 1997.
The Company has also completed a number of other pooling transactions. The
historical operations of these entities are not material to the Company's
consolidated
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
operations on either an individual or an aggregated basis; therefore, prior
period statements have not been restated for these acquisitions. These
transactions are summarized as follows (in millions of shares):
In conjunction with these poolings, the Company also assumed the outstanding
options of these companies, which were converted to options to purchase
approximately 8.5 million shares of the Company's common stock.
PURCHASE COMBINATIONS During the three years ended July 25, 1998, the Company
made a number of purchase acquisitions. 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 an aggregated
basis.
The amounts allocated to purchased research and development were determined
through established valuation techniques in the high-technology communications
industry and were expensed upon acquisition, because technological feasibility
had not been established and no future alternative uses existed. Research and
development costs to bring the products from the acquired companies to
technological feasibility are not expected to have a material impact on the
Company's future results of operations or cash flows. Amounts allocated to
goodwill and other intangibles are amortized on a straight-line basis over
periods not exceeding five years. Each transaction is outlined on the following
page.
36
Summary of purchase transactions (in millions):
PENDING BUSINESS COMBINATIONS In July 1998, the Company signed a definitive
agreement to purchase publicly held Summa Four, Inc. (Summa Four), a provider of
programmable switches. Under the terms of the agreement, between 1.6 and 2.0
million shares of the Company's common stock will be exchanged for all of the
outstanding shares and options of Summa Four. The agreement is subject to the
receipt of certain government approvals and the approval of Summa Four
shareholders. The deal is expected to be consummated in the first or second
quarter of fiscal 1999. The historical operations of Summa Four are not expected
to be material to the financial position or results of operations of the
Company.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. BALANCE SHEET DETAIL (in thousands):
38
5. INVESTMENTS
The following tables summarize the Company's investment in securities (in
thousands):
The following table summarizes debt maturities (including restricted
investments) at July 25,1998 (in thousands):
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During fiscal year 1997, the Company began to sell its minority equity
position in a publicly traded company which was completed in fiscal year 1998.
Also, in fiscal 1997, the Company established the Cisco Systems Foundation ("the
Foundation"). As part of this initiative, the Company donated a portion of the
equity investment, along with other equity securities, to the Foundation, with a
combined cost basis of approximately $2 million and an approximate fair value of
$72 million at July 26, 1997. The realized gains reported on the sale of this
investment, net of the 1997 donation to the Foundation, were $153 million in
fiscal 1997 and $5 million in fiscal 1998.
6. LINE OF CREDIT
As of July 25, 1998, the Company had a syndicated credit agreement under the
terms of which a group of banks committed a maximum of $500 million on an
unsecured, revolving basis for cash borrowings of various maturities. The
commitments made under this agreement expire on July 1, 2002. Under the terms of
the agreement, borrowings bear interest at a spread over the London Interbank
Offered Rate based on certain financial criteria and third-party rating
assessments. As of July 25, 1998, this spread was 20 basis points. A commitment
fee of 7 basis points is assessed against any undrawn amounts. The agreement
includes a single financial covenant that places a variable floor on tangible
net worth, as defined, if certain leverage ratios are exceeded. There have been
no borrowings under this agreement.
7. COMMITMENTS AND CONTINGENCIES
Leases The Company has entered into several agreements to lease 448 acres of
land located in San Jose, California, where it has established its headquarters
operations, and 45 acres of land located in Research Triangle Park, North
Carolina, where it has expanded certain research and development and customer
support activities. All of the leases have initial terms of five to seven years
and options to renew for an additional three to five years, subject to certain
conditions. At any time during the terms of these land leases, the Company may
purchase the land. If the Company elects not to purchase the land at the end of
each of the leases, the Company has guaranteed a residual value of $560 million.
The Company has also entered into agreements to lease certain buildings to
be constructed on the land described above. The lessors of the buildings have
committed to fund up to a maximum of $706 million (subject to reductions based
on certain conditions in the respective leases) for the construction of the
buildings, with the portion of the committed amount actually used to be
determined by the Company. Rent obligations for the buildings commence on
various dates and will expire at the same time as the land leases.
The Company has an option to renew the building leases for an additional
three to five years, subject to certain conditions. The Company may, at its
option, purchase the buildings during or at the ends of the terms of the leases
at approximately the amount expended by the lessors to construct the buildings.
If the Company does not exercise the purchase options by the ends of the leases,
the Company will guarantee a residual value of the buildings as determined at
the lease inception date of each agreement (approximately $323 million at July
25, 1998).
As part of the above lease transactions, the Company restricted $554 million
of its investment securities as collateral for specified obligations of the
lessor under the leases. These investment securities are restricted as to
withdrawal and are managed by a third party subject to certain limitations under
the Company's investment policy. In addition, the Company must maintain a
minimum consolidated tangible net worth, as defined, of $2.8 billion.
The Company also leases office space in Santa Clara, California; Chelmsford,
Massachusetts; and for its various U.S. and international sales offices.
40
Future annual minimum lease payments under all noncancelable operating
leases as of July 25, 1998, are as follows (in thousands):
Rent expense totaled $87 million, $64 million, and $37 million for 1998, 1997,
and 1996, respectively.
Forward Exchange Contracts The Company conducts business on a global basis in
several major international currencies. As such, it is exposed to adverse
movements in foreign currency exchange rates. The Company enters into forward
foreign exchange contracts to reduce certain currency exposures. These contracts
hedge exposures associated with nonfunctional currency assets and liabilities
denominated in Japanese, Canadian, Australian, and several European currencies.
At the present time, the Company hedges only those currency exposures associated
with certain nonfunctional currency assets and liabilities and does not
generally hedge anticipated foreign currency cash flows.
The Company does not enter into forward exchange contracts for trading
purposes. Gains and losses on the contracts are included in other income and
offset foreign exchange gains or losses from the revaluation of intercompany
balances or other current assets and liabilities denominated in currencies other
than the functional currency of the reporting entity. The Company's forward
currency contracts generally range from one to three months in original
maturity. Forward exchange contracts outstanding and their unrealized gains and
(losses) as of July 25, 1998, which are recorded in other assets, are summarized
as follows (in thousands):
The Company's forward exchange contracts contain credit risk in that its banking
counterparties may be unable to meet the terms of the agreements. The Company
minimizes such risk by limiting its counter-parties 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 other parties.
Legal Proceedings Lucent Technologies, Inc. ("Lucent") brought suit in Federal
District Court in Delaware in June 1998, alleging that the Company violated
eight of Lucent's patents related to data networking. Lucent is seeking damages
for infringement and an injunction prohibiting future use of the patents. This
case is in the preliminary stages of discovery; however, management believes
that the Company has meritorious defenses and intends to defend its position
vigorously. Management of the Company is currently unable to predict the final
outcome of this matter and the ultimate effect, if any, on the Company's
consolidated financial position, results of operations, or cash flows.
The Company and its subsidiaries are subject to other legal proceedings,
claims, and litigation arising in the ordinary course of business. The Company's
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.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. SHAREHOLDERS' EQUITY
Stock Splits In August 1998, the Company's Board of Directors approved a
three-for-two split of the Company's common stock that was applicable to
shareholders of record on August 14, 1998 and effective on September 15, 1998.
All references to share and per-share data for all periods presented have been
adjusted to give effect to this three-for-two stock split, the three-for-two
stock split effective December 1997, as well as the two-for-one stock split
effective February 1996.
Par Value At the Annual Meeting of Shareholders held on November 13, 1997, the
shareholders approved an amendment to the Articles of Incorporation changing the
par value of the Company's Common Stock from zero to $0.001 per share. As a
result, the Company has transferred the additional paid-in capital to a separate
account; however, for financial statement purposes, the additional paid-in
capital account has been combined with the common stock account and reflected on
the balance sheet as "Common stock and additional paid-in capital."
Shareholder Rights Plan In June 1998, the Company's Board of Directors approved
a Shareholders' Rights Plan. This 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 one
fifteen-thousandth 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 $433 per right owned, stock of
the surviving corporation having a market value of $867, whether or not Cisco is
the surviving corporation. The dividend was distributed to shareholders of
record in June 1998. The rights, which expire June 2008, are redeemable for
$0.00067 per right at the approval of the Company's 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.
9. EMPLOYEE BENEFIT PLANS
Employee Stock Purchase Plan The Company has an Employee Stock Purchase Plan
("the Purchase Plan") under which 55.7 million shares of common stock have been
reserved for issuance. Eligible employees may purchase a limited number of
shares of the Company's stock at 85% of the market value at certain plan-defined
dates.
In November 1997, the shareholders approved an amendment to the Purchase
Plan which, among other changes, increased the maximum number of shares of
Common Stock authorized for issuance over the term of the Purchase Plan by 33.8
million common shares, which is reflected in the number above, and extended the
term of the Plan from January 3, 2000 to January 3, 2005. In fiscal 1998, 1997,
and 1996, 3.3 million, 3.1 million, and 2.9 million shares, respectively, were
issued under the Purchase Plan. At July 25, 1998, 34.9 million shares were
available for issuance under the Purchase Plan.
Stock Option Plans In November 1996, the Company's shareholders approved the
1996 Stock Incentive Plan (the "1996 Plan"). This plan was the successor to the
Company's 1987 Stock Option Plan (the "Predecessor Plan"). 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 under the 1996 Plan was initially limited to the 154.9
million shares transferred
42
from the Predecessor Plan. Under the terms of the 1996 Plan, the share reserve
will increase each December for the next three fiscal years, beginning with
fiscal 1997, by an amount equal to 4.75% of the outstanding shares on the last
trading day of the immediately preceding November. Although the Board has the
authority to set other terms, the options are generally 25% exercisable one year
from the date of grant and then ratably over the following 36 months. Options
issued under the Predecessor Plan generally had terms of five years. New options
granted under the 1996 Plan expire no later than nine years from the grant date.
A summary of option activity follows (in thousands, except per-share
amounts):
The Company has, in connection with the acquisition of various companies,
assumed the stock option plans of each acquired company. A total of 13.5 million
shares of the Company's common stock have been reserved for issuance under the
assumed plans, and the related options are included in the preceding table.
The following tables summarize information concerning outstanding and
exercisable options at July 25, 1998 (in thousands, except per-share amounts):
At July 26, 1997 and July 28, 1996, approximately 55.9 million, and 48.9 million
outstanding options, respectively, were exercisable. The weighted average
exercise prices for options were $9.18 and $5.08 at July 26, 1997, and July 28,
1996, respectively.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SFAS No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123") requires
the Company to disclose pro forma information regarding option grants made to
its employees. SFAS No. 123 specifies certain valuation techniques that produce
estimated compensation charges that are included in the pro forma results below.
These amounts have not been reflected in the Company's Statements of Operations,
because APB 25, "Accounting for Stock Issued to Employees," specifies that no
compensation charge arises when the price of the employees' stock options equal
the market value of the underlying stock at the grant date, as in the case of
options granted to the Company's employees.
SFAS No. 123 pro forma numbers are as follows (in thousands, except
per-share amounts and percentages):
Under SFAS No. 123, the fair 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 valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. 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 fair value estimate, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of the Company's options. The weighted average estimated fair
values of employee stock options granted during fiscal 1998, 1997, and 1996 were
$14.27, $6.93, and $5.93 per share, respectively.
The above pro forma disclosures are also not likely to be representative of
the effects on net income and net income per common share in future years,
because they do not take into consideration pro forma compensation expense
related to grants made prior to the Company's fiscal year 1996.
Employee 401(k) Plans The Company has adopted a plan known as the Cisco Systems,
Inc. 401(k) Plan ("the Plan") to provide retirement and incidental 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.
Employees may contribute from 1% to 15% of their annual compensation to the
Plan, 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. In addition, the Plan provides for discretionary 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.
44
Company matching contributions to the Plan totaled $15 million in 1998, $13
million in 1997, and $7 million in 1996. No discretionary contributions were
made in 1998, 1997, or 1996.
10. INCOME TAXES
The provision (benefit) for income taxes consists of (in thousands):
Income (loss) before provision for income taxes consisted of the following:
The Company paid income taxes of $438 million, $659 million, and $335 million in
fiscal 1998, 1997, and 1996, respectively. The items accounting for the
difference between income taxes computed at the federal statutory rate and the
provision for income taxes follow:
The components of the deferred income tax assets (liabilities) follow (in
thousands):
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The noncurrent portion of the deferred income tax assets, which totaled $56
million at July 25, 1998 and $66 million at July 26, 1997, is included in other
assets.
The Company's income taxes payable for federal, state, and foreign purposes
have been reduced by the tax benefits of disqualifying dispositions of stock
options. The benefit is the difference between the market value of the stock
issued at the time of exercise and the option price tax effected.
11. GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
The Company operates in a single industry segment encompassing the design,
development, manufacture, marketing, and technical support of networking
products and services.
In 1998, 1997, and 1996, no single customer accounted for 10% or more of the
Company's net sales. International sales, primarily in Europe, the Pacific
region, and Canada, were $3,463 million in 1998, $2,803 million in 1997, and
$1,976 million in 1996. Export sales, primarily to these regions, were $660
million in 1998, $1,939 million in 1997, and $1,530 million in 1996.
Summarized financial information by geographic region for 1998, 1997, and
1996 is as follows (in thousands):
12. EARNINGS PER SHARE
The following table presents the calculation of basic and diluted earnings per
share as required under SFAS 128 (in thousands, except per-share amounts):
46
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Cisco Systems, Inc.
San Jose, California
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations and of shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of Cisco
Systems, Inc. and its subsidiaries at July 25, 1998 and July 26, 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended July 25, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards, which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
San Jose, California
August 4, 1998
47
SUPPLEMENTARY FINANCIAL DATA
(unaudited) (in thousands, except per-share amounts)
(*) Reflects the three-for-two stock split effective September 1998.
(1) Net income and net income per share include purchased research and
development expenses of $47.8 million. Pro forma net income and diluted
net income per share, excluding this nonrecurring item net of tax, would
have been $522.8 million and $0.32, respectively.
(2) Net income and net income per share include purchased research and
development expenses of $418.7 million. Pro forma net income and diluted
net income per share, excluding this nonrecurring item net of tax, would
have been $483.2 million and $0.30, respectively.
(3) Net income and net income per share include purchased research and
development expenses of $127.2 million and realized gains on the sale of
a minority stock investment of $5.4 million. Pro forma net income and
diluted net income per share, excluding these nonrecurring items net of
tax, would have been $415.7 million and $0.26, respectively.
(4) Net income and net income per share include purchased research and
development expenses of $290.6 million and realized gains on the sale of
a minority stock investment of $18.0 million. Pro forma net income and
diluted net income per share, excluding these nonrecurring items net of
tax, would have been $383.2 million and $0.24, respectively.
(5) Net income and net income per share include realized gains on the sale
of a minority stock investment of $32.3 million. Pro forma net income
and diluted net income per share, excluding this nonrecurring item net
of tax, would have been $358.0 million and $0.23, respectively.
(6) Net income and net income per share include purchased research and
development expenses of $43.2 million and realized gains on the sale of
a minority stock investment of $47.3 million. Pro forma net income and
diluted net income per share, excluding these nonrecurring items net of
tax, would have been $351.9 million and $0.23, respectively.
(7) Net income and net income per share include purchased research and
development expenses of $174.6 million and realized gains on the sale of
a minority stock investment of $55.1 million. Pro forma net income and
diluted net income per share, excluding these nonrecurring items net of
tax, would have been $320.8 million and $0.21, respectively.
STOCK MARKET INFORMATION
Cisco Systems' common stock (Nasdaq symbol CSCO) is traded on the Nasdaq
National Market. The following table sets forth the range of high and low
closing prices for each period indicated, adjusted to reflect the three-for-two
splits effective September 1998 and December 1997, and the two-for-one split
effective February 1996:
The Company has never paid cash dividends on the common stock and has no present
plans to do so. There were approximately 16,950 shareholders of record on July
25, 1998.
48